First in a three-part series; with reporting from Fox News analyst James Farrell

It's a compelling, comforting storyline.

The stock market is enjoying a bungee-cord bounce the likes of which have not been seen since the '70s, the housing market appears to be reviving, and economic green shoots may be starting to sprout from the fiscal fertilizer the government has spread around.

Not so fast.

Wall Street economists and analysts say they are now bracing for the second wave of the credit crisis, another tsunami of poisonous loans that could swamp the banks and a still floundering economy.

Prices in the $3.5 tn U.S. commercial real estate have fallen about 39% from the peak in mid 2007, according to the Massachusetts Institute of Technology's Center for Real Estate, with no signs of the plunge stopping.

The 39% drop in commercial real estate prices has already eclipsed the 27% decrease during the S&L crisis of the late '80s to early '90s. And losses from commercial property loans for housing complexes, strip malls, office buildings, hotels and hospitals are careening toward record levels not witnessed even in the S&L crisis, economists and analysts note.

MIT also says the 18.1% drop registered in the second quarter was the biggest quarterly decline in the 25 years since it first published the index.

And the derivatives, the ticking time bonds built on the backs of these potentially Kryptonite loans, could deepen the crater already blown wide open on Wall Street by the more than $1.5 tn in writedowns and losses taken so far in the housing and credit meltdown.

The problem now is, the US government, meaning taxpayers, may be called upon once again for even more bailout help for this struggling sector, beyond the $23.7 tn in gross exposures already in the bailout programs to date.

A bailout that has been hotly criticized for not being so cinematically picture perfect, although the stock market is behaving as if it was flawlessly executed.

This new wave comes at a time when the Federal Reserve has already blown out its balance sheet to twice its size before the crisis, and as the central bank is struggling with its exit strategy out of its own $6.8 tn in gross exposures in the markets, in order to get the plumbing right and avoid a double dip recession.

The Second Wave

Big and regional banks, as well as other companies, are at risk of more losses and writedowns, Moody's Investors Service reports. Insurance companies, General Electric, Fannie Mae and Freddie Mac are under threat, too.

Companies ramped up purchases in the commercial real estate during the go-go bubble years, typically executing a version of the carry trade where they exploited low short-term buildingrates to invest long, as the bubble inflated asset prices beyond recognition.

On top of overpriced housing assets, commercial real estate inflated the asset picture for scores of banks and companies across the country, a vestige of a laissez-faire property market that led to laissez-faire bookkeeping during the sugar-high bubble years, where artificially inflated assets led to more leverage and in turn synthetically boosted earnings--and executive pay.

But as prices plunge, shriveling valuations make it excruciatingly difficult for building owners to qualify for commercial financing in a credit environment that's now as tight as a miser's fist.

Companies are now struggling with loans and assets hanging like blacksmith anvils around their balance sheets, and they could be hung up by writedowns and losses for the next two years, hundreds of billions of dollars worth, analysts estimate.

Warnings from Federal Reserve, Congress, Finance Execs

The problem is so serious, the Federal Reserve in June quietly expanded one of its key bailout programs to deal with this second wave of the credit crisis. "We will certainly be monitoring the situation," Fed chairman Ben Bernanke recently testified about commercial real estate debt.

South Africa ZimbabweMoreover, Bernanke added, it could be that the government will need to take "fiscal" measures to help the market.

Translation: Yet another US taxpayer bailout for the commercial real estate market, using existing government programs.

The $3.5 tn "commercial real estate time bomb is ticking," and if it blows, it may lead to even more losses in the banking industry, said New York Democrat Rep. Carolyn Maloney, chairwoman of the Joint Economic Committee a Democrat, recently at a Congressional hearing.

Finance execs agree.

"Commercial real estate in the United States of America is going to get worse consistently over the next several quarters," Jamie Dimon, chief executive of JPMorgan Chase, said recently when he discussed his company's quarterly earnings.

Bad Datapoints in Commercial Real Estate

Already more than 5,300 commercial properties are either in default, foreclosure or bankruptcy in the ten biggest US metropolitan areas as of the end of June, more than double the number at the end of 2008, says Real Capital Analytics in a recent July 8, 2009 report.

Office buildings and strip malls number among the most "problematic," adds Real Capital Analytics, a research firm basd in New York.

About $2.2 tn of U.S. commercial properties bought or refinanced since early 2004 have gone upside down on their loans, meaning, they've fallen below the price at which they initially were sold at, Real Capital Analytics says.

