hours-longtestimony by top executives at Goldman Sachs.

To be sure, Congress, particularly the Democrats, had been seeking toestablish some controls and transparency over these little-understoodinstruments before the US Securities and Exchange Commission chargedGoldman with fraud in its structure of certain collateralized debtobligations. The suit, though--whatever one's belief in its merits--has clearly heightened tensions and put a spotlight on the issue forthe public. A public, it hardly needs to be said, that is feelingprecious little sympathy for investment bankers these days.

For all of these reasons, the real estate industry is becoming more nervous about what might be handed down in Washington--especially as the CMBS markets continue to show signs of revival. The most strict proposal--put forth by Sen. Blanche Lincoln--may not have the votes to pass. Essentially, Lincoln's bill would have banks wall off their swaps-trading desks completely.

Nonetheless even less strict regulations could hamper thecommercial real estate industry's ability to manage risk--andpossibly tamp down the emerging CMBS market, according to an informalsurvey of executives in this space by GlobeSt.com. Real estate companies, along with other business end-users, employ over-the-counter derivatives products to help manage business risks such as interest rates and foreign currency exchange exposures, saysReal Estate Roundtable senior vice president Chip Rodgers.

"In our view, it is important for reforms to strike the right balancebetween bringing full transparency to the derivatives markets,reducing systemic risk and preserving the ability of real estateend-users to responsibly hedge their risk," Rodgers tells GlobeSt.com. A move too far in one direction could send businesses to offshore centers, says Walter J. Mix III, managing director of LECG Global Financial Services.

Worse, from the perspective of the commercial real estate industry, it could also suffocate the nascent CMBS market. "To the extent that the derivatives in question impact the CMBS market, which is in its incipient stage of recovery, the rates to refinance commercial real estate will remain high and recovery in that area will be negatively impacted," Mix tells GlobeSt.com.

Indeed, with Goldman Sachs under attack by the Senate and the SEC--rightly or wrongly--and with the likelihood that the ratingsagencies will be the next to face scrutiny there will likely be alonger delay in getting conduit lending back to pre-meltdown levels or anything approaching it, says Carl Schwartz, chairman of thecommercial real estate department at Herrick, Feinstein. "There aresome lenders that have been warehousing debt in the hopes that therevitalization of the market would open up in the near future," hetells GlobeSt.com. "But things will need to quiet down and confidence will need to be restored before that happens. This, too, shall pass, as all things do. But for now, the resurgence in the CMBS market we were hoping for might be delayed."

James Jablonski, instructor of finance at the Villanova School ofBusiness, and an expert in derivatives and financial market regulation, offers a primer on the legislation under debate to get a better understanding of how a stopped-in-its-tracks CMBS market could be one end-result.

There are two key issues under discussion, Jablonski tells GlobeSt.com. There is the bill proposed by Lincoln in which banks would be forced to spin off their trading operations to keep the derivatives trading out of institutions deemed too big to fail to avoid systemic risk to the US economy. The other requires companies to put aside large sums of money to cover potential losses.

A side issue, he says, is whether this legislation would apply toexisting contracts--a move that is being vigorously lobbied againstby Berkshire Hathaway because they have $63 billion in existingderivatives contracts on their books. Margining would grossly raisethe cost of capital required to hedge their risks.

"The legislation being proposed would likely have an impact on commercial real estate because of its impact on the cost and availability of financing," Jablonski explains. "Banks and other direct financing firms often manage their commercialreal estate loan business by packaging up loans and selling them toWall Street financial firms so that they can free up more capital tomake new loans," he adds. "If Wall Street firms are more restricted when it comes to hedging their exposure to these loans using derivatives then they will have to require higher interest rates from the lending banks to assume the risk of the loan packages they are trying to sell."

Ultimately, Jablonski concluded, these higher rates will filter backdown to the direct commercial loan market--causing existing variablerate mortgages to become more expensive--and raise the cost of borrowing for potential new customers.

Instant Insights /

RE Concern Over Derivatives Legislation

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