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Fannie Mae: Banking System Instability Could Cause Recession

David Krechevsky
Mar 24, 2023
Fannie Mae HQ

ESR Group says housing activity expected to remain subdued.

The U.S. economy will not see a repeat of the 2008 financial crisis this year, but a “modest recession” is still on the horizon, according to the latest projections by Fannie Mae’s Economic and Strategic Research (ESR) Group.

The ESR Group on Friday revised upward its first-quarter 2023 GDP forecast, citing stronger-than-expected economic data, but it added that the revision was finalized before the recent financial turmoil caused by the banking crisis.

“Inflation has now been joined by financial stability concerns as threats to sustained growth,” said Doug Duncan, Fannie Mae’s senior vice president and chief economist. “These particular pre-recessionary conditions are not unusual, as bank failures often follow monetary tightening – but this may well be the catalyst for the modest recession we’ve been expecting since April 2022.”

He continued: “While housing writ large has responded to the Fed’s monetary tightening in a relatively predictable fashion, the rapid uptick in home sales in response to modest rate declines earlier this year corroborates our long-standing expectation that the housing sector will help moderate any future recession due to the significant pent-up demand.”

The group now projects a modest recession to begin in the second half of 2023, later in the year than its original forecast of the second quarter of 2023.

In its report, the ESR Group said that while uncertainty has risen following turbulence in the banking sector, bank failures often foreshadow economic downturns. 

Because of that, the group believes recent events may act as the catalyst that tips an already precarious economy into recession, primarily through the combination of tighter lending standards among small and midsized regional banks and weakened business and consumer confidence.

The ESR Group does not, however, anticipate a repeat of the 2008 financial crisis.

Instead, it believes the savings & loan crisis of the 1980s “to be a better analog, specifically regarding the significant interest rate rises that set in motion banking system stress and the resultant macroeconomic effects that contributed to a modest recession in 1991.”

The ESR Group also highlighted the downside risk to its interest rate forecast, as banking-related stress may slow the economy and relieve inflationary pressure — in effect relieving the Federal Reserve of potentially having to raise rates as high as previously expected. 

“While home sales experienced a large bump in February following a pullback in mortgage rates,” the ESR Group said, it noted that recent mortgage application data suggest that last month’s levels will be temporary. 

In addition, the ESR Group says the ongoing banking instability may affect the availability of jumbo mortgages and residential construction loans, due to the high concentration of those originations stemming from small and midsized banks. 

The group expects home sales to remain subdued due to ongoing affordability constraints and the “lock-in effect” continuing to create a strong financial disincentive for homeowners to move.

Read the full report here.

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