The BIG Economic Implications of US Bank Failures

Dave Meyer:
Hey everyone. Welcome to On the Market. I’m your host, Dave Meyer and today is going to be one of those episodes where I fanboy a little bit. We have an economist who I’ve been following for many years and is one of the more respected, reputable economists in the country, Mark Zandi from Moody’s Analytics. He’s been covering the housing market and economics for Moody’s, which if you don’t know, we’ve had a couple of their guests on. It’s just a big analytics economics firm that does a lot of original research and Mark is one of their lead economists. Today, we go into an incredible conversation with him about all sorts of things. We start and talk about the banking crisis and Mark provides some really helpful, insightful information about what is going on, why certain banks are at risk and other banks aren’t.
If he thinks this is going to spread, what he makes of the government intervention. Then, we get into a really good conversation about how this is going to impact the economy as a whole, whether we might go into a recession, and of course, at the end we talk a lot about how the banking crisis and yes, it is still unfolding, but based on what we know right now about the banking crisis, if and how that is going to impact both the residential and commercial real estate market. So this is one of my favorite shows we’ve done. Mark is really … makes complex economic information, really easy to understand and he really does a great job shedding light on the particular strange economic climate that we’re in today. So we’re going to take a quick break and then, we’re going to get into our interview with Mark Zandi, who is the chief economist of Moody’s Analytics. Mark Zandi, welcome to On the Market. Thank you so much for being here.

Mark Zandi:
It’s a pleasure, Dave. Thanks for having me.

Dave Meyer:
Well, I hope you’re not too tired of talking about the banking crisis just yet because that is what we are hoping to pick your brain about.

Mark Zandi:
No. Yeah, it’s all that anyone wants to talk about, including my 90-year-old dad and mother-in-law, so it’s the top of mind for sure.

Dave Meyer:
Well, yeah, I think that’s true for myself and for a lot of our listeners, and we did do a show last week sort of talking about what happened specifically at Silicon Valley Bank and what some of the decisions and macroeconomic factors that led to that, but I was hoping to just talk to you in general about the US banking system right now and how much risk you see in the overall sector.

Mark Zandi:
Well, in general, I feel pretty good about it. Because of the post-financial crisis reforms, the banking system in aggregate has lots of capital. Capital is the cushion, the cash cushion that banks have to digest any losses that they might suffer on their loans and securities and it’s records, amounts of capital, particularly the big guys, the so-called GSIBs, the Globally Systemically Important Banks, they got capital everywhere. Plenty of liquidity generally, and pretty good risk management. So credit quality is excellent. I mean, if you look at delinquency and the charge off rates, they’re very low. They’re starting to push up a bit and they’re getting a little worrisome for bank cards and unsecured personal lines, which we can talk about.
Generally speaking, the quality is good, so I would’ve said the system is in very good shape coming into this. Now obviously, it’s under a lot of stress, given the increase in interest rates, which have been very significant over the past year and given the shape of the yield curve, that’s the difference between long and short rates because that’s what determines bank’s net interest margins of their profitability. They are under pressure and you can see that in the banking crisis that we’re suffering now, but generally speaking, the banking system is in good shape, about as good as I’ve seen it, coming into a period like this.

Dave Meyer:
That’s really helpful context because it doesn’t necessarily feel like that, and I want to ask a follow-up question about that, but first I wanted to ask, you said something about GSIBs, which everyone is probably learning this acronym all at once, Global Systemically Important Banks.

Mark Zandi:
Yep.

Dave Meyer:
You said that they are in particularly good shape. Is there a reason why some of these smaller and mid-tier banks are seeing particularly their stocks decline or have at least a higher perceived risk than these GSIBs, which I think for our audience are huge banks like Chase and Wells Fargo and Bank of America kind of banks?

Mark Zandi:
Yeah. One of the big differences is just the amount of capital and liquidity they hold because the GSIBs were deemed to be systemically important, meaning if they fail, they’re going to take out the entire system, regulation post-financial crisis. Dodd-Frank is the legislation that was passed in 2010, requires those big guys to hold a boatload of capital. I mean, just to give you context, you add up all the capital, again, that’s that cash cushion I mentioned earlier. It’s over 20% of their assets. That’s more than double what it was before the financial crisis. So those guys are almost financially meteor proof. I mean they were … because we’re so worried about them going under. The little guys, not so much and in fact, some of those Dodd-Frank reforms that were put into place back in 2010 were rolled back for institutions that were less than 250 billion dollars in assets.
Silicon Valley Bank grew from a 50 billion dollar to a 200 billion dollar bank very, very quickly, so they never got into that tougher regulatory regime. So they had less capital, less obviously liquidity, less oversight, regulatory oversight. We’ll have to learn more exactly what happened here in a good root cause analysis. At core, because they didn’t have the capital and liquidity, they were more vulnerable to the bank runs that they’re suffering and why they failed. So they just didn’t have the same resources the big guys had and the same kind of rock solid underpinnings to their finances that the big guys have in large part because of the changes after the financial crisis back a little over a decade ago.

