The US economic recovery has time and again defied expectations of an imminent recession, withstood supply chain jams, labor shortages, global conflicts and the fastest rate hike in decades.
That resilience now faces a new test: a banking crisis that, at times over the past week, seemed poised to spiral into a full-blown financial meltdown as oil prices plunged and investors poured their money into US government debt and other assets seen as safe.
Markets calmed somewhat by the end of the week on hopes that swift action by leaders in Washington and Wall Street would keep the crisis at bay for small and medium banks where it began.
But even if that happens — and veterans of past crises warned it would be a big “if” — economists said the episode would inevitably hit employment and investments as banks pulled back from lending, and companies struggled to borrow money as a result. Some forecasters said the turmoil had already made a recession more likely.
“There will be real and lasting economic fallout from this, even if all the dust settles well,” said Jay Bryson, chief economist at Wells Fargo. “I will raise the possibility of a recession in light of what happened last week.”
At a minimum, the crisis has complicated the already delicate task facing Federal Reserve officials, who have been trying to gradually slow the economy down in order to stamp out inflation. The task is more urgent than ever: Government data on Tuesday showed that prices continued to rise at a rapid pace in February. But policymakers must now grapple with the risk that the Fed’s efforts to fight inflation could destabilize the financial system.
They don’t have long to consider their options: Fed officials will reserve their options The next regularly scheduled meeting on Tuesday and Wednesday amid extraordinary uncertainty as to what they would do. As recently as 10 days ago, investors predicted that the central bank would re-accelerate its interest rate hike campaign in response to stronger than expected economic data. Now, Fed watchers are debating whether the meeting will end without a change in interest rates.
The notion that a rapid increase in interest rates could threaten financial stability is not new. In recent months, economists have often noted that it is surprising that the Fed has been able to raise interest rates so often, so quickly without severely disrupting a market that has grown accustomed to low borrowing costs.
What was less expected was where the first crack showed: small and medium-sized US banks are, in theory, among the most closely supervised and most regulated parts of the global financial system.
Frequently asked questions about inflation
What is inflation? Inflation is the loss of purchasing power over time, which means that your dollar will not go tomorrow as it did today. It is usually expressed as the annual change in the prices of everyday goods and services such as food, furniture, clothing, transportation, and toys.
“I was surprised where the problem occurred, but I wasn’t surprised that there was a problem,” Kenneth Rogoff, a Harvard professor and leading researcher on financial crises, said in an interview. in Article in early JanuaryHe warned of the risk of a “looming financial contagion” as governments and companies struggle to adjust to an era of rising interest rates.
He said he did not expect a repeat of what happened in 2008, when the mortgage market collapse in the United States quickly engulfed the entire global financial system. Banks around the world are better capitalized and regulated than they were then, and the economy itself is stronger.
“Normally for there to be a more systemic financial crisis, you need more than one shoe to leave,” said Professor Rogoff. “Think of high real interest rates as one shoe, but you need another.”
Still, he and other experts said it was worrying that such serious problems could go undetected for so long at Silicon Valley Bank, the midsize California institution whose failure unleashed the recent turmoil. That raises questions about other threats that could be lurking, perhaps in less regulated corners of finance such as real estate or private equity.
“If we’re not above that, how about some of these other, more obscure parts of the financial system?” said Anil Kashyap, a University of Chicago economist who studies financial crises.
Already, there are hints that the crisis may not be limited to the United States. Credit Suisse said Thursday it would borrow up to $54 billion from the Swiss National Bank after investors dumped its shares amid concerns about its financial health. The 166-year-old lender has faced a long series of scandals and missteps, and its problems are not directly related to those of Silicon Valley Bank and other US institutions. But economists said the market’s violent reaction was a sign of investors’ growing concern about the stability of the broader system.
The turmoil in the financial world comes as the economic recovery, at least in the United States, appears to be gaining momentum. Consumer spending, which fell in late 2022, rebounded early this year. The housing market, which slumped in 2022 as mortgage rates rose, is showing signs of stabilizing. And despite layoffs of high-profile figures at big tech companies, job growth has remained solid or even accelerated in recent months. By early March, forecasters were raising their estimates for economic growth and lowering recession risks, at least this year.
Now, many of them are reversing course. Bryson, of Wells Fargo, said he now estimates the probability of a recession this year at about 65%, compared to about 55% before the recent bank failures. Even Goldman Sachs, among the most optimistic forecasters on Wall Street in recent months, said Thursday that the chances of a recession had risen 10 percentage points, to 35 percent, as a result of the crisis and the uncertainty generated by it.
The immediate impact is likely to be on lending. Small and medium-sized banks could tighten their lending 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 fund their day-to-day operations.
Treasury Secretary Janet L. Yellen said Thursday that the federal government is “watching very carefully” the health of the banking system and credit conditions more broadly.
Understand inflation and how it affects you
“The general problem that concerns us is the possibility that if banks are under pressure, they may be reluctant to lend,” she told members of the Senate Finance Committee. This “could turn this into a source of significant downside economic risk,” she added.
Tighter credit is likely to pose a particular challenge to small firms, which typically do not have easy access to other sources of financing, such as the corporate debt market, and which often rely on relationships with bankers who know their specific industry or local community. Some may be able to obtain loans from the big banks, which hitherto seemed largely immune from 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 may be difficult to replace those small and medium-sized banks with other sources of capital,” said Michael Feroli, chief US economist at JPMorgan. This, in turn, can stunt growth.
Slowing growth, of course, is exactly what the Fed is trying to achieve by raising interest rates – and tightening credit is one of the main channels through which monetary policy is thought to work. If business and consumer activity declines, either because borrowing becomes more expensive or because they worry about the economy, that could, in theory, help the Fed keep inflation under control.
But Philip Schnabel, an economist at New York University has He studied recent banking problemsHe said that policymakers were trying to rein in the economy by curbing demand for goods and services. By contrast, financial turmoil can lead to a sudden loss of access to credit. that Tighter bank lending may also affect aggregate supply in the economy, which is difficult to address through Fed policy.
“We have raised interest rates to affect aggregate demand,” he said. “Now, you get this credit crunch, but that comes from financial stability concerns.”
However, the US economy still holds sources of strength that could help cushion the recent blows. Households, in general, have ample savings and growing incomes. Trading companies, after years of solid profits, have relatively little debt. And despite the struggles of their smaller peers, the largest US banks have a much firmer financial foundation than they did in 2008.
“I still believe — not just hope — that the damage to the real economy from this will be very limited,” said Adam Posen, president of the Peterson Institute for International Economics. “I could tell a very convincing story of why this is scary, but it has to be okay.”
Alan Rapport And Jenna Smyalek Contribute to the preparation of reports.
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