Vulnerability of Banks and Thrifts to a Real Estate Crisis

Abstract

As part of its extensive off-site monitoring efforts, the Federal Deposit Insurance Corporation (FDIC) has evaluated banks' and thrifts' vulnerability to the stress of a real estate crisis similar to the crisis that occurred in New England in the early 1990s. Asking what would happen to banks and thrifts today if the real estate market were to experience a downturn similar to the one in New England a decade ago, we developed the history of the collapse of the New England real estate market into a stress test - the Real Estate Stress Test (REST) - that produces ratings comparable to the CAMELS ratings. The REST ratings indicate the severity of the exposure to real estate and therefore identify institutions that appear vulnerable to real estate problems. The ratings direct the attention of examiners to particular institutions and indicate that the FDIC should be especially concerned about the management of real estate lending at these institutions. Poor practices there could expose the FDIC to substantial losses.This article explains how the model was built with the use of New England data and was tested with the use of data from other historical real estate crises. The REST results for December 2002 are presented and analyzed, and recent trends - both nationally and for selected states - are discussed.