Dave Meyer:
Great, that’s super helpful and I think it helps our audience understand why certain types of banks are seeing more risk and more fear surrounding them than others. You made some great points about why the banking system itself is in relatively good shape. Can you help us square the situation we’re in then? If the banking system is in relatively good shape, why are we seeing banks fail? And I think we’ve talked about that a little bit on this show, but why is there continuing risk and fear about the banking system right now?

Mark Zandi:
Well, the banks that failed are very what I call idiosyncratic, right? There’s been three failures of Silicon Valley Bank, Signature Bank and Silvergate. Silvergate failed a few weeks ago. Silvergate and Signature, they’re just crypto banks. I mean they cater to the crypto craze, which was highly speculative, lots of warnings about that market for a long time. Not surprising it crashed and it took out those two banks because they’re so intimately tied up in what was going on in the crypto market. In the case of Silicon Valley Bank, they’re tied into the tech sector. As we all know, the tech sector is under a lot of pressure for lots of different reasons. You even saw today Amazon laid off another 9,000 people. So the tech sector is under a lot of pressure, especially the small startup tech companies because they need capital to keep going because they run cashflow negative. They’re burning through cash.
So they need constant new equity raises, new debt raises, new capital to function. When the tech sector hit the skids, they couldn’t go out and raise more capital. So they were increasingly vulnerable. Their deposits were starting to run down and making the bank increasingly more vulnerable. So I think SVB is just more … Silicon Valley Bank, I’ll use that going forward, it’s just a lot easier to say, was really tied into the tech sector and got nailed by the tech bust. More broadly, the vulnerability is the fact that interest rates did rise a lot and what happened was with those rising rates, it makes the value of the treasury bonds and mortgage securities that all banks own worth less.
So if a bank is in a position where they have to come up with cash to pay off a depositor and have to sell those securities and they haven’t hedged that risk, meaning they haven’t offloaded that risk into the marketplace for a cost, then they’re vulnerable, because they need the cash. They’re selling these securities at a loss and taking big losses and they may not be able to fill the hole. So the system as a whole, that’s where the vulnerability is, but I think in general, again, going back to my original point, I think that risk is generally manageable across the system. This is not at all a surprise. This was well-understood, and most banks are very careful about their so-called asset liability management, that’s what this is, and hedged a lot of that risk.
So I don’t view the banking system writ large at significant risk of that threat, but that’s the one vulnerability that it has. The other banks that have failed, they’re again, very idiosyncratic tied into what’s going on with crypto and tech.

Dave Meyer:
In addition to the risk that you just cited, of the value of some of these assets and securities going down, what risk of panic is there? Because it seems to me that a lot of the risk comes from human behavior and psychology and not necessarily the bank’s balance sheets.

Mark Zandi:
Yeah, that’s a great point and that may be something that’s different this time than in times past that people … not that human nature has changed. As we know Dave, that never changes.

Dave Meyer:
Yeah.

Mark Zandi:
That never changed, that stays the same, and people are always subject to these kinds of concerns. Remember Jimmy Stewart, Wonderful Life. Bank runs have been around from since the beginning of time, since the beginning of banks.

Dave Meyer:
Someone else was talking to me about that. It’s a Wonderful Life.

Mark Zandi:
A great movie.

Dave Meyer:
If only George were there to solve the bank run, we’d all be okay.

Mark Zandi:
If only he was here, if only. So that’s the same but what makes this time a little bit different, maybe more than a little bit different, is how quickly people’s concerns can get amplified through social media, and that kind of what happened here with the case of Silicon Valley Bank, there’s lots of stories about some of the investors and depositors and customers of the bank publicly tweeting out that they’re getting out and anyone who has anything to do with the bank should get out, and I’m sure they said it in stronger terms and that went viral. So, you amplify these kind of concerns and risks. You go back to 1932 and that bank run Jimmy Stewart, Wonderful Life, you obviously didn’t have any of that, right? I mean it was a community that kind of angst fed on. So, not kind of a global social media platform amplifying these concerns.
So that raises some interesting questions about the future and how we have to think about these bank runs and what regulation needs to be put in place to alleviate the potential risk posed by these bank runs of the future. They’re again amplified by social media. I’m not sure I have an answer to that question, but that’s a question I think we should start asking ourselves going forward. Maybe because of social media and just the amplification of these worries, we’re going to see more bank runs in the future than we have historically, at least since deposit insurance will put on the planet back in the 30s.

Dave Meyer:
That makes a lot of sense about the social media component, and one of the things I’ve been wondering about is I have limited but some experience in the startup and venture capital world and it seems to me that part of the issue here was just the nature of how those businesses investors work together, where these startups get all their money from a very pretty small investor pool. I mean there are probably hundreds or thousands of venture capital companies, but not the big influential ones, there are several dozen and they have so much power in that scenario where maybe a couple of dozens of venture capitalists can send out emails, telling companies that have billions of dollars worth of deposits to withdraw their capital.
I can’t think of any other industry that has that type of power concentrated in just such a small amount of people, but to your point, that plus social media just creates this weird scenario where panicking can spread so quickly.

