2023 was a bad year for banking and 2024 could be worse

Look­ing back, 2023 was the most chal­leng­ing year to America’s bank­ing sec­tor since the Great Reces­sion, and the rough patch may unfor­tu­nate­ly not be over.

Last March, investors and pun­dits were shocked by the sud­den col­lapse of Sil­i­con Val­ley Bank (SVB). A region­al bank locat­ed in San Fran­cis­co, SVB was thought to rep­re­sent some of the best and bright­est in mid-range financing.

Its finan­cial ser­vices and lend­ing prac­tices catered to America’s high-tech com­pa­nies, and like them, it sur­round­ed itself with­in an aura of innovation.

Less than two years pri­or to its col­lapse, a JP Mor­gan-Chase ana­lyst declared that the “good times are just begin­ning” for SVB.

How­ev­er, as was learned dur­ing the sub­prime loan cri­sis, genius and lever­age are not the same. Tak­ing advan­tage of the dereg­u­lat­ed envi­ron­ment cre­at­ed in the first two years of the Trump regime, along with the seem­ing­ly per­pet­u­al low inter­est rates offered by the Fed­er­al Reserve, SVB dra­mat­i­cal­ly over-invest­ed in secu­ri­ties, par­tic­u­lar­ly long-term Trea­sury bonds.

When the val­ue of these secu­ri­ties sig­nif­i­cant­ly decreased when the Fed­er­al Reserve hiked inter­est rates to curb infla­tion, SVB expe­ri­enced a severe liq­uid­i­ty cri­sis. As word quick­ly spread of the bank’s woes on social media, depos­i­tors rapid­ly closed their accounts and the bank collapsed.

SVB was not the only vic­tim of the Fed­er­al Reserve’s hikes in inter­est rates.

Two days lat­er, Sig­na­ture Bank closed after ner­vous cus­tomers with­drew more than $10 bil­lion in deposits. They were fol­lowed by First Repub­lic in May, Heart­land Tri-State in July, and then Cit­i­zens Bank in November.

First Repub­lic, SVB, and Sig­na­ture were the sec­ond, third, and fourth largest bank col­laps­es in Amer­i­can his­to­ry respec­tive­ly; they are only topped by Wash­ing­ton Mutual’s cat­a­stroph­ic mis­man­age­ment and col­lapse in 2008.

To pre­vent the bank runs from spread­ing, the Biden admin­is­tra­tion, the Fed­er­al Reserve, and the Fed­er­al Deposit Insur­ance Cor­po­ra­tion (FDIC) agreed to an unprece­dent­ed exten­sion of FDIC insur­ance to all depos­i­tors, even those who had deposits over $250,000. Mean­while the Fed­er­al Reserve has open­ly turned its back on the Trump era dereg­u­la­tion, and is try­ing to intro­duce new cap­i­tal require­ments across the bank­ing sec­tor — some­thing that both the region­al banks and the large play­ers are aggres­sive­ly fighting.

Still, regard­less of the reg­u­la­to­ry frame­work, region­al banks through­out the Unit­ed States — even ones that have behaved respon­si­bly with depositor’s money—are fac­ing a tor­rid of issues in the after­math of the COVID-19 pandemic.

Since the Great Reces­sion, the Fed­er­al Reserve has used his­tor­i­cal­ly low-inter­est rates to stim­u­late the US econ­o­my. Dur­ing the ear­ly years of the Trump regime, when it appeared that after a decade of slug­gish growth the Unit­ed States was final­ly get­ting back on track, it would have made sense to slight­ly pump the breaks and mod­est­ly increase rates. How­ev­er, by that time, rais­ing rates had become uni­ver­sal­ly polit­i­cal­ly unacceptable.

Trump was adamant­ly opposed, fear­ing that any slow­down in growth would dam­age his already belea­guered popularity.

Lib­er­als and pro­gres­sives were also sus­pi­cious, as no one could clear­ly say we had ful­ly turned the cor­ner on the Great Reces­sion, and if the econ­o­my were to stall the chances of a Key­ne­sian style stim­u­lus pack­age mak­ing it through Con­gress — espe­cial­ly when Repub­li­cans con­trolled both hous­es — seemed nonexistent.

Most crit­i­cal­ly though, the finance sec­tor was opposed.

