Banks Strong Enough to Ride a CRE Bubble

The Federal Reserve reports that valuation pressures in the CRE market are increasing but vulnerabilities in the U.S. financial system have moderated.
Katie Kuehner-HebertJuly 15, 2015
Banks Strong Enough to Ride a CRE Bubble

The commercial real estate market is heating up, but banks are in a stronger capital position to withstand any bubble bursts, the Federal Reserve said Wednesday.

“Valuation pressures in commercial real estate are rising as commercial property prices continue to increase rapidly, and underwriting standards at banks and in commercial mortgage-backed securities have been loosening,” the Fed said in a semiannual report to Congress.

However, banks are more resilient because of stronger capital positions and, overall, vulnerabilities in the U.S. financial system have moderated since the start of the year, according to the Fed report.

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While securities valuations are currently in line, the Fed is nevertheless watching out for any bubbles in financial markets, including in the CRE market, as well as leveraged loans and subprime commercial loans. In fixed-income markets, valuation pressures have eased.

The Greek debt crisis hasn’t impacted the U.S. financial exposure, but the Fed warned that “financial vulnerabilities from the situation could become more concerning if large European counterparties were weakened by a significant deterioration in peripheral European countries.”

Meanwhile, liquidity in bond markets appears healthy, even as the Treasury Department and several other agencies released a joint report on Monday calling for improvements in how liquidity should be measured. The report comes after banks and high-frequency traders were found to have a huge role in the “unusually high level of volatility and a very rapid round-trip in prices” on Oct. 14, 2014.

“All told, while the current level of liquidity in the on-the-run interdealer market seems healthy, some aspects of price movements and liquidity metrics in this market warrant careful monitoring,” the Fed’s report to Congress said.

The Fed report accompanied Fed Chairwoman Janet Yellen’s testimony to the House, where she was expected to reiterate that the Fed plans to begin raising interest rates later this year.

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