A wave of bankruptcies and foreclosures seems to be developing
Economists and professionals in the corporate restructuring and real estate sector have been anticipating a struggling economy for 18 months. So far they have been wrong.
The public is simply confused. Many people today don’t trust their politicians, their sources of information, and surprisingly not even their health care providers and professionals. This lack of trust, coupled with the pandemic-enforced way many employees are working remotely, has caused many people to reassess their lives and where they are willing to provide their services from.
Many employees in mid- and upper-level jobs will choose to work permanently remotely and never return to the office. This change in the way people will work in the future will have a profound effect on many aspects of our economy, including the ability of landlords to keep commercial space rented.
Factors influencing the current economy
COVID-19, the Delta, Omicron and now the highly contagious BA.2 variants have rendered millions of workers unavailable for work, remote or otherwise. This created a serious disruption in the supply and distribution chain. This problem is partly due to manufacturers being unable to supply components due to work disruptions at factories. Add to this shortage of supply the fact that the disruption of personnel in the transport and delivery of products caused by COVID (i.e. the shortage of truck drivers) and we can clearly see the full picture. supply chain disruption.
The threat of a substantial new round of tariffs, embargoes, and other economic sanctions based on the political climate creates new risks of the United States becoming a struggling economy. In addition, the threat of high inflation is imminent. On the positive side, until recently the stock market and the economy as a whole were generally operating at a solid and positive pace. The stock market doesn’t always accurately represent what’s really going on in the economy, but recent market volatility can be a harbinger of troubled times.
Will the accumulation of these factors ultimately cause the ailing economy predicted? No one knows for sure, but in analyzing the situation, it may be instructive to look at the issues that prevented the expected downturn.
Banks and banking services
Since the start of the pandemic, regulators have not pressured banks to take action on defaulted loans. Historically, banks have been willing to “get off the road” on defaulted loans if they could do so without significantly harming the book value of loans relative to banks’ capital requirements. Current regulatory attitudes have allowed banks to do just that.
Although regulators’ laissez-faire attitude has had a definite positive short-term effect on the economy, at some point regulators know that the effect of their actions will lead to banks having misleading financial statements.
Regulator behavior is unlikely to change before the midterm elections later this year. At some point, however, they will have to stop allowing banks to avoid ranking loans. Otherwise, they risk allowing the banking system to continue to misrepresent the value of its loan assets, with all the risks of this affecting the credibility and stability of the banking system.
My view is that when banking regulators change their stance on their treatment of defaulted loans, an anticipated tsunami of foreclosures and bankruptcies will be upon us..
Additional factors to watch out for
Interest rates have historically had a substantial impact on the economy, particularly on the real estate sector.
The Feds kept interest rates near zero to support the economy. Now, however, the specter of high inflation will almost certainly put an end to near-zero interest rates. Annual inflation in 2022 is expected to be close to 7%. The Fed has already announced its intention to fight inflation by raising interest rates from March. The question is not whether interest rates will rise. It’s more by how much and when.
Rising interest rates hurt individuals in several ways:
- The most obvious is that they make housing less affordable. As interest rates rise, fewer and fewer people will be eligible to buy their own homes. Current homeowners with variable rate mortgages will also be negatively affected by interest rate increases.
- Rising interest rates also have a negative impact on corporate profits. This will impact the stock market, and therefore the value of shares in individual IRAs and 401(k)s.
- Major changes in the way people work will mean winners and losers. Time will tell how that plays out, but it certainly looks like the economy will be disrupted.
Pressures on businesses are piling up
The re-emergence of COVID in the form of the current variants has all but destroyed society’s timeline for returning to normal. There is no reliable way to predict the effect of this re-emergence on the country’s psyche. However, it is foreseeable that this re-emergence will have a negative impact on the economy and further delay the return to normal.
In fact, it is likely that normalcy as it existed before the pandemic will never fully return. Trends such as the shift of consumers shopping primarily online will have a negative effect on physical retail sales. The need for retail space looks set to continue to decline even more than it has already. This problem has been accelerated by the pandemic.
Shopping center and retail property owners are bracing for the wave of vacancies that is sure to be on the horizon. Individuals would be well advised to assume that inflation and higher interest rates are on the near horizon and should act in any way possible to mitigate the damage from the impending dual threat. It is unclear how federal, state and local governments will react to the situation.
Uncertainty is the enemy of business, and it’s clear that we face uncertain and unpredictable times. The general perception of all this by the public remains to be seen. There is a lot of distrust among the people of our nation. These factors will combine to create a perfect storm for businesses and real estate investors to experience increasingly difficult financial times.
Steps to consider
The best advice we can offer is for entities to deal with their distressed assets early on.
- For owners, interest rates will almost certainly rise in the near future. If a homeowner can refinance their mortgage to take advantage of today’s low interest rates, this course of action should be considered.
- For consumers, accelerating the timing of any major purchase will make sense since impending inflation will cause the dollar to be worth less and less and make the effective cost of an item more expensive over time.
- Individuals should also consider exiting the stock market or minimizing their stock portfolios as soon as possible. Converting stocks to cash is not a good strategy in times when the value of the dollar keeps falling. Conventional wisdom holds that investing in precious metals, such as gold and silver, is a safe haven. So selling stocks and buying gold and silver makes sense.
- business owners should analyze their business based on the assumption that the near future will bring high inflation, high interest rates and continued supply chain disruption. It is prudent to take steps to restructure the business in a way that mitigates the damage if these future assumptions come to pass.
The general public will be alert to inflation and rising interest rates and react accordingly. The sooner people and businesses accept and respond to these changes, and respond appropriately, the more likely Chapter 11 bankruptcies can be avoided. This not only increases the chances that companies can solve their financial problems without resorting to bankruptcy, but often reduces the need for layoffs.
Founder and Chairman, Distressed Capital Resources LLP
William N. Lobel is the founder and president of Distressed Capital Resources LLCa company that has brought together virtually every resource available to assist borrowers with financially distressed real estate or businesses, with the goal of maximizing a borrower’s leverage and options to successfully resolve financial problems of this borrower.