Most of us imagine recessions as a V shape on a graph. Things are good, then they go bad, hit bottom, and go back up again. Using the S&P 500 as a metric of the economy you can see we’ve got the beginning of a pretty good looking “V”.

Special note, this graph has been reposted WITHOUT the permission of Yahoo Finance. This is copywritten material, but I love Yahoo Finance so much I’m using the chart. Please Yahoo don’t be upset, you’re getting a free plug. I love you! I will however take it down if requested.

But sometimes our economy looks more like a “W” that’s suffered a stroke. That is to say we get on the road to recovery only to discover things are much worse than we thought. Few can argue that this recession started with sub prime mortgages getting out of control. Their collapse dinged finance hard enough that the entire banking and investment industry suffered. The ripple effect spread into the corners of the economy leading us to where we are today.

However some parts of the economy are slower to react. If these areas were to suddenly turn south things could get much, much worse. If we can recover before these aspects of the economy are affected than we’re good, but if we can’t pass that threshold in time we may end up in a whole new world of hurt. Imagine a river with two dams. The first dam broke which flooded the town below. Things were bad, but the town is starting to recover. When the dam broke the second dam which is closest to the city overflowed allowing this damage, but it did not break. Now in this recovery we’re in a hurry to fix the first dam before the second one cracks.

The first dam to break unleashing hell on the town was residential real estate. The one that’s holding, but may not for much longer is commercial real estate. What’s that? That’s Yankee Stadium, the Willis Tower (formerly Sears Tower), that apartment you lived in in college, and likely the building you work in every day. These are all properties that must be paid for. They are bought using financing, constructed using financing, and the people responsible for making those payments are running out of money. Like mortgages, they are financed with the help of banks, packaged into investments, and sold off to hedge funds, pensions, and anyone else looking for a “safe investment.” An estimated $3.5 trillion in commercial loans are currently in the marketplace. Much of this debt, like the mortgage real estate boom, was financed using easy money and questionable lending practices. Though the level of which is unknown, everything from bubble prices to falsified income statements exists in this market. In this way, there is not difference between commercial and mortgaged real estate.

Except that the commercial bubble hasn’t popped yet. It’s generally accepted that the bubble will deflate, however the rate is unknown and it could potentially pop as well. It’s also expected that commercial real estate loan defaults will increase to some very high levels not previously seen. Why is commercial real estate suffering? Because business is suffering. Shopping malls have less foot traffic and thusly sales, meaning that monthly payment is getting harder to make. That skyscraper downtown lost its biggest tenant and can’t get new businesses to move in. Your company was doing fine at their current rate but business has lagged and that five year teaser rate is over in October, it’s layoffs or moving.

This isn’t meant to scare you. The point is to make you aware that we may not be out of this yet. If the economy recovers so might business revenues allowing the commercial real estate market to stabilize. However even if the economy recovers this could still keep us from climbing out of this hole as fast as we’d like. Of course it’s entirely possible that this commercial real estate thing is so big it sends us into depression.

I’m not an alarmist. This could work itself out or not hurt us as much as some think. I just want to get you more informed. The links in this post are good sources of additional information.

Photo: springsun