Moody's Talks - Inside Economics - Forecast Surprises, Successes and Slip-Ups

Episode Date: July 23, 2023

Mark and Cris take stock of the economy’s performance so far this year, and consider what surprised them (think the job market), what they got right (think weaker house prices), and what they got wrong (think the banking crisis). They also look forward and discuss what people are overly considered about, and what they should be more worried about.  Where’s Marisa?For the full transcript, click here.Follow Mark Zandi @MarkZandi, Cris deRitis @MiddleWayEcon, and Marisa DiNatale on LinkedIn for additional insight. Questions or Comments, please email us at [e-mail]. We would love to hear from you.  To stay informed and follow the insights of Moody's Analytics economists, visit Economic View. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

Welcome to Inside Economics. I'm Mark Sandy, the chief economist of Moody's Analytics, and I got a slim down crew today. That's Mr. DeRees, Dr. DeRees, good to see you. Good to see you, Mark. Yeah, it's just mono-a-mano again. You're missing, Marissa, the Dante, the whole team. Everyone's gone where it's just us. And this is Saturday morning, which is really unusual.

I've been traveling all week, so got back late yesterday and couldn't record the podcast until now. So thanks for doing this. Absolutely. Where were you? West Coast? Yeah, we were in Salt Lake for a day and then Southern California for a few days. So the folks in Salt Lake told me I picked a good day to come. It was only 100 degrees outside. Oh, wow. Okay. It was pretty brutal. I don't, I really don't know how you manage through all that, but, you know, people do. Southern California was gorgeous. That was beautiful. Yeah, it was always nice there, but it was really. really, you know, very nice. And you got back from Italy? I did. I was back earlier this week. Very hot there too. So another, really heat wave going. Oh, yeah. They're in the hundreds as well.

Really? Wow. For Italy, does Italy, I mean, is this unprecedented heat or just just hot? Yeah. It usually does. It gets hot in the summer. That's, that's natural. But yeah, this year really, brutal. Really brutal. Oh, boy. I wonder what that means for the vineyards. That can't be good. I don't know.

Maybe I have no idea. Do you know? I don't know. I think it might be, I think it might be makes it sweeter or something. Yeah, smaller production, lower production, but higher quality perhaps. But I think it really depends.

Because they also had this, they had a lot of rain early this year as well. So, you know, the timing of those weather events. Right, right. Well, good to have you back. You had a good vacation. You were there for a couple weeks, I think.

I was. It was nice. Yeah, you do look rusted. That's great. I'm glad you're back. Well, I thought for this podcast, we kind of take stock of 20, 23 year to date. You know, we're kind of a little over halfway through. And, you know, a lot's happened.

I've already forgotten a lot of what's happened. It's pretty action-packed. I thought we'd take stock of that and maybe also think a little bit about the second half of the year as well. It sounded like a good game plan? Does it sound like? Absolutely. Okay.

All right. Well, I think kind of top of mind, first question is that I've, you know, I've been getting is, you know, what about the economy's performance so far this year has surprised you the most? A lot of different things going on. What's been the most surprised? for you. Yeah, I would say it's really the resilience of consumers and businesses. You mentioned all the risks, all the things that happened this year.

I think we already forgot that there was a debt ceiling drama for a few months, and we had the banking mini-crisis, right? High rates. And I think I underappreciated just how resilient consumers and consumer balance sheets really were. I knew they were strong. That's why I didn't expect to see. a major drop-off, but consumers have just been continuing right through, right? Their spending just keeps going, even with high levels of inflation still, they're tapping

into their savings, continuing to support the economy through their spending. Business is also still looking ahead, right? Obviously, they face a number of challenges, but they've also continued with their investments and looking ahead to expand. So I think that's a key source of the strength of the economy so far. If we hadn't had those types of supports, I think the shocks we did experience would have created more ripples in a different environment. Yeah, I mean, the economy has been resilient. We're going to get the GDP for the second quarter.

I think on this coming Thursday, is that right? Or Wednesday, Thursday? I can't remember which day. I think it's generally Thursday. in the our tracking estimate we we take all the monthly data as it comes in and translate that into what it means for GDP growth in the current quarter I think we're at 2.2% real GDP growth in Q2 that's on top of 2% in the first course that means first half of the year 2% ish which you know that's the economy's potential rate of growth you know that rate of growth

consistent with enough jobs to maintain stable unemployment, unemployment has been rock solid in the mid-threes. So consistent with that, that's pretty good. And you're saying, you know, we were having this conversation at the end of last year thinking about the first half of this year, you would not have thought 2% growth. No. Right. I thought it was positive still, but certainly weaker.

Right. And, of course, hand in hand with that is the job growth also. So, yeah. More resilient. But, you know, you, you say, okay, consumers hung in there, they're spending has been more resilient. Why? I mean, what do you think is going on there? Why has it been more resilient?

Yeah, I give a lot of credit to the balance sheets, right? The excess savings that we point to, or we have pointed to on the podcast. Just that's a significant source of support that you can tap into, or consumers have been willing to tap into, to continue to support their spending. On top of that, you mentioned the job market. Wage growth has been strong, right? That certainly is another source of support, particularly for those households at the lower end, which may have already exhausted most of their savings. at least they have this wage increase coming in that can help to offset some of the financial pressures as well.

So again, I see I see that as really the reason why consumers have continued to be willing to spend. Yeah. Now, okay. I mean, that seems a little unsatisfying to me, right? Because we knew about the excess saving, right? We've been tracking the excess saving. and the excess saving, but this for the listener is the extra saving that occurred during the pandemic, above which would have happened if there had been no pandemic.

And part of that was lower income households getting government support, although that probably is pretty much gone at this point. The other part of that is all middle income, high income households sheltering in place and not being able to spend. during the pandemic and they saved and they have all this cash, you know, they're sitting in their checking accounts and they've been using it. But, you know, we knew that coming into this year that there was a lot of excess saving. We did, but I think there was, I believe there was a debate. At least I, I was debating whether that saving was truly available for spending or if consumers were viewing that as wealth, that they, maybe they were just parking those, that cash in an account for now, trying to see where they should, how they should deploy it, whether they

should buy stocks or bonds or, you know, kind of wait and see, but not that they would actually be using that to continue to support spending in the absence of a crisis, right? We were truly in recession, sure, that's when people will deplete their savings and do whatever they can to stay afloat. But this was depleting savings just to continue the level of spending that, the trajectory that they were already on. It's funny, I'm not, I wasn't, I'm not surprised by folks using cash. in their checking account to maintain their spending.

That seems like, oh, duh, they're going to do that, right? Especially the American consumer, right? I mean, what's the old adage, never underestimate the hedonism of the American consumer? That's been a pretty good forecast rule forever. What actually surprised me on the spending side was they didn't spend more. I mean, you know, they haven't been spending with abandon. It's not like they're out, you know, dropping their saving rate to a significant degree. they've been amazingly calibrating their spending, right?

So if you look at real consumer spending, that's the kind of the whole shooting match. That's everything that people spend their money on from vehicles and other goods to travel and other services. It's 2% on the nose, 2% on the nose. And it's been like that for well over a year, maybe a year and a half now. I mean, just, you know,

some months a little higher growth. someone's a little lower, but about 2%. I find that, that's what I find so surprising, that it's been so, you know, carefully calibrated. You know, consumers have been using, drawing down their excess saving over the past year just to supplement their purchasing power. Their real incomes have been under pressure because of the high inflation, but they've been able to draw down that savings to supplement their purchasing power

just enough to maintain the spending and hit that number right on the nose, the 2% of real growth. And, of course, consumers are the bulk of GDP, thus you get 2% GDP, you know, that kind of thing. No? Yeah, yeah. No, I'd accept that. But there's certainly a lot of shocks still out there, right? So why didn't consumers spend even more?

