The Outsider Perspective Issue 339 | The Beltway Outsiders

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Good Friday Morning! Especially to more people coming to terms with the errors of quantitate easing and the era of easy money. Last week, I highlighted the documentary “Age of Easy Money” by PBS Frontline. This week, I listened to two guests on opposite ends of the political spectrum do the same thing on the Lead-Lag Report.

First was Ryan McMaken with the Mises Institute. I wasn’t shocked to see him or the Mises Institute against quantitate easing, as they’ve been making that case since 2008. If you’re unfamiliar with all that, it’s more on the libertarian side. I first encountered this Austrian critique in college at the height of the Ron Paul movement. I wasn’t a Ron Paul guy, but I knew several Paul fans in college. The Mises/libertarian criticism has always centered around QE instigating inflation. For me, QE has always been about inflating the next asset bubble and replaying 2008.

Next up was a guy on the left, Christopher Leonard, author of the book “Lords of Easy Money.” Leonard made an appearance on the Frontline documentary too. It was interesting to listen to him talk about getting into this topic in 2016 and realize that no one on the political left paid any attention to the dangers of QE.

Again, if you have time, those interviews are well worth your time (as is the Lead-Lag Report in general; one of the more diverse sets of guests you’ll find in the financial talking-heads space, and Michael Gayed is a great host). We’re hopping back to an economy coverage week, as developments are worth noting—links to follow.

Where you can find me this week

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[04/10/2023] Left seeks to ban guns, knives, & all self-defense. – Conservative Institute

[04/14/2023] The narcissism and pathological lies from the Tennessee Three – Conservative Institute

Recession talk looms again, with commercial real estate on deck as the next domino.

The White House spent part of this week fighting off questions about a recession around the corner. What’s different about this week? The White House is almost the only group left arguing that we’re not going into recession. The Federal Reserve released its minutes from the March meeting, where they hiked rates. As a reminder, that meeting was still days and weeks after the recent banking crisis. These notes are a glimpse into that moment.

The Fed Whisperer, Nick Timiraos, says of the minutes, “Stubbornly high inflation and tight labor markets led Federal Reserve officials to signal they could raise interest rates at their next meeting despite a greater likelihood of a recession later this year.” By the next meeting, he means the one upcoming in May.

The million-dollar question is this: are we headed toward a credit crunch? The answer to that question likely tells you whether more rate hikes are coming. A credit crunch is where bank lending standards tighten so much that credit isn’t flowing. That leads to much lower growth and recession. If we get that, there’s no need for more rate hikes from the Fed. If we don’t get that, well… Timiraos explains:

The rate outlook became much more uncertain after banking-system stresses flared last month, beginning March 9 when panicked depositors pulled money from Silicon Valley Bank, which regulators closed the following day. Regulators closed a second institution that also faced a run, Signature Bank, on March 12 and intervened aggressively to shore up confidence in the banking system.

Many Fed officials anticipated “there would be some tightening of credit conditions, and that would really have the same effects as our policies do,” Fed Chair Jerome Powell said at a news conference March 22. “If that did not turn out to be the case, in principle, you would need more rate hikes.”

Timiraos notes on Twitter that the Federal Reserve is still lending more than $125 billion to banks through emergency measures. At the height of the panic, it was lending more than $150 billion weekly. So while the emergency measure cash flow has slowed, it’s still enormously large. And we’re in a moment where everyone says the banking crisis is fixed.

It’s not; everyone is just holding their breath, hoping for no more bumps on the road.

I started with the White House and the recession point because the Federal Reserve’s minutes also discussed that possibility. The Federal Reserve’s Staff Economic Outlook led with this:

For some time, the forecast for the U.S. economy prepared by the staff had featured subdued real GDP growth for this year and some softening in the labor market. Given their assessment of the potential economic effects of the recent banking-sector developments, the staff’s projection at the time of the March meeting included a mild recession starting later this year, with a recovery over the subsequent two years.

Again, the Federal Reserve describes recession in the rosiest of terms. Recovery is always right around the corner. But this is notable because the “R” word has made it into the Fed minutes. That forced the White House into a defensive crouch over inflation.

Here’s a very easy prediction for this White House: they will say there’s no recession until the day one gets announced. Then, they will immediately pivot to saying that a recession is over almost the moment it gets declared. NBER calls are always delayed. So they’ll spend every month after that, claiming the recession is over.

That might not make sense right now. But it will happen.

Those are the big economic stories of the week. With that macroeconomic backdrop, I want to drop down to the local level and mention a story that caught my eye. This story is out of Houston, Texas:

A landmark Uptown-Houston office tower just sold for much less than its last appraised value of $219 million.

Sovereign Partners, led by brothers Darius and Cyrus Sakhai, bought the San Felipe Plaza, a 959,000-square-foot building at 5847 San Felipe Street, from Orlando-based Parkway Property Investments for nearly $83 million, the Houston Business Journal reported. That’s roughly $86 per square foot.

San Felipe Plaza’s sharp decline in value can be attributed to factors including high vacancy caused by the pandemic, rising interest rates and newer buildings being favored over older ones, the outlet said.

