[Joint House and Senate Hearing, 111 Congress]
[From the U.S. Government Publishing Office]


                                                        S. Hrg. 111-261
 
    COMMERCIAL REAL ESTATE: DO RISING DEFAULTS POSE A SYSTEMIC RISK?

=======================================================================


                                HEARING

                               before the

                        JOINT ECONOMIC COMMITTEE
                     CONGRESS OF THE UNITED STATES

                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                               __________

                              JULY 9, 2009

                               __________

          Printed for the use of the Joint Economic Committee


                        JOINT ECONOMIC COMMITTEE

    [Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]

HOUSE OF REPRESENTATIVES             SENATE
Carolyn B. Maloney, New York, Chair  Charles E. Schumer, New York, Vice 
Maurice D. Hinchey, New York             Chairman
Baron P. Hill, Indiana               Edward M. Kennedy, Massachusetts
Loretta Sanchez, California          Jeff Bingaman, New Mexico
Elijah E. Cummings, Maryland         Amy Klobuchar, Minnesota
Vic Snyder, Arkansas                 Robert P. Casey, Jr., Pennsylvania
Kevin Brady, Texas                   Jim Webb, Virginia
Ron Paul, Texas                      Sam Brownback, Kansas, Ranking 
Michael C. Burgess, M.D., Texas          Minority
John Campbell, California            Jim DeMint, South Carolina
                                     James E. Risch, Idaho
                                     Robert F. Bennett, Utah

                     Nan Gibson, Executive Director
               Jeff Schlagenhauf, Minority Staff Director
          Christopher Frenze, House Republican Staff Director


                            C O N T E N T S

                              ----------                              

                                Members

Hon. Carolyn B. Maloney, Chair, a U.S. Representative from New 
  York...........................................................     1
Hon. Sam Brownback, Ranking Minority, a U.S. Senator from Kansas.     3
Hon. Maurice Hinchey, a U.S. Representative from New York........     4
Hon. Kevin Brady, a U.S. Representative from Texas...............     5

                               Witnesses

Statement of Jon D. Greenlee, Associate Director, Division of 
  Banking Supervision and Regulation, Federal Reserve Board of 
  Governors, Washington, DC......................................     6
Statement of Richard Parkus, Head of CMBS and ABS Synthetics 
  Research, Deutsche Bank Securities, Inc., New York, NY.........     8
Statement of Jeffrey D. DeBoer, President and Chief Executive 
  Officer, The Real Estate Roundtable, Washington, DC............    10
Statement of James Helsel, Partner, RSR Realtors, Harrisburg, PA, 
  and Treasurer, National Association of Realtors, Washington, DC    12

                       Submissions for the Record

Prepared statement of Representative Carolyn B. Maloney..........    34
Prepared statement of Representative Kevin Brady.................    34
Witness biographies..............................................    35
Prepared statement of Jon D. Greenlee............................    36
Prepared statement of Richard Parkus.............................    40
    Deutsche Bank research report ``The Future Refinancing Crisis 
      in Commercial Real Estate''................................    42
    Deutsche Bank research report ``TALF for New Issue CMBS: Fed 
      Releases Terms''...........................................    66
    Deutsche Bank research report ``TALF for Legacy CMBS: Fed 
      Releases Terms''...........................................    74
    Deutsche Bank research report ``The Future Refinancing Crisis 
      in Commercial Real Estate. Part II: Extensions and 
      Refinements''..............................................    86
Prepared statement of Jeffrey D. DeBoer..........................   117
Prepared statement of James Helsel...............................   132
Prepared statement of Michael C. Burgess, M.D....................   139
Letter from Chair Maloney to witness Greenlee....................   140
Letter from witness Greenlee to Chair Maloney....................   141


    COMMERCIAL REAL ESTATE: DO RISING DEFAULTS POSE A SYSTEMIC RISK?

                              ----------                              


                         THURSDAY, JULY 9, 2009

             Congress of the United States,
                          Joint Economic Committee,
                                                    Washington, DC.
    The committee met at 10:00 a.m., in Room 2226, Rayburn 
House Office Building, The Honorable Carolyn B. Maloney (Chair) 
presiding.
    Senators present: Brownback.
    Representatives present: Maloney, Hinchey, Sanchez, Brady, 
Burgess, and Campbell.
    Staff present: Gail Cohen; Nan Gibson; Colleen Healy; Aaron 
Kabaker; Andrew Wilson; Jeff Schlagenhauf; Chris Frenze; and 
Robert O'Quinn.

OPENING STATEMENT OF THE HONORABLE CAROLYN B. MALONEY, CHAIR, A 
               U.S. REPRESENTATIVE FROM NEW YORK

    Chair Maloney. The meeting will be called to order, and it 
is such a busy time on Capitol Hill. I am told they are going 
to be calling votes shortly, and I just came from a Financial 
Services Committee where we were voting in the committee on 
another bill, but we are focusing on a very important challenge 
today, and I would like to thank our distinguished guests and 
experts for agreeing to testify today on the growing financing 
problems we are facing in the commercial real estate market and 
the extent to which they pose a systemic risk to our economy.
    The current financial crisis is the result of significant 
losses experienced by key financial institutions with large 
exposures to residential mortgage assets. But banks now face a 
second wave of losses as commercial real estate loans, issued 
at the height of the real estate bubble, are coming due for 
refinancing.
    Tenant rent payments are often not sufficient to cover the 
loan payments and many borrowers' commercial mortgages are 
underwater because the property simply isn't worth today what 
they paid for it a few years ago.
    The decline in property values is astounding, particularly 
when you look at my home city of New York. For the year ending 
in March 2009, prices on commercial office space properties 
have dropped almost 13 percent. Deutsche Bank reportedly sold 
Worldwide Plaza in Manhattan for less than $400 per square 
foot, which I understand is less than one-third of the price 
the property could have commanded back in 2006. Many of my 
constituents and others that come to this committee tell me 
they can't find any buyers, and they cannot find anyone who 
will refinance their commercial loans. The bubble has burst, 
but a 60 to 70 percent collapse in prices poses a tremendous 
obstacle to the refinancing process.
    Moreover, in this highly constrained credit market that we 
now live in, even borrowers with performing commercial real 
estate loans who have equity in their properties report to me 
that they are having trouble getting refinancing.
    The commercial real estate time bomb is ticking. An 
estimated $400 billion in commercial real estate debt is set to 
mature this year with another $300 billion due in 2010. If 
mortgagers are unable to refinance, or otherwise pay their 
large balloon payments, we could expect to see the default rate 
soar. That, in turn, translates into potentially crippling bank 
losses, especially among smaller and regional banks.
    Doing nothing is not an option, because this looming crisis 
in commercial real estate lending could lead to an all-too-
familiar predicament where banks suffer significant losses, 
major owners of hotels and shopping centers are forced into 
bankruptcy, foreclosed properties push commercial real estate 
prices further downward, and a perfect storm of all these 
factors combine to inhibit prospects for a sustained economic 
recovery.
    In recent speeches, New York Fed President William Dudley 
and San Francisco Fed President Janet Yellen raised concern 
about the potential systemic threats due to commercial real 
estate defaults and the need to reactivate the secondary 
market, in part through the TALF--the Term Asset-Backed 
Securities Loan Facility--in the Federal Reserve.
    The Federal Reserve has announced that it will extend the 
TALF to include both new and legacy commercial mortgage-backed 
securities in hopes that the July auction will be more 
successful than the June auction, which drew no takers. The 
expansion of TALF into legacy commercial-backed securities 
could increase the supply of credit to the commercial real 
estate market, which remains frozen with no new securities 
issued in over a year.
    Additionally, further details about the Public-Private 
Investment Program are emerging, which could potentially help 
with this problem.
    I also look forward to working with the Treasury on what 
has been referred to as ``Plan C''--efforts to head off looming 
problems, such as commercial mortgage defaults, rising 
homeowner delinquencies and solvency issues at community and 
regional banks, before they cascade into a greater crisis.
    But as we evaluate proposed solutions, we must be very wary 
of potential pitfalls. For example, the TALF program is set to 
expire at the end of this year, which may cut short the 
program's effectiveness just as it begins to ramp up. Credit 
rating downgrades for CBMS could significantly limit the impact 
that the legacy TALF auctions have in providing liquidity to 
that market.
    Uncertainty about the PPIP's future has reportedly kept 
some on the sidelines, so there is some urgency to the Treasury 
providing additional clarity about that program.
    We are all watching closely to see if these measures help 
to restart the commercial real estate market, but we need to be 
ready in the event that they fall short.
    I look forward to testimony from our panel to help us find 
the keys to unlocking the commercial real estate loan market, 
and I thank all of my colleagues for coming.
    [The prepared statement of Representative Maloney appears 
in the Submissions for the Record on page 34.]
    And I recognize the ranking minority member, Senator 
Brownback.

   OPENING STATEMENT OF THE HONORABLE SAM BROWNBACK, RANKING 
              MINORITY, A U.S. SENATOR FROM KANSAS

    Senator Brownback. Thank you very much, Chairwoman, 
appreciate that. And thank you very much for holding this 
hearing.
    I think this is one of the most important issues for us to 
keep our eye on at this point in time. Clearly, it is one that 
has been brewing for some period of time. Now it is on us. And 
I think we need to look at what it is that is taking place and 
what policy issues we can address to try to make it better or 
at least not as bad as it could possibly get.
    Similar to the market for residential real estate, the CRE 
market saw significant price increases from 2005 to 2007, and 
that resulted in large numbers of commercial properties being 
purchased or refinanced at unsustainable values.
    As in the housing market, we witnessed significant price 
declines. Prices have fallen by more than 20 percent since 
peaking in late 2007, and my guess is there is still further 
downward trending taking place, and I look forward to what the 
witnesses say, what they see taking place now and what looks to 
be in the future.
    Credit markets for commercial real estate are under 
significant stress, and the market for securitized commercial 
mortgages has evaporated. This coupled with tighter lending by 
banks is particularly troublesome in light of the hundreds of 
billions of dollars worth of commercial real estate loans that 
are maturing in the near future and must be refinanced, as the 
chairman noted.
    I know that the Federal Reserve has taken steps under the 
TALF to attempt to assist these markets returning to normal 
operations, but a number of items cause me concern, and I hope 
our witnesses will be able to touch upon those issues in their 
testimony or any questions we would have.
    From a financial market's perspective, the defaults in the 
subprime mortgage market specifically in the broader 
residential market appears to have taken its toll primarily on 
large, supposedly more sophisticated, financial institutions.
    I know from my conversations with my banks back home and 
lending institutions, they didn't have much exposure to the 
subprime market. However, lending on commercial real estate is 
the bread and butter of most community and regional backs, and 
I am very interested to understand the potential threats posed 
to those institutions by current and projected market 
conditions.
    I am also interested to learn whether, under current market 
conditions, the recently completed stress test was stressful 
enough to provide a clear picture of potential risk posed by 
deteriorating conditions in the commercial real estate market.
    And I go back to my only early personal experiences of the 
early 1980s when we went through a farm crisis. We had loans 
going into a number of situations where you had 50 percent 
equity in the loan, but then the land value cut in half, and 
now, you are at a 100 percent debt in this situation, and 
unfortunately, it happened rapidly, and it put a lot of people 
in a very difficult situation very fast.
    Lastly, I am concerned that the recent actions by FASB in 
relation to qualified special purpose entities will serve to 
exacerbate already challenging market conditions. I hope that 
our witnesses will be able to discuss the potential impact of 
FASB's actions, as well as discuss how the use of PSPEs in the 
commercial market differs from the use of SIBs in the residence 
and consumer lending side of the ledger.
    Overall, I really hope the witnesses can give us an 
accurate picture of where we are today, where a reasonable 
projection is that we could be headed to in the next 6 to 12 
months and what policy issues you are most concerned about that 
we need to address to try to alleviate to the degree that we 
can further problems from happening in the commercial real 
estate market that could be caused by government action or 
inaction. So I hope you will really put your comments on a fine 
point to give us actionable items that we can follow on.
    And again, Ms. Chairwoman, I really appreciate you holding 
this hearing because I think it is very timely for what we are 
facing right now.
    Chair Maloney. Thank you. Thank you for your kind comments.
    And Mr. Hinchey is recognized for 5 minutes.

  OPENING STATEMENT OF THE HONORABLE MAURICE HINCHEY, A U.S. 
                  REPRESENTATIVE FROM NEW YORK

    Representative Hinchey. Well, just very briefly, I want to 
express my appreciation to you for being here because the 
subject that you are dealing with, of course, as has been 
mentioned, is critically important, and we respect your insight 
into this.
    The commercial real estate market now is in dire trouble. 
We are seeing a whole host of banks that have failed. I think 
the estimate is something in the neighborhood of 50 banks have 
so far failed. There is some speculation that that number is 
going to go up dramatically, that a dramatically increasing 
number of these banks is likely to fail. The huge debt of 
commercial real estate is very, very significant and roughly 
about half of what the value of the real estate market really 
is.
    So the circumstances we are facing are difficult and dire 
and need to be addressed. It is an interesting headline in the 
Financial Times this morning talking about how the 
International Monetary Fund is being optimistic about the 
global recession and how it is about to recover. Well, 
eventually it probably will, but there are a lot of things that 
need to be done I think to deal with this aspect of it, and the 
commercial aspect is critically important.
    Other things that we have to face, of course, is the 
dramatic increase in unemployment which is very, very severe, 
and it is likely to continue to increase in spite of the fact 
that a small fraction of the stimulus bill has just begun to 
get out there.
    But in any case, the issues that you are dealing with are 
critically important. We understand how critical it is. We very 
much appreciate your being here, and look very much forward to 
hearing what you are about to say, and I thank you very much.
    Chair Maloney. Thank you very much.
    And Mr. Brady for 5 minutes.

