Regulators Delay Bursting of Commercial Real Estate Bubble

Reality, it appears, is a dish Washington believes is best served, never.

Late Friday evening, long after most Americans had shut off their computer screens and turned their attention to more important things — namely, Halloween — banking regulators dropped a silent, rotten egg onto the financial system.

Despite an alarming increase in the number of troubled commercial real estate loans gumming up bank balance sheets, the Federal Reserve, FDIC, and Office of the Comptroller of the Currency issued new guidelines Friday easing the burden this souring debt will have on lenders. Regulators are encouraging banks to modify loans, rather than foreclose and repossess property, even if the value of the building has fallen below the amount of the loan.

Loan workouts, regulators argue, can be beneficial to both lender and borrower, and are preferred to foreclosures, which drag down prices. But one look at the earlier-to-crash residential real estate market quickly proves this notion as fallacy.

In many of the hardest hit real estate markets, ones which imploded well before ill-fated mortgage modification attempts were launched, true price discovery was given a slim opening to take hold. Now, as prices have fallen back to more affordable levels, traditional homebuyers and real estate investors have stepped back into the market, helping to stabilize prices. Sure, there’s still a healthy dose of government intervention propping up in the housing market as a whole, but only through these fresh starts can markets begin a genuine healing process.

Well-to-do markets, on the other hand, are yet to have had their requisite dose of price discovery, as corrective market mechanisms are being prevented from functioning. Foreclosure moratoria (ongoing) and modification efforts (floundering) are simply kicking the proverbial can down a long proverbial road.

So too in commercial real estate, as landlords face increasing vacancies, falling rents, and, according to the Wall Street Journal, $1.4 trillion in maturing loans over the next five years. Around half of these are said to be underwater, and thus cannot be refinanced at current price levels.

Regulators’ answer, not unlike the failed mortgage modification programs introduced by the Bush Administration and continued by Obama and his ilk, is to allow big banks like Citigroup (C), JPMorgan (JPM), and Bank of America (BAC) to forestall the recognition of losses, trying to delay the inevitable bursting of the commercial real estate bubble.

With Wall Street’s collective eyes focused on Monday’s headlines — CIT’s (CIT) bankruptcy, Goldman Sachs (GS) picking up tax credits from Fannie Mae (FNM) and Freddie Mac (FRE), and of course the Yankees a single win away from their twenty-seventh World Series title — regulators are hoping investors will ignore the stench of this well-timed announcement as just another holdover from Halloween revelry gone awry.

And while the new guidelines may bolster efforts to make the banking system look healthier than it actually is, it’s further proof that rumors of a legitimate economic recovery are, in fact, greatly overestimated.

This post first appeared on Minyanville.