Yesterday, Federal Deposit Insurance Corporation Chairwoman Sheila Bair gave a speech at the Commercial Mortgage Securities Association Annual Conference. In it, she said a lot of what we already know about Bair's intentions for regulation going forward. But she also summarized some data the FDIC had compiled on the commercial real estate market. One item particularly caught my attention: the big banks' exposure.

For some time now, commercial real estate has been characterized as what may be the next shoe to drop. If anything threatens to cause a double-dip recession, it's a widespread deterioration in commercial mortgages. I've written about this several times. Megan's magazine column this month in The Atlantic also addressed the topic.



But up to now, most of what I've read and heard about the upcoming commercial real estate doom had been mostly isolated to smaller, regional banks. They were said to hold greater CRE risk than the bigger banks. While bad news for the FDIC's insurance fund, at least it would imply that the big banks might not need another bailout due to commercial mortgages going bad.



But yesterday, Bair said:





Despite what you may be hearing, CRE credit problems are affecting big and small banks alike. In fact, CRE noncurrent and charge-off rates are higher at banks with over one billion dollars in assets than at community banks. Industry analysts expect CMBS delinquency rates to continue climbing.





That's pretty disturbing. Big banks are actually exposed to uglier commercial mortgages than smaller banks. But what does this mean in a broader context?



First, if we do see enormous losses from CRE, they'll probably hit big banks first, since their delinquency and charge-off rates are initially higher. Then regional banks' CRE losses will follow. Even if the smaller banks' mortgages are a tad cleaner than those the bigger banks hold, it might not matter: just as we saw with residential mortgages, even prime loans can experience deterioration in an environment like this.



I think this is actually worse news than if the situation was reversed, and the losses began at regional banks first instead. If the big banks begin to encounter problems again before an economic recovery is well underway, this would almost certainly throw the financial markets back into disarray. A fragile economy couldn't handle it.



But if regional banks got hit first, then the pain would initially be more dispersed and less front-page. That would more likely allow the economic recovery to slowly continue, without too strong a shock to the market or sentiment. Then, if it hit the big banks later, the economy might have recovered enough to better endure it.



We still don't know how much pain CRE will bring. It could be a false alarm. But the sobering information Bair provides above at least provides some clue of how to know when we're in the early bands of the storm. If large banks begin reporting big CRE losses, then we're likely in for a heap of trouble.

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