Ominous News As The Economy Re-Opens

Corporate decision making has begun to take an ominous turn. When the lockdowns began, most managers thought in terms of bridging the emergency – conserving cash and cutting costs but otherwise standing ready to resume previously high levels of production as soon as the virus-fighting strictures lifted. Little discussion of downsizing occurred. But as the quarantines and shutdowns persisted, business managers seem to have changed their views. More and more, they have begun to talk about downsizing layoffs and permanently shuttering less efficient facilities.

The news is spotty, mere straws in the wind so far, but even at that, the changing attitude is threatening. As long as companies had simply suspended operations, it was reasonable to look for an economic snapback when circumstances allowed. But once firms turn to more permanent shutdowns and layoffs, recovery will require the long and arduous process of rebuilding. Instead of a proverbial v-shaped recovery, the nation might suffer a U-shaped one or something with a still less encouraging shape.

Though as yet no statistical evidence of the change has emerged, the flow of anecdotes is discouraging. Such a shift, of course, should hardly surprise. As the lockdowns have continued, companies have quickly burned through their capital cushions and their ability to rely on lines of credit. Those with less financial backing face the stark possibility of bankruptcy. Those managers who only a few weeks ago remained firmly committed to only temporary furloughs for workers and efforts to maintain existing facilities have found themselves faced with a reality that has made such an encouraging approach impossible.

Here are some of the unsettling reports: Caterpillar has announced its decision to close one of its German factories permanently. The company has not yet announced anything ominous for the United States, but the German action is hardly encouraging. More stark are decisions by Polaris, Inc. and Goodyear Tire and Rubber, the first to completely shutter a boat and motorcycle manufacturing facility in Indiana, the second to close a plant in Alabama. Lennox China had identified the effect of the lockdowns and quarantines as a kind of last straw and decided to close its last domestic facility located in North Carolina. Maple Block Company, a medium-sized Michigan-based firm, at first issued temporary furloughs, but more recently has announced its decision to close of its facilities for good. Raytheon has hinted at “further reductions.” Less well-known small and medium-sized firms across the Mid West and in the North East have announced closures and bankruptcies. Other companies, if not making outright announcements, have issued warnings of a coming change from bridging the emergency to permanent downsizings. Typical is the announcement from MGM Resorts International. Its management has identified August as a deadline to make clear more permanent downsizing moves unless the nation’s reopening proceeds well.

Other ominous signs of impending bankruptcies have emerged. Credit rating agencies of reveled that increasing numbers of firms are moving toward what Wall Street calls “distressed debt exchanges.” In these, borrowers offer new or restructured debt in place of outstanding issues. Alternatively, firms buy back outstanding notes at substantial discounts. Such actions were common in 2008, often before bankruptcies. Research from New York University’s Salomon Center indicates that historically some 40% of such distressed exchanges precede bankruptcy. To be sure, these problems have roots that predate the coronavirus emergency. Because interest rates and bond yields have remained so low for so long, managements have actively borrowed to lock up long-term credit at favorable rates. Many have not used the funds but have kept them in cash as a kind of reserve for future investments. The income from those cash investments failed to cover the servicing requirements of the long-term borrowing but managers could justify the loss in terms of locking in historically low long-term rates.  But now that the lockdowns and quarantines stemming revenue flows, this debt has become an unsupportable burden. 

It is some comfort that these announced permanent closings and financial maneuvers have yet to become widespread. A successful re-opening for the general economy – one that perhaps adequately re-starts business by August (to use MGM’s date) – can head off these trends and justify the original plans to bridge the emergency with a temporary pause. But that is only a “perhaps,” not the least because there is no telling the direction of the virus and because political calculations often differ from those that might most help the economy.