Are Commercial Mortgages the Next Crisis?
By - May 05, 2009

Two years after fissures in the residential housing market gave way to a national collapse of home prices and sales, experts warn the next shoe to drop is the commercial real estate market, bringing more woes to the battered economy. Thousands of commercial mortgages valued at hundreds of billions of dollars are approaching a renewal date. By some estimates, two out of every three will no longer meet the original loan conditions and won't be able to refinance. And with prices for commercial properties expected to plunge, a vicious cycle may unfold much as it has in the nation's housing market. ''It's the next wave to hit,'' said Scott Talbott, senior vice president of government affairs for the Financial Services Roundtable, a trade group for big banks and other financial institutions who are collectively concerned about the coming problems. A commercial mortgage meltdown is likely to prolong the nation's economic recovery. The falling prices in commercial real estate will lead to additional bank losses at a time when banks are sapped by home mortgage defaults and soaring credit card defaults. This could lead to future additional taxpayer assistance for the banks. – Miami Herald

Dominant Social Theme: A ways to go yet? …

Free-Market Analysis: Do you know what time it is? Are you ready to jump back into the stock market? Our take on the American stock market, and markets worldwide, is that the economic slump of the early 2000s is far from over. From our point of view, there are only two kinds of business cycles, paper-money and honest-money. During the paper-money part of the cycle, stocks and other securitized investments are dominant. During the honest-money cycle, gold and silver perform best. Gold has already quadrupled in value in this decade, and silver has gone up, too – and there is certainly a long ways to go, in our opinion, before the prices of either of these metals tops out. That's just the way the business cycle works.

Think of a clock and visualize the numbers from 12 at the top to 9 at the left-hand-side, the paper money business cycle usually lasts this long from 12 to 9. It begins with stimulation via central bank money printing, including low interest rates. Around 3, the economy starts to rebound thanks to fiat stimulation and businesses start to rebuild their prospects and capital. Around 6 the economy is in full swing and businesses and entrepreneurs have plenty of paper money at their disposal. Banks and investment banks are flush and some new process or inventor is hailed as the next genius because there is plenty of money and the professional money class want to make a killing before the good times inevitably unravel.

So stories are invented by the Masters of the Universe, and the mainstream media dutifully relays them. In the late 1990s it was the Internet that was going to suspend the operation of the business cycle with its increased efficiencies. No more need for brick and mortar, etc. Then in the later 2000s, it was housing itself that was driving the business cycle, along with derivatives and the hedge funds that invented them. No one had to worry about the business cycle anymore because the amount of money sloshing around was proof positive that the untrammeled market itself could be counted on to generate unlimited prosperity. Didn't work out quite that way.

What happened in the most recent cycle, as in all such cycles, was general overbuilding and over-investing. Central banks printed so much money that people were fooled into thinking the boom-time was going to go on forever. Almost every corner of every major city in America and Britain seemed to have a bank branch on it – and right next to the bank branch was a Starbucks. And some ways away another restaurant, mall and housing development rose up. It was a boom to end all booms, and it nearly ended the Western paper-money economic system. And it still may.

The mal-investment was huge and had little to do with subprime mortgages and everything to do with people being fooled by the amount of money, electronic and paper, that was available to them. Seen this way, the economic crisis has not "spread" from subprime losses to other areas. The economic crisis is not a virus. These metaphors are describing a process that does not exist. What happened to the Western (and world) economy in early 2000s was that the business cycle clock ran headlong into 9 o'clock.

For paper-money economies, 9 o'clock is the witching hour. It is the numeral of doom, for it is at that time that those who "invest" suddenly realize they have been fooled by central bank overprinting of money. The massive imbalances or industry – the factories churning out unnecessary widgets, the endless coffee-shops and mall meccas – all the paraphernalia of modern Western society is suddenly called into question. The scales drop from the eyes of those who participated with greater or lesser amounts of eagerness. The business cycle has not been suspended, after all. In fact, money has been wasted in the trillions. Banks that have loaned money to ridiculous enterprises suddenly teeter on the brink. Defaults occur. Wave on wave on bankruptcies occurs.

