Is the Fed supposed to be such a wild card?!
When the Fed comes up, it’s usually to start a conversation about interest rates. Which is currently the topic of many a conversation as they have been on a wild ride since February. I won’t mark that with a year, because depending on your definition of wild – it could be any one of the last several. This week we have something different to blame the Fed for, the second largest bank failure in US history. On Friday of last week, the news broke that Silicon Valley Bank was folding and it stole all of the headlines away from the jobs report.
Why does this matter in our space of real estate?
For those of you who have been annoyed with the Fed, it just adds fuel to your fire. As we are all painfully aware, the Fed is on a HOT rate hiking spree. This obviously has an impact on the bond market (which is why we see mortgage rates move – because remember, the Fed funds rate is not the mortgage rate). The impact on the bond market goes beyond short- and long-term interest rates though. Before I get into that, I need to explain how banks gamble…I mean operate.
Silicon Valley Bank was not a consumer bank, it lent to venture capital firms. But I can explain what happened from the point of view of a consumer bank. When you, the consumer, deposit your money at the bank – they don’t just hold on to it. They lend it out, they make loans and collect interest on those loans using your money. They bank (pun intended) on the fact that everyone won’t want their money out at once; they won’t all withdraw at the same time.
Behind the scenes they also buy bonds. The return or yield they get on these bonds is directly tied to the Fed’s monetary policy. The Fed held interest rates too low for a long time, since the Great Recession. This meant banks couldn’t make as much on interest from lending to average folks. Thus, most banks have put the majority of their portfolio in long term bonds. The only problem would be if rates rise fast, the depreciation on long term bonds is severe. And what have rates done over the past year? RISE FUCKING FAST. So, the value of the bank’s bond portfolio plummets.
This puts banks in a tough position, an insolvent position if you will. Which is what happened to SVB on Friday. The FDIC insures your deposits with any FDIC insured institution up to $250k. Many folks, including the venture capital firms banking with SVB have balances significantly higher than that. When a rumor starts spinning that the bank is headed towards insolvency – what do they do? PULL THEIR MONEY. And then things spiral fast. Leaving a lot of people pointing figures at the Fed. Their monetary policy and singular goal of getting inflation under 2% at all costs, has not only put those of us in the mortgage industry under severe stress but is also putting the banking system (arguably the entire US economic ecosystem) in a very dicey position.
But again, why does this matter in our space?
The first question that will matter across all sectors is – was this a one-off bank failure or will other institutions be at risk for similar outcomes as SVB? We are already getting the impression there are other banks in similar positions right? I’ll be watching this closely because while it could lead to lower interest rates, it will also lead to a lot of panic in the market and folks don’t tend to buy homes during panic. And, well… this should impact the Fed’s next steps. You know - since it’s their fault this happened. That’s why they jumped in Sunday night. Then there is the big second question: Will it affect their future policy – meaning rate hikes? Days before the SVB news, Powell alluded in his testimony to a 50 bps rate hike in March. That’s just two weeks away. One would hope that they realize how fragile the system is becoming and take it easy…but I honestly don’t know how likely that is.
Inflation is stubborn. We’ve definitely been made painfully aware of that this first quarter of 2023. However, that doesn’t necessarily mean further action is needed from the Fed. It’s possible that the only thing needed is time. They could, maybe should, just let the actions (rate hikes) they’ve already taken settle. The CPI numbers didn’t come in as great as we would like this morning. Core inflation only dropped to 5.5 from 5.6%. The big driver of this was Shelter at 8.1% year over year. Apartment rents are dropping though and the CPI measure on shelter has not caught up. If it had caught up, the CPI would have been 3.3% which is much closer to the Fed’s 2 percent goal. That supports the strategy of just let things settle and catch up, no more rate hikes. A lot of analysts are predicting that the data surrounding shelter costs will catch up in time for the May 10 inflation reading, and that’s when we could see some major relief.
What will the Fed do between now and then? Will they let things settle or will they hike until they break something else?