Japan made this mistake when its economy collapsed. However, there is no analogy to the mistakes made by the Japanese as long as we include the actual performance of the underlying loans in our analysis. Others argue that we need transparency, so investors can tell what the underlying assets are. But hold-to-term treatment will allow and encourage the disclosure of the underlying assets since reserves will be directly connected to the performance of those assets.

We effectively converted an asset class from a performance-based valuation to a trading value system. In fact, today commercial mortgages largely continue to perform with very low default rates.

A flawed premise

So why don't they trade? Because no price makes sense if we are arbitrarily setting a value and that valuation process makes every investor more fearful. One life company executive recently told me, “If I pay 50 cents today, someone will be in my office tomorrow saying it's worth 40 cents. Or worse, I'll actually try to buy at the advertised price of 50 cents. But if I try to buy a material amount at the offered price, the price goes up.”

Here is the issue: The premise of liquidity for this product is flawed. The ratings bestowed upon CMBS were at best compromised or maybe misunderstood; at worst, incompetent and conflicted. Were investors in this asset class really in need of liquidity, or was it just convenience? The premise of converting an asset class in the interest of the investor was incorrect. There's no transparency of value issue, only confusion and fear.

Wall Street sold, investors bought. Even when a new buyer needed to be found to buy the lower-rated tranche, Wall Street created solutions that were usually highly leveraged, and with sophisticated structures: collateralized-debt obligations (CDOs), structured investment vehicles (SIVs) and funds.

There was no question Wall Street could create it and sell it, but did they intend to convert an asset class? No. Did they intend to misrepresent value? No. They just wanted something to sell.

The point is that this asset class needs to be treated financially as we have always treated long-term mortgage loans: as long-term investments. We have approximately $800 billion of CMBS held by many of the finest institutions that had the need to invest in fixed-income assets to match fixed-income liabilities.

Why do we insist on bankrupting these institutions by creating an accounting tool that will require another public financial bailout? It's time to understand that liquidity is just one element of value. There are endless examples of valuable private investments that are not liquid — art, collectibles, antiques.

What's the need to devalue the CMBS investments by anywhere from 20% to 50% or even more, when the underlying asset is performing? This is not about protecting firms that intend to make money in the trading environment.

If a firm doesn't have corresponding long-term liabilities and is subject to a capital call at any moment, then it should not have purchased illiquid investments and it should be subject to a valuation based on mark-to-market value. Those firms fail because they don't have sufficient liquidity and did poorly matching asset terms to liability terms.

Call to action

Do we understand that if we proceed down this road, we will not only bankrupt these institutions, but also ultimately choke off capital to the commercial real estate sector? No matter how much cash we believe is in the system, it's difficult to lend and transact when the threat of devaluation is so arbitrary that hoarding cash is the only defense. The three-point solution is so simple it defies any argument:

1. Allow companies with long-term liabilities and sufficient liquidity to move any currently performing CMBS into the “hold-to-term” classification.

2. Reserve for anticipated losses based on actual performance of the loans supporting those investments.

3. Enforce restrictions on sale requirements and potential penalties if the company moves the asset out of this hold-to-term classification with the intent to sell.

Ultimately, financial health will relate to the performance of the asset and the ability of the company involved to actually match those assets and liabilities.

We are in the worst financial crisis in over 70 years. These simple steps will go a long way to calming the marketplace, and may resolve the institutional financial picture to the point that capital will begin moving again.

Most importantly, taking these steps may avoid the pending, unintended consequence of totally shutting down liquidity and destroying the commercial real estate market. It is critical to avoid further delays in addressing this issue.

Edward Padilla is CEO of NorthMarq Capital, a commercial mortgage banking firm with a $37 billion servicing portfolio. He can be reached at epadilla@northmarq.com.