April 1, 2020
COVID19 Feature – “The Hip Bone is Connected to the Leg Bone …”
“Dem Dry Bones” is a spiritual song composed by the brothers James Weldon Johnson and J. Rosamond Johnson that was first recorded by The Myers Jubilee Singers in 1928. Could the lyrics to this song guide us again through a period of crisis much like the original song did many Americans though the polio outbreak, the Great Depression and World War II? The lyrics were inspired by the biblical verse Ezekiel 37:1-14, where the prophet Ezekiel visits the "Valley of Dry Bones" and prophesies that they will one day be resurrected. So how could this spiritual song rooted in a biblical verse relate to the coronavirus and the economy today? In short, it provides perspective – and is in no means meant to inject a religious view by ACRE or The University of Alabama.
The lyrics referencing how each bone is connected to another bone is how our nation’s leaders and the CRE industry should be thinking about our lives, families, businesses, economy, government intervention (financially via the CARES bill and restrictively with “Shelter in Place” orders), and global connectivity (virus transmission and supply-chain dependence) in this public health crisis.
In other words, what is connected to what - and how do those connections need reconnecting, and in what sequence - for life and business to resume without “Shelter in Place” remaining to “Infinity & Beyond?” Let’s start with a review of the lyrics and then focus on how the bones of our daily lives, businesses, industries, economy, etc. need reconnecting.
As the lyrics suggest, there is a sequencing that must be understood for all to function properly. The sequencing, as we are discovering, commences with the virus itself and then extends to the logisitics of operating an economy under the constraints of a public health crisis. Let’s examine the connections from three key perspectives:
1. The Virus
Like the skeletal structure, the virus started in what was previously thought to be an innocuous part of the world (Wuhan, China) and then spread with increasing speed to the entire economic skeleton of the world. Johns Hopkins University (JHU) maintains a comprehensive and credible resource center on COVID-19’s statistics, its spread, medical intervention, etc.
As of April 1, 2020 the virus had spread to every part of the world except Antarctica. By the end of this week, an estimated 1.0 million persons will have been confirmed as having contracted the virus (861k today). And, although the coronavirus is reported to have originated in China, the United States, Italy, and Spain now have more outbreak cases than China. While we have had other deadly incidents of influenza and infectious diseases dating back to the early 1900s (Spanish Flu in 1918, Polio Outbreak 1916-1955, Hong Kong Flu 1968, SARS 2003, H1N1 2009, Ebola, etc.), COVID-19 is the first to essentially shut down the global economy - and transmit so rapidly across the world (approximately 120 days).
This background is important to understanding the primary response (mostly “Shelter In Place”) to mitigate further spread to the secondary bones of the skeleton (smaller countries within continents, less-populated states in the U.S., etc.). Think of the COVID-19 virus responses as triage on a patient who has undergone a serious trauma. The focus is on the major bones and organs first with the objective being patient survivability, which in turn may lead to consequences to the secondary bone structure of our economy. Combatting the virus to live another day is the focus now, and standing up the economy will have to follow at a later date. Tough medicine is required with measures like “Shelter In Place” that will have unintended consequences that we will be discovering and trying to rehabilitate – not for months or quarters – but likely years. Some bones or aspects of our economy – in say travel, tourism, entertainment, dining, etc. – may never fully recover like we knew them before 2020. However, new economic tissue will emerge to mitigate what was lost. Logistics 2.0, telemedicine, remote everything, etc. will likely emerge and flourish creating new employment and CRE opportunities. The millennial and Gen Z generations will point back to this period of time like the Greatest Generation did on Pearl Harbor and WWII. An enemy had to be defeated at all costs. And it was costly for years to follow – but great periods of economic growth did follow, and will as well again post COVID-19.
2. The Intervention
Extraordinary intervention is required to stabilize the skeleton until the broken bones can be reset and the severed economic limbs reattached. In the month of March, the United States has evidenced this through three fiscal actions (each larger than the previous) that have added trillions to an already debt-laden economy.
