Andrew Lo, the director of the MIT Laboratory for Financial Engineering, and founder of the AlphaSimplex hedge fund, believes the next big meltdown will be in commercial mortgages (see Reuters article). While many traders and investors have been predicting that the CMBS market would be the next one to take a hit after blowups in the residential market, Lo is predicting that the losses will accelerate later this year as rates begin to be reset higher. Also of note is how Lo believes that it will be pension funds, and not the banks, that will be hurt the most when commercial real estate comes under additional pressure. In an effort to increase yield when the markets were more static, pension funds loaded up on CMBS in the years before the market meltdown. There is an expectation that many pension funds will now have a difficult time meeting liabilities, forcing the government to once again step-in with some type of bailout. While this is certainly not good news for the economy if the commercial real estate market was to play out as predicted by Lo, given the hits commercial real estate has already taken, the pressure pension funds are already under, and the number of bailouts which have already occurred, it is difficult to know - even in general terms - what the reaction and impact on the markets will be. Maybe this is the saddest realization of all.

The Worlds' Largest Hedge Fund (yes, that one, the one owned by you and I, the U.S. taxpayer) may now be adding additional securities to its portfolio. According to a recent Bloomberg article, the Fed is considering expanding the Term Asset-Backed Securities Loan Facility (TALF) to include loans for the purchase of Commercial Mortgage Backed Securities (CMBS). As you may recall, the TALF was developed to provide low-cost Federal Reverse loans that would be used to buy securities backed by consumer debt - essentially using taxpayer money to provide debt to help other taxpayers purchase the debt of still other taxpayers that took out too much debt [Yes, I know, using debt to solve a problem caused by too much debt does not really make sense, but I digress]. Anyway, since the TALF has previously been used to purchase securities tied to automotive debt and credit cards by offering three-year loans, why not try it now using five-year loans for commercial real estate? After all, it has been so successful for the auto and credit card industries (GM, Chrysler, and a White House Presidential scolding of credit card executives, notwithstanding - tongue in cheek, of course).

All kidding aside, it is hoped that such loans will create buying pressure for CBMS, thereby decreasing yields - many of which are near junk levels, making it unprofitable for banks to make new loans at such high yields. The down fall, of course, is that with such loans having a five instead of three year maturity, it will be even harder for the Fed to timely withdraw money from the system in later years, just when inflation is likely to creep back with a vengeance as the economy begins to hopefully recover. While maybe too late, at some point we are going to have to ask, are we preventing collapse and saving entire industries, or are we simply, and needlessly, juicing the system in order to save a few select companies, all the while unnaturally speeding-up the recovery? If the later, we may want to start planning for the hangover now.