    OPENING STATEMENT OF THE HONORABLE KEVIN BRADY, A U.S. 
                   REPRESENTATIVE FROM TEXAS

    Representative Brady. Thank you, Madam Chairman, for 
hosting and holding this hearing. I want to join you in 
welcoming the witnesses before the committee.
    The spreading crisis in the commercial real estate sector 
poses a serious threat to our financial system and economic 
recovery. The good news is, Americans hate to be in a 
recession. We are naturally positive, anxious to move toward 
positive recovery.
    The problem, though, in commercial real estate, it is not 
so much a pothole in the road to economic recovery but a sink 
hole, and I think issues we need to address today include 
liquidity, include cyclically biased appraisals that tend to 
magnify value swings in the commercial real estate market. And 
I think we are seeing bank regulators who assume today that 
every commercial real estate loan is a problem loan and are 
practically pressuring local bankers, especially small- and 
medium-sized banks, to reduce their commercial real estate 
lending, even when the loans are solid and even when the local 
market conditions are favorable.
    What I have heard repeatedly from people associated with 
the commercial real estate industry is that they are unable to 
refinance outstanding mortgage loans when they mature. While 
officials here in Washington talk about the need to boost the 
economy, Federal regulators are pressuring banks to reduce 
their exposure to commercial real estate loans. The result is 
that even some profitable commercial real estate firms that 
cannot rollover their debt now face bankruptcy proceedings.
    The magnitude of this problem is huge with at least $1 
trillion of commercial real estate debt requiring refinancing 
over the next several years. Bank loans typically have maturity 
of 5 years or less. Loans on commercial mortgage-backed 
securities typically have longer ones, and these loans were 
made when credit conditions were very favorable and now have to 
be refinanced during the most serious liquidity crisis in many 
decades.
    The economic weakness resulting from the bursting of the 
credit bubble has reduced the market value of shopping centers, 
hotels and office buildings. Consumers are cutting back 
purchases, and companies are retrenching to cut coasts. High 
vacancy rates are boosting delinquency rates on commercial 
mortgage loans, and although the commercial real estate crunch 
began after the housing bubble burst, there is little doubt 
that the financial crisis has now spawned another dangerous 
threat to our prospect of economic recovery.
    Consequently, now is the time to repeal the punitive tax 
treatment of commercial real estate, including provisions 
taxing foreigners on U.S. capital gains from real estate sales. 
Congress should consider reducing the depreciation period for 
commercial real estate and reject proposed tax increases that 
will undermine the potential economic recovery.
    Another problem affecting commercial real estate relates to 
depressed appraisals of property. Obviously, low appraisals on 
property are only going to make mortgage rollovers even more 
difficult in a liquidity crisis. Although it is understandable 
that appraisals will be affected by current depressed 
conditions in the industry, perhaps there is an alternative to 
valuing a long-lived asset in the trough of a severe recession. 
If a longer period of time were used as the basis for a 
property appraisal, a more accurate view of its long-term value 
might be available.
    In conclusion, the problems in the commercial real estate 
industry are a serious threat to the economy. Congress should 
consider policies to increase financial liquidity in the 
industry and avoid policies such as tax increases that will 
only aggravate the financial and economic distress.
    I would yield back, Chairwoman.
    [The prepared statement of Representative Brady appears in 
the Submissions for the Record on page 34.]
    Chair Maloney. I thank the gentleman for his testimony.
    And I thank Congresswoman Sanchez and Congressman Campbell 
for relinquishing their opening statements in the interest of 
moving to our distinguished panel, and in the interest of time, 
since we will be called for votes, I would like to put all of 
your extremely impressive bios into the record and just 
introduce you with your current title.
    [Witness biographies appear in the Submissions for the 
Record on page 35.]
    Mr. Greenlee, the Associate Director for Risk Management in 
the Division of Banking Supervision and Regulation at the 
Federal Reserve Board of Governors.
    Also, followed by Mr. Richard Parkus. He has been global 
head of CMBS Research at Deutsche Bank Securities.
    And Mr. Jeffrey DeBoer, who is the founder and President of 
the Real Estate Roundtable.
    And also, Mr. James Helsel. He is a realtor from 
Pennsylvania who currently serves as Treasurer for the National 
Association of Realtors.
    Thank you all for coming.
    And Mr. Greenlee, you are recognized for 5 minutes. Thank 
you.

 STATEMENT OF JON D. GREENLEE, ASSOCIATE DIRECTOR, DIVISION OF 
 BANKING SUPERVISION AND REGULATION, FEDERAL RESERVE BOARD OF 
                   GOVERNORS, WASHINGTON, DC

    Mr. Greenlee. Chair Maloney, Vice Chairman Schumer, Ranking 
Members Brownback and Brady, and other members of the 
committee, I am pleased to appear today to discuss commercial 
real estate lending.
    Financial market dislocation and the continuing economic 
downturn are clearly challenging CRE markets. The pace of 
property sales has slowed dramatically since peaking in 2007, 
in large part due to accelerating job losses, declining demand 
for commercial space, and increasing vacancies.
    According to first quarter 2009 data, about 7 percent of 
commercial real estate loans almost doubled the level a year 
ago on banks' books were considered delinquent, a reflection of 
the current challenges in the CRE market. To address some of 
these challenges in the CRE markets, the Federal Reserve----
    Chair Maloney. Mr. Greenlee, could you pull your mike 
closer and speak a little louder? Some of the panelists are 
having difficulty hearing you.
    Mr. Greenlee [continuing]. I am sorry.
    To address some of the challenges in the CRE market, the 
Federal Reserve announced that, starting in June 2009, newly 
issued high quality CMBS would be eligible collateral under 
TALF, followed by an announcement on May 19th that high quality 
legacy CMBS issued before January 1, 2009, would be eligible 
collateral under TALF beginning this month.
    The provision of TALF financing for high quality issued 
CMBS is consistent with other Federal Reserve programs to 
improve credit markets and should support new lending for 
credit worthy properties.
    From a supervisory perspective, the Federal Reserve has 
been focused on CRE exposures for some time. In response to 
concerns about building CRE concentrations in the early 2000s, 
we led an interagency effort to issue guidance on CRE 
concentrations in 2006 to ensure institutions have effective 
risk management processes. As economic conditions have 
deteriorated, we have devoted more resources to assessing the 
quality of CRE portfolios at institutions with large 
concentrations, and we have also enhanced our training efforts.
    The recent Supervisory Capital Assessment Process, or SCAP, 
of 19 firms, which is more commonly known as the stress test, 
provided an important perspective on CRE exposure risk. The 
SCAP estimated that cumulative 2-year CRE losses under the 
adverse scenario would be more than 8 percent of total exposure 
with losses on construction loans significantly higher. Using 
this information, we are working with smaller firms that have 
substantial CRE exposure to ensure that their risk management 
practices are adequate and that reserves of capital can support 
increased losses.
    The Federal Reserve has longstanding policies that promote 
proven risk-management practices that support sound bank 
lending. More recently, interagency guidance in November 2008 
encouraged banks to meet the needs of credit worthy borrowers. 
Across the Federal Reserve system, we have also enhanced our 
training efforts to underscore these intentions. We are mindful 
of the potential for bankers to overshoot in their attempt to 
tighten lending standards and want them to understand it is in 
their own interests to continue making loans to credit-worthy 
borrowers.
    In summary, it will take some time for the financial 
markets to fully recover. The Federal Reserve is committed to 
working with other banking agencies and the Congress to promote 
the concurrent goals of fostering credit availability and a 
safe and sound banking system.
    Accordingly, we thank the committee for holding this 
important hearing, and I look forward to your questions.
    [The prepared statement of Jon D. Greenlee appears in the 
Submissions for the Record on page 36.]
    Chair Maloney. Thank you.
    Mr. Parkus.

 STATEMENT OF RICHARD PARKUS, HEAD OF CMBS AND ABS SYNTHETICS 
     RESEARCH, DEUTSCHE BANK SECURITIES, INC., NEW YORK, NY

    Mr. Parkus. Chair Maloney, Ranking Members Brownback and 
Brady, and other distinguished members of the committee, my 
name is Richard Parkus. I am a research analyst at Deutsche 
Bank, specializing in commercial mortgage-backed securities. It 
is a privilege for me to testify at this important meeting 
today to explore the growing problems in commercial real estate 
and the potential impact on regional and local banks.
    Before addressing my research, I must note that my views 
today are expressly my own and do not necessarily represent 
those of Deutsche Bank or any of its members.
    The commercial real estate sector is currently under 
greater stress than at any time since the crash of the early 
1990s. In fact, I believe the severity of the current downturn 
is likely to exceed, possibly by a significant magnitude, that 
of the 1990s.
    The problems are twofold.
    First, the extraordinarily severe economic downturn has 
resulted in vacancy increases and rent declines that are 
similar to what was experienced in the previous crash. This, in 
turn, has already pushed default rates to levels of those 
approaching the 1990s.
    The second problem, one that is potentially even more 
serious, is that for those loans that do reach maturity, a very 
large percentage, perhaps in excess of 65 percent, may not 
qualify for refinancing under the dramatically tighter new 
underwriting standards, particularly in view of the fact that 
commercial real estate prices have already declined by 25 to 35 
percent or more from their 2007 peak and almost surely have 
further to fall.
    In order to work through this extremely stressful process, 
it will be critically important that commercial real estate 
financing markets begin to function again with some degree of 
normalcy. By this, we mean that loans which qualify under the 
new tighter underwriting standards must be able to obtain 
financing at commercially reasonable rates.
    At the moment, this is not the case. Commercial real estate 
financing markets are largely closed, at least for loans in 
excess of $35 million to $55 million. Smaller loans on 
properties that are performing well continue to have some 
degree of success in refinancing, namely, with regional banks. 
However, this source of financing is likely to continue to 
deteriorate as problem loans in bank portfolios mount.
    One common misconception, in my view, is that commercial 
real estate problems started in the CMBS and somehow spread to 
banks and other commercial real estate finance sectors. In 
fact, we believe that banks will once again prove to be the 
epicenter of commercial real estate loan problems.
    When looking at commercial real estate exposure in banks, 
one must distinguish between three categories of loans: 
construction and development loans; core commercial real estate 
loans and multifamily loans.
    In aggregate, banks have exposure to about $550 billion in 
construction loans; about $1.1 trillion in core commercial real 
estate; and $150 billion in multifamily loans.
    By far, the most problematic of these is construction 
loans, which contain high proportions of both loans to home 
builders and condo construction loans. Furthermore, exposure to 
construction loans as a percentage of total bank assets rises 
rapidly as one moves from large money center banks to smaller 
regional and local banks. The four largest U.S. banks have an 
average exposure of less than 2 percent of total assets, while 
the 31st to 100 largest banks have an average exposure of 12 
percent.
    Given that commercial real estate prices are already down 
40 to 45 percent on stabilized commercial properties, they must 
be down vastly more than this on newly completed or only 
partially completed properties. Loss severities on defaulted 
construction loans could well exceed 80 percent.
    The 90-plus day delinquency rate for construction loans in 
bank portfolios was in the 12 percent region by the end of the 
first quarter of 2009, approximately 12 times higher than that 
for CMBS loans indicating the extreme risk in this project. 
Nevertheless, it is quite surprising that delinquency rates are 
not far higher. This is explained by the fact that construction 
loans are typically structured with reserves that are used to 
cover interest payments until the expected completion of the 
project. Thus, construction loan delinquency rates are 
currently artificially low due to interest reserves but will 
likely rise dramatically within the next 6 to 12 months.
    Losses on construction loans are likely to be in excess of 
25 percent, possibly well in excess, which would imply losses 
of at least $140 billion for banks. This, of course, would be 
disproportionately borne by regional and local banks as they 
have much higher exposures to these loans.
    In terms of core commercial real estate, the story is much 
the same, at least qualitatively. Again, exposures are much 
higher for regional and local banks than for the largest money 
center banks. The four largest banks have an average exposure 
of 3 to 4 percent for commercial real estate loans; while 
smaller regional banks have an average exposure of 15 to 20 
percent.
    In my view, commercial real estate loans in bank portfolios 
are likely to be riskier than those in fixed rate CMBS. The 
view that core commercial real estate loans in bank portfolios 
are likely to underperform those in CMBS is supported by the 
fact that delinquency rates for bank loans have for many years 
exceeded those for CMBS loans. As of the end of the first 
quarter of 2009, delinquency rates on core commercial real 
estate loans in banks was approximately two and a half times 
that of fixed rate CMBS loans.
    In terms of specific loss estimates, it is reasonable to 
assume that loss rates on core commercial real estate loans in 
bank portfolios will be at least as large as those on the 2005 
to 2007 vintage CMBS loans, which I expect will be in the 12 to 
15 percent range. This would imply losses of at least $120 
billion to $150 billion on bank core commercial real estate 
loan portfolios.
    The problems facing commercial real estate today are severe 
and will likely take many years to work through. There are no 
easy solutions. However, there are measures that can be taken 
that will help mitigate the pain and disruption of this 
process. By far, the most important of these are steps that 
promote the recovery of commercial real estate financing 
markets. These should focus on reviving the public 
securitization market.
    We expect that over the coming 3 to 5 years, the amount of 
capital from traditional sources, e.g. banks, insurance 
companies, pension funds, committed to financing commercial 
real estate will decline significantly. It is absolutely 
critical that a revitalized CMBS market be able to step in and 
help fill the void.
    The CMBS market worked effectively and efficiently for well 
over a decade providing critical pricing information and 
tremendous transparency to the market. With the right changes 
and modifications, it is capable of playing a vital role again 
in the future.
    I thank you for your time and am happy to take questions 
that you may have.
    [The prepared statement of Richard Parkus appears in the 
Submissions for the Record on page 40.]
    [Deutsche Bank research report ``The Future Refinancing 
Crisis in Commercial Real Estate'' appears in the Submissions 
for the Record on page 42.]
    [Deutsche Bank research report ``TALF for New Issue CMBS: 
Fed Releases Terms'' appears in the Submissions for the Record 
on page 66.]
    [Deutsche Bank research report ``TALF for Legacy CMBS: Fed 
Releases Terms'' appears in the Submissions for the Record on 
page 74.]
    [Deutsche Bank research report ``The Future Refinancing 
Crisis in Commercial Real Estate. Part II: Extensions and 
Refinements'' appears in the Submissions for the Record on page 
86.]
    Chair Maloney. Thank you.
    Mr. DeBoer.

