subprime

Between 2010 and 2014, $1,400bn US commercial real estate loans will reach the end of their terms. Nearly half of them are currently in negative equity – that is, the borrower owes more than the property is worth. And banks are reducing the number of loans in the sector, and have been doing so throughout 2009.

More shocking is that banks and their auditors are typically well aware of the problem, but have not written down the value of property as prices have fallen. Instead they are “extending and pretending” – or “delaying and praying”: holding property values steady and assisting the borrowers where possible. They need to. If banks were accurately to record property values, they would write down assets on their own balance sheets and jeopardise their business (see example to right).

A very thorough report just released from the Congressional Oversight Panel expects many banks to go under when the pretence comes to an end. The report concludes: “There is a commercial real estate crisis on the horizon, and there are no easy solutions to the risks commercial real estate may pose to the financial system and the public.”

When a government body admits things are at crisis proportions, you have to take notice. This isn’t journalistic hyperbole. It is hard to overstate the impact of the coming second subprime, hitting, as it will, a very fragile economic recovery.

So, who will be most affected? In a nutshell, banks, and mostly the smaller ones.