An increasingly popular tactic that’s being used by banks to avoid writing off bad loans – and, in turn, taking huge hits on their capital – could be setting the stage for even more dramatic economic woes. The tactic is popularly referred to as “extending and pretending,” and it takes many different forms. Stretching out maturities and extending below-market interest rates are two of the most popular techniques. These strategies allow banks to prevent the default of billions of dollars of loans that were made during the real estate boom; however, they may be drawing out a process that could ultimately trigger their demise.

The Statistics of Extending and Pretending

To get an idea about how rampant the problem of extending and pretending is, one only needs to look at the statistics that are being bandied about these days. For example, the restructuring of commercial loans totaled $23.9 billion dollars at the end of the first quarter of 2010. That number is more than three times the total for the same period in 2009, and more than seven times the total for the same period in 2008. This reflects a dramatic spike in the number of commercial loan restructurings that have been granted.

According to Foresight Analytics, there is currently $176 billion worth of bad commercial real estate loans on the books. Even more troubling is the report, by that same agency, that approximately two-thirds of all commercial real estate loans that will mature between now and 2014 are currently underwater. In other words, more is owed on those loans than what the property the loans were made for is worth. In such situations, the likelihood of repayment drops dramatically. Banks could very well be delaying inevitable defaults. The main problem with doing so is that they aren’t setting aside the cash to accommodate future losses.

The Consequences of Extending and Pretending

In addition to setting themselves up for going under, the practice of classifying troublesome loans as “performing” – along with other extending and pretending tactics – is limiting the number of new loans that can be taken out. Some analysts believe that in order for the economy to make a true recovery, banks will need to let these bad loans go into default. By delaying the inevitable, then, banks could be playing a major part in the ongoing financial crisis. Legitimate new ventures that could pump new life into the economy are unable to get off the ground, since new loans are hard to come by. There appears to be no end in sight for this vicious cycle, and additional trouble could be right around the bend.