I’m not an economist, but my post paramedic career has been as a Building Contractor, software designer, and business consultant. I also hold a mortgage brokers license.
All of which does not make me an expert in macro-economics, it merely shows I can’t hold a job.
But I do have some experience in big business, particularly in residential and commercial construction. And I see a possible scenario, come a disruption from a pandemic (or other national disaster), that could greatly increase the impact of such a crisis.
Allow me to paint a scenario. Hypothetical, true. But one not out of the question.
Here in Florida, at any given time, there are scores of builders putting up spec houses (unsold). Some builders will construct 1,000 single family homes, and another 1,000 multi-family units a year. The average time of construction is about 5 months.
So let’s take a fictional construction company, Behemoth Homes Corp (BHC) , that has a half dozen subdivisions scattered across Florida. Today, PUD’s (planned unit developments) come with golf courses, retail shops, club houses, and often private water and sewer plants. They cost a lot of money to develop and maintain.
In order to create these subdivisions, the builder/developer submits a plan to a lending institution. They receive draws based on the percentage of completion of each phase of a development. Additionally, when a house is built, the builder submits (4 or 5) draws to the bank at various stages of completion to receive another chunk of money to continue the construction.
Now, for the part that most folks don’t know. Builders and lenders engage in a Kabuki dance of sorts, highly stylized and ritualistic. The builder is constantly trying to get ahead of the bank, so that they can pay their suppliers and subcontractors. The lenders are supposed to ensure that substantial work has been completed before releasing funds. But the lenders also understand that the builder has to get into their knickers a bit, else they run out of money, so they turn a blind eye. Often they will release monies for work that has not, in fact, been completed.
While all of this is going on, the subcontractors (roofers, plumbers, electricians) wait for THEIR money, and THEIR suppliers are waiting for the subcontractor to be paid. When I worked for a Fortune 500 Builder, my job was as the choreographer for this little musical comedy.
Hard to believe a mess like this works.
But it does, as long as the builder manages to sell houses at the same rate as they put them into the ground. The builder lives off of the cash flow from the bank draws, doles out the money as slowly as possible to the subs and suppliers, and prays the economy doesn’t tank. If you put 5 new houses in the ground today, you'd better hope you're selling 5 houses a day 5 months from now.
Now, let’s say a pandemic happens. Doesn’t have to be the worst case scenario, but bad enough to cause significant social isolation and worker absenteeism.
What happens?
First, the housing market will tank. People will not be going out looking at houses to buy during a pandemic.
Second, BHC will be caught will hundreds of milions of dollars worth of homes under construction, and will not have the workforce or the building materials to finish them.
Third, overhead continues for the builders. Interest on those hundreds of millions of dollars in construction loans pile up. Unpaid subcontractors (who had to borrow money to pay their workers and suppliers) will be hung out to dry. As will their suppliers and their employees.
Fourth, with work stopped, houses that are not dried in (shingled) will begin to suffer damage from the elements. Golf Courses cost hundreds of thousands of dollars a year to maintain, even if no one is using them. Fail to maintain them, and they revert to the wild. Very expensive to reclaim later.
Fifth, the lenders will find themselves suddenly out hundreds of millions in construction loans, and the builders will quickly default. Without the interest income, or the satisfaction of the construction loans when the houses sell, they are in deep trouble.
Sixth, large institutions (Insurance companies, pension funds, etc) routinely invest their money in the stock Market, and mutual funds, which supply the lenders and builders with funds to operate. Now they’re in trouble.
The ripple effect of even one large builder going down the tubes would send a chill thru the market. Multiply that times a thousand or more across the country, and this one industry would bring the stock market, the banking system, and our economy to it’s knees.
Were talking hundreds of billions of dollars, just in residential construction. By the time you follow all the ripples, we’re talking trillions.
But wait, there’s more.
Say the first wave passes after 12 weeks. The all clear is sounded. Can’t we just re-start things?
After 3 months, people may come out of isolation. Many will fear another wave (we’ve been warned) and so the mood of the public will be to hunker down, not to attempt to buy a new house or move.
