Are Banks Carrying Overvalued Commercial Real Estate Loans?

Question: I have read some comments that commercial real estate is the next bubble soon to burst. Are banks carrying overvalued loans on their books and the borrowers not being foreclosed on so that these banks will seem to be solvent? Is this what is meant by banks reluctance to “mark to market”?

Paul Solman: We did a story on the perils of commercial real estate debt that is, not surprisingly, the first place I’d suggest turning. (Not because we’re so great, but because we put our best thought and reporting into it.)

The fact that interest rates in the U.S. continue to be so low lessens the threat right now. Hey, I listened to the radio this morning and said to my wife: “I think WE ought to refinance. We’d save money.”

As to your second question — “Are banks carrying over-valued loans on their books?” — yes they are. And yes, you’re right, if and when they foreclose, they have to mark the value of those loans down to how much less they get for the house then they got in the loan.

But no, that’s not what’s generally meant by “banks’ reluctance to ‘mark to market.’” Banks simply don’t want to acknowledge, on their books, what the not-yet-foreclosed loans are now worth on the open market. That’s because they’d have to set aside more loan loss reserves to cover the anticipated losses. The reserves would eat into — first — their profits and after that, their capital cushion. Here’s our explanation during the so-called “stress tests” of last year.