The US Debt CLock is a real time website showing the debt levels for our country overall, and across a myriad of categories from credit card and student loan debt to state and local debt. This debt perspective before the coronavirus outbreak is critical to comprehending the rescue, stability and then stimulus response that will eventually be required. Elected leaders need to be held accountable to not making the intervention worse than the virus. Below is an April 1, 2020, screen shot of the U.S. Debt Clock – and no, this is not an April Fool’s Day prank.
The latest CARES bill exceeded $2.0 trillion and equated to the suspension of the federal income tax for an entire year. Throw in another $1.0 trillion – added from a CARES 2.0 bill – and the U.S. could have suspended Federal Individual Income and Payroll Taxes for FY 2021.
The U.S. entered CY 2020 with approximately $23 trillion in debt and was on track for its first $1.0 trillion annual deficit since 2009.
U.S. Debt at the State Level: But our debt problem goes deeper than the federal level to the state level. The following three images portray important perspectives as to the fiscal health of states and their intervention thus far in the COVID-19 battle. Going into 2020, the fiscally weakest states were in the Northeast and West coast with Illinois in between the two coasts; while the healthiest were in the South. Nebraska and South Dakota lead in the top two spots. (Image Source Mercatus.org)
The PEW Charitable Trusts just published a study on how well states’ “Total Balances” (inclusive of Rainy Day funds) are funded to absorb costs from COVID-19. The good news here is that most states have “Total Balances” at their highest levels post the financial crisis. The states in best shape are Wyoming, Oregon, and Texas with 397, 137, and 103 days, respectively, of balances to fund state operations. In the middle are states in the South like Alabama (68 days), Florida (40 days), North Carolina (45 days), South Carolina (76 days), Georgia and Tennessee (42 days), and states in the West such as Arizonia (59 days), California (56 days), and Oregon (137 days). In worst shape are Pennsylvania (0.3 days or less than 1 day), Illinois (4.7 days), and Kentucky (8.1 days). (Image Source PEW Charitable Trusts)
The good news here is that most states have “Total Balances” at their highest levels post the financial crisis. The states in best shape are Wyoming, Oregon, and Texas with 397, 137, and 103 days, respectively, of balances to fund state operations. In the middle are states in the South like Alabama (68 days), Florida (40 days), North Carolina (45 days), South Carolina (76 days), Georgia and Tennessee (42 days), and states in the West such as Arizonia (59 days), California (56 days), and Oregon (137 days). In worst shape are Pennsylvania (0.3 days or less than 1 day), Illinois (4.7 days), and Kentucky (8.1 days). This perspective on state balances/reserves is germane to the third and final image below from the NCSL - National Conference of State Legislators that shows recently passed and enacted state legislature actions to combat COVID-19 that all carry costs from overtime, paid sick-leave, added police, first-responder pay, added state medicaid burdens, etc.
From the NCSL, here is the summary of the actions to date that you can follow weekly on the NCSL website:
“At least thirty-five states, the District of Columbia and Puerto Rico have introduced legislation to support state action related to COVID-19. Several resolutions adjourn legislative sessions or adopt temporary rules to allow governing bodies to meet or vote electronically. Many bills appropriate funds or focus on health topics such as insurance coverage, medical costs or telehealth services. Others involve paid leave, unemployment benefits, guidance for schools, or workforce protections for those in quarantine or isolation. Some bills address price gouging or eligibility for public services, temporarily prohibit evictions and ensure utility services, or extend certain legal deadlines. Thirty-one states, the District of Columbia and Puerto Rico have enacted or adopted legislation.”
In addition to the legislative fiscal intervention, there has also been action by the Federal Reserve. The Federal Reserve has essentially thrown everything including the kitchen sink at COVID-19 intervention while all waited on Congress and the passage of CARES. It has ballooned its balance sheet to a record $5.0 trillion and is likely not finished as it discovers holes that still need plugging, like mortgage intermediaries, the consequences on Fannie & Freddie from forbearance mitigation actions.
