US: Is rising loan default harbinger of real estate crisis?

Omkar Patil

The US economy is facing significant trouble, much like the 2008 crisis, with rising loan defaults a major concern. After the 2008 crash, Ben Bernanke introduced measures to boost the economy by injecting money through low Federal Reserve (Fed) rates and stimulus packages. However, this led to risky lending practices and higher loan defaults. From 2000 to 2004, US debt increased steadily, and subprime loans became common. Fed rates rose from 0.95% in 2004 to 5.25% in 2006, which caused loan defaults to spike. Despite these issues, low-interest rates continued after 2008, with public debt growing rapidly. Today, the economic situation is dire, with Fed rates now higher than during the 2008 crisis. Loan defaults have increased significantly since the COVID-19 period, despite $11 trillion being pumped into the economy from 2019 to 2023. While GDP saw a temporary spike in 2021, it has not held up after rate hikes, and unemployment remains high. Investors are cautious, with small-cap stocks underperforming compared to large-cap stocks, indicating risk aversion. The US Treasury Bond yield curve has inverted, showing a preference for long-term bonds due to high default rates, interest hikes, and unemployment. The stock market is highly overvalued, with the Dow Jones' current price-to-earnings ratio at 31.29, about 60% above its five-year average of 19.58. This overvaluation, combined with changing investor sentiment, suggests a potential market crash of up to 45%. In conclusion, the combination of rising loan defaults, high Fed rates, unemployment, and an overvalued stock market signals an impending economic downturn. Investors should be cautious, as both raising and lowering rates could worsen the situation. The rising loan default rate is a critical sign of financial instability that needs close monitoring.

(The writer is student, TA Pai Management Institute)