What If Commercial Real Estate Had Collapsed First?

New York NYC skyline night

Just as large banks may be reaching the end of their housing-related asset writedowns, it appears as though the writedowns in the commercial sector are just getting started.

Only this time, the risk spreads well beyond the large, too-big-to-fail institutions, potentially taking down hundreds of local and regional institutions as well.

The timing and order of this raises a nausea-inducing thought experiment: What if commercial real estate had collapsed first, and housing only started to falter in the last couple quarters.

Would we, instead, be worrying about the tidal waive of small, failing institutions? It’s easy to imagine some of what people would be saying right about now:

  • There was no way regulators could have kept an eye on the thousands of tiny banks around the country! They should’ve been much more aggressive about having them merge.
  • Small banks are too exposed to a narrow market, and should have merged to diversify risk.
  • It’s too hard to coordinate a thousand small banks in a time of crisis. A crisis confined to big banks would make it easier to get a handle on the problem.

And on and on the argument would go.

Indeed, we did have waves of small bank failures in the past (e.g. the S&L crisis), which is what fostered a regulatory philosophy of promoting large, diversified banks that can weather the storm. Whoops, turns out not so much.

So now we’re going the other direction, and regulators are talking about bank size taxes and increased reserve requirements for large institutions — some of which might make sense.

But it’s scary to think how much mental horsepower commentators and regulators have put into understanding this crisis, and how the emerging conventional wisdom about bank size may be purely the result of accidental timing, rather than anything fundamental.

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.