The professional apologists begin to emerge from the woodwork. Regulation was astray, they say, or was misapplied. Or there was not enough of it. Anyway, they conclude, greed triumphed over common sense. Only government and technocratic management of the economy (econometrics) can save the day. Businesses that are too big too fail must be salvaged, by the way. The banking system itself must be propped up until it regains its footing.

So what happens from 9-12 in terms of the business cycle? Rates stay absurdly low, money printing is in the ascendency, more regulations and more taxes are imposed (which impedes the recovery) and gradually, slowly, painfully, the economy begins to realign. Depending on the amount of taxation and general government interference, the 9-12 period of the business cycle can stretch out beyond its quarterly allotment. Mathematically speaking, the current business cycle began in the late 1970s and limped along until the early 2000s. Say 25 years. That's the paper money business cycle – the one stretching from 12 to 9.

We're past that now. We're well into the 9-12 hard-money cycle. And based on the math (admittedly a very superficial way to look at things) the hard-money cycle should last one third as long as the paper money one. Say eight years. We figured it would run its course by the end of 2010 – not-so-coincidentally the same end date as mainstream "experts" are predicting.

But two things are interfering with the 2010 end date. The first one is that 9-12 hard-money cycle is a lot bigger and stronger than the last one in the 1970s. It's a super-cycle, so far as we can tell, one that is shaking out the excesses not only of the past 25 years, but the mal-investments that have built up over the past century, or at least since the 1940s. That's why some hard-money business cycles are deeper than others. And this is a deep one. Recovery is going to involve a basic reconstitution of paper money and banking. That's what's going now, with talk of a global currency, global regulations, etc. It's not about making the system more solvent – it's actually all about rebuilding it from the ground up.

The second reason that this hard-money 9-12 rebalancing of the business cycle may stretch out past 2010 is because Western governments, especially America, are reacting so aggressively with increased taxation and money printing. The more paper money that is poured back into the system, the more money and resources that individuals are deprived of via taxation and regulation, the fewer adjustments the larger economy is allowed to make. The adjustments, the major ones, will be made, but it may take years longer than it would otherwise. Here's some more from the article excerpted above:

The reality is already on display. On April 16, the nation's second-largest mall developer, General Growth Properties, filed for bankruptcy protection. The Chicago-based company owns more than 200 malls across the U.S., and was unable to renegotiate its debts as they came due. Six days later, a 40-story office tower on New York's Avenue of the Americas was seized by its creditor, a Canadian-owned pension fund. The tower's owner, Macklowe Properties, couldn't meet loan terms. ''On the street, the rumor is it is coming and it's going to come fast and furious. Some people are predicting September,'' said Paul Waters, a New York-based executive vice president of brokerage operations in North America for NAI Global, a top-five commercial real estate brokerage with operations across the globe. Just like the housing meltdown, the commercial real estate crunch is likely to begin as a slow bleed that gains momentum. It is likely to be spread evenly across the nation, in large part because of an outgoing economic tide that's spared few companies anywhere. ''There's going to be a lot of trouble on Main Street with some of these commercial and industrial buildings. The biggest impact will be on some of the smaller owners,'' Waters said. “The smaller local regional players that are stretched thin may have some great difficulties with their mortgages.'' How bad it gets will depend on speed of economic recovery. Office space and multifamily apartments, two huge components of commercial real estate, are highly dependent on employment. Even if the economy begins growing again late this year as forecast, the number of unemployed is expected to keep rising well into next year.

After Thoughts

Commercial real-estate in America and abroad will surely constitute the next wave of defaults. Perhaps it will not be as severe a wave as the one that came before, but we wouldn't bet on it. The hard money business cycle is in full-swing and the central bankers and Western politicians are hell-bent on retarding its progress. The more money that pours into the system, the more companies that are identified as "too big too fail" the longer the hard-money cycle will stretch out. The Japanese, with their consensus-oriented culture – managed to stretch it out well over a decade, and Western countries are making a good start on that time-horizon with the amount of economic interference evidently taking place. Oh, one more thing – we didn't get to derivatives – those massive bets that number in the hundreds of trillions, worldwide. They helped destabilize AIG, but we think there's more to come, yet. A third wave?

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