This article is part of a series on personal finance during the coronavirus pandemic. Please check out the Coronavirus and Your Finances Series (link will open in a new window).
Every time you use a coffeemaker for your morning cappuccino, you are benefiting from the fragility of the coffeemaking entrepreneur who failed.
At the present time, one person is dying of diabetes every seven seconds, but the news can only talk about victims of hurricanes with houses flying in the air.
–Nassim Nicholas Taleb
My wife and I went to Belize a few years ago. We did a black cave river tour, and on the bus ride out to the launching point, we went by several houses that were half completed.
We asked our tour guide why there were so many unfinished houses, and the answer was Occam’s Razor simple.
He explained that people who owned the properties would save up some money, and once they’d saved up some, they’d hire a contractor to do some work. Once they had exhausted those funds, then they would stop construction until they could save up some more money and restart the process.
The Belize forum at expat.com supports what our guide told us about the start-stop nature of Belizean construction. This was out in the countryside, not in the expat hotspots like Ambergris Caye, so our guide was fairly confident that the properties we were seeing were owned by locals.
Once upon a time, the United States had home building and financing practices much more akin to the current practices we saw in Belize. As the University of Pennsylvania’s Susan Wachter and George Washington University’s Richard Green explain, prior to the Great Depression, mortgages had 5 to 10 year spans with a balloon payment at the end, with variable rates that homeowners often renegotiated annually. The loan-to-value ratios were 50% or less. However, in 1949, the U.S. government stepped in to prop up the mortgage lending market, and from 1949 to 2000, the mortgage debt to income ratio rose from 20% to 73%, and the mortgage debt to household assets ratio rose from 15% to 41%.
As Green and Wachter noted, at the peak of the Great Depression, nearly 10% of U.S. houses were in foreclosure.
During the Great Recession, which, arguably was shorter and less impactful than the Great Depression, a cumulative total of 6.28% homes were in foreclosure. Only 59% more foreclosures despite 252% more unemployment.
Why was this?
The savings rates at the beginning of the Great Recession was almost the same as the savings rates at the beginning of the Great Depression. The savings rate was negative – unsurprising given the unemployment rate and the need to draw down on assets to support themselves – however, mortgage debt was 2.73 times in the Great Recession as it was in the Great Depression. Therefore, the shock of unemployment in the Great Recession hit much more drastically than it did in the Great Depression.
Even in non-shock years (though the late 1970s and 1982 certainly counted as economic shocks for a lot of people), we can see the inverse relationship between personal savings rates and foreclosures.
(Source for foreclosure rate is Wachter and Green; source for personal savings rate is Federal Reserve of St. Louis.)
Personal savings rates as of February 2020 were 8.2%, which would be a little less than what we saw in 1993, which had a 5.6% foreclosure rate without the economic shock that we are seeing as a result of the COVID-19 crisis. Therefore, I’d expect a higher foreclosure rate, since that year, as another market comparison, the S&P 500 was up 7.06%.
This level of shock isn’t just hitting the average American. It’s hitting small businesses, too. For all of the companies where I serve on the Board of Directors, we started telling the CEOs in January and February to start to conserve as much cash and reduce as many unnecessary expenses as possible. We moved early and aggressively because we want our companies to be in a strong position coming out of the coronavirus pandemic. Being awash in cash will allow our companies (hopefully) to accomplish 3 things:
- Buy weaker competitors. There are some companies who were doing well before the crisis, but were financially unprepared for the shock. Their owners are going to be shaken, and, perhaps, mortally wounded, and we can buy them at a discount to what we could have bought them for before the pandemic.
- Be aggressive in taking market share. We can not only buy market share through buying weaker competitors, but we can also buy market share through aggressive advertising and price competitiveness. While competitors will have the urge to raise prices to make up for previous shortfalls, we can be aggressive to take away their customers.
- Hire away great talent. As we saw in “Asymmetric Outcomes: Why You Shouldn’t Invest Your COVID-19 Government Stimulus Check,” some economists are predicting a 30% unemployment rate. There will be a lot of great people who are put on the sidelines because of their employers’ unpreparedness, and our companies can hopefully snap up some great talent.
