The weather report for commercial real estate is bad, according to The New York Times, which reports rapid falls in value in local office buildings. In California, the weatherman is predicting flurries of half-empty office buildings and shopping malls to fall on Golden State cities during the next two years. For local governments, which have already watched an exodus of local and national retailers from local shopping centers and office buildings, the prospect of further trouble in commercial real estate is not a cheerful one.  

According to various estimates, at least $500 billion of mortgages on commercial buildings – including office buildings, multi-family complexes and hotels – is due to be refinanced during the next two years. Most banks don't want to touch those mortgages, because the buildings have lost value. With a continuing credit crunch and growing vacancy rates in all major markets, investors who paid – and in many cases overpaid – for buildings during the most recent wave of magical thinking now find themselves unable to refinance buildings that are worth less than their mortgages. Sound familiar?

Inability to refinance will force investors to default and give the buildings back to their lenders, who almost certainly do not want them. Banks almost always lose money on "real estate owned" properties. Everybody loses, because real estate values will tank across the board (actually, they already have) and lenders will act like you're speaking Swahili if you ask about refinancing.

Securitization problems will also increase havoc in markets already melting down. Currently, about $800 billion in commercial real estate – office buildings, hotels, shopping centers and larger multi-family complexes – has been securitized. In essence, the mortgages have been pooled with billions of dollars worth of other mortgages, "sliced and diced," received ratings from credit agencies like Standard & Poor, and sold off primarily to institutional investors like pension funds and life insurance companies. In other words, it's the exact same story as that of securitized home mortgages. As with the mortgage-backed securities, the rating agencies gave thumbs up on ridiculously optimistic assurances of return without adequate acknowledgement of any potential downside. Sooner or later, a large number of those commercial real estate-backed securities will tank. The losses could stack up to $150 billion nationwide.

Given that we have already damaged our financial system by absorbing the cost of failed mortgage-backed securities, is there a sensible public policy to cushion the coming crash? The prospect of the government shelling out $150 billion or so to save fat-cat institutional investors and their lenders would be political poison for the Obama administration. The now-infamous "bailout" of major financial institutions in the past year, although it may have prevented a global depression, was almost equally unpopular with both progressives and conservatives.

A better idea, perhaps, is for investors to cut their losses by negotiating the sale of the mortgages and/or mortgage-based securities at some discount rate with new investors. If it were politically feasible, which it's not, it might be useful for the federal government to set up a "bad bank" to buy commercial real estate-backed securities at a discounted rate and resell them to investors, who will make a killing on them if they buy them cheaply enough.

The "bad bank" might arguably have the advantage of stabilizing the commercial real estate market by creating an efficient "second market" for non-performing mortgages. Yet this model almost certainly entails a big investment of public money, so it's probably a non-starter, too. For the time being, as the bluesman Robert Johnson once sang, you'd better stay inside, "'cause it's gonna be rainin' outdoors."   

– Morris Newman