The Next Shoe to Drop in the Financial Crisis

October 7th, 2009

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Originally published in Roll Call.

In July, the Joint Economic Committee held a hearing on one of the least talked about dangers to our economy — a collapse of commercial real estate. The chairwoman, Rep. Carolyn Maloney (D-N.Y.), called it “a ticking time bomb,” the next shoe to drop in the ongoing national real estate crisis. To avoid another round of default, recession and bailout, the federal government should look to Main Street rather than Wall Street.

At the hearing, the Real Estate Roundtable estimated $300 billion to $500 billion in commercial real estate loans fall due this year, to be followed, on average, by $400 billion in maturing loans each year for the next decade. More than 50 percent of these maturing loans originated during the boom years of 2004 to 2008. Many of those deals were bad investments.

Shopping centers, office buildings, hotels and industrial parks acquired, constructed, renovated and financed during the years when reason took a back seat to irrational exuberance were severely overvalued. And, as with home mortgages, massive borrowing financed the development — borrowing leveraged many times over through complicated securitization instruments that metastasized into every pore of the economy.

But unlike home mortgages, commercial real estate loans tend to be short term — three- to five-year loans to finance acquisition or construction. In the past, these loans were converted to long-term financing prudently repaid over the life of the property. But in this decade, long-term financing was ignored in favor of short-term notes now falling due with banks and commercial mortgage-backed securities either unwilling or unable to make long-term financing commitments.

This promises one of two bad results: massive defaults or bargain basement fire sales to a handful of Wall Street predatory funds with available cash to feast on dying commercial properties.

Either scenario would deal another body blow to banks and financial institutions just beginning to recover from the worst recession since the Great Depression. Credit tightens and blocks business expansion. Foreclosed properties depress the value of surrounding properties causing a major drop in local property tax revenues. A decline in property tax collections leads to job cuts and reductions in funding for public schools, police and fire protection and recreation programs for children and seniors. And once again, taxpayers bail out failing financial institutions.

But this time, Main Street, not Wall Street, can stabilize commercial real estate.

First, toxic commercial assets must be separated from properties that are over-financed but can still perform. Let’s face it: Some commercial properties constructed in this decade should never have been built at any price. Many are almost worthless. But many others generate revenue through rents and leases. Main Street developers and owners know the difference between toxic and performing assets. They and their experienced teams successfully lease, manage, market and operate commercial real estate in every city and town. As important, each lives, works and is invested in the local community.

Second, the federal government can generate more than a trillion dollars of new revenue over the next 20 years by providing long-term guarantees of income-producing commercial real estate loans based upon today’s values. Federal guarantees would encourage lending by banks and other financial institutions and ensure continued operation by current owners of the properties instead of forcing banks and leaders to seek outside predatory third parties interested only in turning a quick profit. By guaranteeing 75 percent of the newly reduced appraised values for self-amortizing 20-year loans to responsible property owners, a large percentage of commercial real estate would stabilize and remain productive assets for our communities.

Third, these guarantees should profit the taxpayers through a payback of the loans. The Obama administration has created a financing program called PPIC to provide 92.5 percent (85 percent debt and 7.5 percent equity) of all capital needs to acquire toxic assets at deep discounts. A federal guarantee of 20-year self-amortizing loans on income-producing properties at 75 percent of the current value is far less risky. The government could charge an annual interest rate of 9 percent to 10 percent for its guarantee, netting the taxpayer an approximate 6 percent annual profit above the federal cost of money for the 20-year term of the loan guarantee. Translating that amount for $1 trillion dollars of loans, taxpayers make an annual profit of about $60 billion a year, or more than $1.2 trillion over the entire loan term, enough to help reduce the federal debt and finance all of national health care reform.

If Congress leads the way and uses the talents and expertise of Main Street instead of Wall Street to stabilize the commercial real estate market, the government can forestall a wholesale collapse of trillions of dollars of real estate and avoid serious damage to financial markets as well as the taxpayers and communities who rely on a thriving commercial marketplace. Members of Congress, local developers are invested in their local communities. It only makes sense that Congress leads this beneficial approach to stabilizing the commercial markets in their communities while producing more than a trillion dollars in new federal dollars, enough to pay for health care reform with money to spare.