Finally regarding the financial intervention topic, one news story over the weekend - and one slide from Real Capital Analytics during a most insightful webinar this weekt – that corroborate this “Fed intervention is not done” point, and which provides the coronavirus triage team with vital stats on the CRE and CRE finance industries are as follows:
Invesco: Atlanta's Invesco Mortgage Capital Rocked by COVID-19 – From last week’s Atlanta BizJournal feature on this CRE finance tentacle impacted by COVID-19, note the following and how intertwined mortgage capital entities are to CRE finance, residential mortgages and the impact from COVID-19 intervention measures like forbearance. What is good for one bone of the skeleton may be very bad for another limb.
- Atlanta-based Invesco Mortgage Capital Inc., which is focused on investing in, financing, and managing residential and commercial mortgage-backed securities, has been rocked by the coronavirus pandemic, with its shares (NYSE: IVR) losing half their value
- Invesco Mortgage Capital is externally managed and advised by Invesco Advisers Inc. , a wholly-owned subsidiary of Invesco Ltd. Invesco Advisers provides Invesco Mortgage Capital its management team, including its officers and appropriate support personnel. Invesco Mortgage Capital does not have any of its own employees. Invesco Mortgage Capital invests in a diversified pool of mortgage assets that "generate attractive risk-adjusted returns," the company says.
- It primarily invests in residential mortgage-backed securities and commercial mortgage-backed securities, including those that are and are not guaranteed by a U.S. government agency. The company also invests in credit risk transfer securities, residential and commercial mortgage loans, and other real estate-related financing arrangements.
- "In recent weeks, due to the turmoil in the financial markets resulting from the global pandemic of the COVID-19 virus, the company and its subsidiaries have received an unusually high number of margin calls from financing counterparties," the company said today. "Through Friday, March 20, 2020, the company had timely met all margin calls received. However, on Monday afternoon, March 23, 2020, the company notified its financing counterparties that it was not in a position to fund the margin calls that it received on March 23, 2020, and that the company did not expect to be in a position to fund the anticipated volume of future margin calls under its financing arrangements in the near term as a result of market disruptions created by the COVID-19 pandemic."
On the Real Capital Analytics slide from the March 31st webinar, Jim Costello profiles who has what financing exposure by property type. Note the GSE exposure to multifamily CRE with 93% of the debt financing. Wonder why the Federal Reserve intervened on behalf of the GSEs? Think more is ahead as the consequences of forbearance play out? And then note how diverse the financing of hotels has been and that the entity with the most ability to absorb losses is actually the one with the most outstanding debt – Life Companies.
3. Supply-Chain Bones
Last year, ACRE published a ports, supply chain, and logistics paper titled: Logisitics Infrastructure: Transformational Opportunities. In it, ACRE connected the dots on logistics infrastructure and how the port-bone is connected to rail-bone which is connected to the trucking, e-commerce and distribution warehouse bones. It fortuitously called for action to update our still largely 1950’s supply-chain and explain how LI (Logistics Infrastructure) was driving the where and why decisions for commercial real estate development. And finally, it explained the transformation of our economy from a “shop and take home” concentric model to an “order online and deliver to me” model.
Fast forward one year and we are learning how critical our logistics infrastructure is to all aspects of our lives and supply chain. In essence, LI is the spine connecting the head bone to the hip-bone that enables all forward movement in the legs of the supply chain. We have 600,000 small businesses that depend on the likes of Amazon, WalMart, FedEx, and UPS of the world. The Etsy CEO tells us that more than 50 million taxpayers have a sole proprietor business that is largely linked to entertainment and consumer discretionary retail. Online grocery was just getting traction one to two years ago with Amazon acquiring Whole Foods and Target buying Alabama based Shipt to help evolve its online grocery business. Now online grocery is a recipe for COVID-19 mitigation and maybe the only way seniors and at-risk population groups can attain needed groceries, medication, and consumer staples.