Here is the killer quote from that story:

Like many cities around the country, developers and commercial investors are relying on newer, flashier structures to lure tenants back into the office after the COVID-19 sparked the work-from-home trend.

“For the next three to five years, you might see more building owners throw in the towel and hand the keys over to the bank,” Houston real estate expert Jon Silberman told the outlet in January. “It’s not good for the owners, but for the market in general, it is sort of a cleansing process.”

So you have a building that was last appraised at $219 million sell for $83 million, a difference of $136 million in the commercial real estate space. The previous landlords are just washing their hands and walking away, trying again another day. Canary in the coal mine?

It’s possible. Commercial Real Estate is seen as a ticking time bomb right now. Landlords of these spaces struggle with historically high vacancy rates, and tenants are not renewing leases. Axios reports:

The U.S. office vacancy rate is at an all-time high as commercial real estate reels from remote-work arrangements.

By the numbers: 12.9% of office space is vacant, marking the sixth straight quarter the rate has increased and up from a post-financial-crisis low of 9.4% in the second quarter of 2019, CoStar Group reports.

Zoom in: Lessees are reducing office space as their deals come up for renewal.

Worth noting: The office space “availability” rate — which measures vacant offices plus currently leased space that isn’t being renewed or has been listed for subleasing — is also at an all-time high of 16.4%, CoStar reported.

Quick take: Office landlords should be concerned.

Goldman Sachs and other investors are increasingly pointing to the commercial real estate market as the place where the economy could suffer a severe blow due to rising interest rates.

Three factors contribute to this: 1) Commercial real estate is exposed to higher interest rates on mortgages because they use floating rates, which are pinned to interest rates set by the Fed. 2) Refinancing of those mortgages is coming – more than 50% of the $2.9 trillion will need to be refinanced over the next 24 months (before the end of 2024). And 3) The banking crisis creates a credit crunch at small and medium-sized banks, which loan out the bulk of these commercial real estate loans.

The other area this could impact is commercial real estate construction. We’ve seen a high-profile example of this from Amazon, which paused the construction of six of its major new corporate offices. Additionally, Amazon paused the development of Amazon Fresh stores.

Put all these anecdotal and bigger-picture data together, and you get a rather gloomy outlook for commercial real estate. Morgan Stanley went so far as to say this space could see a worse downturn than 2008. Morgan Stanley also pointed to private equity as being under pressure from similar forces (for those of you more economically inclined, Morgan Stanley is revealing there are real fears the shadow banking sector is vulnerable – a story for another day).

Is this a guarantee things are headed downhill? No. CNBC has some reporting suggesting this could all end up being a big nothing-burger. From what I’ve seen, this viewpoint is the minority view in markets.

We also see both markets and governments start to pivot towards looking at debt differently due to higher interest rates. The IMF and World Bank are pushing to get sovereign debt restructured earlier for smaller countries. If you believe a credit crunch is coming which will adversely impact these governments in the next 12-24 months, it’s a smart move. It’s also telling the table is tilting toward people sobering up at the punch bowl.

The main reason people are pivoting towards looking at the commercial real estate market is because of the factors above. The banking crisis impacted banks that loaned commercial real estate the most. If we see those loans tighten up even more, we could start seeing landlords give up and send the property back to the bank. If you can’t sell it in this environment, and vacancy rates are too low to make a profit, then you’re up a creek with a paddle.

I don’t know how the White House will spin commercial real estate. With the Federal Reserve and several large banks all calling for a recession in 2023, the White House is alone on the “everything is fine” media line. Not even the Federal Reserve is holding that line anymore.

And remember, the Fed and White House touted “transitory” the longest. We’ve gone from that to predictions on which month the recession starts. Mainstream consensus is shifting rapidly. You can believe whatever political narratives you want in life, but do you want to be the last one on the ship while everyone else is jumping?

The answer is increasingly “No.”

Links of the week

Why The Fed Will Ignore Better Inflation Data – Logan Mahtashami

Eat Me, MSNBC: Reviewing the last six years at the network that claims now to be concerned with integrity and accuracy – Matt Taibbi

Concerns Grow as Tighter Lending Threatens Commercial Real Estate: The recent banking turmoil added scrutiny to a sector already weighed down by office vacancies, rising interest rates and mounting debt. – NYTimes

A $1.5 Trillion Wall of Debt Is Looming for US Commercial Properties: Office, retail property valuations could fall as much as 40% – Bloomberg

Declines in Loan Values Are Widespread Among Banks: Lenders could face pressure on earnings or liquidity, or to pay higher rates for deposits – WSJ

Shadow lenders to bridge real estate void left by banks and bonds – Crains Chicago Business

The IMF warns the shadow banks that hold nearly 50% of global assets are vulnerable as central banks raise rates to tackle inflation – Fortune

China’s shadow banking sector poses ‘rising risks of a financial crisis’: report – Marketwatch

New tax rule on apps like Venmo, PayPal could spell confusion for small businesses: Starting next year, a new IRS rule will require anyone earning over $600 on payment apps, like Venmo, in 2023 to receive a 1099-K form. The old threshold was earning $20,000 over 200 transactions – CBS News

The Working Class Isn’t Down with the Green Transition: The stubborn fact Democrats blithely ignore – Ruy Teixeira