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Severe Weather Warning for Commercial Real Estate: New TARP Not the Answer

Posted By James Gattuso On February 11, 2010 @ 10:20 pm In Economics | Comments Disabled

Commercial building for sale [1]

The Congressional Oversight Panel (COP), the watchdog board created by Congress to oversee the TARP program, yesterday issued [2] the equivalent of a severe weather warning for commercial real estate markets. Like the residential market before it, the markets for retail, apartment, and other business properties are facing a wave of defaults which, says the panel, “would trigger economic damage that could touch the lives of nearly every American.”

The numbers are grim. According to the COP, over the next four years $1.4 trillion in commercial real estate loans will come due, of which half are currently underwater, sunk by a 40 percent drop in values since 2007. Total losses could be some $300-400 billion. These losses would be in large part borne by mid-sized and community banks, who tend to invest most heavily in to the commercial market.

Certainly, the negative effects of such a meltdown would be significant. The question, however, is how to address it. The COP admits that there is no easy answer.

Possible steps, according to COP, include using government funds to provide fresh capital for affected banks, buying the troubled assets from the banks, and creating a guarantee funds for loans. In other words, extend the TARP bailout program – or key components of it – beyond its current October expiration date to address the problem.

Policymakers should stop, however, before going down this particular rabbit hole again. As a first matter, this is not the sort of threat TARP was created to address. While economically painful, the situation does not threaten a sudden, catastrophic failure that would endanger the functioning of financial markets. None of the banks at risk would threaten the financial system by their failure. And the effects would be spread out over a number of years.

By contrast, TARP-like intervention would impede the ability of markets to function properly. The COP itself warns of the dangers, saying:

“Any government capital support program can create as much moral hazard for small banks as for large financial institutions, and government interference in the marketplace could result in bailing out the imprudent, upsetting the credit allocation function of the capital markets, or protecting developers and investors from the consequences of their
decisions.”

And that’s only the start of the problems. Would intervention lead to federal control of pay and other business decisions at hundreds more banks? To long-term government ownership? To Americans weary of the side effects of the original TARP, these are real concerns.

Perhaps worst of all, intervention would not address the underlying problem: the fact the value of commercial real estate has dropped. No amount of government cash would change that fact.

Ultimately, the best way for policymakers to address problems in the commercial real estate market — and help the financial institutions and the average Americans that would be hurt by its travails, is to improve the economy on which it depends. And that means reducing, not increasing, government intervention in that economy.


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URL to article: http://blog.heritage.org/2010/02/11/severe-weather-warning-for-commercial-real-estate-new-tarp-not-the-answer/

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[1] Image: http://www.foundry.org/wp-content/uploads/100212-commercial-bldg-sale.jpg

[2] issued: http://cop.senate.gov/documents/cop-021110-report.pdf

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