Posted on 03/05/2024 9:51:42 AM PST by Red Badger
This is the first of a three-part series
Doomsaying, as Jonah complained to God, is a game that a doomsayer cannot win. This applies in spades to predicting a financial crisis. If proven wrong, the doomsayer is discredited. If proven right, he may be blamed for helping to precipitate the crisis by undermining public confidence.
Far be it from me, therefore, to predict a US financial crisis in the coming months. However, indicators that a US financial crisis might occur during this session of Congress, described by this first part of a three-part essay, warrant prompt attention, especially by the Republican Caucus of the House of Representatives, to two questions:
First, if a financial crisis does occur this year, will the still little-tested financial-sector-funded bail-ins authorized by Title II of the Dodd-Frank Act, enacted in 2010, prove adequate to obviate the Biden administration’s asking Congress again, as in October 2008, to appropriate funds to bail out the financial system? The second part of this three-part essay discusses why financial-sector-funded bail-ins might fail to obviate a bailout.
Second, if the Biden administration does ask Congress this year for funds to bail out the financial sector, then how might the House Republican Caucus best respond? For House Republicans to support another bailout of Wall Street, or even to fail to prevent one, would outrage tens of millions of populists who dominate Republican primary elections.
However, for House Republicans to nix a bailout needed to mitigate an incipient economic contraction could enable Democrats to shift onto the Republican Party the preponderance of public blame for that contraction.
The third part of this three-part series suggests that the House Republicans might best respond to a 2024 bailout request by conditioning their support for it on prior enactment of legislation eliminating obstacles to profitable private conversion of banks, which are limited-liability corporations, into proportional-liability financial firms that would be less prone to default and would not need government insurance of their depositors.
To convert all banks into such financial firms – without any change in their employees, payrolls, physical plant, equipment, deposits, depositors or financial assets including outstanding loans – would render financial crises less frequent and less acute, and would lastingly obviate government bailouts of the financial system when such crises do occur.
The obstacles impeding profitable private conversion of banks into proportional liability financial firms appear to be wholly governmental. The greatest of them is government insurance of bank deposits, which reduces the profitability of such conversions.
By conditioning House approval of one last financial-sector bailout on prior enactment of legislation mandating imminent elimination of the governmental obstacles to the profitable private conversion of banks into financial firms that are less default-prone, need no deposit insurance and will generate fewer and less severe financial crises that will not require government bail-outs when they do occur, the House Republican Caucus could avoid blame for refusing to mitigate an incipient economic contraction in a way that does not alienate the affections of working-class populists who loathe having to bail out rich and systematically corrupt financiers.
In doing so, House Republicans would also seize a rare opportunity presented by a financial crisis to remove governmental obstacles to a simple, robust, and profitable private reform of the financial system that would make it lastingly more efficient and more stable. Opportunities to do so much good at so little cost are so rare that if a 2024 financial crisis presents one, all Americans might end up remembering that crisis as a blessing in disguise.
The Quarterly Banking Profile (QBP) for the third quarter of 2023, released by the Federal Deposit Insurance Corporation (FDIC) on November 29, reported that US banks’ “unrealized losses on [non-equity] securities totaled US$683.9 billion in the third quarter, up $125.5 billion (22.5%) from the prior quarter, primarily due to an increase in mortgage rates that reduced the value of mortgage-backed securities” – the same sort of financial instruments’ overvaluation that proved unsustainable in 2007-08, precipitating the last US financial crisis.
That QBP stated that only $76.5 billion of those $683.9 billion in unrealized losses were held by community banks. It also showed that US banks’ unrealized losses on non-equity securities, which were never greater than $75 billion for any quarter from the start of 2008 through the end of 2021, grew to nearly $300 billion in the first quarter of 2022, have exceeded $450 billion in every subsequent quarter and exceeded $650 billion in the third quarters of both 2022 and 2023.
On February 29, the FDIC announced that its QBP for the fourth quarter of 2023, will be released on March 7. For reasons not stated, it will be released a week later after the quarter’s end than the three prior QBPs, which were released on November 29, August 29 and May 29, 2023.
The unrealized losses quantified in the FDIC’s QBPs are merely those of US banks, deposits in which the FDIC may be obligated to insure against bank default. Data on the unrealized losses of the whole US financial system, including non-bank financial firms, seems not to be collected or published by any government agency.
A former economics professor who has decades of bank risk-assessment experience working at the Bank for International Settlements, the US Federal Reserve, the IMF, the FDIC and the Basel Committee on Bank Supervision, recently suggested that the above-cited FDIC data may greatly understate the unrealized losses of the US “banking system in aggregate,” which he estimated to have amounted to about $1.5 trillion at the end of September 2023.
