The Dioguardi Flynn Blog

The Recessions of 1990 vs. 2008: Which will be worse?

By: Mark Dioguardi on November 26, 2008

2006 marked the end of a special period of time in our country’s – and the Valley’s – history, during which we experienced the longest stretch of sustained economic growth we have known. Those who are under the age of 40 have never known a real recession during their entire business careers – until now. Sure, we had the “drive-by recession” of 2001, but it was short and mild, with a 6% unemployment rate that was tame by comparison to the 8% rate of 1992 or the 11% rate of 1982.

After bottoming out at 4.4% in early-2007, the unemployment rate recently hit 6% and is likely headed higher.

Everywhere in Arizona, the recession is starting to take its toll. By an “Arizona recession,” I mean we are experiencing negative employment growth in our state. Employment in the Phoenix-Mesa MSA is expected to be down about 1% in 2008.

But of course the negative 1% overall employment dip in Arizona severely understates the far more severe drop in employment in the real estate industries, which are the most severely affected sectors of our local economy. Real estate brokers, real estate lenders, title companies, mortgage brokers, architects, engineers, real estate and lending lawyers, contractors and their suppliers, local governments, furniture companies and even homeowners’ associations are all experiencing severe pain. And yes, it is possible that it will get a lot worse for them and others.

Arizona is not alone, of course. One of the nation’s largest law firms, Sonnenschein Nath & Rosenthal, has laid off 124 employees so far this year including 37 lawyers. Cadwalader, Wickersham and Taft, the country’s 64th largest law firm, has axed upwards of 130 attorneys, quickly making it known as “America’s firingest law firm.”

But where is our local economy headed? Will things get much worse? How long will it take before we enter a recovery? A year? Two years? Longer? What does that recovery look like?

Perhaps we can get a feel for the potential depth and breadth of the current recession by comparing it to our last major recession – the one of 1990. While people are beginning to compare the current recession to the depression of 1929, there are so many differences in our economic and political system today versus then, and no one really expects things to get that bad, so a comparison to 1990 is far more interesting and instructive.

Things are bad in Arizona now. But, if you were toiling in business back in 1990, you know that things can still get much worse. Really. Let’s roll back time and think about what Arizona was like in 1990:

Looking at the financial sector, the 1990 recession saw every savings and loan association close in the Valley, and every locally grown bank of any significance sold to out-of-state institutions. Not only did the high-flying Lincoln Savings controlled by Charley Keating go under, but Merabank, Arizona’s largest S&L then controlled by APS, went into receivership. And while Western Savings had grown during the 80’s to the 37th largest S&L in the country with more than $6 billion in assets, Western Savings moved into second place in 1989 for the most losses of any S&L in the country with a $1 billion loss. Pima Savings was at one time a $2.7 billion institution, but it was dissolved by the taxpayers in 1989.

The “Mortgages Ltd.” of its day, the Baptist Foundation, filed bankruptcy in 1991 after losing several hundred million dollars from thousands of retirees’ IRA funds.

Virtually every real estate developer in the Valley went out of business around 1990 with a few notable exceptions such as the Najafi brothers’ Pivotal Group, DMB, Robert Sarver, and Starwood, all of whom used their access to scarce capital to take advantage of the plethora of opportunities created by the recession.

The nimblest of the troubled developers were able to negotiate releases of liability on their personal guaranties of their real estate debt in exchange for giving their lenders deeds-in-lieu-of-foreclosure to their real estate empires. A good number of real estate developers and syndicators sucked all the cash they could out of their projects and then fled to Florida or Texas where those state’s unlimited homestead exemption laws allowed them to reinvest their cash in homes in order to shelter a significant amount of net worth from creditors.

The recession of 1990 was largely a result of excesses in the commercial property and land development sectors. A dramatic example from the 1990 recession was Sun Valley, about 45 miles west of downtown Phoenix. It was planned as a 28,000-acre master-planned community. Fifty of the 95 Sun Valley land owners filed Chapter 11 bankruptcy reorganization petitions in 1990 to protect their land from reverting to Heron International of London. Heron had guaranteed $82 million in bonds that the landowners used to finance the Sun Valley Parkway, a four-lane, 30-mile road that connects with Interstate 10 on the south and sweeps around the White Tank Mountains through what was to be the heart of the planned community. Today, few but cycling enthusiasts use the parkway.