I think there's still a lot of uncertainty, right? So that would calibrate, that would cause them to calibrate a bit more. I'll tell you that the consumers are definitely spending in Europe, right? In Italy, it's full of Americans. The whole of America. More than I've seen in the past. So clearly there's some segment of Americans out there that's Well, also the strong dollar.

The strong dollar has got to help too, right? I mean, sort of strong. I guess the dollar euro is what, 1.13, 114, something like that, which is pretty strong dollar. It's weaker. It's weaker than it was. But, you know, in the grand scheme of things, that's a pretty strong dollar, I think. Yeah. No?

Yeah. Yeah. Okay. I'll tell you what the thing that's surprised. me, and it's not unrelated to the consumer, but a little kind of different perspective is jobs. I've been surprised by how resilient the job market has been and how consistently businesses have been able to generate new jobs that, you know, I think average monthly job growth in 20, 23 year to date is got to be overthrined.

hundred thousand around 300,000 per month. I think it's right there. Yeah. It's right there, which is pretty incredible. Yeah. Yeah. I mean, because, you know, kind of the rule of thumb we've had is, you know, underlying labor force growth, you know, abstracting from the ups and downs and all around is probably not more than 100K per month, right? So, you know, an economy can't sustain them up above 100K for, you know, likely periods of time. Ken, in the current, in 2023, because we had a lot more labor supply, too, a lot more working-age population, labor force participation picked up, so that's been helpful. But, you know, longer run, you know, we can't support job growth that's over 100K.

And here we are, you know, well into this job's recovery, and we're still creating 300K. And, you know, it goes to, interestingly, it goes to just pretty low layoffs. I mean, layoffs have picked up, you know, this year compared to last. particularly in the tech sector, maybe a little bit in single-family housing or mortgage originations, a bit manufacturing. But, you know, outside of that, layoffs remain incredibly low. And the dynamics are, you know, it's less clear to me what's driving that. In the case of the consumer, they got cash in the bank.

So they, you know, that feels like that's a pretty easy explanation for why they're able to spend. the explanation for why businesses aren't laying off workers and why job growth is so strong, that's a little bit more difficult, don't you think, to explain? Well, I think the labor force participation was a bit of a surprise, right? Not so much the fact that we are creating all these jobs, but that they're surprised by a lot of stuff. I wasn't surprised by that. Come on.

That we keep finding people that are willing to come back in the labor market, that, you've got to be surprised. Women's labor force participation at an all-time high. That keeps growing, that we're going to continue to find people. Yeah. Our labor force. Go look at our forecast that we did before the pandemic of what the labor force participation rate would be today is exactly where the labor participation rate is today.

Nothing, no surprise. No, at least, you know, no. So I would say that hasn't been surprising. But why do you think businesses aren't, well, first of all, do you agree with the characterization that job growth has been strong largely because layoffs have remained. low. I mean, you know, hiring is strong, although that feels like that's more normalized more recently. So it feels like it's more on the layoff side that, you know, the reason why we can be able to continue to generate a strong job growth. Is that fair characterization? That sounds right.

Yeah. Okay. And so what's going on? I mean, the kind of the pat, you know, explanation is labor hoarding, right? Businesses realize that their number one, is going to be through thick and thin, you know, through whatever it is that we're experiencing now, on the other side of it, they're still going to be left with a tight labor market, just demographics, you know, aging out of the boomer generation, me, the slower foreign immigration into the country, which is key to labor force. So they know that they're going to have the perennial problem filling positions and retaining workers. And therefore, they're just not willing to do that right now. Is that the answer?

You know, I'm a little dissatisfied by that. Yeah. I can see it to some extent. Sure. If I know that this slowdown is going to be temporary, right? Yeah, I'm willing to hang on to some folks that otherwise I might not otherwise have. Because I know what the other sign of this is going to have. But there's a limit to that.

I can't, a business can't afford just to, you know, hold a reserve army of workers out there doing nothing. and hoping that the demand comes back later. So that just doesn't sound right to me as that being the major reason. I think there is true growth. I think the consumers do remain strong and they're still seeing a lot of demand for their services and the products. And that's why they continue to hang out to their workers, right? But productivity growth has weakened, right? I mean, consistent with the idea that there's labor hoarding, that demand, it still grow.

but it's growing more slowly than the growth in labor input, the job growth. And so productivity growth. I mean, you saw this big pop in productivity growth coming out of the pandemic, you know, like you typically do coming out of recession. But since then, it's been flatlined, you know, it hasn't gone anywhere. So that is consistent with the idea that businesses are saying, okay, I'm willing to live with less productivity growth, which means weaker profit margins, which means lower profitability, at least for a while.

that's consistent with that. Yeah, I still see productivity as undergoing through a transformation here, though. I think we're still dealing with the remote work, hybrid work, optimizing around that. So in the interim, in the short term, you can have productivity growth being low.

You're investing, if you will, for a future where productivity growth will pick up. AI might be the next factor example for that, where in the short term, you actually may see productivity go down as you're trying to figure out how to use these new tools and technologies, you're actually, you know, you're running the old process in parallel with the new process that's actually reducing your productivity, but then longer term things will turn around.

I still see firms struggling with the whole remote work, hybrid work environment. So I see that as being another structural factor on top that may explain some of that weaker productivity growth. So, you know, I don't see that as hoarding, though. I see that as transformational, right? Right. Yeah. And you said something that kind of resonates with me that hadn't dawned on me until

recently. If I'm a business person and, you know, I hear the words recession, but then I hear in the same breath, oh, it's going to be a short, mild recession, you know, maybe a few months, maybe six months, maybe down a little bit. I go, oh, okay. And I've been now through many years of fighting to find people to work for me. You know, because this goes back to way before the pandemic, right? This labor shortage, business is number of women.

Problem being labor is not new. It's been around for a while, almost a decade now. Well, not quite a decade, but, you know, kind of in that ballpark. And you're saying, oh, okay, if it's going to be short and mild, I'm not going to lay on anybody off. You know, maybe on the margin, on the, you know, on the fringes, you know, you just an opportunity to, you know, maybe restructure a little bit, but I'm not going to lay off in a big way. Yeah.

Sound right? That's what you're saying. Yeah, I just won't hire. Right. I'm going to reduce my hiring at that point. Yeah. Yeah. Right. I reduce hiring, but not, not layoff workers.

Right. Yeah. Yeah. No, that makes sense. Okay. Yeah, I think the, oh, here's the other thing, though, I'd point out with regard to this. surprise, particularly around the job market, is maybe we'll find out that there wasn't as many jobs

created. And it wasn't the surprise. Really, it's just we're surprised because it never happened. It's wrong. It's wrong, right? Yeah. And this goes to the revisions, right? Because the job market data that we look at, the monthly data, the payroll survey data, the data based on our survey businesses, that, that's a survey you know so you know i don't know how it's what 250 000 establishments something like that you know so it's big but it's still a survey you get this data gets so-called benchmark to actual employment estimates based on unemployment insurance records once a year by the bureau statistics and sometimes those revisions are big uh and we could see you know pretty and i wouldn't be surprised at all if we saw some substantive downward revision in

the estimated job growth that we've seen so far this year. Yeah. Yeah. I mean, 300,000 a month is just an incredible pace, even in any environment, right? Right. Yeah, that's the one thing I've learned over 35 years as a professional economist. When something doesn't quite add up, it really doesn't. It doesn't add up.

And the data ultimately is revised. Even the GDP number, I bet you the GDP, certainly last year when you saw those two quarters of negative numbers in the first half of 2022, which that would, if we had done this podcast a year ago, that would have been the surprise. You know, where did those negative numbers come from? I'm still betting that once all those revisions on GDP come in, and they're a lot more coming, that gets a revised away. And, you know, it wasn't strong. I'm not saying you had strong growth, but I'm not, I bet you that we didn't experience two quarters of negative GDP. Just my intuition. And right now, GDI, gross domestic income is pointing to weakness, right?