Mark Zandi:
Yeah. No, absolutely. I totally agree with you. I mean, again, it goes back to my point that it feels … I keep using the word idiosyncratic. It’s just unique. It’s different. It’s not your mother’s and father’s bank. It’s a very untraditional bank with a very different set of customers and with their own kind of issues that created this … I think this situation that we find ourselves in.

Dave Meyer:
Yeah, absolutely. So I know you have no crystal ball, but I do have to ask-

Mark Zandi:
I’ve got three, by the way, Dave. I don’t know if they were, but I got three of them. Yeah. Yeah.

Dave Meyer:
There you go.

Mark Zandi:
Yeah.

Dave Meyer:
Well, I’m curious what you think will happen from here. The government has obviously stepped in, a few different agencies have stepped in to try and stem the crisis. Do you think what so far the Fed and the FDIC has done to reassure depositors is enough or do you think there’s more uncertainty and potentially more bank failures or an extension of this crisis in our future?

Mark Zandi:
Well, I think the policy response has been impressive, massive, very different from what happened in the financial crisis. It took a long time for policymakers, the Fed, the FDIC and the Bush administration at the time to kind of kick in the gear in part because they hadn’t experienced anything since the 1930s like that, so it was just all new, but this go around, very aggressive response guaranteeing the deposits of all depositors, small and big in the institutions that failed and my sense is if not explicitly, implicitly suggesting that if another failure occurs, those depositors will be made whole again, small and big in the current environment where they’re concerned about systemic risk and bank runs. The Fed set up a credit facility to provide liquidity to the banks.
Those treasury mortgage securities I talked about earlier, they’re sitting on the balance sheet of the banks at a loss because of the run-up in interest rates. The banks can go to the Fed, post those treasuries and mortgages as collateral for a loan at par, so that … as if they have not lost any value. They got to pay a high interest rate for that, but that’s no big deal, I mean to meet deposit demands. Of course, the government has stepped in to resolve the weak links in the system either through shutting down institutions. We’ve talked about SVB and Silvergate and Signature or merging, that’s the weakened institutions and the stronger ones that we saw over the weekend when UBS, the big Swiss bank took over Credit Suisse, the troubled bank, which was troubled well before all this mess, but got pushed over because of this mess.
Then, organizing other banks to come in and step up and help banks that are in trouble. That’ll be the first Republic case. So the government is taking very aggressive steps to take those idiosyncratic, weak links out of the system, putting them over there so that people feel comfortable that the bank that they’re doing business with is money good and they’re going to get their deposit out. So I feel very good about that. There are other … if I were king for the day, there’s a few other things I’d be thinking about. There’s a big decision the Fed’s got to make here in a couple days around interest rates. There’s a reasonable probability they’re going to raise rates, another quarter point, which I just don’t get, in the context of this banking crisis.
I mean, one week you’re setting up a credit facility to provide liquidity to help take pressure off the banks and then, the next week you’re going to raise interest rates, which will put pressure on the banks. I have a hard time squaring that circle. So on the Fed, I might have … well, we’ll have to see what they do, but I fear they’re going to raise rates. In my view that would be a mistake, but let’s see what they actually end up doing here. Also, in terms of the guarantee provided to depositors, that’s institution by institution right now, it’s not a blanket. If someone fails, those depositors are going to get guaranteed by the government. I’m not so sure I would’ve done that in the current context. Again, I think this is an environment where bank runs are very possible and you want to make people very confident.
I would’ve just said in this systemic environment, and I’m labeling this systemic environment, it’s temporary, but here we are. I will guarantee all deposits of any failed institutions just to put anyone’s mind at rest, my 93-year-old mother-in-law’s mind at rest. I mean, why not just come on, just do that and then, we get to the other side of the crisis, then you get rid of that systemic risk exemption and you move on. So there’s things I would do on the margin that are different, but in the grand scheme of things, I think they’ve done a good job, a very aggressive response to the problems.

Dave Meyer:
Well, for everyone listening, we will know by the time this comes out, it’s comes … we’re film recording on Monday, the Friday it comes out, we’ll hear from the Fed I think between then.

Mark Zandi:
Yeah.

Dave Meyer:
Just about the deposit insurance, this seems to be sort of a hot button issue, right? People are, I think … many people seem to be tired of “Bailing out” banks, and I know you’re not a politician, but can you help us understand … and I know this is a little different there-

Mark Zandi:
I watched the politicians on TV, so I can play one. I can play one. Go ahead.

