Moody's Talks - Inside Economics - Top of Mind, Turbulent Financial Times

Episode Date: August 18, 2023

Despite the light week of economic data, there was lots going in in the economy to discuss for the Inside Economics team, including the runup in 10-year Treasury yields and fixed mortgage rates. Noted investment banker Chris Whalen then joins the conversation to talk about the banking system, its’ under significant pressure, the independent mortgage banks, a shakeout is underway, and the Fed and other regulators, he’s not a fan.For more on Chris Whalen, click hereFor the full transcript, click hereFollow 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 Zandi, the chief economist of Moody's Analytics, and I'm joined by my two trusty co-host, Marissa Dinaali and Chris Dorene's. Hi, guys. Hi, Mark. How are you guys doing this week? Good. You sound a little congested.

Yeah, I got a bit of a cold, you know, ugh. But I'm feeling better. I took some NyQuil last night. Got a good night's rest, so I'm feeling better, but still a little congested. Wow. NyQuil. You have new perspectives on the economy after that? Really? What do you mean? It gives me funny dreams, right?

Did you hallucinate? Oh, NyQuil does? Yeah. No, I don't really. No, okay. Oh. My wife swears by it. Any ailment NyQuil. I see. Because it just knocks you out. And then she seems to tell me, don't take NyQuil during the day. So, okay.

I think she's done that a couple times. You really don't want to do that. But anyway, thanks for asking. And we have a guest. We're going to talk to in a little bit. Chris Whalen. Chris is a great banking analyst. He has a great view of the financial system more broadly,

mortgage finance in particular, and we'll have a good conversation with him in just a few minutes. But before we go there, I thought we could. start our conversation with what's top of mind, you know, this past week. What in the world of economics and financial markets kind of caught your attention? And maybe I'll begin with you, Chris. Go with you first. What's top of mind for you? Yeah. So this week was a little light on economic data and releases I found, but there was quite a bit of movement in financial markets. That

That certainly caught my eye with the 10-year treasury moving up pretty significantly this week. I think that in part because of the, we got the minutes from the FOMC, right, which maybe influenced investors' positions as well. So I think there's been a lot of chatter around the tenure. And then also mortgage rates as a result of that have also gotten a lot of attention. So that certainly caught my eyes. Mortgage rates are now firmly above 7%. right, lots of discussion about whether that's going to slow down home prices significantly

or buyer's going to really retreat. I think that feeds into the second part of your discussion here today. Yeah, that's exactly where my mind went. That's top of mind. The, excuse me, the 10-year treasury yield, I think it got as high as 4.3%, which in the grand historical scheme of things isn't that high, but, you know. No, no. I think it's as high as it's been in over 10 years.

I mean, you have to go back, I think, even longer than that, maybe 15 years. I think so. Yeah, 15. Right. Well, let me ask you this. I mean, why do you think it's increased? You mentioned the FMC minutes. That's not it.

That can't be it. That's not it. Why do you think? Maybe a contributing factor, right? The minutes got to suggest that. Perhaps recession risks are no longer. There are certainly reduced, right? That's all news, Chris.

Come on. I mean, now it's from the July meeting. That's not what's going on here. Fundamentally, what do you think is, you know, behind the increase in yield? I mean, maybe investors are beginning to, you know, fully discount the likelihood that that's not going to be easing policy anytime. So maybe that's what you're saying. Okay. That's what I'm saying.

So, yeah, you're right. There was a lot of speculation after the meeting, but this guy is a bit of a confirmation. Yeah. You're saying it's just coincidence that tenure went up and FMC minutes were released? You don't see any. I think it was going up before the FMC minutes were released. I think it was already up. I mean, my sense is that, you know, I'm sure you're right.

Contributing factor, but not a contributing factor. Yeah. I'm right. Okay. Yeah, my guess is that there's a lot of trouble. Treasury issuance. You know, the budget deficit is very high for lots of different reasons. Some temporary, some not so much.

I mean, we've got a large structural deficit. And so there's a lot of treasury issuance, bond issuance. And I think the Treasury increased the size of its auctions to accommodate the large deficit. And that took, I think, investors by some surprise. I think that, you know, probably played a role. There was also, interestingly, some speculation that the Japanese central bank, the Bank of Japan, didn't end, but kind of tweaked its yield curve control.

They have this policy of buying 10-year JGBs, Japanese government bonds, to keep it low. That was a way to help stimulate the economy. And now that their economy is doing better, they've relaxed that that buying. And so this has raised the whole kind of level of interest rates around the globe, including here in the United States. Japan's interesting. We should talk about that sometime. I think you mentioned we should get our colleague Stefan Angric on, and we are. He's going to come on and talk to us about Japan. Mercia, any other explanations for the run-up and 10-year treasurials that you can think of?

you know, what's going on there? I've seen so many articles this week about how economists are, you know, raising their expectations for the, for this so-called soft landing. Inflation's coming in. The job market is slowing, but it's not cratering. We're probably out of the woods in terms of recession. It's been all over the news starting from late last week to this week. And I wonder if bond investors are reacting, finally saying, you know, the Fed's going to pull it off.

We don't have to buy 10-year bonds anymore. Maybe we can be in something shorter term and perhaps riskier if we're going to avoid a recession. Right, right, right, right. You know, the interesting thing is 4.3% is not materially different than our expectation for 10 year, where 10 year treasury yields should be in the long run. In fact, I'll point out, you know, we have had in our forecast for a long time for many years, the 10 year yield ultimately rising to about 4%. The logic being that that's consistent with the nominal potential growth rate of the economy, nominal GDP growth. That's 2% real growth plus 2% inflation.

And in the long run, the cost of capital, which is the 10-year yield, needs to be roughly equal to the return on that capital economy-wide, which is the potential growth rate of the economy, so 4%. And actually, empirically, if you go back and look over the last 50 years at nominal GDP growth and compared to the 10-year treasury yield, they're exactly equal to each other, you know, to the basis point. Now, there's long periods when they can diverge for various reasons. reasons. You know, for example, when the Fed was working hard to lift inflation between the financial

crisis and the pandemic, it was easing, managing, creating an easy monetary policy. Ten-year yields were low, well below nominal potential growth. But generally speaking, that's the case. And so we've always had in our forecast that increase in yields up to about four. And we were getting a lot of criticism, Chris, remember? We had clients that were critical of that forecast. It looks like it's right. I mean, you know, it's hard to know when that was going to happen, when it was going to get back to fair value. But, you know, that's like within the asset price, it can be, you know, higher or low relative to fair value for long periods of time. You know, you don't know exactly when it gets back to equilibrium to its long run value, but you know that it will.

the other thing is there's volatility here right yeah even today on uh Friday right was 4.3 earlier this week's 4. It's close to 4.2 today right so oh is it is it back down to 4 2 2 or 2 3 something like that so okay now these you know things are still moving around here yeah just a couple days doesn't mean it's equilibrium yeah and I don't I don't think 4.3 is different than 4 yeah in the grand scheme of things right you think great scheme of things yeah now let me at the course you mentioned mortgage rates 30 year fixed mortgage rate is now over 7% uh so that's the four and a quarter let's say 10 year yield plus some spread some difference and here the spread is very wide it's about three percentage points or 300 basis points

yeah historically it's about half that uh you know the spread is about half the 300 basis points you know, I guess do you think we're going to be above seven here for a while? I mean, I think in our forecast we have at six and a half to seven, I believe. But, you know, maybe we're too low. Do you think we're going to be hanging above seven here for a while? I think the 300 basis point spread is going to remain intact. That's going to remain. Right?

