Janet Yellen On The Outlook For The US Economy And Community Banks
San Fran Fed's Janet Yellen presenting before the Oregon Bankers Association Annual Convention
"Financial trauma of this magnitude could have nothing but the direst effects on economic activity. As we all know, the financial earthquake of the summer and fall was quickly followed by aftershocks that rocked the broader economy, intensifying a credit crunch, and producing precipitous drops in employment and economic output. The interaction between the economy and the credit crunch—often described as an adverse feedback loop—led to what could become the most severe recession since the Great Depression."
"The fiscal stimulus program passed by Congress in February provides tax cuts that have raised household income. In addition, government spending is directly adding to payrolls and boosting demand. More stimulus will come on line as the year proceeds. This program wasn’t designed to produce an economic recovery by itself, but rather to cushion our fall. In that sense, it’s doing its job. Looking forward, the demand for houses and durables should also eventually revive as old and broken-down goods need to be replaced. The resulting demand will help the economy recover."
On systemic risk:
"We need a better way to manage systemic risk. By that I mean improved oversight of the financial system as a whole. Focusing on systemic risk is different than our traditional institution-oriented approach to supervision. It has become painfully clear that when regulators focus exclusively on individual institutions, they can miss broader risks building in the system. In particular, we need to do a better job of assessing how the practices of large institutions may affect their counterparties and the system as a whole."
On community banks:
"Now let me turn to the business environment facing banks. The industry is going through one of the most difficult periods in modern times. First-quarter data show that the 12th District has been hit harder than any other area of the country. Bank profits are down, loan delinquencies are up, and failures are climbing. To date, the community banks under greatest financial stress are those with high real estate concentrations in construction and land development lending. Banks that liberally funded speculative housing and condominium construction, and those that funded land acquisition and development, have been hardest hit."
On CRE exposure:
"The next area of significant vulnerability for the banking system, particularly for community and regional banks with real estate concentrations, is income-producing office, warehouse, and retail commercial property. Market fundamentals in most western states are deteriorating. Vacancy rates are rising and rent pressures are hurting property cash flows. Office vacancy rates in both Boise and Portland are expected to reach or exceed 20 percent over the next year or two, the highest rates these cities have seen in many years. Retail shopping centers are struggling with falling occupancy rates and pressures to grant rent concessions. Property values are falling sharply across wide areas of the country, including the Pacific Northwest. Some analysts forecast that commercial property values could experience falls similar to housing of 30 to 40 percent."
On reconciling facts with hope:
"I know this sounds woeful, but my advice is to hope for the best and plan for the worst. That means anticipating a range of bad and worst-case scenarios that reflect local economic conditions and a bank’s particular risk profile. It can be helpful to perform stress tests based on these scenarios to assess potential effects on earnings and capital, and to develop appropriate contingency plans. The commercial real estate guidance that I mentioned earlier emphasizes the importance of stress tests. The testing that the largest 19 banks recently conducted offers examples of techniques that community banks can adopt, such as two-year portfolio loss estimates and methods of estimating revenue. Appropriately designed stress tests can help bank managements and boards make decisions about loan-loss provisioning, capital planning, and strategic initiatives."