Meta-Description: A leading economist is warning that the FDIC could be overwhelmed if a commercial real estate crisis causes multiple regional banks to fail.
Although the Federal Reserve's latest stress test showed America's biggest banks could withstand a major crash in commercial real estate, economist Paul Kupiec still sees the potential for immense danger in the banking sector. Kupiec told Money Talks News that a spike in commercial loan defaults could lead to a wave of regional banks closing in a short period, a scenario he believes has the potential to overwhelm the Federal Deposit Insurance Corporation (FDIC).
The FDIC was set up as a backstop to bank failures by insuring individual bank customer deposits up to a certain amount. Its primary purpose is to spur consumer confidence in America's banking industry by preventing "runs" on banks. A "run" on a bank is a scenario where enough bank customers are sufficiently spooked by the prospect of their bank failing that they all show up simultaneously to get their money out.
Don't Miss:
- If there was a new fund backed by Jeff Bezos offering a 7-9% target yield with monthly dividends would you invest in it?
- Warren Buffett once said, "If you don't find a way to make money while you sleep, you will work until you die." This high-yield real estate fund, offering an 8% yield, makes earning passive income easier than ever.
Bank runs were frequent in the run-up to the Great Depression when many underfunded and overextended banks were failing on a near-daily basis around the country. The biggest issue with a bank run is that it can be the knockout blow for a bank already struggling with losses. When too many clients demand their money back simultaneously, it can easily push a bank into insolvency.
Perhaps the most famous recent example of this was the collapse of First Republic Bank in early 2023. Clients who were spooked about unrealized potential losses in First Republic's commercial loan portfolio began withdrawing funds en masse, leaving the First Republic teetering on the brink of collapse until Chase Bank purchased it. If First Republic had failed, the FDIC would have been on the hook for lost consumer deposits up to the $250,000 coverage limit.
Trending: Private credit offers up to 20% APY to potential accredited investors looking to capitalize on this growing asset class.
Here is where Kupiec sees the problem. Even though the FDIC guarantees consumer deposits up to $250,000 per bank account, it does not have the cash to cover a massive wave of bank failures that simultaneously sweep across the nation. Kupiec estimates that 2,667 banks are responsible for nearly 30% of all assets in the banking system. He also believes they are over-exposed to risk in the commercial loan sector.
A lot of that exposure is in the commercial office market. This sector has been suffering severely since the COVID crisis due to factors like remote work, which holds occupancy down, and high interest rates, which prevent borrowers from refinancing their debts. Kupiec thinks a 10% loss on the banking system's total exposure to commercial loans could leave as many as 700 banks insolvent.
Trending: Elon Musk and Jeff Bezos are bullish on one city that could dethrone New York. Investing in its booming real estate market has never been more accessible.
If several hundred banks go insolvent at or around the same time, Kupiec does not think the FDIC's reserve fund of roughly $121 billion is enough to cover consumer loss claims. Kupiec fears that the losses would grow exponentially larger as economic growth slows, leaving the FDIC with a tremendous challenge in meeting its obligations. This nightmare scenario would essentially repeat the Savings and Loans Banking crisis of the 1980s.
During that crisis, Savings and Loan banks leaned primarily on mortgage lending to deliver returns. As interest rates rose, Savings and Loan banks had to offer depositors higher returns to continue attracting customers. Unfortunately, the mortgages the banks relied on to deliver the returns were locked in at lower rates, which eventually led to an industry-wide collapse with hundreds of insolvent banks.
The fallout was that the Federal Savings and Loan Insurance Corporation (FSLIC) did not have adequate resources to cover losses for all the consumer deposits at the failed banks. This led to the biggest banking crisis since the Great Depression, which cost taxpayers an estimated $124 billion in bailouts. Kupiec sees the potential for a repeat of that scenario for the FDIC. It goes without saying that America's banking sector hopes he is wrong.
Keep Reading:
- This Jeff Bezos-backed startup will allow you to become a landlord in just 10 minutes, and you only need $100.
- Elon Musk reportedly bought 6,000 acres of land outside of Austin. Here’s how to invest in the city’s growth before he floods it with new tech workers.
© 2024 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.
Trade confidently with insights and alerts from analyst ratings, free reports and breaking news that affects the stocks you care about.