So are we going to be above seven? It really depends what your tenure. If indeed we stay above four, then yes, I think we'll stick around seven, seven a half for a while. Probably based on our forecast, it's until the middle of next year when the, that's when the yield curve in our assumption goes from inversion to more upward sloping. And that could be the sign that you'll start to see those spreads come in. But in the meantime, I don't see a lot of movement to bring that spread down significantly. So mortgage rates are going to remain high here. I think so, yeah.

And again, 10-year could actually go up a bit more. So there's risk that get closer to 8 percent. Right, right. Well, that's a good one. The 10-year yield was top of mind. And Marissa, if I ask you the same question, what was top of mind for you this week? That was going to be my answer. Really?

Oh, my gosh. All three of us were going to say the same thing? Yeah. Yeah. That's the big news, right? What about China? It's getting a lot of play. Yeah.

That's true. Yeah. Chinese real estate market, again, in the news with a very, very large. commercial real estate company potentially flirting with default. Yeah, I mean, the economy in general, right? The Chinese government stopped producing some unemployment statistics, ostensibly because they don't want people to see what they are. You're talking about the youth unemployment rate.

Yeah, yeah. They used to, well, until this past month, they were published, the unemployment rate for people. I can't remember what their ages were, like 16 to 25 or something. And that had been, it's high and it's been increasing, and they stopped publishing it this past month. Presumably, I don't know what explanation they gave, but it feels like it's because they just don't want that to be the center of attention. Yeah. It's funny, you know, a conversation around China gone from, you know,

It's a joggernaut to it's a basket case. It's like. Yeah. In months, right? Yeah. It's just pretty amazing. I mean, it's got its problems. And, you know, we've had discussions about China on the podcast before and with bears.

You know, people are pessimistic about China. And I, you know, I'm sympathetic to that. But it feels like this might be a little bit overdone. I'm not sure the kind of the pessimism around the Chinese economy. I don't know. What do you think, Chris? Yeah, I mean, it's still a huge economy, right? Lots of resources at their disposal still.

So it could be overdone, but also hard to make the, I find it hard to make the bowl case at this point. What is the, what turns this around? I don't see that politics are going to improve anytime soon, right? Especially as we go into an election year. So I think they're going to be under pressure for a while, not just between the U.S. and China, but also Europe and China, other countries as well. There seems to be a lot of pressure there.

But they are still integral to the supply chains, right? As much as we talk about moving things around, it's China Plus One is the mantra for adjusting supply chain. So it's still very difficult for manufacturers to move away from China. So they're still playing a very important role. But how do we see additional growth? or how do we see them really turning things around in the short term? That's where I'm scratching my head a bit.

Yeah. No, I hear you. I hear you. There's just a long list of challenges. But, you know, I always get worried about this thing called home bias. You know, it's funny. You talk to people around the world about their economies, you know, wherever they're from. and they tend to be more upbeat, optimistic about their own economy.

There's a few exceptions. Marissa and Chris, you'll appreciate this, except for the Italians. I find the Italians, they're more pessimistic than they ought to be about the Italian economy. I mean, there's a lot to be nervous about. I mean, growth rates are depressed, but. I think you need to look a little closer, Mark, if you're optimistic. Well, it's such a wealthy country, right? know, right, it's not growing, but on the other hand, you know, but anyway, I digress.

I think you're right. I get my broader point is that there's a kind of a home bias and I worry that we're guilty of that here because China is kind of our, in the case of the U.S., are certainly our competitor. You know, I don't want to say foe, but, you know, it feels like they're a foe for many, you know, kind of American politicians, they get the blame for, you know, a lot of our hills. So, you know, I just wonder if we're not overstating the case here, you know, whether, you know, the economy's not going to be, you know, it's not going to grow like it did, but maybe it's not going to grow quite as, not be quite as bad as we're making it out

to be at this point of time. I don't know. I just throw that out. I just worry about it. At least I'm self-aware. Yeah, I potentially have some bias. Yeah. So I worry about that. Okay. Well, why don't we play the statistics game? The game is we each come forward with the statistic. The rest of the group tries to figure it out through questions, deductive reasoning, and clues. The best statistic is one that's not so easy. We get it immediately, one that's not so hard. we never get it. And then if it's apropos to the topic at hand,

and I'm not sure what the topic of hand is here. You know, we are going to talk about banking with Chris Whalen soon, but that's the game. So tradition has it. We begin with Marissa. Marissa, what's your statistic of the week? Well, my statistic was going to be 7.62%,

which is the... Oh, no. Oh, it's not the fixed mortgage rate. It is. It's the average 30-year fixed today. Where are you looking? It's index. Yeah.

It's the, I'm looking on bank rate. Oh, no. I think that may be, really? Okay. You will look at Mortgage Daily News, right, Chris? Yes. Mortgage News Daily, right? Sorry, mortgage news daily.

Yeah. What does that say? 7.37. Yeah, that's more like it. Yeah. But I don't know. Okay, fair enough. You thought we would know that right off the hand.

Right off the hand. It's high. That's high. That is high. Right. It's higher than what the NBA or the Freddie Mac reports is back. Surely what Freddie says. Yeah.

Right. But anyway, that's, The point is my statistic is now out of date because of our conversation about what was top of mind. That was going to be my statistics. I got another one point. Okay. Give us another. 5.2%.

5.2%. It was a statistic that came out this week? Yes. Was it a government statistic? Yes. Oh, okay. What do you think, Chris? Housing related?

We had permits and starts and no? No, it's not housing related. All right. I didn't think so. Retail sales came out. Retail sales came out. Is it retail sales related? It's not, no.

I think we got industrial production, didn't we? Is it IP related? That came? Is IP related, yes. Oh, 5.2. It's something like utilities. output or something in the month. No. Mining output. No. Utilities output. No. Vehicle manufacturing output. Yes. Yes. Nice. Nice. Oh, boy. That's digging deep, baby.

It's the motor vehicles and parts month over month industrial, the production change in in autos, It's 5.2%. It's up 10.3% year over year. It's on the rise. And the reason I bring, this isn't really germane to what we were talking about this week. I was kind of digging deep into the stats. We've been talking a lot about auto production and how it is coming back. It's been contributing quite strongly to getting more cars out there has caused prices. to come down in the vehicle market, which has been important for inflation month over month. So we're starting to see the auto market normalize supply chain disruptions largely worked their way through.