One of the most severely brutalized industries in Arizona in 1990 was the legal community.

In 1989, the Arizona Republic quoted Shirley Murray of the Arizona State Bar’s membership department as saying that, “It’s been an unreal year. Usually we have 10 new firms. This year there are about 100 new law firms due to the dizzying pace of lawyers switching, closing and starting new firms.”

In Nov. 1990, the Phoenix Gazette reported that of the 290 attorneys being admitted to the bar, only 50 had jobs awaiting them as they were being sworn in by the Arizona Supreme Court.

Streich Lang shrank by a third in terms of the number of attorneys. Evans Kitchel & Jenckes, one of the state’s largest firms at the time, and which claimed the accolade of being the state’s oldest firm, closed its doors in 1989 on its 40 attorneys. Winston & Strawn, with 950 attorneys internationally today, closed its Phoenix office in 1989.

The firms that survived then did so largely by representing lenders in bankruptcies and workouts. While many firms were precluded by conflicts, having previously represented troubled borrowers, among the lucky firms that represented the FDIC and RTC were Ridenour Swenson Cleere & Evans, McCabe & Pietsch and Robbins & Green.

So, how does today’s recession differ from 1990?

In one respect, today’s recession is largely driven by the residential mortgage debacle, whereas the recession of 1990 was driven by commercial overbuilding and excess. While there is significant stress in today’s commercial markets due to the retraction of real estate-related firms, we do not enter this recession with the severe commercial vacancy rates of 1990.

As bad as it now is, the current housing crisis can still get worse. At a minimum, we will see a more gradual recovery than in the past. Tightened residential credit standards will forever reduce the pool of potential homebuyers. Some have predicted that the “Alt A” mortgage default “bulge in the python” has yet to flood the market with additional foreclosures, and that this arrival can be expected soon. The glut of homes on the market will continue to put a lid on construction and remain a drag on the economy.

The Valley’s population is still increasing, so we will grow out of this recession as we always do, but it will take some time.

Unemployment can, and likely will, go higher. There will be more commercial and land loans going into default, bankruptcy and foreclosure, as loans come due and cannot be renewed or refinanced due to owners’ inadequate cash flow to service the debt and lower appraised values for the collateral. On the other hand, we will not see the massive wave of foreclosures in the commercial sector that occurred in 1990.

We will see additional bank closures and sales, but most banks will survive this recession, unlike 1990 when most banks disappeared. When the RTC took over all the S&L’s and most banks’ assets in 1990, they foreclosed on all their real estate assets, and then flooded the market with these 3,000 properties for sale at a time when there was little liquidity in the marketplace to absorb the glut of product, resulting in properties selling for 25 cents on the dollar. In 2009/2010, most banks will survive and, if property owners can service the debt on their properties, lenders will have no choice but to work with the borrowers until the market rebounds.

Most of the disruption in the legal community has already occurred, but there will be more. As with the early 90’s, many real estate transactional attorneys will retool into workout artists and bankruptcy experts.

In summary, commercial real estate defaults are still working their way through the foreclosure pipeline and will increase. Commercial bankruptcies will increase before peaking. Law firms will need to keep an eye on their receivables since litigation is on the increase, yet clients are increasingly unable to pay the cost of court battles. Banks will struggle, and some will close or merge, but unlike the 1990 recession, most banks will survive. Most likely, things will not get as bad as 1990, but for those who lived through 1990 and survived, they know that the potential exists for things to still get much worse.

Mark Dioguardi is a partner with the law firm of Dioguardi Flynn LLP. His firm practices in the areas of general business transactions and litigation, including the areas of finance, banking and real estate transactions, as well as commercial real estate workouts, bankruptcies, and litigation. He a founding principal shareholder of West Valley National Bank and its former Chairman of the Board, and currently serves on the board of directors of Friends of Public Radio Arizona. He is a graduate of Stanford University and ASU’s School of Law. Mark can be reached at MDioguardi@DioguardiFlynn.com or 480-970-2430.

Tags: Economy, Mark Dioguardi, Real Estate

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