Surviving The Recession: Tips From The Experienced

America ― and perhaps the entire world ― seems to be on the brink of another recession. This should not come as a particular surprise to anybody. An economic bubble was created by the combination of a flood of cheap money during the pandemic and then pent-up post-pandemic spending. This particular bubble seems to have been popped by the recent tariff wars. Busts come in cycles and the last true economic bust was in 2008 so we were overdue anyway.

The purpose of this article is not, however, to examine how or why a recession arose but rather to talk about how to survive it. In my law career, I’ve been through several busts: The aftermath of the Savings & Loan crash of the 1980s, the combination of the Dot.con bust in 2000 and the 2001 terrorist attacks, and then of course the 2008 debt financing crash. While all of these busts had their peculiarities, from a creditor-debtor standpoint they were all about the same. Wash. Rinse. Repeat. So here is some friendly advice for how folks should deal with them.

Hope Is Not An Option

The first piece of advice is that “hope is not an option.” Whenever there is a bust, there is always hope that the bust will be short and things will return to boom pretty quickly. Where this manifests itself with business owners and investors is that they may have a deal going on that will be underwater during the bust, but the potential of the deal is so good that they don’t want to let go of it.

For instance, real estate developers (the folks who inevitably cleaned out the most during a bust) will have some dirt project going on that will eventually make them a lot of money, but in the meantime they have to carry a lot of leverage on the deal. The prudent thing to do when a bust arises is to get rid of that project as quickly as possible and with as little pain as possible, yet blind hope will keep them throwing money good money into what is quickly becoming a bad money black hole. With this mentality, they will almost inevitably ride the deal all the way down to where it is finally thrown into bankruptcy and they lose everything related to the deal (and more if they have given personal guarantees, discussed more further below).

Stated a little differently, when times are good then it is often a good wager to bet today’s investment against tomorrow’s profits. When times are bad, however, the smart bet is that taking a small loss today is better than taking a bigger loss tomorrow. The folks who survive busts are those who see early that the economic winds are shifting and are able to unload their potentially sour investments quickly, before the market craters entirely and then they can’t unload at all. The folks who get killed are those who hope that things will turn around quickly, but really don’t have a Plan B if it doesn’t — or they wait too late and then have to sell off at distress prices.

The thing about recessions is that money dries up almost immediately. When times are good, a business may have numerous lenders willing to exchange credit, but in a bust those lenders go away. If you can find lenders in a bust at all, they will be hard-money lenders who charge very high interest rates to compensate them for their risks. So, if you think that you can basically kite loans to keep things afloat until the economic climate improves (and I’ve had lots of clients entertain this particular false hope), you are probably wrong.

Fly To The Crash

Pilots are taught that if you are going to crash, you want to make a controlled crash which is known as “flying to the crash.” The same thing applies in business when things go badly. If you business is going to collapse for whatever reason, then you want to make it a controlled crash. Lenders will often work with distressed debtors if things can be done quickly so that they can realize the best value of their collateral before prices deteriorate further. This is why is it often possible to turn distressed assets back to the bank for liquidation in exchange for liability releases.

While painful, it is often preferable to liquidate many distressed assets (and assets likely to become distressed) as soon as possible. Busts usually trigger a phenomena known as “debt spiral” where the failure of one business will trigger failures of other businesses, which themselves trigger more failures, and this cascades like rows of dominos. Another way to think of this is that “a rising tide lifts all boats” but so does “a lowering tide strand all boats”. The key here is that turnback deals and other workouts that allow for the survival of a business may be available at the start of the bust but will fade away quickly.

To accomplish this, a business would want to hire workout counsel as quickly as possible and preferably before any asset goes underwater. Then, develop a good plan to trim the business down to its core assets which are very likely to remain profitable and shed everything else. Be positive about the situation: Recessions are actually good for businesses in the sense that finally they make business trim off the lingering dead weight so that the organization becomes fully efficient again.

Personal Guarantees

Most folks who enter into personal guarantees don’t think much about them when times are good since, in their mind, the deal is going to work out and the guarantee will never be called. This attitude doesn’t work out so well in a bust.

I previously discussed this in my article, Personal Guarantees Are A Financial Noose That Can And Will Cause Financial Death (Jan. 7, 2019), a personal guarantee is basically a financial noose that the guarantor puts their head into and then hopes that the trapdoor doesn’t fall out. The problem is that if a deal goes bad, then the trapdoor does indeed fall out and the financial breaking of the back and subsequent strangulation does occur. When times are good, the trapdoor generally stays shut but when a bust comes along these trapdoors start springing open.