The auto supply worldwide is coming back online. We are watching the UAW strike, which could be a problem here in the U.S., but it's a big part of manufacturing. So that's why I mention it. Well, manufacturing's held up pretty well. I think IP year over year is basically flat, isn't it? I mean, industrial production has gone nowhere over the past year. Yeah, it actually perked up quite a bit this past month.

It was up 1%, which is like the largest month-on-month gain that we've seen in, I think, since January. And I do think utility output, mining output were up a lot. That's why I said those. They were, and they're pretty volatile, so I don't know. Yeah, I wouldn't read too much into that. But it is pretty amazing that manufacturing is held up as well as it's held up, right? It's outside of housing, the most rate-sensitive sector of the economy, and it's kind of, you know, navigated through reasonably, you know, very, very well. You know, if IP is flat, that that's pretty good.

Okay, that was a good one. Chris, you want to go next? Sure. My original statistic was going to be blank, but we already covered that with the. Blank? Yes, that was the Chinese youth on unemployment rate. Oh. What is the Chinese youth unemployment rate?

Well, we don't know. N.A. Oh, I see. I mean, last month it was what, 22% or something? Oh, yeah, it was in the 20s. In the 20s, close to a quarter, I think. But my statistic is 12. I know what it is.

It's your favorite. Yeah. Yeah. Yeah. Yeah. Yeah, we are, we are. dig in deep here. So the Philly Fed Index went to 12. You want to explain? Yeah. So that's a manufacturing business survey, right? So a positive number of 12, it was minus 10. The previous

month, actually is the first positive since August of 2022. So indicating, I guess it's very similar to Marissa's statistic there that manufacturing is picking up in the Philadelphia region. shipments up, new orders are up, positive as well. So, you know, certainly more optimism when it comes to manufacturing. So kind of consistent with that more positive vibe. I would say, I will say, qualify, it is one number, one month, right? So you don't want to read too much into it, but certainly it's moving in a more positive direction. I think the affiliate Fed Index historically has been a very good,

accurate, prescient predictor of recession, hasn't it? I mean, I think it's particularly good. I mean, I've seen different studies, you know, trying to find indicators that predict recessions. And, you know, it's not the, it's not the same as the yield curve, but it's pretty, pretty good. It does track, it's of all the Fed district manufacturing surveys, it's one of the one that tracks the national ISM composite index the best. Oh, is that right? Yeah. Yeah.

And it was firmly negative and now it's positive again. So another reason to think maybe no recession, if it's behind us. No recession next month. Let's go with it. No recession next month. Okay. Where there wasn't a recession last month.

That's right. A bit of a lag too. Okay. Ready for mine? Yeah. $1.7 trillion. Dollars? Is this?

I'm sorry. Yeah, $1.7 trillion. Is this part of the Fed's balance sheet? No, no. I don't want to mislead you. It could be somewhat related, I guess, but no. Is this CRE related? CRE, commercial real estate?

No. Is it housing, residential housing related? No, no. We did talk about it in the context of the 10-year treasury yield. for the increase in the yield and it so think about the reasons for the reasons for the so increase in government

debt issuance is that or just the deficit the deficit itself yeah fair enough yeah 12 month moving some of the you know we get we get the size of the deficit every month from the US Treasury you took like I

I think the last data point is for July. I think that's right. For the 12 months ending in July, the deficit is $1.7 trillion. So, you know, not inconsequential, you know, starting to rise. Well, good. All right. Well, before you move on and get Chris here talking with us, just very quickly, probability is a recession. Marissa, you are at one third.

Of a probability for a second. Are we talking about the next, what, year? 12 months. Yeah, next 12 months, next year, this time, through this time next year. You still at one third? Yeah. Yeah. Okay.

I am as well. I'm still at one third. Still relatively optimistic. You, Chris, you were at 45%. I'm going to stick there. This, uh, you can, the fact that everyone else is marking down their odds makes me even more nervous that the. Yeah.

I hear you. I hear you. Yeah, okay, very good. Anything else? Anything else that we should have covered that we did before we move on? Brisa? I just have a question, what your opinion? And Chris, with the mortgage rate above 7%, do you have a, do you have any different outlook for the housing market? I mean, what do you seem to have been bottoming house prices even rising a little bit? Does this change anything in your mind? Chris, go ahead. Yeah, I'd say we have about a 4.5% decline from the peak in our house price forecast.

And that's perhaps already quite bearish relative to other forecasters. I would stick to that. I think that there's certainly still a lot of demand out there. We see investors still playing a role. And there's very limited supply of housing. So certainly that has kept prices up. But 7%. that now is really starting to dig in even further into the affordability.

So I remain convinced that we'll see some weakness here. I just don't see how we can continue to power forward even with rates rising above 7%. Yeah, I agree. You know, I think rates will come back below 7. I do think the 10-year will hang around four. Of course, forecasting interest rates, forecasting anything is pretty intrepid. Forecasting interest rates in the near term is downright crazy to try to do. But, okay, we have to do it.

So, you know, I have rates coming back down to six and a half percent-ish to seven maybe. And if that's the case, then I think we get down four or five percent peak to trial. If we're above seven, if we hang above seven for, you know, three, six, nine months, it can do more damage for sure. It feels like the market's very interest rate sensitive as you would anticipate, given the high house prices. So if you're at seven plus, really weak. Six and lower, you know, starts to come back to life.

So I think if we're actually going to be above seven for a while, we got a, you know, market's going to take it on the chin. Home sales are going to get hit. And I do expect some house price, more meaningful house price declines. I think that's going. It does increase the lock-in effect even more, though, right? It does. Well, I guess but we're all locked in.

Does it really matter if it's six and a half or seven? I guess. Probably not. Probably not. Because the average coupon, the average, the rate on the average, the rate on the average mortgage outstanding is about three, three and a half percent, something like that. Yeah.

Yeah. Yeah. Yeah. Okay. All right. Very good. Well, thank you. And we're going to move on to the next.

part of the podcast. I'd like to welcome Chris Whalen to the podcast. Chris, hey, good to see you. Good morning, Mark. Where is a pleasure? Where are you hailing from? I am in Westchester County, New York. We moved up to Briarcliffe a couple of years ago. I've got a Fannie 3, by the way, which I will never get rid of. And, you know, what's interesting is this is an affluent area, but we cut our expenses more than an half, leaving the city. So what does that say about a affordability. That's interesting. By half, I mean...

Yeah, half. Easy. Really? Yeah. The city is just prohibitively expensive. I think we should relocate people, frankly. Well, Briarcliffe is a beautiful spot. My brother lives in Chappaqua, so I get out there quite a bit.

God's country. The Whalans have been here for 270 years. Oh, okay. Congratulations. The kipsy. So your ancestors were friends with. with Alexander Hamilton. No, these were the Irish.

