The lurking crisis of sovereign debt including that of the US remains a huge potential problem for the capital markets and the US economy as well as real estate values. Value is always a function of potential return and net present value of the future cash flows including, and most important, the terminal value at sale or refinance. For the past two years, and going forward for at least most of this year, the interest rates prevailing in the US and other major economies is artificially low. At the same time many of the major economies, and many smaller ones, continue to build up increasing deficits. The US deficit if ramping up at an alarming rate and there is absolutely no leadership from the White House to deal with this. It is now so serious that a bipartisan group of 64 senators had to write a public letter to the president to get involved. Instead he lets Harry Reid fight any budget reductions and stonewall any progress on this issue.

What does all this mean for the capital markets and real estate values? The world cannot continue to have increasing deficits, more fiscal and monetary stimulus, and inflation of oil and food prices, and not have increases in interest rates. Rates will rise by next year. Just look at the yield curve. In time many countries, including the US will be forced to raise rates to deal with inflation and to attract capital to fund these deficits. The magnitude of the federal capital needs, plus the magnitude of state and local government needs, the $3 trillion unfunded liabilities of the state and municipal pensions, will drive up rates and will also cause some level of crowding out of private capital. Taxes at all levels of government have to rise. Fees of all sorts will have to rise. Combine this with the clear intent of Elizabeth Warren and Obama to clamp down on banks and to materially squeeze profits out of all types of consumer lending and you will force the banks to raise rates on commercial lending to make up for these profit reductions. Lastly, lending underwriting for real estate will continue to be restrictive for quite awhile for the secondary type assets in secondary locations. That means to get financing to pay off maturing loans, borrowers will pay higher rates.

Over the next eighteen months rates will rise, and will continue to rise thereafter. Given the growing and unsustainable deficits at the sovereign level in the US and other nations, at some point in the next couple of years we will hit a tipping point if Obama and Harry Reid do not start to agree on fixing the problem. Prime Minister Cameron has shown real political leadership by tackling the issue head on and taking great pressure to do what is required long term. Governor walker and other governors like Christie are doing the same in the face of massive efforts by unions to stop them and to continue the old way of over paying teachers and other government worker, and way over promising on pensions.