Many potential buyers will have been out of work for 3 months, and are behind in their bills. They will be more concerned with stocking up and preparing for the next wave. Those who might have had good credit before the first wave, have probably lost their credit rating, and can no longer obtain a mortgage.
The CEO of the now failing BHC has to decide what to do. Assuming his lender would agree, he could begin to finish the 800 homes he has under construction, but that would only put him further in debt. He has an unsold inventory of maybe a hundred FINISHED homes. UNTIL THEY SELL, it would be madness to commit to finishing the others.
The building industry (which includes real estate, banking, material suppliers, subcontractors, insurance companies, ad nauseum) is at an impasse. A Morton’s Fork. Two options, both equally bad.
Go deeper in debt and finish the houses (tempting because it would generate cash flow), or try to wait it out until the buyers reappear. Which is worse?
But the CEO knows that it will take months before we know if another wave will come. He can’t simply increase his inventory to 900 unsold homes with no prospects of selling them.
What happens then is the builder goes under. The subcontractors go under. Their suppliers go under. And the lender goes under, taking with it the stock market, mutual fund investors, and institutional investors that have been funding the lender. It’s a cascade effect.
Now all of this is just one industry, albeit a big one. Add in retail sales. Restaurants. The staggering health care costs incurred during a pandemic. Losses due in the Insurance Industry. Infrastructure losses due to social unrest and lack of maintenence. The list goes on . . .
While the economy might handle a 3 month interruption, it is unlikely to be limted to that, even if there is only one wave. People will be waiting for the next shoe to drop. Even if it doesn’t, there will be a period of at least six months after the first wave where everyone will be expecting it.
If a second wave does occur, now we bump this `frozen’ economic outlook to extend a year or more.
Listen to TV ads for an hour, and you will undoubtedly hear a couple of ads for refinancing your home. It’s a big business. Bad credit? No problem. They’ll loan you up to 125% of the value of your home. They are playing the same game.
The average American has no savings to speak of, a big mortgage, and credit card debt of probably 10,000. These personal debts, during a time of massive work stoppages, will cause massive defaults.
The banks won’t want the properties, although existing homes will be more attractive to them than unfinished ones. They would simply be stuck with assets they can’t sell. They will, however, probably want to do paper foreclosures, in hopes they may survive long enough to liquidate these assets when things turn around.
We saw something akin to this scenario in Altanta in 1975. A large lender had 200 million dollars in construction loans out, when the market tanked. They ended up selling $150K homes for $50K, just to try to keep their cash flow alive. It didn’t work. They went under after 18 months. The only ones that make out were those with cash who bought the homes for 30 cents on the dollar.
These fire sales of homes also hurt the other builders and lenders in Altanta, because while still solvent, they couldn’t compete against prices like that.
Sorry for such a long post. I did restrain myself a bit. Could have written war and peace on this subject.
Bottom line, ANY long term interruption in the cash flow/credit system will have extreme effects on the economy, both here, and internationally. While I greatly fear the virus, and the health ramifications of a pandemic, what I truly fear are the financial ramifications they will bring.
While I’m hesitant to post this (I dislike presenting a problem without a solution), I think it is important that people understand just how fragile our economy is. How dependent everything is on things going forward without a major interruption.
While you may not grieve over the losses of the Behemoth Home Corp, or the Banks, or those heavily invested in the stock market: do not think that their misfortunes won’t affect you.
How all of this will shake out is anyone’s guess. Will the government decide to crank up the printing presses and try to hyper-inflate ourselves out of debt? Possible, and some people have suggested it, but that may just make matters worse.
Will the glut of goods (homes, real estate, consumer items) with damn few dollars chasing them drive prices and wages down after a pandemic? That’s possible too. You may well be able to buy your $250K dream home for $50K … if you have the cash.
If you wonder why we get mixed messages about a pandemic from our government, and the governments around the world, remember: This isn’t just a public health crisis.
A pandemic will affect us in ways few people have considered. But I guarantee you, those that ARE thinking about it are scared to death. While I’m not expecting a Mad-Max scenario, I can see a pandemic setting off a global depression that could last for years.
Of course, all of this is speculation. Maybe the Power That Be have it all figured out and we will have a soft landing. But right now, I don’t see one.
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