Might big cities like New York soon undergo Detroitification?
Credit standards are tightening.
That means it is becoming harder to get a loan.
Whether you want to get a mortgage to buy a home or take out a loan for your small business, banks are becoming less and less willing to hand over the cash.
At the same time, borrowers are becoming less willing to take on any debt.
This is what the Federal Reserve’s latest senior-loan-officer-opinion survey shows.
You don’t need to be an economist to guess what is going on.
The past few months have seen several significant bank failures. Silicon Valley Bank was the first to go pop in March, followed shortly by Signature Bank.
At the start of May, First Republic was struggling on life support and had to be bought out by JPMorgan, which only took on the bank on condition the federal government threw wads of cash on the table.
With all this chaos, is it any wonder banks are becoming more nervous about lending?
Potential borrowers, meanwhile, are looking at higher interest rates.
In May 2021, the average 30-year fixed mortgage rate was just below 3%.
Today it is well over 6%.
Since inflation-adjusted house prices are now the highest they have ever been, this sort of borrowing rate is daunting for most people.
So it is no surprise potential borrowers are having second thoughts about asking their bank manager for a loan.
This raises the prospect of a credit crunch, a sharp decline in lending in the economy.
This happened before, in 2008, and the impact on the financial sector and the economy were grim.
When banks stop lending and consumers and businesspeople stop borrowing, the economy goes into recession.
As in 2008, the sector that is of most concern is real estate, especially commercial real estate, which has been under immense pressure since many people started working from home during the lockdowns.
Some might hope for a decline in property prices as they have become so expensive in recent years.
But this is a case of “Be careful what you wish for” if there ever was one.
The construction sector employs just over 7.9 million people.
Real estate, lending and leasing employs another 2.4 million people.
One in 16 people in the United States works in either construction or real estate.
If real-estate properties fall, many of these jobs are under threat.
Then there are the consequences for governments, especially city governments.
Apart from transfers from the federal government, property taxes make up the largest component of state and local government revenue (around 17% on average).
Last time there was a credit crunch, in 2008, state and local government revenue got hammered, and the Obama administration had to include bailouts for these governments in its American Recovery and Reinvestment Act of 2009.
Yet there are reasons to believe the problems this time around are even worse for many metropolises.
Crime, especially violent crime, has gotten completely out of control in many American cities.
From 2019 to 2022, the Major Cities Chiefs Association estimates a shocking 50% increase in homicides and 36% rise in aggravated assaults in their member cities.
This has led many to simply leave the cities.
We see this in the house-price data, with prices declining in states where people are fleeing, like California, and rising in states where people are settling, like Florida.
Many of the cities in these states have strained budgets that were highly reliant on property taxes to begin with.
Take San Francisco.
Its annual budget is around $6.2 billion. But $2 billion of this comes from property taxes.
San Francisco already runs a budget deficit of around $290 million.
Its property market is already under pressure.
In 2020, the asking price for one newly built commercial office tower in downtown was $250 million.
The property recently sold for $60 million, a shocking 75% discount.
New York City isn’t looking much better.
Its overall budget is nearly $107 billion, but around $35 billion of that comes from property-tax revenues.
The Big Apple already runs a deficit of around $1.3 billion.
When the credit crunch really bites, cities like San Francisco and New York are in a lot of trouble.
Many already run large budget deficits.
Their revenue base is highly concentrated in property taxes.
Lax policing policies are already causing an exodus in these cities.
This raises the possibility that many of them will go bankrupt and collapse.
This decade we could see the Detroitification of many American cities.
Philip Pilkington is a macroeconomist and investment professional.
