The ranks of zombie companies remain stubbornly high as corporate bankruptcies trend at record lows, stunting job growth, experts in restructuring, distressed debt, and accounting warn.
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It’s the sideshow of the historic bailouts to rescue the economy from the financial collapse. The same debate Japan has been having since the ‘90s over undead businesses still in operation is now breaking out in the U.S. and in Europe.
Historic bailouts have increased the number of corporate zombies living off of easy money, hindering restructurings and holding back the expansion of healthier companies, restructuring experts here and in the U.K. warn.
Capital is not being recycled and reinvested, impeding the “creative destruction” process Austrian economist Joseph Schumpeter says is vital for any healthy economy. Executives at big accounting firms like Ernst & Young have also warned zombie companies are grabbing market share from healthy companies.
Mistakes are the classroom of entrepreneurs, but corporate mistakes are now career ladders for profligate government officials who think they have to be the first responders to every economic hiccup. The U.S. has deployed zero-bound rates, $3.5 trillion in Fed bond purchases, and about $7 trillion in new federal deficit spending. This, as the regulatory and tax state balloons, the tax code now Google for bureaucrats to torment businesses and consumers to justify their paychecks.
The U.S. and Federal Reserve bailouts have "merely delayed the bankruptcy boom,” says the American Bankruptcy Institute’s ABI Journal.
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“It appeared that a big restructuring cycle was on the horizon in the summer of 2007 after years of easy money and lax lending oversight,” but “the sustained caseload never materialized,” wrote James Doak of Miller Buckfire, Steven Argan and Alan Dalsass of MorrisAnderson.
They point out that instead, a lot of government handholding of zombie companies carries on, since “many of the programs and policies that were designed to be temporary responses to the 2008 crisis are still in place today.”
The irony is government officials are fixing a rare economic event -- a debt collapse that could take 17 years to recover from -- with even more debt and money printing while letting fiscal policy run haywire, throwing banana peels under hiring.
As a result, the U.S. continues “to struggle with stubbornly high unemployment and slack gross domestic product growth rates; this despite historically low Fed rates” and Fed bond buying, the ABI authors note. And they add another irony, that corporate debt has actually “crept back up to 2007 and 2008 levels, in spite of--and encouraged by--the Fed and federal policy.”
Thanks to the Fed’s low rates, “companies that didn’t previously have access to capital markets have access and are able to refinance their way out of trouble,” becoming zombies, notes a lawyer specializing in distressed investments at law firm Weil, Gotshal & Manges.
Historically, bankruptcies usually peak post-recession. But U.S. “corporate bankruptcy activity has declined to an unprecedented and record-breaking low,” BankruptcyData.com reported. U.S. corporate bankruptcies plunged an historic 24% in 2013, to their lowest level since the boom years of 2006, says the American Bankruptcy Institute. They came in at 43,934 in 2013.
In fact, there was an unheard of “zero public filings in the entire month of January 2014,” a 60-day stretch which saw just one corporate bankruptcy, in December 2013.
The downward trend has held so far this year. For the twelve-month period ending June, the latest data available, 30,113 companies went under, according to the U.S. Bankruptcy Courts. That’s a drop from the 31,671 that belly-flopped in the twelve-month period through March (see here: http://www.uscourts.gov/uscourts/Statistics/BankruptcyStatistics/BankruptcyFilings/2014/0614_f2.pdf).
Meanwhile, over in the U.K., 25,000 companies went bankrupt and restructured during the 1992 downturn, according to its Insolvency Service. But the trend went in the other direction, with 20,000 restructuring in the thick of the crisis in 2008, dropping down to about 15,000 companies that went bankrupt in 2012.
The corporate zombie debate is on fire in the U.K., with 108,000 bankrupt firms still operating in Great Britain due to easy money, barely earning enough to pay the carrying costs on their loans, estimates the Adam Smith Institute, a free-market research shop.
It argues banks should quit giving money to the corporate undead, because it distracts funding away from healthier companies that can create jobs. Instead, it says these companies should be put to rest or restructured, to clear the way for more innovative companies.
"Low interest rates and bank forbearance represent a vast and badly targeted attempt to avoid dealing with the recession,” said Tom Papworth, senior fellow of the institute. “Rather than solving our current crisis, they risk dooming the U.K. to a decade of stagnation."
Papworth added: "We tend to see zombies as slow-moving and faintly laughable works of fiction. Economically, zombies are quite real and hugely damaging, and governments and entrepreneurs cannot simply walk away."
An executive with R3 executive, the U.K. bankruptcy trade group agreed: “Corporate insolvencies have always jumped up after recessions, but a stuttering recovery, government support schemes, creditor forbearance, and low interest rates have kept thousands of otherwise unviable businesses going this time around.”
R3 noted the roughly 108,000 zombie businesses equal about 6% of Great Britain’s companies, a third lower than the 160,000 zombies a year prior. But here’s the problem. Almost all, about 96,000 companies, told the insolvency firm they simply could not pay their loans if interest rates rose.
"When cheap money goes away and interest rates tick up, some companies will have a hard time" paying their debt, Brian Shaw, president of the American Bankruptcy Institute, has cautioned. The International Monetary Fund says that’s already the case in Europe, where half of the companies in Portugal can’t make their interest payments, versus 40% in Spain.
