May 14, 2020

Axios Capital

It's hardly original to point out that the rich have been able to survive this crisis much more easily than the poor — but it still bears repeating.

  • In this week's 1,758 words, which will take you about 7 minutes to read, I look at the insurance companies (rich, doing well), large corporations with access to capital markets (rich, doing well), restaurants (not rich, not doing well) and other small businesses (dicked around by moving government goalposts).
1 big thing: The insurers' crisis

Illustration: Sarah Grillo/Axios

Megacatastrophes, or megacats, as they're known in the insurance industry, are events that hit millions of people at once and cause hundreds of billions of dollars in damage.

  • The COVID-19 pandemic is much worse than a megacat — it has hit billions of people and is causing tens of trillions of dollars in damage. But don't worry about the insurers. They're doing just fine.

Why it matters: As far as insurers are concerned, this is not some kind of unprecedented giga-catastrophe. In fact, it's not even a megacat. We still don't know what kind of non-pandemic disasters 2020 might yet bring, but so far this year is tracking well behind 2017 in terms of economic harm to insurers.

The big picture: The first purpose of insurance is to insure against calamity. Insurers make money in quiet times, taking in more money than they pay out in claims — but then, in bad years, they are expected to lose billions.

  • COVID-19 will probably cause some losses for the industry. Insurance brokerage Willis Towers Watson estimates that the losses might be $30 billion under a "moderate" scenario featuring six months of social-distancing controls and 3 million total deaths. That's about the same amount of insured losses as Hurricane Irma caused in 2017, while causing 134 deaths.

How it works: Insurers are happy to cover uncorrelated risks, where the majority of unaffected businesses and individuals paying premiums can easily cover the costs associated with the minority of claimants. A pandemic is a classic case of a highly correlated risk that hits everybody at once — and no insurer can afford to pay out on all of its policies at the same time.

  • The vast majority of policies therefore explicitly exclude pandemics, and organizations like Wimbledon that do have pandemic coverage pay large sums for having it.

The other side: Even if insurers have avoided paying out on things like business interruption insurance, some hits are unavoidable.

  • The money from premiums is invested in the market, so when the market falls, insurers lose money.
  • Life insurers have to pay out on excess mortality — people dying before they were actuarially expected to — although the insurance industry as a whole sells about twice as many annuities as it does life insurance policies, and annuities stop paying out when covered individuals die.
  • A bigger problem for the insurers is the interest rates that they have promised on annuities: Those look harder to obtain in the market now that rates in general have plunged.
  • Other losses are likely to come from worker's comp insurance, especially in the healthcare sector, as well as insurance against cyberattacks, which are likely to increase now more people are working from home.
  • Future total premiums are also going to fall, especially for things like travel insurance.

Insurers are meanwhile seeing gains, especially on auto policies. With the number of cars on the road down by 50% or more, the number of accidents has similarly plunged. Some insurers are rebating a portion of those gains — but only about 40%, according to Willis Towers Watson. The rest is excess profit.

  • Health insurers are also making profits, at least for the time being. Doctors' visits have been canceled, and elective surgeries — a lot of which cost much more than a two-week stay in the ICU — have been postponed, many indefinitely.
  • Rebates and other financial support from insurers remains relatively small, at least so long as the long-term health implications of the pandemic remain unknown. Insofar as Americans avoid doctors and hospitals in general, that will benefit health insurers.
  • Insurers might be able to raise rates for 2021, given that the chances of the industry facing a pandemic next year are close to 100%.

The bottom line: The world's greatest all-time insurance executive, Warren Buffett, said in his 2018 annual letter that every year there's a 2% chance of an event causing more than $400 billion in insured losses. Even given the current crisis, however, the industry has never come close to seeing a hit that big.

2. The value of antici...

Illustration: Aïda Amer/Axios

Foremost among Fed chair Jay Powell's achievements during this crisis is that he has fixed a broken corporate bond market. Large businesses with access to capital markets are able to borrow what they need to cover their near-term losses.

  • Impressively, he managed to do so without buying a single corporate bond, at least until this week.

Details: The Fed announced key measures to ensure well-functioning markets on March 23. The Secondary Market Corporate Credit Facility, in particular, unfroze the bond markets: It reassured investors that the Fed would ensure the liquidity they require when they lend money to corporations.

  • Seven weeks later, the SMCCF still hadn't bought a single bond; purchases only started on Tuesday. That was fine: The markets have priced in those purchases since March.
  • The intervening time allowed the Fed to draw up hundreds of pages of agreements detailing how the fund would be administered and managed.

The big picture: Capitalism works when it has the luxury of being able to anticipate the future. Corporate share prices rise when companies announce buybacks, not when they actually do them. Creditors lend new money to avoid a debtor filing for bankruptcy protection from them. Individuals work for two weeks in the knowledge that their work will eventually be remunerated on payday.

The bottom line: The Fed has proved adept at using market tools to fix the market. Millions of individuals and small businesses facing hunger, poverty and ruin, however, had no market access to begin with. Helping them is much harder for the Fed to do.

3. The future for restaurants

Photo: James D. Morgan/Getty Images

Restaurants are slowly being allowed to reopen — with restrictions. In Australia, for instance, dining rooms can serve no more than 10 patrons at a time, and each customer needs at least 43 square feet of space. That's resulted in Frank Angeletta, the owner of Five Dock Dining, putting cardboard cutouts of diners at tables that would otherwise be disconcertingly empty.

