Bank Failures Are Coming (Do This ASAP)

What's up you guys? It's Graham here, and it looks like it's happening again. Not even a year after the failure of Silicon Valley, Signature, and First Republic Bank, another storm seems to be brewing. And no, I'm not talking about the insane amount of rain that California just received. Instead, it's the newest banking crisis that every single major headline seems to be talking about.

Just like 2008, it all has to do with real estate. That's right; there are concerns again that more regional banks could soon go out of business, with the prominent New York Community Bank already having lost more than half of its value in the last few days. Not to mention, there's also the worry that this could soon be the first of many, especially after Jerome Powell's comments that smaller banks will have to be closed or merged out of existence because of falling property values.

That's why it's crucial that you understand exactly what's going on, how this is going to affect you, which banks are most likely to be impacted, and then finally what you could do about this right now to make sure you put yourself in the best position possible. Oh, and also, if you find this video helpful, feel free to hit the like button or subscribe since that helps the YouTube algorithm push this out to a brand new audience who might never have heard of this otherwise. So thank you so much, and also a big thank you to EcoFlow for sponsoring today's video, but more on that later.

All right, so to start, all of this begins with the original banking crisis, which I'll do my best to explain in really basic detail in under a minute. As of now, banks operate under what's called fractional reserve banking. This means that banks are only required to keep 10% of customer deposits available for withdrawal at any given time. Just imagine it like this: you give me your $1,000 to hold on to for safekeeping, but I can turn around to give $900 of that to somebody else, who gives $810 to somebody else, who gives $729 to somebody else.

Under this situation, banks hope that enough people give their $1,000 deposits so that when the first person wants their money back, they have enough customers to be able to make up for it. The benefit of a system like this is that customers like you and I get access to a greater pool of money in the form of loans, and we get to earn interest on our deposits. But it also relies on us having faith that the system works and hoping that not everyone is going to withdraw their money at the exact same time.

Of course, to be fair, banks aren't lending their money to other banks, who are lending their money to other banks, who are lending to other banks. Instead, banks simply take your money, loan it out to other people, and invest in very safe assets. This ensures that, as long as those investments are held to maturity, the bank will get a nearly guaranteed return, customers will be made whole, and everybody wins.

Except today, there's a slight twist. Throughout 2020 and 2021, interest rates were held at 0% as a way to help stimulate the economy during a time when everything was shut down. This allowed people to borrow a lot of money, and as a result, a lot of that funneled back into the banks, which would have been the smart place to keep it. However, like I mentioned earlier, when banks take your deposit, they don't just keep it sitting idle in a vault.

Instead, they lend and invest your money with the expectation that they would be able to make a little bit of profit and pay you back some interest as a reward for keeping your money with the bank. Except this time, it didn't exactly go as planned. That is because U.S. banks had so much money during a time where interest rates were at record lows, and because they had such a big surplus, they invested a large chunk of those proceeds into low-yield U.S. treasuries, which plummeted in value once the Fed began raising rates.

Now, in a normal market, this wouldn't be that big of a concern since the banks still technically have the money locked away until the loans mature. But smaller banks were the exception, and when their customers began withdrawing all of their money at the exact same time, that caused a liquidity crisis, which eventually resulted in three banks completely collapsing.

So what does that have to do with today? Well, just like the banks of 2023 had their money tied up in low-yield U.S. treasuries that had lost a significant amount of value, today's banks have their money tied up in another asset class that's also not doing well, and that would be commercial real estate. See, during a time where treasuries paid you next to nothing and bank deposits paid you less than 1% interest, if you were lucky, commercial real estate was booming because you could borrow money at 1-2% to buy a property that earns you 3-4%.

Because of this, commercial real estate values soared between 10-30%, depending on the type of property, and banks were the ones issuing all of these low-interest rate loans because they were flush with cash. However, now that interest rates have increased at the fastest pace ever in history, there's a problem. Commercial real estate values are plummeting, with Morgan Stanley estimating that the entire market could decline 40%, which is the same magnitude that we saw throughout the 2008 financial crisis.

Why is this such a big deal? Well, as CNN explains, U.S. banks hold about $2.7 trillion in commercial real estate loans, and about 80% of that is held by smaller regional banks, the ones the U.S. government has not classified as too big to fail. Now, unlike most normal real estate loans that you and I would get when going and buying a house, commercial real estate loans are not fixed for 30 years.

Instead, these interest rates often reset after 3 to 7 years, much like the introductory rate mortgages that we saw in 2005. According to the data from Trip, more than $2.2 trillion will come due between now and the end of 2027. So regional banks could have problems collecting on these loans. After all, commercial real estate values are almost entirely dependent on two factors: how much a property earns and how high interest rates are.

In this case, the higher the rates, the higher the return an investor needs for the deal to make sense, and as a result, values drop. Just imagine in really basic terms that you have a $1 million building that makes $660,000 a year, which is a 6% return. If interest rates decline to 1%, that building could sell for $1.5 million, or a 4% return, since you could borrow at 1% to make a 3% profit. But if interest rates spike to 6%, that building could only sell for $666,000, or a 9% return, since now you'd have to borrow at 6% to make that very same 3% profit.