The extent to which the high-interest rates on US government debt that are now distressing the US financial system can still be blamed on money supply contraction seems questionable. Data for the broad US money supply, M2, released by the Federal Reserve on February 27, indicate that M2 increased from $20.565 trillion on October 30, 2023, to $20.949 trillion on January 8, 2024, before falling to $20.751 trillion on January 29 and rising to $20.877 trillion on February 5, 2024, the most recent M2 data publicly available.
In the 99 days from October 30 to February 5, M2 grew by 1.52%, at a rate equivalent to more than 7.9% per year. Diverse indices suggesting that US aggregate price inflation has not decelerated in recent months seem unsurprising in light of the recent M2 data.
Moreover, the Federal Reserve fully controls only overnight interest rates. Even if it stops fighting inflation between now and this autumn’s elections, medium- and long-term default-risk-free interest rates may remain high if high future price inflation is widely expected. The central government’s burgeoning fiscal deficit may render such expectations increasingly difficult to dispel.
The US banking system is afflicted not only by default risk-free interest rates higher than those paid by banks’ long-term debt assets but also by the growing risk of collateral depreciation or default on debt held by banks.
The greatest source of collateral depreciation or default risk to US banks appears to be commercial real estate (CRE) mortgages, especially office building mortgages. On February 12, the Mortgage Bankers’ Association reported that $929 billion in US outstanding commercial real estate mortgages, including $441 billion held by banks, will come due this year – a 28% increase from the $728 billion that matured in 2023.
A large proportion of these CRE mortgages maturing in 2024 are mortgages on office buildings that may have a market value substantially less than their book value due to unprecedentedly high office vacancy rates resulting from increased electronic working-from-home by white-collar workers during and since the Covid lockdowns of 2020-2021.
During 2023, the US office vacancy rate rose to an all-time high and hit 18% in January 2024, according to one industry report, and 19.7% according to another. Diverse reports suggest that a large proportion of outstanding US office mortgages have been bundled into transferable commercial mortgage-backed securities (CMBS) comparable to the residential mortgage-backed securities, Wall Street’s systematic and arguably fraudulent overvaluation of which helped sustain the decades-long US housing bubble that burst in and after 2006.
The same commercial-mortgage industry analysis firm that estimates that the US office vacancy rate was 19.7% in January 2024 also estimates that the delinquency rate (by loan balance) of office mortgages securitized into CMBSs tripled during the past year, from 1.9% in January 2023 to 6.3% in January 2024.
Although US office listing prices reportedly fell only 1.8%, on average during 2023, Capital Economics reportedly estimated in December 2023 that average US office prices paid fell 11% in 2023 and will fall another 10% in 2024. Morgan Stanley reportedly has projected that US office prices may fall as much as 30% from pre-Covid levels.
Some partly empty office buildings that have been able to service decade-old maturing mortgages with interest rates of around 3% a year may prove unable to renew their mortgages at the higher rates now required. Many outstanding office mortgages reportedly are “zero-principal” or “interest-only” debt that leave the creditor owning 100% of the equity in an office building when the mortgage matures.
When such an office mortgage matures and cannot be renewed, the mortgage creditors realize a loss – which only creative accounting can delay booking – equivalent to 100% of the decline in the market value of the office building.
On February 20, the Financial Times reported that US banks’ delinquent commercial real estate loans had grown to about $24.3 billion, equivalent to about 70% of their reserves, from $11.2 billion, equivalent to about 45% of their reserves, a year earlier. The same article reported that the value of delinquent commercial real estate loans held by the six largest US banks has nearly tripled, to $9.3 billion, during the past year.
Of those six banks, only one, JPMorgan Chase, now has reserves greater than the value of its delinquent commercial real estate loans; two of the six banks, Citigroup and Goldman Sachs, have reserves worth less than half the value of their delinquent commercial real estate loans, the FT report said.
Growing default-risk threats to the US banking system are also posed by rising delinquencies on relatively short-term consumer debt, notably credit card debt and automobile loans.
The “charge off rate” on consumer loans from US commercial banks –the proportion of nominal par value lost to default, net of collateral recovery – rose every quarter throughout 2022 and 2023 to 2.65% in the fourth quarter of 2023 – a level higher than has been observed since 2008-2011.
The portion of US consumers’ credit card debt and auto loans that is delinquent by at least 90 days rose throughout 2022 and 2023, to over 6% and nearly 3%, levels not observed since 2007-2011.