  • The Inn at Little Washington, an ultra-high-end Virginia restaurant, is doing something very similar.

The big picture: Restaurant economics have been upended, and many restaurants will never reopen. Those that do will be changed radically.

  • Space per diner will increase — and customers will be newly hyper-attuned to things like ventilation and ceiling height. Restaurants lucky enough to be able to offer outdoor seating will have a huge advantage.
  • Menus will become more limited, as kitchens become less crowded. Expect much more emphasis on daily specials.
  • Take-out and delivery will become central to the business, to the point at which dishes will only appear on the menu if they lend themselves to at-home dining.
  • Reservations will become scarcer than they used to be, and companies like Tock will allow restaurants to monetize them by selling different time slots at different prices.
  • Landlords will often be the deciding factor in terms of which restaurants survive and which do not. Momofuku founder David Chang is closing two locations that won't reduce rents, saying: "I understand their decisions. I don't respect their decisions."

The bottom line: Restaurants have been driving urban revitalization for the past 20 years. Now they might be at the forefront of urban decline. Their suburban counterparts, by contrast, are probably in much better shape.

4. ...pation

Illustration: Aïda Amer/Axios

America's small businesses are breathing much more easily now that the government has announced that anybody borrowing less than $2 million under the PPP will simply be presumed to have needed the money.

  • By the numbers: The new guidance, as laid out in the answer to question 46 of the official FAQ, applies to 4,198,656 of the 4,232,534 loans issued through May 8. That's more than 99% of all the PPP loans.

The big picture: When the PPP was first launched, to bipartisan acclaim, it raised hopes across the country. Those hopes were dashed when it ran out of its allotted $342 billion quickly, leaving millions of small businesses without any government-backed funds at all.

  • There's nothing worse than raising hopes only to dash them, and the result was a wave of anger and recrimination. Politicians soon turned to vilifying larger companies that had applied for funds.

The PPP's second round freed up another $310 billion for loans. As of yesterday evening, there's more than $117 billion of that money remaining.

The bottom line: When the government moves the goalposts, that's a function of how cash-constrained the PPP program is.

  • Initially, businesses were encouraged to apply for loans, so the money could be put to good use.
  • When it became obvious that there wasn't enough money to go around, politicians became very strict about who should get it.
  • Now that the program's funding exceeds demand, the policy rhetoric has been loosened up significantly.

Why it matters: The PPP did little to help many small businesses, including restaurants, and was designed primarily to funnel cash to employees rather than to support struggling owners. Within its narrow and flawed design parameters, however, it now seems at least to have been adequately funded.

Of note: Axios applied for a PPP loan, received it, and then returned it when the program became politicized. Thanks thanks in large part to the Fed, we found an alternative source of capital in the private markets.

5. Deflation arrives
Data: U.S. Bureau of Labor Statistics via FRED; Chart: Andrew Witherspoon/Axios

Consumer prices fell by 0.8% in April, led by the plunging price of gasoline.

  • Strip out volatile food and energy components, and the "core" inflation rate was still deep into negative territory, at 0.4%.

Why it matters: Deflation is a terrible thing. It rewards consumers for not shopping, and waiting instead for prices to fall further. That's a recipe for an ever-deepening recession.

The bottom line: In a crisis, people prefer saving to spending. And collapsing demand causes prices to fall. The Fed's top priority now is to try to get inflation back above zero.

6. Auto sales rebound
Data: J.D. Power; Chart: Naema Ahmed/Axios 

U.S. auto sales, which tanked at the end of March amid widespread stay-at-home orders, have been steadily recovering, writes Axios' Joann Muller.

Why it matters: The auto industry represents about 3% of GDP, and the week ending May 10 was the sixth consecutive week of improving vehicle sales at auto dealerships.

  • Driving some of the sales: 0% interest rates on 7-year loans.
7. Coming up: Mnuchin and Powell testify

Photo: Kim Kyung-Hoon/AFP via Getty Images

Steven Mnuchin and Jerome Powell will both testify before the Senate Banking committee next Tuesday, writes Axios' Courtenay Brown.

  • The CARES Act requires them to give quarterly updates to Congress on economic programs.

Why it matters: The Treasury and the Fed have been closely linked amid the downturn. Mnuchin at one point was speaking to Powell "30 times a day." This hearing will be the first time since the coronavirus crisis began that the pair will publicly — albeit virtually — appear together.

What to watch: Mnuchin has cautioned against moving too quickly with additional stimulus. Powell said this week that more fiscal action is needed.

8. Building of the week: The Robie House

Photo: Raymond Boyd/Getty Images

Frank Lloyd Wright's Frederick C. Robie House, completed in 1910, feels bracingly contemporary to this day.

  • The house is on the South Side of Chicago, on the University of Chicago campus, and has been a National Historic Landmark since 1963.
  • Wright himself, then 90 years old, was instrumental in saving it from demolition in 1957.

The house's straight cantilevered rooflines help to define the Prairie School, as do its wide-open interiors.

  • The first truly American architectural movement, the Prairie School used striking horizontals to echo America's wide and flat Midwestern landscape.

Guided tours of the Robie House will once again be available when Chicago wakes from lockdown. Until then, several other Wright houses are doing virtual visits during the pandemic.