Dave Meyer:
So I know that technically, just so everyone knows what the FDIC has done, does not bailed out the shareholders of Silicon Valley Bank or the credit holders, they’re making whole any depositors who had some deposits at risk. Can you just tell us about, from an economics perspective, what is the rationalization for doing this when some people could argue that the bank was risky, they weren’t doing what they should have, shouldn’t have had proper risk management. Why are they getting some sort of special treatment and why is that necessary in the mind of the FDIC, and it sounds like you agree with it?

Mark Zandi:
Yeah, and the current environment, which is I think we can all agree, confidence is very brittle, people are on edge. Again, I’m getting questions from my mother-in-law about, is her CD safe? That’s the question I’m getting that gives you a sense of the level of angst out there. I think what I would call a systemic environment, meaning there is risks of bank runs of the system, problems cascading throughout the system and taking the entire system out. So that’s a judgment call, but if you buy into that judgment, then you’re saying to yourself, “Okay, what’s the least costly way to do this so that it doesn’t cost taxpayers money or cost them less?” So if I bail … if I say, “Yeah. Okay, I’m going to make all these depositors whole of these failed institutions,” the cost there is relatively small and maybe to taxpayers it’s directly nothing because those deposits are going to be paid out by the banks.
There’s a deposit insurance fund, they pay into the FDIC deposit insurance fund for times like this, and that money that they pay into goes to the deposits. Now, you could say, “Okay, well the banks are going to raise lending rates and lower deposit rates and ultimately, taxpayers are going to pay,” maybe, maybe not. Maybe it comes out of earnings. Maybe it comes out of bank CEO pay and bonuses. I’m sure it’s all of the above, but the bigger question is, if you don’t do that back to my judgment, then you’re risking the entire system and then, the cost to taxpayers is going to be measurably greater and it’s going to be a direct cost to taxpayers. It’s going to overwhelm potentially the FDIC’s insurance fund. So it’s just a question of how do I … this is a mess.
There’s going to be a cost and what’s the best way to resolve this and keep the cost down as well as possible? In my mind … again, it’s a judgment call, but in my mind and I think in the minds of the folks that made this decision, the treasury, the Fed, the FDIC, that this is the least cost way of going about doing it. As you pointed out, it’s not bailing out … the shareholder is getting wiped out and if they own shares in these banks, they’re getting wiped out. If they’re bond holders, I don’t know, we’ll see, but I suspect if they’re not wiped out, there’s pennies on the dollar. So it’s not like you’re … the executives are out of … they’re gone, they’ve left, they’re not not at the bank anymore. So you’re not bailing those guys out.
If you’re bailing out anyone, it’s you and I. We’re bailing each other out. So I’m on board … if you want to call it a bailout, go ahead, but I’m on board with that kind of bailout.

Dave Meyer:
Got it. That makes a lot of sense. Thank you. Thank you for explaining that. So I want to move on from the banking situation itself and sort of the direct things that are happening there and try and understand what some of the second order of implications are here. First and foremost, how do you see this … you’ve told us a little bit about the Fed, you think that they shouldn’t raise rates now. We’ll see what happens there. How do you think this could impact the broader economy?

Mark Zandi:
It’s negative. It’s just a question of how negative. I mean, the primary channel through what is going on in the banking system to the economy is through credit. Banks make loans to businesses and households, and because the banks are now under a lot of pressure and scrambling, they’re going to be much more cautious in giving loans to banks and to businesses and households. They were already turning cautious, and a lot of nervousness about the economy and recession risks, understandably so, given the high inflation and they’re up in interest rates. So, if you look at lending standards, they had already started to tighten those quite significantly. So loan growth hadn’t really slowed a lot, but it was going to slow anyway. Now with this, the banks, particularly the mid-sized and smaller banks that are under tremendous pressure are going to be much more cautious in extending out credit.
Auto loans, personal finance loans, business loans, C and I loans, the commercial real estate market is going to take it on the chin. The multifamily lenders were already struggling to get credit to start new multifamily property development later in the year, they’re building now because it reflects the underwriting environment back six, 12 months, 18 months ago, but a year from now, the lending development is going to be significantly curtailed by the lack of credit, which is now only going to get worse by this mess. Just to give you a context, if you look at the banks that are less than 250 billion in assets, let’s call those mid and small banks, they account for about a half of all C and I loans, commercial and industrial loans.
Those are loans from banks to businesses, they account for about half of all consumer loans, that’s credit cards and unsecured personal lines. They account for almost two thirds of CRE, commercial real estate loans. So they’re a big deal and if you know, they’re pulling back on the availability credit, then we see less lending. Less lending means less economic growth activity, less spending, less investment, less hiring. So, it’s a weight on the economy. Now, there’s going to be some offset to that from the lower rates. This goes back to … when I was talking about the Fed, I’m saying, “Hey fed, given what’s going on here that’s worth at least one, two, three quarter point rate hike, so why don’t we just pause a little bit here, take a look around, see what kind of damage this does.”
Then inflation, if it’s still an issue six weeks from now, that’s when you meet again. You start raising rates again, but let’s make sure the financial system is on solid ground, but we have seen some decline in a little bit on the margin in terms of mortgage rates. Not a lot, a little bit, not as much as you would think given the decline in treasury yields, and we can talk about that.