 STATEMENT OF JEFFREY D. DeBOER, PRESIDENT AND CHIEF EXECUTIVE 
      OFFICER, THE REAL ESTATE ROUNDTABLE, WASHINGTON, DC

    Mr. DeBoer. Good morning. My name is Jeff DeBoer. I am 
president and CEO of The Real Estate Roundtable. Thank you for 
the opportunity to testify here this morning.
    I want to commend you, Madam Chairwoman and members of the 
committee, for holding this hearing, for sounding the alarm 
about the ongoing commercial real estate financing problems and 
the dangers that it poses to the economy. I also want to 
commend you for helping to lay the foundation for policy 
actions that are much needed to address this increasingly 
troublesome situation.
    The bottom line is this: The current financial system in 
America simply cannot meet the financing demands of the 
commercial real estate marketplace. Today, even well-
positioned, strong assets which have good debt coverage find it 
very difficult, if not impossible, to find financing. This is 
true for all types of assets, and it is true all across 
America.
    With very limited capacity to meet the ongoing demand for 
credit, there is an increasing concern in our industry about a 
potential wave of maturity defaults. This fact, coupled with 
what has already been discussed about net operating income 
having dropped substantially, has caused commercial property 
values to plunge. Most estimate across the board drops in 
commercial real estate at somewhere between 25 and 35 percent. 
Mr. Parkus just gave a larger number. In any event, it is 
serious.
    In fact, the number of distressed commercial properties in 
the Nation has more than doubled in the past year and is 
expected to continue to rise. Maturity defaults, caused by the 
inability to refinance, and the distressed properties, caused 
by the weak economic conditions, are resulting in an incredibly 
stressed commercial real estate marketplace.
    Some might ask, why should we care? I will leave to others 
to discuss the potential impact on the financial institutions 
and systems in general, but let me offer a couple of other 
quick reasons.
    We should all care because a sick commercial real estate 
market reduces revenues for local governments. People are 
sometimes surprised to learn that about 50 percent of local 
revenues come from local property taxes, recording fees and 
transaction taxes. These fund education, road construction, law 
enforcement, energy planning and other things that we all like 
to have in our communities.
    Further, a sick commercial real estate marketplace means 
fewer transactions. Commercial property transactions on a year-
over-year basis are down about 80 percent. This means fewer 
jobs. It means fewer construction jobs. It means fewer 
retrofitting jobs, and it means fewer opportunities for 
building owners to become more energy efficient and create 
green jobs. And importantly, we should care because a growing 
number of Americans invest in real estate through their pension 
and retirement plans. About $160 billion today is in it.
    So, as real estate goes, so go local budgets, so go jobs 
and so go retirement accounts. In my written statement, I 
detail a policy mix that we believe policymakers on and off the 
Hill should look at.
    First, we favor the TALF, but it must be given time to 
work. It only became operative for commercial real estate in 
mid June; yet it is scheduled to expire at year end. We need 
this announcement soon that the TALF will be extended into the 
end of 2010.
    Second, we need a new program to incentivize new lending. 
Without it, we don't think new lending will start. We think 
that a privately funded--and my testimony offers a couple of 
ideas. We think one might be to explore a privately funded 
insurance program for securities backed by new loans similar to 
the FDIC program that now exists, or alternatively, a public-
private financing vehicle similar to the PPIP that now is 
operative to buy legacy assets. It could be put in place to 
purchase new loans.
    Third, banks need to be encouraged, not discouraged, from 
extending performing loans. We have a proposal at the Treasury 
Department now that would provide greater guidance to the 
process of restructuring loans that have been securitized in a 
REMIC format.
    Fourth, there is a huge need--and Senator Brownback 
mentioned it in the agriculture situation--a huge need for 
equity infusion. We estimate this in our testimony to be about 
$1 trillion shortfall in equity across America. We think one 
way to get this is to reform the laws applicable to foreign 
investment in U.S. real property. Congressman Brady mentioned 
that, appreciate that. The current law is called FIRPTA. It is 
badly outdated, and it discriminates against investment in real 
estate. Simple reforms could be done that would bring more 
robust investment without turning control over to foreigners.
    And finally, I would conclude by saying, now is certainly 
not the time for tax increases on real estate ownership. In 
particular, the carried interest proposal that seems to rear 
its head every few years is particularly a bad idea now given 
the state of the markets. This would seriously increase taxes 
on general partners in real estate partnerships, large and 
small, and all property types. We would urge that Congress 
reject that.
    Thank you again for the opportunity to be here. It is a 
very important hearing, and I look forward to your questions, 
and hope I can answer them. Thank you.
    [The prepared statement of Jeffrey D. DeBoer appears in the 
Submissions for the Record on page 117.]
    Chair Maloney. Thank you.
    Mr. Helsel.

 STATEMENT OF JAMES HELSEL, PARTNER, RSR REALTORS, HARRISBURG, 
     PA, AND TREASURER, NATIONAL ASSOCIATION OF REALTORS, 
                         WASHINGTON, DC

