Ten financial bubbles in the making


Clusterstock cheerfully lists ten financial bubbles to watch out for. Some are relatively minor, with the biggies being China and commercial real estate (which is already popping.)

For example, half a trillion in shopping center loans originally financed at low rates comes due in the next three years. Many will not be able to refinance because terms are tighter and their properties have dropped in value.

Commercial Real Estate seen falling 35%-40%

cre pricing example


Green Street Advisors has put together an excellent deck [slide show] showing the coming mess for commercial real estate. Bottom line: A 35-40% decline in commercial real estate values should be “right.” And that’s if the market doesn’t overshoot.

The big problem in CRE is deals were funded using excessive valuations and high Loan To Value percentages. The funding is short-term, so the loans need to be re-financed within a few years. But valuations have dropped sharply, loans are much harder to get now, and the allowable LTV has dropped too. All of which means big trouble.

From the diagram. A loan in 2007 is for $100 million with 75% LTV. Thus, they owe $75 million. They need to re-fi in 2009. But the property is only worth $63 million now and the max LTV allowed is 60%. They can only re-fi for $38 million but they owe $75 million. So, “who will write this check” for the additional $37 million to pay off the original loan? That is the serious, growing problem that commercial real estate faces now.

Commercial real estate. The next to fall

office building
Commercial real estate will be the next domino to fall. Portfolio explains why.

Lending standards fell, starkly. Or as I prefer to see it, they were thrown out of the 60th-floor window of that gleaming office tower in downtown Atlanta/Phoenix/New York/San Francisco/insert your city here. The gap between the cost of debt servicing and the cash actually being generated by the buildings narrowed. What’s more, it used to be that banks made loans for no more than 80 percent of the value of a property to ensure a healthy cushion of protection, but by the early part of 2007, loans were sometimes made for 120 percent of a property’s value. Who would be so crazy as to lend more than a property is worth? Anyone who believes in perpetual-motion machines—that is, that rents and underlying property values must always go up.

Or someone who was making large fees for doing so and who care if loan went bad. Because the real point was to package the loans into bonds so they could be sold, thus making more money.

Regulators did nothing to stop this until the bubble burst. For those who say that markets function best when unregulated, I say, this is what happens when they are.