Prices have dropped so far and so fast that about $1.3 tn of commercial properties have lost their buyers' down payment, notes Robert White, president of Real Capital Analytics in the report.

Furthermore, this study covers only office, industrial, multifamily and retail properties, and not hotels or land, which would likely "add billions [of dollars] more to the total," Real Capital notes.

And while many of these assets were healthy and performing, loans on them are rapidly turning over, making it difficult to get refinancing in an iced-over lending market.

US accounting rulemakers have already relaxed the rules governing asset writedowns, called "mark to market" accounting, where banks can now avoid writedowns by warehousing certain assets in line items reserved for securities held long term. 

But despite the relaxation, commercial loans still turn over more rapidly than regular mortgages, in five to seven to ten years time, and need to be refinanced or risk default.

At the end of the first quarter of this year, banks held about $1.8 tn in commercial real estate loans. About 7% of those loans were considered delinquent, nearly double the sum a year ago, Jon D. Greenlee, the Federal Reserve's associate director for banking supervision and regulation, recently testified to Congress.

Given the speed of the defaults, that rate will likely rise, analysts estimate. Greenlee also told Congress that a high number of small and medium-sized banks have "sizable exposure" to commercial real estate mortgages.

Much of the problem centers on the largest concentration of distressed properties, the biggest being in New York City, analysts note, with Las Vegas, Los Angeles, Detroit, Phoenix, Chicago, Dallas and Boston also experiencing high distress rates.

When Will the Defaults Start Flooding In?

Based on their vintage, approximately $1.4 tn of commercial real estate mortgage loans will be maturing within the next five years, and as much as $750 bn will be maturing in less than three years, says Steven Sandler, chief executive officer of the private equity firm Crosswind Capital in Rye, NY.

An estimated $165 bn to $204 bn in U.S. commercial real estate loans could be maturing this year alone, analysts estimate. All of these loans will likely need to be refinanced in an already jammed-tight lending market.

"Doing nothing is not an option," Rep. Maloney also noted, adding that this "looming crisis" could also push shopping center and hotel owners into bankruptcy, and hurt any chances of economic recovery.

Many banks are already reporting a steep rise in commercial loan defaults for property ranging from office buildings to shopping malls to hospitals to hotels. Most vulnerable are INDIA/retail, hotel and office properties near distressed housing markets and areas with high unemployment.

The problem is, the commercial real estate market depends mightily on a defrosted securitization market as well as increased business and consumer spending.

But the securitization market is still frozen over, with asset-backed bonds still priced for the Ice Age, and consumer and business spending still virtually moribund. Both of these twin engines fell off the commercial property jet over a year ago.

In turn, more than $200 bn of commercial mortgage-backed securities or CMBSs with initially gold plated Triple-A ratings were recently downgraded, causing banks and insurance companies who own them to put aside more regulatory capital to back them up. And potentially disqualifying them for government help, as the Federal Reserve will only accept Triple A collateral for its credit lending programs.

However, rapidly maturing loans pose more of a threat.

Banks and thrifts own more than $168 bn of the $204 bn in commercial mortgages coming due this year versus the smaller $19.1 bn maturing in the CMBS market, says Crosswind Capital's Steven Sandler.

All of this spells trouble for the still recovering U.S. banking system. There's a parallel here. Almost 20 years have passed since the Japanese property market peaked. Prices still fell by 4.7% last year, the Economist Magazinenotes.

The debate on Wall Street now is this: Is the US now in its own Japan-like, zombie decade?

Will Commercial Loans Qualify for Refinancing?

The prognosis is grim.

"As underwriting standards have now tightened, and commercial real estate values have fallen, and continue to fall, it is likely that the uncomfortable majority of that debt will not qualify for refinancing," Crosswind Capital's Sandler says.

"Most of the problem loans were originated in the bubble years of 2005-2007, when underwriting standards were loose, valuations were high, and rents were robust," he added, and since "none of those conditions exist today" and the market has severely retrenched, "real estate values will not support the re-issuance of all that debt at maturity."

The result will be massive maturity defaults, Sandler warns, "and commensurate losses that will sap capital from the lenders holding those mortgages. He adds: "Essentially, there is not enough capital capacity or valuation headroom for banks and commercial real estate borrowers to refinance their way out of this problem."

Why All that Cash on the Sidelines Is Not Enough

Crosswind Capital's Sandler says that "most estimates peg the money on the sidelines," at private equity groups, hedge funds, money management firms and the like, "in the range of $50 bn to $75 bn."

