Paycheck to paycheck: Majority of U.S. households feel they are living on the economic edge

The Federal Reserve’s latest quarter-point interest rate increase was another attempt by the U.S. central bank to curtail four-decade highs with inflation after massive monetary and fiscal infusions during the coronavirus pandemic.

Fed Chairman Jerome Powell, who previously said the inflation wave was “transitory” and initially said interest rate hikes in early May were aimed at constraining workers’ wages and said the bank is committed to getting annual price increases down to the 2% range. He also acknowledged the impacts higher lending rates have on banks, real estate as well as consumer and business financing.

“We have raised interest rates by 5 percentage points in a little more than a year. We are seeing the effects of our policy tightening on demand in the most interest rate-sensitive sectors of the economy, particularly housing and investment. It will take time, however, for the full effects of monetary restraint to be realized, especially on inflation,” Powell said May 3 after announcing the latest hike taking the central lending rate from 5% to 5.25%.

Tough times for many

Inflation has eased some with the latest Consumer Price Index showing U.S. consumer prices up 5% in March. That is the lowest annual price increase reported in the bellwether inflation gauge since May 2021, according to the U.S. Bureau of Labor Statistics.

Still, a new national survey by financial firms Pymnts Inc. and LendingClub shows 60% of all U.S. consumers say they are living paycheck to paycheck. That includes 73% of millennials, 65% of middle class workers and 75% of lower-income and working class households.

Roughy two out of three “Gen-Xers” and younger “Gen-Zers” also reported living based on pay cycles. The same survey showed 28% of U.S. workers say they are paying for expenses for other family and household members.

Prices remain high for food and shelter and inflation is also a global concern with high rates in parts of Europe (including Hungary, Serbia and Turkey which have 35%, 16.2% and 44% inflation rates, respectively). Other countries with high inflation rates and potential turmoil include Lebanon (264%), Argentina (104%) and Pakistan (36.4%)

Powell acknowledged the interest rates hikes are challenging two sectors also at the forefront of economic stresses — commercial real estate and banking.

“The U.S. economy slowed significantly last year, with real GDP rising at a below-trend pace of 0.9 percent. The pace of economic growth in the first quarter of this year continued to be modest, at 1.1 percent, despite a pickup in consumer spending,” Powell said. “Activity in the housing sector remains weak, largely reflecting higher mortgage rates. Higher interest rates and slower output growth also appear to be weighing on business fixed investment.”

Banking troubles?

The failures of Silicon Valley Bank and Signature Bank, the shutdown of crypto-heavy Silvergate Bank and the struggles of First Republic Bank and Credit Suisse spark concerns about the banking sector health after the pandemic and what the future holds for smaller players.

The failures in February have resulted in significant deposits and other money being moved from small banks to larger ‘too big too fail’ institutions with more cash reserves and more certain federal backing. That has resulted in big money moving to big banks such JP Morgan Chase & Co., Citigroup and Bank of America.

Powell stressed at a May 3 briefing that the U.S. banking system is “sound.”

“Conditions in that sector have broadly improved since early March, and the U.S banking system is sound and resilient. We will continue to monitor conditions in this sector. We are committed to learning the right lessons from this episode and will work to prevent events like these from happening again,” Powell said.

Still, regional and community banks face financial pressures if they lose significant deposits and capital reserves to bigger banks and face tighter lending rules.

That could reduce real estate lending and investing — especially in smaller markets. Regional and community banks make up 70% to 80% of commercial real estate lending, according to Moody’s Analytics.

John Baen, a professor or real estate at the University of North Texas’s business school, said economic components such as banking and real estate are due for a “toilet flush”.

That could be as unpleasant as it sounds.

“I think there will be 30% fewer regional and smaller banks in five years,” Baen said. “I think there will be mergers, etc.”

In the aftermath of February’s bank failures, President Joe Biden called for increased banking regulations and prohibitions on bank executives holding new jobs after big failures. Democrats want to see increased banking regulations after the troubles blaming rollbacks on rules during the Trump administration. New regulations and higher interest rates could cut into lending capabilities — especially for smaller community and regional banks.

Those local institutions tend to make more of the small business and real estate loans in mid-sized and smaller markets.

Commercial and multifamily real estate landlords and investment groups with short-term loans that previously took advantage of lower interest rates have tough situations and decisions on the horizon when they need to refinance.

“They are going to hand them back,” Baen said of landlords and real estate investment trusts potentially defaulting on commercial loans and giving “the keys’ to properties back to lenders. “We don’t call them foreclosures. They are asset reallocations.”

The Texas-based real estate expert, who is also a real estate broker, said turbulent ripples in real estate will be felt throughout the broader economy.

Baen said as much as 50% of the U.S. economy is tied into real estate and construction, and 50% of the world’s wealth is stored in real estate assets.

He said consumers are getting smacked by inflation and now higher interest rates that drive up the costs of mortgages, car financing and other expenditures.

“Consumers are living on credit and negative savings. Balances are skyrocketing,” Baen said in a market analysis report last month before a Texas economic development group.

Nashville-based investment firm AllianceBernstein said office space — which has been impacted by pandemic work-at-home trends and expectations from workers and more recently big layoffs by technology and e-commerce firms including Amazon.com and Microsoft — is a top concern.

The investment firm is concerned about the banking situation and its impacts on commercial real estate markets.

“Recent turmoil in the banking industry has renewed concerns that the crosswinds buffeting commercial real estate could turn into headwinds. Of particular concern are midsized and regional banks, which purchase commercial mortgage-backed securities (CMBS) and are active commercial real estate lenders. A pullback in lending by regional banks could create a credit crunch that would have a negative impact on real estate valuations,” AllianceBernstein analysts write an April 28 outlook report.

Stanley Longhofer, professor and chair of real estate and finance at Wichita State University’s Center for Real Estate, said interest rate hikes by the Fed are having a “dramatic impact on commercial real estate going forward.”

He hopes the Fed eases up on interest rate hikes as more expensive lending costs exact their own economic toll in the inflation fight.

Longhofer said the higher rates puts pressure not only on real estate lending but pushes investors and big capital players away from real estate into financial securities and other investment options.

“There is softening demand for those real estate assets,” he said.

Longhofer and other real estate industry experts expect to see ‘a flight to quality’ mentality among investors. That could see capital focus on established, larger markets potentially at the expense of smaller and outlying areas.

He also warns against big national brushes predicting real estate and banking trajectories.

“There is no such thing as a national real estate market. Every market is local and has a very unique situation within it,” he said.