The Quitter Economy

"EVERYTHING MUST GO!" blares a bright yellow sign at the Circuit City store on Broadway and 80th Street in Manhattan. The revolving doors whir with curious customers looking for bargains. As can be inferred from the huddles of dejected employees wearing bright-red Circuit City polos, this store will soon be closing, along with the other 566 outlets of the nation's second-largest electronics retailer, leaving 34,000 people unemployed. Circuit City must liquidate some $1 billion in merchandise by the end of March.

There was a time, not so long ago, that a company like Circuit City would have stuck it out by filing for Chapter 11, which is sort of the corporate world's version of rehab. A Chapter 11 bankruptcy filing gives companies breathing room from creditors in order to regroup and relaunch. Circuit City started down this path in November, but in mid-January it decided that rehab was too tough and threw in the towel. The company's move signals an alarming trend: more firms are deciding to forgo the time-consuming work of restructuring their finances, and instead selling off the inventory and fixtures and folding their tents. Sharper Image, Linens 'n Things, retailer Steve & Barry's, the department store Mervyns. All filed for bankruptcy with the intent of reorganizing. And all have wound up liquidating. "The reason we're seeing liquidation rather than bankruptcy from so many retailers is because people are hopeless," says Dean Baker, codirector of the Center for Economic and Policy Research. "We're still looking at a very bad year in 2009 and probably most of 2010, so it's very difficult to be optimistic about reorganizing and coming out of it stronger."

Liquidation has become the corporate analog to residential foreclosures—with banks slow to restructure mortgages to help out shaky borrowers, and borrowers too quick to mail in the keys to the bank when the value of their house plummets. Foreclosures rose 79 percent in 2007 and spiked another 81 percent in 2008, to a record 2.3 million households. "It wouldn't surprise me if we approach 3 million households in 2009," says Rick Sharga, senior vice president of RealtyTrac, which compiles foreclosure data. At the same time, hedge funds, which helped foment the boom, have started mailing in their own keys. If a fund suffers losses in a year, the managers can't start earning lucrative performance fees unless the fund returns above its high-water mark. Rather than soldier on, many operators have opted to simply fold, returning money to investors.

Companies, homeowners and money managers willing to quit rather than fight is both a symptom of the nation's deep economic woes and emblematic of the challenge the Obama administration faces. More than a mere "economic crisis" is facing Barack Obama. Our "Yes, We Can" president is going to have to fix a "No, We Can't" economy. In his Inaugural Address, Obama noted he was taking office "amidst gathering clouds and raging storms." That's almost an understatement. The macroeconomic numbers have been simply horrible, with job losses mounting, sales data plummeting and the already frayed safety net coming undone. Several states' unemployment funds are in danger of being depleted. The crisis has rendered the last several years something of a lost decade. By the end of 2008, stocks had fallen back to where they were in 1997. Household net worth dropped from its peak of $62.6 trillion in the third quarter of 2007 to $56.5 trillion in the third quarter of 2008, below the level of 2005. The economy has lost 2.6 million jobs in the past 12 months.

The pessimism is most evident in the troubled sector that relies most on faith: lending. Champion Mortgage used to run ubiquitous advertisements that promised "When your bank says no, Champion says yes." Now all lenders seem to be saying no. In October 2008, about 85 percent of domestic banks reported having tightened lending standards on commercial loans, according to the Federal Reserve, while 70 percent said they had tightened standards on prime mortgages.

This knee-jerk reeling in of credit can be fatal for a bankrupt company. The first thing a company does when it goes into Chapter 11 is arrange what's known as debtor in possession (DIP) financing, which enables the firm to keep stores open and pay salaries even as it starts stiffing other creditors. But the market for these loans has dried up. "One blow to the availability of DIP financing came when General Electric Capital, a large provider of DIP loans, announced that it would withdraw from the market," says Diane Vazza, head of global fixed-income research at Standard & Poor's. The result: bankrupt firms face increasing pressures to liquidate.

The challenge for Obama is twofold: deal with the crisis of confidence and with the crisis of economic reality. If housing doesn't stop imploding, the confidence businesses (i.e. credit) won't recover. But without the return of confidence, the credit markets will plunge further into dysfunction, hampering a recovery in housing, and in every other industry. Through word and deed, Obama can try to exhort Americans to remain in the game. When Franklin D. Roosevelt entered the White House, he declared a bank holiday, putting a brake, for the moment, on the process of creative destruction. But FDR's most powerful tool may have been his rhetoric of reassurance, expressed so clearly in his fireside chats.