We were building the railroads and the tunnels. Oh, I see. Yeah, we were Sandhawks. Thank you very much. And railroad people. My name's sake was a railroad engineer and Civil War hero. Well, thanks for coming on. You know, we've known each other for many, many years,

but maybe you can take a few minutes and just describe to the folks out there, you know, what you're up to and how you got to where you are. Indeed. Well, my name is Christopher Whalen, and I'm a banker, but I'm also a banker that writes. My entire career is an investment banker and a member of FINRA. I've also been a credentialed journalist. So I write a blog called the Institutional Risk Analyst, and I've been doing that for a long time. In fact, I owned it when I was at Crowell Bond ratings, and then I resurrected it after I left in 2017. And basically, I work in the capital markets. I'm affiliated with a broker-dealer, affiliate of co-owning company in New York.

We finance loans. We trade TBAs. So I have a ground-level view of the world of mortgage finance. And at the same time, I grew up in Washington. My dad was a serious mocker in politics under Nixon and Reagan. And just passed away, by the way, read his a bit in The New York Times. So, sorry. No, he was a great guy.

And he played a great outfield, too, by the way, went to Queens College. And, you know, I grew up in a political household. So everybody always looks at me, goes, Chris, where did you learn to write about this stuff? When I say, my dad and hanging out with members of the cabinet and Fed chairman and everybody else who was in our salaa. My mother was the greatest entertainer in Washington during that era of the 70s and the 80s. If he didn't have a Christmas invite to Jones House, there was something wrong with you, you know? And so, you know, that's how I got to be who I am. And I feel very fortunate and really blessed to have had this kind of a life.

I've done a lot of stuff, but, you know, mostly fixed income capital markets. And the institutional risk investor, how long have you been writing that? Well, the institutional risk analyst. Oh, sorry. Yeah. That goes back to 2003. When I worked with my dear friend, Denison, Santiago, I may actually be working with him again on an index product.

And we built a model for doing essentially a public data camel's rating of banks. And this model is actually still used by the SEC in Corpfin for looking for outliers. Our model is very accusatory. We turned it up a lot for the SEC. But mostly it's just a census of the banks. It says, how did you do this quarter? You would like it, I think, the way it was constructed. And, you know, essentially we index five factors that are in a camel rating, and we arrayed the entire population against the index.

In the old days, Mark, the center line for bank performance was 1995. But today you would really have to recalibrate that model, you know, given what's happened since the data has changed. This is the problem with time series data. It changes over time. So if you're not cognizant of that, you're looking at the wrong thing, you know. Yeah. That's the short version. Very good.

Well, it's good to have you on. And I guess there's a lot of different directions we can go here. But maybe to start with the banking crisis that hit back in March, do you think the crisis is over or there's another shoot-up call here? No, I think the crisis is ongoing. The Fed responded with liquidity. We also had a bond market rally of sorts. between last year, this time, say Q3, when the market was really ugly. It was almost a trillion dollars just on held to maturity securities and available for

sales securities. We weren't even talking about loans. So since then, we had a bit of a bond rally, but now the 10 years over four. And if you think of the 10-year treasury as your benchmark for paying on bank balance sheets in terms of mark-to-market, it could be considerably worse this quarter. Q1 of this year was really just about interest rate moves that banks did not anticipate. You look at Silicon Valley Bank with 40% of assets in mortgage-backed securities, which was four times the average, by the way. And that's the problem.

They were betting the bank on a interest rate drop. Very simple market. And the scary part is, I don't know that management realized from a duration perspective, just how deep in the hole they were, I'd say the middle of 2022. Because the book that they owned, that 40% of total assets, was prepaying 50% a year. So they were buying more. They were buying more every quarter,

and the coupons were falling, and the duration of that book was falling. So when the Fed decided to raise interest rates, they were basically dead on arrival. So that's what happened. The other banks all had, I would call idiosyncratic outlier business models that made them vulnerable.

You know, even Western Alliance, which is one of my favorite banks. But they were in the, you know, the loan sales business. Same thing with Pack West. They were in the loan sales business and they had to sell that business. They got out.

So I think during the, you know, if you go back to 2008 till today, you know, very low interest rates and banks put more sale up on the sailboat to try and compensate. They took more risk. Think of it as spinnickers on a boat running free, right?

on a beautiful sunny day. But then when interest rates started to rise, they had to very quickly adjust. And we're seeing a massive adjustment ongoing today, Mark, both on the deposit side and the loan side. The people in the industry who want to be in business a year from now are moving fast. They are restructuring their balance sheets. People that don't, I don't know. I think there's going to be some big banks that are going to be quite ugly by the end of the year. Bank America, for example.

They just keep everything. they have twos that they should have sold, Mark. You don't keep twos, and now those twos are trading at, you know, 78 cents on the dollar. Just for the listener, I mean, when you say two, these are loans. Loans with $2.5.5.000 in truce. Wealth management client, mutual friend of ours, by the way. I won't mention his name.

But, you know, the guys of BA wrote the guy of mortgage, and they should have immediately sold it, but they don't. VA keeps everything. They have a very long duration book, both commercial loans and consumer. Right. You know, and their salvation has been low funding costs until now, but look at them now. They're actually moving faster than the rest of the group. Jamie Diamond, by the way, is hitting it out of the park just from a bank perspective.

He had an efficiency ratio of 49 last quarter, which is 15 points below the rest of the group, which means more profit drops to the bottom line. Well, I guess JP Morgan got out of the mortgage business or a big chunk of them. There's quite a time ago. No, no, they're in prime. Jamie Diamond is the largest. Are they in prime? Okay.

Jamie Diamond is the largest mortgage servicer in the United States, Mark. Oh. He's bigger than Wells Fargo now. Oh, oh. I guess I was thinking FHA lending. He got out of FHA lending. Yes. Yes, but he kept that machinery that kept investing in it,

and they have become the dollar. dominant player in those high value loans and conventional, say the top half in terms of size, very high quality, at least 20% down, you know, ADLTB kind of stuff. And then he's been dominant in jumbo. He finances that market too. He's a warehouse lender. He has a large MSR, mortgage servicing right. So Jamie is now the king of RESI, believe it or not, but not the low part.

And unfortunately, the Basel proposal is basically going to take. take banks out of lending to low-income families entirely. They won't be able to do it. And I don't know what people in Washington are thinking. Let's come back to that in a second because I started, the question I asked was, is the banking crisis over? And you said no. And so how does that manifest?

I mean, two things are going on. If you think of the average coupon today for most bank loans being, you know, somewhere below 4% average. Banks are trying on one hand to move out of lower coupon securities and loans with as little pain as possible. On the other hand, they are trying to buy higher coupon paper to increase their return on assets and equity, right? At the same time, they are negotiating with their depositors.

Depositors are moving funds out of non-interest bearing accounts into time deposits at a double-digit rate. The rate of growth in time deposits mark is like 30% annualized right now. So the good news is the banks are keeping those funds. They're not going into T-bills or money market funds, but it is changing the characteristics of bank funding dramatically. They have to pay for funding now. Even people like U.S. Bank who've historically had 40% of their deposit-based non-interest bearing because they're a money center. They have a big payments platform. So all the banks are having to readjust their business models. And now we're saying, you know, we're saying we're going to be higher for longer.

