Fed signals fears about commercial real estate woes

The minutes of the Federal Reserve's last meeting show a board losing hope on a housing recovery, fearful about rising problems in commercial real estate and "surprised" by the pace of economic declines overseas.

The summary of the Jan. 27-28 meeting, released today, indicates that the Fed still expected that "a gradual recovery in U.S. economic activity would begin during the third or fourth quarter of this year as the economy begins to respond to fiscal stimulus, relatively low energy prices, and continuing efforts to stabilize the financial sector and increase the availability of credit."

But a few sentences later, the minutes say that "all but a few [Fed officials] saw the risks to growth as tilted to the downside; in light of financial stresses and tight credit conditions, they saw a significant risk that the economic recovery would be both delayed and initially quite weak."

In fact, the Fed’s official forecast now is for the economy to contract between 0.5% and 1.3% in 2009, which, if it's on target, still could mean some growth in the second half after further contraction in the first half.

The Fed also admitted to being "surprised by the speed and magnitude of the slowdown in economic growth abroad and the resulting drop in demand for U.S. exports. . . . Moreover, participants did not expect foreign economies to rebound quickly, suggesting that net exports would not provide much support for U.S. economic activity in coming quarters."

As for residential housing, "Participants saw no indication that the housing sector was beginning to stabilize," the minutes say. "Though sales of existing homes appeared to have flattened out, a large fraction of those transactions seemed to have resulted from foreclosures or other forced sales; moreover, new home sales, housing starts, and permits all continued to decline steeply. Lower house prices and mortgage rates had increased housing affordability, but concerns that house prices may fall further appeared to be holding back potential buyers."

The Fed also signaled growing worries about commercial real estate. From the meeting minutes:

A number of participants expressed concern that the commercial real estate sector could deteriorate sharply in the months ahead. They noted that a large number of commercial real estate mortgages will come due at a time when banks likely will still be facing balance-sheet constraints, the ability to securitize commercial real estate mortgages may remain severely restricted, and vacancy rates in commercial properties could well be climbing.

Some participants worried that the outcome could be an increase in defaults on commercial real estate mortgages and forced sales of commercial properties, which could push prices down further and generate additional losses on banks' commercial real estate loan portfolios.

However, the commercial real estate sector had expanded more moderately during the recent expansion than during the expansion of the late 1980s, suggesting that the downturn in the current cycle could be milder than that seen in the early 1990s.

-- Tom Petruno

Photo: The Fed's headquarters in Washington. Credit: Mark Wilson / Getty Images

Comments

[mr.bilko]

The Fed was ""surprised" by the pace of economic declines overseas."?
Wow! The guys running the show are even more clueless than I thought.

Old adage: When the U.S. catches a cold, the rest of the world gets pneumonia

No wonder Greenspan, Bernanke, Larry Summers and Tim Geithner failed to see the housing bubble, dangers of unregulated credit default swaps and pay option ARM/Alt-A/subprime mortgages.

[smrr]

TP. Do you really believe CRE has less of a downside than in the early 90s? Put down the pipe. Pour out the coolaid. It's no longer about the failure of RE, rather it is the failure of the consumer economy. I can't believe you're still hawking the 'things not as bad as they seem line.' You're a journalist for chrissakes. Do some journaling.

[Tom Petruno]

@smrr: Whoa, I think you're confusing me with the Fed. Those last three paragraphs are from the minutes of the Fed meeting, verbatim.

I am sure commercial real estate has far more downside this time around than last, at least in places like California and Florida. The developers did what they always do, which is overdevelop. This time, they did it on steroids -- the loosest credit in modern history.

Tom Petruno

[just_in]

Bernanke said,
"a gradual recovery in U.S. economic activity would begin during the third or fourth quarter of this year as the economy begins to respond to fiscal stimulus , relatively low energy prices, and continuing efforts to stabilize the financial sector and increase the availability of credit."

I think some of the key points in this statement are that it will be a gradual recovery will begin during the third or fourth quarter. In other words, were talking about an expectation of a gradual L shaped recovery, rather than a roaring V shaped recovery 'begining' sometime in the back half of 2009. Then notice that he does not say part of this recovery will be due to government efforts to stimulate the financial institutions to their former robust selves, but rather he says part of this gradual recovery is due to government efforts to 'stabalize' the economy, and to increase [read restore] credit availability.

As for residential housing, "Participants saw no indication that the housing sector was beginning to stabilize...[due to] foreclosures or other forced sales...[and] concerns that house prices may fall further appeared to be holding back potential buyers."

The Fed also signaled growing worries about commercial real estate. They sited the fact that approximately one third of U.S. commercial mortgages are coming due this year; that the Commercial Mortgage Backed Securities (CMBS) market is frozen; and hat most banks are barely able to stay solvent, let alone able to fully restore CMBS or other lending. The Fed committee also cited the drop in vacany rates accross all property types. They might has well have thrown in the declining operating incomes and rent rolls, as well as increasing capitalization rates. In other words, the commercial real estate markets are in for a massive price correction, and some notable backruptcies.

Then the article goes on to mention that:
The Commercial Real Estate (CRE) sector had expanded more moderately during the recent expansion than during the expansion of the late 1980s, suggesting that the downturn in the current cycle could be milder than that seen in the early 1990s.

This does not seem to be the correct conclusion. The argument goes that because this commercial real estate recession is caused by a fall out in demand and a simultaneous credit bust, instead of the overbuilding of supply and credit bust that caused CRE's worst recession in the early 90's, then the recession will be milder for CRE this time around. Not overbuilding will help create a strong recovery for the CRE industry, but a fall out in demand can be just as severe as a ridiculous oversupply. Also, CRE has historically laged the general economy, and the U.S. economy is waiting for stabalization before it can begin its expected gradual recovery.

[James Monachino]

Near Term Recovery -- Forget about it.

A long saucer shaped bottom is being suggested. Time line is just a wild guess or a politically constructed number to try an help people keep the faith.

We have to stabilize before we see a recovery. This is a multi year endeavor with alot more new faces and ideas yet to go.

James Monachino

[Sheldon]

Given the Fed's less than stellar record, I would not take to the bank their belief that the commercail real estate problems are less sever then the early 1990s.