The Accounting Podcast

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Blake Oliver: [00:00:00] Hey, listeners. Blake here. Navigating today's economy feels like we're all sailing in the fog. We can't see too far ahead. But the waters have been relatively calm so far. Earlier this year, recession fears emerged like a storm brewing on the horizon. But the winds changed and that threat passed almost as quickly as it came. Still, risks loom in the mist. Things like talent shortages, vulnerable banks, unpredictable inflation, you know, the usual suspects. To help make sense of all these conflicting signals, I spoke with Liz Wilke, chief economist over at Gusto. Liz takes a nuanced, data driven approach to evaluating our economic outlook. She's not afraid to challenge simplistic narratives either. We analyze things like recession odds, labor trends, interest rate impacts and risks regional banks are facing these days. The forecast may be foggy, but I hope this overview equips you to navigate the waters ahead with your clients and make smarter decisions. All right, Let's join my conversation with Gusto's chief economist Liz Wilke. Cheers. Cheers. We kick this off.

Liz Wilke: [00:01:03] Let's kick this off.

Blake Oliver: [00:01:05] Good morning, everyone. I am Blake Oliver, CPA, talking today with Liz Wilke. It's been a wild year. Two things spring to mind. I taking over the world, potentially changing everything we do as accountants, as white collar professionals. And then right after that, we had Silicon Valley Bank collapsing and taking two other banks with it. And for a moment there it was looking like we were going to have a recession, you know,

Liz Wilke: [00:01:37] for a quick moment,

Blake Oliver: [00:01:37] For like two weeks, we were all really freaking out. And then it kind of passed. And the recession has not materialized. We had a pretty nice summer, it seems like, right? We had Barbie, we had Oppenheimer. You know, we had our blockbusters. Seems like things are getting back to normal a little bit.

Liz Wilke: [00:01:55] It does seem like things are getting back to normal, except the you know, I feel like we get these interludes between crises right? Chatgpt took the world by storm and then there was SVB. And, you know, we've had sort of a nice summer. People are feeling a little relaxed. But you have to ask the question like, what's the next thing? Right? Because I do think we're in sort of a period of turmoil and change, and I think we all really want to like go back to the normal and we really want to appreciate where we can just like take a sigh of relief. But yeah, part of me is like, what's the next thing? Because there's going to be a next thing you know. That's just the moment that we're in.

Blake Oliver: [00:02:30] So in your professional opinion, are we in for a soft landing or is the recession coming?

Liz Wilke: [00:02:36] Honestly, I'm pretty bullish on a soft landing. I think that if we have a recession, we're going to have, you know, -1%. Like we're going to sort of sit right at that 0% growth. And I honestly don't think it's coming until 2024 if it's coming at all. I think at the very beginning of the year, you know, when my economist friends and circles were like, oh, it's going to happen, it's going to happen, it's just a matter of time. And I was like, These labor market numbers are at best drifting sideways, right? These consumers are spending so much money and I think they're really like the wind beneath the wings for these jacked up interest rates. And I think they are really going to bring us into a soft landing or there's a lot of space for that to happen. Right. Which is exactly what Jerome Powell is counting on.

Blake Oliver: [00:03:21] So soft landing or mild recession is what it sounds like.

Liz Wilke: [00:03:24] Yeah, I think the most people, especially if you're younger, remember the 2008 recession, right? So recession is like recession with a capital R seems really big, but recessions can be really mild. They can they can be technical recessions where people just feel a little like it's not as good as it could be, but it's really not so bad. And I think that's where we're headed. I don't think we're headed for a capital recession.

Blake Oliver: [00:03:48] Oh, good. That's that's good because I have PTSD still from the Great Recession. Not a good time to be graduating from college.

Liz Wilke: [00:03:56] It was a terrible time to be graduating from college, although I know I mean, a bunch of people went to grad school, like right out. They were like, I'm out. I'm not going in this labor market. Let's get some more education.

Blake Oliver: [00:04:05] A bunch of my friends became lawyers. That was the that was the go to. Okay, So recession maybe, maybe we don't have one. Maybe we have a mild one. The cause of the next recession. We thought maybe it was going to be this SVB thing or it looked like that was going to set things off and we were going to have this totally banking contagion and all the the small banks were going to have trouble. And that's bad for business because small businesses.