The floor on one to four family mortgages may be five, five and a half percent right now. So if you think of the average coupon in the mortgage complex at $13 trillion worth of paper, right, is still below three and a half. That means two thirds of that population will not be eligible for refinance for a long time, maybe not for decades. It depends how you feel about interest rates, right? But that's kind of, you know, banks are struggling to grow yield while they are at the same time seeing their funding costs

moving twice three times as fast. And again, look at the big guys. Look at Goldman. Goldman's got the highest funding costs of the top five banks. And that's not going to change. You know, they're not really a depository. They're a broker-dealer. Morgan Stanley, same way.

Big changes in their funding profile. but it's okay. They don't take credit risk. You know, Gorman, I think, has won the fight in the U.S. among the asset gatherers. And then you have UBS in Europe. Those are the two winners, I think, in the world of asset management, right? The Universal Bank. And in the U.S., you know, we're going to see consolidation, definitely. But overall, I think the banks will be okay, Mark.

It's just they're going to take some big hickeys the next couple of quarters. Yeah. Okay, so not a crisis. I mean, obviously it's not painful, really bad for shareholders. Yeah, right. It's going to take a while for banks to be able to restore profitability in any meaningful way. Look, in an economic sense, quantitative easing took almost a point out of the return on average, return on earning assets for U.S. banks.

They're trying to get that back now. But really, financial repression, if you look at it over a long-term basis, has really been taking from banks going back to the 90s. 90s were bad, by the way. 90s banks really got killed by interest rates, as you know. But, you know, they had a really good run for about 40 years, where they were making what you and I would say were super normal returns. Now that's, you know, changing, I think.

Does come back to the, you mentioned the Basel three capital standards. This next round of changes to the Basel standards for bank capital liquidity. And one of the changes that there's a lot of moving parts there. And it's very complex, a lot of things. G-Sibs, the big systemically important banks have to raise a lot more capital if this thing is, you know, goes through. But you mentioned on the mortgage side that, you know, that this, if the standards go through, it will have a very chilling effect on the ability of banks to invest in, mortgage assets. You want to explain that a little bit?

Yeah, sure. What we're seeing is very interesting, Mark. The whole idea that banks are now going to be penalized for holding loans that have less equity in a minute of the words, high LTV loans that say have 10 or even 5% down. That's typically the government market, the FHA market, right? The potential equity returns for all one of four family mortgages for banks is basically going to be cut in half if the current Basel proposal goes through. So whereas in the past, you know, Wells or J.P. Morgan could earn 15, 20 percent equity returns holding a portfolio prime, you know, mortgage loans, not junk, but really good, solid 80, 20 kind

of loans. Now they'll be lucky to do high single digits. What that means is that the banks are going to move away from. from holding one to four family mortgage. And they already were, as you know. They've already gotten out of the bottom third of the market in terms of government lending just because of reputational risk. So what we're seeing, Mark, is that they're going to take the economics of mortgage lending

down to such a degree that I think you'll only see the banks involved on the wholesale side. So they'll lend to independent mortgage bankers. They'll do warehouse. They'll fund mortgage servicing assets. corporate lending, right? Because that's already 100% risk weight. What the regulators are doing is they're taking a one to four family mortgage, which normally would have been a 50% risk weight, and it's going to go up to 70 or 100. So it'll look just like a commercial loan from a risk perspective and a capital perspective, but you earn half as much. So you might as well do the

commercial loan, no reputational risk, right, and just stay away from anything that's direct to consumer. Let me ask, I mean, I don't think we want to go deeper into the weeds. This is really obtuse, but it clearly is making it more difficult for banks to invest in mortgages. Yes. What's going on? I mean, fundamentally in your mind, why are they, why are the regulators doing this? Because this, my understanding, maybe I have this wrong, is that this increase in standards, the change in the risk weight. is even greater than what's being proposed overseas. You know, Basil, it's capital standards for all global banks.

And this is here in the U.S., we're layering on top of that, those standards and making them more restrictive. So what do you think the – I'm just confused by it. What's the motivation do you think? Well, Bank Policy Institute in Washington, Bill Nelson and his colleagues have been writing really great stuff about this, by the way. I would recommend that your list is to make a look at that. Very good.

And what you'll see when you go look at is this, this Basel proposal is five years old. It's stale bread. Okay. It should have been reworked. And the Fed is in such a defensive posture because of the bank failures earlier this year, which they totally missed, that I think they are just desperately trying to put something together that from a political perspective, they can use to defend themselves. So you hear talk about higher capital. You hear talking about living wills, which are a total waste of time. Living wills are the most ridiculous thing I've ever seen.

And I worked at the Fed. I've worked for two receivers, okay? I know about restructuring companies. No restructuring professional. Nobody at the FDIC or the Fed would ever look at a living will. A living will being, the bank is a road map. Yeah, for restructuring and closing the bank. We don't close big banks, Mark.

We put them in conservatorship. We fix them up and we sell them. And that's the key is that in the first quarter this year, you couldn't get a bid on a bank because nobody knew what the assets were worth. The move in interest rates was so large and so fast that it caught everybody by surprise. And so FDIC goes out and tries to get a bid for Silicon Valley Bank. Guess what? It was crickets. There was no one in the room.

It was like when Sheila Bear tried to sell Indy Mac. There was no one in the room, right? And she had to throw loss sharing on the table to get the parties started. Likewise, here, FDIC essentially gives you the assets at a deep discount to create new capital to support the system. And if you don't have a bid from somebody else, right, then the FDIC has to liquefy the whole thing. And that doesn't work. You know, our system is based on inflation. Let's be fair.

That's how we make this work. Asset prices must go up. So, you know, I think the Fed and the regulators are just so. So behind the curve, Mark, they should be focused on market risk. They should be raising the risk weight on mortgage-backed securities to 50% at least. Just to say, hello, everyone, these are dangerous. You are short a put if you own a mortgage-backed security. Nobody talks about this.

And I think, unfortunately, they just didn't have the time or the political opportunity to rework the Basel proposal to make it relevant. You know, capital doesn't matter. If you look at those three bank failures, Mark, do you think anybody, ever thought about their capital? No. They're thinking about the worth of their assets, and that's really the Fed at the end of the day. Well, you know, Chris, I get this real sense. You're very critical regulators of the Fed. You know, yeah. Well, because I was one. I worked at the Fed in New York for some of the best. I worked for Billy Rutledge and Jerry Corrigan,

okay? I was hired by Paul Volker. So I look at this, and I say to myself, why, can't these regulators characterize business models? Why don't they know what business a bank is in like Silicon Valley Bank? It was a hedge fund. Sorry, that was not a bank. That was an FDIC insured hedge fund, but they can't do business model characterizations, Mark. So if you don't know what business your banks are in, how do you regulate them? How do you possibly look for outliers that will lead to contagion events? And they don't. So, yeah, I'm critical of them because they're not doing their jobs. Honestly, they have the data in-house to do this kind of work. And frankly, I'm thinking about creating a couple of ETFs based on my work and our work on banks,

because I know how to characterize these institutions. It's funny, the street does it. The street just buys everything, and they hope it's going to come out okay. Look at the big ETFs. They buy the good banks and the bad, and they mush it together, and they hope it's going to come out because the whole market's going to go up, right? In fact, my whole bank complex this year has rallied considerably. Has anything changed? No, I think their fundamentals are probably weaker today than they were in January. Okay, so just to characterize things so far, we've been focused on the banking system, and the system is going to remain under pressure for obvious reasons. Funding costs are up, lending rates are down. They're going to have a hard time.

