At the end of March this year, bank regulators announced a change to rules that were implemented after the financial collapse a decade ago to reign in reckless bank lending. This rule will relax regulations on commercial real estate lending, allowing “more deals to go ahead without an independent appraisal of the property’s value.”
Some worry based on recent history that this will only invite another crisis, especially at a time when the U.S. is fast approaching the ten year mark of recovery (the longest in history if it continues through next year) post recession. Others say that this will free up more money for commercial real estate leading to more deals.
Reasons to Worry about a New Crisis due to Relaxed Rules
“When you ease these standards, you invite a crisis,” says the President of the Better Markets think tank. Before the great recession which was propelled by the housing collapse in 2007, lenders were making increasingly risky loans. Big banks gambled with debt – instead of less is more, more became more – until the inevitable bust in the boom came.
Experts fear that exempting a full third of all property sales in the commercial real estate sector from appraisal will add more risk to the system. Relaxing these rules is eerily reminiscent to the total relaxed lending environment that preceded the last crisis in the first place.
In the wake of the collapse, the threshold amount of capital that had to be placed in reserves with the FDIC (Federal Deposit Insurance Corporation) and the OCC (Office of the Comptroller of the Currency) was lowered to $250K in commercial real estate in order to require an appraisal. Now, the threshold has been raised up to $500K ($100K more than was recommended by regulators based on current inflation).
These government agencies contradicted regulators, arguing that this rule change poses no threat to “the safety and soundness of financial institutions.” Regulators note that it was this difference in property value assessment and the hyperinflation of those values that made the housing collapse worse and that these rules were put in place to prevent another escalation in inflated property values.
Why Relax the Rules?
So why the risk if doing so could potentially cause another economic collapse just as the U.S. economy is beginning to see the headwinds of a looming recession on the horizon? Bluntly it’s competition from non-traditional lenders.
Big banks have largely left the playing field for commercial financing of real estate projects being undertaken by the booming entrepreneur sector of the economy to new startup lenders and non-traditional fintech firms. This is largely due to the regulations put on mostly the biggest banks because of the risks they pose to the global economy, not just the U.S. economy.
Some of the largest institutions want to compete in this space but rules, they argue, which were devised nearly 25 years ago should be updated. Big banks have an ally in the current administration, seeing the appointment of many in top positions at the Federal Reserve and the CFPB taken over by people largely against the Dodd-Frank Wall Street Reform Act that created the new protective standards for large lenders.