In the United States, at least 10% of publicly listed
companies are taking on debts that they probably
can't repay.
Economists call these unviable companies zombie
firms.
They crowd out capital that would otherwise be available
to healthy firms.
Zombie firms are a growing problem around the world.
The share of zombie firms has been increasing over
time. This has detrimental effects to the healthy firms
that compete in the same sector.
Banks and governments keep zombie firms alive when they
bail out unviable businesses.
I actually don't want the government to prop up zombie
companies anymore.
If a company has to die because the world has
changed permanently, let it die.
The Fed's swift interest rate hikes are making
long-suspected zombie firms go bankrupt.
The stance of policy is restrictive, meaning that
tight policy is putting downward pressure on
economic activity and inflation.
As these rates rise, it's becoming more expensive to
do a lot of things, including operating a
business.
There are some firms that actually really should no
longer exist, but there are other times that you have
firms where the underlying business model still has a
potential to create real value.
The fed doesn't see zombie firms as a problem in the
United States, at least not yet.
So we might have come into this year thinking zombie
firms are a small problem and one that will quickly go
away as things normalize.
But if this is the new normal, the problem of
zombie firms, zombie banks and even slower growth for
the whole economy will only become a bigger challenge.
Is the U.S. financial system propping up zombie firms and
how many are left after the pandemic?
Zombie firms are failing businesses that manage to
stay open for years due to cheap credit.
There is no single accepted definition of zombie firms,
but there are common characteristics that we look
for. Usually it's an older firm.
It's not a new firm.
So this is an overly indebted firm.
And on top of that, it's consistently displaying
negative sales growth.
Roughly 10% of publicly listed companies in the
United States are zombies, according to the Fed's most
recent estimate, which was collected before the
pandemic began.
Which is almost twice as large relative to the share
20 years ago.
So there is really a trend here.
Other accounts estimate higher levels of
unprofitable firms weighing on the economy.
One of the more aggressive accounts come from Credit
Risk Monitor, which says that as many as 40% of
publicly listed U.S. companies are actually
unviable. Zombie firms can appear in any sector where
debt is involved.
Like real estate, energy.
These are sectors that traditionally are less
exposed to competition and also tend to be more
financially vulnerable and more prone to swings in
demand.
A big chunk of the universe of unprofitable companies in
the U.S. are actually growth companies.
They're also oftentimes companies that are
under-leveraged. They don't have a lot of debt on
balance sheets and that's a really key difference with
the typical zombie.
It's really important to sort of separate them.
When compared to their peers, zombie firms are
smaller in size, have lower returns on assets, hold less
cash and have lower investment opportunities
than their non-zombie counterparts. Those weak
financials set zombies up for failure if they can't
find a new creditor to bridge the gap.
That's what's happening in 2023.
516 corporations have filed for bankruptcy through
September. That's a huge surge from recent levels.
Companies that used to borrow at zero to invest or
grow their business are now paying, in some cases,
upwards of 9% and 10%.
So if your cost of doing business goes way up and
your sales are growing way less than they used to,
that's a huge problem that's making a lot of
businesses simply not profitable.
Businesses like the trucking giant Yellow.
It filed for bankruptcy in August.
Some 30,000 workers were laid off in the process.
This company had really been in trouble for over a
decade, and what they did in order to make a go of it
was continue to borrow money, use private equity at
times to find new ways of funding themselves, and hope
for new growth options.
But none of those really panned out.
Yellow stayed afloat in its final years with a $700
million bailout loan from the government.
Yellow repaid $54.8 million in interest on that loan,
but just $230 of the loan principal was repaid before
the business shuttered.
The company did not respond to CNBC's request for a
comment.
It was very important during the pandemic that
governments stepped up.
One of the unintended effects could be that the
support was initially mostly untargeted.
So if it's not well calibrated, it might have
kept pre-pandemic zombie firms alive for longer.
And the era of cheap money went away.
And they have to pay market rates to borrow.
Suddenly they don't have as much traffic as they used
to. Their business model doesn't work, and worse,
they're left with the legacy of all the debt they
took on during the zero rate era.
And that's what a lot of other companies share.
It's really raising the bar for what companies have to
achieve. At the same time, we're realizing companies
take a lot longer to achieve profitability than a
lot of people had hoped.
There are people like Sheila Bair, the former head
of the FDIC, who think that these bankruptcies are what
we need to get back to a healthy economy.
I'm hoping we can pull off the proverbial soft landing
and make this transition not too painful.
But once we do get to the other side, it's going to be
better for the economy.
There are some firms that actually really should no
longer exist. There can be a tendency of those weak
banks to continue to extend new loans, because that
helps those firms stay afloat and allows those weak
banks to avoid having to recognize the losses on the
loans that they've already made.
Economists studied the lost decade of the 1990s and
Japan to learn the full effects of zombie firms.
Japan was an early example of this concern that zombie
firms could cause a lost decade of economic growth.
And it's not out of the question that we could face
a similar problem today.
So the issue in Japan was at the time, the combination of
undercapitalized banks and weak supervision.
So they had an incentive to keep these zombie firms
alive under the expectation that the government would
bail them out.
The effect: the share of zombie firms in Japan shot
up after 1994 and a decade of slow growth followed.
Well, what's happening with the U.S.
banks now? They have big losses on their portfolios
while they're hoping that they can continue to make a
nice spread on interest rates. It's not so much a
question of earnings season right now and whether the
banks can get through it. It's really a question of
how much capital do the banks really have to lend
into the economy over the next decade?
And if they don't have as much as we previously
thought, there's a risk that for the broader
economy, we experience a lost decade here, too.
Economists say key U.S.
industries, like airlines and autos, appear to operate
on high debt and potentially an expectation
of government bailouts.
What's happening now is that even if the economy weakens
substantially, the government is constrained.
It can't borrow and come to the rescue the way that it
once did. It's almost a luxury to be able to debate
the idea of whether the government would step in and
lead to a Japanese-style lost decade.
It's not a secret.
And about all I can say is we know that we're on an
unsustainable path fiscally.
It's not that the level of the debt is unsustainable.
It's not. It's that the path we're on is
unsustainable, and we'll have to get off that path
sooner rather than later.
Even in the face of growing debt nationwide, some
investors see this economy as unusually resilient.
I don't think the parallel with Japan holds at all.
The supply side of the economy continues to sort of
grow a little bit.
You're bringing more supply to the labor market.
You're taking down the pressure on wages.
You have the differences that we went through a
massive shock in 2008.
A lot of things have been put in place to reduce the
risk of financial instability.
I think one of the challenges that the Fed and
other bank regulators are having to pay attention to
is have the assumptions that we've traditionally
used when assessing the healthiness of banks.
Do those still hold?
This is where supervision comes in, filling the
inevitable gaps in the rule system.
The Fed's interest rate hikes are expected to rid
the economy of weak performers.
We've raised our policy interest rate by five and a
quarter percentage points, and have continued to reduce
our securities holdings at a brisk pace.
We've covered a lot of ground, and the full effects
of our tightening have yet to be felt.
The biggest implication of the rapid rise in interest
rates that we've seen is that reintroduced the value
proposition of cash as an asset class, and that
actually, you know, puts some constraints on risk
assets.
I think we're only just beginning to see the toll
that high rates are taking.
If rates stay where they are, it's going to reshape
business banks and the U.S.
economy as we know it.
It's aversion to losses.
You might have made a bad loan with information you
had at the time. You know, maybe the firm was like
potentially promising, but it never paid off.
And I don't want to recognize that I, the
investor, or the bank, I was wrong.
And that's human behavior.