Dave Meyer:
Yeah.

Mark Zandi:
Corporate lending yields have come down ever so slightly, so maybe you get a little riff on the interest rate side, but the tightening and underwriting is going to overwhelm that. So the net of all of that, it’s going to slow economic activity, all else being equal.

Dave Meyer:
I want to get to the real estate part in just a minute, but you’ve been pretty vocal about what you call … I think call a slow session. So, I’d love for you to just explain that to our audience if they’re not familiar with that, and I haven’t heard since this crisis, if you think that the banking situation has altered your changing to your forecast of a “Slow session.”

Mark Zandi:
Yeah. This is about the economic outlook and the prevailing view at the moment is recession. The economy is going to experience a broad base, persistent decline in economic activity. I don’t think that’s necessarily our future, but I don’t like the alternative description, soft landing. That this isn’t going to be soft. As we can see, this is going to be a bit harrowing as we come into the tarmac. So, I didn’t like the soft landing description, so slow session seems to fit. It’s not a recession, but it’s an economy that’s not going anywhere. It’s very slow, sluggish, kind of flat line, and that’s the economy that I have been expecting to unfold here over the next 12, 18, 24 months under any scenario. That was before the banking crisis.
I still think odds are, that’s what’s going to happen here. The economy is amazing, really resilient. We can talk about that too, but I think that resilience will pay off, but having said that, I say it with less confidence today for sure, because of the banking crisis. So the odds that I’m wrong are definitively higher today than two weeks ago before this mess occurred. So I still think … I had lowered my growth projections, two, three, four tenths of a percent in terms of real GDP, growth over the next year. GDP is the value of all the things we produce. In a typical year, you grow 2%, so if you shave two, three, four tenths of a percent, that’s meaningful. So you’re going to feel that, but it’s still not to a place where we actually go into recession.
Having said that … again, I’m not as confident and having said that, the script is still being written as we speak, so we’ll have to see how this plays out.

Dave Meyer:
So in your mind, the slow session, we would see GDP growth, just some modest GDP growth just under that 2% normal rate?

Mark Zandi:
Yeah, maybe zero to one, basically going nowhere, flat. In that world, you probably might see some job loss, certainly not much job growth and you would definitely see unemployment rise. So unemployment would go from very low 3.6 to something north of four over the course of the next 12, 18 months. So again, that doesn’t feel like a soft landing. That feel is … it feels very uncomfortable, but again, not a full-blown outright recession, which typically would mean we lose five, six million jobs, unemployment goes to 6%. I think we can avoid that but I say again, with less confidence, and we’re now, even more vulnerable than we were before. We’re weaker, and if anything else comes off the rails and the other wheel falls off then very likely … and I can think a lot of things.
Debt limit is coming up here in the next few months. There’s a lot of things to worry about out there that could do us in.

Dave Meyer:
Yeah, definitely. There’s the overwhelming media narrative that you see is just mostly negative about the economy. In our industry, people listening to this, mostly in the real estate industry, it’s been a really tough year, last six or 12 months. So curious, what are the areas of the economy that you say are resilient and that you believe will help keep this, you, us out of a recession?

Mark Zandi:
Well, the obvious, businesses don’t want to lay off outside of tech. The tech is laying off, but those folks, at least so far, they’re getting hired pretty quickly by the other companies that have been starved for tech workers for a long time. So they’re not even showing up in the unemployment insurance roles. They get laid off and they’re ending up somewhere else. They’re not going to the UI, getting unemployment insurance, and I think it goes to the fact that labor markets have been very tight and will continue to be very tight going forward. Just demographics, staging out of the baby boom generation, my generation, me, I’ll never leave Dave, but-

Dave Meyer:
We need you.

Mark Zandi:
Weaker immigration for lots of reasons, and that’s key to our growth in the labor force. So labor markets are tight. So businesses say … thinking to themselves, “Look, it’s going to be real … on the other side of whatever this is recession, slow session, whatever, if I think fast-forward 18, 24 months from now, I’m going to be back to how do I find people and how do I retain people? And I’m not going to make that worse by laying off workers now.” Now I may … and I am expecting that they hire less, right? So, you have natural turnover and right now, turnover is a little elevated from where it was. People have been quitting their jobs at a higher rate, all of that is coming in. That creates an open position, but businesses aren’t filling those open positions quickly.
They’re slow walking, they’re hiring. So that way, you can manage your payrolls or labor costs without laying off workers, and if you don’t lay off workers, if we don’t see significant layoffs across the economy, I don’t think we get a recession, because you need those layoffs, to go back to what we were saying earlier about psychology, to scare people saying, “Oh my gosh, I’m going to lose my job or I lost my job, or my neighbor lost their job, or my kids lost their job and I got to help them out.” Then, you pull back on your spending and that’s a recession. Everyone running into the bunker and stops spending, but if you don’t get the layoffs, it’s harder to … you can get there, I suppose, but it’s a lot harder to get there, and that’s a fundamental difference, what I’m just described in the labor market, job market than any other time that I’m aware of, historically.
So very, very different kind of backdrop. I can go on, but that’s I think a very clear reason why I think the economy is resilient and can be able to navigate through some of these hits without going into a full-blown outright downturn. Does that make sense?

