Spectre of default haunts US banks
The research head was of the view that the critically low foreign exchange reserves would not allow improvement in the rupee-dollar exchange rate. photo: file
The Covid-19 pandemic is almost gone, but it is still haunting the US real estate sector and its banking system. Large office buildings, vacated right after the outbreak of the deadly virus, are still empty as the work-from-home model has been increasingly adopted, causing hefty losses to owners of high rises and making it impossible for them to repay bank financing.
In another crisis, the eruption of Russia-Ukraine war in February 2022 triggered a spike in inflation across the world, which forced scores of central banks including the US Federal Reserve to jack up interest rate to record highs. This deepened the real estate and banking crisis in the world’s largest economy, which has long been a champion of capitalism.
The real estate-driven financial turmoil has taken its toll on a number of regional and small banks in America and has also badly shaken large financial institutions but they are believed to have survived the crisis.
The recent trouble at New York Community Bank and Japan’s Aozora Bank sparks fears among people that some banks may have started feeling the repercussions of the commercial real estate sector’s downturn, it has been learnt.
New York Community Bank unexpectedly reported on January 31 a loss for the fourth quarter of 2023 and slashed dividend by more than two-thirds. Its stock price fell nearly 38% that day, the largest decline in 30 years since its listing. The stock hit a 23-year low.
US-based global business magazine Fortune reported that some of the commercial real estate loans had been acquired from big banks such as JPMorgan, Bank of America, Wells Fargo and Citi. However, it is the primary business of regional banks, which is why the crisis is feared to hit the regional banking space hard.
Many commercial real estate developers and investors took out large loans after the global financial crisis in 2009 when rates were low, but these are maturing and due to be repaid in the coming years.
In the aftermath of the pandemic, many companies adopted a completely remote or hybrid work model, which has led companies, large and small, to shed a great deal of their office footprint. Take for example Fannie Mae and Wells Fargo, which both recently let go of hundreds of thousands of square feet of office space in Washington DC and Raleigh NC, respectively, the magazine added.
Read: Default probability not strong: Fitch
What is even worse than the current losses is that, according to the American Mortgage Bankers Association, commercial mortgage loans for hundreds of large US office buildings are due this year, with a total value of $117 billion.
By the end of 2025, with up to $560 billion in loans due, these property owners may have difficulty refinancing in the current high interest rate environment. A large number of commercial properties in the United States are facing difficulties in repaying or refinancing, which may further fuel banking crisis.
Federal Reserve Chair Jerome Powell delivered further bad news to the commercial real estate industry at the Federal Open Market Committee (FOMC) meeting. While he warned that a March rate cut may not happen, the Fed removed the following sentence from the policy statement: “The US banking system is sound and resilient”.
Sceptics say the Federal Reserve no longer believes that “the US banking system is sound and resilient” – is this sign of recent economic turmoil, or was it just a lie before, and now the banking dominoes are falling again.
The collapse also means that the US banking industry is no longer stable, and is also facing a potential systemic crisis.
Defaults could put pressure on regional banks. In December 2023, US economists found that 40% of office loans on banks’ balance sheets showed a negative equity, which could pile pressure on dozens of regional banks that hold those loans.
In a TV interview the other day, Powell said “it feels like a problem we’ll be working on for years…it’s a sizable problem (albeit) a manageable one” that is more likely to affect smaller or regional banks.
Talking to The Express Tribune, Pakistan-based independent analyst Adnan Agar said the US Federal Reserve had apparently delayed the first cut in its benchmark interest rate to May 2024 from the previously expected timeline of March 2024, severely impacting businesses and households as they heavily relied on bank financing.
He said new job opportunities in the US remained higher than expected with no significant impact from the high rate scenario. This situation has forced the central bank to keep delaying the rate cut for quite a long time.
The Fed is not reducing the rate despite a slowdown in inflation to 3.5% from the multi-decade high of 9-9.5% in the recent past. “The US usually finds inflation reading suitable at 2%,” he said.
The high interest rate is badly hurting households. They are defaulting on loan repayments including mortgage financing as a large number of employees in the US work on daily or weekly wages. Banks are the ultimate loser in this scenario.
The writer is a staff correspondent
Published in The Express Tribune, February 12th, 2024.
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