ill the future of mortgage finance look like? This week, MortgageOrb talked with Jack Chimento, principal of commercial real estate lender and advisory firm Palisades Financial, about what we can expect. Chimento also analyzes the current dysfunction both within and surrounding the commercial real estate finance market, including what went wrong with the Troubled Asset Relief Program (TARP) and when conditions might improve sufficiently to spark a recovery. [b]Q: [/b]When might we see liquidity start to return to the commercial real estate lending markets? What factors might affect the time line? [b]Jack Chimento:[/b] There are a couple things that have to happen. First, the yield curve needs to re-steepen, which is currently taking place. In order to spark the return of liquidity to the commercial markets, the banks need to start making money. Banks do not make money in a flat yield curve. A steeping yield curve gives the banks the ability to earn themselves out of their current predicament. Secondly, confidence needs to be reestablished. The TED spread [the difference between the interest rates on interbank loans and short-term U.S. government debt] got to historic wides by October 2008, and banks effectively stopped lending to one another. At that point, the TARP was introduced. The result was the beginning of a significant narrowing of the TED spread. Increased confidence in the banking industry will lead to tighter spreads and more lending among counterparties. In general, profitability and confidence among the banks are needed to bring liquidity back to the commercial real estate market. This process should evolve over the next 18 months. [b]Q:[/b] What should be done with the TARP, Term Asset-Backed Securities Loan Facility (TALF), etc.? Should commercial real estate developers and related market players have access to these or similar facilities? [b]Chimento: [/b]First, I think we should account for the first $350 billion of TARP money and evaluate the effects of the bailout. It doesn't seem that the goals and strategy of this money were well planned, and these procedures need to change for any future bailout money. With the TARP money, there was a tremendous amount of confusion. Financial institutions were unsure what to do with the money they received. Upon receiving this money, executives learned quickly that they couldn't run their businesses they way they used to – not that their way was the formula for success, but they had to accommodate and answer to the government. What we are seeing now is that a lot of company executives who received the money are now regretting it. I think the ones who can afford to do so would really like to give the money back so that they don't have the government essentially running their business. I feel the government and banks have learned from the first rounds of bailout money, and the next round will deal more effectively with the issues that presented themselves at the introduction of the TARP program. For the TALF money, I think disbursement should be done in stages and work its way down the food chain, starting with commercial banks, followed by investment bankers and then hedge funds and private equity funds. By allowing this process to gradually evolve, developers and other market players would gradually be given proper access to this money. It is one thing to lend against an AAA asset versus valuing a toxic asset to determine value for lending purposes. The problem continues to be how to price these securities on balance sheets in an unstable market environment, where everyone is a seller and the bid and offer is too wide to complete any sales. The Treasury is presently introducing a program to give direction and financial support for the disposition of these toxic assets. If successful, this program will free up bank reserves for renewed lending and create the needed liquidity for this market. [b]Q:[/b] What is your view on recent and future interest rate cuts? What direct and indirect roles do interest rates play in commercial mortgage lending and borrowing? Where might these rates go? [b]Chimento: [/b]The current rates are among the lowest we have seen. They really cannot go much lower. In an effort to keep the market going, the federal government cut Treasury rates in an attempt to create as much liquidity in the market as possible. The current rates are a reflection of that cut. If the federal government continues to press for never-before-seen levels of debt for the next fiscal budget, rates will move up due to inflationary pressures they represent. That said, you could see 10-year Treasury trading at 4.75 within the next 12 months. [b]Q: [/b]Is private money the wave of the future for commercial mortgage lending? Conversely, what challenges might private money firms face? [b]Chimento: [/b]Right now, private money is in the best position to capitalize in the current market environment. These firms have fewer restrictions to leverage and regulations dealing with deployment of capital than their counterparts at the bank. This situation, however, will change and begin to level the playing field if and when private equity accepts bailout money. Moving forward, we will see more competition and a fight for business, which makes for a good market for the borrowers. But it will take at least a year to get to this point and really turn around the current trend, bringing optimism back to banks and the market in general. It's going to be a completely different animal as we move forward. Firms will not be as profitable as they were in the past. As Wall Street tries to figure out how to make money going forward, expectations about profits will be reduced, and price-earning multipliers will go down. We have never experienced anything like this before – at least nothing as violent as the current market. In prior periods of financial meltdown, we never saw financial giants like Bear Stearns, Fannie Mae, Freddie Mac, Lehman Brothers, Washington Mutual, Countrywide and AIG all close or be taken over within a year. The model that made these and other institutions is broken. A new business model needs to be created in order to survive in the new order of banking – an environment with greater transparency and oversight.