    Mr. Helsel. Thank you.
    Chairwoman Maloney, Vice Chairman Schumer, Ranking Members 
Brady and Brownback, and members of the Joint Economic 
Committee, thank you for inviting me to testify on the crisis 
facing the commercial real estate markets. My name is Jim 
Helsel. I am the 2009 Association of Realtors treasurer.
    I have been a realtor specializing in the commercial sector 
for more than 34 years. Currently I am a partner with RSR 
Realtors, a full service real estate company in Harrisburg, 
Pennsylvania. I testify today on behalf of 1.2 million Realtors 
who are involved in all aspects of the real estate industry.
    Having a sound and well functioning commercial and 
multifamily real estate sector is critical to our country's 
economic growth and development and to millions of U.S. 
businesses of all sizes that provide local communities with 
jobs and services.
    Many of us in the commercial real estate business have been 
warning for some time that the liquidity crisis facing our 
industry has the potential to wreak havoc on the overall 
economy. In fact, an apt description for this situation is that 
commercial real estate is the next shoe to drop.
    A crisis is looming in the commercial real estate market 
due to a confluence of issues, including deteriorating property 
fundamentals, declining property values and a severe tightening 
of the lending markets.
    Banks remain reluctant to extend loans, and the commercial 
mortgage-backed securities markets, or CMBS, which have been a 
key source of liquidity, have ceased to function. At the same 
time, hundreds of billions of dollars of commercial real estate 
loans from a variety of sources are expected to mature in 2009 
and over $1 trillion by 2012.
    Under current conditions, there is an insufficient credit 
capacity to refinance a huge wave of loan maturities. Without 
greater liquidity, we face a threat of rising delinquencies and 
foreclosures.
    The biggest challenge in this environment is the inability 
to complete transactions due to the severe lack of liquidity in 
the markets. Underscoring this fact, a full 44 percent of our 
members reported financing as the most significant current 
challenge in recent real estate and realtor market history.
    On a personal note, I would just tell you this is a very 
interesting time for this hearing. I am in the process of 
refinancing a very small property of my own, about 10,000 
square feet. When I purchased the property in 1999 the loan-to-
value ratio I had was 60 equity, 40 percent loan. Today, I am 
lucky if it is still at that number. At one time it was 80 
percent equity, 20 percent loan. I have gone to three banks. I 
am frankly going to a credit union right now who is going to 
refinance the property. Three banks--it is a performing asset, 
it has been a performing loan. I have never missed a payment. 
The property has positive cash flow. It tells you the position 
that most of our members are in, as myself as a member. So, on 
a personal note, kind of tells you where our marketplace is 
right now.
    The overall economic downturn has taken a toll on the 
commercial market. As demand for space has dropped, vacancies 
have risen across all sectors, and investment activity has 
slowed down considerably. During the first quarter of 2009, 
nationwide only 607 major properties exchanged hands for a 
total volume of $9.5 billion. This figure represents a 51 
percent drop in investment activity compared to the fourth 
quarter of 2008.
    The troublesome market fundamentals are taking a toll on 
property values. Declining property values only further 
exacerbate the difficulty in securing financing. We see this 
reflected in the fact that the volume of distressed commercial 
properties more than doubled this year alone.
    Geographically, as Madam Chairman indicated, New York 
represents the largest problem, Manhattan possessing nearly $8 
billion distressed commercial properties. We support the 
development and implementation of innovative programs, such as 
the Term Asset-Backed Lending Facility, what we commonly call 
TALF, and the PPIP program, the Public-Private Investment 
Program.
    And we strongly support recent efforts to strengthen the 
TALF program, including expanding TALF to include CMBS as 
eligible collateral while also extending TALF loans to 5 years. 
However, this important program is set to expire, as Mr. DeBoer 
mentioned earlier, at the end of this year. We believe it is 
absolutely essential that the TALF program be extended for 
another year. This move will ensure that important economic 
recovery efforts continue.
    In addition, NAR believes it is essential to protect and 
promote policies that support securitized credit markets. This 
will include action on the part of accounting policymakers.
    With respect to the issue of mark-to-market accounting, NAR 
believes that the ability to value assets in inactive markets 
continues to be a serious issue. Under current conditions, 
clear policy guidance is needed to encourage reporting entities 
and auditors to look at alternative and appropriate methods of 
asset valuation, such as the discounted cash-flow method.
    Finally, NAR will continue to support and promote Federal 
tax policies that strengthen and support commercial real 
estate. The commercial real estate market is in a state of 
crisis and remains vulnerable to any modifications to current 
tax rules that would result in reduced property values or 
investment. NAR stands ready to oppose any such modifications 
and would urge policymakers to do the same.
    In conclusion, I would say that, on behalf of the 1.2 
million realtors that I represent today, I want to thank you 
for this opportunity to give this presentation. NAR stands 
ready to help Congress, the financial regulators and the 
administration in any way possible to find solutions to 
stabilize and ensure strong recovery of the real estate 
markets.
    Thank you very much for this time.
    [The prepared statement of James Helsel appears in the 
Submissions for the Record on page 132.]
    Chair Maloney. I thank all the panelists for your 
testimony, and regretfully, we have been called for a series of 
votes. So I am going to place this hearing in recess subject to 
the questions of Senator Brownback, who will then be called for 
votes, too.
    So we are wanted on the floor. Please excuse us, and after 
his questioning, we will be in recess and back as quickly as we 
can. Thank you very much.
    Senator Brownback. I want to thank the chairwoman for doing 
that, and I promise I won't do a coup here.
    Chair Maloney. Helping the economy is a bipartisan effort.
    Senator Brownback. There you go.
    Thank you very much. I think it is an excellent panel. 
Although you have put me in quite bit of distress from what I 
hear you say.
    Mr. Helsel, I wanted to start with you. You say a 51 
percent drop in investment activity the first quarter of this 
year. Is that correct? Am I getting your number right?
    Mr. Helsel. What I said was that 50 percent--there is a 50 
percent reduction over the fourth quarter of 2008 activity and 
the first quarter of 2009. I think I am answering your 
question. Yes, to answer your question.
    Senator Brownback. So we are seeing half the commercial 
real estate activity the first quarter this year of what we did 
the last quarter of last year?
    Mr. Helsel. And that was based on--and I am going to go 
back to my testimony--607 of the larger transactions done in 
the United States.
    Senator Brownback. I guess what I am asking is, I have been 
in one of these before where you can't get a price for anything 
because there is just nobody out there buying. And so we are 
talking about a drop in 25 percent in commercial real estate, I 
used the term; Mr. Parkus used 35 to 45, but the actual truth 
of the matter is nobody is buying.
    Mr. Helsel. That is correct.
    Senator Brownback. So there is just not much of a market 
that you can establish at this point in time, or are some 
properties moving but just at a very distressed----
    Mr. Helsel. Mr. Brownback, there are properties that are 
moving. The problem is, if I find a buyer, I can't find the 
financing.
    Senator Brownback. So even at that 50 percent equity, you 
were giving an example of, you think you have got a property 
you have 60 percent equity in it, and you are not getting 
financing for it?
    Mr. Helsel. I thought I had one that had 80 percent equity 
in it that I own, and I am down now to probably about 50, 60 
percent equity. I have gone to three banks. It is a performing 
asset. It is a performing loan. We have never missed a payment. 
It is a positive cash flow, and the banks are saying, you know 
what, we are just not lending right now.
    Senator Brownback. At any rate----
    Mr. Helsel. At any rate, and if they do, the lending rates 
both in terms of interest and time are so severe that it makes 
the property almost become a nonperforming asset.
    Senator Brownback. Mr. Parkus, you studied the overall 
numbers on this. What is--we just don't have it? There is just 
not a market there right now?
    Mr. Parkus. There are very, very, very few transactions 
taking place at the moment.
    Senator Brownback. Give me a number on that, can you?
    Mr. Parkus. I can't give you an absolute number, but I can 
tell you that percentage-wise the number of commercial real 
estate transactions has dropped by roughly 95 percent or more.
    Senator Brownback. From last year or from normal?
    Mr. Parkus. Over the last 18 months.
    Senator Brownback. Over the last 18 months, you have had a 
95 percent drop?
    Mr. Parkus. That is right.
    Senator Brownback. So the only thing that is selling is 
something at a real fire sale or distressed, somebody just 
dumping on the market?
    Mr. Parkus. That is right.
    What we are seeing today and use as a gauge for price 
declines to the extent that we can are distressed assets like 
the office buildings that we have recently sold in New York for 
roughly one-third of their value over--a decline of one-third--
I am sorry, a decline of two-thirds in their value over the 
past 24 months. So those are the magnitudes for the distressed 
side.
    Our best guess is that prices pretty much overall across 
property types, across markets, are down 35 to 45 percent. Many 
markets will see prices like New York office will see prices 
down potentially well in excess of 50 percent by the end.
    Senator Brownback. Now, my experience again on these 
things, everybody is bottom feeding, if you will, on these, 
that once a bottom is found, the price jumps 20 percent just 
because a lot of people are waiting, sitting on the sideline, 
and if I can get a good deal out of this, I will do it, but I 
am not getting in while the thing is still going down. And when 
the bottom is found--I am pulling that number a bit out of the 
air but not that much. You find a bottom, it bounces back 20 
percent. But we are nowhere finding the bottom yet?
    Mr. Parkus. We don't believe the bottom--I should say we 
believe the bottom is several years away.
    Senator Brownback. Several years away?
    Mr. Parkus. Several years away.
    Senator Brownback. That was going to be my next question. 
If the Fed Chairman is right that we start to--we have had this 
real precipitous fall off in economic activity where we are 
going to start to see a less slow fall off and then a weak 
uptick first part of next year, do you know any factors as to 
what the length of time is before the commercial real estate 
market recovers once the economy starts to flatten out and pick 
back up?
    Mr. Parkus. Typically, commercial real estate fundamentals 
begin to pick up 12 to 18 months after unemployment begins to 
pick up.
    Senator Brownback. After unemployment? Unemployment lags 
the economic activity?
    Mr. Parkus. That is right. So you are typically pegged to 
sort of unemployment.
    Senator Brownback. All right. So unemployment is not 
projected presently to pick up until middle part of next year, 
I don't think.
    Mr. Parkus. I would say at the earliest, that is right.
    Senator Brownback. So you are looking at a year after the 
middle of 2010.
    Mr. Parkus. Before we expect to see palpable improvements.
    Senator Brownback. So we are in the middle of 2011 before 
you would project an improvement in commercial real estate 
markets based on historical----
    Mr. Parkus. I would say beyond that.
    Senator Brownback. What is that?
    Mr. Parkus. I would say beyond that, 2012, and the problem 
is that there will be, we are expecting to see--it is hard to 
imagine fundamentals improving in an environment where we are 
likely to see or beginning to see and already seeing massive 
increases in defaults occurring now. Commercial real estate is 
really, it is kind of between a rock and a hard place. The rock 
is the very, very real quick pick-up in current defaults, where 
buildings that are under severe cash flow constraints simply 
cannot meet their current mortgage payments. This is happening 
right now and at an alarming rate.
    Then you look down the road, somewhere between three to 7 
years, and you find at the maturity of these assets potentially 
even greater problems with assets failing to qualify to 
refinance. So there are problems at both ends, and in that kind 
of environment, it is difficult to have--it is certainly 
difficult to have valuation growth.
    Senator Brownback. Mr. DeBoer--I appreciate, Mr. Parkus, 
your assessment. That is one of the more bearish ones I have 
heard in this climate, but I am not discounting it.
    But, Mr. DeBoer, do you agree generally with his assessment 
from your industry's perspective?
    Mr. DeBoer. Absolutely. First----
    Senator Brownback. 2012 or----
    Mr. DeBoer [continuing]. Well, it depends on what you are 
asking is going to happen in 2012. I guess I would start off by 
saying, both of these problems that the industry is facing, the 
fundamentals in the overall economy, meaning net operating 
incomes--if you own office buildings, people are not extending 
their office leases. They are not committing for more office 
space. If you are in the mall business, people aren't shopping. 
Retailers are having difficulties. If you are a hotel owner, 
business and personal travel is down. So net operating income 
across the board is down, and that is pushing values down, and 
that is not going to turn around.
    And I think Mr. Parkus has hit it correctly in terms of, it 
is not going to turn around until employment settles and starts 
to rise. And it is not going to turn around until consumers and 
businesses feel like spending money again, and so we are a 
lagging indicator in terms of the fundamentals of the asset.
    On top of that, we have this financial crisis where the box 
that is left standing, in terms of the financing system, is too 
small to fit the items that we need to put in the box, meaning 
all of this debt that is coming due. And so there is a lot of 
tension from that, and we don't see that clearing up anytime 
soon.
    So, yeah, I am unhappy to associate myself with Mr. Parkus' 
bearish comments, but I don't think there is any other way to 
look at it.
    Senator Brownback [continuing]. But I am just trying to 
track this timeline. If we are saying an economic recovery 
happens, things bottom out the end of this year, start to pick 
up very slowly next year, unemployment usually doesn't start 
following that for a year normally. Then a year, a year after 
that, we are already 2 and a half years out from where we are 
today.
    Mr. DeBoer. Yes, and so then if you want to----
    Senator Brownback. And you agree with that?
    Mr. DeBoer [continuing]. Yes, certainly. If your metric is 
valuation in terms of comparing the peak of values, which were 
let's say 2007 for commercial real estate, when will those 
values be back up at that level? I think that Mr. Parkus and 
others on the panel would agree it will be many years.
    Senator Brownback. Yeah, that is--let's talk about policy 
proposals here.
    Several of you have talked about the TALF for commercial 
real estate needing to be extended and done quickly to try to 
help that market. I think that is an agreement that most people 
on the panel have.
    And then programs to incentivize I found interesting to try 
to get more capital. We need to get more equity infusion into 
the system. Some of the foreign investment rules that you were 
citing to, Mr. DeBoer, that apparently are hurting from being 
able to get those in.
    Those are the--and then I think, Mr. Parkus, you also 
talked about getting a securitization market for commercial 
real estate going again. Is that by use of the TALF or how?
    Mr. Parkus. It would be by I think making some refinements 
to TALF through the use of the PPIP program. There are a number 
of different alternative suggestions to raise in which 
securitization can be modified, different paradigms, if you 
will, that are out there. And some of those paradigms, the 
government, some of those paradigms envision government at 
least in the early stage as partner. There are a number of 
different possibilities on the table.
    But I think the critical thing is, is that, as this 
incredibly stressful process unfolds, we must have a financing 
market out there. There will be an overwhelming number of loans 
that default over the next 5 years. Those loans have to be able 
to be foreclosed upon and sold. You can't sell a loan, you 
can't foreclose a loan and sell it unless there is somebody out 
there who can finance it somewhere. And until these issues are 
dealt with, the problems will remain in commercial real estate. 
There is no waiting this out. It has to be dealt with.
    Senator Brownback. In looking at past commercial real 
estate difficulties, you cited to the early 1990s, Mr. Parkus. 
Can we learn anything from past difficulties on policy moves 
that we should or should not make that can either make this 
easier or exacerbate it? And I open that up to anybody on the 
panel.
    Mr. Helsel. I will speak to it just quickly. I would say 
that the 1986 and early 1990s tax policies that changed real 
estate and created the problems that we had during that time 
have to be looked at again, and we have to make sure we don't 
do those things again.
    Senator Brownback. What specific----
    Mr. Helsel. Things that affect passive loss, capital gains, 
depreciation, things like that, that automatically stop or do 
not incentivize investment in real estate, hurt us terribly 
back then.
    Senator Brownback [continuing]. So any of those that we can 
change to make it easier and make it more value on 
depreciation, or any of these investments, would be helpful?
    Mr. Helsel. If we don't decrease the length of time for 
depreciation, if we increase the capital gains tax so that the 
capital gains tax that somebody who is involved in real estate 
pays exceeds what anybody else does for any other form of 
investment in the United States or if we change it so that the 
capital gains tax goes up, it stops people from buying. It 
stops people from selling because they can't afford to sell 
because they pay too much in taxes.
    Senator Brownback. I sure want to invite you or any of your 
industry associations to come up with specific proposals to put 
forward because certainly my office would be interested in 
putting them forward. Whether we get them through or not, I 
think if we people are talking about looking at a second 
stimulus package, the one we have got to do this time, if we do 
something, is to stimulate the economy, not to stimulate the 
government.
    And these are the sort of things that I think we ought to 
be looking at anyway, that you try to give more incentivization 
or incentivizing the marketplace to work and to get people's 
capital out here and in the system rather than taking it away. 
But please feel free to put forward those, and I hope you will.
    Mr. Helsel. We will.
    Senator Brownback. In the overall.
    Any other historical lessons?
    Mr. DeBoer. I think one positive that came out of the last 
real estate debacle in the early 1990s was the move on both 
debt and equity to a more public, more transparent world. And 
part of what I think Mr. Parkus is talking about is we need to 
not be afraid to get a securitization market going again. It 
has to be a new securitization market that has stronger 
underwriting features, has more equity involved and so forth, 
but securitization in and of itself has to be part of the 
solution. The TALF will be helpful, but it is not a panacea. 
The PPIP will be helpful.
    Some of these other ideas, for example, I put out this 
notion that we might have a federally chartered insurance 
program that is financed by private issuers and users of 
securitization models. That would ensure a securitization 
product that would then go out and be attractive or more 
attractive to investors.
    So I just want to throw this out that in 1992, 1993, one of 
the things that really helped the commercial real estate 
industry and the overall economy get over the problems it then 
faced was the expansion of both debt and equity in the public 
or at least spreading of activities. Again, the system we have 