That's pointing to weakness, yeah, right. You know, the strength you're seeing right now may not be quite as strong. Yeah, right, right. Because GDI, gross domestic income was stronger in the first half of 2020, the flip of what's happening right now. So, yeah, you take the average of those two things. That's probably reality. It's basically saying slow growth, 1% kind of growth, GDP growth, which is more

consistent with kind of what we're observing out there. So. And our original forecast. In our original forecast. Yeah. Yeah, exactly. In terms of surprises, let me throw one more out. I got a couple of other surprises.

Do you have more surprises as well? I got plenty of surprises. Oh, you got plenty of surprise. Let me throw one out that I know is your favorite house prices. Oh, that's where I was going to go. Oh, is that where you going to go? Okay, go there. So I guess.

I guess I wasn't terribly surprised by the slowdown, right? We had been calling for slowdown and prices throughout last year. We actually got some heat, right? We were kind of on the low end of consensus at the time. So when house prices actually did slow down, I actually even turned negative on a year over year. It wasn't terribly surprised by that. But more recently, you know, we see house prices holding up much better.

And I think the where perhaps missed was just how strong the lock-in effect is. the fact that you have very limited inventory of homes for sale, people hanging onto their homes because they've locked in these very low mortgage rates. And that has overwhelmed the affordability issues given the higher interest rate you would have thought demand would pull back and has, but that's that lack of supply that has really kept prices from falling much at all. In fact, they're starting to rise again in many markets. Yeah. So the idea is that, Most homeowners with mortgages, oh, here, I'm going to play a little statistics game with you right now. Okay.

All right. I want to see how good you are, really good. There's no Marissa. Here you go. How many single family homeowners are out there, do you think, roughly speaking? Oh, roughly speaking, because I don't know the exact answer either, because I didn't think I was going to ask you this question before I asked it. I think through it's been a one. So 100, what do we have? Well, you know the homeownership rate is we know about 120, 130 million households. Right. Home ownership rate is about two thirds.

It's on the nose actually, 66%. Yeah. That another data point you should take with a grain of salt. True, true. But yeah, it's a two-thirds on the nose. So. Yeah, do the arithmetic. So what is that? So what is that? Seventy-five, 80 million people? Yeah, something like that. Okay. And how many of them have mortgages? How many people have more. Oh, about half. It's, oh, I thought it was a little more than, well, yeah, yeah, it's a little more. Oh, about almost 50 million have mortgages. Okay.

Yeah. You don't believe me. You're doubt. Oh, no. I see it on your face. I have an old number, right? Yeah, yeah. I haven't looked at a reason.

We know exactly because we get the data from Equifax, all the credit files in the country every month. So we know exactly. So we can go take a look. I think it's like $49.3 million. I'm just, maybe we'll look that up before. Are you subtracting out the second mortgage is there? That's just first mortgage, first mortgage. Well, but it's a first mortgage, but you could have.

Well, as defined by the Bureau's first mortgage, right? I mean, it's first mortgage on the property, but the owner might know. You're just trying to squirrel out of you. You know the answer. I think it's 50%. I think it's second mortgage. It's closer. No, I don't.

Okay, maybe you're right. Sandy over counting going. Yeah, maybe you're right. Anyway, where was I gone with that? Oh, this is it. So you got, you know, say, let's just round to 50 million. 50 million people, the average coupon, the average interest rate on their mortgage because of all the refinancing that's been done over the years and the fact that mortgage rates got so

low. I mean, if you go back before the Fed started raising rates in 2021, I think we got down to what, two and a half, two and three quarter percent on a three-year fixed. I mean, something like outrageous number. Ridiculous. By the way, have you noticed when you asked people about their mortgage rate, everybody's got that two and a half percent mortgage? Oh, yeah, I got two point five three. You know, everyone's, everyone's a genius. It's like so shocking to me. Like, everyone's got that lower. Well, maybe they do because the average coupon is three and a half percent. Right, roughly three and a half. So, okay, current mortgage rates are seven, roughly.

So are you really going to sell your home, you know, you extinguish that mortgage at three and a half, go get another home, get another mortgage at seven. The economics of that are pretty tough, right? Yeah, that's right. And so that's what you mean by interest rate lock. People are locked into their home. Even if they hate their home, they love their mortgage. They're not going to, at least not unless they're, you know, life happens. And that may be, we still have house price declines occurring in our forecast because over time, over the next couple, I don't know, two, two and a half years because divorce, death, children, job change, people got to move.

And, you know, once they have to decide they have, they've been putting off those things. You know, they've been, those things happen and they've been putting off moves because they don't want to move. But at some point, they're going to have to move. and when they go out to sell, you know, if at the current house price, which is so elevated, and at the current mortgage rate, things are just not affordable, they're going to have to start cutting prices. So we expect prices to still come in. Although our peak to trough decline in house prices now is not as significant as it was before, right? That's right.

Yeah. At the worst of, at the height of our pessimism around house prices, what do we have pete to trough decline? in prices. Do you recall? That's close to 10%. Close to 10. Yeah, that's the entire market. Yeah.

The Fannie Freddie market, the FHA market, the bank, the market that's non-government. Yeah, yeah, right, okay. So that was a surprise. How's the kind of the, and that may go back to consumers too to some degree, right? The fact that housing values have held up means that people's housing wealth is also held up and another reason for them to be a little bit more confident about going out and spending. By the way, going back to your point about labor force participation, the one place where I have been surprised about labor force participation is the fact that people who have retired have not come back into the workforce to the same degree as they have historically in the post-pandemic period. right so people people we're getting a lot of retire retire retirements because the boomers are

retiring and typically historically when people retire you know they many of them come back in to look to get work either perhaps because of a lifestyle choice they just say I you know I just don't like retirement I want some kind of work and or financial reasons they oh I'm not as prepared financially as I thought I need to work a little bit longer I need some income but that's not happening this go-round. It may be because people are wealthy, right? I mean, house prices are hanging in there. Stock prices are almost back to their previous record high. So they're saying, well, I mean, I'm fine. I don't really need to come back in. Yeah. Yeah. Although I think, though, so you're right. They haven't come back to the extent that they were at prior to the pandemic,

kind of between the great financial crisis and the pandemic, the labor force participation rate of the folks over 65 was pretty high. But if you go back a little bit further, I believe it was lower. I think we're getting back to that historical norm. If you go back into the 90s. I don't think that's a fair comparison, though, because, yeah, because you've got to look at the distribution of ages of people in retirement. you've got a big chunk of folks that have newly retired. That's the boomers. You go back in the 90s, the average age of a person in retirement, that was a lot old.

They were a lot older back then, right? Because you've got this wave of retirements occurring. So I'm not sure. So you want to look at 65 to 70. Exactly. Yeah, that's what I want to look at. Take a look. Oh, you've got the data.

Oh, damn. I'll find it somewhere. I could be wrong. I could be wrong. No, I think that's, you might be right. Okay, so, okay, so are we going to come back in, though, or is this permanent, you think? The longer it goes on, the more I'm thinking this is going to stick, you know, and I do think it goes back to asset prices. I think it does go back to stock prices in particular.

It goes to housing values and the cash that people have that they did save. There's still a lot of excess cash for high middle and high income households. And, you know, the other interesting thing about boomers is they have invested more of their wealth in stocks than previous generations. And unlike previous generations, they, you know, as they've aged, they've not left the stock market. They've continued to invest in the stock market, which is, you know, kind of counter to a lot of theory. Personal financial advice, right? You're supposed to take less risk. But people don't want to do that.

They're very comfortable with the equity market. It's got a lot of easy. it's gotten a lot easier to invest in the equity market. You got all these trading platforms and everything else. So, you know, it's just a lot easier. And so now that stock prices are so high, elevated, that, you know, I think there's a lot more wealthier boomers out there than has been the case, you know, in previous generations.

And that's less likely they're coming back in. Hey, so, okay, the surprises are the resilience of the economy. You mentioned consumers. I don't think that was a surprise, but, you know, you know, you get surprised about lots of things. That didn't surprise me. But the resilience of the labor market, that surprises me, you know, if it's real, you know, if it ends up being real.

