The US economic recovery has repeatedly defied predictions of an impending recession, enduring supply chain delays, labor shortages, global conflicts, and the fastest rising interest rates in decades.
That resilience now faces a new test: a banking crisis that, at times over the past week, seemed on the verge of turning into a full-blown financial meltdown as oil prices plummeted and investors poured money into government debt. of the US and other assets perceived as safe.
Markets calmed somewhat at the end of the week amid hopes that quick action by leaders in Washington and Wall Street would keep the crisis contained in small and midsize banks where it started.
But even if that did happen — and veterans of past crises warned it was a big “if” — economists said the episode would inevitably hurt hiring and investment as banks pulled lending and companies struggled as a result. for borrowing money. Some forecasters said the turmoil had already made a recession more likely.
“This will have real and lasting economic repercussions, even if everything settles down well,” said Jay Bryson, Wells Fargo chief economist. “It would increase the probability of a recession given what has happened in the last week.”
At the very least, the crisis has complicated the already delicate task facing Federal Reserve officials, who have been trying to gradually slow the economy down to control inflation. That task is more urgent than ever: Government data on Tuesday showed that prices continued to rise at a rapid pace in February. But now politicians must grapple with the risk that the Fed’s efforts to fight inflation could destabilize the financial system.
They don’t have much time to weigh their options: Fed officials will stand by their next regularly scheduled meeting on Tuesday and Wednesday amid unusual uncertainty about what they will do. Just 10 days ago, investors expected the central bank to re-accelerate its interest rate hike campaign in response to better-than-expected economic data. Now Fed watchers are debating whether the meeting will end with rates unchanged.
The notion that rapidly rising interest rates could threaten financial stability is not new. In recent months, economists have often commented that it is surprising that the Fed has been able to raise rates so much, so quickly, and without serious disruption in a market that has accustomed to minimal borrowing costs.
What was least expected is where the first crack appeared: small and medium-sized US banks, theoretically among the most closely monitored and highly regulated pieces of the global financial system.
What is inflation? inflation is a loss of purchasing power over time, which means your dollar won’t go as far tomorrow as it did today. It is usually expressed as the yearly change in the prices of everyday goods and services, such as food, furniture, clothing, transportation, and toys.
“I was surprised where the problem was coming from, but I wasn’t surprised that there was a problem,” Kenneth Rogoff, a Harvard professor and leading scholar of financial crises, said in an interview. in a rehearsal in early januarywarned of the risk of “imminent financial contagion” as governments and businesses struggle to adjust to an era of higher interest rates.
He said he did not expect a repeat of 2008, when the collapse of the US mortgage market quickly engulfed virtually the entire global financial system. Banks around the world are better capitalized and better regulated than then, and the economy itself is stronger.
“Usually, to have a more systemic financial crisis, you need to drop more than one shoe,” said Professor Rogoff. “Think of higher real interest rates as one shoe, but you need another.”
Still, he and other experts said it was alarming that such serious problems could go unnoticed for so long at Silicon Valley Bank, the midsize California bank whose failure sparked the latest turmoil. That raises questions about what other threats might be lurking, perhaps in less regulated corners of finance, like real estate or private equity.
“If we’re not aware of that, what about some of these other, shadier parts of the financial system?” said Anil Kashyap, an economist at the University of Chicago who studies financial crises.
There are already signs that the crisis may not be limited to the United States. Credit Suisse said Thursday that borrow up to $54 billion of the Swiss National Bank after investors dumped its shares due to fears about its financial health. The 166-year-old lender has faced a long series of scandals and mistakes, and his problems are not directly related to those of Silicon Valley Bank and other US institutions. But economists said the backlash in the market was a sign that investors were becoming increasingly concerned about the stability of the overall system.
The turmoil in the financial world comes just as the economic recovery, at least in the United States, seemed to be gaining momentum. Consumer spending, which fell at the end of 2022, picked up earlier this year. The housing market, which plunged in 2022 as mortgage rates rose, had shown signs of stabilizing. And despite high-profile layoffs at big tech companies, job growth has remained strong or even accelerated in recent months. By early March, forecasters were raising their estimates for economic growth and reducing the risks of a recession, at least this year.
Now, many of them are changing course. Wells Fargo’s Mr. Bryson said he now puts the probability of a recession this year at about 65 percent, up from 55 percent before the recent bank failures. Even Goldman Sachs, one of Wall Street’s most bullish forecasters in recent months, said on Thursday that the chances of a recession had risen 10 percentage points, to 35 percent, as a result of the crisis and the resulting uncertainty.
The most immediate impact is likely to be on loans. Small and midsize banks could tighten their credit standards and issue fewer loans, either in a voluntary effort to shore up their finances or in response to increased scrutiny from regulators. That could be a blow to residential and commercial developers, manufacturers and other businesses that rely on debt to finance their day-to-day operations.
Treasury Secretary Janet L. Yellen said Thursday that the federal government was “very closely monitoring” the health of the banking system and overall credit conditions.
Understand inflation and how it affects you
“A more general issue that worries us is the possibility that if banks are under stress, they might be reluctant to lend,” he said. told members of the Senate Finance Committee. That, she added, “could make this a source of significant economic downside risk.”
Tighter credit is likely to be a particular challenge for small businesses, which typically don’t have easy access to other sources of financing, such as the corporate debt market, and often rely on relationships with bankers who know their specific industry or local community. . Some can borrow from the big banks, which until now have seemed largely immune to the problems facing smaller institutions. But they will almost certainly pay more to do so, and many companies may not be able to get credit at all, forcing them to cut back on hiring, investment and spending.
“It can be difficult to replace these small and midsize banks with other sources of capital,” said Michael Feroli, chief US economist at JP Morgan. “That, in turn, could hinder growth.”
Slower growth, of course, is exactly what the Fed has been trying to achieve by raising interest rates, and credit tightening is one of the main channels through which monetary policy is thought to work. If businesses and consumers slow down, either because borrowing is getting more expensive or because they are nervous about the economy, that could, in theory, help the Fed control inflation.
But Philipp Schnabl, an economist at New York University who has studied recent banking problemsHe said that policymakers had been trying to control the economy by limiting the demand for goods and services. A financial turmoil, by contrast, could result in a sudden loss of access to credit. That Tighter bank lending could also affect overall supply in the economy, which is difficult to address through Fed policy.
“We have been raising rates to affect aggregate demand,” he said. “Now, you get this credit crunch, but that stems from financial stability concerns.”
Still, the US economy retains sources of strength that could help cushion the latest blows. Households as a whole have ample savings and growing incomes. Companies, after years of strong profits, have relatively little debt. And despite the struggles of their smaller peers, the largest US banks are on much stronger financial footing than they were in 2008.
“I still believe, not just hope, that the damage to the real economy from this will be fairly limited,” said Adam Posen, president of the Peterson Institute for International Economics. “I can tell a very compelling story of why this is scary, but it should be okay.”
alan rapport and Juana Smialek contributed reporting.