Federal Reserve & Interest Rates

Nearly a hundred banks have already failed this year and the FDIC’s bad bank list contains hundreds more that are in danger of failing in the next few years.  With it’s insurance fund running dangerously low, the FDIC put forward a plan earlier this month, in which banks would prepay three years worth of fees to replenish the fund.

It’s the worst stretch of bank failures since the Savings and Loan crisis of the 1990’s when nearly two hundred banks and thrifts failed, costing taxpayers over $100 billion.  The insurance fund has shrunk by nearly $35 billion since the recession began and has a little over $10 billion remaining.

While banking system has stabilized somewhat, it’s still in a fragile state and the continued weakness in the residential and commercial real estate markets will lead to more failures in the next few years.  At this point, the FDIC estimates that bank failures will cost the insurance fund $100 billion by 2013.

The proposed prepayment plan is expected to raise somewhere in the neighborhood $50 billion and while the banking industry isn’t happy about it, they prefer this option to a special fee assessment which was also a possibility. In May, Congress increased the FDIC’s line of credit with the Treasury to $100 billion, but it been reluctant thus far to borrow from the Treasury and putting more of the onus of bank failures on taxpayers.

Officials at the Federal Reserve gave testimony today before Congress over the current state of the commercial real estate(CRE) market.  Although it hasn’t faced a meltdown like the residential market, prices have continued to fall over the past year and a half.

Financial market dislocations and the continuing economic downturn are clearly challenging CRE markets. The pace of property sales has slowed dramatically since peaking in 2007, from quarterly sales of roughly $195 billion to about $20 billion in the first quarter of 2009. Demand for commercial property is sensitive to trends in the labor market, and, as job losses have accelerated, tenant demand for space has declined and vacancy rates have increased.

Demand for office space fell for the sixth straight quarter and with the employment picture expected to worsen through the end of the year, that trend will likely continue as well.  It’s really no surprise, the country is at it’s highest unemployment level in nearly three decades

There are growing concerns at the Fed about what effect the weakening market will have on the loan portfolios of many large banks, many of whom are still struggling to meet capital requirements and maintaining effective liquidity levels.  The recent Supervisory Capital Assessment Process, highlighted the riskiest CRE loans in the nation’s 19 largest banks and government has increased their supervisory efforts in response.

Financial markets remain fragile and a number of institutions already face liquidity difficulties.  Some real estate analysts have predicted it may take at least two years for both commercial and residential prices to start rising again and the banking system will likely face danger over a similar timeframe.

A report released by the ratings service Moody’s states that commercial real estate values have dipped approximately 21% since it’s high in October of 2007.  The report sent bank stocks tumbling as worries over future losses continue to plague the banking sector.

While commercial real estate has fared better than it’s residential counterpart thus far, the ongoing recession is clearly having a major impact.  We’re seeing a big drop in commercial real estate activity across the entire country and the outlook is for further declines as the year moves forward.

Obviously this is more bad news for banks as well as for the government, which has already spent over a trillion dollars trying to fix the banking system.  This will definitely hamper efforts to get private investment back into the mortgage backed securities market.

Even if the housing market has finally turned the corner which some people believe, if the commercial markets declines for any appreciable amount of time, it’s clearly going to delay the time frame for an economic recovery.  Many investors can’t wait for the chance to jump back into the market, I’m sure many of them are getting tired of settling for lackluster returns in Treasury securities but this just adds more uncertainty into the mix once again.

Some analysts are already critical of the government’s stress test on the nation’s largest banks and many of them feel that banks are underestimating the potential of their future losses and this report just adds fuel to the fire.