Still Waiting for the Other Shoe to Drop

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Uncertainty is the enemy of business, and it is certain that we are facing uncertain, unpredictable times...

Economists and professionals in the restructuring sector of business and real estate have been anticipating a distressed economy for the past 18 months. Thus far they have been wrong.

Factors Influencing the Current Economy

Covid 19, the Delta and other variants, and now the highly contagious Omicron variant, have caused millions of workers to choose to work from home or to not work at all. This has created a serious supply and distribution chain disruption, and the threat of a substantial new round of tariffs, embargoes, and other economic sanctions based on the political climate. And there is a looming threat of high inflation. On the positive side, the stock market and the overall economy are clicking along at a solid and positive pace.

Will these factors ultimately cause the predicted distressed economy?

No one knows for sure, but in analyzing the situation it may be instructive to look at the issues that have prevented the anticipated downturn.

Banks and Banking

Since the pandemic began, regulators have not been pressuring banks to take action with respect to defaulted loans. Historically, banks have been willing to “kick the can down the road” with respect to defaulted loans if they could do so without significantly impairing the accounting value of the loan with respect to the bank’s capital requirements. The current attitude of the regulators has allowed the banks to do just this.

While the 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 in turn will most likely create substantial losses, not being recognized as a result of defaulted loans not being written down to their true value, if they had been classified.

It is not likely that the regulators’ lassiez-fair attitude will change before the mid-term elections later this year. But at some point, they will have to stop allowing banks to avoid classifying loans. Otherwise, they risk allowing the banking system to mispresent the value of its loan assets to an even great degree with all of the risks of that situation impacting the creditability and stability of the system.

When the bank regulators change their position with respect to their treatment of defaulted loans the anticipated tsunami of real estate foreclosures and bankruptcies will be upon us.

Additional Factors to Watch

Interest rates have historically had a substantial impact on the economy, especially in the real estate sector.

The Feds have kept interest rates at almost zero to support the economy. Now, however, the specter of high inflation will almost certainly bring an end to near-zero interest rates. Annual inflation during 2022 is projected to be in excess of 6%. The Fed has already announced its intention to rein in inflation by raising interest rates. The issue is not whether interest rates will rise. Rather, it is by how much and when the rates will increase.

...the country is experiencing a real shift in the way Americans view work.

Coupled with rising interest rates, the country is experiencing a real shift in the way Americans view work. Projections state that about 23% of employees holding mid and upper-level jobs will opt to permanently work remotely and never return to the office. This shift in the way people will work in the future will have a profound effect on the ability of landlords to keep commercial space leased.

Major shifts in the way people work will result in wins and losses. Time will tell how this will play out, but it is certainly looking like the economy will be disrupted.

A close corollary to the change in work attitudes is the disruption in the country’s supply and distribution system. While there are many reasons for the current distribution issues, a lack of necessary employees, specifically truck drivers, is certainly part of the problem.

The lack of ships necessary to produce new cars will almost certainly negatively impact the auto industry in 2022. Similar examples exist in many sectors of the economy.

The re-emergence of the Covid cases in the form of the Omicron variant has all but destroyed the timetable for society’s return to normalcy. This is no reliable way to predict the effect of the re-emergence of Covid on the psyche of the country. It is predictable, however, that the re-emergence will negatively impact the money, and will further delay a return to normalcy.

In fact, it is likely that normalcy, as it existed pre-pandemic, will never fully return. Trends like the shift of consumers primarily conducting their shopping online will have a negative effect on brick-and-mortar retail sales. The need for retail space seems poised to continue to decline even more than it has already. This problem has been accelerated by the pandemic.

Owners of shopping centers and commercial buildings are girding for the rash of vacancies that are most assuredly on the horizon. It is uncertain how the federal, state, and local governments will react to the situation.

Uncertainty is the enemy of business, and it is certain that we are facing uncertain, unpredictable times.

There is the uncertainty of the public’s general perception that we cannot trust politicians, news outlets, and perhaps even doctors and healthcare workers. All of these factors will combine to create a perfect storm for companies and real estate investors to experience increasing distressed assets.

The best advice we can offer is for entities to deal with their distressed assets early on. The earlier the intervention occurs the more likely it is that chapter 11 bankruptcy can be avoided. This not only saves companies from working out of bankruptcy but also keeps employees in their jobs.

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William (Bill) Lobel Bill Lobel is a bankruptcy lawyer best known for his 30-plus years of experience helping owners of real estate and businesses in financial distress avoid or successfully emerge from chapter 11.

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