The other problem with personal guarantees is that they can negate what might otherwise be effective asset protection planning. A personal guarantee is basically a pledge of all one’s non-exempt assets to back an indebtedness, which means that every asset of the debtor becomes exposed to the guarantee if it is called. This omnibus pledge can have the effect of rendering the debtor insolvent such that any transfer that the debtor tries to make for asset protection purposes is voidable by a creditor. The upshot is that if one has a personal guarantee it is unlikely that any subsequent asset protection planning they do will be effective.

Also, quite practically, when folks give their personal guarantee as part of a financing transaction, they almost always give the lender a financial balance sheet which lists their valuable personal assets so as to establish creditworthiness. A creditor rights lawyer doesn’t have to be a genius to take that financial statement and go item-by-item asking where assets went. I’ve been in a lot of those debtor examinations on both sides. Suffice it to say that a painful fraudulent transfer case usually follows.

Thus, when a bust comes, it is critically important to try to unwind deals — even at a considerable loss — where personal guarantees are present. Once the personal guarantees are gone, then the threat against personal assets disappears. It then becomes feasible, if necessary, for the business to avail itself of bankruptcy protection without the business owner worrying too much about whether the sheriff will show up with an order for the debtor to clear out of his home within 72 hours so that it can be sold at auction.

Pay Everything Off

When times are good, debt is generally an acceptable answer. The rates of returns that a person can make from their business or financial investments will usually be greater than the rate at which they have borrowed money and so there is something of an arbitrage going on. In a bust, this concept gets turned on its head. The financial markets will quickly become some unhappy combination of fickle and volatile. This means that it can be difficult to generate returns that are greater than the rate of borrowing without taking excessive risks.

In other words, the debt-growth arbitrage operates backwards in a recession.

Moreover, what also happens in a bust is that income streams tend to dry off and what was a positive carry can quickly become a negative carry. Or, in other words, one can start to financially bleed out if they are having to maintain a bunch of debt.

The solution here is to liquidate investments and use them to pay down debt. This stops the bleeding of periodic loan payments. The happiest clients that I have during busts are those who have paid everything off and thus carry little more than nominal consumer debt that they can easily pay.

Very importantly, no matter what else happens pay your taxes. If you get behind to the tax authorities, bad things can happen since they often have the ability to circumvent some normal creditor exemptions.

Cash Is King

Recessions are a financial disaster that bring sad consequences throughout society. Recessions also, however, present great opportunities. Cash becomes king. Those who have cash will be able to pick up distressed assets as they come on the block at fire-sale prices.

There is an issue of timing. While some assets will bottom out immediately in a bust, most assets — predominantly real estate — usually take a couple of years before prices find the bottom. This is because a backlog develops with lenders going through the process of liquidating collateral while the bankruptcy courts will face a similar backlog in the liquidation of debtors’ estates. The backlogs and their attendant delays results in additional assets hitting the weak market over a period of time so prices will remain soft.

Nevertheless, recessions created tremendous buying opportunities for those who have the cash and the patience to wait until things turn back around. Suffice it to say that it is a good time to learn about auctions and bankruptcy sales.

It Is A Great Time For Planning

Because recessions reduce the value of assets, it becomes easier to transfer those assets around for estate tax, succession and asset protection purposes. Thus, when the economy picks up again, the appreciation of those assets will be where they need to be and not stuck in the estate.

This presumes, however, that the person making the transfers does not have personal guarantees outstanding or significant creditor problems at the time. As mentioned above, transfers made while a person has personal guarantees outstanding or debt problems become susceptible to being set aside as fraudulent transfers.

Beware The Scams

When recessions hit, scam artists change their game plans too. Some unscrupulous persons will start to offer debt relief services or sell various sophisticated-sounding transactions to get rid of creditors. The prey is the financially desperate with the idea being that debtors are going to lose their money to creditors anyway.

The best way to avoid these scams is to always get a second opinion about whatever is proposed. If something works then it works, but if it doesn’t work then some professional will usually be able to spot why. Such professionals might also be able to be able to give some real advice as to how to dig out of situations.

Hopefully, the world’s economy will pull back from the brink of a recession and we’ll get another soft landing. But maybe it is a good idea to fasten your seatbelt anyway.