The Doctrine of Preemptive Bailouts and the Biggest Bailout you haven’t Heard About: The U.S. Treasury Plan C and the $3.5 Trillion You will be Paying

Last week a story which gained very little traction hit the financial newswires. The U.S. Treasury is working on an internal project informally called “Plan C” which seeks to deal with further problems in the economy before they occur. The anonymous report came out stating the administration is reluctant to commit any additional money especially to the level mentioned in the report. However this is a disturbing new development in our bailout nation since this is one of the first times that the U.S. Treasury will try to preemptively deal with a financial problem.

The issues with this Plan C is that it is setup to be a buffer on further deterioration in various loan categories but the big one is commercial real estate. The commercial real estate market is gigantic and many of those loans are still active:

Some $3.5 trillion in commercial real estate loans are out in the market. The problem is complicated because commercial real estate holders simply rollover their debt into new loans. That of course has changed since the economy and credit markets have shutdown and many of these properties are now severely underwater. Take a look at how many loans will be turning over:

*Source: ZeroHedge

The amount of maturing loans in commercial real estate will double in 2010 and will continue upward into 2010. The chart is very clear and this is only for debt in CMBS and not held by regional banks which is over $2 trillion. This is the next multi-trillion dollar bailout you have yet to hear about. In fact, while many are discussing a second half recovery higher up officials are already planning a bailout for the commercial real estate industry. The challenge with this bailout is you are asking a public with 26,000,000 unemployed and underemployed Americans to shoulder the debt of largely speculative plays. To many it is palatable to bailout the residential real estate market because the public can understand that (even if it may be wrong) or bailing out the 2 large U.S. automakers. Yet bailing out the commercial real estate market is going to be a political nightmare.

Of course the U.S. Treasury would like you to believe this is merely a precaution but most of the last precautions we have heard about have turned out to be trillions and trillions in full on commitments shouldered by the American public:

“(WaPo) We are continually examining different scenarios going forward; that’s just prudent planning,” Treasury spokesman Andrew Williams said.

The officials in charge of Plan C — named to allude to a last line of defense — face a particular challenge in addressing the breakdown of commercial real estate lending.

Banks and other firms that provided such loans in the past have sharply curtailed lending.

That has left many developers and construction companies out in the cold. Over the next few years, these groups face a tidal wave of commercial real estate debt — some estimates peg the total at more than $3 trillion — that they will need to refinance. These loans were issued during this decade’s construction boom with the mistaken expectation that they would be refinanced on the same generous terms after a few years.

The credit crisis changed all of that. Now few developers can find anyone to refinance their debt, endangering healthy and distressed properties.”

The end of the road has been reached for commercial real estate. Many regional banks jumped into the commercial real estate market since they had little chance of competing with big subprime and Alt-A mortgage factories like WaMu or Countrywide. Many regional banks saw this as a way to stay competitive in local regions across the country. This is a much more diverse problem and the tentacles of the commercial real estate bust will be felt in every state.

These loans were made on strip malls, doctor’s offices, and drive-through restaurants for communities that are hurting from the recession. This is an enormous amount of debt that is out there that will surely default since there is no way to refinance this debt since many of these projects are literally underwater. Take a look at the composition of over 8,000 banks and thrifts across the country:

Factoring in construction and commercial loans you arrive at a stunning 26 percent of all loans in FDIC banks and thrifts. This is a staggering figure and the U.S. Treasury is well aware of this. The question isn’t whether there will be major defaults here but who will shoulder the cost? So far, each consecutive bailout has largely been taken up by the U.S. taxpayer. The problem of course is the cost of all these bailouts will eventually catch up through a tanking dollar and possibly the long-term viability of our economy. Plan C is a preemptive bailout on an entire industry. The reason the government is devising a plan is that these loans will start going bad in large amounts and they are gearing up on a process of dumping this large mess on the American people. Yet it is going to be a politically hard sell for many to bailout a strip-mall from some large developer.

And make no mistake, the market for commercial loans is all but closed:

You are reading the above graph correctly. In the 1^st quarter commercial loans fell by a stunning 50 percent on a quarterly basis. And the amount of bad loans is only growing:

If you haven’t heard of Plan C you soon will. The commercial real estate bailout is the next ploy from Wall Street and the U.S. Treasury.