Second Wave of Bad Economic News is Here

The New York Times is reporting that General Growth Properties, the largest retail mall operator in the country, is declaring bankruptcy, largely because of its inability to refinance its existing mortgage debt.

“Our operational model is sound,” Thomas H. Nolan Jr., the company’s president and chief operating officer, said on a conference call early Thursday morning, citing “the unprecedented disruption in the real estate financing markets and the need to extend maturing debt” as the reason the company filed.

“We made extensive efforts to modify existing maturing debt outside of bankruptcy,” he added.

More and more commercial properties, property owners, and the banks that provided highly aggressive financing based on questionable valuations, are going to find themselves going down this path in the coming months. In my opinion, that is one of the reasons the Obama administration is encouraging banks to keep TARP funds, and otherwise fortify their balance sheets. This is potentially a tsunami compared to what happened in the residential markets. On the other hand, there was not nearly the amount of re-leveraging and re-packaging of these loans into derivatives as there was on the residential side, so the effect may not be as widespread.

We have one more wave to come after this – of credit card defaults. The commercial real estate mortgage market collapse will be a bellwether of whether larger banks will survive. It is both a threat and an opportunity, because commercial real estate assets will be available at once in a lifetime bargain prices, and their owners and the banks that hold the notes will be more likely to bail on the current arrangements than individual homeowners ever could or would be. It’s going to look very strange, but large banks are going to be playing both sides of this market simultaneously. If the private banking industry pulls through this in the coming months, it will easily survive its credit card problems.