The Sound of Falling Shoes

You raved about The Subprime Mortgage Debacle, you found the The Credit Default Swap that Ate New York compelling, critics trashed My Bonus is Bigger than Your Bailout, you’re curious about The Little Credit Card that Couldn’t, but now you can’t wait for the premiere of I Want to be a “Commercial Real Estate” Loan! And the best line in all of these films is, of course, the line at the unemployment office.

19 of our largest banks “passed” the government’s stress test… okay, a few of them still have to raise enough capital to fund a small army (I wonder exactly how much of that will be taxpayer money), but we can’t get picky anymore. And yeah, those banks could face a massive $599 billion if this economy slides into a worst-case zone, but the capital shortfalls needed to deal with potential are viewed as “manageable.” We need to keep ‘em around. After all, these stud-muffin banks with exceptionally well-compensated executives, account for 70% of the bank lending in this country, so killing a few of these and letting them fail is a bit like fixing the trigger mechanism of a loaded gun with the barrel stuck in your mouth. No, blackmail is never pretty.

But we’ve got well over 8,000 banks in this country (we lost 33 so far this year; 58 since January 2008), and these all-encompassing “stress tests” aren’t going to be applied across the board to the lower tier (I know, bad choice of words) of these lenders. So the Wall Street Journal, noting that the next shoe to drop, particularly as the unemployment numbers continue to rise, is probably commercial real estate. The lead story in their March 19^th paper starts out with a heart-warming: “Commercial real-estate loans could generate losses of $100 billion by the end of next year [next year?!] at more than 900 small and mid-sized U.S. banks if the economy’s woes deepen…” They’re deepening, by the way. How much, nobody really knows.

We already know the big retail malls have tanked, but there is plenty of other business-oriented land use, from factories to office buildings to apartment complexes to hotels, etc., that clearly faces a “readjustment.” And that market sector appears to have been the main focus of economic activity of the small and medium-sized banks. And so many of this nation’s small business lending activities, receivable financing, capital for growth (working capital), etc. come from this “less-than-huge-banks” segment of the financial industry. Destroy this market, and watch small businesses squirm even more, laying off even more employees to cover an impossible financial future.

As so many newspapers struggle to find a path to survival, the Rupert Murdoch’s Wall Street Journal decided to provide its readers with “something special’ (my words). They did their own little “stress test” applying basically the same parameters the feds applied to the big banks, based on the publicly available material on 940 of the remaining banks. Their not-so-rosy conclusions? If the losses on home loans are so far on the order of $50 billion, the Journal believes, total losses at the banks they looked at could total $200+ billion by the end of next year – most of that from commercial real estate loans. Basically, that would put about 1/3 of our banks in financial peril and would probably create a scenario where 600 more banks would fail and be “handled” by the FDIC (which is probably going to raise bank fees significantly to cover expected future losses).

Okay, what does all this tell us? First, it means this credit freeze, particularly at the small business level, is going to be around a lot longer than most of us believe. Second, without small business credit, our unemployment picture will continue to decline, and when it finally hits bottom, new hires are not exactly going to be returning to work particularly quickly. While the official “big bank” stress test by the feds may result in larger companies accessing the credit markets sooner, and given the way Wall Street works, other financial debt alternatives are available for big public companies, the unofficial reality at the lower levels of lending reflects this harsh current reality: “Big companies are rushing to issue stocks and bonds to suddenly hungry investors. But credit is still scarce for thousands of smaller companies that rely on bank lending.” (WSJ, Page B1). In short, credit for small businesses is tighter today than it was when the government sought to unfreeze the credit markets with TARP money last year!

While Bill McConnell, writing for the May 19^th theDeal.com thinks that smaller banks need to be really coming to grips with their own realities, he thinks the dire predictions in the Journal are too extreme: “Commercial real estate and C&I [commercial & industrial] are the other shoes many have been waiting to drop on the banking industry following the collapse of the housing market… And, according to the Fed, delinquency rates are rising significantly on commercial real estate and C&I loans at smaller and regional banks, but they are booking failure at a slower pace.”

Smaller banks are having trouble accessing investors and depositors in this impaired marketplace, so their tools to recovery are more limited. Bottom line: a credit freeze = high unemployment; they are inextricably linked. Because these issues are so complex and paying blackmailers appears to be a part of the process, ordinary citizens are angry at the banks and angrier at the government for helping them. “Let ‘em fail,” they cry. They might be even angrier if the credit freeze got colder and the unemployment statistics began to look more like a great big “D”epression. It’s all ugly.

I’m Peter Dekom, and I continue to shake my head in disbelief!