Yeah, yeah. And then house prices, anything else that's kind of that happened here recently, first half of 2023, that's been a surprise to you? Well, I think the, if I'm honest, the banking mini crisis. Yeah. Yeah. Right. Could have expected something.

to mean. That happened. And it happened so quickly and to fairly large institutions. We're not just talking about a few small banks. Silicon Valley was a huge bank, right? So yeah, that was a bit of surprise, certainly. Yeah, oh, that came out of note. For me, that was my most disappointing miss, right?

of all the things that I, you know, I say my biggest forecast error in the following sense that I actually talked about the bank, before the crisis, I talked about the banking system as a basis of strength in the economy. One of the reasons why I didn't think we'd have a recession because the banking system was on such fundamentally strong ground. So I got that wrong. And, you know, it's a good lesson for me that I learn every 10 years. And that is look at the distribution.

What I mean by that is if you go look at the averages or the medians of measures that are reflective of the health of the system, the banking system, financial system, you look at them, you go, the system's in great shape, right? I mean, the level of capital is extraordinarily high. It risen meaningfully since in the wake of the financial crisis and all the regulatory changes. frank and everything else. Liquidity is much, much better than it was historically. Again, going back to those changes, underwriting has been really

actually very good, you know, since the financial crisis. Banks have been very cautious in their underwriting, the lending standards that they, you know, impose to extend out credit. So I, you know, I looked at those numbers and I go, oh, and even the profitability of the banking system, right? I mean, you know, one of the things that I find so amazing is despite the higher levels of capitalization and despite the more restrictive regulatory environment and despite the liquidity, the demands for higher levels of liquidity, the return on assets, the return on equity of the banking system is not much lower than it was prior to the financial crisis.

And, of course, part of the financial crisis, that was a, the world had lost their minds. And the banks had extended out way too much credit. Underwriting was way too weak. And that juiced up their return on equity and assets. So, you know, accounting for that, the system had returned, you know, completely back to the profitability that prevailed prior to that. By the way, that brings up another point about now the system is being required to hold even more capital in the wake of SBB and bank increase. So we can come back to that if you'd like. But the thing that I missed, in hindsight, it's always like, you idiot, how could you

have missed this, is the distribution, right? If you look at, you know, the distribution across all the banks, you know, if you just had simply done a scatter plot of all the banks on the X axis, you know, share of deposits that are to uninsured depositors on the other axis, the share of unrealized. realized losses on securities portfolios because of the increase in interest rates, they're way out on the, you know, standing all by itself, you know, obviously screaming, I got a problem was SVB, you know, SBB. Now, I would have actually, in all fairness, to me, to me.

That's what it's all about. It's all about that, you know, SBB was a $200 billion bank. Like, hey me a break, you know. if that thing goes belly up, would you have really thought that it would trigger the deposit run that it occurred across the banking system? Probably not, right? Probably not, even if you'd seen that. Of course, I missed that. But that's a cautionary tale. We've got to look at the distribution, you know, particularly when it comes to things like the financial system, can't just look at the averages. But that, that's what, that's, you know, my biggest forecast, you know, mistake, you know,

I think. But, but having said that, I'll say one more thing because I'm saying, a lot. The fallout, the economic fallout from the banking crisis has also been a lot less than I would have thought. No? Yeah, yeah. At least so far. At least so far, right. Well, I mean, here we are. We're like, what? April, May, June, we're four months away, you know, since the crisis. So what are you thinking? Well, the tightening of the standards, lending standards, right? Maybe that hasn't filtered through. Filtered through because of the balance sheets we talked about.

If consumers still have cash and businesses have cash, they haven't really needed to borrow to a large degree. As loans come due, as those resources get depleted, that may be the time when you actually feel the pressure. Yeah, but on the other hand, you look at the, because we get weekly data on loans out standing by loan type, you know, credit cards and construction land development loans and multifamily mortgage loans and commercial industrial loans. And that doesn't seem to show any meaningful weakening. It may be a little bit on the margin, but I don't see it, you know,

in the data, at least not so far. But not yet because the rates are time. Just like the mortgage market, right? Rates are locked in for a period of time. Yeah. When they ban. And, businesses actually need to refinance. Oh, I see. It's more capital. Yeah. Later this year next year. I see.

That could be when you see. The real problem happens. Yeah. Like when that multifamily property owner, his mortgage comes due. Do. Her mortgage comes due. And she goes to the banker and says, hey, I need to refinance this mortgage, roll this mortgage over.

And the banker says, oh, yeah, I'll be happy to do that. But, you know, the interest rate is 400 basis points higher. The LTV is. much lower, you know, that's what you're saying. That's right. That's when it could, yeah. The real impact could be seen. Okay.

All right. Okay. So I gave you my biggest forecast regret, you know, that I completely, and when I say missed the banking crisis, I remember giving a speech at a Moody's conference. I think it was the day, maybe it was two days before SBV failed. I will say we had this risk matrix, you know, which shows encapsulation. all the risks we think that exists to the economy. It was there.

It was on the risk matrix. It's just I didn't even call it out. I felt so dumb not doing that, but I missed that one. But so, okay, that's me. I did my forecast me a colp, what about you? What's your biggest? Oh, I thought I gave it. You did?

Existing home sales and the That's your worst. Home price resilience for the first half of this year. We're just talking this year, right? I think you've got many more than that, my friend. No. to them. Really? Okay. All right. That's, that's, that's it. That's what you're going to give me. The house price one. All right, okay, fair enough. All right. Let me ask you, let me ask the flip of that. What are you most proud of? You know, what forecast are you most proud of? Oh, also house price forecast before that, right? The fact that the house prices were coming in, right? Last year, there was a lot of pushback that, no way the prices could come down from 20% year-over-year growth. to anything close to zero.

So, that's when I'd be more proud. Hold on, I don't understand it. So you're saying people, forecasters out there weren't forecasting house price declines at all? No, very, no, very modest. Oh, is that right? Very few people were forecasting house price.

Last year we were getting quite a bit of heat that we were calling for. Boy, that seems like that was so obvious that was going to happen. But no, okay. Very interesting. Yeah. Because why? Because prices, because the prices, I think in part,

because of the momentum, prices had been going up for around 2020, 21, 22. How could they go from 20% year-over-year growth to... Oh, I see. Oh, I missed all that. So people were banging on your door saying, what are you doing? Yeah, that we were being too pessimistic. Oh, okay. All right.

Okay. Very good. Okay. So let me ask you this. A lot of... This is now we're kind of forward looking here. Yeah, we've been kind of retrospective now, a little bit more forward-looking. Of all the things that people are hand-wringing about, and, you know, I've been out talking to clients.

As I said, I just got back from a long West Coast trip listening to folks. And I know you do, you know, you talk to clients all the time. What do you think is the most, what are they most concerned about that they just, it's just misplaced? they're overly worried about, you know, what's going on. They're not at risk. It's a long list. Probably at the top I would put CRE, commercial real estate. You'd say they're overly concerned about commercial real estate as a threat to the economy.

Exactly. Oh, okay. I think that's, I think it's changing, right? I think people are coming around to terms that this, yeah, there are issues with the commercial real estate market, but it's going to play out over time. It's still relatively small market, unlikely to. hit the economy more broadly, but certainly for a while there, there were a lot of concerns that this was it. This is going to be the straw that breaks the economies back. So I think those fears

would have been a little bit too much. Overdone. Not overdone, right. Not that we shouldn't be worried. That certainly there's an impact, but from a macro. So flesh that out. So why shouldn't people be worried about CRE commercial real estate? Well, in terms of the impact on the banking sector, I think that's where people think the risks are really heightened. It's kind of an extension of the banking risks that we talked about earlier. Banks do have exposure to commercial estate loans. If the values of those loans go down, then there could be problems in terms of the solvency of their balance sheets. Banks certainly do have some exposure, but it's not as large, perhaps, as a number of analysts suggest.

