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The Commercial Real-Estate Dam is Breaking
David Haggith

So are stocks. So are bonds. So are banks. The deluge is washing everything away!

The image above shows the badly swollen Mendenhall River, which has risen to something like a thousand-year/never-happens level as an ice dam on Mendenhall Glacier has given way, dumping a raging torrent from the glacier’s trapped lake at Suicide Basin into the river. That is a fitting symbol of what just happened in commercial real estate and to its bankers today.

First, Fitch downgraded the US government last week. Naughty business that busted Biden’s chops. (Busted Republican chops, too, because both parties played games with the nation’s credit.) It said, “You don’t get to forever use the nation’s credit as a bargaining chip with no consequence to US credit ratings.”

Now Moody’s is in a bad mood, downgrading a swath of ten US minor-league banks overnight while also issuing a big threat that it may downgrade some of the majors. As stocks tumble into the current of this downgrade and bonds flip over wildly in response with volatility bouncing around in the rapids of it all, Biden boasts that, thanks to him, the US economy is strong. He’s going to campaign on that. He made his boast, of course, just before Moody’s left its mark on the economy he wants to own.

That’s fine. He can own the economy because his charade of an economy is going to crumble into the river all around his feet. Owning the economy now assures he can also own it months from now when the whole mess has tumbled into the inflated river that forced the Fed to tighten hard, hitting real-estate like a crumbling ice dam.

Housing prices have risen back to and above all previous levels in a number of cities, in spite of mortgage interest hovering around 7% and also rising. That may seem great to some like Boastful Biden, but such falderal is only happening because no one wants to sell a home right now when they will have to replace it via a mortgage that jumps from the 2.5% they had to 3x greater than that. With few houses to buy, even the few interested buyers have to compete and pay a premium. It’s really just a seriously overturning market. As seen in the photo above, sometimes the roof on prices may tip up into the air on one end, as the rest of the home slides into the deluge that is undermining housing.

The Fed is not about to lower interest rates for many months to come because, as one headline below states today, the toughest part of the Fed’s inflation battle is the final effort to beat the life out of inflation by getting it down to 2%. If it doesn’t get inflation down the rest of the way, inflation will quickly rise again. Housing prices are already rising again in the face of scorching interest rates, and that doesn’t make lowering inflation numbers any easier. Neither has the recently rising cost of fuel, which eventually affects everything else. So, real-estate loans have a long period of rising defaults that will keep pouring over the banks. In fact, the worst is yet to come in real-estate defaults. Today’s announcement by Moody’s merely broke the ice dam that was holding back the disastrous flow.

Moody’s particularly downgraded banks due to the commercial real-estate troubles that I have been predicting for the past few months would come home to rest at the banks, stating specifically that CRE troubles will lead to more banks collapsing into a rising river of real-estate defaults that will soon sweep over the banks. I am holding with that prediction, which is starting to look like a no-brainer at this point, anyway. 

However, Janet Yellen and J. Powell certainly didn’t see it coming when they said banks are fundamentally strong back when I started saying the next wave of collapses would hit when commercial real-estate defaults started to rise more later in the year. This is now the start of later in the year. The double peak in housing prices is sure to blow up before long, too. Commercial real estate has the greater troubles, but housing will become a confluence in the flow later on.

In related headlines, The Baltimore Sun just shined upon the hearts of Baltimorians, warming them with assurances that there is nothing to see, nothing to fear in commercial real estate. All will be fine. (They must be campaigning for Biden.) Unfortunately for them, they — like boastful Biden — made their case just beforeMoody’s ran through the middle of town with its stream of unwanted news.

The banks Moody’s rightly downgraded will now experience further troubles because of those downgrades. The downgrades could, of course, even cause bank runs in the named banks and maybe others if contagion should develop. Depositors tend not to trust banks as much when news comes out that their bank has been downgraded due to high CRE defaults.

Moody’s mood must have run sour because they even brought up that nasty business from last spring about bank reserves. Who could imagine, with the massive government bond deluge that is about to come, that bond prices might fall further, draining bank reserves even more, and pushing more banks into the river along with the flow of real estate, flushing everything out to sea? Who can see anything like that coming? (Raise your hands, you astute wonders, in the comments section.)

The flood of Treasuries I’ve been writing about will certainly test the ability of bond markets to absorb a flow that will be, in itself, as historic as the Mendenhall River action over the past twenty-four hours. The first release has to be absorbed during the course of this week. Yields have already risen higher than expected at each of the last five Treasury auctions.

My path to writing this blog began as a personal journey. Prior to the start of this so-called “Great Recession,” my ex-wife had a family home that was an inheritance from her mother. I worked as a property manger at the time, and near the end of 2007, I could tell from rumblings in the industry that the U.S. housing market was on the verge of catastrophic collapse. I urged her to press her brothers to sell the family home before prices dropped. The house went on the market and sold right away — and just three months before Bear-Stearns and others crashed, taking the U.S. housing market down for the tumble. Her family sold at the peak of the market.

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