The Economic Threat and the Uncharted Path Ahead


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.

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.

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?


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.

The Lost Decade

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.

Debt and bailouts

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.

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.

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.

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.

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.

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