The Next Shoe to Drop? Fed Focuses on Commercial Real Estate Problems

Sept. 16, 2009— -- Despite Federal Reserve Chairman Ben Bernanke's declaration Tuesday that the recession is "very likely over," some economists have expressed concern that a downturn in the commercial real estate market could derail the country's recovery.

Now, the Fed is ramping up its focus on this potential next big shoe to drop.

The Fed is undertaking a review of commercial real estate loans held by hundreds of smaller banks that have been hit hard by delinquencies, a Fed official told ABC News Wednesday. Supervisors hope to gain a better understanding of this issue, the official said, by comparing and analyzing results across a wide swath of these smaller institutions.

However, the official noted, this analysis differs from the stress tests used last spring to assess the health of the nation's 19 biggest banks.

Government regulators used the stress tests to determine how banks would fare under a worse-than-expected economic downturn, told certain banks to raise more capital, and released the results to the public.

This review of commercial real estate loans, the official said, represents increased attention on this issue, but nothing beyond normal supervision. The results of the review, the official added, likely will not be released to the public.

At a hearing on Aug. 4, Federal Reserve governor Daniel Tarullo said that the central bank was keeping a close eye on commercial real estate problems.

"Now that weaker housing markets and deteriorating economic conditions have, in fact, impaired the quality of CRE [commercial real estate] loans at many banking organizations, we are monitoring carefully the effect that declining collateral values may have on CRE exposures and assessing the extent to which banking organizations have been complying with the CRE guidance," Tarullo said.

In an interview earlier this week with ABC News' Diane Sawyer, Treasury Secretary Tim Geithner noted that risky commercial real estate bets could turn sour, but voiced confidence that the economy could overcome the challenges.

"I think that the U.S. economy can weather those pressures ahead," he said. "Because of the scale of support we provided to the financial system and that the government's committed to provide, I think we can manage and weather those challenges. We just got a lot of challenges ahead still and, you know, you just had a lot of people in a lot of industries, particularly in real estate, just take too much risk."