February 5, 2024 - 1:00pm
On the face of it, America is in a healthy economic position. The latest US labour report has found that over 350,000 new jobs were added to the economy, along with an unemployment rate stuck in the basement and a further uptick in wage growth that had already been pretty solid.
Despite the sharp rise in interest rates over the previous year, the economy is chugging along just fine, and workers are apparently managing to absorb the increase in their mortgage and credit-card costs thanks to their growing real wages.
But all isn’t quite as rosy as it seems. In another part of the economy, trouble is looming: the commercial real estate sector could be entering a crisis point. In particular, many smaller regional banks are proving to be a lot less resilient than their own clients, the retail investors that make up their deposit base.
After New York’s Signature Bank collapsed in the brief banking panic of spring 2023, New York Community Bancorp took over its assets. Last week, though, NYCB’s own shares collapsed after it posted a surprise loss. Its problem is that, like many regional banks, NYCB is particularly exposed to commercial real estate.
Ultimately, many ordinary people will be affected by the woes in this corner of the financial system. Pension funds in particular lean on commercial real estate for their income, so this could hit several of their balance sheets. More broadly, the sector may be a canary in the financial system’s coal mine: what happens there may not stay there, since there is a great deal of leverage in the American corporate sector.
There has been a crisis building in the commercial real estate sector for some time. Until recently, investors had kept troubled properties on the books in the hope that better days would return. But as time passes and the pressure to generate cash rises, they’re starting to go to market, with sometimes shocking results. For example, it emerged last week that the Canada Pension Plan recently offloaded its 29% stake in a prestigious Manhattan office block for $1. If one of the world’s biggest investment funds, which like many pension plans has a considerable exposure to real estate, is looking to cut and run, it could mean a fire sale is about to begin.
To forestall more such collapses, the sector is pleading for interest rates to fall. Therein lies the Federal Reserve’s dilemma. Since taking his victory lap in the fight against inflation back in December, Chairman Jerome Powell has been dialling back the rhetoric, and recent events suggest that this is a wise move. Indeed, economists remain divided on whether this is a blip or the start of a new inflation cycle, but it would be a brave bet to conclude that inflation is licked at this point.
If the Fed cuts rates too soon, it risks a resurgence of inflation. But if it cuts too late, asset markets could tumble. More banks could fail and this may trigger a chain reaction through this section of the financial system.
For Joe Biden, this could be a win-win. If interest rates are cut, the economy will get an election-year sugar rush. If they aren’t, the economy’s resilience will probably endure but property prices could fall, solving one of the economic problems for which Americans still blame him — unaffordable homes.
But for poor old Jerome Powell, there may be no good solution. It appears the chickens hatched by a decade of cheap money have come home to roost, and he’s struggling to find where to coop them all.
John Rapley is an author and academic who divides his time between London, Johannesburg and Ottawa. His books include Why Empires Fall: Rome, America and the Future of the West (with Peter Heather, Penguin, 2023) and Twilight of the Money Gods: Economics as a religion (Simon & Schuster, 2017).
jarapley
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SubscribeExcellent piece, but overly focussed on the American market. Germany and the Nordics are also in trouble (https://www.reuters.com/markets/europe/sweden-braces-property-storm-clouds-darken-2023-09-15/), and world waits with bated breath to see if last week’s collapse of Evergrande, the Chinese commercial real estate company, will prove to be systemic.
The latest US labour report has found that over 350,000 new jobs were added to the economy, — and in a few weeks, those numbers will be revised downward, as has been the case for the past 12-13 months or so. Each glittering report is later found to be something less than gold. And looking into the numbers finds an uptick in govt hiring and part-time work. But, hey; the stock market is doing great and nothing else matters. Except it does. As the case of commercial real estate shows.
No wonder some companies are clamoring for employees who were forced to work remotely to now come back. There is an enormous amount of commercial real estate debt that is coming up for refinancing. 2019 is not coming back. There will be fallout. There may well also be a lot converting of office space into residential to further the 15-minute city ambitions of the central planners.
Residential property prices aren’t going anywhere before the election unless rates really go down. No one’s selling because they don’t want to switch from a 2% to 7% mortgage and any new housing is still going to take a while to produce.
I suspect that people aren’t really absorbing the exorbitant increases to the cost of mortgage and other personal debt as much as it may seem. I think the extent to which people are willing to literally beg, borrow and steal (thinking of the Tik Tok investors/realtors I see, trying to dupe the last greater fools here in Canada to catch the falling knives they are holding), counting on rates returning to the record lows they see as “normal”, is greatly underestimated.
As a leftover from years of those silly low interest rates, people are simply all too willing to take on more and more absolutely ruinous debt on the assumption that their assets will soon enough start to inflate at the entirely unsustainable rates they became all too used to, and thus it will all be okay and they will never really have to pay for it.
Much like, on a wider scale, those keeping depreciating commercial real estate on their books on the assumption that things will go back to the way they were soon.
It will all start crashing down when people realize that even when rates start coming down, they probably won’t come down anywhere near as low as they were, or not fast enough for them to keep holding on, and they truly can’t hold on any longer.
Something in the air just feels kind of crashy, like that may finally happen pretty soon.
Yes and there’s another banking crisis in the offing. It’s a crock of merde.
Even worse is the reduction in real estate tax that large cities will reap when the prices of all that expensive commercial real estate gets marked down by about 50%.
Claiming inflation has been licked only means already high prices will continue to rise slower. Biden is toast.