now is too small to absorb what needs to go in it. It simply 
won't work the way it is.
    Senator Brownback. It is interesting, too small of a 
capital pool to absorb the problem that you are in?
    Mr. DeBoer. Yes. Well, keep in mind, if you turn the clock 
back, seven of the more significant providers of capital to the 
commercial real estate market no longer exist in terms of large 
financial institutions that have either been merged out of 
existence or have simply gone out of existence. They are gone.
    On top of that, the securities market that was providing 
roughly $200-plus billion a year to this marketplace last year 
did 12 and this year did zero and is expected to do zero. And 
so when you just take all of those players off the field, those 
that are left are not--they don't have the capacity to meet the 
very legitimate demand. Even at more sustainable loan-to-value 
levels, at more equity infusions, it is just not going to 
happen.
    Senator Brownback. Mr. Greenlee, you have a comment on 
this?
    Mr. Greenlee. I would agree that if you look back at 
history, the previous cycle in 1990, 1991, the tax law change 
was a key driver, and clearly the introduction of the capital 
markets for commercial real estate properties provided a lot of 
liquidity and additional capital into the system.
    You know, looking at the banks, I mean, they roughly hold 
half of all outstanding CRE debt at the present time, and of 
those banks that we looked at in the stress test process, they 
hold roughly around $600 billion in commercial real estate 
loans with the total market being $3.5 trillion.
    You know, in terms of what we learned from the 1990, 1991 
experience is, again, we put in a place, a number of 
regulations were put in place around appraisals, real estate 
lending standards, and we have also tried to, as I mentioned in 
my testimony, work with our examiners in terms of taking a 
balanced approach to how we evaluate banks' loan portfolios in 
terms of making sure there is proper risk identification by the 
bank and based on real estate market values and realistic 
assumptions and not to go to too far in terms of taking too 
Draconian of a view.
    Senator Brownback. Just an excellent panel.
    Mr. Parkus, in conclusion, I just want to, what number are 
you pegging for a loss in value when we hit the bottom of this 
commercial real estate trough? You were saying we were falling 
off 35 to 45 percent I believe from the values that were at the 
peak. Do you project a bottom on the trough?
    Mr. Parkus. Right. I would think that 40 to 45 percent on 
average, but that will be more severe in certain MSAs, certain 
cities, locations and property types. In particular, the assets 
that depreciated the most during the run up, for example, New 
York office, I would expect to be down potentially 
significantly more.
    Senator Brownback. What about retail space, big boxes?
    Mr. Parkus. Very badly hit. Very badly hit. I think much of 
that----
    Senator Brownback. What are you projecting on those?
    Mr. Parkus [continuing]. About 45 percent.
    Senator Brownback. But at the bottom of the trough?
    Mr. Parkus. At the bottom.
    Senator Brownback. And that is not far, so if you are going 
to have any that if they are going to be moving----
    Mr. Parkus. Fire-sale prices are--I would prefer not to 
mention today. They are down 60 to 70 percent.
    Senator Brownback [continuing]. Today?
    Mr. Parkus. Fire-sale prices on distressed assets. As we 
were saying, these office towers in New York that are being 
sold under sort of unfortunate circumstances, some of them have 
vacancy issues. You know, any office building with a vacancy 
issue today is in a lot of trouble.
    Senator Brownback. Well, gentlemen, thank you very much for 
the information. Again, I invite you on the policy proposals to 
get them forward because they would be ones I would be 
interested in putting forward so we can get some view on it. I 
think, on these things, what we have got to do is try to 
stimulate money back into the marketplace. That is what I see 
our role as trying to do is help you get money back into the 
marketplace. It isn't going to change the basic fundamentals of 
the overall situation, but it can help get a market to function 
again and hopefully help fund some of the severity.
    As the Chairperson noted, this hearing will go into recess 
at this point in time. I know the other members will be back 
subject to however--I am being told about 45 minutes to an 
hour. So we will be in recess for that period of time subject 
to call of the Chair. Thank you very much for being here.
    [Whereupon, the Committee recessed, to reconvene at 12:45 
p.m.]
    Chair Maloney. My apologies to the witnesses. We had quite 
a series of votes. Thank you for being here. We are back in 
session, and we have to be out of this room very shortly.
    So I really would like to ask any of the panelists about 
systemic risks, and what are the risks about doing nothing in 
the commercial real estate sector? Are there concentrations of 
loans and securities and important banks or financial 
institutions that might cause a shock to the fragile financial 
sector, as the Lehman Brothers failure did?
    I would just like two of you to respond because we have to 
move on to other questions. I have quite a series, and as I 
said, we don't have much time in the room. Is it systemic risk? 
Is it going to be a shock to our fragile financial sector?
    Mr. Helsel.
    Mr. Helsel. Yes is the short answer to your question. It is 
systemic, I believe. I think doing nothing, which was one of 
your options, will only increase the problems that already 
exist, exacerbate them. I think that if nothing happens, if we 
don't move, we being both Congress and the GSEs and everyone 
else involved in this process, if we don't move in a manner 
that will begin to shore up what right now is a financial 
crisis in terms of even the simple availability of funds for 
financing, I think you will find that the problem will be 
considerably worse.
    Chair Maloney. I would like to specifically hear from the 
Federal Reserve since their goal is safety and soundness. Do 
you see this as a possible shock to the fragile financial 
sector? Do you see it as a systemic risk, Mr. Greenlee?
    Mr. Greenlee. Yes. If you look at the exposure on banks' 
balance sheets from commercial real estate, it is roughly half 
of the total outstanding commercial real estate. It is about 
$1.8 trillion. We have been focused on this naturally as an 
asset class and as an issue for many years and have worked hard 
to try to expand our information around the markets and, you 
know, try to share that across the system.
    In the SCAP process, where we did the stress test, we 
looked specifically at the commercial real estate exposures, 
and we looked at the loss rates of about 8 percent for the CRE 
portfolios of the 19 largest domestic banking organizations to, 
under a stress scenario, to make sure they have enough capital 
in reserves to, you know, absorb those losses and remain as 
viable entities. So we have put a lot of effort into looking at 
how this plays out.
    Coming out of the SCAP process, we are taking those lessons 
and those observations and are actively working now to look at 
how that would play out.
    Chair Maloney. Do you see it as systemic risk?
    Mr. Greenlee. We view it as a very key risk in the banking 
sector, and we have put a lot of emphasis on it.
    Chair Maloney. I would like to ask a question about 
regional effects, and Mr. DeBoer probably on this one. Is it 
hitting states and large cities like New York equally, or is 
there a disproportionate share of losses in some areas? I think 
Mr. Helsel testified that there was $8 billion that could be 
lost in Manhattan alone. I believe that was your testimony. If 
we are not--if individuals or companies are not able to obtain 
the financing to roll over their expiring loans, what will the 
effect be across the country? Will it be even across the 
country? Are there certain areas that will be more impacted?
    Mr. DeBoer. Right. Well, first of all, in my opening 
statement, I said that the problems that we are seeing on 
refinancing are pretty consistent across the country and pretty 
consistent across asset type. So it really doesn't matter if 
you have an office building or a shopping mall or a hotel, and 
it really doesn't matter that much where you are in the 
country. It is very, very difficult to get financing.
    Having said that, certainly regions of the country that are 
harder hit by the employment problems are going to have more 
difficulties in the fundamentals of real estate to begin with. 
So there will be some regional disparity, but the basic problem 
of finance runs across the board.
    Chair Maloney. Okay. This question is for the Federal 
Reserve. Many people have testified, several in the group here, 
that we need to extend the TALF program that just went into 
effect in June. Can we extend it? What is involved in extending 
it? And are there other steps that the Fed could take to modify 
the TALF program that will address the lack of financing in the 
commercial real estate sector?
    What I find so troubling was the testimony that people can 
make their payments, but no one will refinance them. So, 
therefore, you are going to have a default or a bankruptcy that 
is going to close a viable business, board it up, lose jobs and 
roll the economy backwards. Are there other things that we 
could do, such as extend the TALF program, modify it, or have a 
blanket statement that possibly, in this case, commercial real 
estate loans could have another year before they become due so 
that we could work on changing the laws to address these 
issues.
    My time is up--but, I would just like to ask any of the 
panelists to talk about ways that we can address this to stop 
what would be a devastating blow to the overall economy. Also, 
what percentage of our economy is real estate, would you say?
    Mr. DeBoer. Well, I will take a crack at the percentage 
because it is in our statement. On a revenue basis, commercial 
real estate is measured around 13 percent of GDP, commercial 
real estate. Now, if you throw in single family, it may get a 
little higher and there are different ways to measure the 
relative percent per GDP. We have done it on revenue basis, and 
it is 13 percent. So reasonably significant.
    Chair Maloney. So it is huge. Solutions, Mr. Greenlee? What 
is involved in getting the TALF program extended? You have 
heard it from many of the panelists today. Do you need a bill 
from Congress to extend it? What do you need to extend it? Will 
you be extending it, and what are the other ways the Fed could 
modify the TALF program or address the financing of commercial 
real estate?
    Mr. Greenlee. So the TALF program was originally created to 
ease some of these pressures in the marketplace, particularly 
on the CMBS. As you noted, it has just gone into effect in June 
for the new CMBS, and July will be the first round for the 
legacy CMBS assets.
    The TALF was created and improved by the Board of Governors 
under 13(3) of the Federal Reserve Act where loans can be 
extended under unusual and exigent circumstances. So to extend 
the TALF would require the Board to make a finding and vote to 
approve to extend that.
    Chair Maloney. Okay. And other ways that we could modify or 
help alleviate this problem? Do you have any other ideas?
    And then I would like to hear from Mr. Parkus, Mr. DeBoer 
and Mr. Helsel.
    Mr. Greenlee. We look at and we have had discussions with 
various industry groups and look at the issues and how we can, 
you know, address the challenges in the financial markets. We 
have rolled out a number of these programs. We periodically 
look at how they are working and consider--the Board would 
consider how they might want to modify to address specific 
issues that come up.
    Chair Maloney. Mr. Parkus.
    Mr. Parkus. Thank you. Chairman Maloney, there is one thing 
that comes to mind in terms of the current way the TALF renew 
issue operates, and I think, I guess from my perspective, I am 
mainly interested in starting--restarting markets and, 
therefore, mainly interested in TALF renew issue.
    Right now, one of the problems in getting borrowers to step 
up to TALF has to do with the cost of borrowing. The cost of 
borrowing today under TALF turns out to be roughly 8.5 to 10.5 
or 8.5 to 10 percent mortgage rates, which is quite high. In 
order to get borrowers to sort of step up and be interested, I 
think that we need to offer floating rate loans as well as 
fixed rate loans. That would allow us with some additional 
details to I believe lower the cost of borrowing, potentially 
significantly, to borrowers and potentially bring in 
significantly more interest.
    Chair Maloney. Good idea.
    Mr. DeBoer.
    Mr. DeBoer. I think what was just mentioned on the TALF is 
right on in terms of not just fixed rate but also floating.
    There is also this issue out there about downgrading of 
earlier issued or rated triple-As that are no longer triple-As, 
and I think that, obviously, given what is happening in the 
marketplace, downgrades are probably appropriate. I am not 
criticizing the downgrades, but I am saying that maybe the 
program should be flexible enough to adapt to the new market 
that we are seeing here to make the program work as well.
    I also want to reiterate what Mr. Parkus just said. The 
main focus here needs to be on new lending, new issuance going 
forward, new securitization, new lending, bringing new equity. 
We need to turn the page and get the market back working again.
    Chair Maloney. I agree with you, Mr. DeBoer, not only for 
commercial real estate but for our economy as a whole. We need 
to get liquidity and lending out there. I find it shocking that 
some of the most respected and successful businessmen and women 
from the district that I am honored to represent tell me they 
can't get loans. They have been in business their whole lives. 
They have never missed a payment. They have always paid on 
time, and yet the liquidity's not there.
    I had a major captain of industry suggest to me that maybe 
we should start a bank in the Fed. I almost fell out of my 
chair. But if they can't get loans from the private sector, 
maybe some money should be put at the Federal Reserve where 
they can get a loan.
    So the main question is, how do we get the liquidity out 
there and the money into the system, because it is not there. 
It is not there for commercial real estate, probably more 
pinched than others in other areas, but the liquidity is not 
there.
    Maybe we need some hearings on that, Mr. Brady, on the 
crucial issue of the lack of liquidity in the economy?
    Mr. Helsel.
    Mr. Helsel. Good afternoon. I agree with what Mr. DeBoer 
and Mr. Parkus both said.
    I would add one other thing that maybe makes it clear a 
little bit, and that is, I would say we supported expanding the 
TALF to include commercial mortgage-backed securities and also 
extending TALF loans to 5 years. But, right now, as we know, 
the program dies at the end of this year. I would want to make 
sure it is extended. So that if we can collateralize the use of 
mortgage-backed securities, that would help a lot as well.
    Chair Maloney. That is a very good suggestion.
    Mr. Greenlee, what is the degree of probability of 
expanding it for mortgage-backed securities and extending it 
for 5 years?
    Mr. Greenlee. It is an issue that is being looked at right 
now in terms of broader asset classes, as we have started the 
TALF with student loans and auto loans and those types of 
things. We have introduced CMBS.
    Chair Maloney. Certainly the commercial loans are far 
larger and a greater threat to the economy, should there be a 
default, than the other categories. Wouldn't you say?
    Mr. Greenlee. Well, I think that is something we have been 
trying to address through introducing the new CMBS and the 
legacy CMBS TALF.
    Chair Maloney. Well, I hope you will take these 
recommendations back to your board.
    My time has expired, and I recognize Mr. Brady for 8 
minutes. Because I took 8 minutes, you are certainly entitled. 
This is a bipartisan committee effort here. You are entitled to 
8 minutes. Thank you.
    Representative Brady. Thank you. Madam Chairman, thank you 
for holding the hearing, and I support any follow-up on this. 
There is a lot here to go into, so thank you for your 
leadership on that.
    Let me telegraph my questions in advance. What I would like 
to ask the entire panel, on the issue of liquidity, should 
Congress give clear legal authority to servicers to renegotiate 
commercial real estate loans within the CMBSs because they hold 
25 percent of the capital for commercial real estate today?
    Mr. DeBoer, I wanted to have you elaborate a little on your 
idea on privately funded insurance programs, again might create 
liquidity within the system.
    Wanted to hear from our practitioners, Mr. DeBoer and Mr. 
Helsel, you know, do you believe the pendulum has swung too far 
on the issue of bank regulation, that there is too much 
pressure to reduce solid commercial real estate lending at the 
local level, even when the market conditions support it?
    And then, finally, for our guidance as we look at a number 
of tax proposals, can you elaborate further on the impact of 
repatriating standard U.S. profits back to U.S. to invest in 
real estate, the issue of opening up more foreign investment in 
real estate, and then the thoughts on how carried interest, 
which is shooting at the giant hedge funds but hitting the 
traditional real estate partnerships, the ones that actually we 
are depending upon these days and this hearing is about, what 
impact that might be, and I would open it up.
    Mr. Helsel. I will start. Just quickly, I would say that 
the question on regulation of the banks--and I forget how you 
exactly worded it--but the essence of it is I think that we 
have gone where we needed to go, but it has almost become a 
circle because, on one hand, we are telling the banks to lend 
money, and on the other hand, the regulators are saying, be 
careful what you do, don't lend money. So it puts the banks in 
a very difficult position. If they don't lend the money that is 
out there, if they don't use the money they were given under 
TARP and they have available to them through other programs 
now, I don't know how we can get out of the cycle we are in.
    Representative Brady. This even relates though to banks 
that haven't accepted TARP.
    Mr. Helsel. That is correct. That is absolutely correct.
    Representative Brady. Small- and medium-sized banks that 
have capital, have longstanding relationships with local 
lenders but are still being told by regulators, we want these 
types of loans off your books, which is what we are seeing.
    Mr. Helsel. Mr. Brady, you are absolutely correct. I would 
also say that I guess you raised one of the questions I wanted 
to speak to you--it seems to me that if the Federal Government, 
at any level, whether it is the GSEs, whether it is Congress, 
whether it is any of the regulators, doesn't matter who it is, 
if they don't step back in and encourage actions that will 
create financing--and I want to just take a side note and say, 
to go to a place where we haven't really talked about today--
much of what we have talked about today has dealt with large 
office towers, large big-box buildings, things like that.
    I don't want the committee to forget the typical investor 
in the street every day as a practitioner who is dealing with a 
family who has a property that might be worth $300,000 to $1 
million, that they can't get the financing for right now 
either. And I don't know what the range or the delta is between 
the total dollars of what I will call large and jumbo 
transactions versus a typical transaction in the marketplace 
today, but I can tell you those people are the ones who feed 
the small communities across the country right now, with tax 
dollars for the schools and things look that. They are not here 
either right now. They can't get financing right now either, 
and that creates a huge problem. It goes well beyond where the 
REITs and all the other people are who are suffering as well 
right now.
    Representative Brady. All right. Thanks.
    Mr. DeBoer.
    Mr. DeBoer. Concerning overregulation or the pendulum 
swinging too far, I think it probably has, but I think that is 
probably expected.
    Part of the problem out there I think now for a bank to 
lend into the real estate world is the inability to clearly 
determine what the value of the asset is. And when we are in a 
situation when values are dropping like they are, and you are 
basically asking people to catch the falling knife, if you 
will, it is very hard for and understandable that people would 
be reluctant to lend on appraisals. And perhaps there could be 
a period of time where bank examiners would tell banks to lend 
on a cash flow basis or on a debt service coverage basis rather 
than on an appraisal basis, and that might help get through 
this temporary period of time. I just throw that out.
    The other issues that you suggested that I talk about, one 
