A leading economist predicts a potential situation in which the FDIC could be overwhelmed by a commercial real estate crisis. As a result, this could ultimately cause the failure and downfall of multiple regional banks.
While the Federal Reserve’s most recent stress test showed America’s biggest banks to be adequately capable of withstanding a major crash in commercial real estate, noted economist Paul Kupiec is not so optimistic. Rather, Kupiec warned the nation on Money Talks News that a spike in commercial loan defaults could lead to a huge swath of regional bank closures over a very short period of time. In Kupiec’s estimation, such a series stands a strong chance of overwhelming the Federal Deposit Insurance Corporation (FDIC) altogether.
This would be especially tragic given that the entire reason the FDIC was founded in the first place was to assuage concerns of this very nature. The primary purpose of the FDIC has always been to inspire consumers to have confidence in America’s banking industry, specifically because the FDIC acts as a safeguard against “runs” on banks. A “run” on a bank occurs when numerous bank customers become scared simultaneously that a given bank is going to go under, and they all rush to retrieve their money from said bank, essentially causing the very thing they were afraid of in the first place.
Bank runs were frequent in the years immediately preceding the Great Depression, as many banks were failing nationwide. Famously, Frank Capra’s “It’s A Wonderful Life” dramatizes one such bank run, as Jimmy Stewart’s George Bailey desperately tries to assuage the concerns of the residents of the town where the film is set.
A more recent example of a ‘run’ and a demonstration of the ways in which these sorts of fears and paranoias remain so deeply potent to consumers was the collapse of First Republic Bank in early 2023. Consumers got scared about unrealized potential losses in First Republic’s commercial loan portfolio and suddenly began withdrawing large amounts of funds. Once some started to do this, it further scared others, and before long, the majority of
First Republic’s consumers were actively looking to withdraw. This left the First Republic suffering greatly and very near total ruin, right up until they were purchased and acquiesced by Chase Bank. If First Republic had failed, the FDIC would have had to cover deposits up to the $250,000 coverage limit, which would have been a real problem.
While the FDIC guarantees consumer deposits up to $250,000 per bank account, it does not have enough physical funds to cover a massive wave of bank failures simultaneously. It is here that Kupiec sees the potential for huge failings. Kupiec reasons that 2,667 banks are responsible for nearly 30% of all assets in the banking system.
The commercial office market has been suffering severely since the pandemic, with factors like the shift toward remote work and the steady increase in high interest rates. Kupiec states that even a 10% loss on the banking system’s total exposure to commercial loans could result in upwards of 700 banks becoming insolvent.
If all of these banks were to go at the same time, Kupiec says that the FDIC’s reserve fund (approximately $121 billion) is enough to cover them all. Kupiec’s fear is that these losses would only grow larger as economic growth slows, ultimately leaving the FDIC struggling desperately to meet its obligations.