Net interest margin compression. Some banks are going to turn the quarter in the third quarter. I think you're going to see some nymph growth from some of these banks. But does it feel like we're talking about anything breaking? No, but you may have more failures. You've got to be ready for that. There's embedded losses in the system of hundreds of billions of dollars. The U.S. banking system, 18 trillion in assets, has about 2 trillion in tangible equity.

the top level number is a little over three, but you subtract at least a trillion dollars from that to get to tangible equity. So if you're already impaired a trillion dollars, that's not a good place to be. In fact, I think that's why the Fed's going to slow down on rate hikes more, very definitely. They're getting the message. Okay, so I want to move now to the shadow system, the non-bank part of the financial system, because I know you do a lot of work there. And My peeps. My people. Your people. Before I do that, let me turn it back to Chris and Marissa and see anything you want to push on that Chris said. Do we move on for it, Chris Deereides?

No, my interpretation was, you know, the Fed's really what just want more capital in the system, right? That's what I heard. But that's their old thought. I'll find any way to do it. That's all they can talk about in Washington. If you sit down with members of Congress and you talk about anything more complex than capital, you're going to lose them. Right. You know, so that's part of the issue.

I don't think our regulatory community is tuned up enough on market risk. They just don't understand it. And I help them in the background. You know, I never out these people publicly. So. Okay. Mercia, anything you wanted to weigh in on? No, I don't think so. I think we talked, I think, last week about the Fed's stress testing and their lack, the big hole in the stress test of not stress testing interest rate risk, right? Which was what ultimately brought down SBB and some of these other banks that got into trouble.

Well, you know what they really should do? Follow Jamie Dodd. What does Jamie do with his bank? He always knows where the net duration of the bank. bankers and they have a view on rates. And depending on their view on rates, they're either leaning up or down in terms of duration, right? They do a good job on this. They really do. And it shows up in their earnings. If you see somebody like, you know, Penny Mac or Mr. Cooper, those guys have to manage interest rate risk too. So what's the answer?

The whole industry, the banking industry, you should have to generate a net duration number every month. And they should be able to discuss it. Okay. If they can't discuss it, then they have to dumb down the bank until they get to the point where they understand the risk, to your point, right? I mean, otherwise, I think we're missing it. They're focused on credit risk. Everybody keeps waiting for a credit risk event. And then, you know, my one to fours are still at zero loss given default for banks.

You're not worried about credit risk. You're not worried about it. No, it's in commercial this time. Commercial is up front right now. Right, right, right. Okay, well, let's move on to the non-bank part of the system. And the area that you focus on is mostly is the, well, you focus on all of it, but the area where you're kind of down into the DNA is the mortgage finance system, the independent mortgage banks. And, you know, one of the issues there, and I think you've kind of been out there, shining a light on this, is that the independent, the funding for the independent mortgage banks.

That, you know, there, that feels pretty tenuous to me. They rely on, in most cases, warehouse lines. That's getting funding from the large, from larger financial institutions, like a JP Morgan Chase, provides the funding for the independent mortgage bank to go out and make their loans, their mortgage loans. How, and of course, the independent mortgage banks are now dominate the government mortgage finance system, Fannie Mae, Freddie Mac and FHA, they're the production. dominant lenders, the big banks have largely exited that business. How worried, do you think that's a real significant vulnerability in the mortgage finance system and the financial system more broadly, the kind of the tenuous funding that the independent mortgage banks have?

No, it really depends on who you're talking about. If you're talking about the big players with large servicing books, no. No. They're going to inherit the earth. I think you're going to see consolidation in this market where the top five or six in terms to the unpaid principal balance of their servicing book, mostly well above, you know, half a billion dollars or excuse me, half a trillion dollars. You got to have at least $200 billion in servicing book to be stable. Okay.

Once you get above that level, you start really generating a lot of cash flow. And that's what the business is about. So those old-fashioned guys that save their pennies and invest in servicing and keep it are going to do very well. The rest of the industry, as you know, that's been geared to basically selling the loan and the servicing together and not keeping anything, they're going to exit the door. They have to get out because they're losing money on every loan they make right now. The inversion of the yield curve means that there's very little premium out there. And it also means that when you close a loan and you have it sitting in your warehouse line before you're going to sell the pool, you're losing money on the carrot every day. So there's no juice here, Mark.

It's not like 2000, you know, 20 and 21 when we were making four or five points on clothes, including the funding, right? The funding was generating a point. Now it's the opposite. So we're going to force out those lenders that don't have servicing income to protect them. So the industry is going to consolidate it. Oh, yeah. We've got to drop half of capacity. We're going to do two trillion mortgages this year, two trillion next year. 90% purchase business, by the way. Very expensive loans, $13,000, $14,000 per loan to

acquire and close. So, you know, a refi cost you $3,000, $4,000. That's the difference. And, you know, when the sun was shining and rates were low, this industry did record volumes, right? But now we are short. We don't have that business to do today. But at the same time, what's interesting is Americans are still doing refunds. They're still looking to take money out 7, 7.5% a year because otherwise they're going to pay 20 on their credit card. Right. Right. So rates are still not that high relative firms. But going back to the independent mortgage banks, I have to believe that the entry of the banks into mortgages was an anomaly after the SNL crisis in the 90s. You know, beginning of the 2000s, you

had GE, City, Norwest, all the boys playing in there, right? But they were still mostly wholesale players. They were buying loans from non-banks. Since then, you know, with the settlement in 2012 and the financial crisis, everything else, banks have basically gotten out of lending to the bottom third of American consumers in terms of FICO scores and just the loan. So mostly they've run away from government lending. Even banks that lend to non-bank lenders have sold.

their servicing, Flagstar, for example. They don't want to know. Most of the big banks you mentioned before, they've pretty much sold their government servicing. They keep the conventionals. And that, I think, is the model going forward. Banks will still make conventional loans to rich people. They'll do jumbo loans, but the banks will mostly sell those loans to the non-bank sector. And I think non-bank share in servicing is going to increase if this Basel proposal goes through. So look at the F SOC discussion this year about non-banks, which you're basically referring to, right? And then look at the Basel proposal and tell me how these two proposals interact. The answer is they don't.

But I must tell you, I think having non-bank servicing loans and making loans is the optimal model, because they're much better at it. Banks can't get out of their own way when it comes to servicing. So having the banks as the wholesale funding makes sense. mostly what we have to fix, Mark, is just housing finance. The home loan banks, Fannie and Freddie. You know, the politics, unfortunately, during the Biden administration around Fannie and Freddie have been bad.