Liz Wilke: [00:04:32] Yeah, they depend on those banks.

Blake Oliver: [00:04:34] Depend on those regional banks. And it didn't happen. Why? Why didn't we get that? How did we save the day? Fdic was enough. The Fed stepped in and everybody was like, okay, we're going to be all right, to.

Liz Wilke: [00:04:48] Be honest, kind of. Yeah.

Blake Oliver: [00:04:49] I think they did their job.

Liz Wilke: [00:04:51] I really do think that the Fed did their job in this case. I think that with the controls in place from the Dodd-Frank Act, I really do think there were a lot of lessons learned from the bank failures of the financial crisis. And, you know, to put it in perspective, the amount of money wrapped up in these three failed banks equals the amount of money in the financial crisis that failed. So the magnitude of the failure is totally on par. And we just did not see the fallout that we saw in 2008. And that is because of these improved governance standards that were put in from the Dodd-Frank Act. But the Fed came in and did its job. They said, don't worry, we know how to solve this like everybody is going to get their money back. Right. And that really helped to calm the fear. Right? That causes that contagion. And then they quietly transferred it to receivership and found a buyer. And then we could all sort of get on as normal. And I think it really I don't think the Fed got the right kind of credit that I think it deserves. Right. For dealing with the situation as smoothly as it did, because we had the almost exact same situation 13 years ago and it was chaos. Yeah. Yeah.

Blake Oliver: [00:06:02] So. We escaped this immediate problem. The three banks went under, right? It was what? Cb? Cb Signature? Yeah, it was the other one. The other banks, you know, didn't get impacted or they're okay. But the underlying issue that caused all this, which is the interest rates going up, that hasn't gone away. No. So it's sort of like, you know, we've dealt with the symptoms of this disease, but the underlying. Condition, which is these high interest rates that that cause SVB to collapse, like that's still there. So, I mean, are we really out of the woods?

Liz Wilke: [00:06:41] I would say the risk is still present. Right. Which is what you're trying to say. The risk is still there. So a lot of banks, especially small and regional banks, have assets on their balance sheet. Right. That were put on their way back when interest rates were really low. We'll talk about commercial real estate loans in this context. I expect because of sort of the elephant in the room for them. But the risk is going to is going to be there. I think honestly, it's sort of anybody's guess at this point how that's going to fall out, because whether or not it's going to be a calamity or kind of just like, you know, what has already happened, where it's sort of silently and smoothly happens, it really depends on how much the Fed wants to step in. Right. Every single time this happens and facilitate. Honestly, it was probably going to be a bunch of mergers and acquisitions right in this space as that risk sort of unfolds.

Blake Oliver: [00:07:31] So just have the bigger banks get bigger, buy up the struggling smaller banks and you solve the problem, get the balance sheets in order that way.

Liz Wilke: [00:07:39] I mean, you solve a problem, right, with that. So one of two things I think is most likely to happen, either small and community banks are going to come under stress because the real estate loans and the assets that they have will come under stress and then they will either fail and go into receivership, right, like SVB, and then they'll be bought up or the additional regulatory requirements that will be put on them because they were previously exempt. Right. Small and regional banks didn't have to do the kind of stress testing. Right. The bigger banks have to do the Dodd-Frank. Exactly. Okay. Yeah. Yeah. But so if the Fed is like, hey, there's all these risks and you guys need to be doing a lot more small and regional banks may say we can't support that right. And still serve our customers. So then they'll just sort of be bought up and there will be this consolidation. So you sort of solve some of the risk part in the financial system overall. But I think one of the real knock on effects for small businesses is that where's their money going to come from? Right? These relational banking systems are really, really important to small businesses. Right. And if those businesses aren't there anymore, they're being run by BofA or Citibank. You know, what's going to happen to that source of finance for them? And I think that's the real open question that we need to think forward about how we're going to address.

Blake Oliver: [00:08:55] Yeah, that's a not a great situation. I mean, I've I own a business, I've had a firm and trying to get BofA to give me the time of day, you know, is not something they do really for a small business but that, you know local bank who has like a person I know in the community will talk to me, you know, will give me the the loan that I need to start my business.

