The U.S. commercial real estate sector could be the next shoe to drop for the Federal Reserve; it may need some emergency triage. There were $3.66 trillion of commercial mortgage-backed securities outstanding at the end of 2019, more than one-fifth of the overall U.S. mortgage securities market. And the signs of distress are appearing.

Real estate investor Tom Barrack has issued dire warnings of a “domino effect” of margin calls, cross defaults and other related debt failures if financing in the sector dries up. To prove his fears might be well placed, Invesco Mortgage Capital Inc., a real estate investment trust, said on Tuesday that it can’t make its margin calls (demands for extra capital or securities that kick in when asset prices fall). It won’t be alone.

The coronavirus-inflicted crisis of confidence is also afflicting the primary market for commercial property debt as deals slated for sale aren’t being completed. A syndicate of banks led by Citigroup Inc. — and including Deutsche Bank AG, Barclays Plc and Societe Generale — has been left holding billions of dollars of debt on a Las Vegas casino deal, involving currently shuttered MGM Grand and Mandalay Bay properties, according to Bloomberg News.

This won’t be the last project that debt investors back away from, leaving the underwriting banks exposed. And unfortunately, this isn’t just about large, well-capitalized banks being overgenerous in financing risky projects. This could become a systemic problem if risk appetite is pared to the bone. If things keep heading in this direction, the world’s other central banks will be looking to take their lead from how the Fed’s prepared to respond. The commercial property market is under severe strain internationally because of the Covid-19 enforced shutdowns of retail and leisure businesses.

That said, the commercial mortgage-backed security market is considerably larger in the U.S. than elsewhere, and has a much wider variety of credit quality. In Europe, there are measures in place to manage the fallout from similar asset-backed securities, although commercial mortgage-backed stuff is rarer there. The European Central Bank doesn’t buy the latter, but it has already purchased more than 30 billion euros ($33 billion) of investment grade asset-backed securities in an ongoing program.

A crisis in commercial property could force the Fed and other central banks to ease up on a lot of accounting regulations, maybe by not making lenders mark assets to market prices and allowing more forbearance on loans. It might even require the Fed and the U.S. Treasury to build further on its bailout template from the last financial crisis and restart the Troubled Asset Relief Program (TARP) to buy toxic assets directly. It used the Public-Private Investment Program (P-PIP), unveiled back in March 2009, to buy legacy loans and securities.

This time around, the U.S. has already restarted the Term Asset-Backed Securities Loan Facility (TALF), but that doesn’t include non-public distressed real-estate assets and commercial property derivatives. 

The Fed has fired several bazookas in response to the virus crisis, including unlimited Quantitative Easing for Treasury bonds and residential mortgage-backed debt. It’s even buying investment-grade corporate bonds, to the despair of some. But it won’t end there. The wider risk now is how commercial real estate copes if the banking system gums up its access to financing.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

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