Paying for COVID-19

Morgan Housel, describing how we’ll hopefully “pay” for the truly massive bailouts we’ll need to get through the Covid-19 pandemic:

I’ve heard many people ask recently, “How are we going to pay for that?”

With debt, of course. Enormous, hard-to-fathom, piles of debt.

But the question is really asking, “How will we get out from underneath that debt?”

How do we pay it off?

Three things are important here:
1. We won’t ever pay it off.
2. That’s fine.
3. We’re lucky to have a fascinating history of how this works.

The analogy here is with World War II. It’s a great read.

I think Housel is right that high bracket tax increases will be inevitable. They’re almost comically low now compared with other countries as well as our own history, and this country was far more functional when they were higher. There are plenty of important reasons to do so even before tacking on several trillion dollars in additional debt and now presumably precipitously less political tailwind to preserving the top 0.1% than there has been in decades.

Private Equity and Healthcare, a Marriage in Crisis

Is Private Equity Having Its Minsky Moment?” is another excellent article from Matt Stoller’s BIG newsletter, something that anyone who is interested in PE and corporate finance should be reading (I referenced a couple of his newsletters previously).

You’ve probably been hearing about salary cuts, furloughed employees, and big losses in health systems around the country. I myself am currently experiencing a sizable pay cut. You may have even heard about the possible impending bankruptcy of healthcare megacorp, Envision. Envision is now drowning because they grew to massive size by buying companies using tons of debt. Because of that massive leverage, if those businesses do poorly, they can’t meet their debt obligations. To give you an idea of how Envision operates, they have less than $500 million in deployable cash on hand to cover $7.5 billion of debt.

Stoller gives a nice summary of why these highly-leveraged private equity companies (and other companies using the same toolbox) are ripe for failure when credit markets collapse.

Private equity is undergoing what the great theorist Hyman Minsky pointed out is the Ponzi stage of the credit cycle financial systems. This is the final stage before a blow-up. As Minsky observed, a period of placidity starts with firms borrowing money but being able to cover their borrowing with cash flow. Eventually, there’s more risk-taking until there’s a speculative frenzy, and firms can’t cover their debts with cash flow. They keep rolling over loans, and just hope that their assets keep going up in value so that they can sell assets to cover loans if necessary. To give an analogy, in 2006, when people in Las Vegas were flipping homes with no income, assuming that home values always went up, that was the Ponzi stage.

Now, what happens with Ponzi financing is that at some point, nicknamed a “Minsky Moment,” the bubble pops, and there’s mass distress as asset values fall and credit is withdrawn. Selling assets isn’t enough to pay back loans, because asset prices have collapsed and there’s not enough cash flow to service the debt. Mass bankruptcies or bailouts, which are really both a restructuring of capital structures, are the result.

I think you can see where I’m going with this. PE portfolio companies are heavily indebted, and they aren’t generating enough cash to service debts. The steady increase in asset values since 2009 has enabled funds to make tremendous gains because of the use of borrowed money. But now they are exposed to tremendous losses should there be any sort of disruption. And oh has this ever been a disruption. The coronavirus has exposed the entire sector.

Everyone wants to make the easy money in a bull market. It makes finance professionals seem competent in running multiple businesses across multiple industries even though their performance often has more to do with the amount of money in the pot driving valuations up. Rolling up companies in high-growth industries by paying top dollar? Piece of cake. But what do you do when the hard times hit? How can your businesses survive when you’ve saddled them to barely function in the best of times?

The business model of the 1980s has been institutionalized in ways that are hard to conceptualize. Sycamore Partners’ takeover of Staples was a recent legendary leveraged buy-out that shows how PE really works. Sycamore Partners is a private equity firm that specializes in buying retailers. Sycamore bought Staples for roughly $1.6 billion in 2017, immediately had Staples take out $5.4 billion of loans, acquired another company, and then paid itself a $300 million payment and then a $1 billion special dividend. Then, Sycamore had Staples gift its $150 million headquarters in the suburbans of Boston for free, after which Staples signed a $135 million ten year lease with Sycamore to lease back its own building.