The underwriting on CRA loans by banks has actually been fairly concerned. after the Great Recession. So, you know, it could be a loan to value ratio of 50%, right? So there's quite a bit of buffer, I would say, in terms of the depreciation in those CRA assets that can go on without actually causing massive losses for a bank. So that would be the first thing I would point to. And then secondly, I do see this as playing out over time, right? This isn't, So far, I haven't seen the trigger that would cause all CRE prices to collapse suddenly, unlike what happened with the residential mortgage market during the Great Recession. These, you know, the leases are staggered out over time.

The mortgage has also come due at different points in time. So I think it will be a rolling issue, if you will, but not that critical Minsky moment, kind of sudden crash that goes on. So a long, slow bleed rather than a direct impact on the economy. Yeah, I agree with you. You know, just to put a finer point on it, give a couple numbers. I mean, the total amount of CRE commercial estate mortgage debt that's coming due this year, 2024 and 2025, is about $1.2 trillion of that dollars, you know, outstanding that's coming due. of that, a $400 billion is owed to the banking system.

The rest of it is, you know, reeds and commercial mortgage-backed security, sovereign wealth funds, all kinds of insurance companies, they need a bunch of stuff. It's widely dispersed around institutions in the global financial system. And of that, $100 billion is a mortgage is backing office properties. And that's really where the problem is, right? It's really, and it's really very specific. It's office properties sitting in downtown areas of big urban centers, you know, where we live, Philly. I think occupancy here is, I don't know what, 60, 70 percent probably and not rising.

People aren't going back in. If that. If that, yeah. You can look at the Castle data. I can't quite remember, you know, Boston, New York, D.C., Chicago. Seattle, Bay Area, you know, the poster child for all of the mess. Southern California, where I was, there was some high-profile defaults, you know, very recently. That's where the problem is.

So 100 billion, people say, 100 billion, that sounds like a lot. No, no. I mean, look, I think total, I'm making this number up, but the, you know, total assets sitting in the banking system, I think it's 20 trillion, something like that. I mean, some outrageous, you know, it's, you know, you know, this 100 billion is nothing. You know, so now, now having said that, the, the, the, true, let me try this out on you, the kind of the risk scenario, because you just kind of laid out the base case, you know, optimism. And you got to think about, you know, what could go wrong. You know, it does, going back to the distribution, you know, looking at, you know, institutions.

I think the typical bank, you know, has maybe 10 to 15 percent of their assets. assets and CRA total assets, you know, loans, securities, the whole shooting thing match. But there are a fair number of small banks that have a much higher share, you know, 25, 30, 35%. And as a share of their capital base, their equity, they're like, you know, tier one capital, it could be close to 100%. It could be over 100%. So, you know, you have one or two properties that, you know, go belly up, default on the mortgage, and it's owed to a smaller institution, those institutions could get into trouble. Now, you're saying, okay, why should I be worried about that? They're too small. They're not too big to fail. They're not systemically important.

But I would point out, given our experience back in March, I'm not sure, you know, what systemically important means anymore because because if people are nervous and start pulling their money out, even if a, you know, smaller bank fails, then everyone's too big to fail, right? So you could get into a, and right now people are on edge, obviously, you know, depositors are on edge. You know, my, I think I told the story about my 93-year-old mother-in-law who's got some cash sitting in the bank and, you know, well below the deposit insurance limit asking me, you know, whether she should take her money out and I saying, no, don't worry. And then she's asking me what I do for my, you know, for a living just to make sure, you know, I'm credible, you know, that kind of thing.

So, you know, if she's nervous and she's watching CNN, then, you know, every news outlet was, you know, saying the same thing, that people are very nervous and you could get a deposit run. Is that, does that sound like the most likely risk scenario, the things go off the rails? That's why it would go off the rails. Yeah, yeah. Not that the, not that J.P. Morgan or a large institution gets into trouble. But, but yeah, even a small one, because we are in kind of a fragile psychological state here that it may not take much to cause more bank runs. Right. And just one other reason why I'm not that nervous about it is, you know, the big banks have had to stress their. portfolios or commercial real estate portfolios under the stress testing scenarios, the so-called

C-car stress scenario. And I think, correct me if I'm wrong, Chris, because I knew you know this did really well, the peak to trough decline assumed in last year's stress test was 40% on CRE. That's right. 40% peak to trough. I mean, so that would mean, it had to be almost Armageddon, you know, for prices, you know, because I, you know, office prices would probably have to go down by 75, 80%, something like that. That's right. Yeah, because the 40% was across the entire. The entire CRE, multifamily, industrial properties that actually are.

Retail hotels, the whole shoot and match. Yeah. Okay. Okay. Yeah, that, that feels like that. And you're right. Also, I think talking to people, they're getting a little, they're getting less exorcised by that risk because as they work through the numbers like we just did, they're

becoming, they're nervous, but they're less nervous than they were. Yeah. So what are you hearing? What are you? Well, to answer that question, you know, what out there is bothering people that might be overdone? I think it's student loans. You know, the student loan debt moratorium, because I've been getting this question a lot, too, you know, comes to an payment moratorium that was put in place during the pandemic. That ends here.

And I think the first payment due of student loan borrowers is October. If you do the kind of calculation, by our calculation, using Department of Education data, 22 million student loan borrowers will have to start paying. Their average monthly payment is, say, $275, $300 a month. You do the arithmetic. That means if all those student loan borrowers started to pay and didn't have other financial resources, then it had to cut back on other spending or stop paying on other debt to make that debt payment on their student loan.

It's 70, maybe 75 billion per annum. So that, you know, 75 billion is, you know, a quarter percentage point of GDP. That kind of gives you a sense of magnitude. So if they all stopped in October and over December of the fourth quarter, and so you take a quarter percentage point, annualize on a quarterly basis, that's one percent. of GDP, you know, maybe you get a, you know, given all the things that we know that are going on,

maybe you get a negative GDP number in Q4. But that's a vast overstatement of what's going to happen because, you know, a lot of student loan borrowers have other financial resources. And here's the other thing. I don't know. I'm not sure how many of those 22 million borrowers are actually going to stop, start paying on their debt. Because as you, as we learned, President Biden, through executive order, told servicers that they cannot report delinquent student loan borrowers to the bureaus. So there's no penalty to the borrower for not paying, at least for a year. I think this was in place for a year. So I'd be surprised if 22 million borrowers started paying on their debt.

I mean, it could be half that. It could be a quarter of that. It could be, you know, shadow of, you know, what they're expecting. So, you know, it's not great. The timing isn't great. The economy is going to be soft and getting softer and probably will be at its softest point late this year going into next. But I don't think by, certainly not by itself. It's that big a deal.

What do you think? Yeah, I'd agree. That's what I've been saying as well. That certainly doesn't help, right? And given some of the other pressures we've talked about, right, if indeed savings are running out. It doesn't certainly point a positive picture. but on its own, it's not enough to really be the root cause of the next recession. Right, right.

Okay. I want to also ask, maybe before we answer the question, maybe we should play a little bit of a statistics game, which is going to feel a little weird because it's just the two of us. I don't know how that's going to go, but we might give it a shot, but I do want to ask, you know, what is the thing that people are missing? You know, what, you know, the kind of the standard you always get, you know, what keeps you up at night question. But before I come back to that, let me, let's, you want to play? Do you have a statistic?

I got one. I have one. You have one? We kind of alluded to it earlier, but okay. That makes it easier. Not really because we've covered a lot of ground already. I don't know how helpful that is. But okay, fire away.

All right. All right. 117. Oh, and I should say. Oh, wait a second. Yeah. To the listener, I'm taking it for granted, but they know what the game is. The game is we put forward a statistic. The rest of us, meaning me, in this case, try to figure out and not look stupid, you know, what that statistic is. And I'm, you know, through cues and deductive reasoning and, you know, clues. And the best statistic is one that's not so easy. I'm going to get it immediately and not so hard. I never get it. But so fire away. 117.6. 117.6.

