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Reopening – a dream for some, a rude awakening for others

The long-anticipated reopening has begun – aggressively in some states, more gradually in others. While it has certainly electrified the stock market and thrilled many business owners, the reopening has economic repercussions that are somewhat lost behind heated discussions on voting, social distancing, and a second wave of infections. By summer’s end, (1) most bans on evictions and foreclosures will expire, (2) COVID-related unemployment benefits will be phased out, (3) borrowers will have to resume payments on loan deferrals they opted into at the outset of the crisis, and (4) the minimum 8-week period to maintain staff levels on PPP loans will have ended and business owners will be able to conduct layoffs without fear of not qualifying for loan forgiveness. All this while the unemployment rate is expected to remain above 10% throughout the rest of the year.

Evictions have resumed in some states and are about to resume in most of the others

To limit the fallout from the unprecedented crisis, the Federal government together with Freddie Mac, Fannie Mae, and many big banks placed a temporary moratorium on all foreclosures. All but six states have implemented some types of bans on evictions and utility shut-offs. As states begin to lift emergency status, evictions are set to resume. By the end of June, restrictions on evictions and foreclosures will have expired in most states.

Phasing out of COVID-related unemployment benefits

An unprecedented $2 trillion economic stimulus package (CARES Act) was put into motion at the end of March. Enhanced unemployment insurance, one-time cash payments, and Paycheck Protection Programs were all targeted at helping individuals in need. Most are likely to expire by the end of July while high unemployment rates are expected to persist throughout the end of the year. As states gradually lift restrictions and try to restart local economies businesses struggle to adjust to the new reality. Thinner or nonexistent profit margins from operating under social distancing guidelines, decimated consumer demand, and disrupted supply chains are only a few of the obstacles businesses will have to overcome before welcoming all their employees back. Some jobs will be lost forever. May saw the largest number of bankruptcies by large corporations ($50MM+ in liabilities) since 2009, according to Bloomberg. The travel, tourism, and hospitality sectors will need years to recover. The phasing out of COVID unemployment benefits at a time of persistently high unemployment rate and uncertainty around a potential second wave of infections later this year will prove to be a considerable hardship for many.

Loan deferrals and forbearances

Once the CARES Act became a reality in March, many distressed borrowers put their mortgage, credit card, or car loan payments on hold. As of May, about 10% of all mortgages were in forbearance, a type of relief where borrowers can suspend payments for up to 12 months. Propped up by the staggering financial stimulus package, roughly one in four still opted to make scheduled payments in May. The rest will have to deal with the harsh reality at the end of the forbearance period – make a lump sum of the missed payments or work with their lender towards some type of loan modification.

Payments on other loans – credit cards, auto, and personal loans – can be paused for up to 3 months. Those 3 months will expire in June for the earliest opt-ins so the first payments will have to be made in July around the same time that most COVID-related assistance will have expired.

Paycheck Protection Program (PPP) Loans

PPP loans were a lifeline for many businesses as a state of emergency was declared across the country. While they are technically loans, if businesses meet certain requirements they can be partially or fully forgiven. One such requirement is that employers maintain pre-COVID staff levels, unchanged, for 8 weeks (they have until June 30th to re-hire). Additional requirements also apply. Many businesses who took PPP loans will have tough choices to make at the end of the 8-week period. Maintaining the same level of employment will simply be untenable for many of them and once they’ve met the PPP forgiveness requirement they may still decide to resort to layoffs.

Layoffs and furloughs in the public sector

Many state and local governments will be soon left with huge holes in their budgets due to drops in tax payments and other revenues. Some have already launched substantial cost-cutting measures but as the end of the fiscal year looms many public employees will likely be furloughed or laid off.

In summary, economic conditions in the second half of 2020 may become a perfect storm and bring unparalleled hardship to many. Persistently high unemployment rate, imminent layoffs in both the public and the private sectors, and possibly a second wave of infections at a time when COVID-related protections and benefits have ended will combine to put tremendous pressure on households and lead to further erosion in consumer confidence.

Economic Contagion or The Case for a Prolonged Recession

In February we were still enjoying the longest economic expansion in US history, yet, that now feels like an eternity ago. As of the second quarter of this year, there is no doubt in anybody’s mind that the US economy is in a recession. Treasury Secretary Mnuchin recently said that he expected it to last months rather than years, but economists are more cautious – forecasts call for a V, a U, a W, or even an L shaped recovery.

The ‘re-opening’ of the economy, sadly, will not be like flipping an on/off switch which smoothly takes things from 0% to a 100% in an instant. There is a very strong argument to be made about the contagious nature of economic weakness.

The first and most immediate effect is unemployment.
The number of initial claims for unemployment benefits have shot up so high that the scales on analysts’ charts have had to be adjusted. While some of those folks will go back to work as soon as it becomes safe to do so (PPE, regular temperature checks, modified work space) for others that will not be an option. Big chains, such as J Crew, Neiman Marcus, have started filing for bankruptcy, mostly in the retail and traveling/hospitality industries. Those jobs will not be coming back. Other companies will function for an extended (and uncertain) period of time under diminished capacity – social distancing, eroded demand, disruptions in supply chains or some combination thereof.

Secondary effects will be more subtle – eroded consumer confidence.
For those who have already lost income, or believe they are about to, the impact on spending patterns is immediate. However, even for families with stable income the decision to buy that new car or to replace the TV with a more recent model is not going to be as easy as it was a few months ago. That wide-spread and indiscriminate contraction in demand will bring a second wave of hardship for companies which so far have been unaffected – real estate, construction, manufacturing, etc.

Lastly, a longer-term effect will be a reduction in credit availability.
The current unprecedented measures allow vulnerable consumers to keep their house and continue using their credit cards and forgo the monthly payments with no negative repercussions. No doubt, this is the right thing to do. However, the consequences down the road will be significant.

The most immediate impact is that banks and lending companies have already started tightening their lending criteria. Someone who may have been ‘bombarded’ with credit card solicitations in the past may not be as easily approved for one now. Even when approved, things like balance transfer offers will not be as readily available and credit lines will not be as generous. This will be especially true for those who may need credit the most – consumers with mortgage in forbearance or ‘frozen’ credit card payments.

Lending criteria tightening is a response not only to the current deterioration and down-turn in business cycle, but also in anticipation of a future wave of defaults expected when the ‘payment freezes’ expire. Under business-as-usual conditions companies have a wide array of options to help distressed customers. Now, because of the unusual circumstances, they will not be able to do that. What this means is that at some point in the future, there will be a tsunami of customers who will have accrued levels of debt that will preclude them from many remediation options. That will be especially hard on those who may be forced into having to sell their house as the market will have turned and it would have lost much of its value.

Corporate debt will also be impacted. Companies experiencing financial strain are already actively trying to restructure their obligations to banks. A likely outcome in some instances will be re-negotiated covenants where banks include guarantees in the form of claims on revenues and/or cost cutting. That, in turn, will severely limit the ability of borrowers to keep their payrolls unaffected.

The aggregate effect of these compounding factors could export distress into otherwise unaffected parts of the economy, mediated through a severe contraction in consumer demand, and deepen a recession that will linger for years. Unless, of course, a COVID-19 treatment and/or vaccine become a reality in the very near future and can be rapidly scaled into mass production.