Healthcare is different because the biggest cost center of most healthcare practices is personnel. And those providers are also typically the only source of profit. This limits the shenanigans you can pull, limits how you can grow, limits the cost floor, and—because of Medicare and agreements with other insurers—limits your profit ceiling. Taking care of people is not a software company or a tech business that can achieve limitless scale at near-zero marginal cost. And what seemed like an easy positive cash flow business isn’t as simple as selling toner.

Tens of millions of people no longer have income, and even those who do are afraid to go back to their old lifestyles. The Fed can’t ultimately can’t print a functional economy. And at the end of the day, no matter how many games you play with debt loads and capital structures, firms have to have customers, and people can only be customers if they have income.

We’re currently in process of bailing out a lot of companies, and low-interest rates will let some of these folks continue borrowing money trying to bide time until they can raise more capital or potentially grow out of their debt. That may not be feasible for long enough to outlast this downturn, especially if the money spigots shut off.

But the issue with bailouts in situations like these is that in recent history they’ve perpetuated a private-profit public-loss business model where PE firms are rewarded for taking on absurd risk because that risk is really on the shoulders of the American people. And without meaningful regulation, this perpetuates the growth of the industry instead of reining in its excesses. Our historically “strong” economy crumbled within about two weeks of the shutdown. That’s overleverage at work.

The actual underlying businesses within these organizations are often still sound once you remove the onerous debt obligations, leasebacks, and other financial machinations. A tiny silver lining of this horrible scenario may be getting some of the rent-seekers out of polluting healthcare.

Student Loans & The CARES Act

The new CARES act pauses student loans for six months without interest. A few important facts:

  • This is a pause (administrative forbearance) until September 30, not a typical forbearance. No capitalization will occur.
  • You don’t need to do anything. It’s automatic for those currently in IDR.
  • These $0 “payments” count for PSLF and long-term IDR loan forgiveness.
  • You can call your servicer to request a refund for any payments made on March 13 or after.

There are a bunch of folks going for PSLF asking if they should pause their auto-payments to avoid making an extra unnecessary payment. Yes, it’s possible you could get charged and then subsequently reimbursed if you have an early April payment as the servicers try to rapidly implement the law. Folks are already reporting that their payment due amounts are now showing $0, and the servicers have until April 10 to implement the new law. It’s also already been stated that all benefits will be applied retroactively, so delays will not impact you in the long term–but you being impatient and foolhardy could.

Personally, if going for PSLF, I would absolutely not make any active changes to save money upfront unless you absolutely need to cashflow-wise. I am deeply suspicious in situations like these that the more you mess with the more likely it is for something bad to happen, requiring more work on the tail end. PSLF requires on-time monthly payments; if you call and get placed on a forbearance due to trying to pause payments, then you will not be in repayment status and these months may not count. Or, trying to manually pause autopay and then make a manual payment at the last second if you don’t see an account update is a massive hassle and places an additional burden on a company that was already strained by its day to day operations before the pandemic. I would just wait and let the servicer do their job.

Outside of the CARES act itself, if you’re PSLF bound and your income has fallen substantially, consider recertifying your income now with pay stubs to lock-in lower payments for when the $0 period expires.

What is the impact?

For most of the non-PSLF-bound, it’s just a pause. You can choose to not make payments for six months (or more, it could always be lengthened later), and there will be no penalty at all. Nice flexibility, but it doesn’t really change the natural history of your loans unless you choose to continue making payments during the pause. If you are fresh off of a capitalization step like consolidation or the end-of-grace period, then you have no unpaid accrued interest and so any optional payments you make will go straight to the principal, which is neat.

For PSLF, how much this will save you in the long run depends on where you are in the repayment process.

For graduating medical students:

Many folks consolidating at the end of school will earn $0 payments for their first year, so your monthly payments will not change. There will be no interest accruing for a while, but this will only be relevant should you eventually take a non-qualifying job. So, basically, it’s quite possible this will have literally no impact on you. For anyone considering PSLF, it’s just another reason to consolidate ASAP, because a full six month grace period could be an even bigger waste.