Let’s look at Apple. They have $48.8 billion in cash and cash equivalents on their balance sheet. They have $35.4 billion in operating expenses and sales and general and administrative expenses.
I didn’t even include their short-term investments, because those short-term investments may have taken some losses as a result of the coronavirus pandemic, but, even discounting that by 10% means that they’re also sitting on $46.5 billion in short-term investments.
Add the two together, and they’re sitting on $95.4 billion, give or take (what’s a billion amongst friends?) in easily accessible cash, or about 2.7 years’ worth of expenses.
Guess what they’re going to be doing at the end of the COVID-19 pandemic? Buying companies on sale. Leveraging their cash to do so.
Businesses are not the only ones leveraging cash to take advantage of systemic shocks.
As Brooklyn College’s Emily Molina’s research shows, 54% of investors used cash to purchase homes in Los Angeles, Riverside, and San Bernadino counties in 2008-2009, compared to 29% of owner occupants during the same period. In Oakland, 40% of foreclosures were sold to investors, and most of those investors purchased in cash.
I’ve recently been reading Antifragile: Things That Gain From Disorder (#aff) by Nassim Nicholas Taleb (you can also read “Six Reasons I am Not Nassim Nicholas Taleb and Neither Are You” for more on my take on his books). One of the areas that he focuses on in the book is how do you make people and systems more resilient to large shocks, and, potentially, to grow from them.
They were antifragile.
They did not have debt burdening them.
They had large amounts of cash to protect them during the shocks and to deploy to scoop up assets of those who were not so well insulated.
Furthermore, we see that, in the Great Recession, there was a lag in bankruptcy filings compared to when the actual recession occurred.
So, just as the economy turns, people run out of gas.
I’d expect the same thing to happen as a result of the COVID-19 pandemic.
Given that we’re in the middle of the pandemic when I’m writing this article (April 5, 2020), it’s a little late to do much to protect yourself in the middle of this financial hurricane, although you can check out my coronavirus and personal finance resource page.
However, once we’re on the other side of the COVID-19 pandemic, there are things that you can do to be more prepared for the next shock (which will happen…if you think about it, there’s generally a major economic shock about every decade):
- Have a large cash cushion. There’s the cash cushion you have to protect yourself from emergencies, but there’s also the capital you have in cash to fire at investment opportunities. The more cash you have to fire when others are exhibiting weakness, the more disproportionate your returns should be. Missing the 10 best days in the stock market between January 1, 1999 and December 31, 2018 cut overall returns by more than half. The best performing investment days were usually not too far removed from the worst performing days.
- Have other sources of income that are not correlated with your job. In Antifragile, Taleb tells the story of the banker and the taxi driver. While the banker has a steady income, he is very subject to shocks in terms of job loss. The taxi driver may have variability in daily or weekly income, but his annual income is very steady. Obviously, this anecdote doesn’t always hold, since Uber demand has also dropped precipitously during the coronavirus pandemic, but the idea holds true. Diversification is generally your friend.
- Have a fallback plan to quickly reduce expenses if needed. Before we made the decision to FIRE (financial independence retire early), my wife and I went through a dozen different actions we could take to reduce expenses before needing to go get a job to make up for any shortfalls.
- Reduce and eventually eliminate debt. While I advocate considering drawing down a home equity line of credit if the COVID-19 pandemic has left you economically vulnerable, I’m generally a proponent of the idea that there is no such thing as “good debt.” It’s much easier to create your contingency plan above if you don’t have to worry about making a mortgage, credit card, or student loan payment.
Yes, this isn’t an easy place to get to. But, it’s not just the realm of those who are born with silver spoons in their mouths. I lived in a mobile home when I was a kid. For a while, I was in a single parent household. My mom was a teacher. My dad was a cop. My grandparents lived on farms and on the railroads. I did not come from money. Yes, there’s a little bit of luck involved in our outcomes, but that’s also a result of decisions that focused on getting us to PIRE.
We got there. So can you, and, in the next economic shock, you’ll be glad that you made yourself antifragile.
What will you do differently in your financial life once the coronavirus pandemic is over? Let’s talk about it in the comments below!