Is it a economic statistic that came out this week? It did. It came out on Monday. It is an index just to give it the units. Well, I was going to say that. You establish a little credibility. It's not the conference board survey, a leading indicator, a coincident indicator.

No, I didn't think so. By the way, on that one, Yeah. That's getting to be pretty weird, right? Because the leading indicators, as measured by the conference board, have been declining for well over a year now. Yeah. But where's that recession, my friend? Recession is coming.

Okay. Here's what I want to know. I haven't had been able to chance to do it. But can you go back and look historically? Has there ever been a case where the leading indicators has fallen for so much for so long in a recession, not a recession? not occurred? No. No, it's got a perfect track record.

Okay. So far. And this started falling, I think, well over a year ago. Has that ever happened where the recession has followed that? So, oh, okay. With that much of a lag? I don't believe so. But I'll double check.

There might be some cases where, yeah. I've been looking at the magnitude. We've never had a case where we fought the leading economic interricators. have fallen so much and not had a recession within a six, 12 month period. But just so folks know, no, the conference board puts these so-called leading indicator, coincidental indicator, lagging indicator. It's a compilation of different economic financial statistics that historically have tended to lead, be coincident with, or lag the business cycle, lag recessions.

And the, you know, as you can imagine, the leading indicator is heavily dependent on the shape of the yield curve, the Tregor Yoke curve. That's been inverted, which historically has been a very good, you know, prescient predictor of recession. So that's driving a lot of the train. Also, I think it also includes University of Michigan Consumer Sentiment Index, which is, you know, a little saying something very different than some of the other confidence measures, including the conference. Which is a weird thing. Don't they use the conference board? Oh, I was just going to say, oh, do they use the conference?

They should probably. Do they be odd if they? I don't think they do, though. Now that I say it, I just said it. And I'm not sure. But that would be odd. wouldn't it? But no, they, they would pick the one that is the most prescient, wouldn't they, historically? I don't know. Can you, we should find that out.

That's a way. Wait. That would be weird. That would be weird. Oh, it would be really weird. We should check it out. The other thing, though, that, you know, maybe a reason why the leading indicators are a little off this time compared to previous. They're very heavy on interest rate sensitive sector activity, housing, manufacturing activity, right? And those two sectors have held up a lot better than anticipate, you know, for lots of different reasons. And so they may not be as good a leading indicators may not be that as good a leading indicator because of, you know, those, those, those, what's the idiosyncratic kind of environment that we're in. Okay, but going back to your statistic. I like how you, uh, yeah, I'm delayed, delay.

Is it a housing related statistic? It's not. It's not. It's from the Fed. Oh. That helps. Federal Reserve. Oh, industrial production?

Nope. Because that's an index. It is. Did it come from the Board of Governors? Yes, indeed. Is it a monthly statistic? It comes out weekly. Even daily.

Sorry, daily. Oh, a daily statistic. From the Federal Reserve Board. Is it financial related? Yes. H-10. H-10. Does that help?

No, you know what, I don't know. H-10. Is it financial conditions index or something? No, no. Damn, I should know this. H-10 is the foreign exchange rate table. Oh, it's broad trade-weight a dollar? Yes.

Nominal? Yes. Nominal broad-trade-a-dollar. Oh, gosh. There's got to be a lesson in you picking that statistic. You just picked that. Trump me. We kind of referred to it with the American tourists.

Yeah, we did. We did. So the dollar is weakening. Yeah. Right. Relative, it was really strong a year or so ago. Right. It is weakening now.

So something to watch. But it's still relative to where we were prior to the pandemic, still relatively strong. So as we think about inflation and implications of a strong dollar, right? Certainly a weaker dollar. could put some upper pressure on that inflation. But again, weaker, I mean... It's all relative. I get it.

It means well, it's well above its long run average, right? Yes, it is still. But it's still strong. It's falling pretty swiftly now. Really? Okay. I'm not so sure. When you say swiftly, against what exactly?

Against itself, all right? Against what other... It's a broad trade weighted, so it's got all these baskets of other... currencies. What is the dollar we mentioned that you're all appreciating? Yeah, a little bit. Okay. Yeah. Well, again, I'm not saying that it's collapsing, buddy. It's not collapsing, but it's yeah. Okay. Okay. Fair enough. All right. That's the fodder for a future discussion. Okay. Fair enough. Yeah. I'm not so sure. Okay. I got a statistic. I don't know how fair this is.

It's probably more fair than one. But it's more fair than one you just gave me. And this goes to, I'm going to give you a hint. It goes to a surprise, a positive surprise about the economy. I'll stop there. I can give more, but I'll give you the statistic, $194.3 billion. $194.3 billion. It is an economic statistic that is produced by the, well, I'm not going to tell you, but by the government.

And it didn't, I don't think it came out this past week. I think it came out a week before. So I, I apologize for that. Yeah. But it's a really good one. And it's apropos to the conversation at hand because it is a surprise, a very meaningful surprise, at least to me, and a reason for why the economy is held up better than expected. I'll give you one.

I'll give you one more hint. It's, oh, no, maybe I shouldn't give you that one. It's produced by the Bureau of Census. That should help a lot. Oh, okay. Yeah. It's monthly. $194 billion.

$194.3 billion. This is as of May, the May data. Yeah. And we were talking about it in the context of the leading indicators and, you know, how the interest rate sensitive sectors are holding up better than has been the case historically. And this is a one reason why that's the case. A housing construction. Okay, you got half right.

You got the construction right. Yeah. Oh, not just housing, but. No, 194 billion is too small for all of construction, right? Yeah, that's true. This is annualized. It's annualized data. I think annualized construction put in places well over a trillion.

Yeah. Which sector? Which sector? Oh, this is a good. You should know this one. Oh, now you should know it. Yeah, what's booming in the construction? second. Oh, industrial. Yeah, industrial manufacturing, manufacturing construction put in place,

194.3 billion. Can you believe it two years ago? You go back to May of 2021. It was like 75 billion. Yeah. 75 billion to almost 200 billion. And it's going, it's going straight up. It's almost vertical. It's almost vertical. It was so cool, right? Pretty amazing. Yeah. And that goes to the, you know, a lot of government support, the Chips Act in particular. That's the piece of legislation that was passed, you know, a little over a year, I think it was a little over a year ago, that provides tax incentives for global chip producers to, you know, manufacture here in the United States. And it's pulling in a lot of construction, a lot of the new manufacturing construction activity, you know, actual fab plants are being constructed. In fact, I just saw TMCS, that's the large Taiwanese chip manufacturers, building a plant in Arizona. we were talking about this when I was in Southern California, they are going to be delayed

in starting that plant, going back to something, some of the issues we were talking about earlier, because they can't find skilled labor. Yeah. Yeah. This is so funny. So this comes out of one of the conversations I was having with one of the banking clients this this past week because they're following it very carefully. And he was saying, you know, because TSMC said they're probably going to have to bring in some

Taiwanese labor engineers, you know, here to help finish this thing. Yeah. He goes, I don't know how that's going to work at all. They're never going to get any of those Taiwanese workers come because the closest Chinese restaurant to the fab plan is seven miles away. That's what he said. I go, that's pretty precise. That's pretty precise. Then he said, well, yeah, and the, the closest decent Chinese restaurant is 20 miles away, 20 miles away. And, but, by the way, there's no direct flights from, I think he said Phoenix to Taipei, which surprised me a little bit. But, you know, but he knew, he knew, he knew this. I thought that was pretty, you know, took this very seriously.

So what do you think? That was a pretty good, that's a pretty good, pretty interesting. Yeah, that's a good one. And you were very generous with your hints. And I was generous to my hints. Yeah. Generously. Okay.

Let's go back. You know, you know, have you noticed we've been speaking, talking with. each other on this podcast for about an hour. It's just a two of us. I'm not even sure we need Marissa anymore. You know, I'm just saying. Oh, really? Okay.