Dave Meyer:
That’s super helpful. Yeah, it does. I’m just curious what other economists, as so many people are forecasting a recession, see differently?

Mark Zandi:
Well, okay, I can do that too, Dave.

Dave Meyer:
Yeah, let’s see the devil’s advocate side.

Mark Zandi:
I can do that too.

Dave Meyer:
Let’s do it.

Mark Zandi:
Well, all right. I mean, it goes back to psychology and then, what happens is the economy weakens, it weakens, it weakens, you start getting more layoffs in the construction trades, which we haven’t seen yet. For example, you see more manufacturing layoffs, labor markets starts to ease up, unemployment starts to rise and then, some businesses say, “Oh, maybe it isn’t going to be so hard to find workers and it isn’t going to be so hard to retain them. By the way, I’m really worried that I’ve got these high labor costs and no business. I’m losing money, cash flow and I’m going to cut.” Then, the layoffs become suffering and forcing. People see layoffs and more people out there looking for work, they become less concerned about their tight labor market. It kind of feeds on itself and then, you get the layoffs and then you get the pullback and spending, and then, you get the recession.
So it’s kind of … one of the metaphor, I’m not sure what it is, it’s like you’re bending a piece of metal that’s the economy, all these pressures that they’re bending, bending, bending, and I’m saying it’s not going to break, but you get to a place, at some point, it breaks, and that’s kind of how I think about it in a kind of metaphysical sense.

Dave Meyer:
Okay, great. That was good, devil’s advocate. I appreciate it.

Mark Zandi:
Yeah, there you go. I told you I could do it.

Dave Meyer:
I can see both sides. Obviously, I mean, I think as an economist, you probably say this all the time, what you’re describing is you’re telling us what you think is the most probable scenarios, but it’s not like other futures are impossible.

Mark Zandi:
There are many possible futures and again, the risks here are very high, uncomfortably high. So yeah, in fact, that’s what I do for a living. It’s about kind of the scenario in the middle of the distribution of possible outcomes, but for most thinking business people, it’s about the whole panoply of possible outcomes, and how do I think about navigating in those different worlds and what kind of probability should I be attaching to those worlds, to those different worlds? So it’s not about one scenario, we all kind of fixate on that. It’s about this distribution of possible outcomes.

Dave Meyer:
I love that. I think that’s so important for people to understand that when anyone gives their … any honest person gives their opinion about what might happen in the future, I’m not saying this is definitely going to happen or this is the way it is. People are trying to understand the different possible outcomes and tell you what they think the most probable outcome is, but obviously, anyone who’s honest knows that their forecasting is not always going to be correct.

Mark Zandi:
We all do that. We all forecast something … people say, I don’t like to forecast. Well, everybody on the planet is forecasting all the time. That’s exactly … people don’t think about it, but that’s exactly what they’re doing. They got, “Oh, this is what I think is going to happen, but it could be this, it could be that, and I’m going to think about the range of possibilities and how I would behave and navigate given those different possible outcomes.” So everyone is doing that. The economist, just makes that process explicit, as explicit as they can.

Dave Meyer:
Well, you’ve done my job for me, you’ve done a great transition into the last thing I want to talk about, which is of course, the real estate market, and you’ve hit a bit on commercial real estate and how you think at least funding for new projects might get hit, but I’m curious, what are some of the scenarios or more probable scenarios you see both for commercial and the residential real estate markets?