Both of the GSEs are penalizing lenders now if they don't bring them mission loans to poor people. So, you know, it's unfortunate right now is the way I would put it. We could fix most of the problems with the non-banks if we had the opportunity. but the politics of this, you know, Washington is so dysfunctional. You can't even have a conversation with people about this. So that's kind of where we are. You know, in my view, home loan banks should be the balance sheet.

They should buy loans from everybody. Why can't they buy loans from non-banks? Non-banks were the first members of the home loan bank system. And then, you know, Daphany and Freddie will issue securities, but I think you should allow anyone to use that platform, private label, whatever, right? And then we cleaned up this mess. We need financing for the Ginny market, clearly. It may have to come from the Fed.

But look at it. Let me leave you with this thought, and I'll shut up. We had to take over a reverse servicer in November, early December, reverse mortgage funding. Treasury owns that book now. They can't sell it. So I think Treasury has to get more actively involved, supporting HUD and Ginni Mae.

Ginny doesn't have the people right now with the skills for restructuring that I just wrote about in the blog. But if we had some enlightened people get involved in this, we could prevent another seizure. If we have another government lender go down and the Treasury has to pick up the asset, that's not going to be good.

And I think we've got to get proactive. I use Conceco as an example of how you fix things like this. And I think it's, you know, the good news is I think we can fix all of the issues around Nambect. It's not that hard. So just to reiterate, the kind of the concern around the non-bank is they get cut off from their funding sources all at once. And if they get cut off, then difficult for them to make loans. And they're such a big part of the market.

Then no mortgage loans, housing activity goes down. And, of course, that's a big deal. But you don't think that's a big deal. No, these are the terrified nightmares of economists that don't have any. market sense. This is Janet Yellen and the rest of them. But you see, what they don't understand is that non-bank companies like Mr. Kruper or Pennymac have a very close and personal relationship with their banks.

The banks hold their escrow balances for the mortgages. Okay. So basically the bank is lending the mortgage bank, the escrow balances with FDIC insurance. Okay? That's how it works. So do you really think that J.P. Morgan is going to get up one morning and say, well, I'm going to go out and cut off all my customers, but yeah, the deposits are going to go somewhere else. No. No, that's not how this works. This is some of the highest margin business they have. So they don't want to be involved in lending to consumers. That's a very low margin, very dangerous business. But lending money to independent mortgage bankers to finance their operations at 100% risk weight. Yep. because the yield on those loans was two or three times higher than the yield on a one-to-four family mortgage. No reputational risk.

We're really deep into the weeds here. I know, and I don't know how many people are actually following along. Well, no, but I'll put you a little bit. I just want to ask one other question about this. You mentioned the federal home loan banks. And federal home loan banks for folks out there are kind of the question. quiet set of institutions that provide liquidity to banks, banking members, and others, insurance companies, CDFIs.

And the banks can borrow from the federal home loan banks very, very cheaply because they've got backing from the federal government, and therefore their cost of funds are very low. No, no. They are the highest cost. If I'm an independent mortgage bank, my bank is my cheapest funding. Well, depend. In a risk-off environment, when you need them, they're definitely cheaper. But they're always there.

They're always there. Yeah, they're always there. But high collateralization, they have very high haircuts. They can't take losses. So the home loan banks tell them to be very cautious. And, you know, honestly, they need to be renovated. If I were made head of FHFA, first thing I would do is go up to Capitol Hill and demand that they pass legislation. That's a whole other podcast.

But let me ask you. Because the independent mortgage banks are not part of the federal home loan bank system. They can't get funding. And one of the reasons is they're not regulated, right? There's no prudential regulator, right? FHFA can take care of this. Sandra Thompson has come very close to picking up the ball and saying, okay, I am now the regulator for all independent mortgage banks. She hasn't done this because she doesn't want to bury Ginny Mae.

Jenny Mae has a role here. But really, if you think about it, Mark, FHFA can provide the regulatory overlay that should satisfy the home. Because remember, we're talking about eligible collateral here that can be sold in a mortgage back security. So every 30 days, these things roll. And you know what? If the independent mortgage bank fails, we deliver the collateral and we go on our merry way. These are self-liquidating transactions. There is no risk here.

This is what all of these talking heads in Washington do not understand. I finance loans. This is what I do in my spare time during the day when I'm not writing, right? So I know how this works. There is no risk. And that's the point. So home loan banks, they have some risk. This is why, you know, when FDIC takes over a bank, the first thing they do is pay off the

home loan banks. They don't have to, but they do. Just send them on their way. Goodbye. And then they keep the cloud. You know, that's how it works. I think we make too much of this, Mark. If we had a little bit more attention from Congress, we could fix this in an afternoon.

You and I. So you're saying the independent mortgage banks are, well, at least the ones with servicing portfolios are on pretty solid ground. The rest of them are going to go by-bye because they're sales organizations. That's why they're here. Right. And you know what? If you have a small shop right now, Mark, and you don't have a big servicing book, why do you want to lose money? You made a ton of money in 20 and 21.

You should send your people to the beach, pay for it, shut it down, and come back at two years. Yeah, right. But yet you think the system could be stronger if better home loan banks were able to provide that sort of liquidity. Look, U.S. mortgage finance, including Ginny HUD, the home loan banks, is 100 years out of date. it goes back to the age of Smokey the Bear and FDR and the New Deal. It's worked pretty well, though, Chris. I mean, for 100 years, right? What do you think about it?

Yes, but in a very quirky and intersyncratic fashion. You know, home loan banks need to do what the Fed did, which was the centralized market execution and credit in New York. Now, I'm not going to tell them which bank to pick, but they need to get into the 21st century, the risk management and market execution capabilities of the different home loan banks are so widely disparate that I think it just begs the question, but nobody pays attention to these things.

So, you know, there are ways that non-banks, you know, let me break it up for you. Conventional loans, the GSEs already take care of the non-banks. They reimburse them after four months for all their expenses. In Genie, you have a funding problem. And I think one way or another, if we had a crisis tomorrow, the Fed would have to step in and lend. That's the answer. Ginny has tried to fashion some interesting things. VA just came out with a proposal to help bankers fund delinquency, which is a big challenge.

And it doesn't work because of the statute. We need Congress. So whether you want home loan bank membership for non-banks, which I think is an obvious thing to do, we still need Congress to come and fix the statute. And there's a long list of stuff we have to do in that regard, by the way. Well, any chance you become FHFAA director? Well, if they offered to me, yes, but I would use my Republican connections to get stuff done. I would merge Fannie and Freddie together.

Really, at the end of the day... Oh, you've thought about this. You really thought about this. Oh, yeah. Oh, yeah. Well, because we don't need these pieces the way they were. Remember in the old days before Fannie Mae even issued securities? You and I were children.

Today, do we need them to issue securities? Maybe. But the point is that the pieces need to be redirected. We have all the pieces we need. You know, the home loan bank should be at a place where people sell loans if they have to. And they will compete with Fannie and Freddie in that regard. But I think the charm of the platform that Fannie and Freddie have built is maybe to let everyone use it and have a national standard for all securitizations.

