The U.S. economic recovery has repeatedly defied predictions of an impending recession, withstanding supply-chain backlogs, labor shortages, global conflicts and the fastest increase in rates of interest in many years.
That resilience now faces a latest test: a banking crisis that, at times over the past week, seemed poised to show right into a full-blown financial meltdown as oil prices plunged and investors poured money into U.S. government debt and other assets perceived as secure.
Markets remained volatile on Friday — stocks had their worst day of the week — as leaders in Washington and on Wall Street sought to maintain the crisis contained.
Even when those efforts succeed — and veterans of previous crises cautioned that was a giant “if” — economists said the episode would inevitably take a toll on hiring and investments as banks pulled back on lending, and businesses struggled to borrow money because of this. Some forecasters said the turmoil had already made a recession more likely.
“There might be real and lasting economic repercussions from this, even when all of the dust settles well,” said Jay Bryson, chief economist at Wells Fargo. “I might raise the probability of a recession given what’s happened within the last week.”
At a minimum, the crisis has complicated the already delicate task facing officials on the Federal Reserve, who’ve been attempting to slow the economy steadily with the intention to bring inflation to heel. That task is as urgent as ever: Government data on Tuesday showed that prices continued to rise at a rapid clip in February. But now policymakers must grapple with the danger that the Fed’s efforts to fight inflation might be destabilizing the economic system.
They don’t have long to weigh their options: Fed officials will hold their next usually scheduled meeting on Tuesday and Wednesday amid unusual uncertainty about what they are going to do. As recently as 10 days ago, investors expected the central bank to reaccelerate its campaign of rate of interest increases in response to stronger-than-expected economic data. Now, Fed watchers are debating whether the meeting will end with rates unchanged.
The notion that the rapid increase in rates of interest could threaten financial stability is hardly latest. In recent months, economists have remarked often that it’s surprising that the Fed has been capable of raise rates a lot, so fast without severe disruptions to a marketplace that has grown used to rock-bottom borrowing costs.
What was less expected is where the primary crack showed: small and midsize U.S. banks, in theory amongst essentially the most closely monitored and tightly regulated pieces of the worldwide economic system.
“I used to be surprised where the issue got here, but I wasn’t surprised there was an issue,” Kenneth Rogoff, a Harvard professor and leading scholar of monetary crises, said in an interview. In an essay in early January, he warned of the danger of a “looming financial contagion” as governments and businesses struggled to regulate to an era of upper rates of interest.
He said he didn’t expect a repeat of 2008, when the collapse of the U.S. mortgage market quickly engulfed virtually your entire global economic system. Banks all over the world are higher capitalized and higher regulated than they were back then, and the economy itself is stronger.
“Often to have a more systemic financial crisis, you wish a couple of shoe to drop,” Professor Rogoff said. “Think of upper real rates of interest as one shoe, but you wish one other.”
Still, he and other experts said it was alarming that such severe problems could go undetected so long at Silicon Valley Bank, the midsize California institution whose failure set in motion the most recent turmoil. That raises questions on what other threats might be lurking, perhaps in less regulated corners of finance akin to real estate or private equity.
“If we’re not on top of that, then what about a few of these other, more shadowy parts of the economic system?” said Anil Kashyap, a University of Chicago economist who studies financial crises.
Already, there are hints that the crisis will not be limited to america. Credit Suisse said on Thursday that it might borrow as much as $54 billion from the Swiss National Bank after investors dumped its stock as fears arose about its financial health. The 166-year-old lender has faced an extended series of scandals and missteps, and its problems aren’t directly related to those of Silicon Valley Bank and other U.S. institutions. But economists said the violent market response was an indication that investors were growing concerned concerning the stability of the broader system.
The turmoil within the financial world comes just because the economic recovery, not less than in america, appeared to be gaining momentum. Consumer spending, which fell in late 2022, rebounded early this 12 months. The housing market, which slumped in 2022 as mortgage rates rose, had shown signs of stabilizing. And despite high-profile layoffs at large tech corporations, job growth has stayed strong and even accelerated in recent months. By early March, forecasters were raising their estimates of economic growth and marking down the risks of a recession, not less than this 12 months.
Now, a lot of them are reversing course. Mr. Bryson, of Wells Fargo, said he now put the probability of a recession this 12 months at about 65 percent, up from about 55 percent before the recent bank failures. Even Goldman Sachs, amongst essentially the most optimistic forecasters on Wall Street in recent months, said Thursday that the probabilities of a recession had risen 10 percentage points, to 35 percent, because of this of the crisis and the resulting uncertainty.
Essentially the most immediate impact is prone to be on lending. Small and midsize banks could tighten their lending standards and issue fewer loans, either in a voluntary effort to shore up their funds or in response to heightened scrutiny from regulators. That might be a blow to residential and industrial developers, manufacturers and other businesses that depend on debt to finance their day-to-day operations.
Janet L. Yellen, the Treasury secretary, said Thursday that the federal government was “monitoring very fastidiously” the health of the banking system and of credit conditions more broadly.
“A more general problem that concerns us is the likelihood that if banks are under stress, they may be reluctant to lend,” she told members of the Senate Finance Committee. That, she added, “could turn this right into a source of great downside economic risk.”
Tighter credit is prone to be a specific challenge for small businesses, which generally don’t have ready access to other sources of financing, akin to the company debt market, and which regularly depend on relationships with bankers who know their specific industry or local people. Some may have the option to get loans from big banks, which have thus far seemed largely immune from the issues facing smaller institutions. But they are going to almost definitely pay more to achieve this, and plenty of businesses may not have the option to acquire credit in any respect, forcing them to reduce on hiring, investing and spending.
“It could be hard to interchange those small and medium-size banks with other sources of capital,” said Michael Feroli, chief U.S. economist at J.P. Morgan. “That, in turn, could hinder growth.”
Slower growth, after all, is strictly what the Fed has been trying to attain by raising rates of interest — and tighter credit is considered one of the primary channels through which monetary policy is believed to work. If businesses and consumers pull back activity, either because borrowing becomes costlier or because they’re nervous concerning the economy, that would, in theory, help the Fed bring inflation under control.
But Philipp Schnabl, a Recent York University economist who has studied the recent banking problems, said policymakers had been attempting to rein within the economy by crimping demand for goods and services. A financial upheaval, against this, could end in a sudden lack of access to credit. That tighter bank lending could also affect overall supply within the economy, which is tough to handle through Fed policy.
“We now have been raising rates to affect aggregate demand,” he said. “Now, you get this credit crunch, but that’s coming from financial stability concerns.”
Still, the U.S. economy retains sources of strength that would help cushion the most recent blows. Households, in the combination, have ample savings and rising incomes. Businesses, after years of strong profits, have relatively little debt. And despite the struggles of their smaller peers, the most important U.S. banks are on much firmer financial footing than they were in 2008.
“I still consider — not only hope — that the damage to the actual economy from that is going to be pretty limited,” said Adam Posen, president of the Peterson Institute for International Economics. “I can tell a really compelling story of why this is frightening, however it ought to be OK.”
Alan Rappeport and Jeanna Smialek contributed reporting.
