Good Friday Morning! Especially to all the newly drafted NFL players today. I always enjoy the draft each year. It’s fun seeing college players you’ve watched for a few years jump up to the next level. Special congrats go out to the Philadelphia Eagles, who somehow managed to draft all the players in the highlight reels of Georgia’s historic defense from 2021.
This week, I’m going to continue noting some of the worrying trends in the economy. At this point, it’s like watching holes appear in a dam, with Janet Yellen trying to stick a finger in each hole to stop the danger. Sure, the water may stop coming out momentarily, but it’s hard to miss the cracks forming everywhere else. Also, I’ll dig into how House Speaker Kevin McCarthy managed to grab the upper hand in the debt ceiling fight, shocking everyone – links to follow.
Where you can find me this week
Please subscribe, rate, and review my podcast on iTunes, Spotify, or Google Play — the reviews help listeners, and readers like you find me in the algorithms. Make sure to sign up for the Conservative Institute’s daily newsletter and become a subscriber at The Dispatch, where I’m a contributor.
[04/24/2023] Biden’s Economy Welcomes the Repo Man – Conservative Institute
[04/28/2023] NYT in Full Panic Over Biden’s Age, Again – Conservative Institute
Economic cracks continue appearing while Republicans gain the upper edge in the debt ceiling showdown.
A couple of weeks ago, I pointed you to a story out of Houston, Texas. A large commercial building last appraised at $219 million sold at fire sale prices of $83 million. I said then that this was a potential canary in the coal mine for more prominent issues in the commercial real estate sector. We had another major fire sale this week, this time in San Francisco, California.
The Wall Street Journal headline tells the whole story: “Fire Sale: $300 Million San Francisco Office Tower, Mostly Empty. Open to Offers: 350 California Street was worth $300 million four years ago. It might sell for 80% less now, brokers say, in a market where office vacancy rates have soared.”
The WSJ included these nuggets:
Many of the city’s most prominent corporate tenants, from Salesforce Inc. to Facebook parent Meta Platforms Inc., are flooding the office market with space for sublet rather than waiting for their leases to expire. The lack of office workers is rippling throughout the financial district, leading restaurants, retailers and other small businesses to lay off employees or close.
Nearly 30% of San Francisco’s office space is vacant, which is more than seven times the rate before the pandemic hit, and the biggest increase of any major U.S. city, according to commercial real estate services firm CBRE Group Inc.
It’s worth noting that the 30% vacancy rate is an average. The building at the center of this WSJ piece was 75% vacant. It’s fair to assume that the commercial buildings at the extreme ends of the vacancy problem are hitting fire sales first.
Remember, though, the vacancies are going up. Any commercial real estate building that relies on white-collar businesses and employees to fill them is in the middle of corporate layoffs. This is yet another data point, a canary in the coal mine telling you that things aren’t good in the economy. In 2008, we had the residential subprime crisis. In 2023, we have a brewing commercial real estate crisis.
The banking crisis hasn’t gone away, either.
First Republic Bank, the last standing from the Silicon Valley bust in March, is starting to go wobbly again. The White House claims they’re monitoring the situation, per usual. But First Republic is back in the news because they reported earnings for the first quarter, and the numbers are brutal.
First Republic lost $100 billion in deposits – people fled with their money. Already battered, since the first of March, First Republic Bank stocks have lost 95% of their value. The total valuation for the bank has collapsed under $1 billion, and bank leadership believes it’ll have to sell somewhere between $50-100 billion to cover losses. It’s the definition of a zombie bank.
The threats of it going under are real, and solutions to fix it are slim. As the WSJ said, “Any solution would likely require assistance from regulators, the government or other lenders. But the darkening economic outlook, bad lending decisions and limits on Washington policy makers pose hurdles for any intervention.”
Even if a large bank like JP Morgan or Bank of America stepped up and bought First Republic Bank for a dollar, they pay tens of billions in costs. “‘It might cost you $30 billion of capital to buy the bank for free,’ says Autonomous Research analyst David Smith.” All the big banks are gun-shy after the disaster that was the 2008 bailouts when they were forced to eat the bad banks and the costs that went with it.
Even with all that, I expect news on First Republic to drop on Friday or over the weekend. Tellingly, First Republic’s leadership team took no questions during their investor call. Janet Yellen can’t allow First Republic to fail because that would restart the bank run crisis from March. But she doesn’t want to save them either; it’s a rock and a hard place.
So, we have cracks showing in commercial real estate and another bank failure on deck. Slowing GDP is the next major data point for this week. First quarter GDP came in at 1.1% versus a 1.9% expectation. WSJ on why growth slowed down:
Businesses pulled back sharply, drawing down inventories, cutting equipment purchases and reducing housing investment.
Many economists expect the economy to slow even more as the year progresses, predicting a recession in the second half of the year as the Federal Reserve continues its campaign to cool the economy and lower inflation.
“Both CEOs and consumers are looking around the corner and not expecting good things in the six to nine months ahead,” said Erik Lundh, principal economist at the Conference Board, adding that there is evidence that an economic slowdown started at the end of last year.