Mark Zandi:
Well, I think the single family side where I spent a lot of my energy, obviously, that’s gotten crushed in terms of housing demand. Home sales are back to kind of levels you don’t see since in the middle of the pandemic or in the financial crisis. Single family housing isn’t already in recession. I will say I think the worst is over in terms of sales. I don’t think they’re coming back fast until affordability is restored, and that requires some combination of lower rates, higher incomes, and probably some house price declines. So I do expect more house price declines here over the next couple of years. In fact, our baseline kind of in the middle of the distribution is for a 10% roughly peak to trough decline in house prices from the last summer or through probably the end of 2024.
So I think single family, the worst on sales and we’re getting pretty close to the worst on construction. Not quite there yet, but we got more to go in terms of house prices. Multifamily as you know has been rip-roaring great, but I do think it’s going to have a comeuppance here. It’s already started in terms of rents because you have more supply coming into the market. Demand has been hurt because rents are just too high. Not only is it unaffordable to own a home, it’s unaffordable to rent, as well at this point. So, you have a weaker demand and more supply. Vacancies are going to start to move north, and that’s going to keep pressure on rents. I do think we’re going to see some meaningful weakening in new supply down the road, given what I just said about underwriting and tightening of lending.
And I do expect some price declines. Prices are pretty high, and I do expect some adjustment there, but on the rest of CRE, I don’t want to paint with too broader brush, but I think it’s pretty fair to say office has got a big problem, particularly big city urban, those towers. Remote work is here to stay. It’s not going away. There’s been some pen swinging back of that pendulum, but as technology improves and as new companies form and optimize around remote work and they will not optimize around an office space, we’re going to see weakening demand. By the way, going back to my point about demographics, one of the implications of that, very little job growth going forward. We’ve been used to a 100, 200, 300K per month. I think everyone needs to get used to 50K per month, 25K per month.
That goes to absorption of office space. So I think office has got some serious adjusting to do, particularly again … Again, I’m painting with a broad brush, but particularly in those big urban centers. Retail, centered in those urban areas, they got problems because they cater to all those office workers. I think industrial probably … that actually got a big lift during the pandemic because of all the movement of goods and services. I think it’s still going to be fine, but probably somewhat diminished on the other side of all that, but generally speaking, I think real estate is going to be in terms of residential and CRE has got some adjusting to do. There’s going to be some adjustment here over the next couple three years in terms of everything.
Prices and rents and everything. Some further adjusting to do. It just depends on the property type location, just how significant that adjustment will be. There’s such a whole podcast in itself, Dave. That’s-

Dave Meyer:
It’s many podcast, yeah-

Mark Zandi:
As you know. Yes, right. Yeah. Yeah.

Dave Meyer:
Yes, it definitely does, but it’s super helpful to know and yeah, commercial is its own thing, but I think the majority of our listeners are mostly involved in the residential space.

Mark Zandi:
Is that right? Okay.

Dave Meyer:
Yeah. It sounds like you think we are in a correction, but it’s not a bottom falling out kind of situation where prices are going to go into some sort of nose dive, more single digits, maybe 10-ish percent declines.

Mark Zandi:
Yeah. No, I don’t … I mean, I would say that the best of times are over. I mean, those were pretty darn good times not too long ago.

Dave Meyer:
In terms of price appreciation?

Mark Zandi:
Yeah, in rents. Everything was going north and that’s over. You got a lot more supply coming into the market. Vacancy rates have hit bottom or start to rise, but I would agree that … and I think you’re going to have opportunity if you have cash, you should … because I think prices will come down for lots of multifamily rental property, and you’ll have an opportunity to step in at some point, but I do think in the longer run, it’s going to be a good investment because fundamentally, what really matters is homeownership, and I’m talking now through the business cycle, 10 years, 20 years out. If you look, homeownership is going to be under pressure. So the homeownership rate is going to decline, which flip of that means higher proportion of the population is going to rent over the next 10, 20 years.
So I think that fundamental support to the market will prevail over a long period of time. In the near term, there’s some adjusting to do, but again, if you have cash, I view that as an opportunity because prices will … prices have gotten way too high. I don’t know but I look at a lot of these properties, if you do the kind of basic Excel spreadsheet thing, you could make it work really. You had to really stretch your imagination. You couldn’t convince a bank … Well, maybe, tell me where that bank was though. I’m not sure what they’re doing now. Now, you got … so once prices come back in, then some of these spreadsheets will start working again.

Dave Meyer:
Yeah, I mean, absolutely. You’re looking in commercial where the cap rates are lower than interest rates on a risk-free asset. You can do better on a 10-year treasury, even two year treasury, than on buying a multifamily, and the treasury is a lot less risk than the multifamily. So something has to change there. Totally, great.

Mark Zandi:
Well, as we know Dave, looking at the banking system, you have to sell it before it matures, that could be a problem.

Dave Meyer:
There you go. Yeah, that’s the lesson. That’s the lesson we’ve learned.

Mark Zandi:
Or, please hedge it.

Dave Meyer:
Yeah. Yes, please.

Mark Zandi:
Yeah.

Dave Meyer:
The last question I want to ask you before we let you get out of here is you said something about mortgage rates and that bond yields have dropped over the last couple months or weeks, excuse me. Mortgage rates, you said hadn’t declined as much as you would’ve thought. So I’m curious if you could just give us your take on mortgage rates right now and where they might head over the course of the year.

