Credit crisis may not be too strong a term for what is happening to the debt markets in the U.S. and elsewhere today. The scope of the problem is staggering. According to various reports in the financial press, worldwide debt underwriting has decreased by $2.3 trillion and the U.S. accounts for $1.3 trillion of that number as of July 2007. This decrease has resulted in a radical rolling readjustment of how both our financial institutions and our financial regulators perceive, evaluate and manage risk, and is occurring among financial entities of all sizes, from the smallest local credit union or community bank to the most sophisticated of our major banks and investment banks.

Because of the widespread and explosive growth of debt securitization, such readjustments are occurring at every level of investor participation, such as private equity funds, hedge funds, pension funds, municipal funds, mutual funds, funds of funds, etc. When you add recognized financial risks—credit, market, leverage and liquidity—to those inherent in financing brownfields—environmental and transactional—you get a perfect storm of funding unavailability.

The subprime residential mortgage market meltdown accompanied by the recent accelerated uptick in commercial mortgage market delinquencies have created, with a vengeance, a newly heightened concern for credit and market risks. Add to this the sea change in the Federal Reserve’s willingness to provide debt support to investment banks along with its past support of commercial banks, and you have, in effect, a revolution in U.S. financial regulation.

The Treasury Secretary has proposed merging all financial regulations under one umbrella, a kind of uber financial regulator similar to that in the U.K. This will keep regulatory issues on the front burner for some time. In the spirit of shutting the barn door after the horse is gone, with every acute financial readjustment or crisis, real or imagined, financial regulators and political factions on the state and federal level are quick to rush in with belated, onerous and often unneeded new regulations. This is not to say, however, that the Fed support for the purchase bail out of Bear Stearns by JPMorgan was a bad thing. It undoubtedly prevented a bankruptcy by Bear, and a chaotic run on other investment banks and funds.

Yet this all has the effect of creating additional debt paranoia on the part of both the providers and users of debt and provides new concerns for the balance of the financial risks mentioned above, as well as a new one (or an old one rediscovered): political risk. Further, triggered by the Fed’s action with Bear and consequently all investment banks in the future, there comes a renewed concern with the old problem of moral hazard.

Looking at these risks in more detail, we might guess where the debt crunch goes from here and how it is likely to affect the funding of brownfields and other real estate projects.

Credit/Market Risk
These are often a cause or result of each other and should be considered together. Providing debt to borrowers who have only the barest chance of repayment, with the expectation that constant increases in market valuation will provide sufficient equity in the event of default, is the height of absurdity. Every borrower needs skin in the game and every lender needs a real cash equity cushion.

The obvious case in point is the subprime mortgage market. Every asset valuation bubble in history has burst. What made us think that housing was any exception? Coupled with zero or little down payment and, in some cases, negative amortization, adjustable rates, and no income or credit checks, the surprise is that this crash did not happen sooner.

Expand this willful ignorance to include the packagers, sellers, resellers and purchasers of this now securitized financial junk, who did no due diligence on the underlying loans and bought into the ever-increasing housing market valuations, and you have a global credit crisis with enormous asset writedowns. Of course, this is now expanding into the commercial real estate market which has yet to play itself out. The belated crackdown on these risks by financial institutions and regulators will continue the crunch for the foreseeable future.

Leverage Risk
This risk can be summed up by the phrase, “Too much debt in proportion to equity.” Commercial, savings and other pure banks, by virtue of their function in society and their charters, are completely over-leveraged. All of their deposits are, in effect, loans from their depositors. Congress and the Fed recognize this and have countered the risk by intensive regulatory oversight and, in the past, by restricting banks from investment banking, which would expand their leverage even more but without the same oversight.

This world has changed in two key respects: banks are now permitted to participate in investment banking, and investment banks have become leveraged to an excessive extent. Again, from the financial press, Bear Stearns was leveraged over 50 times its capital and Goldman Sachs has $1.1 trillion in assets backed by $40 billion in equity.

Now that investment and commercial banks have access to the Fed discount window to alleviate the crunch when all this debt comes due, new and stringent regulations on investment banks, similar to that of banks, will be the result. The impact of this may be twofold. First, U.S. investment banks will become less innovative and therefore less competitive than their international rivals, who are less restricted. Second, there will be generally less debt available in the U.S. than before.

Liquidity Risk
When debt unexpectedly comes due and cannot be rolled over or replaced, liquid assets considered more than adequate can evaporate overnight. Bear Stearns’ liquid assets of $12 billion reportedly dropped to $2 billion in one day. An institution’s liquid assets are almost always inadequate if not fortified by a stable debt market or other assets that are readily marked to market and available for sale. This liquidity crisis, part and parcel of the credit crunch, forced the Fed to open the discount window to investment banks. These Fed borrowings are backed in large part by collateral that is not marketable by—yes, you guessed it—mortgage backed securities. If the markets do not recover in a timely fashion, the Fed is on the hook for the losses; or rather, the U.S. taxpayer.

Political Risk
By now, this risk should be self-explanatory. After the usual Congressional grandstanding (currently in progress), regulators become paranoid and overcompensate for past omissions, new regulations are promulgated and ill-advised laws are passed. Borrowers that should have learned some albeit hard lessons are bailed out, lenders become timid and refuse to lend in any meaningful way, and we slide deeper into the credit crunch, facing the final concern: moral hazard.

Moral Hazard
If anyone doubts the reality of the concern with moral hazard, simply think back to the savings and loan crisis. With loans to deposits insured by the government, questionable asset growth ensued—high-risk speculative condominiums and speculative commercial real estate—and when the inevitable real estate market crash occurred, the government (read taxpayer) again was on the hook. Theoretically, the regulators were minding the risk (exacerbated by the moral hazard), but such was not the case. The two situations are not completely analogous, but the moral hazard exists today when the government becomes the lender/guarantor of last resort in a financial world infinitely more complex and with geometrically more participants at risk than 20 years ago.

When one layers additional levels of risk and complexity that are part of any contaminated raw land (brownfield) deal with the current credit market and regulatory risk outlined above, aggressive financing for brownfields is not likely any time soon. However, credit crises come and go. Market-driven capitalism, despite well-intentioned but futile interference from the government, will again reassert itself. Brownfield redevelopment and the corresponding benefits to our society are now a critical part of our economic wellbeing. Prudent financing of such efforts will surely follow.