Liz Wilke: [00:09:17] They understand your business. They understand the local market for your business. And they can have a real close eye on whether or not you're profitable. Right. I think especially if you're in, you know, not a major city or you're in a rural area, you know, it can be really hard to know how successful your business can be. Right. Which is how you want to make a loan.

Blake Oliver: [00:09:35] So we talked about interest rate interest rates. Staying high for a while seems to be like what? What I'm hearing.

Liz Wilke: [00:09:45] Yeah, I think it's going to be high for a while.

Blake Oliver: [00:09:47] Okay. Yeah. Because what the. The rule of thumb is the Fed can't lower interest rates while the job market is still hot. Right.

Liz Wilke: [00:09:59] I mean, the traditional too fine a point on it, but yeah, that's about right. Right?

Blake Oliver: [00:10:03] Yeah. Because like the idea is can correct me if I'm wrong on this, it's very simple really. They just they raise interest rates until unemployment starts to go up. Right. And then if unemployment is going up, that means the economy is cooling down. So now they can start lowering the interest rates. Yeah, but that hasn't happened. If anything, the labor market has tightened as we've gone up. Yeah.

Liz Wilke: [00:10:22] I mean, yeah, so that was the traditional logic. But honestly, we're in unprecedented times. And I think I said, I've been saying this sort of since last year is like our old models and ways of thinking about the economy. It's not that we can't use them, it's that we need to use them with a healthy openness, right. About how they could be wrong in this environment, because I think we really are in some uncharted territory, right? The magnitude of the change from the pandemic, all the retirements, this huge surge of entrepreneurship, all of the changing industry needs and the digitalization that happened during Covid is still playing out. And so I think what we're seeing is, yeah, you would think I jack up interest rates, people will be unemployed, businesses slow down. We've at best drifted sideways in the labor market, but we have made significant progress on inflation.

Blake Oliver: [00:11:17] We've slowed down the rate of inflation. We haven't got what do they call it? It's not disinflation. We haven't gotten that. Where I was going with this is thinking like we're just going to have high interest rates for a really long time now.

Liz Wilke: [00:11:30] So what I expect to happen is that they'll start taking pauses, right? Or at least skipping rates rate increases. You know, we're up at a 22 year high. We might get a couple more bumps. But now that we're seeing inflation cool, my best guess is that they'll probably just think, let's just keep it here for a while, as long as it takes. And if inflation stalls, we can turn up the notch and if inflation keeps going down and the labor market is healthy, then we might actually have this sort of unprecedented situation where we have really robust labor market and 2% inflation. I don't think that'll happen because I think that model about inflation and interest rates is still basically true. But I think we can expect higher interest rates well into 2024, if not 2025. I just think it's going to take a long time for that to work itself out.

Blake Oliver: [00:12:17] So that's how we come back to the banks, because if interest rates are going to stay high, the banks have been enjoying all of this cheap, almost free for them money. So they basically take money from the Fed. They loan it out to businesses, real estate often. And and it's easy to make a profit because they don't have to make that much on the money that's free. Yeah but now when money costs what I don't know what the federal funds rate is, but it's like 5.5%. Yeah, right. So when they're paying 5.5%, what do they have to earn on the loans that they're putting out there? Yeah. It's it's it's not small. Yeah. So their margin is thin. Yeah. And you mentioned on your podcast that and this is what stuck in my head is that these regional banks, these small banks. 80, 90% of them have a a significant amount of commercial real estate debt on their balance sheets. And that was all financed at these really super low interest rates.

Liz Wilke: [00:13:18] Super low interest rates. And so when you think about giving out a loan at the beginning, right, most of the time, like when you get a mortgage on your house, right. You know, you originate the whole loan, right. And you say, I'm going to get a loan for this whole house. Right? And you do it at a time where you think you're likely to be able to pay it off into the future. That's not how it works with commercial real estate loans, which is why it's sort of so interesting when you do commercial real estate, you get a loan for the whole amount, but you only finance it for like seven years, somewhere between 5 and 10 years. And so you basically have a payment schedule. And then at the end of five, 7 or 10 years, you have to pay the whole rest of it in this balloon payment, which is.