The avail­abil­i­ty of cheap mon­ey had cre­at­ed numer­ous finan­cial bub­bles —par­tic­u­lar­ly in cryp­tocur­ren­cies — that all risked col­laps­ing as soon as investors could not bor­row them­selves out. In gen­er­al, every­one became used to an envi­ron­ment where inter­est rates were kept at rock bot­tom percentages.

Seem­ing­ly overnight, the COVID-19 pan­dem­ic changed all of this.

A com­bi­na­tion of aggres­sive — though vital — pub­lic expen­di­tures, in addi­tion to sup­ply chain dis­rup­tions, a glob­al ener­gy crunch caused by Russia’s inva­sion of Ukraine, and cal­lous cor­po­rate price goug­ing all con­tributed to the high­est infla­tion rate in the Unit­ed States since 1981. Fear­ing the poten­tial for hyper­in­fla­tion, the Fed­er­al Reserve abrupt­ly raised rates. The avail­abil­i­ty of easy mon­ey was over, and the bank­ing sec­tor scram­bled to adjust.

In addi­tion to high inter­est rates, region­al and mid-sized banks had to deal with changes in the com­mer­cial real estate mar­ket. With the explo­sion of remote work­ers, the val­ue of office real estate has plummeted.

In Decem­ber, office spaces were still only 50%-55% occu­pied when com­pared to their pre-pan­dem­ic lev­els. With few­er busi­ness­es rent­ing office spaces, devel­op­ers can­not pay back their loans, and defaults are expect­ed to rise. In 2023, major banks had increased their charge off rates greater than what occurred dur­ing the pan­dem­ic. By the end of 2024, near­ly $150 bil­lion in office loans are sched­uled to mature, while anoth­er $300 bil­lion will come due by the end of 2026.

Since region­al and mid-sized banks are the main insti­tu­tions that make these loans, they are like­ly to bear the cost of these poten­tial­ly cat­a­stroph­ic defaults.

The West Coast is par­tic­u­lar­ly vul­ner­a­ble, with Seat­tle stand­ing out as an espe­cial­ly weak mar­ket. As of Novem­ber, San Fran­cis­co, Seat­tle, and the Bay Area had some of the high­est office vacan­cy rates in the nation, with 24.2%, 22.3%, and 20.3% respec­tive­ly. Mean­while, San Diego, Seat­tle, and Port­land were near the bot­tom of major cities in sales of office spaces for 2023.

Seat­tle does have one redeem­ing qual­i­ty that could help mit­i­gate its com­ing tur­moil; its down­town pop­u­la­tion is grow­ing. Ide­al­ly, the city’s excess office space could be con­vert­ed to oth­er uses, such as des­per­ate­ly need­ed afford­able housing.

The cost of hous­ing in Seat­tle is more than dou­ble when com­pared to the nation­al aver­age, and over­all Seat­tle has the 9th high­est cost of liv­ing of any city in the Unit­ed States. The prob­lem is any dra­mat­ic rede­vel­op­ment plan, which would involve mas­sive ren­o­va­tions to trans­form office spaces into res­i­den­tial units or tear­ing them down com­plete­ly and rebuild­ing from scratch, would require sig­nif­i­cant financ­ing. Unfor­tu­nate­ly, as long as the Fed­er­al Reserve keeps inter­est rates high, access to that financ­ing will be hard to come by.

Amer­i­cans might feel that the worst of the pan­dem­ic is behind them, but the real­i­ty is its eco­nom­ic impact is still caus­ing sig­nif­i­cant waves through the bank­ing sec­tor and will prob­a­bly be felt for years to come.

Unfor­tu­nate­ly, eco­nom­i­cal­ly speak­ing, there is a non­triv­ial pos­si­bil­i­ty that the worst is in front of Amer­i­cans rather than behind them. After the Great Reces­sion, law­mak­ers promised that the reforms they insti­tut­ed secured America’s bank­ing sec­tor. How­ev­er, as long as the Unit­ed States sticks to a pre­dom­i­nate­ly pri­vate bank­ing sec­tor — one that can­not oper­ate counter-cycli­cal­ly nor ded­i­cate financ­ing to social needs — that promise of long-term secu­ri­ty is elusive.