This is deeply concerning! New York Community Bank’s 40% stock drop, dividend cut, and unexpected loss signal potential trouble. Small banks remain vulnerable, especially with the looming Fed’s emergency loan program expiration.
Many of these small banks hold tons of exposure to commercial real estate loans.
70% of all CRE loans in the US are held by small banks.
If CRE project defaults continue, we could see more pressure on banks.
Follow us @KobeissiLetter for real time analysis as this develops.
— The Kobeissi Letter (@KobeissiLetter) January 31, 2024
The Fed Prepares for a Bank Crisis While Telling Americans the Economy is Strong
Last Thursday, Bloomberg reported that federal regulators are preparing a proposal to force US banks to utilize the Federal Reserve’s discount window in preparation for future bank crises. The aim, notes Katanga Johnson, is to remove the stigma around tapping into this financial lifeline, part of the continuing fallout from the failures of several significant regional banks last year.
This new policy is reminiscent of the Fed’s actions during the 2007 financial crisis, where financial authorities encouraged large banks to tap into the discount window, taking loans directly from the Federal Reserve, to make it easier for distressed banks to do the same. The hesitancy from financial institutions to tap into this source of liquidity is justified. If the public believes a bank needs support from the Fed, it is rational for depositors to flee the bank. The Fed’s explicit aim is to provide cover from at-risk banks, trying to hold off bank runs that are an inherent risk in our modern fractional reserve banking system.
By strong-arming healthy banks to comply, the Fed is escalating moral hazard and leaving customers more vulnerable. They are deliberately trying to remove a signal of institutional risk.
The regulator’s concerns about bank fragility are justified. The Fed’s low-interest rate environment meant financial institutions seeking low-risk assets bought up US treasuries with very low yields. As inflationary pressures forced rates upward, the market value of these bonds decreased in favor of new, higher-yield bonds. It was this pressure that sparked the failure of Silicon Valley Bank last year.
Additionally, the state of commercial real estate is a further stress for regional banks, which are responsible for 80 percent of such mortgages. In the previous low-interest rate environment, investors viewed commercial real estate as “a haven for investors in need of reliable returns.” Unfortunately, this same period experienced major changes in consumer behavior. Online shopping, remote work, and shared office space increased at the expense of traditional brick-and-mortar locations. Covid lockdowns only further amplified these trends.