Blake Oliver: [00:13:59] Not even possible.

Liz Wilke: [00:14:00] Which is not even possible. So you refinance it, right? And then you and then you get an amount for like the next 7 to 10 years. So when all these loans were originated that are coming due, you have to pay a significant chunk that needs to be refinanced. But the value of the loan that you originally got, which you need to refinance, is from when the money was cheap and assets were really highly valued. So you have much less profitable projects that needs to be valued at the old value. And so we expect banks to take losses on these, right, because they just won't be profitable like and they.

Blake Oliver: [00:14:31] Haven't had to do it yet because they're holding all these loans on their books at historical values. Yeah, right. So, so that hasn't been marked to market. So that's the that's the landmine that could be there. That's right.

Liz Wilke: [00:14:45] That's that's that's the landmine. Yeah.

Blake Oliver: [00:14:47] We might not know. I mean, and what could be how much could these shrink.

Liz Wilke: [00:14:52] Right. I mean what office. Office rates are down 20, 30% in some areas since the pandemic. Some places they're not down quite so much. But I mean, they're especially in like big cities, right. That are highly remote, workable and where people have moved out to the suburbs or are only coming in 1 or 2 days a week, I mean, the value of these loans could go down significantly. Right. And you you sort of get these like jingle mail that became very popular in the financial crisis where people would just mail the keys back to the bank. Right. Stop the payments and sort of call it in. And you can see that.

Blake Oliver: [00:15:26] This is giving me echoes of the Great Recession, you know, because that was a mortgage crisis. Right. And it was essentially I mean, in some ways it was very similar to what you're describing. Yeah. So where yeah, everyone's on these variable rate loans and suddenly their interest rates go up and now nobody can afford them. Yeah. And it's basically the owners of these buildings. Yeah. Low occupancy they're renters are going to churn out and now the property is not worth what it was and suddenly their payments are going to have to go way up. Yeah. So are the banks going to end up owning a bunch of commercial real estate?

Liz Wilke: [00:16:00] Maybe so, yeah. I mean, somebody's going to own up and or excuse me, somebody's going to end up owning it. And I think the saving grace of some of these banks will really determine how much of their commercial portfolio is in office space because other types of commercial real estate are doing quite well. Warehouses are doing particularly well. Oh, yeah, good point. Right. So like retail space actually is doing better than you would think, especially since we're, you know, our our online shopping trends are actually returning to normal. And so retail space is, you know, having a little bit of a resurgence. So specifically hotels, right? Specifically office space is really struggling. So if you're a small bank and you're financing hotels and warehouses and stuff, you this is not a thing for you to worry about. Right? Those things are going to get refinanced overall. That's good.

Blake Oliver: [00:16:48] That gives me comfort. So I'm thinking I was I was picturing the balance sheets and I'm thinking, you know, a quarter of the balance sheet is these commercial loans. If those all go bad. I mean, banks don't operate on a lot of equity.

Liz Wilke: [00:16:58] They do not write.

Blake Oliver: [00:16:59] Their net position is pretty slim. And that was the case with SVB.

Liz Wilke: [00:17:02] That's definitely the case with SVB. I mean, you can definitely go and look at a bank's balance sheet. I think in my podcast we put in the show notes where you can actually go and look at that information. But the thing to look at is how much of the total balance sheet is in commercial real estate and then how much of that is in offices. There are definitely banks out there who are holding 20% of their assets in offices that those banks, you know, if if if that portfolio loses 20% of its value, it took much less than that in a loss. Right. To create a run on SVB. Yep.

Blake Oliver: [00:17:32] Okay. So those are the banks we need to look out for.

Liz Wilke: [00:17:34] Yeah, those are the banks.

Blake Oliver: [00:17:35] Do they do they typically disclose the breakdown of the commercial real estate? They typically.

Liz Wilke: [00:17:40] Do. Okay.

Blake Oliver: [00:17:40] So we can look into the financials and we can see it. Yeah, that sounds like a job for ChatGPT.

