Let’s start with a fact we can all agree on. NO ONE KNOWS HOW THIS WILL TURN OUT. We are in an unprecedented situation and economies do not follow the laws of physics. We cannot put data in a model and get a useful output. The range of potential outcomes is extraordinarily wide.
So how to decide what to do in our businesses? What decisions do we make now? Accept that you are unlikely to get this perfectly right. Ask yourself, what are the probable outcomes for your company in various scenarios when combined with your potential actions? Which outcomes are unacceptable to you? This line of thinking is sometimes referred to as minimax regret analysis.
What do we know to start the analysis?
- We have NEVER experienced job loss of this magnitude and velocity. We are likely headed to having Great Depression levels of unemployment within 60 days (it took three years to do that in the Depression).
- We have NEVER shut down an economy on purpose before. And there is no plan yet on how it will be restarted. It’s not a switch you can throw and just turn back on. It is highly likely to recover in fits and starts whether due to differences of opinions in various states and cities as to what is appropriate, additional outbreaks, supply chain disruptions, etc.
- Politicians feel under pressure to follow medical communities lead. Whatever your opinion of this, when will damage to economy overwhelm desire to stay “closed” until we are “sure”?
- How will consumer psychology be impacted? Wealth effect? Fear? More likely to want a S-F home in suburbs to shelter in place, or job insecurity leads to more rental demand?
- It is not true, as we are hearing in some quarters, that the economy had no imbalances prior to our medical emergency. Corporate and Federal debt/deficits have skyrocketed this cycle and are at staggering highs–and about to go higher. Total debt in the world compared to economic output has doubled since 2007. The research seems clear that higher levels of government debt leads to lower growth (that does not mean the stimulus is a bad idea, it just has consequences). Coupled with the damage to both companies and consumers we’re experiencing, the suggestion that there is no reason we can’t have a rapid recovery does not seem credible, and certainly not likely.
- Humans are not good at absorbing anything that has not happened to them personally. During the Great Recession as I traveled around the country asking builders and developers what they were planning on, the answers were completely consistent in one way. Everyone related it to the worst thing they had experienced and added a little more time or downside to it to “be conservative”. It had nothing to do with analytics or anything else. Those who had experienced the oil patch collapse in Houston or the aerospace collapse in Southern California had far more negative views. Those whose history was after that, projected a much shorter and shallower downturn. We are experiencing something none of us can relate to. The numbers (20m-30m unemployed in less than a quarter????) are beyond comprehension. Don’t fall back on your past experience to project what will happen.
- Typically, housing markets regain strength after a recession when the total number of employed reach pre-recession levels. That may take a while.
- Did you really see how bad things would get early on in the subprime and financial crisis?
- The second order effects of this will take time to know. How many will lose their jobs due to lower consumer or business demand (as opposed to the immediate impact of businesses simply closed, like hospitality/restaurants)? Impacts on state and local government from falling sales and use taxes? Again, there is more happening here than most of us of can absorb.
- If the Federal Reserve pulled out the big guns for the Financial Crisis, they’ve gone to the nuclear option within weeks for this one. That has prevented complete collapse in financial markets.
- It’s harder to fix solvency problems than liquidity problems. The Fed can fix liquidity. It can’t make people solvent. The financial crisis was largely a liquidity/financial institution problem, with solvency of some home owners (and our industry) as a subset. This crisis is about solvency on a completely different scale.
- The US Government has approved its largest stimulus package ever. Great. But it’s easier to provide unemployment (or as currently, checks) to individuals than to prop up millions of small businesses. They are all different, with different problems. We’ve never done this before and anytime you take on a task you’ve never done before, there are problems (which are starting to get exposed). It does not mean we should not try. We just should not have excessive expectations for the level of success.
- What will be the impact on the US economy from other parts of the world that are not as aggressive with stimulus measures as the US. Whether from political paralysis like the EU, or countries without a “reserve” currency?
- The long-run offers many possibilities. Perhaps optimization of global supply chains will give way to an emphasis on resiliency (less profitable on average, but less prone to disruption) that benefits US manufacturing? Perhaps rising taxes to support a growing social safety net in reaction to the horrific dislocations we’re experiencing? Again, no one knows. But the short term is a very deep hole and the intermediate term, no matter what view you hold of the long run (or your view of the appropriateness of the reaction), is likely a difficult transition. Transitions usually are.
- There is a difference between having insufficient housing supply in the market to fuel a pricing catastrophe (possibly true) with having insufficient sales and closings that creates a cash flow catastrophe. Which is definitely possible. Liquidity is a bigger issue than leverage at the moment.
- It’s very hard for people, when analyzing a problem with multiple outcomes, to, in evaluating the likelihood of each possibility, separate themselves from the outcomes in coming to a conclusion. In plain English, if an outcome would produce a great deal of pain, you’re less likely to accept it as probable. Try to ask the question, if someone smart and capable replaced me tomorrow and they had no emotional attachment to past decisions or people, what would they do?
OK, what to do, if you believe we are in a situation without analog? Understand you can’t calculate the risks of this. Risk implies an understanding of the odds of various outcomes. You cannot effectively do that now. Uncertainty is the unknown/incalculable. That’s where we are, and when you’re in that position you do not attempt the impossible–calculating expected returns/utility. Determine the unacceptable outcomes and focus your plans and efforts on avoiding those.
To profit from distress, first you have to survive.