For those certain they don’t want PSLF, there is now a potential reason to wait to consolidate. A 6-month grace period after graduation will be longer than the CARES act 0% period (at least for now), so waiting until the very end will result in a token amount of increased accrued interest during the last couple of months that will then capitalize. But if you wait you can eek out extra months of $0 payments if you wait to consolidate because you’ll start your IDR cycle later and get a full year of low payments based on last year’s taxes (stacked after the CARES act instead of overlapping it). Ultimately that would result in a full year of the optimal unpaid interest subsidy in REPAYE, likely saving you real money. While waiting does make sense outside of loan forgiveness, I ultimately caution most residents with average or high debt to simply rule out PSLF early in residency.

For residents:

You will save a small amount of money because your monthly payments are generally low to begin with. Certainly not going to hurt, and it’s a good chance to take that extra cash and pay down any high-interest (e.g. credit card) debt you may have previously been unable to make progress on.

For attendings:

Attendings in PSLF will save a lot of money. An average physician debt holder capped at the 10-year-standard could easily save $12-18k thanks to six $0 qualifying payments during their high-paying attending years.

Unintended Consequences

As always, the macro and micro don’t match the way politicians or most people would intend or anticipate. Payment pauses are just the minimum viable cashflow bandaid, a step that will ultimately do little for most borrowers nationwide, who already struggle with student loans at baseline with a 10%+ delinquency/default rate.

Meanwhile, while physicians and other high-earners are certainly not immune to job loss from the COVID pandemic, the actual monetary benefits of this policy disproportionately benefit those with large loans and large incomes.

It’s just not enough.

It’s not enough to prevent an absolute economic crush on young Americans, especially if they are largely left behind in the recovery like they were in 2008.

Student loans–like so many other critical issues from our infrastructure and healthcare system to campaign finance and legislative reform–are crying out for a cohesive, coherent, and complete overhaul, and the developing public health and economic disaster should be a wake-up call.

WCI’s Continuing Financial Education 2020

I was very much looking forward to traveling to Las Vegas to speak at WCICON20 earlier this month but ended up unable to because of the whole devastating pandemic thing, but Jim and crew have released the conference e-course today. I and several other folks who couldn’t make it in person recorded our talks for inclusion after the fact, so there are over 34 hours of lecture worth 10 hours of CME.

Due to horrific computer glitch, I lost audio during my original recording and had to the majority of it again a second time while juggling my infant and 4-year-old, so I welcome you to check it out and see if you can feel the undercurrent of my electronically induced suffering. The struggle is real.

The course is included in the conference fee, so even if you went in person you should still check it out and hear the extra talks. I already enjoyed the talk from Morgan Housel (author of the upcoming The Psychology of Money) earlier today.

For everyone else, the cost is $100 off through April 21 with code CFEINTRO (which is already embedded in this totally monetized affiliate link).

Fragmentation and the Family

Affluent conservatives often pat themselves on the back for having stable nuclear families. They preach that everybody else should build stable families too. But then they ignore one of the main reasons their own families are stable: They can afford to purchase the support that extended family used to provide—and that the people they preach at, further down the income scale, cannot.

[…]

For those who have the human capital to explore, fall down, and have their fall cushioned, that means great freedom and opportunity—and for those who lack those resources, it tends to mean great confusion, drift, and pain.

From conservative columnist David Brooks’ “The Nuclear Family Was a Mistake” in The Atlantic.

Even in medicine, we are seeing a disturbing trend. While the mean and median student debt are rapidly increasing due to high tuition rates, this is actually partially masked by the increasing percentage of medical students graduating with no debt. This suggests that a greater fraction of students come from means and have family support to cover medical school’s incredible cost. And those without that family support are either not getting in or are looking elsewhere.

It doesn’t stop at admission. These disparities and resource differences play out in specialty selection as well:

Over just a six-year period, the number of debt-free graduates almost doubled. And, overall, more competitive specialties like ophthalmology, ENT, urology, radiology have substantially more debt-free graduates than family medicine. Yet, we know we have a specialization problem in medicine. Free tuition at NYU isn’t going to change this massive headwind. The system needs retooling from far, far earlier.