We wrapped up 2020 with some positive news from the Federal Reserve on the health of the US banking system. After performing their most recent financial system stress test, the Fed released a statement saying, in part that, “the largest U.S. banks remain strong enough to survive the coronavirus crisis.”
They did caveat the statement by saying that if the economic downturn is prolonged, many banks could still be left with hundreds of billions of dollars in losses (Fed Stress Tests Show US Banks Can Withstand the COVID19 Pandemic). However, even with that caveat, this is welcome news for an economy that has undergone extreme stress over the past year.
No one can say for certain what’s in store for the economy in 2021. However, most economists are not calling for an extended downturn going forward. If anything, vaccine deployments are adding to an atmosphere of business optimism and momentum. This cautious optimism for the overall economy is taking place even in the face of further travel and contact restrictions due to the recent surge in the virus.
These findings from the Fed are significant, particularly for concerns surrounding commercial real estate markets. Many sectors of commercial real estate have experienced tremendous volatility and disruption during this pandemic. As reported recently in the Wall Street Journal, “The pandemic has emptied commercial real estate across the country as Americans stay home, shop online and avoid offices. Many hotels and retail stores have seen a significant drop-off in occupancy, hitting revenue and property values (Pressure on New York City Commercial Real Estate Worries Investors).” There has been ongoing concern within the banking industry as to the overall exposure these banks have to potential loan losses. The finding that the US banking system still remains strong is an impressive feat, given the disruptions of this year.
The banking stress test system was originally designed in the wake of the 2008/2009 housing crisis, as many global banks experienced extreme balance sheet losses tied to bad residential real estate loans. The system was expanded this year to include potential economic effects of the ongoing COVID19 crisis. Thankfully, the banking system does not appear to be under the same level of duress this time around. This is somewhat surprising given that the US economy suffered this year through the highest level of unemployment seen since the Great Depression of the 1930s. Ideally, this is evidence that the measures taken after the last crisis have improved the system to better withstand risks and the unexpected outliers of the future.
According to Randal Quarles, the Fed’s vice chairman of supervision, the banking system “has been a source of strength during the past year. Today’s stress test results confirm that large banks could continue to lend to households and businesses even during a sharply adverse future turn in the economy.”
Also surprising is that the US residential housing market continues to thrive during the Pandemic. Housing prices and demand are at all-time highs in varied geographies across the country. We’ve written in the past about the various sources of strength in the US residential housing market (Home Prices Continue to Rise. The Residential Lending Market is a Great Way for Investors to Participate).
Increased migration into the suburbs and an increasing number of millennials purchasing homes has contributed to that strong demand. In addition, surging home demand continues to outpace construction of new housing. This is not a situation that can be quickly remedied. We expect the residential housing market to remain strong in 2021.
Unlike the financial crisis of 2008/2009, the Federal Reserve acted swiftly to inject cash and liquidity into the banking system at the onset of the crisis in 2020. So, it would seem that we have learned some lessons from the past. Looking back at the tumultuous year that was 2020, it’s impressive that the banking system held up as well as it did. As we see it today, the apparent overall health of the banking and lending system gives us optimism for a better 2021.
Steve Sapourn is co-founder and portfolio manager at Aloha Capital. He specializes in designing low-risk portfolios that reliably out-perform benchmarks. Steve has managed alternative investments in a variety of asset classes for nearly 25 years. His accomplishments include creating and implementing quantitative trading strategies in the futures, stock, and volatility markets. He’s also served as portfolio manager for a Fund of Funds, where he analyzed hundreds of alternative investment strategies.