The Year the Earth Stood Still

Shutting Down a Global Economy

by  Agent d’Amore

“Tired, wired, expired”—this recent joke describes some aspects of the current environment:

tired—you scolding your kids to be quiet while you are on a call for work from home,

wired—your kids scolding you to be quiet while they attend class via Zoom,

expired—going to an office to do work.

How has COVID-19, the corona virus disease, impacted the US economy?   Are we seeing the death of physical retail?   If so, what are the financial impacts?

Let’s look at some of the types of activities that have been impacted by the COVID-19 virus pandemic and related “stay at home” orders in various sectors:

airline travel—down 95%;

hotel business—down 80-95%;

the cruise industry—dare we say, down 100%?;

retail—businesses around the country having been ordered by governments to close, so maybe down 80% for brick and mortar;

car insurance—10-20% discounts offered, as no one is driving much;

crude oil—a 33% drop in demand, while supply went up, thus causing a 50-70% drop in crude prices (some prices having dropped even lower);

auto sales—not deemed essential, so stores having closed in most places.

And in various other parts of the economy:

Large segments of the food production systems were focused on commercial food service (restaurants, institutions, etc.), and there are vast amounts of food that are being plowed under or destroyed (e.g., potatoes for McDonald’s french fries, vegetables destined for restaurants, etc.), because it is too expensive and complicated to repackage them for retail use.

The COVID-19 breakout in a pork-processing facility completely shut it down, and the entire facility will need to be decontaminated and retrofitted to allow social distancing and a safe working environment.

Unemployment filings had reached more than 25,000,000 by a week ago.   We’ll see soon what the rate of growth of unemployment will become.

Brick-and-mortar retail is not necessary in a “lockdown” scenario, as online shopping and delivery seems to be able to meet the needs of consumers for essential items as well as some non-essentials.   Restaurants are stripped down to the kitchen and prepared-food deliveries like Doordash and Uber Eats are way up.   If the needs of consumers are being met without temples of consumerism for them to visit, then what is the economic sense of these malls, strip malls, restaurants, etc.?

The result of several months of either “lockdown” or consumer hesitancy to mingle socially at such venues could be to drive consumers away permanently from shopping centers.   So it seems that brick and mortar could likely be dead, including malls, restaurants, bars, movie theaters, small stores (anything mom-and-pop) like nail salons, barbers, etc.   The survivors might only be large stores that are considered essential, such as grocery stores, wholesale clubs (Costco, Sam’s Club), or any other stripped-down, value-oriented locations.   (Will we soon be driving up to Amazon warehouse facilities for curbside pickup?)

Office space has been proven to not be as desirable as thought just four months ago.   What is the value of a midtown, high-rise office building when no one wants to go to work in one?   If everyone who could possibly work from home has been forced to do so—and has finally worked out the kinks with internet connections, VPN, Zoom meetings, etc.—will we make them throw those investments in time, money, equipment, and effort out the window?   I don’t think so, mostly because we will need to maintain all of that in case there is a second wave of corona virus or some other disaster that could befall our society (does climate change sound familiar, anyone?).

A related new factor that has been little thought of is the threat of Legionnaires’ disease (a bacterial infection).   This is now a concern for all these office buildings where the occupancy in the past weeks has been extremely low.   It will likely require a huge effort and expense to re-open such buildings. [*2]   Essentially, the buildings left at or near empty for even a few weeks have an increased risk of Legionnaires’-disease bacteria flourishing in the stagnant (or relatively stagnant) water in the buildings’s water infrastructure.   This is just one unanticipated hurdle to “getting things going”.

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The ingrained view and assumptions of the “old world” may take some time to change, as three months of “lockdown” may not be enough to change behavior.   The length of “lockdown”—either government-ordered or self-imposed due to fear of pandemic disease—must be longer than the cash reserves of multiple players in the economy.   Do most businesses have a six-month buffer of cash to cover operating expenses?   If not, then that may be a reasonable timeframe in which to expect the consequences of these changes to take effect.   Similarly, most families do not have six months’ worth of liquid savings to see them through unemployment or layoff.   Six months from now is just about the beginning of the fall flu season, when another wave of corona virus can be expected to return.