The number of corporate zombies with underwater balance sheets is sizable, “there’s distress out there, it’s going to be pretty good to be a distressed investor relatively soon,” Z Capital Management’s Christopher Kipley has reported at a distressed investing conference in Las Vegas.
Meanwhile, there is still no word from the Fed’s latest policy meeting on how a stronger U.S. dollar, plus dialing back taxes and regulation, would have a quantum economic effect, with new investments that can lead to new U.S. jobs. With alarming synchronicity, the same credit binge in the U.S. occurred in the Eurozone. But Ireland and the U.K. cut taxes, and their economies began to turn around.
A stronger dollar keeps oil prices low, helping to reduce energy bills for consumers and U.S. businesses. And a stronger dollar helps U.S. consumer spending power and confidence, which has bailed out the U.S. economy in the past.
Federal Reserve chairman Janet Yellen has said that full-throttle central bank stimulus in the form of mega-purchases of bonds have been the wings under the U.S. recovery, pointing to a healing housing market and increasing stock prices.
Former Fed chair Ben Bernanke recently pushed back on critics when he joked, with a twist on Ronald Reagan, that quantitative easing “works in practice but doesn’t work in theory,” (Reagan: “An economist is someone who sees something happen, and then wonders if it would work in theory.”)
However, Fed officials have also warned central bank help lets elected officials avoid fiscal reform—and voter backlash--because the U.S. government can borrow at teaser rates to do more spending, undermining the value of the U.S. dollar.
Central banks cannot solve structural and fiscal problems in the economy, caution officials at both the Federal Reserve and the Bank for International Settlements. Government officials cannot deter forever rational economic fixes. Only at a high cost to taxpayers in the form of inflation and increased taxes.
Meanwhile, U.S. GDP growth has been historically poor at a Japan-like 1.5% to 2% annually, with many part-time and low-paying jobs created, while the 62.7% labor participation rate is at Carter-era lows. Though unemployment has declined to 5.9% from 9.8% in 2010, labor force dropouts are at historic highs.
A big 23.2%, or 28.9 million workers in their prime working years between the ages of 25-54 are unemployed or out of the labor force, note Republicans on the Senate Budget Committee, adding that sum is more than 3.5 million larger than before the recession began in 2007.
While it’s difficult to ascertain how many became independent contractors, former Fed vice chairman Donald Kohn has said “it’s been a slow recovery from a very deep recession.”
A zombie economy creates zombie job growth and zombie purchasing power. Stephen Roach, former chief economist at Morgan Stanley, now with Yale University, has noted that: “In the 22 quarters since early 2008, real personal-consumption expenditure, which accounts for about 70% of U.S. GDP, has grown at an average annual rate of just 1.1%, easily the weakest period of consumer demand in the post-World War II era.”
Roach added: “That is the main reason why the post-2008 recovery in GDP and employment has been the most anemic on record.”
Lack of demand in an economic era of falling expectations are reasons why companies remain unwilling to use easy money policies to increase capital expenditures on plant and equipment, which could create many jobs, and instead are hoarding cash.
Executives continue to feel like they’re stranded in traffic, U.S. corporations other than financials are sitting on an estimated $ 1.2 trillion in cash — not investing it in creating U.S. jobs.
Instead, companies are buying back stock in record amounts, a cheaper and safer way to goose EPS higher versus investing in U.S. capex under a compulsive U.S. tax and regulatory state.
S&P 500 companies have conducted $1.6 trillion in buybacks since 2011, says Standard & Poor’s/Dow Jones indices. Barclays Capital estimates 30% of S&P 500 companies’ cash flow went to buybacks, double the amount in 2002, while 40% went to capital expenditures versus 50% in 2002.
It would be better if the stock market was rising on a robust recovery built on capital investments and job growth, not central bank or government intervention. Instead, cheap money is pushing stocks higher while capex stays flat. Federal Reserve economists estimate non-residential, private fixed investment increased at a slow average annual rate of just 4% in 2013.
Watch what happened during prior downturns when the U.S. central bank did not do the quantitative easing it is doing today. Panicked companies during the Great Depression also socked away cash. However, many went bankrupt too, the churn of capitalism created many blue-chip companies we know today. They include: Walt Disney, Allstate, United Airlines, Geico, Smithfield Foods, Tyson Foods, Motorola, Hewlett-Packard, Xerox, Unisys and Texas Instruments.
In the 1970s, there were only two corporate bankruptcies of note: Penn Central Transportation Corporation in 1970 and W.T. Grant Company in 1975. But after bankruptcy reform in the late ‘70s through the ‘90s made it easier to reorganize, a record number of corporate bankruptcies occurred, including: Eastern Airlines, Texaco, LTV, Continental Airlines, Federated Department Stores, Greyhound, R.H. Macy and Pan Am.
“Capitalism without bankruptcy is like Christianity without hell,” Frank Borman, former head of Eastern Airlines, once quipped. Meaning: If capitalism is going to be truly free, companies must not be bailed out for making the wrong choices. Else, they’ll increasingly make reckless and bad bets, and we’ll all have to pay for it.