was this insurance concept, and this goes to this idea of 
encouraging new lending. There may be a model that could be 
looked at built off of the FDIC model that provides insurance 
for deposits where issuers and originators of loans would pay a 
fee into a federally chartered insurance corporation that would 
then provide insurance to the securities that are backed by new 
commercial real estate lending. And if that was done, you might 
get more issuers and new lenders to come into play if those 
securities had some insurance. And again, what I am talking 
about is a privately funded over time by a fee from originators 
and from issuers.
    And the final thing that I think you asked me to talk about 
was the whole issue of foreign investment, and I think you had 
two different----
    Representative Brady. Repatriation of stranded profits, as 
well as in your testimony you talked about sort of the 
disparate treatment.
    Mr. DeBoer. Right. The repatriation issue, we have heard 
about that. We know that you are looking at it, and Mr. Crowley 
and others are looking at the idea of allowing institutions or 
companies that have their profits parked overseas, they don't 
want to bring them back to face taxation, and there may be 
something there that if they brought the profits out of a 
foreign bank and put it in a U.S. bank, I suppose that you can 
make the argument that that will spur U.S. lending. We are 
anxious to look at that and learn a more about it, as I know 
you are.
    On the foreign equity side of things, we know precisely 
that there are a lot of foreign pension plans, sovereign wealth 
funds, wealthy families that would love to invest more equity 
into U.S. real estate, but because of this law that was put 
into place in 1980, they are discouraged from doing it today, 
and we have seen foreign investment drop now to a trickle in 
the U.S. where it could be incentivized a lot more.
    And I'll just end with this note. We have a policy in the 
United States where foreigners can buy as much of our Treasury 
debt as they want. They can buy as much of our private debt as 
they want. They can buy as much stock as they want without 
paying a capital gains tax, but when they buy U.S. real estate 
or they invest equity in U.S. real estate, they face a capital 
gains tax. And all I would suggest is that given the situation 
where we are so short in equity and need this to rebalance 
loans, that now is the time for Congress to take a fresh look. 
It has been two decades or more and just take a look at this 
and see whether there is a way to bring some of this equity 
that wants to come inside our borders.
    Representative Brady. Should real estate partnerships, 
traditional real estate partnerships that have had no abuses, 
have operated for decades in virtually every community of the 
country, should they be carved out from the carried interest 
efforts that are generally focused on, you know, quote giant 
hedge funds, whatever the current phrase is? Should real estate 
be carved out of that because it really fits in a whole 
different category?
    Mr. DeBoer. I guess, you know, it is up to other people to 
talk about carve-outs. What I would say is I don't think that 
it makes sense to apply these rules to real estate. Now, 
whether it makes sense to apply the rules to other people, I am 
not in that business, I don't know. But for real estate to take 
the incentive motivation away from a general partner and 
increase their taxes by 150 percent, as the carried interest 
proposal does, will dramatically reduce the risk taking and 
entrepreneurial activities of real estate.
    The final thing that I would say is, at its core, this 
proposal is a pro- debt, anti-equity proposal. It encourages 
people to get debt from banks as opposed to getting equity from 
equity partners, and again, in a world where there is a short 
supply of debt and a world where we are in liquidity, I don't 
understand why we would now have a policy that would tell every 
partnership in America to go out and get bank debt as opposed 
to equity debt. So I think it is questionable.
    Representative Brady. Well, my time is up, but Mr. Parkus, 
could you answer on legal authority to renegotiate commercial 
mortgage backed securities, your thoughts, and I need to turn 
it back to the chairwoman.
    Mr. Parkus. Yes, I do believe that that would be a positive 
to allow special servicers to renegotiate loans. Yes, I believe 
that would be a positive.
    Representative Brady. I know there are a lot of dynamics 
involved with that.
    Chair Maloney. I would be glad to join you in such a bill. 
We can work on it.
    Representative Brady. Thank you and I yield back, Madam 
Chairwoman.
    Chair Maloney. Is any Federal agency responsible for making 
sure that underwriting standards in the commercial real estate 
sector are sound or is it the assumption that the market will 
take care of any problems? Does anyone know?
    Mr. Greenlee. In terms of broader underwriting across the 
marketplace, I am not aware of any, but I do know out of the 
early 1990s as part of the FDICIA Act, there were real estate 
lending standards that were established by the banking 
agencies.
    Chair Maloney. Do you think it would be helpful to have one 
Federal agency responsible for underwriting standards?
    Mr. Greenlee. I am not aware that the board has taken a 
position on that.
    Chair Maloney. Okay. Thank you. And looking at where the 
majority of defaults in the sector are, were these loans 
originated in state or federally chartered financial 
institutions?
    Mr. Greenlee. In terms of the real estate loans that set on 
banks books, it is a mixture of both.
    Chair Maloney. Given potential risks to tenants in 
apartment buildings, should the proposed consumer financial 
protection agency be responsible for monitoring underwriting 
standards for these loans?
    Mr. Greenlee. Again, I am not sure the Federal Reserve's 
taken a position on that, and I think the multifamily runs into 
where you do have a property that then leases out to 
individuals. That is the way that works. There is a consumer 
aspect to it.
    Chair Maloney. Let's look at some lessons from history.
    During the S&L crisis in the late 1980s and early 1990s 
commercial lending also experienced a severe contraction. Can 
any of you comment on the effect that this contraction had, 
especially in States like Texas that were severely affected and 
are there lessons learned from the S&L crisis that would help 
us with the current crisis and how we could stop this from 
happening again? Anyone's comments.
    Mr. DeBoer. Well, look, obviously what happened in Texas 
and some parts of country following the commercial real estate 
collapse of the late eighties, early nineties was devastating, 
you know, but there are a lot of reasons for that. Part of it 
is in the roots of the 1980s that had overly generous lending 
rules, overly generous--some--tax rules. They were shut down 
abruptly. Then the regulators came in and clamped down too hard 
on the regulating lending policy, and it shut the whole system 
down in the late 1980s, early 1990s.
    Part of that was due to overbuilding; too much supply was 
on. That is not what we have here today. And so while the 
recess was on, Senator Brownback asked a similar question, and 
we talked in terms of re-instate--one thing that did come out 
of that debacle that was worthwhile was a move to a more 
transparent and public ownership of both debt and equity in 
commercial real estate, and we need that again. We need 
securitization to come back in a new, more safe way, and you 
raised some very positive questions that need answers about new 
underwriting and so forth. But the point is to get this stuff 
moving back in a new world and sounder footing.
    Chair Maloney. Yes, Mr. Parkus.
    Mr. Parkus. I just wanted to make one comment, Chair 
Maloney, and that is, that I think many of the panelists here 
today believe, along with I, that securitization is critically 
important to play a role in helping to improve the situation as 
we go forward and that there are today quite a number of 
proposed regulations which pose a significant threat to 
securitization, some of them, some of which if enacted, would 
probably kill CMBS, and I think that we need to think very 
carefully about those, the proposed new regulations. I think 
the Fed has itself come out and said that it is critical that 
securitization sort of come back to sort of life and play this 
role.
    Chair Maloney. Thank you. Thank you.
    What is the impact of defaults? If we don't do something, 
we will be facing defaults and bankruptcies across our country. 
What will the impact of defaults or bankruptcies of commercial 
real estate mortgage holders be on tenants of these commercial 
buildings? Are there risks to renters in multifamily dwelling 
units of losing electricity in the heat of the summer or lack 
of maintenance during a period of time before a new mortgage 
holder could be found? And what about tenants in office 
buildings and retail malls if there is a default or bankruptcy 
what happens? Are they booted out, too? Anyone?
    Mr. DeBoer. Well, so far, certainly on the commercial side 
in the retail world, it has been--although there has been a 
large retail owner that has gone into bankruptcy, mall owner, 
that is, it has been more likely that the retailers themselves 
are having difficulty. I don't know of any cases so far in the 
multifamily area where tenants have had their electricity or 
water disrupted because of problems by the owner, and I would 
share your concern and hope that does not be a result that we 
see. That is not a good outcome. Again, I don't know of 
anything like that.
    Chair Maloney. Any other comments? Well, my time has 
expired.
    Mr. Brady.
    Representative Brady. Thank you. I am convinced one of the 
reasons we continue to have capital sitting on the sidelines 
and we have not yet restored confidence in the economy is that 
the commercial real estate crisis is viewed as the other shoe 
that will drop here soon in the next year or two and which is, 
again, why I am so grateful for the Chairwoman to be holding 
this hearing.
    You know, you pointed out earlier that half of all of our 
commercial real estate capital comes from banks, many of them 
regional and local. A quarter comes from the CMBS, and then the 
rest from insurers and pension funds. So clearly liquidity is 
key in the top two tiers. Appraisals seem like an arcane issue 
to discuss, but in the practical standpoint, when people are 
trying to roll over their notes, it is really critical.
    The two dynamics I see today, one, we have a procyclical 
bias in our appraisals. When the market is going up, appraisals 
look at rental income. They tend to evaluate it artificially 
high for years to come, sort of encouraging the cycle to 
continue. In the TALF situation, like they have today, the 
opposite occurs where basically they look at low rental 
incomes, extrapolate it for far too many years and you have got 
artificially low values and prices.
    And the regulators today, in my view, are discounting those 
appraisals even further, making tougher again either for those 
to come up with massive equity calls or basically to be denied 
loans. And again, my question would be from the congressional 
standpoint, without micromanaging the issue of appraisals, is 
there another approach that can be taken that normalizes the 
rental income or market income of commercial properties that 
would create more of a true picture of the value of these as 
people go in to rollover their notes? And again, they tend to 
be 5-year cycles for the regular banks, 10-year cycles for the 
mortgage backed securities.
    You know, should we as Congress--what should we be looking 
at, or what approach could we take to try to get a truer value 
of appraisals that would not exacerbate the problem we have 
today? And I would open it up to the panel members.
    Mr. Helsel. Certainly a discounted cash flow model would 
help that. The problem that you speak to, Mr. Brady, is 
serious, especially right now in the refinancing situation. It 
is also bad when it comes to just new financing, but the fact 
of the matter is--and I am a former appraiser so I understand 
the methodology a little bit probably. I would tell you that 
appraisers I think have a little bit of a conundrum themselves 
right now to the extent that they look at what is happening 
around them, they try and estimate what is going to happen as 
it relates to cash flow. They see a building go a little bit 
dark. They get worried that that might go further dark, and it 
almost self-perpetuates itself.
    So if they don't begin to look at, for instance, discounted 
cash flow, if they don't take--and I don't mean to say that 
they should take an optimistic attitude when they are doing an 
appraisal that creates a false value that doesn't exist, but I 
think if they continue to take a pessimistic attitude, it is a 
little bit of a problem. It drives the values down, which just 
exacerbates everything else we have talked about today. Whether 
Congress should step in and tell an appraiser how to do 
appraisals is a different issue. I don't think that is the 
right thing to do.
    Representative Brady. I don't either.
    Chair Maloney. Gentlemen, we are running out of time and I 
want to recognize Mr. Campbell for his 5 minutes, but first I 
would like to place in the record Congressman Burgess's 
statement.
    [The prepared statement of Representative Michael C. 
Burgess appears in the Submissions for the Record on page 139.]
    Chair Maloney. And I will be submitting additional 
statements and questions for the record.
    [A letter from Chair Maloney to witness Greenlee appears in 
the Submissions for the Record on page 140.]
    [A letter from witness Greenlee in response to Chair 
Maloney appears in the Submissions for the Record on page 141.]
    Chair Maloney. Mr. Campbell will have to be the last one to 
speak because we need to move out of this room for the next 
committee meeting.
    You are recognized for 5 minutes.
    Representative Campbell. Thank you, Madam Chair, and I 
apologize for missing the other questions if I am asking 
something that has been asked already.
    The first question I have generally for the panel, as a 
number of people deep in the commercial real estate market that 
I have spoken to have said this--interestingly used the same 
analogy, have had at least three different ones use it--say 
that we are in the third inning, that if this were a baseball 
game, we are in the third inning of the crisis, if you will, 
within commercial real estate and the CMBS and so forth. Do you 
all generally agree with that or not?
    Mr. Parkus. No.
    Representative Campbell. I see a big no from Mr. Parkus. 
Please.
    Mr. Parkus. Congressman Campbell, I think we are in the 
first inning.
    Representative Campbell. Oh, wow.
    Mr. Parkus. This has a long time to go. We are just now--it 
is only over the past 12 months that we have seen severe stress 
in rents and vacancies, prices declining, and delinquencies 
shooting up. We know from historical experience that commercial 
real estate performance lags economic activity with a 12- to 
18-month lag. So, no. Maybe we are somewhere between the first 
and the second inning. We are definitely not in the third 
inning.
    Representative Campbell. Is there anyone who believes we 
are in the fourth inning or beyond then? All right. So we have 
got a ways to go.
    Next question, I think for Mr. Greenlee and Mr. Parkus. 
What if we do nothing here? What if there is no activity from 
Congress or the government whatsoever and this situation runs 
its natural course, what is the effect of that? What is the 
economic effect, the broader macro effect on banks or whoever? 
What effects do you see?
    Mr. Greenlee. Well, in terms of the exposures in the 
banking system, it is roughly about $1.8 trillion is what banks 
hold in terms of commercial real estate. So if there is a 
continued decline in values and problems and delinquencies and 
bankruptcies, we will see more losses that banks take. It could 
threaten the viability of certain institutions, and we have 
tried to--again, we went through the stress test, the SCAP 
process, recently to look at the 19 largest. We looked at the 
CRE exposures there to ensure they had enough capital and 
reserves to absorb those losses over that time period.
    Representative Campbell. In the stress test, have you 
factored in it running its course then?
    Mr. Greenlee. We looked over a 2-year time horizon. We are 
taking that as observations and lessons we have learned from 
the SCAP, looking at other organizations that we supervise, as 
well as, you know, we will be thinking about a longer horizon 
at some point, depending on how things play out.
    Representative Campbell. Mr. Parkus, do you have a comment?
    Mr. Parkus. I think what Congress can potentially do here 
that would be extremely valuable is to help restart financial 
markets. So I guess I take your question to mean what would the 
difference in outcomes be between going through this process 
with poorly or ill-functioning financing markets versus one 
where we----
    Representative Campbell. My question is simply trying to 
get you to explain better to us. Oftentimes CMBS, commercial, 
all seems very abstract, and so to try and say what is the 
effect on the financial system, on the banking system, on 
employment, on anything that, you know, those sorts of things 
out there that are less abstract.
    Mr. Parkus [continuing]. Right. Well, I think that the 
effect will be much more severe if we do not have a viable 
commercial real estate financial system, financing market, 
operating as we proceed through this.
    Representative Campbell. Okay. And then my final question 
for Mr. Helsel and Mr. DeBoer would be, you both mentioned 
either in your verbal testimony or your written testimony some 
thoughts that I think you have five or various ideas, thoughts, 
different things that Congress should do, that we should be 
looking at doing. Let me ask you, what is the most important? 
And I know sometimes people hate this question. I mean, if 
there is the single most important thing we could do that would 
have the most impact in softening the effects that we are going 
to have through the next eight innings of this process, what 
would that be?
    Mr. Helsel. Increased liquidity, get more liquidity into 
the marketplace. Find a way to get the money to the banks and 
get the banks to lend the money to people who need the money to 
stop the foreclosures and to stop defaults.
    Representative Campbell. Commercially regulated banks you 
are saying?
    Mr. Helsel. Yes.
    Representative Campbell. Okay.
    Mr. DeBoer. I mean, what is within the authority of 
Congress to do versus the regulators, I think those are 
different questions. You know, the TALF needs to be extended. 
It needs to be made to be reactive to changing market 
conditions, and it will be helpful, but we need something to, 
as Jim said, to restart the lending process. We need some sort 
of a program to start new lending.
    As far as what Congress can actually do, I think that this 
issue of equity investment from foreigners is well within the 
purview of Congress. Simple reforms there would go a long way 
to bring about new liquidity.
    I will say one other thing on the RIMIC issue that was 
brought up. There is a request pending at the Treasury 
Department to provide more flexibility for servicers to 
renegotiate mortgages that have been securitized. It was done 
on the residential side. It should be done on the commercial 
side. And thank you for your comments.
    Representative Campbell. Thank you, panel.
    Thank you Madam Chair.
    Chair Maloney. I thank you.
    And the final question is really an issue that was brought 
up by the Special Inspector General for TARP when he testified 
before this committee earlier. He testified that there were 
potential pitfalls in pitting the PPIP program and the TALF 
together, and he basically made the point that he was concerned 
that taxpayers will be on the hook for losses if those two 
could leverage and work together. Are you familiar with the 
points that he was making? If not, maybe you should read his 
testimony and get back to us and tell us your concerns.
    Mr. Greenlee.
    Mr. Greenlee. I am not specifically familiar with that 
point. I do know how the TALF was set up was, we are only going 
to take the highest quality CMBS securities, and there will be, 
you know, a haircut taken in the lending process to ensure that 
the taxpayers aren't exposed to any potential losses.
    Chair Maloney. Well, the Chair would appreciate, and I am 
sure the members, if you take a look at his testimony and 
respond to the concerns that he raised on those two programs.
    I would like to thank the panelists and thank all of our 
witnesses for being here today to examine the potential 
solutions to the commercial real estate time bomb which risks 
posing a systemic risk to our economy.
    And I thank my colleagues. This meeting is adjourned. Thank 
you.
    [Whereupon, at 1:30 p.m., the committee was adjourned.]
                       SUBMISSIONS FOR THE RECORD