US credit card delinquency increased by an even larger proportion in terms of value, for the value of US credit card debt rose steadily from a Covid-lockdown low of 770,000 billion in the first quarter of 2021 to an all-time high of $1.13 trillion in the fourth quarter of 2023. Similarly, US auto loan delinquencies are a growing proportion of a growing volume of US auto loans, driven in part by rising auto prices.
That these credit card and auto loan delinquencies may continue to grow is suggested by an underappreciated datum in recent editions of the Employment Situation Report released monthly by the US Bureau of Labor Statistics (BLS): during 2023, all the growth in US employment was in part-time jobs, while full-time employment shrank.
This trend continued and accelerated in January 2024, during which, per the BLS, “The average workweek for all employees on private nonfarm payrolls decreased by 0.2 hours to 34.1 hours in January and is down by 0.5 hour over the year.”
This is consistent with recent massive layoffs of full-time employees and with the widely-noted transition of the US to a “gig economy” in which employment increasingly is temporary, part-time and with fewer benefits than employers are obligated to give to full-time employees.
Delinquencies and defaults on residential mortgages remained very low but that is scant comfort for the financial institutions that own those mortgages, which typically originated years or decades ago, when interest rates were far lower than they are now and which pay rates lower than banks must pay depositors today.
For those institutions, which now commonly might lose less by repossessing the mortgaged homes than by selling those mortgages, non-default is no blessing.
US consumers are increasingly defaulting on short-term high-interest credit cards and auto loans that are profitable to banks while dutifully servicing long-term low-interest mortgages that are unprofitable to banks. In addition, a growing number of US corporations are at a growing perceived risk of defaulting on debt securities that they have issued, some of which may be held by US banks.
Furthermore, on January 24, 2024, the Federal Reserve announced that on March 11 it would end its Bank Term Funding Program (BTFP), which it began a year earlier, the day after Silicon Valley Bank failed.
The BTFP was set up to lessen temporarily the insolvency risk of US banks by enabling them to borrow funds from the Fed for up to one year against the collateral of debt securities “valued at par” – valuations that can be far higher than market value due to recent interest rate rises. US banks have borrowed more than $160 billion of outstanding loans subsidized by the BTFP.
They appear obligated to repay, by June 12, 2024, the $102 billion that they borrowed under the BTFP between March 11 and June 12, 2023.
“Ichabod” is a former US diplomat.
Round about June things may get dicey. I’m guessing that the Fed will lower rates and accept the increase in inflation. There are no good options.
This is a listing with exterior pictures:
https://dc.urbanturf.com/articles/blog/a-look-at-8-office-to-residential-conversions/21558
[First, if a financial crisis does occur this year, will the still little-tested financial-sector-funded bail-ins authorized by Title II of the Dodd-Frank Act, enacted in 2010, prove adequate to obviate the Biden administration’s asking Congress again, as in October 2008, to appropriate funds to bail out the financial system?]
I ask myself that exact question every time I’m at the ATM.
Construction costs are still on the rise and securing financing is near-impossible right now. “Without the tax incentives, the economics don’t work,” says D.C. developer Oliver Carr.
This is largely due to a lack of windows, he says. Cutting into the building to add “light wells” is difficult and expensive.
https://www.axios.com/local/washington-dc/2023/08/12/office-to-apartment-conversions-washington-dc
Theoretically a mortgage tax could be placed on low-interest mortgages and the tax applied to the underlying bond payouts.
The communists figured out 120yrs ago that it is nearly impossioble to crash a capitalist economy to bring in a cultural revolution. This is why they took the long road to institutional control.
The Biden admin is the most anti business admin in US history. Yet the economy is growing.
I’m not sure what it will take before folks get out of the Great Depression II is coming mindset-but it is not coming.
> For House Republicans to support another bailout of Wall Street… <
Oh, come on now. Of course they will support another bailout. The House Republicans will just need is little smokescreen to fool the rubes back home. And four GOP votes is all that it would take.
“Yes, we supported the bailout. But in return the Democrats have promised to increase border security sometime in the next ten years.”
They can either drop rates give the heroin junkie another hit, that will spark inflation to grow even more rampant, and prices to rise even more. All very damaging to the economy. Or, they can keep rates high and the economy implodes. This is not 1980 when high interest rates can fix the problem. Back then we were the biggest creditor nation. Now we’re the greatest debtor in all of recorded history. Rising interest rates would kill us. They have painted them selves into a corner.
Either way, the pain train is coming. Prep and position your life and protect your health.
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