Coordinated Business Rescue
My previous post is superficially about Daylight Saving Time, but the bigger point is that there are times when universal, off-the-shelf solutions are better than millions of individual negotiations.
Consider our present economic situation. The basic problem is that a lot of people and businesses have suddenly lost income. This has been somewhat offset by government action, but not entirely. There are still large losses to be borne by the private sector, and the question is who will bear them.
To see what I mean, consider a restaurant that has lost most or all of its revenue as a result of the pandemic. The restaurant must still pay rent to its landlord. The landlord, in turn, must still make payments on its mortgage. The holder of the mortgage might have financed it by issuing notes (that is, bonds sold to investors), which must be paid. In each case, there is a legally binding agreement to pay a specified amount of money on a periodic basis. And in each case, the payment of those amounts may depend on receiving a corresponding payment. All along this chain, there are losses to be borne, and the question is how they should be allocated. In the worst-case scenario, the restaurant goes out of business completely because it can't afford the rent. The landlord then has no revenue to pay the mortgage, so the mortgage holder forecloses. But the building isn't worth much with no paying tenant (plus there are a lot of other properties being foreclosed on, so there's a glut and prices plummet). So ultimately the mortgage holder's own creditors, the noteholders, don't get paid in full. The bonds are downgraded, and now you've got a full-blown financial crisis brewing.
This can be avoided, but someone has to bear the cost, and who will it be? The answer, in the absence of a governmental mandate, is that it is a matter of individual negotiation. The tenant can go to the landlord and ask for a break on the rent. The landlord can agree, or it can stand on its legal rights and evict the tenant. Likewise, the landlord can ask the mortgage holder for a break, and again, the mortgage holder can agree or it can stand on its legal rights and foreclose on the property. Finally, the mortgage holder can ask its noteholders for some kind of consensual arrangement, which may be harder or easier to accomplish depending on the terms in the indenture.
It's important to note that standing on your legal rights in this scenario may be very stupid. Sure, the contract says what it says, but it may be better to get 80% of the usual rent rather than 0%. But negotiations are tricky things because it's often difficult to know whether your counterparty is telling the truth, is willing to be rational, etc. For instance, perhaps the restaurant is doing good delivery business and only needs a small, temporary rent reduction to make it through (or doesn't need a break at all). The restaurant owner might still claim that business is way down and that a major rent concession is necessary. The landlord prefers to have a paying tenant and doesn't want to risk driving the restaurant out of business, but doesn't want to give up more rent than it has to. And so on up the chain. A tremendous amount of lawyer time will have to be paid for, and the least sophisticated and poorest parties will tend to bear the brunt of these bare-knuckle negotiations.
Now consider how the government might intervene. The government could do something like this: pay 50% of the rent for any qualifying commercial tenant, on the condition that the landlord waives at least another 25% of the rent. This means that any business that can survive while paying 1/4 the normal rent should make it. Meanwhile it shores up landlords by protecting them from catastrophic losses. A landlord should be able to make ends meet with 75% of the usual rent.
If you're still worried about landlords, though, you could do the same thing at the next level, but less generously. You could pay 5% of all commercial mortgage payments, contingent on the mortgage holder deferring another 5% until the end of the mortgage. The landlord is getting 75% of the usual rent but is also getting a 10% break on the mortgage, so it is only being squeezed a little.
At that point, the mortgage holder should be able to pay its notes without incident. Or if not, it is certainly better than the widespread defaults that would otherwise likely occur. This means that the noteholders, who buy notes (rather than stocks) precisely because they don't want to bear a lot of risk, should get their expected payments, or close to it, and everything downstream from them should function normally.
Now this is far from a perfect solution. (This is also, to be clear, just an illustrative example, the numbers may be unrealistic.) Some tenants who don't need much of a break (e.g. pizza delivery places that never had any significant dine-in business) will get unneeded rent relief, while other tenants who need a bigger break might not get it. (However, note that nothing precludes the landlord from giving extra concessions. The 25% rent reduction is simply the minimum required to get the guaranteed government money.)
But it sure makes things simple! When you go to your landlord, you don't have to haggle over whether you need a 25% break or a 40% break or a 10% break on the rent. You simply get a 25% break as of right (unless your landlord wants to turn down the guaranteed 50% rent payment from the government, which would be a pretty foolhardy thing to do). And likewise at the next level. It's an off-the-rack solution that won't fit everyone perfectly, but it pretty much eliminates the cost and unfairness of doing individual negotiations. And crucially it spreads out the losses in such a way that they are absorbed before they snowball and start spreading to other sectors (for instance, this scheme protects the financial system, and it should help prevent property tax receipts from plummeting).
Now this would be, of course, hugely expensive. But when you consider all of the costs that are avoided, on a net basis it is probably not a terrible deal.
And I want to emphasize the point about fairness. A lot of times there is help available but you have to know to ask for it. That is, one restaurant owner will know to bring a bottle of bourbon when he asks for a break on the rent, and another restaurant owner won't even know to ask. When the landlord threatens legal action, a certain kind of restaurant owner will simply laugh ("What are you going to do, evict me and just let it sit empty, earning you nothing?") while another restaurant owner may be cowed. A uniform system of loss-sharing, generously subsidized with federal dollars, may be the best approach.
