Last week saw me in New York, at what could prove to be a historic moment for both the US and potentially the world's financial markets, what with one of the widest sweeping shake-ups of US financial legislation since the Great Depression of the 1930s being signed into law.  Now let me share how if we just followed the lessons learnt from our childhood fairy tales, we would have constructed a more resilient bank.

Many of you may now know  that I have four children ranging in age from 4 to 14, and when dad returns from any overseas trip we always spend quality time together, playing games, reading books and the like.  This return from the States was no different. As soon as I stepped through the door, my four year old and six year old had their favourite books in hand and we snuggled down on the sofa.... This week's favourite was a good old fashioned English fairy tail - ‘The Three Little Pigs'.

You know the one - where the first little pig built a house of straw and then the big, bad wolf came along and huffed and puffed until he blew that house down!  As with every fairy tail there is always a moral to the story.  There certainly was for the poor little pigs in our story, for the first little pig went running to his brother's house.  The second little pig's house, while stronger than the first, was made of sticks and that wolf easily blew that house down too.

This got me thinking - have the banks that were weak or poorly conceived all fallen? Or will we see more failures against this unmeasured force?  Is the worst yet to come? If the first little pig was you and me, the retail customer  and that house collapsing was the subprime crisis, who is the second little pig? Is he the commercial customer? And what could possibly be represented by the house of sticks?

Could it be anything to do with the US$1.4 trillion in commercial real estate loans at are coming due over the course of the next four years in the United States, that's about US$300 billion per year.

Surely not.... Surely banks and bank supervisors have already addressed these issues after all between 2002 and 2008 CRE lending in the US almost doubled to $3.5 trillion. 

As Michael Mayo (managing director and financial services analyst at Calyon Securities) stated in his testimony to the US Financial Crisis Inquiry Commission back on 13th of January this year "I've been analyzing an ‘industry on steroids' whose prior achievements were artificially enhanced".

Most of the loans coming due were written when the commercial property market was raising between 2005 and its peak in 2008.  With prices now off of their peak and with nearly half of these loans now underwater it's no surprise to see that in 2009 the ‘Net Charge Off' (NCO) rates reached 200 basis points, their highest since the late 1980's.

What happens if that figure reaches 250 basis points in 2010, a jump of 25%?  Which isn't that unrealistic is it? 

Well that could really put stress upon the CRE portfolios of those US community banks that have a heavy balance in their assets and cause the big bad wolf that I call "recession" to come huffing and puffing at the house of sticks.

The catalyst could we be interest rates.  Most countries in the world, (at least within the G7 and for that matter the G20) are experiencing the lowest interest rates that most of us have seen in our lifetimes.   There is only one way for them to go and that is up, and when they do, floating rate notes (as most CRE loans are) will be put under severe stress leading to even more dramatic rises in the number of loan losses if real estate prices haven't recovered by then.

Would you agree?

Some countries have already started to increase interest rates in 2010, the most notable being Canada and some of the commentary coming out of the United States would indicate some form of raise in 2010. Ben Bernanke, chairman of the Federal Reserve, recently commented that the US economy faced "unusually uncertain prospects" and that he saw no immediate relief for a weak job market in the United States.  These remarks triggered a sell-off on Wall Street last Wednesday that saw the S&P 500 index fall by 1.28 percent.   It goes to show how fragile confidence still is and how close to the edge we still are. 

Banks have little, well actually no, control over real estate prices. 

Now  . . .  going back to the fairy tail, that always have happy endings, don't they?   

You can't build a house of stone out of a house of sticks without some radical redevelopment.  

So......  what are banks doing to take a page out of that third little pig's book?  What is being done to build a house of stone so that when Mr. Bernanke increases interest rates in the United States the Wolf's huff and puff can't blow the banks down?