OPINION:
When Silicon Valley Bank failed last year, cries went out for tougher bank regulations and bigger capital requirements to back up loans.
Essentially, banks are in the business of taking deposits and investing those in loans and debt securities—often, U.S. treasuries.
SVB and others took temporary paper losses on treasuries when the Federal Reserve pushed up interest rates in 2022 after keeping those relatively low for a decade. Those bonds would have recovered their value if held to maturity, but depositors bolted.
Regulators don’t require treasuries to be marked to market, but SVB did not have adequate access to the Federal Home Loan Bank to borrow against them and when depositors suddenly withdrew funds it failed.
Banks shun the Fed’s discount window, where treasuries could be offered as collateral, because it is viewed as a sign of weakness. Many small banks don’t have the protocols in place to use the window, and sadly accessing that facility might have saved SVB.
The Fed ultimately stepped in with a special one-year program to provide liquidity and although Signature Bank and 3 other banks also failed in 2023, this helped avert a more general financial crisis.
Recently, New York Community Bank created similar tremors but unlike SVB, it is sitting on too many poorly performing loans.
The commercial real estate market consists of office buildings, warehouses, stores, hotels, apartments and other income generating property.
Generally, loans on these are for 5 to less than 20 years but with much longer amortization periods or for interest only.
Interest payments are a significant landlord expense, and the economics of a building can be substantially impacted by a 2 or 3 percentage point higher rate.
If landlords must refinance at higher rates, they may have to fund a larger down payment. If they don’t have the funds or are not inclined to further invest in a building, they must sell it.
The problem for landlords and their creditors is that work-from-home (WFH) has lowered occupancy rates and the value of many office buildings—outstanding loans on office buildings are over $900 billion.
The loss of value varies greatly—last year, the San Francisco market has lost about 40%, while New York about 15%. Older buildings are more vulnerable, and banks vary considerably in their investments types and exposure.
Interestingly, NYCB’s loan book is not highly concentrated in office buildings—about 16%—but rather apartment buildings—44%.
New York State ratcheted up rent controls just before the pandemic—these limit rent increases and the ability of landlords to pass along the costs of unusual repairs and expenses or to make improvements to properties.
Along with higher interest rates, those have reduced the value of apartment buildings.
Many other states have some kind of rent control. While these may have been manageable when inflation was low, the recent surge in prices and risk that inflation could continue above 2% pulled down the market value of multifamily properties.
In the wake of the failures of SVB and a few others, Fed bank examiners have become more diligent, placing more pressure on banks with vulnerable CRE loans.
In January, NYBC announced it was setting aside $552 million for bad loans—much more than analysts expected. Over two days its stock dropped 45% and the KBW Regional Bank Index of 50 companies fell substantially too.
The risk of more bank failures is significant —especially for smaller banks which often have a higher concentration of CRE loans.
The regulatory industrial complex is gearing up—proposing that banks be required to use the discount window and posting collateral in advance regardless of the composition of their loan books.
Holding more of their assets idle or in short-term treasuries would require banks to charge more for loans and drive more landlords to private creditors. That will ultimately make new buildings more expensive, limit supply and raise rents.
Burdening all banks with these costs won’t really help banks when local market conditions turn against landlords.
The discount window requires good collateral, and those banks are troubled because they hold bad loans. They are not SVB where treasuries would have eventually regained their value.
Much of these woes were created by circumstances these banks could not anticipate—a pandemic, the Fed printing excessive amount of money during the shutdown to enable excessive federal deficits, then fantasizing that inflation was transitory in 2022 and finally having to raise interest rates higher for longer to cover those mistakes.
In the end, the Fed and Treasury will have to bail out some banks or let them fail.
Bailouts are unpopular but this mess was not caused by the loan officers at NYCB and other challenged banks. It was manufactured by unforeseeable, pandemic rise in (WFH), the Fed’s inadept actions regarding inflation and state legislatures acceding to populist demands for rent control.
• Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.
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