Consider our present economic situation. The basic problem is that a lot of people and businesses have suddenly lost income. This has been somewhat offset by government action, but not entirely. There are still large losses to be borne by the private sector, and the question is who will bear them.
To see what I mean, consider a restaurant that has lost most or all of its revenue as a result of the pandemic. The restaurant must still pay rent to its landlord. The landlord, in turn, must still make payments on its mortgage. The holder of the mortgage might have financed it by issuing notes (that is, bonds sold to investors), which must be paid. In each case, there is a legally binding agreement to pay a specified amount of money on a periodic basis. And in each case, the payment of those amounts may depend on receiving a corresponding payment. All along this chain, there are losses to be borne, and the question is how they should be allocated. In the worst-case scenario, the restaurant goes out of business completely because it can't afford the rent. The landlord then has no revenue to pay the mortgage, so the mortgage holder forecloses. But the building isn't worth much with no paying tenant (plus there are a lot of other properties being foreclosed on, so there's a glut and prices plummet). So ultimately the mortgage holder's own creditors, the noteholders, don't get paid in full. The bonds are downgraded, and now you've got a full-blown financial crisis brewing.
This can be avoided, but someone has to bear the cost, and who will it be? The answer, in the absence of a governmental mandate, is that it is a matter of individual negotiation. The tenant can go to the landlord and ask for a break on the rent. The landlord can agree, or it can stand on its legal rights and evict the tenant. Likewise, the landlord can ask the mortgage holder for a break, and again, the mortgage holder can agree or it can stand on its legal rights and foreclose on the property. Finally, the mortgage holder can ask its noteholders for some kind of consensual arrangement, which may be harder or easier to accomplish depending on the terms in the indenture.
It's important to note that standing on your legal rights in this scenario may be very stupid. Sure, the contract says what it says, but it may be better to get 80% of the usual rent rather than 0%. But negotiations are tricky things because it's often difficult to know whether your counterparty is telling the truth, is willing to be rational, etc. For instance, perhaps the restaurant is doing good delivery business and only needs a small, temporary rent reduction to make it through (or doesn't need a break at all). The restaurant owner might still claim that business is way down and that a major rent concession is necessary. The landlord prefers to have a paying tenant and doesn't want to risk driving the restaurant out of business, but doesn't want to give up more rent than it has to. And so on up the chain. A tremendous amount of lawyer time will have to be paid for, and the least sophisticated and poorest parties will tend to bear the brunt of these bare-knuckle negotiations.
Now consider how the government might intervene. The government could do something like this: pay 50% of the rent for any qualifying commercial tenant, on the condition that the landlord waives at least another 25% of the rent. This means that any business that can survive while paying 1/4 the normal rent should make it. Meanwhile it shores up landlords by protecting them from catastrophic losses. A landlord should be able to make ends meet with 75% of the usual rent.
If you're still worried about landlords, though, you could do the same thing at the next level, but less generously. You could pay 5% of all commercial mortgage payments, contingent on the mortgage holder deferring another 5% until the end of the mortgage. The landlord is getting 75% of the usual rent but is also getting a 10% break on the mortgage, so it is only being squeezed a little.
At that point, the mortgage holder should be able to pay its notes without incident. Or if not, it is certainly better than the widespread defaults that would otherwise likely occur. This means that the noteholders, who buy notes (rather than stocks) precisely because they don't want to bear a lot of risk, should get their expected payments, or close to it, and everything downstream from them should function normally.
Now this is far from a perfect solution. (This is also, to be clear, just an illustrative example, the numbers may be unrealistic.) Some tenants who don't need much of a break (e.g. pizza delivery places that never had any significant dine-in business) will get unneeded rent relief, while other tenants who need a bigger break might not get it. (However, note that nothing precludes the landlord from giving extra concessions. The 25% rent reduction is simply the minimum required to get the guaranteed government money.)
But it sure makes things simple! When you go to your landlord, you don't have to haggle over whether you need a 25% break or a 40% break or a 10% break on the rent. You simply get a 25% break as of right (unless your landlord wants to turn down the guaranteed 50% rent payment from the government, which would be a pretty foolhardy thing to do). And likewise at the next level. It's an off-the-rack solution that won't fit everyone perfectly, but it pretty much eliminates the cost and unfairness of doing individual negotiations. And crucially it spreads out the losses in such a way that they are absorbed before they snowball and start spreading to other sectors (for instance, this scheme protects the financial system, and it should help prevent property tax receipts from plummeting).
Now this would be, of course, hugely expensive. But when you consider all of the costs that are avoided, on a net basis it is probably not a terrible deal.
And I want to emphasize the point about fairness. A lot of times there is help available but you have to know to ask for it. That is, one restaurant owner will know to bring a bottle of bourbon when he asks for a break on the rent, and another restaurant owner won't even know to ask. When the landlord threatens legal action, a certain kind of restaurant owner will simply laugh ("What are you going to do, evict me and just let it sit empty, earning you nothing?") while another restaurant owner may be cowed. A uniform system of loss-sharing, generously subsidized with federal dollars, may be the best approach.
posted by James | 7:30 PM
1 Comments:
Good Post. I feel like this is the sort of "explainer" that would be valuable for news outlets to put out there. (Do they? I barely read Vox or the like.) This stuff is neither immediately obvious nor readily gleanable from casual news reading -- but it's essential in order to have a sensible opinion about bailout policy.
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