Bank Failure & The Housing Market
In The Wake Of Devastation, New Growth Is Abundant
Creative destruction: the idea that in order for something new and better to arise, the old must first be cleared out. This destruction may seem terrible at first, but it can ultimately set the stage for renewed growth and a healthier ecosystem.
A wildfire will destroy vast areas of forest, but it also clears out the dead and decaying matter, making room for new growth and promoting biodiversity.
A volcanic eruption may devastate entire ecosystems, but it also brings rich nutrients to the soil and creates new habitats for plants and animals. While these events appear devastating, they are, in fact, essential to the cyclical nature of life and the continued evolution of our ecosystems.
In economic terms, creative destruction is the process by which new technologies, products, and business models displace older ones. This process can be challenging and painful for those affected by it, but it can ultimately lead to progress and increased prosperity. The rise of digital technologies has destroyed and recreated dozens of long-established industries including music, publishing, and much of retail. The auto industry is currently in the throes of a significant destruction-recreation cycle with electric vehicles displacing traditional internal combustion engines. This will extend into dozens of adjacent industries as well. The common element of all these processes is resilience and new growth. This is as true in our economy as it is in the natural environment.
A Brief History
Historically Bay Area housing has gone through multiple corrections in the past 40 years, but the subsequent growth has far outstripped these brief, albeit painful dips. (See chart above.) The average correction over the past 5 cycles has been roughly 10%. 2008 was significantly more and any given town or neighborhood may have experienced more or less, but 10% is a good aggregate number. Every time the narrative you hear is “this is the end of the road for the Bay Area.” If I’ve learned anything in my 30 years here it’s don’t bet against Bay Area housing, and the current cycle is no different.
The Current Cycle
Since 2008 the Fed has injected trillions of dollars into the economy, mostly through quantitative easing, almost tripling the money supply.
History makes it clear that inflation was an inevitable consequence of all this easy money, and the Fed would respond by raising rates. And raise rates they did, at the fastest pace in history. On the heels of the lowest rates in history and the rapid run-up in housing prices, these rate increases hit the brakes hard on the market. When it became clear the Fed would continue to raise rates aggressively sales activity and prices dropped rapidly through the second half of 2022.
Then, around mid-January just as we were getting used to the idea of a slower market, all those buyers that went on strike came pouring back, and with very limited inventory available we are once again seeing multiple offers and bidding wars. Prices have begun moving up again as well, though not quite with the same irrationality as before.
Caveat: I would be remiss not to point out that this chart looks an awful lot like a normal seasonality curve, perhaps just shifted down a bit due to economic conditions.
SVB and Its Impact on Housing
SVB and Its Impact on Housing
Never a dull moment in Silicon Valley. When the SVB news first broke, I was very nervous about the potential wave of layoffs and business failures, and the ripple effect through the housing market. Fortunately, our rich and highly indebted Uncle Sam stepped in. Within three days it was clear that widespread business collapse wasn’t likely. It seems, for now, that we’ll have a robust if not challenging spring housing market.
While this current banking crisis was not brought on by the housing market (unlike 2008) I believe it could impact it positively in the long run for two key reasons: 1) lower, or at least more stable interest rates, and 2) stronger safety regulations on small and mid-tier banks resulting in increased confidence in the financial system among consumers and investors.
Mortgage rates have already softened since the closure of SVB. While the mechanism is complex, many blame the Fed for facilitating the banks' failures due to its aggressive rate policies. And despite inflation's persistence, it has begun to settle down. If investors have confidence in the return of rate and economic stability, we can expect further downward trends in mortgage rates. The current bank failures will likely lead to better, and better-implemented regulations and lending practices, even though the industry has been doing reasonably well on this front since the 2008 financial crisis. The wake-up call for regulators and lenders should result in improvements that make the financial system more resilient to future challenges. While we may not see a major overhaul like Dodd-Frank, we can expect small and mid-tier banks to face tighter regulatory safety controls. This may increase the administrative burden and cost for these banks, it will ultimately improve consumer confidence which is crucial for economic stability. It may take time, but the benefits will be significant.
Of course, this is all predicated on the understanding that the damage has been contained and we won’t see a cascade of bank trouble. If that were to happen we could see a strong flight to safety and a retraction of credit (mortgages) from the market, similar to 2008. Nobody can accurately predict the future, but I don't see much chance of that happening again anytime soon.