After the September 2008 Lehman Brothers bankruptcy triggered the Great Economic Recession, Charles Prince, the former head of Citibank, was asked why his bank kept lending on the eve of the worst economic recession in the postwar period. He replied, “As long as the music is playing, you have to get up and dance.”

Fast forward to today, we have to wonder whether financial markets are dancing on the eve of another financial market crisis that could trigger a meaningful economic recession. This time, the trigger might be a full-blown regional bank crisis caused by the lethal combination of high interest rates and a wave of commercial property loan defaults.

The importance of the regional banks for the U.S. economy cannot be overstated. According to Goldman Sachs, banks with less than $250 billion in assets originate half of the loans made to businesses and corporations for capital expenditures. These smaller banks also account for 60% of all U.S. mortgages, 80% of all commercial real estate loans, and 45% of all consumer loans.

The last thing a slowing economy needs is a credit crunch in the regional bank sector. Unfortunately, it is difficult to see how such a crunch can be avoided, given the sharp spike in long-dated Treasury bond yields and the troubles in the commercial real estate sector.

The regional banks, along with the rest of the banking system, have taken a significant hit from a decline in the value of their bond portfolios due to the spike in Treasury bond rates.

With such significant losses on their bond portfolios, anyone doubting that the regional banks have a solvency problem need only reflect on the heavy exposure of those banks to commercial real estate loans. That exposure is estimated at 18% of those banks’ loan portfolios.

Property developers are widely expected to have serious trouble rolling over the $500 billion in loans that mature over the next year. They will do so due to the combination of low-occupancy rates in a post-COVID world and the higher interest rates they will now have to pay on their loans.

This means that the regional banks will soon be in real trouble when property developers start defaulting in a big way. The loan write-offs they will be forced to do will compound the problems that high interest rates are already causing to their profitability and balance sheets. When that occurs, those banks will be forced to cut back on their lending faster than they are already doing. That could be especially damaging to the prospects for small- and medium-size businesses that account for 45% of our country’s economic activity and employment.

In 2008, the Federal Reserve was caught flat-footed by the Lehman bankruptcy despite many indications that should have been informing it that a financial crisis was brewing. It will be inexcusable if, once again, the Fed misses the clues of another such crisis, especially after the failures of First Republic Bank and Silicon Valley Bank, the second- and third-largest U.S. bank failures on record.

Desmond Lachman is a senior fellow at the American Enterprise Institute/InsideSources