That would be useful. You know, and maybe they don't need a government guarantee. Right? maybe Jamie Diamond can take the deal out without a guarantee. All right. Okay. Good luck with that, Chris. Well, they're not known anywhere.

Fannie and Freddie are postal now. After 12 years of conservatorship, they are not going anywhere. Yeah, I agree with you. Hey, we're running out of time, but, you know, the non-bank part of the financial system is this big place. A lot of things moving parts, a lot of things. We can always do a non-bank session if you want. I mean, I covered them all. Yeah, I did want to ask, you know,

appearing out into the shadow system, so-called shadow system, is there anything out there that really kind of, you mentioned economists, you know, worried about things? Is there anything out there that you're worried about? Any aspect of the shadow system that makes you unsure and very nervous? I'm writing about this for my next column for National Mortgage News. The difference between residential housing and everything else, Mark, is that the federal government guarantees those loans for credit default.

So that means that there's a marketplace for them. There's always a forward market because of treasuries where we price interest rate risk, and we can also price mortgage-backed securities. So this market is very well protected from recession and from interest rate changes. Outside of that, though, in the world of commercial lending, autos, credit cards, all of the other pieces of asset-backed finance, I worry because those areas are shut down right now. I think you're going to see real trouble in commercial real estate

and in the bonds at finance commercial real estate. And you can't generalize about this because these are big assets. Some of them are fine. Some of them are not fine. Some of them are being marked down by 50 or 75% from valuations of two years ago, especially legacy office buildings in big cities. So I'm worried about everything but residential mortgage right now, Mark.

That's where I'm really focused. Resi mortgage, like I said to you before, I tracked the bank data really carefully. Loss given default on one to four families owned by banks. It's $2.5 trillion for the loans is negative. It's below zero. Multifamily bank loans, on the other hand, have totally reverted to above the average.

They're almost 100% loss given default. That's not good. So it tells you that the real heat in terms of loss today is commercial assets. You know, think of CNI loans at U.S. banks. It's another $2.5 trillion worth assets, right? A third of that is commercial real estate. You know, Marina Walsh at MBA, told me that a while back. And it's a pretty consistent number.

The C&I, the commercial and industrial loans, two-thirds are? About a third of it is real estate exposure. Really? These are seen I loans to real estate firms. And that would include warehouse loans. That would include any commercial credit. Okay. You know what I mean? It's all in there.

They don't break it out beyond that. I wish they did. That's interesting. It would be neat to see the subsets, but that's considered non-public. They don't make that available. That's an interesting point. Yeah. So you're worried about really credit risk in the non-residential side of the

of the financial system? Anything related to that? Well, look, you know, when I was at Kroll, I rated most of the community banks in New York City. Their major asset is one of four family stuff and then multifamily apartment buildings. Right. Which went up in value for 75, maybe 100 years. The whole commercial complex mark is predicated on seven-year loans, interest only, that they roll. Okay?

And they anticipate that the value of the asset is going to rise. This is the way this sector has been forever. So when you have falling asset prices, that puts a lot of pressure on people because the lender is going to turn to you and say, Mark, happy to roll the mortgage for you, but you've got to bring it back to 50 LTV. And by the way, the value of the building just fell 20% because your rent roll is down. You've had to make concessions to tenants. This is why New York is really scaring me.

you know, rent rolls are falling in New York City for most B, C, D kind of properties. Well, how are we going to finance them? You know, nobody's going to put more equity into a building like that. Why? Does it make any sense? So the trophy properties are still okay. The really nice stuff and then outside the city is fine. But, you know, go down to Houston, go down even San Antonio, for Christ's sake, overdeveloped.

It's correcting right now. So, you know, the asset allocation in commercial real estate's even crazier than residential. They move in hearts. When you say you're worried, is that, I mean, again, going back to the way you characterize the banking system, it's just, you know, it's going to be painful. It's not going to be any fun. Is that kind of sort of how you're thinking about this as well? Or do you think this is more than that?

This is an event. Yeah. The hits to some small and mid-sized banks could be significant enough to the causes their failure. Yeah, right. And remember, regulators want 50% equity in commercial real estate. That's tough because, you know what happens? You see the headlines. They do the numbers and they say, we're not putting any more money in.

They give the keys to the bank. Remember jingle bells from the great financial crisis? Well, it's going to be for commercial this time. Instead of the house keys, you're going to get the keys to the mall. To the mall back. You don't want the mall. I mean, think about signature bank. Did FDIC want to take over those assets?

No. No other banks were willing to buy them. So all of the 8-A properties, all of the subsidized multifamily in New York City, you know, they're going to be sold to non-banks. It's the only bid out there. Now, interestingly, everything was sold, by the way. FDIC had no trouble selling the securities at all. They're all gone.

I didn't know that. I see the stuff every day. So it was good. That's the good news. In fact, they should sell more, Mark. You know these people. Tell them to sell some bonds. They want to tighten things up.

You want to drain some liquidity? You've got to sell some bonds. Because otherwise, I think this economy runs hot for another year. And I think, you know, people are going to see home prices go up, Mark. Really? Well, that's a whole other whole other kind of conversation. Even at 7% plus mortgage rate, you expect that. No, it's not enough. We've got to get rates up above eight.

Lenders would make money at 8% they're not making money now. And you would slow down housing enough to maybe declare success on inflation. I think Powell's painted himself in a corner because he doesn't want to sell the bonds. How do you cool this economy down with trillions of dollars of excess liquidity

sloshing around. I think most people don't want to cool it down too much, right? You think it's really red hot that strong? There's no supply in the bottom half. You know, Lori Goodman,

dear friend of mine at Urban Institute, always reminds everybody that we lose a couple points a year in existing homes because of obsolescence. So we're not building enough homes. And it's concentrated in that bottom half of the FICO band. The top half? No, those home prices will compress. You know the story. Espirational pricing in the millions of dollars. But remember, the market for those big loans has disappeared.

A year ago, people would have no problem buying a $5 million jumbo mortgage. It was interest only. You know, the stuff First Republic was originating. There's no market for that loan today. So people who need to refinance a big house, for example, are going to have to go to their bank. you know, Jamie Diamond will do that loan. He'll keep that loan, but he's not going to do anything

to a lower income borrower. Well, Chris, I want to thank you for spending time with us. That was very instructive. I'm just trying to figure out whether I should be nervous or not nervous. I can't quite. I'm not sure.

I'm not sure. I am cautiously nervous. Cautiously nervous. I accept the fact that the market, look, this equity market wants to go up. JP's back to one and a half times book. Is there a recession here somewhere? I don't see it.

Okay. Okay, okay, fine. So fundamentally you're okay. Yeah. Watch the government loan market. I wrote a very detailed blog about the aftermath of that failure in December. If we have to seize another government asset, we're in big trouble. To my point, I'm not sure whether I should be nervous or not nervous.

If you can't sell things in our market. You know, remember the rule. Inflation is the rule. If the asset prices aren't going up, then we have a problem. Yeah, that's true. All right. Well, thank you so much for taking the time and really appreciate that. And to the dear listener, we'll talk to you next week.

Take care now.