Deutsche Bank says that the commercial real estate market in America will not recover until 2017. Richard Parkus, Deutsche Bank head of Commercial Mortgage-backed Securities and Asset-Backed Securities Synthetics Research, told Reuters that values could drop 50% from their 2007 peaks. Some experts in the housing markets have produced similar numbers, showing that the current 25% drop in the value of American homes could be followed by another 20% decline. The residential figures are plausible even if they are based on nothing more than rising unemployment and interest rates. There are no inertia breaks on the housing price free fall while Americans lose jobs at a record pace.
Most of the losses in both the home and commercial real estate markets will make their way through bank balance sheets. Commercial property values cannot withstand the bankruptcies and defaults of tenants and the paucity of new renters. Banks will end up owning multi-story glass offices and retail malls, half empty and spread out next to empty car lots which are rarely even part full. Accountants will be watching the value of the paper on bank balance sheets as will be newly zealous bank regulators. The amount of red ink from real estate may actually grow during the next four quarters compared with the last four. The “stress tests” of large financial firms may have erred in estimating how severe that part of the leverage problem may be.
The government and banks have also probably underestimated their exposure to consumer credit. “The banks have been through the market losses — now its time for them to go through the credit losses,” Diane Vazza, head of global fixed income research at Standard & Poor’s, told the New York Post. S&P puts the amount owed on credit cards at between $900 billion and $1 trillion. That number is much larger if home equity loans and lines of credit are factored in. S&P speculates that all of these problems could send banks back to the government for more bailout money.
Taxpayers did get one important piece of paper from each bank that received funds from the TARP. It was a warrant given to the Treasury as part of the security for the loans. The department says that the value of this paper is worth $5 billion. One analyst put the figure much higher at $12 billion, according to Bloomberg. Ten banks that got money from the TARP, including Goldman Sachs (GS), JPMorgan (JPM), Morgan Stanley (MS), and American Express (AXP), have paid back a total of $68 billion. They had the money for less than a year. A return of $12 billion on the money that has been paid back plus the large sums still owed, primarily by Citigroup (C), Wells Fargo (WFC), and Bank of America (BAC), is not a bad return for an investment that looked very risky at the end of last year but turned out otherwise.
The minority of economists who believe that the credit crisis will be substantially worse than imaged are forecasting unemployment rates that will go well above 10% and unexpectedly high levels of business loan defaults which could certainly bring some of the banks back to the government hat in hand. The government might do well to give them additional money and chide them for paying their loans back too soon. Now that the Treasury and Fed have gone through the awkward and unpopular process of saving the banking system once, it can hardly let it fail just a few quarters later. The Fed and Treasury are likely to be able to drive a much harder bargain on warrants the second time around. The taxpayer can get another exorbitant return for his money if the economy does finally turn for the good sometime in 2011.
Looking across the length and breadth of the federal government’s bailout activity, there is only one thing that is absolutely certain which is that it did not get enough leverage for the taxpayers in the event that the rescues worked. The Treasury should own a much larger piece of the car industry and have an option to make double from recapitalizing banks. The money would not eliminate the budget deficit, but a few extra tens of billions of dollars would go a great distance in helping ease the upcoming taxpayer burden.
Douglas A. McIntyre