So why do all these banks have anything to do with this? Well, the other week, New York Community Bank reported a surprise loan loss of $552 million, driven partly by expected losses on commercial real estate loans. Germany's largest lender, Deutsche Bank, also said that they allocated $133 million during the last quarter to absorb potential defaults on its U.S. commercial real estate loans. That's more than quadruple the amount it set aside during the same 3-month period in 2022.

The risk in this case is that it's quite easy for contagion to spread throughout the rest of the market and cause values to decline even further. After all, sales of financially distressed properties can red market value of nearby properties and lead to a broader downtrend valuation spiral. In response to this, Jerome Powell said that there are some smaller regional banks that have concentrated exposure in these areas that are challenged, and "we're working with them. It feels like a problem we'll be working on for years. It's a sizable problem."

To make matters worse, one of the sectors seeing the most difficulty also happens to be the largest, and that would be office space. According to The Wall Street Journal, as work from home picked up, 19.6% of all office space is now vacant, which is the highest level since 1979. As they say, many office parks built in the 1980s and earlier struggled to find tenants as companies cut back on space or leave for more modern buildings.

The Atlantic even called this out 8 months ago, saying that the next crisis will start with empty office buildings and pointing to the fact that a third of all office leases are expiring by 2026. From there, we could expect higher vacancies, significantly lower rents, or both. This is also happening at the same time that 25% of office building loans are coming due in the next year, and with rates now five times higher than they were a year ago, ownership costs are going to go a lot higher.

And if you thought this was the end of it, oh no, it continues. According to the National Bureau of Economic Research, about 14% of all commercial real estate loans and 44% of loans in office buildings appear to be in a negative equity position, meaning the debt is greater than the property's value. As they say, that increases the risk the borrowers won't repay will default on their loans, which eventually falls back on smaller banks that may or may not have the ability to survive the loss.

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All right, so in terms of what's realistically likely to happen, the worst-case scenario, according to a regional banking analyst, is if inflation goes back up, forcing the Fed to keep rates higher for longer, and the U.S. economy enters a recession. Borrowers would then have problems keeping up with their loans. But if those things don't happen, Jerome Powell said that there will be losses for the owners and for the lenders, but it should be manageable.

He also went on to say that the economy is strong, the labor market's strong, and as cooling down, we don't have a perfect crystal ball about the future, and things could happen. But I do think that the economy is in a good place, and there's every reason to think it can get better. The other good news is that not all real estate markets are at risk, and surprisingly, the commercial real estate market is made up of several segments that are actually doing quite well.

Like Bloomberg recently reported, vacancy rates for warehouses and industrial space are low, retail vacancy is only 5.7%, and hotels are garnering record revenue. In addition to that, about 34% of commercial real estate debt generates enough income to pass banks' recent refinancing standards without major changes, and delinquency rates as of now are only barely higher than they were pre-pandemic.

Office space, though, is probably the exception to this. For example, JP Morgan warned that 21% of office loans are destined to go bad, with lenders losing an average of 41% of the loan principal on the failures. Because of that, banks are likely to scale back on their lending, be way more cautious about who they lend money to, and to you personally, that affects you the next time you go and apply for a house, a car, or try to use any of the bank's money.

That's why I think if you're looking to invest in real estate right now, don't be afraid to take your time, make low offers, and really evaluate if the property makes sense to purchase long-term. I personally believe that if you find a good deal, real estate could still be a great opportunity, but short-term, we'll probably continue to see banks scaling back and making it more difficult to get a loan.

Now, in terms of people who hold their money with regional banks, as we've seen, there's always a small risk that something could happen, as evidenced by the failures and bankruptcies a year ago. But in those cases, FDIC insurance made all of those customers whole to the point where none of them lost any of their deposits. Instead, the losses were really limited to just the investors and people who bought the stock, which is really the same for any company that you would invest into.

For that reason, unless you keep more than $250,000 worth of cash in a smaller regional bank, you'll probably be fine. And if you keep more than that within the bank, based on the previous events, FDIC insurance kicks in and makes sure that all customers come out unscathed. Of course, full disclosure, this is only based on what happened a year ago.

In terms of New York Community Bank, analysts at Bank of America cited feedback from management that New York Community Bank was not experiencing any unusual deposit activity. However, their share price has continued to decline a lot, so investors aren't exactly optimistic about their short-term future despite what the analysts say.

Oh, and also, if it's not already obvious, I have no clue what I'm talking about. Don't listen to a random guy on YouTube. Anything can happen; consult the professional for your own specific situation, and all of this is purely just my opinion. Anyway, I do think this information is something to consider. There is a chance this crisis does continue getting worse for certain banks, and it's a good idea to at least know what's going on.

But based on nearly everything before us so far, customers have not lost any of their own deposits at the bank, and it's always worthwhile to be a bit cautious about what's going on, as well as hit the like button and subscribe if you haven't done that already.

So with that said, you guys, thank you so much for watching, and don't forget that you can get some free stocks down below in the description with a paid affiliate link when you make a deposit because those stocks could be worth all the way up to a few thousand. Now keep in mind I do get a commission if you sign up, but you also get some free stocks. So let me know what stocks you get. Thank you so much, and until next time!