Liz Wilke: [00:17:45] It sounds like a job for somebody for sure.

Blake Oliver: [00:17:47] I'm not reading 180 pages of financial statements right now.

Liz Wilke: [00:17:51] You have to go through one by one. It's much easier to look at like, what's my specific bank doing, right? As opposed to generating the whole list of banks that you really want to keep an eye on.

Blake Oliver: [00:18:01] Okay, I'm going to go do some homework. Homework for our listeners is to listen to your new podcast. It's called The Gusto.

Liz Wilke: [00:18:08] The Gas Dynamics podcast and.

Blake Oliver: [00:18:10] That was really the impetus for this discussion was your first episode is all about commercial real estate. That's right. Loans and how they work. And yeah, I didn't know about that balloon thing that happens at the end of seven years or whatever. But yeah, yeah, that's, that's really fascinating. Like you wonder, like why? Imagine if we all had that on our houses, you know, and you had to refinance every 5 or 6 years. Yeah.

Liz Wilke: [00:18:33] I mean I think the, the, the way mortgages work is so different. Right. And we just don't think about all the other ways that loans could be structured. Some of them are really not so good. Right, for the people doing the borrowing but in.

Blake Oliver: [00:18:45] A way it's like kicking the can down the road is what happens with those commercial loans.

Liz Wilke: [00:18:50] Yeah, that's exactly what.

Blake Oliver: [00:18:51] Happens and it works well. As long as the economy is growing and the buildings have occupancy and you know, but not so good if it turns the other way.

Liz Wilke: [00:18:58] Yeah, well, it also could work well if just interest rates, right? If you sort of don't have these big jumps in interest rates. Right. Or you have some kind of a bridge program to sort of help, you say you could you could imagine a program where you say, you know, the interest rate on your specific loan can sort of never go up by more than this, that or amount or the other, which is a protection that was put in for variable mortgages right after the financial crisis. We haven't faced those problems yet, but I sort of imagine we could be having those conversations about commercial real estate loans.

Blake Oliver: [00:19:27] So everyone check out the Gust Dynamics podcast and also Gusto does really incredible research. Thank you. Reporting. Thank we do I think the last one was in August. That's right. We'll put the link to that report in the show notes. Anything in particular you want to call out from that study?

Liz Wilke: [00:19:45] I mean, I think I would just call out, you know, really it's the talent market that I think we're transitioning from this idea that the talent shortage, the great resignation is like a temporary thing that we're working through. And we're I think we just need to get ready for the forever talent shortage. I think that talent and workers are going to be scarce for some time. And, you know, we are just going to have to figure out how to retain, how to train, how to develop people. So that whole program is called the Economy Explained. We put out a quarterly video blog post to sort of talk about big trends in the economy and what they.

Blake Oliver: [00:20:20] Mean forever talent shortage and sounds like maybe forever interest rates.

Liz Wilke: [00:20:24] Maybe forever. Interest rates. Definitely. Medium term interest rates for a while in interest.

Liz Wilke: [00:20:29] Rates know.

Blake Oliver: [00:20:30] None of us can ever move again. If you bought a house, you're stuck.

Liz Wilke: [00:20:34] Well, that's why housing prices haven't gone down, right? So interest rates went up. Everybody who owns a house owns it at 3% or less, and they're like, Well, I can't buy a better house than the one I have now. So they, you know, took their house on the market, off the market, or they're not putting it back on. And so all the buyers in the market are not only facing an increased interest rate, but they're not even getting that housing price reduction. Right. That you would think of as being the result of a higher interest rate.

Blake Oliver: [00:21:01] But everything's counterintuitive. It's like the opposite of what we learn in school growing up, and it must be an exciting time to be an economist.

Liz Wilke: [00:21:08] Yeah, mostly because people are really exciting. I say in the podcast and I will say it a lot, is that the economy is just people doing people stuff with other people all the time, right? And the dynamics of that are always rich and complex and even more so in this time.

Blake Oliver: [00:21:23] Well, thanks for talking with me, Liz.

Liz Wilke: [00:21:25] Thanks. My pleasure.

Liz Wilke: [00:21:25] Yeah, it was a pleasure.