Tuesday, June 30, 2020

COVID-19 Bankruptcies: What Really Are the Ramifications?

At the post, Cirque Du Soleil Files For Bankruptcy, Dominick asks an important question:
RW, any opinion on how harmful (to the economy) these bankruptcies actually are? After all, it is a way to shed debt and reorganize the balance sheet...and come back leaner and meaner than before. Any comment?
There is a lot to consider here.

First, if it is a small mom and pop shop that files for bankruptcy and doesn't have strong relationships with banks and suppliers, it could very well be a direct hit. These type shops do go out of business and COVID-19 lockdowns are the clear direct cause.

In situations of larger operations such as Cirque Du Soleil that have stronger relationships with banks and other financiers, the cases are different. Such operations are very likely to recover and come back "leaner and meaner."

However, in these cases, it does not mean there is no damage to the economy. The creditors of Cirque Du Soleil will certainly be damaged since they are unlikely to receive 100 cents on the dollar of what they are owed. This could mean losses for suppliers, to landlords to banks.

And we shouldn't dismiss the losses to banks from these types of bankruptcies with a wave of the hand and the thought "Oh, it is just the banks. They can absorb it."

To the degree such banks face losses from bankruptcies, it is a shrinkage of the banks' capital and thus a shrinkage of the amount of capital they can put out in the economy to help it grow. It does get a little bit complicated with the current fractional reserve banking system but the point is that the structure of the economy does change with these bankruptcies even if the firms themselves are able to come back with a stronger balance sheet.

But bottom line, there are all kinds of twists and turns and distortions on going with these COVID-19 related bankruptcies beyond the firms coming back lean and mean.


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