The COVID-19 outbreak is revealing the “where” things are made (maybe too much in China – and not just auto parts and items that go into a WalMart store, but pharmaceuticals and paper products like diapers and toilet paper that are made possible by “fluff pulp” via the port of Mobile). It’s also unveiling how things connect and maybe enable rapid transmission of a coronavirus. For example, China bought a number of luxury retail brand companies in Italy in recent years and then moved their workers to Italy to sustain a “made in Italy” manufacturing claim. That is now the hypothesis for how the coronavirus spread so quickly to Northern Italy - and then Spain and the rest of Europe.
We are now understanding the intricacy of the movement of supply-chain goods from ports to rail to trucking and distribution warehouses. Just because we shelter at home to wait out the virus and mitigate transmission doesn’t mean online is safe. What if a virus breaks out in, say, an Amazon warehouse? How does a FedEx modify operations for things like required signatures on packages? How can truckers function to get to all of our warehouses and grocery stores when all facilities that support truckers with necessities like rest areas, restrooms and food close their doors? There are a lot of supply-chain bones in disarray. With container ships now on their way to our busiest container ports in Los Angeles and Long Beach, Calif., and a state with a mandatory “Shelter in Place” order, how do we unload the containers to restock our needed supplies that we no longer manufacture?
The port statistics, container movement via rail data from sources like the American Railroad Association (AAR.org) are more vital than ever. The RailTime Indicators report by AAR.org so integral to my economic outlooks are no longer trivia during a presentation or an interesting chart; rather, they are vital to government and businesses understanding the impact on the flow of key merchandise, pharmaceuticals and supplies to combat the coronavirus while we shelter in place.
More on the details of our impacted logistics infrastructure to follow in ACRE features on supply chain and the logistics bones; but for now, understand the supply-chain skeleton and know how the port bone is connected to the railroad bone which is connected to the trucking bone which then powers the industrial warehouse limbs and enables e-commerce at your fingertip bones. If we get it right, the ACRE “Logistics Transformer” skelton will once again stand upright and be functioning like it did pre COVID-19.
March came in like a lion, but it’s not going out like a lamb. We have a lengthy and costly battle ahead. It is incumbent upon all working on the COVID-19 skeleton/patient to keep the resources equation in front of us during the intervention decision-making process. Tough choices in our future will be required if we don’t focus on what is necessary now, versus desired. What we need is very different from what we may want. That is what the Greatest Generation understood before us - and what will forge a new Greatest Generation from the millennials and Gen Z generations at the front line of this battle. They are the ones with college and career disruption (much like the WWII GIs), assisting isolated grandparents with shopping and daily needs they can no longer go outside to accomplish, working a majority of the front line consumer staples retail and logistics supply-chain jobs, and most importantly as the front-facing healthcare workers. As we await new record jobless claims numbers on Thursday, April 2nd, the government’s February jobs report on Friday, April 3rd, and Q1 earnings commencing the week of April 14th, keep in mind the statement proffered below from the March 11, 2020 WIN. I thought I would never have to say the following in the remainder of my career:
“Today’s economic data is largely irrelevant and not predictive of what is ahead. We are flying by the seat of our pants. Get out of the office and talk to banks, borrowers, and businesses most affected to understand what is happening and the type of intervention that will be effective. “
The above quote was part of my briefings on CRE conditions at the Atlanta and New York Fed 2007 to 2009. This guidance proved fortuitous then - and I believe will again as we confront a public health crisis versus an economic crisis. Stephen Roach was correct this week. The latest new economic metric I shared on LinkedIn earlier this week that is both shocking and what will be predictive of when and how quickly our skeleton stands up again is the TSA Passenger-Throughput numbers. The daily airline traffic passenger counts through TSA have fallen from a 2.0 to 2.3 million passengers per day level the first week of March to a mere 150,000 per day as we ended March. This is the kind of new forward-looking economic data to monitor for the “when” and “how well” we recover and stand up our economy after we defeat the COVID-19 enemy.
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