Commercial Real Estate the Next Crisis

There is a commercial mortgage problem that is growing in America. According to analysts the commercial retail market is in serious trouble, with a large number of foreclosures and mortgage defaults, and the pace is expected to quicken. Analysts say the number of late payments and defaults will double, if not triple, by the end of next year. The commercial real estate market is quite similar to private real estate market, and so the potential for crisis is very high, except the numbers are much larger and payment terms are much shorter. Unlike home mortgages, businesses don't pay their loans over 30 years. Commercial mortgages are usually written for five, seven or 10 years with big payments due at the end. About $20 billion will be due next year, covering everything from office and condo complexes to hotels and malls.

This is really bad news for more than just these particular property owners. When businesses go out of business, employees lose their jobs. Communities and towns lose the tax revenue, which cause problems for school budgets and the social services.

Yes lots of companies have survived plenty of downturns, and this is no different, but a lot of economists see this recession playing out like never before. In the past, when businesses hit rough patches, owners negotiated with banks or refinanced their loans. But many banks are no longer hold the loans they made. Over the past decade, banks have increasingly bundled mortgages and sold them to investors. Pension funds, insurance companies, and hedge funds bought the seemingly safe securities and are now bracing for losses that could ripple through the financial system.

The retail outlook is particularly bad. Circuit City and Linens 'n Things have sought bankruptcy protection. Home Depot, Sears, Ann Taylor and Foot Locker are closing stores.

Don't Be Fooled

There are those who are watching the stock market today, where the Dow was recently up more than 250 points, and getting the mistaken impression all is well with the world on the Tuesday after the latest Black Monday. Don't be fooled. Overnight dollar Libor rates more than doubled to 6.875%, as banks are hoarding cash, most probably for the end of quarter that is fast approaching, but still this is another sign that the financial crisis is spreading.

I think some people are fooled by the Great Depression, and what is going on now. They remember looking at their history books and reading about the stock market crash, and seeing pictures of bread lines, and then look around and do not see the same things today, and think well we are not really in trouble.

Yes the disaster that is facing America is not clearly visible, if you look outside today you see people at the grocery store, buying a Big Mac, and getting on with life, but this is just the surface, and there is a lot of turmoil in the economy right now. Take for example the Libor rate, something most people don't know about, but last night banks were so desperate for funds that they paid 11% for $30 billion in overnight funds from the European Central Bank (ECB), up from 3% just Monday. This premium for overnight liquidity is "out of control," and will make it hard for central banks to instill confidence in the future.

Yes a second round of dollars from the ECB and a 28-day injection of funds from the Fed Reserve helped calm some of the worst panic in the markets, but the world economy is a long way from normal.

Credit is near frozen, in part because institutions are hoarding liquidity for the end of the quarter. Problems with the credit market will make it harder for stores who are setting inventory for the upcoming holiday season. Do you see the problem we could be facing?