A weird quiet seems to have settled over the country. We're in the
midst of the financial crisis, yet it feels like the whole thing has
somehow passed. In fact, the ionized air around us suggests we're in
the eye of this hurricane—experiencing a moment of calm before the
storm whips up again.

Which is to say we are probably experiencing a rolling recession.
And some analysts believe the crisis has yet to fully ripple across the
myriad types of assets held by banks and investors. The failure of
residential mortgage-backed securities was just the first ripple of
this much larger wave. Asset types that didn't exist on the same scale
in 1929—like credit cards, industrial loans, and commercial real
estate—still hold the force to wreak more havoc. And on the tip of Wall
Street's and Washington's tongues are commercial mortgage-backed
securities. They sure look like the tsunami in this financial storm.
But it might just be the Geithner plan that halts the wave and saves
our shopping malls from looking as dead as some suburbs.

So first, why do CMBS have to blow up? Like residential
mortgages, the premise behind commercial loans was faulty. And that
premise is, of course, that the market would never go down. Commercial
loans, which are packaged into CMBS, are given to owners of buildings
that have multiple streams of income, like apartment complexes and
shopping malls. Unlike residential mortgages, their terms are as short
as five years with a lump-sum payment due at the end. In residential
mortgages, only savvier homeowners—well, they seemed so at the
time—thought to treat their homes like cash machines and take out
equity in the form of refinancing. But in the commercial market,
especially the crazed one of 1993-2006, it was de rigueur to refinance
loans and pull out equity before the big payout came due.

Thanks to that practice, America's $6.5 trillion commercial real
estate market, of which nearly 50 percent was financed, may be in dire
straits, too. More than half a trillion dollars in commercials
mortgages are coming due between now and 2011 (which is five years out
from the market's 2006 peak). And just like the homeowners who never
expected to actually face their balloon payments, the frozen credit
markets are leaving commercial loan holders unable to pay off their
loans. Delinquencies in CMBS loans are already up 246 percent over this
quarter last year, and analysts say they could go much higher.

Real estate investment trusts are built on commercial loans, which
are often packaged into CMBS. REITs are a special type of company that
allows investors to avoid corporate income taxes if they distribute 90
percent of their profits back to investors, usually as a dividend.
Which is why it was scary for many of those investors to watch General
Growth Properties, the largest REIT in the country, declare bankruptcy
last week. The company, which owns 200-plus malls, faces $5.5 billion
in commercial real estate loans due in two years. Basically, it was
hugely overleveraged. It has been a dead REIT walking for months—Sam
Zell predicted the bankruptcy at a REIT conference in New York three
weeks ago. But General Growth was holding out hope that it could
convince its investors to simply hang in there—to give them an
additional year to pay off their loans with no penalty either in a
moratorium or a forbearance. Ultimately, investors said no, and here's

Analysts, media, and investors are lashing the commercial real
estate sector with their tongues. Zell called it Darwinian. Stock
values of public REITs, despite a recent upswing, have been routed,
according to the Wall Street Journal. REITs are wrecks and have
turned to the tenets of religion to survive: faith, hope, and charity.
Their future is clouded, according to one unusually sanguine headline
writer. Commercial Property Faces Crisis, says another.

A strip mall, the quintessential piece of commercial real estate, is
only as valuable as the rent it earns its landlords. When tenants,
i.e., stores, stopped making money, they stopped paying rent.
Commercial landlords were faced with two unsavory choices: allow stores
to leave or lower their rents. (Several stores, from Circuit City to
Steve and Barry's, gave their landlords no choice at all; they went out
of business, leaving large vacant holes in malls and balance sheets.)
Landlords are now allowing down-market stores into previously
off-limits malls and investing in gimmicks like the Flowrider, an
indoor wave-surfing machine, to draw people back in the hope that they
might purchase a latte or T-shirt before leaving. Needless to say, when
landlords are hanging ten to avoid a wipeout, the times, they are

But what's puzzling is that several of the largest public REITs,
though not General Growth, have lately been raising cash through
secondary stock offerings—and have found willing investors. One
plausible explanation for why real estate moguls like Zell, Steve Roth,
and William Mack are bemoaning the fate of their industry while REITs
are padding their bank accounts is that REITs were prepping for General
Growth's and other weak REITs' liquidations. It is a Darwinian
sector, then, and everyone in it is trying to avoid looking like the
dodo bird. As General Growth's 200-plus shopping malls hit the auction
block, stronger REITs will become the latest vulture capitalists,
buying up the distressed properties and assuming their debts. But here
is where, unlike last time, the carnage stops. Those debts, commercial
mortgages, are probably about to be a lot safer, as they are likely
soon to be protected by the Geithner Public-Private Investment Plan.

The PPIP, as has been explained here among other places, protects
investors to an absurd degree against losses in assets they buy in the
coming distressed asset auctions. An investor with government
protection can potentially make 45 cents on a dollar of investment,
according to a Credit Suisse analysis, while a theoretical unprotected
one would make only 15 cents per dollar invested. The mortgages on
those empty strip malls and shopping centers full of wave-surfing,
unemployed, nonshopping shoppers will magically become sound
investments! Therefore, REITs that have extra cash in hand may find a
way, working with the government's handpicked PPIP managers, to bail
themselves out of their own mortgages, mostly on Uncle Sam's dime.

So while commercial real estate values could indeed be headed for
collapse, savvy REITs are already putting aside money for umbrellas and
galoshes. And Obama and Geithner are hoping they have built a
weather-changing machine for the entire economy in the form of the
PPIP. Of course, the PPIP has promised only up to $1 trillion in
investor protection across all asset-backed securities, not just CMBS,
so far. Yet the blog REIT Wrecks estimates that up to $1.8 trillion may
be required for complete investor prophylacticism in the CMBS market

The REITs that survive this extinction are going to be on sounder
financial footing than even the strongest REITs now. After
overleveraging their holdings in reckless pursuit of profit, they are
positioned to swoop in and buy up, in the form of auctioned distressed
assets, well, themselves. And their weaker brethren. At a discount.
With government backing. Welcome to Bailout Economics.

If all of this smarts a bit, consider what the collapse of the residential mortgage market has shown us about not
providing a government safety net in times like these. If our options
are bank collapses, shotgun mergers, and investor panic versus a mild
form of economic socialism, then call me comrade. (Though there is
still no reason for the administration to privatize the gains from what
can fairly be called the CMBS bailout and socialize only the potential

My only question is, why haven't Rick Santelli and his tea partiers
criticized this latest promotion of bad behavior by Obama and Geithner?
The residential mortgage bailout that launched Santelli's screed has a
mere $75 billion price tag. Yet the commercial mortgage bailout could
end up costing us $500 billion in taxpayer money. Could it be because
the ultimate beneficiaries of this bailout will be billionaire
developers who dug themselves too deep a debt hole rather than mere
homeowners? Subsidized bad behavior, indeed.