Using the higher estimate and applying a conservative leverage ratio to that figure, the prospective buying power of $75 bn in equity probably equates to $250 bn worth of buying power for real estate assets, Sandler figures.

But that is "only a portion of the value of distressed real estate and real estate debt ready to cascade to the deck," meaning, "there may not be enough committed capital to soak up the supply, and that will only depress prices, credit availability, and loan values even further," Sandler warns.

Who is Exposed?

Here's a breakdown from Sandler on which sectors are exposed to commercial real estate problems:

Commercial banks - $1.5 tn

S&Ls - $300 bn

CMBS/Conduit Issuers - $900 bn (meaning the money warehoused by financial firms and the like in off balance sheet entities, such as structured investment vehicles--it's unclear how much may come streaming back onto balance sheets thanks to new accounting rules);

Life insurers - $300 bn;

Fannie and Freddie - $190 bn;

Private lenders and others - $350 bn.

Notably, the life insurers' exposure to mortgage assets has grown 24% between 2003 and 2007, with much of that growth occurring between 2005 and 2007, the time when mortgage underwriting standards were most relaxed, analysts estimate.

Insurance company MetLife's chief investment officer Steven Kandarian said last month that "the worst is yet to come" for commercial property loans as defaults may rise for two to three years after the economic slump subsides, reports indicate.

Which Banks Could Get Hurt?

Big banks such as Wells Fargo, Citigroup, Bank of America, and Wall Street players such as Morgan Stanley and JPMorgan Chase are at risk from problematic commercial real estate financings now acting like blacksmith anvils on their balance sheets.

Smaller regional players like KeyCorp, SunTrust Banks, U.S. Bancorp and Regions Financial have recently reported an increase in the number of nonperforming commercial real estate loans.

Commercial real estate problems helped create losses at major Wall Street houses such as Morgan Stanley, now a bank holding company. Morgan recently booked a second-quarter loss of more than $1.2 bn.

Wells Fargo of San Francisco said 2.3% of its commercial real estate loans were nonperforming as of the second quarter, nearly triple the 0.8% level a year ago.

Wells Fargo bought rival Wachovia Corp. at the end of last year, and now is struggling with $138 bn in commercial real estate mortgages, surpassing the amount held by other lenders, analysts say.

Wachovia had blown out its balance sheet with commercial real estate during the bubble years, much as it did with its disastrous foray into 'pick a payment' or option mortgages, which let borrowers essentially pay the loan amounts they chose.

Almost 33% of Wells Fargo's commercial real estate loan book is linked to properties in California or Florida, two states smacked hard by the downturn in real estate.

Bank of America Corp. has $105.5 bn in commercial real estate loans, and J.P. Morgan has $67.6 bn, says the credit rating agency Standard and Poor's.

Citigroup's $306 bn government backstop to its balance sheets also includes taxpayer guarantees for its commercial loans.

Smaller banks such as Birmingham, Ala.-based Regions Financial Corp. are also exposed. So is SunTrust Banks, an Atlanta-based bank.

More than a fifth of SunTrust's $8.2 bn in commercial loans, $1.9 bn, are tied to construction projects that are now "nonperforming," or uncollectable, as of June 30. That's more than triple the amount SunTrust was dealing with at the same time last year, 6%.

At KeyCorp, a Cleveland-based regional bank, more than one out of ten of its $6.3 bn in commercial construction loans, or $1.2 bn, were nonperforming in the second quarter. That's more than triple last year's second quarter performance of 3% of construction loans that were recorded as nonperforming.

KeyCorp already has set aside $850 mn in its recent quarter for current and future loan losses. The bank got $2.5 bn in TARP money, and has raised $1.8 bn in common equity recently to deal with growing problems.

Synovus Financial Corp and Colonial BancGroup are also under pressure from commercial real estate loans.

Real estate investment trusts, or REITs, are getting hurt too. REITS, which are traded on major exchanges, are essentially either a corporation or trust which use the pooled capital of investors to buy and manage properties.

The trouble is, unlike mortgage terms that typically are 15 or 30 years, REIT debt generally comes due after just three to seven years and in turn must be rapidly rolled over--painful to do when credit has shut down.

Next in EMac's Stock Watch: Part 2: Commercial Real Estate's ticking time bonds; and Part 3: The government's rescue of the commercial real estate market--will it be enough, or will it be too late?