Under Seige From Every Direction

Even as the Obama administration and the main street media hype the recovery, the system known as the United States economy implodes. The housing crises catalyzed the recession, but free-falling home values are now only the tip of the iceberg. Over the next two years, we will see the default rate continuing to rise as option arms recast. But there is much more. Fannie Mae and Freddie Mac have accumulated over $6.3 trillion of debt not on the government balance sheet which is filled with toxicity. Commercial real estate is now a time bomb which has begun exploding. State governments are rapidly seeing revenue fall while deficits mount. Should the federal government not intervene, massive cuts in services and layoffs will follow. The alternative is more bailouts which would only postpone the day of reckoning and add to the national debt. As the government takes on more and more debt, the traditional source of funding - treasury bonds - becomes more difficult to find buyers. 

Just today, the Congressional Oversight Panel published their report on Commercial Real Estate Losses and the Risk to Financial Stability. Read the Conclusion below.

Conclusion

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. An extended
severe recession and continuing high levels of unemployment can drive up the LTVs, and add to
the difficulties of refinancing for even solidly underwritten properties. But delaying write-downs
in advance of a hoped-for recovery in mid- and longer-term property valuations also runs the risk of postponing recognition of the costs that must ultimately be absorbed by the financial system to eliminate the commercial real estate overhang. 

It should be understood that not all banks are the same. There are “A” banks, those who
have operated on the most prudent terms and have financed only the strongest projects. There
are “B” banks, whose commercial real estate portfolios have weakened but are largely still based on performing loans. There are “C” banks, whose portfolios are weak across the board. The key to managing the crisis is to eliminate the C banks, manage the risks of the B banks, and to avoid unnecessary actions that force banks into lower categories. 

Any approach to the problem raises issues previously identified by the Panel: the creation
of moral hazard, subsidization of financial institutions, and providing a floor under otherwise
seriously undercapitalized institutions. That should be balanced against the importance of the
banks involved to local communities, the fact that smaller banks were not the recipients of
substantial attention during the administration of the TARP, and the desire that any shake-out of
the community banking sector should proceed in a way that does not repeat the pattern of the
1980s. The alternative, illustrated by recent actions of the FDIC, is to accept bank failures, and,
when write-downs are no longer a consideration, sell the assets at a discount, and either create a
partnership with the buyers to realize future value (as was done in the Corus Bank situation) or
absorb the losses. 

There appears to be a consensus, strongly supported by current data, that commercial real
estate markets will suffer substantial difficulties for a number of years. Those difficulties can
weigh heavily on depository institutions, particularly mid-size and community banks that hold a
greater amount of commercial real estate mortgages relative to total size than larger institutions,
and have – especially in the case of community banks – far less margin for error. But some
aspects of the structure of the commercial real estate markets, including the heavy reliance on
CMBS (themselves backed in some cases by CDS) and the fact that at least one of the nation’s
largest financial institutions holds a substantial portfolio of problem loans, mean that the
potential for a larger impact is also present. 

There is no way to predict with assurance whether an economic recovery of sufficient
strength will occur to reduce these risks before the large-scale need for commercial mortgage
refinancing that is expected to begin in 2011-2013. The supervisors bear a critical responsibility
to determine whether current regulatory policies that attempt to ease the way for workouts and lease modifications will hold the system in place until cash flows improve, or whether the
supervisors must take more affirmative action quickly, as they attempted to do in 2006, even if
such action requires write-downs (with whatever consequences they bring for particular
institutions). And, of course, they must be especially firm with individual institutions that have
large portfolios of loans for projects that should never have been underwritten. 

The stated purpose of the TARP, and the purpose of financial regulation, is to assure
financial stability and promote jobs and economic growth. The breakdown of the residential real
estate markets triggered economic consequences throughout the country. Treasury has used its
authority under the TARP, and the supervisors have taken related measures in ways they believe
will protect financial stability, revive economic growth, and expand credit for the broader
economy. 

The Panel is concerned that until Treasury and bank supervisors take coordinated action
to address forthrightly and transparently the state of the commercial real estate markets – and the potential impact that a breakdown in those markets could have on local communities, small
businesses, and individuals – the financial crisis will not end.

As the trend of expanding debt continues, eventually the only option available for funding will be monetization. Before we reach this critical stage, expect the government to find ways to extract the remaining savings and wealth of the citizenry to prop up a dying bureacratic monstrousity. Taxes will be raised both through legislating  higher tax rates and stealth measures such as health care or environmental decrees. Retirement funds will forced to annuitize part of the portfolio into treasury bonds. At the lmicro levels, states, cities, and municipalities will hike fees and fines. Small businesses will shut down or opt out as they no longer can afford to stay profitable.

As the country spirals into the abyss, politicians will offer plans. Some will suggest even more government spending. Others will demand austerity measures which will be confronted by the various groups affected by such proposals. As always, there will be no consensus and whatever changes are implemented the winners will be those with the most political clout.

I don't think there can be a political solution. The rule of law has begun to erode. The founding documents  designed to serve as the template for governance have largely been discarded. At some point, our system will no longer function effectively. Once that happens, Americans must find true leaders and work together to forge a system that works as our system once performed. Most likely, a slow devolution will devastate the country before the citizens finally recognize what happened.