Powell: ‘There will be bank failures’ caused by commercial real estate losses

Federal Reserve Chair Jerome Powell said Thursday that he expects to see some banks fail due to their exposure to the commercial real estate sector, which has declined significantly in value following the shift to remote work.

Powell said the banks that are in trouble with falling office space and retail assets are not the big banks, which were designated as “systemically important” in the aftermath of the 2008 financial crisis. That episode, which resulted in a taxpayer bailout of the financial sector, was also triggered by unsound real estate assets.

Rather, the banks at risk of failure now Powell identified as smaller and medium-sized.

“This is a problem we’ll be working on for years more, I’m sure. There will be bank failures,” he said during a Thursday hearing on the Fed’s monetary policy in the Senate Banking Committee.

“It’s not a first-order issue for any of the very large banks. It’s more smaller and medium-sized banks that have these issues. We’re working with them. We’re getting through it. I think it’s manageable, is the word I would use,” he said.

Powell didn’t go into detail about the specific regulatory actions regarding commercial real estate exposure that are now being undertaken by the Fed, which is both the federal currency issuer and one of the primary bank supervising agencies, though he did say he had identified the banks most at risk.

“We are in dialogue with them: Do you have your arms around this problem? Do you have enough capital? Do you have enough liquidity? Do you have a plan? You’re going to take losses here – are you being truthful with yourself and with your owners?” he said.

Commercial real estate investment vehicles, known as REITs, have taken a hit over the past few months. Alexandria Real Estate Equities, Boston Properties, Kilroy Realty Cop., and Vornado Realty trust are all in negative territory since the beginning of the year.

Powell described the decline in value of commercial real estate as a result of remote work following the economic shutdowns of the pandemic as a “secular change” in the economy.

“In many cities, the downtown office district is very underpopulated. There are empty buildings in many major and minor cities. It also means that all the retail that was there to serve those thousands and thousands of people who work in those buildings, they’re under pressure, too,” he said. 

While the decline of commericial real estate values could put some banks out of business, Powell expressed confidence that the Fed and financial regulators would be able to contain the fallout and prevent a broader crisis. Thirty-four U.S. banks have failed since 2015, according to the Federal Deposit Insurance Corp. (FDIC), which insures desposits at regulated banks.

The Fed and Treasury Department also jumped into action last year to bail out Sillicon Valley Bank and Signature Bank, and extend lifelines to other troubled banks as they threatened broader confidence in the banking system.