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Job loss, government revenues, the growing number of 90-day delinquent residential mortgages, expanding bank failures (the FDIC’s problem bank list jumped 33% to 552 in the third quarter), rising stress in commercial real estate markets, continued declines in leasing activity, falling occupancy rates, decaying property net operating incomes and rising commercial defaults. This was the story of 2009. It will likely be the story in 2010, maybe longer.

Washington regulators have taken recent actions to promote a soft landing–and unfortunately maybe extend the pain of the current economic downturn–with the following four significant recent policy statements in order of occurrence:

1) Aug. 28, 2009: At the urging of Congress, FASB issues new guidelines regarding mark-to-market rules (FASB 157; Fair Value Measurements). In an apparent effort to reduce banking system stress, FASB introduced the concept that an inactive market–i.e. CMBS and real estate investments) casts doubt about the true value of the asset. This decision provided banks the flexibility to determine their own value–i.e., their own mark-to-model by declaring a secondary market for their assets as inactive.

2) Sept. 15, 2009: The US Treasury issues new REMIC regulations allowing a) CMBS borrowers the ability to speak to special servicers in the event of an impending default (in the past, borrowers had to default in order to speak with the special servicer of the mortgage bonds), and b) special servicers the ability to restructure mortgages–e.g., lower interest rates, amortization and pay rates–and extend terms on loans.

3) Oct. 30, 2009: The FDIC issued its “Policy Statement on Prudent Commercial Real Estate Loan Workouts.” This memo is a reminder by the FDIC of regulatory policy enacted in the 1991 real estate debacle and delivers a roadmap to financial institutions to implement “prudent commercial real estate loan workout arrangements” to avoid regulator criticism and reduce adverse regulator treatment of restructured loans. Rather than foreclose, banks were guided to extend and amend loans.

4) Fannie Mae and Freddie Mac indicated they will be issuing memos detailing how they will deal with a rising multifamily delinquency rate and how their institutions intend to deal with same.

All four of these policy statements contribute to the prevalent theme of “extend, amend and hope for a better day.” These proposed solutions may work, but they also promote a drawn-out asset clearing process and postpone a clear recovery.

Regulators in Washington fear the banking system is not yet sound enough to absorb the necessary commercial real estate assets and value write-downs over mark-to-market. As a result, they have decided to prolong the pain and delay what may be the inevitable realization of losses. Regulators looking at the steep yield curve believe the banks can earn their way out of the current crisis, generate record earnings, strengthen bank balance sheets and either a) hope asset values return to some semblance of their previously lofty levels, or b) take write-downs when the banks are stronger.

For those real estate and banking veterans old enough to remember, in the early 1990s regulators formed the Resolution Trust Corp. The RTC took over failed institutions and packaged up their assets–loans and real estate-owned–and held them for a period of time then sold them off in an orderly fashion individually or in bulk. The RTC had a limited life.

But this aggressive action by regulators in the late 1980s and early 1990s acted as a stabilizing mechanism, restored liquidity into institutions clogged with toxic assets and encouraged transactional activity. The lifeblood of much of the real estate industry, transactional activity is necessary for the market to reach an equilibrium clearing level and allow values to begin to rise.

The commercial finance market has begun to thaw from the epic systemic fear and lockup of late 2008 and early 2009. Droplets of liquidity are currently returning to the market under stricter underwriting standards. As we look ahead to 2010, it portends to be a year of slow and delayed opportunity for recovery in the commercial real estate market.

Maybe we should bring back the RTC?

Mark Scott is president of Commercial Mortgage Capital. Contact him at [email protected] The views expressed here are those of the author.

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