Treasury Secretary Janet Yellen stated on Thursday that high vacancies in commercial real estate might cause some stress for smaller banks but not for the nation's financial system.

Smaller Banks Stress Caused by Increasing Vacancies

During her annual testimony before the Senate Banking Committee on Thursday, Yellen informed lawmakers that while large banks have limited exposure, some smaller banks might face stress due to high office building vacancy rates, high-interest rates, and declining valuations.

Earlier this week, Yellen praised the country's economic recovery from the pandemic and highlighted regulators' actions to prevent a bank run last spring following the sudden collapse of Silicon Valley Bank. Yellen expressed concern about commercial real estate, highlighting issues arising from higher interest rates and increasing vacancy rates in office buildings, particularly as real estate loans become due. Yellen thinks the problem is controllable, noting that banking regulators and the Financial Stability Oversight Council, which she leads, are collaborating closely with institutions to address the needs of borrowers.

Focusing on Non-Bank Mortgage Lenders

According to Yellen, the council is closely watching non-traditional banking institutions, particularly non-bank mortgage lenders, which differs from traditional financial institutions as they don't have access to deposits, rely more on short-term financing, face the risk of credit line withdrawals during tough times, and don't have access to the Fed's discount window, which is the central bank's way to lend directly to banks.

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She mentioned that these companies tend to have minimal capital and loss-absorbing capacity, and mortgage servicing rights are a less liquid asset," there's concern that one of them could fail in challenging market conditions, which has become a significant concern in the mortgage market.

Regional Banks' Industry Pressure

Yellen's congressional testimony this week comes as some regional banks face pressure.

New York Community Bancorp recently revealed an unexpected loss and a surge in loan losses due to commercial real estate loans turning sour.

On Wednesday, the struggling regional bank tried to reassure investors that it had sufficient cash to continue operating after its stock had plummeted by around 60% over the past eight days. Moody's Investors Service downgraded the bank's credit rating to junk status.

Shares in the Hicksville-based bank, which acquired $40 billion worth of assets from the collapsed Signature Bank last March, fell 2% on Thursday morning.

Confidence in The Economy

Yellen noted that the U.S. economy is doing better than other major global economies, pointing out that inflation is decreasing while wages continue to increase. Prices are no longer growing rapidly, and wage growth is already surpassing inflation, which means that the average worker in the United States can afford the same usual items in 2019 and still have $1,400 remaining to spend or save.

However, Pennsylvania Democratic Senator John Fetterman pointed out that despite the strong economic data, many Americans do not feel its effects in their everyday lives, citing viral videos showcasing expensive McDonald's meals.

Yellen responded that recent consumer sentiment surveys indicate an improvement in Americans' views on the economy and their finances, notably as inflation has decreased. Yellen noted that individuals express negativity when questioned about the economy and others' financial situations. However, their assessment of their situation, spending habits, or entrepreneurial endeavors tends to be more positive.

According to Census Bureau data, a record 5.45 million business applications were submitted in 2023. Yellen believes that small business creation continues to thrive, highlighting that this trend only "occurs when people feel confident about the future of the economy."

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