Thursday, May 6, 2021

Should we fear zombie companies?

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Many investors fear that a corporate “zombiepocalypse” will be one of the thorniest issues the global economy will face in the years to come. But an explosive article from the New York Federal Reserve argues that this fear could be exaggerated.

Even before the coronavirus eruption, concerns about a growing horde of dead businesses – generally defined as those unable to meet the costs of servicing debt from long-term profits – were pervasive.

Two years ago, the Bank for International Settlements calculated that the share of zombie companies in the 14 major economies studied, it fell from 2% at the end of the 1980s to 12% in 2016. The driving force is that they remained undead longer than in the past, neither recovering nor extinguishing. The most likely reasons are interest rate cuts that have reduced debt repayments and banks reluctant to pull the plug.

The trend was no accident. In fact, after the 2008 financial crisis, policymakers felt that low interest rates and tolerance were absolutely necessary to prevent a massive corporate shutdown that would have caused the loss of millions of jobs. In this, the authorities had learned from the mistakes of history.

In 1929, Treasury Secretary Andrew Mellon advocated the massive liquidation of troubled companies to “purge the rottenness of the system.” Announcing Joseph Schumpeter’s “creative destruction” theory, he argued that this would be the best way to ensure recovery. Instead, the Mellon Doctrine helped turn the 1929 crash into a depression.

Still, many economists are concerned that allowing weak companies to scramble indefinitely carries real economic costs in the longer run. the BIS 2018 paper found that “zombie businesses” are unproductive, invest less, and absorb resources that could otherwise be redeployed to more dynamic areas. Even beyond the zombie society phenomenon, economists worry that growing corporate debt in general is hindering the ability of companies to invest.

These fears have been supercharged in the wake of the coronavirus crisis. Among the many legacies that the pandemic will leave in its wake, a monstrous corporate debt burden is one of the most important.

Line graph of global non-financial corporate debt as a percentage of global GDP (%).  showing that the level of corporate debt in the world has reached a new record in 2020

The rise in corporate bankruptcies has so far been surprisingly modest, thanks to the extraordinarily aggressive response from governments and central banks, the latter alone injecting more than $ 7 billion in stimulus into bond markets, according to at the IMF.

But the net result has been that the debt burden of companies in the developed world has fallen from an already record high of 91% of gross domestic product in 2019 to 102% at the end of September 2020, according to the Institute of international finance. Although low interest rates make this situation more bearable, economists are concerned that over-indebtedness will be a cornerstone around the neck of the global economy for years to come.

Maybe not, depending on the paper released by the New York Fed this month. Using a database spanning 17 economies dating back to the 19th century, Oscar Jordà, Martin Kornejew, Moritz Schularick, and Alan Taylor studied whether large increases in corporate debt lead to deeper and longer recessions, such as this is historically the case after booms and collapses of households. or finance industry debts.

Their conclusion is counter-intuitive. “There is no evidence that corporate debt booms lead to deeper declines in investment or output, or that the economy takes longer to recover than at other times.” , indicates the log. Economists also failed to find evidence that large corporate debt overhang made economies more fragile and prone to less frequent but greater downturns.

Why is it? the Fed NY Paper argues that corporate bankruptcy and restructuring regimes are generally much more effective than those for individuals. Business owners and creditors are best served with a speedy resolution.

However, when creditors are scattered and combative, contract enforcement is weak, or court proceedings are cumbersome, it can discourage or delay rapid restructuring or liquidation. It can fuel more undead businesses. “More friction leads to more underinvestment and survival of zombie firms, which can hurt overall productivity growth and slow recovery from recessions,” note economists.

In other words, policymakers should worry less about low interest rates, allowing the number of companies to linger in the twilight zone of survival. Instead, they should ensure that bankruptcies and restructurings are dealt with as quickly and efficiently as possible.

robin.wigglesworth@ft.com

Twitter: @robinwigg



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