That was rude. Oh, come on. Okay. We can only do this so often. We need, we need Marissa. Bring her back, please. Where is she, by the way? Hawaii.

Oh, good for her. She's doing detailed economic research into the economy. Okay. Good for her. I expect a full report when she's- Yeah. Well, Hawaii is an interesting economy. That's a topic for another day, though.

Okay, let's end this conversation this way, because it's always part of the conversations we have. You know, what is it that people are missing on the downside? You know, what could go wrong here? What should people start being focused on that they're not focused on? What do you think? You must get that question all the time. Yeah, for sure. I'm going to go back to my upside surprise, which you don't think is a lot.

an upside surprise, but that was the consumer. And I would say the consumer, consumer, consumer credit is another area. Blah, blah, blah. Focused on the downside. Really? Yeah. What's bugging you there? I just, I just, this wage are concerned around student loans. So what's the, what's the deal? Well, I'm not, not concerned about student loans. I just don't think it's the rigor. I'm not concerned. Okay. Okay. I don't think it's the concern, or I don't think it's the trigger for a recession, but I think it adds to pressure on consumer balance sheets. As, you know, labor market does slow, wages are going to come in, right? That is going to guarantee that. And certainly that's going to start to put more pressure on consumers. I think the excess savings we've been talking about have been a real boon, but those are running lower and lower every

month. So I think it's going to get tighter here. And we're going to be walking the tightrope. And I worry about the consumer credit, delinquency default rates starting to really ramp up here. And that could have a real chilling effect from not only a banking standpoint, but even a psychological standpoint, if you start to see a lot of defaults of delinquencies, right? Might lead to consumers thinking twice about taking on additional credit or continuing that spending at the levels that we talked about. So when you say consumer credit, precisely, What do you mean? You mean bank card? Anything outside of mortgage, really.

Oh, well, so you're starting in student loans, auto loans, auto loans, bank cards, bank card, personal loans. Unsecure personal loans, so-called consumer finance. And so you're saying clearly delinquencies are rising here pretty quickly. That's right. Part of that is the stress that lower income households or financial stress that they're under, in part because of the inflation. they've blown through their excess saving. Also it goes to, we've talked about this in previous podcast, score inflation back in the particularly...

21, 22. Right. That's the bad so-called vintage of loans. That's where the delinquencies are, you know, really popping. Right. You're saying that this could get meaningfully worse, even if we don't go into recession, could get meaningfully worse.

But obviously, we go into recession. Yeah. I see it getting worse, certainly. It's not going to get better until we move through. these particular vintages, right? That's going to take another year or two. So expect the delinquencies to get worse, but the risk is that they get, they really take off if there is some other weakness out. If the job market slows considerably, if you do start to see unemployment ticking up a bit further, right, that's going to put additional pressure on these markets and

cause those delinquency and default rates to rise. And that's going to cause the banks to start to pull back even more ISIS funds. Okay, okay, fair enough. I mean, the dollar amounts are, I guess they're consequential, about a trillion in bank card debt outstanding. I think consumer finance is, what, $250, $300 billion, probably? Yeah, not that large. Yeah.

Auto is significant. That's $1.5 trillion. And student loans are another $1.5.16. So you add that all up. That's real money. That's what you're saying. Yeah. And it's, again, it's really what the impact on the margins.

in terms of the diminished spending in an economy that might already be facing some headways. Boy, if that's the worst you can come up with, I'm feeling pretty good. I mean, I agree. I mean, it's definitely a soft spot and going to be some issue. But it already feels like the lenders have tightened up, but loan growth is slowing. Still growing quickly, but starting to slow. You pointed that out in the last podcast. Yeah.

You were pointing that out, right? And it feels like delinquency is starting to top out. You know, it's, no, you don't think so? I don't know about that. Okay, interesting. Okay. Okay. Because it's now, it is back to pre-pendemic, right?

Yeah. Maybe even a little higher than pre-pendemic. In some of the markets, yeah. In some of the markets, yeah. Okay. Okay, fair enough. Okay, I got two. One's near term.

One's, you know, a little bit longer. longer term. Actually, I can give you three, one, the short term, intermediate term, long term. Actually, I can give you four. No, I'm like, I could give you four, but that's, I don't want to depress people. Near term, government shutdown, right? I mean, I think there's a growing possibility that lawmakers can't come to terms before the end of the fiscal year, which is the end of September, passed a piece of legislation that funds the government. So we could shut down. And my sense is that we could stay shut down for the entire fourth quarter because the real pressure, yeah, the real pressure point politically is that if they, if they don't come to terms on January 1, there will be what's called sequestration, a 1% cut across all discretionary spending, both defense and non-defense. And I don't think anybody wants that, both Republican and Democrat. So they'll come to terms. But that, you know, the Republican House could want to send a message here because they're pretty strident and decide, hey, say, we're going to shut down for a full quarter. If it's a full quarter, Q4, hmm, you know, that adds up.

That adds up, particularly with the student loan thing I just mentioned, which adds up. So, you know, Q4 feels a little iffy to me at this point. You know, we may get, that could send us into negative GDP territory. So I worry about that. And so. Yeah, I was thinking a few weeks, you know, we brush it off as usual. But yeah, it's a quarter. Yeah, I think it could be that long.

Could be that long. Here's the intermediate term concern. And it goes back to the financial system, not the banking system. Because I think the banking system is on much sounder ground because of the policy response to the crisis that occurred in March. You know, the bank term funding program, the Fed's established to allow banks to borrow against their security holdings at par. You know, the willingness of regulators' treasury to ensure all depositors come push to shove, you know, those kinds of things. They're resolving troubled institutions very rapidly. They're not letting them fester, which is, you know, I think a good thing.

from the perspective of safety and soundness and, you know, making sure the system doesn't fall apart. It's the non-bank part of the system, the shadow system, particularly the part I know best. And I'm worried about all of it, in part because I don't understand it and it's not transparent. It's very opaque. You don't have really good data on big chunks of the, you know, private credit market, for example, leverage loan market. But I'll point to the non-bank mortgage industry. Yeah. that makes me a little nervous, you know, because they're under a lot of pressure because there's no,

as we talked, interest rate lock, no home sales, therefore no mortgage origination. And that's their business. That's how they make their money. And if there's no origination, you can, you know, they're going to start to see some failure there. And there's no, you know, these institutions, you know, they're mostly intermediaries, but they do have some risk and they do have some capital, but it's very thin capital. But here's the real kind of vulnerability. they're funding, you know, they're non-banked. They don't have deposit. So they rely on warehouse credit lines from the big banks and, you know, capital markets for their funding. And I could,

you could easily see that under some scenarios drying up. And if they can't get funding and can't make loans, then they go out of business very rapidly. And if, you know, they're small in the grand scheme of things, so they're not systemically important. But again, if you get a rash of failure, And then creditors and the other bigger non-bank mortgage companies start to say, hey, I don't really know what's going on here. It's not as transparent as I thought. And they just kind of run for the hills and stop providing funding or equity. Then, you know, the system kind of stops, shuts down. And these guys are a big chunk of the mortgage market now, I think, right?

They're like 75% of the mortgage market, you know, in terms of origination volume. If they stop lending, then the housing market shuts down. Then those house price declines we were talking about. Yeah. We're going to get some pretty big price declines. And then you can then, then, of course, your mind can go in lots of different directions pretty fast. So, you know, and I guess adding to that is how does how does the government respond to that? You know, what's the response?

I mean, maybe the first. Fed could establish a facility, but that's pretty tough to do. Maybe FHFA, which is the regulator for Fannie and Freddie, you know, tells the Fannie and Freddie to establish, you know, a source of funding for the non-bank mortgage loan. I don't know. I'm, you know, right? Right. It's uncharted. Uncharted territory there. Yeah. Yeah. Okay. So you would agree. You agree. Yeah. You would think that the federal home loan bank's system would be. They can't. But these guys are not, that's the irony, right?

