How Housing Market Could Collapse if Banking Crisis 'Contagion' Spreads

how housing market could collapse if banking crisis 'contagion' spreads

In an aerial view, a sign is posted in front of a KB Home housing development on March 22, 2023 in Folsom, California.

The meltdown of Silicon Valley Bank earlier this month—the first of three bank failures in the U.S. in March—sparked fears that an unfolding crisis might spread from the banking sector to the housing market, causing its collapse.

But is this just an understandable but unreasonable feeling of panic at a time of apparent crisis, or an actual potential scenario looming on the turbulent housing sector? The answer is something in the middle, according to Cris DeRitis, deputy chief economist at Moody’s Analytics, who spoke to Newsweek.

At the moment, the financial services company—which is monitoring the unfolding situation in the banking sector as well as trends in the housing market—has formulated two potential scenarios that may emerge from the recent bank failures in the U.S.

In one scenario—which DeRitis and Moody’s Analytics considered the most likely—the current panic around the banking sector would be resolved quickly. In the worst-case scenario, the current crisis led to a recession that wouldn’t be solved until 2024.

The Threat Of A Lasting Recession

People prefer to hear bad news before good ones, so let’s start by analyzing the worst-case scenario. This is the case that would materialize, said DeRitis, if “the panic continues and depositors continue to worry about the safety of their banks.”

In this case, depositors would continue to transfer money from small or regional mid-sized banks to larger banks, DeRitis said. “The deposits move around and that causes more stress on portfolios, bank failures rise, and that continues to create a contagion effect,” the economist told Newsweek.

“The economy then will weaken and lending standards would tighten even more,” DeRitis added. “The commercial real estate market is likely to be hit the hardest, as small- to medium-medium sized banks do about 75 percent of the lending to commercial real estate.”

In this case, the economist said, the country would enter a recession, “a classic recession cycle brought on by credit, tightening a credit crunch. That recession would eventually resolve—probably—in 2024.”

Under this worst-case scenario, DeRitis said, “the good news is that inflation does come down because demand dries up.” That would lead the Federal Reserve to cut rates to support the economy later in the year, “and that’s what helps us get out of recession.

“So I guess the message here is that this is a serious situation and if it is not resolved, if the banking panic becomes a crisis, that certainly could tip the U.S. economy into recession.”

But at the moment, Moody’s Analytics is counting on a quick resolution of the current banking crisis.

A Swift End To The Panic

“Our baseline view does call for a swift resolution,” DeRitis said. “There may be additional bank failures, but nothing systemic, nothing that really causes consumers and businesses to be overly concerned about the safety of their deposits.”

But the U.S. economy and housing market won’t come out of it unscathed. If the bank panic is resolved quickly, there still will be a long-lasting effect on the banking sector, the Moody’s Analytics economist said, “because the banks are going to continue to preserve liquidity.”

“Even if everything blows over this week, and there are no other bank failures, the industry is going to be cautious,” DeRitis said. “So they are going to tighten credit, they are going to restrict lending. And that is going to have some negative impact on the economy overall.”

Moody’s Analytics has marked down its forecast for 2023 by a quarter percentage point and now anticipates that the U.S. economy will grow by 1.3 percent in 2023 versus the 1.6 percent estimated before the bank panic.

“That’s the baseline scenario, the bank panic cools down, there is some lasting impact, but then we continue to focus on getting inflation down,” DeRitis said.

“The economy remains weak, because of the high interest rate environment. But there’s no very strong impact in terms of growth or unemployment, from the panic itself.”

To understand how consumers are feeling and make concrete predictions about how homebuyers and owners will be impacted by the bank failures in the long term, we’ll have to wait for at least a couple of weeks, DeRitis said.

“In the immediate aftermath [of the bank failures], any immediate impact has actually been positive in the sense that we see some activity,” the economist said, referring to the latest data showing that existing home sales actually grew in February, reverting a recent trend that saw demand for homes and sales plunge.

“But it’s probable that last week you had buyers that were already about to buy, thinking about buying, and then they saw the rate go down and they took advantage of it,” DeRitis said.

“So it may not have really affected their decision, in terms of the longer term possibility of economic weakness, but this week, next week, a couple of weeks from now, I think we’ll get a better sense of what consumers really are feeling.”

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