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Are You Really Prepared To Weather A Recession?

The economy is like the tides: They are cyclical, and come and go with some regularity even if the timing of the highs and lows are not easily predictable. In my thirty years of practicing law, I’ve been through three such cycles, being those triggered by the Savings & Loan banks crisis of the late 1980s, the dot-com bust of 2000, and the collapse of the real estate bubble in 2007-8. I’m thus practically familiar with the joke that “in economics, the 1000-year flood occurs every ten years or so”.

If their cycle is like the tides, the effects of recessions are much like earthquakes. There are “slow rollers” where the fundamentals of the economy are somewhere flawed and glide into a long recession that can last many years (the S&L crisis); “rattlers” which follow a bubble in some industry, occur at a snap and are over within a couple of years (the dot-com bust and the Great Recession); and then the massive tectonic plate shifts that are both sudden and lasting (the Great Depression), in which everything bad happens at once and lingers for a while. Predicting the type of recession that will occur is somewhat easier than predicting when it will start, since rattlers tend to follow bubbles and slow rollers usually follow some (realized in hindsight) bad governmental policy. Tectonic plate shifts usually occur with global slowdowns.

The purpose of this article is neither to speculate on when a recession will occur nor what type it will be. Rather, the purpose of this article is to give some friendly and hopefully practical advice on how one should prepare for the recession which will inevitably come, whether sooner or later.

The first advice is to have sufficient liquidity (cash or equivalents) to last for at least six months without any external income. When a recession hits, folks get laid off and formerly sound businesses can find themselves without sufficient customers and thus suddenly fail. This is particularly true for recession-sensitive industries, such as finance and those involved in real estate development. When the last recession hit, folks with a good job one month suddenly found themselves unemployed the next month, and a bevy of real estate developers, contractors, subcontractors, etc., received notices that their projects were being cancelled and to stop work. Note that six months is the minimum amount of liquid reserves that one should keep, since as noted, recessions will often last for years before the economy rebounds.

Folks should also strive to get rid of their debt. Whenever recessions hit, a lot of folks go to the financial gallows of their own debt, particularly when they have personally guaranteed projects. The time to realize that a personal guarantee is a financial noose around one’s neck is before the recession hits when you get out of the noose more easily, than once it starts and values of secured assets start to decline. The same is true for consumer debt, such as credit card debt and home mortgages. Get that paid off to the greatest extent possible.

But how? This is the most obvious advice, but also the advice that most folks can’t stomach and simply ignore: Reign in your living expenses. When times are good, folks adopt a lifestyle based on times being good. They subscribe to services they don’t really need, buy stuff they don’t really need, have houses that are too big for their real needs, and accumulate junk. Time to go cold turkey and quit that. (The truth is that most self-made millionaires are frugal to begin with aka the “millionaire next door,” which is a large part of how they got to be millionaires. Folks should learn from that.)

The time before a recession is also a good time to sell stuff because after the recession starts there aren’t going to be buyers except at fire-sale prices. Have a lake house that you rarely go to? Time to put it on the market. Have a sports car that you only drive every other Sunday? Sold. If nothing else, think of it this way: When a recession starts, Cash Is King, and if somebody is otherwise stable and has lots of cash on hand, there will be great bargains. But if somebody has debt, use these wasting assets to pay down that debt now, because they won’t be worth much later.

Folks should also be talking with their financial advisers about getting out of risky positions and into defensive positions. The hardest part here for most folks is giving up the income or gains from their investments, and going into assets that may be much safer but produce little income. This is where the wise words of Will Rogers should be remembered: “I am not so concerned about the return on my money as I am about the return of my money.” And Cash Is King with financial investments during a recession as well: There is a good reason that Warren Buffett and a lot of America’s best investors have already gone to cash in anticipation of a downturn, which is that they expect that later there will be plenty of bargains to be found on Wall Street.

This is also a good time for folks to evaluate their legal planning, so that assets and liabilities are segregated from one another to the greatest degree allowed by law. This is a good time to update business documents, and make sure that all company records are in good shape and current. Likewise, company loans should be paid back and any inadvertent crossovers of personal and business affairs (i.e., using the business credit card to pay personal expenses) should be eliminated. The reason for this is that if something goes south in the business, keeping a separate relationship substantially reduces the chances of a creditor bringing an alter ego challenge.

Business owners should likewise start to become defensive in how they run various aspects of their businesses, not least of which is monitoring the credit worthiness of their vendors and and other business partners. Many a business has been hurt because they paid for something, but before it arrived the vendor declared bankruptcy and it was a couple of years before the business could get part of its money back. The same is true for subcontractors trying to get paid from contractors, and contractors trying to get paid by owners. There may come a time when a business will have to demand that money be escrowed to ensure payment.

There is also no immunity from business owners needing to contract their business in anticipation of a recession. Office space and expenses should be trimmed back when possible. Even for one of the rare “recession proof” businesses, owners should keep in mind that by reducing now that creates the potential to take advantages of better deals later, such as when landlords must reduce office and warehouse rentals to keep some cash flowing in. In other words, get “lean and mean” now and don’t wait for the recession to hit before trimming back.

Businesses are also not immune from the need to reduce their debt load prior to the recession hitting. As a business contracts, its ability to secure credit decreases at the same time that its cost to service its debt increases its percentage of the business cash outflows. A hallmark of the Great Recession was the freezing up of the credit markets, such that hardly any operating credit was available to businesses at any rate for several months.

On a side note, a recession usually creates what is known as a “hard insurance market” in which the prices for insurance skyrocket. This is caused to some degree by increased claims, but to an even greater degree by the inability of the insurance companies to offset insurance losses with gains in the financial markets. For businesses that qualify, captive insurance companies can often substantially mitigate the increased costs of a hard business market. The time to explore that is now.

Likewise, a business that knows that it will have to trim employees in a downturn had better start making preparations to do that now. Recession tend to spur discrimination-related employment litigation, particularly as older workers are let go and cannot find another job in a tight marketplace. Prior planning and having a strategic plan to downsize, instead of having to do it suddenly and in a haphazard fashion, can mitigate these risks.

None of the foregoing is the result of any great genius; indeed, it is all simply common sense. Nor does it suggest anything like everything that folks should consider. The most important thing is for a person to get a defensive mindset before the recession kicks in, instead of a panic mindset once it happens.

Having represented literally hundreds of formerly-successful business owners in the aftermath of these busts, there is one thing they all had in common: Denial. Business owners have a psychological barrier when it comes to recessions: They don’t believe that it is really coming, that it will be deep enough or last long enough to hurt them, and they think that their smarts or good luck will just get them by. Sometimes that happens, but in a very large number of cases it doesn’t. Distressed business owners will sit across from my desk and tell me that everything would have been swell had just X, Y and Z happened in time. But one can see with the clarity of retrospect that X, Y and Z were not particularly realistic at the time.

This is the Denial factor that must be overcome. Folks need to get in their minds that a recession is coming, sooner or later, and get ready for it. And that mostly means mentally, although they need to then actually take the common sense steps necessary to protect themselves and their businesses.

 

 

This article was written by Jay Adkisson from Forbes and was legally licensed through the NewsCred publisher network. Please direct all licensing questions to legal@newscred.com.