Is the mortgage originators today are not part of that system, right? Yeah, because they can't. I mean, the way the system works, the federal loan bank system, they take securities as collateral. These guys don't have the collateral. They post the collateral to get their lines of credit. So there's no way of, so the federal homeland banks isn't a source of liquidity either. So you would agree. So is my, is that more of a concern to you,

than the consumer credit? Oh, I'm just, I guess, Vieta rank order. I guess I'm still more concerned about the consumer. You are, okay. Yeah, just in the sense that there are. Because we know that, we know those, that's a problem. We know delinquencies are arising.

The other we don't, it's more speculative. It's more speculative. And, you know, you're right, there's concentration of, in terms of originations, but there are a number of them out, a number of these originators out there. So, yeah. If one goes down, there are others. that could step up to fill the volume. But I take your point regarding the nature of a run, right?

Yeah. If suddenly a large mortgage originator gets into trouble, suddenly all the other ones become tainted, the banks don't want to lend necessarily to any of them until they figure it out. The system could really seize up for a while. Yeah. Okay, you want one more?

And then we'll call it a podcast. Go for it. Go for it. AI. Oh, you know, that was the one I was going. going to mention if we were going to go long term. I mean, because I get that now every single meeting, right? What about AI? Okay. So actually on this trip I had out west, I had Dante with me. Listeners know Dante. Dante is a great labor market, great economist who comes on every job Friday.

And at the, you know, I had him come because I wanted to see, I wanted him to kind of shadow me and just, you know, see how this is done. You know, yeah, yeah. He's going to be doing this, you know, out meeting clients a lot more than he has historically. He talks to clients all the time, but he hasn't done a lot of traveling. So the last dinner we had, which was in Southern California, someone, of course, asked about AI. And I made, I asked him to answer the question. Did a great job. So I'm going to turn that back to you.

How would you answer the question around AI? how big a concern is that? I mean, obviously the concern is it's dystopic to the labor market, but I'll turn it back to you. How would you answer that question? Yeah, dystopia is certainly one version of the picture you can paint here. I guess I would, to answer the question directly, in terms of the short-term implications, I see them as very limited, right? AI, like any technology takes a long time, is going to take some time to be fully integrated into the economy. You have to train people up on a it may be maybe maybe the learning curve for using AI technologies for certain knowledge workers is shorter than computers in the past but still it's not going to be

instantaneous so there's some training that needs to be conducted people have to get people need to figure out how to use this new technology effectively in their job so I don't see this as a 2023 2024 even 2025 type of risk. This is longer term, right? It's certainly going to have some structural, or it has the potential for some structural changes in the economy. So I think that we could take off the table in terms of the immediate effect. There's a lot of buzz around AI right now, but just go back to the internet. There was a lot of buzz around the internet too initially, but it took years, decades, to actually bring that up to speed. So I would remove the short-term risk.

longer term, you know, the risk really depend on how this AI project works itself out. I remain quite optimistic, though, that AI is coming at the time when we actually need it, given all the lack of labor that we have. The issue with the labor market today and into the future is going to be a real lack of workers to fill all the positions that are available. And so we need these productivity enhancements to, continue to grow the economy, continue to grow productivity, and ultimately continue to grow wages. So I see this as a real benefit to the economy overall.

Will there be disruptions, certainly? But there always are disruptions in the economy with any new technology. So I don't see those as being any worse, though, with AI than with other technologies, meaning over time, we will adjust. This isn't going to be an immediate shock where we lay off all the program. in the country and we just go to AI. It's going to be something that gets integrated with industry over time, makes people more productive.

And I think you'll barely notice at the end of the day the real implications in terms of layoffs on the economy more broadly because it's going to play out over a number of years. Yeah. I thought I do. Yeah, well said. Yeah. No, I agree. I mean, I say, I preface the response to the question by saying, I forecast lots of things,

some things I'm confident in, some not so much. This one, I'm not so much because, you know, this is a tough one, like all technologies. But, you know, if history is a guide, and we always use history as a guide, everyone does when they forecast, they go, okay, what happened in the past, I'm going to use that as a basis for predicting the future. And you go back and you look at technologies, big technologies, and like the internet or electrification, it takes time for those technologies to diffuse out into the economy and to have big impact. And actually, it doesn't really have a big impact until new businesses form and optimize around that new technology. that existing businesses that tie to gerrymander the technology into their existing business practices, that's problematic. And in fact, to your point, could be actually counterproductive, you know, at least for a time because they've got to, oh, what do I do with this thing? How do I organize myself? How do I take advantage of it? I'm spending all these resources on it. And by the way, the initial impact could be positive, not negative, because, you know, companies have to have to invest in the underlying, you know, physical, hardware and software and people to be able to actually do it, you know, actually implement it,

to bring it on. And so it's not this labor saving thing. It actually may be creating demand for labor in the near term. Not hurting it. Yeah, good point. Yeah. So I, you know, I agree with you. I think it's going to take some time to diffuse out into the economy. But, you know, having said that, like the internet, the internet probably, added, you know, in the 2000s when it really kicked into high gear, probably added half a point, maybe a point to productivity growth. Productivity growth in that period was 3% per annum. So, and I think that, you know, was the internet.

Electrification, you know, if it go back into the 20s, same deal, you know, added it could have been a half a point to a point. So if you told me over the next 10, 15 years, you get a period of, you know, 5, 10 years of, you know, 3% productivity growth. I don't know that I'd argue with you. You know, that's a real possibility. But I don't think that's dystopic, you know, dystopic in the sense that you throw so many folks out of work so fast that they can't find another job. And here's the other thing.

These technologies, they create wealth, right? Yeah. And by creating wealth, they create more demand for stuff we can't even anticipate, you know, because, you know, we can't even think about, you know, think about all the things that we're consuming now that weren't even in our mind's eye, you know, back before the internet was in full swing, right? You know, mobile phones, right? I mean, you know, you know, so forth and so on. So, so I'm, you know, I, I'm, I think we'll be able to digest it. But obviously it's a risk, you know, so it's a, you know, potential, you know, downside risk going forward.

You know, certainly, I don't know if it keeps me up at night, but it's something I'm thinking about, you know, more, more deeply as we move forward here. Okay, we cover a lot of ground. What's that? Are you using AI at all? I had, I had, yeah, I have been using it, uh, kind of like a glorified Google. You know? Take it with a grain of salt, though. And it's not particularly useful, you know, for, like I thought, oh, I could use this

for helping me understand what's happening now in different economies. You can't, right? Because I think it's limited at this point, chat GPTs to 2021, right? So I go, I go to chat GPT. How's the New York economy doing, you know, and it says, well, as an AI, I don't have. access to the data past 2021. I can't really answer the question. Then I, you know, stupidly say certainly hindsight stupid, quick hindsight stupid, well, how's economy going to do in the future? You idiot. You moron. I just told you. I can't go beyond 2021. Come on. Wake up over there,

human, you know, that kind of thing. So I felt a little diminished, you know, after that. But, you know, But yeah, are you using it? It's great for coming up with titles. Oh, I think Mercer uses it for the statistics game, to be frank. Yeah. Also, if she can't get the latest data in there. Oh, yeah, good point, you idiot. You moron.

It's really good at summarizing things. You big dummy. Yeah, all right. Okay, very good. I was thinking about badgering you about your recession call, but, you know, I'm going to wait for the right moment for that. I felt it. It was coming. It was going to.

I'm not going to do it because we're wrong in the tooth here. And this is Saturday morning. Or script to be written, my friend. Or script to read. Yeah. Whose line is that, my friend? Yeah. Yeah.

Anyway, all right. We're going to call this a podcast, unless you got anything else you want to say. No, I think the listeners have had enough. I've had enough. All right, dear listener, you've had enough. It was very good chatting with you. And I think next week, next week, we, do we have a guest? I think we do.

Yeah, Marissa will be back, put us, you know, back on, you know, put us back on the straight and narrow. Okay, with that, we're going to call it a podcast. Take care, everyone.