Remember three years ago when the subprime mortgage market showed signs of collapsing? My articles about shorting the now-bankrupt NovaStar Financial -- whose now-pink-sheeted-stock has fallen from $116 when I suggested shorting it to a split-adjusted 25 cents and just warned it could file for bankruptcy -- drew significant hate from people who were positive its stock would go up. It took a few years, but by last summer the subprime mortgage market was collapsing. Worse, the subprime mortgage-backed securities (MBS) that institutions bought led to the near collapse of the global financial system.

But that's all over now and it's smooth sailing from here, right? Not so fast! Now a related market looks poised to implode and it remains to be seen how much damage that implosion will cause. I am talking about the $6.7 trillion commercial real estate (CRE) market and the parallel $700 billion CMBS industry.

This industry is suffering two problems: a spike in loan defaults, and a need to refinance loans in a market where there is little appetite for such refinancing. Specifically, the CRE loan default rate for August was up six-fold to 3.14 percent from the previous year. These loans were made based on optimistic assumptions about occupancy rates and rents -- which are now a joke as retail stores close their doors and companies fire the people who occupied desks.

And by 2012, $153 billion worth of CMBS loans are coming due and since the property values have declined so much, about two-thirds of those loans will not be refinanced -- even though the borrowers are paying the principal and interest on them. More recently, Realpoint found that the owners of 281 CMBS loans worth $6.3 billion weren't able to refinance when the loans matured in the past three months, even though 173 of them worth $5.1 billion generated sufficient cash to service their debt.

These problems could lead to another financial crisis. After all, many property owners are likely to file for bankruptcy when they can't refinance. This will force banks to write off the loans and take possession of the real estate. The banks will need to raise capital to offset the write-offs. And they'll throw those properties on the market so they can get them off their books -- which will further depress property prices.

Meanwhile, institutional investors who own the CMBS loans will be forced to take hits as well. This will cost investors plenty and add more headaches to those hoping to retire based on the returns from those securities.

Since March it seems we've had a break from the really awful news. But this looming CMBS crisis looks to be a source of big trouble.

Peter Cohan is a management consultant, Babson professor and author of eight books including, You Can't Order Change. Follow him on Twitter.


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