For the Want of a Horseshoe Nail

For want of a nail, the shoe was lost;
For want of the shoe, the horse was lost;
For want of the horse, the rider was lost;
For want of the rider, the battle was lost;
For want of the battle, the kingdom was lost;
And all for the want of a horseshoe nail.

This morning as I was going out to walk Nola, our two and a half year old Samoyed bitch, I ran into my neighbor. Now this neighbor, a man just approaching fifty, is a building contractor and has been in the building trades all of his life as have his several brothers. Lately I’ve been making a point of asking people in the building trades how things were going as a sort of barometer and I asked my neighbor how his business was going.

He responded that it was really dead and that he was facing a specific problem today that served as a good illustration. He’s got a substantial job for which he must put up a performance bond, a form of insurance issued by an insurance company or bank that a job will be completed, not uncommon in the construction business. He’s having trouble getting anyone to issue one.

It’s not that he’s particularly risky or that the job is particularly risky or even that banks are willing to issue the bond, just not under the terms he’s accustomed to (I asked this question specifically). It’s that banks and insurance companies have very little appetite for risk and, where they probably underestimated risks in the past, they’re seeing high risk everywhere.

If my neighbor doesn’t secure his bond today, he loses the job. If he loses the job, all of the subcontractors he’d hire to execute the job will lose work, too. If he’s right and nobody is willing to issue performance bonds, it wouldn’t be surprising if the job doesn’t get done at all. If the job doesn’t get done at all, the people who would be hired by the restaurant he’s got a contract to build won’t be getting those jobs nor will the equipment suppliers and all of the other people involved in running a restaurant.

I suppose there’s more than one way of looking at this. It might be true that this is just a temporary situation and, once the shock has worn off, things will get back to normal, the appetite of banks and insurance companies for risk will increase, and the business activity that was supported by the willingness to take risks would come back again.

Or it may be true that we’ve been living with an unrealistically low perception of risk for some time that’s supported a similarly unrealistic level of economic activity. If that’s true, this may be the new normal and the coming times could be very hard, indeed.

10 comments… add one
  • Drew Link

    The performance bond issue is real. We have seen it in several project oriented businesses we have evaluated the past year. However, as you perceptively queried, bonds are still available, at a price, for larger organizations. Smaller ones are having a great deal of trouble.

    This all said. Many contractors simply price the increased bonding cost into their bids, and this cost increase should not be the deciding factor in the build or not build decision.

    I suspect the utility/overall economics of the project is the prime driver.

  • PD Shaw Link

    “just not under the terms he’s accustomed to”

    I wouldn’t be surprised if the terms are that the contractor secure the bond with personal assets. This is not just happening on construction bonds, but simple loans a construction company might take from a bank to maintain payroll during a lull. The principle has to make a decision whether to protect their family and their retirement or risk these to keep the business going.

  • I know the value of the bond that’s being required and have a pretty good idea of the assets that my neighbor can draw on. In this particular case there’s no way he can provide the necessary bond out of his own pocket.

  • Drew Link

    As I often note, we are to a degree all prisoners of our own experience…

    In mine, these bonds are routinely (almost always, actually) personally guaranteed, a practice in place well before the recent troubles.

    Further, small loans to small companies are routinely personally guaranteed. Again, a well worn practice.

    Any wonder small business owners get mad when they get screwed if it doesn’t work, but have a govt tax man’s hand in their pocket if it does?

  • PD Shaw Link

    Thanks Drew, my experiences tend to be where [er] problems arise. I have no idea how common personal guartees are on construction bonds, but they can be quite pernicious. The more I think about it though, given what a surety bond is — security against the principal’s inability to pay the penal amount — you might expect the surety to require collateral approaching the amount. I know some of the smaller court bonds are issued only with a letter of credit equal to the face value of the bond.

  • PD Shaw Link

    One other observations: AIG was one of the big companies in the construction bond industry, either issuing them directly or underwriting bonds issued by smaller companies. I wouldn’t be surprised if some of these smaller companies have left the business.

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