I Disbelieve The Economy

Via John Cole comes this Henry Blodget piece on our old friend commercial Real Estate, and why the collapse isn't quite happening yet but may soon will.

Most experts agree that one reason Japan's economy has taken so long to recover from its bubble crash is that Japan's banks spent the first decade in denial.

Specifically, when loans went bad, the banks didn't write the loans off--they lent the bankrupt borrowers more money so the borrowers could keep paying interest on the original loan. Thus, the bank and the borrower could pretend that everything was hunky dory.

Except it wasn't. Because the borrowers were bankrupt. And, eventually, everyone figured that out. And, finally, more than a decade into the collapse, the banks began owning up to reality and writing off some of the bad loans.

This practice, "extend and pretend," isn't always a bad strategy. If the economy recovers strongly and quickly, sometimes banks can make more money (or at least lose less) by working with with troubled borrowers who will eventually make good on their debts.  This is what most of the ideas to "save the housing market" have been about--encouraging banks to restructure mortgages to keep borrowers in their homes.  And sometimes, it actually works.

But, usually it doesn't--especially when practiced on an industry-wide scale, and especially when borrowers aren't just temporarily strapped. When banks "extend and pretend" just to avoid write-offs and protect their capital, they're just delaying the inevitable.  And the financial health they're bragging about in the quarterly reports becomes bogus.

And that's what appears to be happening in the commercial real-estate market right now.

Applied denial as lending policy.  The banks, flush with taxpayer money, are playing Big Casino again with the CRE market to keep the band playing.  Once the music stops however, the explosion is going to pretty much cripple our economy.  Basically the banks are throwing money at commercial real estate hoping magically that the market will turn around and that everything will be fine.

The irony of course is that businesses are doing everything they can to screw over their employees in this economy, and that's cutting their own throats on demand.  People are cutting back.  Meanwhile, banks are making the same bet with construction companies, building more commercial properties in the hope that the market will come roaring back.

All of this is going to detonate in our faces spectacularly and soon.  The question is when and how ruthless it will be when it happens.  The answer of course is that we'll have no choice but to bail out the banks again to the tune of trillions...again...and that cost will get squeezed out of every American.

The next decade or so looks really, really bad.  Standing around trying to disbelieve it will not solve the problem.