     Prepared Statement of Representative Carolyn B. Maloney, Chair
    Good morning. I would like to thank our distinguished experts for 
agreeing to testify today on the growing financing problems we are 
facing in the commercial real estate market and the extent to which 
they pose a systemic threat.
    The current financial crisis is the result of significant losses 
experienced by key financial institutions with large exposures to 
residential mortgage assets. But banks now face a second wave of losses 
as commercial real estate loans issued at the height of the real estate 
bubble are coming due for refinancing.
    Tenant rent payments are often not sufficient to cover the loan 
payments and many borrowers' commercial mortgages are underwater 
because the property simply isn't worth today what they paid for it a 
few years ago.
    The decline in property values is astounding, particularly when you 
look at my home city of New York. For the year ending in March 2009, 
prices on commercial office space properties have dropped almost 13 
percent. Deutsche Bank reportedly sold Worldwide Plaza in Manhattan for 
less than $400 per square foot, which I understand is less than one-
third of the price the property could have commanded back in 2006. The 
bubble has burst, but a 60 to 70 percent collapse in prices poses a 
tremendous obstacle to the refinancing process.
    Moreover, in this highly constrained credit market that we now live 
in, even borrowers with performing C.R.E. loans who have equity in 
their properties report to me that they are having trouble getting 
refinancing.
    The commercial real estate time bomb is ticking. An estimated $400 
billion in commercial real estate debt is set to mature this year with 
another $300 billion due in 2010. If mortgagers are unable to refinance 
or otherwise pay their large balloon payments, we could expect to see 
the default rate soar. That in turn translates into potentially 
crippling bank losses--especially among smaller and regional banks.
    Doing nothing is not an option, because this looming crisis in 
commercial real estate lending could lead to an all-too-familiar 
predicament, where banks suffer significant losses, major owners of 
hotels and shopping centers are forced into bankruptcy, foreclosed 
properties push commercial real estate prices further downward, and a 
perfect storm of all these factors combine to inhibit prospects for a 
sustained economic recovery.
    In recent speeches, New York Fed President William Dudley and San 
Francisco Fed President Janet Yellen raised concern about the potential 
systemic threats due to C.R.E. defaults and the need to reactivate the 
secondary market, in part through the TALF--the Term Asset-Backed 
Securities Loan Facility.
    The Federal Reserve has announced that it will extend the TALF to 
include both new and ``legacy'' commercial mortgage-backed securities 
(C.M.B.S.), in hopes that the July auction will be more successful than 
the June auction which drew no takers. The expansion of TALF into 
legacy C.M.B.S. should increase the supply of credit to the commercial 
real estate market, which remains frozen with no new securities issued 
in over a year.
    Additionally, further details about the Public Private Investment 
Program are emerging, which could potentially help with this problem.
    I also look forward to working with the Treasury on what has been 
referred to as ``Plan C''--efforts to head off looming problems--such 
as commercial mortgage defaults, rising homeowner delinquencies and 
solvency issues at community and regional banks--before they cascade 
into a crisis.
    But as we evaluate proposed solutions, we must be wary of potential 
pitfalls. For example, the TALF program is set to expire at the end of 
this year, which may cut short the program's effectiveness just as it 
begins to ramp up. Credit rating downgrades for CBMS could 
significantly limit the impact that the legacy TALF auctions have in 
providing liquidity to that market.
    Uncertainty about the PPIP's future has reportedly kept some on the 
sidelines, so there is some urgency to the Treasury providing 
additional clarity about the program.
    We are all watching closely to see if these measures help to 
restart the commercial real estate market, but we need to be ready in 
the event they fall short.
    I look forward to the testimony from our panel to help us find the 
keys to unlocking the commercial real estate loan market.
                               __________
    Prepared Statement of Representative Kevin Brady, Senior House 
                               Republican
    I am pleased to join in welcoming the witnesses before the 
Committee this morning. The spreading crisis in the commercial real 
estate sector poses a serious threat to our financial system and 
economic recovery.
    What I have heard repeatedly from people associated with the 
commercial real estate industry is that they are unable to refinance 
outstanding mortgage loans when they mature. While officials here in 
Washington talk about the need to boost the economy, federal regulators 
are pressuring banks to reduce their exposure to commercial real estate 
loans. The result is that even some profitable commercial real estate 
firms that cannot rollover their debt now face bankruptcy proceedings.
    The magnitude of this problem is huge, with at least $1 trillion of 
commercial real estate debt requiring refinancing over the next several 
years. Bank loans typically have a maturity of five years or less. 
Loans in commercial mortgage-backed securities typically have longer 
terms. These loans were made when credit conditions were very favorable 
and now will have to be refinanced during the most serious liquidity 
crisis in many decades.
    The economic weakness resulting from the bursting of the credit 
bubble has reduced the market value of shopping centers, hotels, and 
office buildings. Consumers are cutting back purchases, and companies 
are retrenching to cut costs. Higher vacancy rates are boosting 
delinquency rates on commercial mortgage loans. Although the commercial 
real estate crunch began after the housing bubble burst, there is 
little doubt that the financial crisis has now spawned another 
dangerous threat to the prospect of economic recovery.
    Consequently, now is the time to repeal the punitive tax treatment 
of commercial real estate, including provisions taxing foreigners on 
U.S. capital gains from real estate sales. Congress should consider 
reducing the depreciation period for commercial real estate and reject 
proposed tax increases that will undermine a potential economic 
recovery.
    Another problem affecting commercial real estate relates to 
depressed appraisals of property. Obviously, low appraisals on property 
being refinanced are only going to make mortgage rollovers even more 
difficult in a liquidity crisis. Although it is understandable that 
appraisals will be affected by current depressed conditions in the 
industry, perhaps there is an alternative to valuing a long-lived asset 
in the trough of a severe recession. If a longer period of time were 
used as the basis for a property appraisal, a more accurate view of its 
long-term value might be available.
    In conclusion, the problems in the commercial real estate industry 
are a serious threat to the economy. Congress should consider policies 
to increase financial liquidity in the industry and avoid policies such 
as tax increases that will only aggravate the financial and economic 
distress.
                               __________
                          Witness Biographies
jon d. greenlee, associate director, board of governors of the federal 
     reserve system, division of banking supervision and regulation
    Jon D. Greenlee is currently the Associate Director for Risk 
Management in the Division of Banking Supervision and Regulation at the 
Board of Governors. In this capacity, he oversees the strategic 
direction and work of the Board's credit, market and liquidity, 
operational, and compliance risk sections. His responsibilities include 
the identification and analysis of current and emerging risks in his 
capacity as Chair of the Division's Risk Committee, and for ensuring 
the Federal Reserve has appropriate supervisory guidance and policies 
in place. In addition, he has responsibility for coordinating 
supervisory activities related to key risks and risk management issues 
across the organizations supervised by the Federal Reserve System.
    Mr. Greenlee has over twenty-two years of experience as a regulator 
and most recently was the Deputy Associate Director for the Board of 
Governors Large Banking Organization section. He joined the Board in 
2001 as the manager of the Regional Banking Organization and was 
appointed to the official staff in 2003. Prior to joining the Board of 
Governors, he was an examiner at the Federal Reserve Bank of San 
Francisco for 12 years. He also worked for the Office of the 
Comptroller of the Currency and the Indiana Department of Financial 
Institutions prior to joining the San Francisco Reserve Bank. Mr. 
Greenlee has a BS degree in Finance from Indiana State University.
 richard parkus, global head of cmbs research, deutsche bank securities
    Richard Parkus has been Global Head of CMBS Research at Deutsche 
Bank Securities in New York since joining the firm in 1998. Prior to 
this, Richard worked for Lehman Brothers in London as head of non-
dollar exotic option trading from 1994 though 1998. Prior to that, 
Richard was Co-Head of the Quantitative Mortgage Research group at 
Lehman Brothers in New York.
    Richard graduated summa cum laude with a B.A. in Economics in 1981 
and an M.A. in Mathematics in 1983 from the University of Michigan. 
Richard attended the Ph.D. program at the University of Chicago's 
Graduate School of Business, and received his M.B.A. in 1989.
  jeffrey d. deboer, president and chief executive officer, the real 
                           estate roundtable
    Jeff DeBoer is the founding President and CEO of The Real Estate 
Roundtable. The Real Estate Roundtable represents the leadership of the 
nation's top 100 privately owned and publicly-held real estate 
ownership development, lending and management firms, as well as the 
elected leaders of the 16 major national real estate industry trade 
associations. Collectively, Roundtable members' portfolios contain over 
5 billion square feet of office, retail and industrial properties 
valued at more than $1 trillion; over 1.5 million apartment units; and 
in excess of 1.3 million hotel rooms.
    Mr. DeBoer has served as President and CEO of The Real Estate 
Roundtable since 1997, and through a variety of positions, he has been 
at the forefront of every major piece of legislation affecting the real 
estate industry during the last twenty-five years.
    In addition to his position at the Roundtable, Mr. DeBoer serves as 
Chairman of the Real Estate Industry Information Sharing and Analysis 
Center (RE-ISAC), an organization dedicated to enhancing the two-way 
communication between the industry and federal policymakers on matters 
relating to building security, terrorist threats, and incident 
reporting. He also serves as co-chairman of the Advisory Board of the 
RAND Corporation's Center for Terrorism Risk Management Policy, and is 
chairman of the National Real Estate Organizations, a coalition of real 
estate trade associations working together to enhance the coordination 
of the industry's overall Washington advocacy efforts. He is also a 
founding member of the steering committee of the Coalition to Insure 
Against Terrorism (CIAT).
    Mr. DeBoer has discussed real estate and economic policy issues on 
FOX News, Bloomberg Television and CNBC; and his editorials have been 
published in the Wall Street Journal and USA Today.
    He is a member of the Virginia Bar Association and the American Bar 
Association. A native of Rapid City, South Dakota, Mr. DeBoer earned a 
law degree from Washington and Lee University in Lexington, Virginia, 
and an undergraduate degree from Yankton College in Yankton, South 
Dakota. Mr. DeBoer and his wife, Joan, and son, Mitchell, live in 
Alexandria, VA.
      james l. helsel, treasurer, national association of realtors
    James L. Helsel, Jr., a REALTOR from Lemoyne, Pa., is 2009 
Treasurer of the National Association of REALTORS. Helsel holds the 
professional designations of Certified Property Manager, Graduate, 
Realtor Institute, and Certified Commercial Investment Member.
    On the national level, Helsel was treasurer in 2008 and a member of 
the NAR Board of Directors from 1989 until 1999 and joined again in 
2001. He was a member of NAR's Finance Committee in 2002 and 2003, and 
again from 2005 to 2007. He chaired the Real Property Operations 
Committee in 2002 and 2003, which was responsible for building NAR's 
award-winning Washington, D.C. headquarters. He has served on NAR's 
Executive Committee and Strategic Planning Committee as well as 
numerous Presidential Advisory Groups.
    In 2001, he was selected ``REALTOR of the Year'' by his state 
peers.
                               __________
                 Prepared Statement of Jon D. Greenlee
    Chair Maloney, Vice Chairman Schumer, Ranking Members Brownback and 
Brady, and other members of the Committee, I am pleased to be here 
today to discuss several issues related to commercial real estate (CRE) 
lending in the United States. I will start by describing the current 
conditions in CRE markets, then discuss Federal Reserve efforts to help 
revitalize CRE markets and promote lending to creditworthy borrowers. I 
will also outline Federal Reserve supervisory actions relating to CRE, 
and discuss the need to ensure a healthy balance between strong 
underwriting, risk management, and financial institution safety and 
soundness on the one hand, and credit availability, on the other.
               current conditions in cre and cmbs markets
    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.
    The decline in the CRE market has been aggravated by two additional 
factors. First, the values of commercial real estate increased 
significantly between 2005 and 2007, driven by many of the same factors 
behind the residential housing bubble, resulting in many properties 
either purchased or refinanced at inflated values. Prices have declined 
about 24 percent since their peak in the fall of 2007 and market 
participants expect significant further declines. Second, the market 
for securitized commercial mortgages (CMBS), which accounts for roughly 
one-fourth of outstanding commercial mortgages, has been largely 
dormant since early 2008 while many banks have substantially tightened 
credit. The decline in property values and higher underwriting 
standards in place at banks will increase the potential that borrowers 
will find it difficult to refinance their maturing outstanding debt, 
which often includes substantial balloon payments.
    The higher vacancy levels and significant decline in value of 
existing properties has also placed pressure on new construction 
projects. As a result, the construction market has experienced sharp 
declines in both the demand for and the supply of new construction 
loans since peaking in 2007.
    The negative fundamentals in the commercial real estate property 
markets have broadly affected the credit performance of loans in banks' 
portfolios and loans in commercial mortgage backed securities. At the 
end of the first quarter of 2009, there was approximately $3.5 trillion 
of outstanding debt associated with commercial real estate. Of this, 
$1.8 trillion was held on the books of banks, and an additional $900 
billion represented collateral for CMBS. At the end of the first 
quarter, about seven percent of commercial real estate loans on banks' 
books were considered delinquent.\1\ This was almost double from the 
level a year earlier. The loan performance problems were the most 
striking for construction and land development loans, especially for 
those that finance residential development. Notably, a high proportion 
of small and medium-sized institutions continue to have sizable 
exposure to commercial real estate, including land development and 
construction loans, built up earlier this decade, with some having 
concentrations equal to several multiples of their capital.
---------------------------------------------------------------------------
    \1\ Loans 30 or more days past due.
---------------------------------------------------------------------------
    The Federal Reserve's Senior Loan Officer Opinion Survey regularly 
provides useful information about lending conditions. In the most 
recent survey, conducted in April of this year, almost two-thirds of 
the domestic banks surveyed reported having tightened standards and 
terms on commercial real estate loans over the previous three months. 
Additionally, almost two-thirds of the respondents reported weaker 
demand for CRE loans, the highest net percentage so reporting since the 
survey began tracking demand for CRE loans in April 1995.
    The current fundamentals in CRE markets are exacerbated by a lack 
of demand for CMBS, previously a financing vehicle for about 30 percent 
of originations. New CMBS issuance has come to a halt as risk spreads 
widened to prohibitively high levels in response to the increase in CRE 
specific risk and the general lack of liquidity in structured debt 
markets. There has been virtually no new issuance since the middle of 
2008. Increases in credit risk have significantly softened demand in 
the secondary trading markets for all but the most highly rated 
tranches of these securities. Delinquencies of mortgages in CMBS have 
increased markedly in recent months and market participants anticipate 
these rates will climb higher by the end of this year, driven not only 
by negative fundamentals but also borrowers' difficulty in rolling-over 
maturing debt. In addition, the decline in CMBS prices has generated 
significant stresses on the balance sheets of institutions that must 
mark these securities to market.
       federal reserve activities to help revitalize cre markets
    U.S. government agencies have taken a number of actions to 
strengthen the financial sector and to promote the availability of 
credit to businesses and households. In addition to aggressive actions 
related to monetary policy, the Federal Reserve has taken strong 
actions to improve liquidity in financial markets by establishing 
numerous liquidity facilities. One of the more recent liquidity 
programs is the Term Asset-Backed Securities Loan Facility (TALF), 
begun in November 2008, to facilitate the extension of credit to 
households and small businesses.
    In an effort to target CMBS markets, in May of this year, the 
Federal Reserve announced that, starting in June 2009, certain newly 
issued high quality CMBS would become eligible collateral under the 
TALF, followed in July by high quality ``legacy'' CMBS issued before 
January 1, 2009. The provision of TALF financing for newly issued CMBS 
was intended to support new lending for creditworthy properties, 
especially those whose loans are set to mature soon. TALF financing for 
legacy CMBS was intended to lower secondary market spreads and enhance 
liquidity. Lower spreads should then encourage new lending and ease the 
balance sheet pressures on owners of CMBS. The resulting improvement in 
CMBS markets should facilitate the issuance of new CMBS, thereby 
helping borrowers finance new purchases of commercial properties or 
refinance existing commercial mortgages on better terms.
    TALF loans will be offered to finance new issuances of CMBS and 
purchases of legacy CMBS once a month. No TALF loans collateralized by 
new CMBS have been made yet, in part because CMBS take some time to 
arrange. The first subscription to include legacy CMBS will be on July 
16, 2009.
         federal reserve supervisory activities related to cre
    The Federal Reserve has been focused on commercial real estate 
(CRE) exposures at supervised institutions for some time. As part of 