Again, we’re always talking about the recession that’s six to nine months away. The timing of when that starts is less important than the trendlines and signs of stuff breaking.
I’ve hit this point countless times in the last year: the Federal Reserve wants unemployment to increase. Until that happens, all the strain and pressure we’re witnessing is fine with the Fed. If the Fed cuts rates, it’s a sign that something serious has broken, and they’re panicking.
Speaking of something breaking, Yellen is already blaming a government shutdown for an “economic catastrophe” if it happens. Notably, House Speaker McCarthy got the votes together to pass legislation raising the debt limit with spending cuts included.
This maneuver seems to have shocked Democratic Congressional leadership and the White House. McCarthy has passed the only measure to deal with the debt ceiling crisis. Neither Senate nor House Democrats have put forward any legislation. Also absent is the White House, which hasn’t negotiated or talked with Republicans about the debt ceiling.
Democrats are predictably attacking the plan put forward by McCarthy and Republicans. But they haven’t even put forward a proposal on raising the debt ceiling themselves. The WSJ Editorial Board noticed this split too:
What part of divided government and bicameral legislature doesn’t the President understand? Perhaps he’s still under the illusion that he can refuse to negotiate and cause Republicans to panic as the debt deadline looms. No doubt the press corps will try to give him cover.
But Wall Street will grow increasingly anxious, and even some Democrats have noticed that Nancy Pelosi is now a backbencher. “While I do not agree with everything proposed,” Sen. Joe Manchin said of the House plan, “it remains the only bill moving through Congress that would prevent default and that cannot be ignored.”
Mr. Biden’s refusal even to meet is weird given his long record as a politician willing to talk to the opposition. In 2012 as Vice President, he negotiated a deal to avoid the “fiscal cliff,” after President Obama’s haughty approach stalled. Mr. Biden reminisces occasionally about his younger years in the Senate, sparring with segregationists like Mississippi Democrat James Eastland. “We’d debate like hell on the floor of the Senate,” Mr. Biden said last year, “and go and have lunch together.”
Neither Biden nor the Democrats need to have a solution in the immediate term. But it appears they had no plan for the scenario where McCarthy passed legislation before them.
Last week, I suggested that the White House may want a shutdown to blame negative economic impacts on Republicans. That plan works if you’re the one offering a solution. Right now, bizarrely, Democrats aren’t even trying to pass a “clean” debt ceiling measure. Republicans are the only group offering to raise the debt ceiling.
The press can cover for the President all it wants. The WSJ Editorial Board is right, “If Mr. Biden won’t work with Republicans in the House and Senate on a compromise, then he’ll be responsible for the financial calamity he’s been warning about.”
Relatedly, both Democrats and Biden are playing this as if they have a long timeline. Goldman Sachs suggests that the timetable on a measure won’t be needed until July, pushing back the original June deadline. That’s all well and fine, but I keep looking at a deteriorating economy and wonder if events won’t force a rushed solution.
If we start seeing more fire sales in commercial real estate, or First Republic Bank fails, or we see some other cracks appear in the economy, that could signal an economic downturn is hitting faster than anticipated. If that’s the case, Democrats won’t have the long rope they believe they have to play this card against Republicans.
Right now, you must treat this situation as Biden wanting a government shutdown. Political game theory says the issue benefits Democrats, and they’re right to push Republicans on it. But to have that strong hand, you must set up your cards correctly. Democrats don’t have any cards right now. It’s a weird strategy.
Again, part of that is because they didn’t believe McCarthy would be good at the job. McCarthy is perceived as weak and stupid. But McCarthy has managed to do what Boehner and Paul Ryan couldn’t: get the firebomb throwers onboard. The House GOP caucus is now united, something no one predicted. That places pressure on Democrat moderates, as shown above with Joe Manchin.
On the Democratic side, Hakeem Jeffries is untested in the House. Chuck Schumer doesn’t have Diane Feinstein as a vote, nor can he rely on Manchin or Sinema. Schumer also hasn’t had the insight to have a proposal ready to go. Jeffries hasn’t tried a Pelosi tactic of getting GOP support for an alternative clean debt ceiling proposal. If you want to vote for a solution, the only game in town is McCarthy and House Republicans.
I don’t know where this is all going to head. But it’s easy to say: 1) Democrats may not have the time they believe they do to negotiate this legislative fight. 2) The economy is deteriorating. 3) McCarthy has managed to unite Republicans and outflank Democrats quietly.
If the economy starts crashing, the debt ceiling fight will amplify even more. It’s unclear if Democrats realize any of these points right now. I’m curious about what shakes them out of that daze.
Links of the week
The Ruins of Our Media Landscape – National Review
The New Right is going nowhere — and knows it: What the realigners got wrong – Ben Domenech, The Spectator
Twitter Thread(s) of the week
Satire of the week
Beloved Actor We’re Not Naming Until You Click Has Died – Waterford Whispers News
Thanks for reading!