Uncertainty is the enemy of business, and we certainly face uncertain, unpredictable times…
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.
Factors influencing the current economy
Covid 19, the Delta and other variants, and now the highly contagious variant of Omicron, have caused millions of workers to choose to work from home or not work at all. This has created a severe supply and distribution chain disruption and the threat of a substantial new round of tariffs, embargoes and other economic sanctions depending on the political climate. And there is an imminent threat of high inflation. On the positive side, the stock market and the economy as a whole are operating at a solid and positive pace.
Will these factors eventually cause the predicted troubled economy?
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 delinquent loans if they could do so without significantly harming the book value of the loan relative to the bank’s capital requirements. The current attitude of regulators has allowed banks to do just that.
Although regulators have a definite positive effect on the economy, at some point they will realize that the effect of their actions will cause banks to have misleading financial statements. This will most likely create substantial losses, which will not be recognized as defaulted loans are not written down to their true value, had they been filed.
The laissez-fair attitude of regulators is unlikely to change before the midterm elections later this year. But at some point they will have to stop allowing banks to avoid ranking loans. Otherwise, they risk allowing the banking system to misrepresent the value of its loan assets even more, with all the risks of this affecting the credibility and stability of the system.
When banking regulators change their stance on their treatment of defaulted loans, the predicted tsunami of foreclosures and bankruptcies will be upon us..
Additional factors to watch out for
Interest rates have always had a substantial impact on the economy, particularly in 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 exceed 6%. The Fed has already announced its intention to contain inflation by raising interest rates. The question is not whether interest rates will rise. Rather, it is about how much and when rates will rise.
…the country is experiencing a real shift in the way Americans think about work.
Coupled with rising interest rates, the country is experiencing a real shift in the way Americans view work. Projections indicate that approximately 23% of employees in mid-level and senior 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 landlords’ ability to keep commercial space rented.
Major changes in the way people work will mean gains and losses. Time will tell how that plays out, but it certainly looks like the economy will be disrupted.
A close corollary of changing work attitudes is the disruption of the country’s supply and distribution system. Although the current distribution problems have many reasons, the lack of necessary employees, especially truckers, is certainly part of the problem.
The lack of ships needed to produce new cars will almost certainly negatively impact the automotive industry in 2022. Similar examples exist in many sectors of the economy.
The re-emergence of Covid cases in the form of the Omicron variant has all but destroyed society’s timeline for returning to normal. This is not a reliable way to predict the effect of the re-emergence of Covid on the country’s psyche. It is, however, foreseeable that the re-emergence will have a negative impact on the money 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 brick-and-mortar 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. It is unclear how federal, state and local governments will react to the situation.
Uncertainty is the enemy of business, and we certainly face uncertain and unpredictable times.
There is the uncertainty of the general public perception that we cannot trust politicians, the media, and perhaps even doctors and healthcare workers. All of these factors will combine to create a perfect storm for businesses and real estate investors to experience an increase in distressed assets.
The best advice we can offer is for entities to deal with their distressed assets early on. The earlier the intervention, the more likely it is that Chapter 11 bankruptcy can be avoided. This not only saves companies from coming out of bankruptcy, but also keeps employees in their jobs.
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William (Bill) Lobel Bill Lobel is a bankruptcy attorney best known for his more than 30 years of experience helping financially distressed real estate and business owners avoid or successfully emerge from Chapter 11.
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