Mark Zandi:
Yeah, the mortgage rate, the 30-year fix is roughly equal to … and the way I think about it, the 10-year treasury yield plus a spread. The spread is a function of lots of stuff. Origination costs, servicing costs. If it’s a Fannie and Freddie loan, a G-fee. Then, there’s also the compensation that the investor in the mortgage needs for prepayment risk, the risk that they get paid back early, and that prepayment risk is elevated when you have a lot of volatility in rates. And you have, as we know, a lot of volatility in rates. So that spread is very wide. So the 10-year treasury yield today is three and a half percent. The 30-year fix is six and 660, something like that. That’s a 310 basis point spread. Typically, long run, it’s 150, 175 basis points. So that gives you a sense of magnitude.
It’s going to stay elevated like that as long as the environment remains as uncertain as it is until the … it’s clear the Fed has done raising rates, and that we know when it’s going to start coming back down, they’re going to start coming back down to earth. So I expect six and a half, seven year until that happens. That won’t happen for another three, six, nine maybe 12 months. It eventually will, but I’ll leave you with, in the long run, when everything kind of settles down and where things go to where they should be, which by the way never happens, but let’s theoretically … let’s just go with that, 30-year fixed rate mortgages should be five and a half percent. That’s where they should be going. So they’re elevated now by 100 or 150 basis points, something like that, that spread I talked about. Does that make sense, what I just said?

Dave Meyer:
Yes, it does, and just reinforcing for anyone who is waiting for those three or 4% interest rates to come back, you’re going to be waiting a long time.

Mark Zandi:
It could happen, but that’s a recession, and then you’re in that recession scenario. It’s possible, but yeah.

Dave Meyer:
Okay, great. Well, Mark. Thank you so much for being here. This has been fantastic. I learned a lot, and this has been a lot of fun. If anyone wants to learn more about you or follow your work, where should they do that?

Mark Zandi:
They can go to economy.com, at that URL. I bought it before I sold my company to Moody’s. So we’ve had that URL for a long time, and you can learn a lot about us there. We’ve got this cool website called Economic View, and feel free. I did want to plug one thing.

Dave Meyer:
Yes.

Mark Zandi:
My own podcast. Dave, I got to have you on my podcast. I’ve got a podcast-

Dave Meyer:
Yeah. I would love to.

Mark Zandi:
Inside Economics. Yeah, you should take a listen. It’s the funnest thing I do all week.

Dave Meyer:
Can you just tell us a little bit about it?

Mark Zandi:
Yeah, you got to be a little nerdy because it is Economist, and I do bring on … last week I had Aaron Klein, he’s a very well-respected fellow of economic studies at Brookings Institution that focuses on financial institutions and markets. He was a chief economist of the Senate Banking Committee. He was in Obama’s treasury. So he lived through the … he actually did a lot of work on tarp. You remember the Bailout Plan?

Dave Meyer:
Yep, of course.

Mark Zandi:
So he knows banking inside and out. In fact, he’s a really interesting guy, but when he started reading from the 1933 Banking Act, I go, “Hey, Aaron, what the heck?”

Dave Meyer:
Mark, you’re not selling this podcast.

Mark Zandi:
Yeah. No, no. Hey, I got a great statistics game that people love.

Dave Meyer:
Okay.

Mark Zandi:
Great guests, a lot of fun. People will enjoy it. Yeah, people will enjoy it. At least I do. It doesn’t matter, it’s almost to … I don’t really care what people think.

Dave Meyer:
No, that that’s the kind of stuff I really like, and I think we’ve all learned over the last few years how much economics matters and how much it impacts everyday life and things that you don’t even know that it impacts. So learning about these things is really helpful, and I will definitely be tuning in. Well, Mark. Thank you so much for being here. We appreciate it, and hopefully, we’ll have you on again sometime.

Mark Zandi:
Thank you so much.

Dave Meyer:
Thanks again to Mark Zandi, chief economist of Moody’s Analytics for joining us for this episode of On the Market. I hope you all learned as much as I did. I found that show super fascinating. I think Mark does a really good job giving context and backgrounds about his opinions, and I think that’s really important when you listen to anyone specifically, and particularly economists, everyone has opinions, and as we talked about in the show, Mark or anyone, me, whoever else is talking, is really trying to give you the thing they think is most probable to happen. They’re not saying this is definitely going to happen, or this is the right thing to do. This is the wrong thing to do. They’re basing their information and opinions on probabilities.
I think Mark does a really good job of explaining his thinking and some of the context that goes into why he thinks certain things are really important, and which indicators are really important to follow, which ones are less important too. So I found this super interesting and very helpful in adding some context to my own thinking about the economy and my own thinking about my real estate portfolio. If you have any questions, thoughts or feedback about this episode, we always really appreciate that. I know we say that, but we really do, so if you have any comments, you can always find me on Bigger Pockets or on Instagram where I’m @thedatadeli. If you’re watching this on YouTube, make sure to leave us a comment or a question there.
We do our best to get back to you, or if you found this one particularly interesting, we always appreciate a review on either Spotify or Apple. It really does mean a lot to us. Thanks again for listening. We’ll see you for the next episode, next week of On the Market. On The Market is created by me, Dave Meyer and Kaitlin Bennett, produced by Kaitlin Bennett, editing by Joel Esparza and OnyxMedia. Researched by Puja Gendal, and a big thanks to the entire Bigger Pockets team. The content on the show, On The Market are opinions only. All listeners should independently verify data points, opinions and investment strategies.