Once the benefits of the new ways of working, schooling, shopping, and socializing have become normalized, then the old ways will perhaps seem less attractive, or at least take on a patina of “outdatedness”.

What is happening with the housing finance system?   Most houses and apartments are purchased with borrowed money.   Are there negative implications if the housing cash flow from mortgage payments stops?   Nearly a third of US tenants didn’t pay their rent in the first week of this month. [*3]

And what is the “kill chain” (the chain of causative events) associated with refusal to pay rent?   There’s a cascade effect sparked by skipping rent payments. [*1]   These steps are a rough guide to what happens when payments are missed (generally used reasons may include: I don’t have the money; I need the money for food or for other things; or the state government has said I don’t have to pay for 90 days):

1.   The tenant doesn’t pay the rent—with 26,000,000+ people currently having become unemployed just since February, it is not surprising that these people may have trouble paying their rent.   There have been some orders in certain states that have prohibited evictions for three months.   While this helps, it doesn’t pay the rent for anyone, and it just seems to postpone the inevitable.

2.   The tenant doesn’t pay, so the landlord can’t pay the mortgage—if you as a landlord don’t have multiple months’ reserve of expenses, you may be forced to postpone or avoid your mortgage payment on your rental property.   (We’ll assume here that the rental property is not the landlord’s primary residence.)   If the landlord owns the building outright, the cash flow impact may only impact maintenance of rental properties.

3.   Or a homeowner can’t or won’t pay the mortgage—the downstream impact is again on the holder of the mortgage.

4.   The mortgagor (the holder of the mortage) may be forced to write down the value of the loan once the payments fall three months behind, possibly starting foreclosure.   This will have a further downward impact, as the loan will not likely be as valuable as before, and the property value may also go down due to the eviction/foreclosure moratorium (no way to clear the problem).

5.   This lack of payments means cash flow declines for any direct mortgage holder or any mortgage-backed security which contains the problematic loan.   If a bank owns the mortgage, then the value of the loan may be written down or written off, which means the bank balance sheet comes under stress.   This is the kind of stress that bank balance sheets came under, which led to the enormous bank bailout during the 2008 sub-prime mortgage debacle.

6.   If the mortgage in question is part of a securitized loan—a mortgage-backed security (a bond consisting of many mortgages)—when the mortgage servicer ends up not paying expected cash flow payments to the bond holders, the value of the security drops in value, as in the 2008 crisis.

The ultimate endgame arising from the 2008 crisis was that there were many properties foreclosed on and many people lost their places to live (in today’s scenario: their shelter-in-place facilities), and the foreclosed real estate (mostly single-family homes, but also some smaller apartment complexes) was largely bought up by large, cash-rich hedge funds.   The properties were then turned into rentals at high rates or sold off at a profit.

The loss of homes by many families and the conversion to high-priced rental properties seemed to decrease the affordable housing supply for many people.   We could have a similar outcome this time, replete with bank risk and bailouts and other subsidies to the financial elites in this country again.   The additional impact that we of course did not experience in the 2008 mortgage crisis would be the lack of housing that would directly impact the ability of the unemployed to deal with the current ongoing pandemic.

If we look at the oil market, the airline companies, and many other indicators, such as company profits and missed rental and mortgage payments, as well as the swelling rolls of the unemployed, it is fair to say that the world economy has been rapidly coming to a standstill.

Will we be able to “get things moving” again?   What mechanisms might be available to us as a global civilization to restart a stopped economy?   Have we seen enough, even just in recent decades, to be convinced that the structures of the old economy that is quickly being brought to a halt have been far too fragile?   And if so, are we capable of devising stonger structures that can more securely provide for the needs of our civilization and society?   ( More to come on this. )

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