Comment by Nevermark
10 hours ago
The problem is the bank didn’t leave a buffer to meet their requirements, so arbitrage between reality and official reality comes to the rescue.
If a bank only loaned 60% of a buildings value, it could be devalued, the operator would eat the shortfall, but the bank could reappraise, with the loan continuing as before.
[So a regulation setting a banks maximum loan percentage, at a percentage less than they are required to maintain, is an obvious regulatory fix.]
However, another way to look at this from a banks point of view is while they may loan 80%, they might have been happy to loan 100% but for regulations. So perversely, they may not be as concerned about this happening as it appears.
For them, the 80% max loan is already providing a buffer, in terms of the risk they would be happy to take. So if they can avoid acknowledging they have loans that have risen in percentage terms, it is in their business interest to encourage, facilitate, giving operators breathing room.
And in the meantime, inflation, property value growth, and future demand increases provide three statistically “expected” ways for the situation to self-correct over time.
For financial investment products, all value is “expected” value.
And the operator may not be losing money, so much as paying for the buildings accrued value growth. Which would be a wash, but avoids the practical problems of defaults. Not the best, but not losing (as much) money as it appears.
And for the bank, if the loan payments are made there is no problem.
So there are two hidden buffers: banks willingness to loan more than regulators want them to, and natural property value increases, lowering rent prices (i.e. inflation) over time.
> The problem is the bank didn’t leave a buffer to meet their requirements
They did though. It was a $20M building and they only loaned out $16M, providing a $4M buffer. It isn't possible to require an amount that the value of the building could never fall below under any circumstances because that would require the loan amount to be zero. It's always possible for the value of the property to crash, e.g. it becomes contaminated with toxic waste and the remediation costs more than the property value, or the area's major employer shuts down and the area becomes a ghost town.
Meanwhile increasing the size of the buffer has costs that can exceed the value of a larger buffer, i.e. fewer people can afford a mortgage, which is both economically bad and not in the interests of the bank who wants to make more loans rather than fewer.
> However, another way to look at this from a banks point of view is while they may loan 80%, they might have been happy to loan 100% but for regulations.
The reason banks require a down payment instead of loaning out 100% of the value of the property is definitely because the banks want the buffer to not be zero.
> And for the bank, if the loan payments are made there is no problem.
But that's the issue. If they prevent the landlord from lowering rents to increase occupancy then they may not be able to make the payments anymore, and then the bank is screwed.