A report released by a congressional panel flagged commercial real estate loans as a danger to the stability of the economy. Between now and 2014, around $1.4 trillion worth of commercial loans will become due, requiring the loans to be paid in full (known as a balloon payment). Close to half of these properties are underwater – the negative equity phenomenon of this mortgage financial crisis.

Close to 3,000 banks in the U.S. hold mainly commercial real estate loans, putting these banks severely at risk of failure. The majority of at-risk banks are small and mid-sized, with 2,000 of these banks holding $100 million to $ 1 billion in total assets.

While the panel explained that it is not the government’s job to keep every part of the banking industry solvent, it did note the foolishness of allowing the sort of bank failures seen in 2008.

The panel recommended that the federal government:

  • provide capital stimulus for smaller at-risk banks;
  • give financial assistance for small businesses whose commercial property is underwater;
  • set government funds aside to guarantee loans held at small banks;
  • extend the Term Asset-Backed Securities Loan Facility; or
  • purchase loans directly from at-risk banks.

first tuesday take: The most unstable banks are located here in California. Currently, the nation is experiencing bank failure of around four banks a week, up from around three weekly in 2009. Nearly all failures are being transitioned the following work day into a branch of another bank, handled by the Federal Deposit Insurance Corporation (FDIC) and sufficiently funded by the banking industry to handle the losses on the failures. Some failed banks are not incorporated with other banks, and that leaves the FDIC with a vacant single purpose building to dispose of – a slow process at the moment. [For more information regarding the troubled banks in the 12th district, see the October 2009 Federal Reserve Bank of San Francisco report, 12th District Banking Profile.]

A flood of new bank failures will destabilize the fragile market and cause the market to double-dip — a situation beneficial to no one since banks exist primarily to provide the money (issued by the Federal Reserve) for the economy to function.

Currently, banks too big to fail are intentionally receiving preferential government treatment. The treatment is stifling and eliminating competition in the financial industry. This cannot last, but will continue while the long-term stability of the financial market is tenuous.

Re: “TARP Watchdog Says Commercial Real Estate Loans Pose Danger,” from The Wall Street Journal