our supervision of banking organizations in the early 2000s, we began 
to observe rising CRE concentrations. Given the central role that CRE 
lending played in the banking problems of the late 1980s and early 
1990s, we led an interagency effort to issue supervisory guidance on 
CRE concentrations in 2006. In that guidance, we emphasized our concern 
that some institutions' strategic- and capital-planning processes did 
not adequately acknowledge the risks from their CRE concentrations. We 
stated that stress testing and similar exercises were necessary for 
institutions to identify the impact of potential CRE shocks on earnings 
and capital, especially the impact from credit concentrations.
    As weaker housing markets and deteriorating economic conditions 
have impaired the quality of CRE loans at supervised banking 
organizations, we have devoted significantly more supervisory resources 
to assessing the quality of regulated institutions' CRE portfolios. 
These efforts include monitoring carefully the impact that declining 
collateral values may have on institutions' CRE exposures as well as 
assessing the extent to which banks have been complying with the 
interagency CRE guidance. Reserve Banks with geographic areas suffering 
more acute price declines in real estate have been particularly focused 
on evaluating exposures arising from CRE lending. We have found, 
through horizontal reviews and other examination activities, that many 
institutions would benefit from additional and better stress testing, 
improved management information systems, and stronger appraisal 
practices, and that some banks need to improve their understanding of 
how concentrations--both single-name and sectoral/geographical 
concentrations--can impact capital levels during shocks.
    The recently concluded Supervisory Capital Assessment Process 
(SCAP) provides a perspective of the risks of CRE exposures. The 19 
firms reviewed in the SCAP had over $600 billion in CRE loans, of which 
more than half were for nonfarm/nonresidential properties, and about 
one-third were related to construction and land development. The SCAP 
estimated that cumulative two-year CRE losses under the adverse 
scenario, in which residential house prices would continue to fall 
dramatically in 2009 and 2010, would be more than eight percent of 
total CRE exposures, with losses on construction loans significantly 
higher. Using information gained from the SCAP simulation exercise, we 
are also working with smaller firms that have substantial CRE exposures 
to ensure that their risk management practices are adequate and that 
they continue to maintain appropriate reserves and capital to support 
an expected increase in CRE losses.
    As part of our ongoing supervisory efforts related to CRE, we 
implemented additional examiner training so that our examiners are 
equipped to deal with more serious CRE problems at both community and 
regional banking organizations on a consistent basis. Further, we have 
enhanced our outreach to key real estate market participants and 
obtained additional market data sources to help support our supervisory 
monitoring activities. We have also issued guidance to our examiners on 
real estate appraisals, proper use of interest reserves in construction 
and development loans, evaluation of loan loss reserving methodologies, 
and troubled debt restructuring practices.
             maintaining balance in the supervisory process
    The Federal Reserve has long-standing policies and procedures in 
place to promote institutions' risk identification and management 
practices that support sound bank lending and the credit intermediation 
process. In fact, guidance issued in 1991, during the last commercial 
real estate crisis, specifically instructs examiners to ensure that 
regulatory policies and actions do not inadvertently curtail the 
availability of credit to sound borrowers.\2\ The 1991 guidance also 
states that examiners are to ensure that supervisory personnel are 
reviewing loans in a consistent, prudent, and balanced fashion.
---------------------------------------------------------------------------
    \2\ ``Interagency Policy Statement on the Review and Classification 
of Commercial Real Estate Loans,'' (November 1991); 
www.federalreserve.gov/boarddocs/srletters/1991/SR9124.HTM.
---------------------------------------------------------------------------
    The 1991 guidance covers a wide range of specific topics, including 
the general principles that examiners follow in reviewing commercial 
real estate loan portfolios, the indicators of troubled real estate 
markets, projects, and related indebtedness, and the factors that 
examiners consider in their review of individual loans, including the 
use of appraisals and the determination of collateral value. Credit 
classification guidelines were also addressed.
    This emphasis on achieving an appropriate balance between credit 
availability and safety and soundness continues, and applies equally to 
today's CRE markets. Consistent with the 2006 CRE guidance, 
institutions that have experienced losses, hold less capital, and are 
operating in a more risk-sensitive environment are expected to employ 
appropriate risk-management practices to ensure their viability. At the 
same time, it is important that supervisors remain balanced and not 
place unreasonable or artificial constraints on lenders that could 
hamper credit availability.
    As part of our effort to help stimulate appropriate bank lending, 
the Federal Reserve and the other federal banking agencies issued 
regulatory guidance in November 2008 to encourage banks to meet the 
needs of creditworthy borrowers.\3\ The guidance was issued to 
encourage bank lending in a manner consistent with safety and 
soundness--specifically, by taking a balanced approach in assessing 
borrowers' ability to repay and making realistic assessments of 
collateral valuations.
---------------------------------------------------------------------------
    \3\ ``Interagency Statement on Meeting the Needs of Credit Worthy 
Borrowers,'' (November 2008); www.federalreserve.gov/newsevents/press/
bcreg/20081112a.htm.
---------------------------------------------------------------------------
    More generally, we have directed our examiners to be mindful of the 
pro-cyclical effects of excessive credit tightening. Across the Federal 
Reserve System, we have implemented training and outreach to underscore 
these intentions. We are mindful of the potential for bankers to 
overshoot in their attempt to rectify lending standards, and want them 
to understand that it is in their own interest to continue making loans 
to creditworthy borrowers.
                               conclusion
    Financial markets in the United States continue to be somewhat 
fragile, with CRE markets particularly so. Banking institutions have 
been adversely impacted by recent problems in CRE markets. The Federal 
Reserve, working with the other banking agencies has acted--and will 
continue to act--to ensure that the banking system remains safe and 
sound and is able to meet the credit needs of our economy. We have 
aggressively pursued monetary policy actions and provided liquidity to 
help repair the financial system. The recent launch of the CMBS portion 
of the TALF is an effort to revitalize lending in broader CRE markets. 
In our supervisory efforts, we are mindful of the risk-management 
deficiencies at banking institutions revealed by the current crisis and 
are ensuring that institutions develop appropriate corrective actions. 
Within the Federal Reserve, we have been able to apply our 
interdisciplinary approach to addressing problems with CRE markets, 
relying on supervisors, economists, accountants, quantitative analysts, 
and other experts.
    It will take some time for the banking industry to work through 
this current set of challenges and for the financial markets to fully 
recover. In this environment, the economy will need a strong and stable 
financial system that can make credit available. We want banks to 
deploy capital and liquidity, but in a responsible way that avoids past 
mistakes and does not create new ones. The Federal Reserve is committed 
to working with other banking agencies and the Congress to promote the 
concurrent goals of fostering credit availability and a safe and sound 
banking system.
                               __________
                  Prepared Statement of Richard Parkus
    Chair Maloney, Vice Chairman Schumer, Ranking Members Brownback and 
Brady, and other distinguished members of the Committee:
    My name is Richard Parkus. I am a research analyst working for 
Deutsche Bank Securities Inc. in New York. I have been employed by 
Deutsche Bank since 1998 to provide research coverage of the 
securitization markets, with a focus on the commercial mortgage backed 
securities (CMBS) market. It is a privilege for me to testify at this 
important hearing to explore the current state of commercial and 
industrial lending, and to discuss the effectiveness of government 
efforts to restart credit markets.
    My testimony today will focus on three research reports that I 
recently published. The first report, published on April 23 of this 
year, titled ``The Future Refinancing Crisis in Commercial Real 
Estate,'' addresses what I believe will be widespread refinancing 
problems for commercial mortgages over the coming decade. The other two 
reports, both published in May of this year, provide my views on the 
likely efficacy of the TALF programs, both for legacy CMBS and for new 
issue CMBS. All three of these reports have been provided to the Panel 
as my written submission. With the Chair's permission, I would also 
like to submit as part of the written record a forthcoming report to be 
issued this month, focusing on the potential impact of commercial real 
estate loan defaults on banks.
    Before addressing my research, I must note that the views I express 
today are my own and do not necessarily represent those of Deutsche 
Bank or any of its staff members.
    The commercial real estate sector is currently under greater stress 
than at any time since the crash of the early 1990s. In fact, I believe 
that the severity of the current downturn is likely to exceed, possibly 
by a large magnitude, that of the early 1990s. The problems are two-
fold. First, the extraordinarily severe economic recession has resulted 
in vacancy increases and rent declines that are already of a similar 
magnitude to what occurred in the previous episode. This has pushed 
default rates to levels approaching those of the 1990s. The second 
problem, one that is potentially even more serious, is that for those 
loans that do make it to maturity, a very large percentage, perhaps in 
excess of 65%, may not qualify for refinancing under the dramatically 
tighter new underwriting standards, particularly in view of the fact 
that commercial real estate prices on stabilized properties have 
declined by 35-45% or more from their peak in 2007, and almost surely 
have further to go.
    On the whole, I expect that total losses in CMBS will be 
approximately 9-12% of the outstanding CMBS loan universe, or about 
$65-$90 billion. For the 2005-2007 vintage loans, my estimate of total 
losses is somewhat higher, about 12-15%. For the 2007 vintage alone, I 
expect in excess of 20% losses. This compares with approximately 10% 
total losses for the worst performing vintage--the 1986 vintage--in the 
early 1990s.
    In order to manage through this extremely stressful process, it is 
critical that commercial real estate financing markets begin 
functioning again with some degree of normalcy. By this I mean that 
loans which qualify for refinancing must be able to obtain financing. 
At the moment, this is not the case. Commercial real estate financing 
markets are effectively closed, at least for loans in excess of $25-
$35MM. Smaller loans on properties that are performing well have 
continued to have some degree of success refinancing, mainly with 
regional banks. However, we believe that this source will continue to 
deteriorate as problem loans mount in bank portfolios.
    Within the larger commercial real estate finance sector CMBS has 
roughly a 25-30% market share, while banks have about 50% market share, 
life insurance companies about 10% and pension funds about 10%. One 
common misconception, in my view, is that commercial real estate 
problems started in CMBS and somehow migrated to banks and other 
sectors. In fact, I believe that banks will, once again, prove to be 
the epicenter of commercial real estate loan problems.
    When looking at ``commercial real estate'' exposure in banks, one 
must distinguish between three categories of loans: construction and 
land development loans, core commercial real estate loans, and 
multifamily loans. In aggregate, banks have exposure to about $550 
billion in construction loans, $1.1 trillion of core commercial real 
estate loans and $150 billion of multifamily loans. By far the most 
problematic of these are the construction loans, which contain high 
proportions of both loans to home builders and condo construction 
loans. Moreover, exposure to construction loans rises rapidly as one 
moves from large money center banks to smaller regional and local 
banks--the four largest US banks have an average exposure of less than 
2% of total assets, while the 31-100 largest banks have an average 
exposure of about 12%. Given that prices are down 40-45% on stabilized 
commercial properties, they must be down vastly more than this on newly 
completed or only partially completed properties. I expect that loss 
severities on defaulted construction loans could approach 80-90% in 
many cases. 90+ day delinquency rates are currently in the 12% range 
for construction loans in bank portfolios, but are somewhat higher for 
construction loans in regional bank portfolios. In fact, I am perplexed 
by the fact that construction loan delinquency rates are only 12% at 
this point. However, I believe that this can be explained by the fact 
that they are typically structured with interest reserves which are 
sufficient to cover interest payments until the expected completion of 
the project. Thus, construction loan delinquency rates are currently 
artificially low due to interest reserves, but will likely rise 
dramatically within the coming 6-12 months. In my view, losses on 
construction loans are likely to be in excess of 25%, possibly well in 
excess, which would imply losses of at least $140 billion. This, of 
course, would be disproportionately borne by regional and local banks.
    In terms of core commercial real estate, the story is much the 
same, at least qualitatively. Again exposures are much higher for 
regional and local banks than for the largest money center banks. The 
four largest banks have an average exposure of 3-4% to commercial real 
estate loans, while smaller regional banks have an average exposure of 
15-20%. I also believe that core commercial real estate loans in bank 
portfolios are likely to be riskier than those in fixed rate CMBS. 
There are two main reasons for this view: First, bank loans tend to 
have fairly short terms, typically 3-5 years, while fixed-rate CMBS 
loans have much longer terms, typically 7-10 years. As a result, a much 
higher percentage of bank loans will have been made at the peak of the 
market and will come up for refinancing at the bottom of the market, 
the 2010-2012 period, when they are least likely to qualify. Second, 
bank loans tend to be used to finance transitional properties, while 
fixed-rate CMBS loans typically finance stabilized properties. Loans on 
transitional properties are generally riskier than loans on stabilized 
properties, particularly in a economic downturn.
    The view that core commercial real estate loans in bank portfolios 
are likely to underperform those in CMBS is supported by the fact that 
delinquency rates for bank loans have for many years far exceeded those 
of CMBS loans. As of the end of Q1 2009, the delinquency rate on bank 
commercial real estate loans was approximately two and a half times 
that on CMBS loans.
    In terms of specific loss estimates, it is reasonable to assume 
that loss rates on core commercial real estate loans in bank portfolios 
will be at least as large as those of the 2005-2007 vintage CMBS 
loans--which I expect will be in the 12-15% range. This would imply 
losses of at least $120-$150 billion on banks' core commercial real 
estate loan portfolios.
    The problems facing commercial real estate are severe and will 
likely take many years to resolve. There are no easy solutions. 
However, there are measures that can be taken that will help mitigate 
the pain and disruption of this process. By far the most important of 
these are steps that promote the recovery of commercial real estate 
financing markets. In my view, these should focus on reviving the 
public securitization market. I expect that over the coming decade the 
amount of capital from traditional sources (e.g., banks, insurance 
companies, pension funds) committed to financing commercial real estate 
will decline significantly. It is absolutely critical that a 
revitalized CMBS market be able to step in and fill the void. The CMBS 
market worked effectively and efficiently for well over a decade and, 
with the right changes, is capable of playing a vital role again in the 
future.
    I thank you for your time and am happy to answer any questions you 
may have.
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        Prepared Statement of Representative Michael C. Burgess
    Thank you Madam Chair, and I would like to thank the witnesses for 
testifying here today.
    Loan defaults in the commercial real estate market are one of those 
issues that have been on the fringe of the financial crisis since the 
beginning of the financial collapse. The observed lack of ability to 
securitize home mortgages in the secondary market was certainly an 
indicator that the commercial markets were in a similar position, yet, 
they're not fixed. So, I'm interested to hear the witnesses' suggested 
approach to address this very complex problem.
    In my observation, the situation in commercial real estate has the 
potential to cause equal or more collateral damage than the problems in 
the residential mortgage market because a default by a developer on a 
major multi-unit apartment complex or double-decker shopping mall 
obviously affects more lives than a default on a single family home. 
You can clearly see the domino effect from a default of that nature 
which leads me to believe that these probable defaults do carry the 
systemic risk gene if not the ``Too Big to Fail'' factor we've heard so 
much about in this committee. As Mr. Parkus points out in his 
testimony, commercial real estate financing markets are closed for 
loans in excess of $25-$35 million, so from that assessment it appears 
the biggest firms are most at risk of failure here.
    Placing the potential back-end collateral damage aside for a 
moment, it seems the only probable solution is some form of government 
guarantee or a regulation to extend all properly performing commercial 
mortgages to an unknown point in the future when these financing 
markets are functioning again. Either choice carries some serious 
government intrusion into commerce and into the relationship between 
contractually bound parties. I agree with Ranking Member Brady's 
assessment that we need to repeal punitive tax treatments and tax 
increases that will undermine economic recovery efforts.
    After what we've witnessed over the last 10 months in the financial 
markets, I'm concerned that Congress simply doesn't have the tools, the 
resources, or the will of the public to use the government to back 
another private market and their participants. Our guarantee is 
tarnished, and as a result, this will be a very tough situation to deal 
with legislatively.
    I do hope we have a constructive and informative dialogue about 
this problem and with that, I yield back my time.
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