Banks and Real Estate: Regulating the Unholy Alliance

Banking and real estate have always had an uneasy relationship. It was not until early this century that national banks were even permitted to extend loans collateralized by real estate. To this day, national banks, bank holding companies, and many state-chartered banks are prohibited from owning real estate directly, except when obtained through foreclosure or if used for bank premises.~ In addition, savings and loan institutions generally have had authority to make commercial real estate loans and to invest in real estate directly for only a little more than a decade. The uneasy attitude toward bank involvement in real estate lending is not difficult to understand. Real estate lending has played a significant role in several of the major episodes of banking difficulties in the postwar era: in particular, in the mid 1970s through bank-established "real estate investment trusts" or REITs; in the mid 1980s among banks and savings and loans in the Southwest; and more recently among banks in the Northeast and (thus far to a lesser extent) in California. This paper will attempt to answer four key questions that the most recent real estate troubles have provoked. First, could the problems that banks in particular have suffered have been prevented or significantly minimized in any way by reasonably prudent regulation in advance? Second, did regulators actually make the problems worse once they