We've seen this movie before: Zombies stalk the land, threatening to infect those around them and ... impairing economic growth. Maybe that doesn't seem as scary as The Walking Dead, but the threat of zombies — companies that struggle to service their debt or banks that are technically insolvent but avoid collapse — is real. Their rise has been tied to the era of easy money that the US Federal Reserve and other central banks ended last year when they rapidly raised interest rates. Now, tighter money threatens to create new zombies and kill off others that had been barely holding on. Central bankers face tricky balancing acts as they try to cool inflation without swelling the ranks of the financially undead.
1. What are financial zombies?
A zombie firm typically refers to a company that doesn't earn enough to pay its interest costs for an extended period. In financial statements, that's reflected as an interest coverage ratio of under one. Ricardo Caballero, an economics professor at the Massachusetts Institute of Technology, used the word in 2008 to analyze Japan's lost decade of the 1990s. Then it gained more popularity in the US during and after the global financial crisis. But the term was originally coined by Edward Kane of Boston College in the late 1980s to describe banks that were allowed to stay in business even though they were essentially wiped out by commercial-mortgage losses. Whether it's a company zombie or a bank zombie, the basic concept is the same: They are allowed to keep walking in the hope that life may return to them someday.
2. How many are there?
Estimates vary, but around 15% of listed firms in developed nations were considered zombies as of 2017, up from about 4% in the late 1980s, according to a study by the Bank for International Settlements. A Goldman Sachs analysis in 2022 estimated that some 13% of firms based in the US could be zombies. A Fed study showed the number of zombies among listed firms hovering around 10% between 2000 and 2020, with higher numbers during recessions. Companies like AMC Entertainment Holdings Inc. and Carnival Corp. have been labeled zombies in the US in recent years. The European Bank for Reconstruction and Development estimated that in the years before the pandemic, roughly 5% of companies there could be classified as zombie firms. Since 2016, China has pushed supply-side reforms that have sought to cull the number of zombies, especially in the state sector, where they were most prevalent in the steel and coal industries.
3. What caused the rise of zombies?
Zombies survive on easy money. They found fertile conditions in the past decade as monetary authorities eased policy to stimulate economies. During the Covid pandemic in particular, many central banks cut their key interest rates to record lows while some also bolstered purchases of bonds to drive down market yields. The effect of that aid is debated — a 2021 note from the Federal Reserve said that zombie companies didn't benefit from particularly favorable rates during the pandemic. Others say that zombies were lurking but weren't visible until rates shot up.
4. Are there more zombies now?
More of them are evident. A rise in debt-service costs can tip a vulnerable company into zombie status, and interest rates have been going up around the world. For example, some 36% of South Korea's publicly traded developers struggled to service debt fully last year, up from 29% in 2021, according to the Bank of Korea. There are fewer of them in nations where borrowing costs remain very low. About 13% of Japan's companies were considered zombies in the year that ended in March 2022, according to research firm Teikoku Databank Ltd. While that's up from 9.9% two years ago, the ratio remains relatively low in Japan, which has been the exception to many central bank trends: The Bank of Japan's aggressive monetary easing has kept borrowing costs down.
5. What about banks?
The market turmoil that followed the collapse of Silicon Valley Bank in March reflected fears that the new regime of higher interest rates had weakened not only corporate borrowers but also important parts of the banking sector. For SVB and Signature Bank, which was also shut by regulators, their problems stemmed from large losses they had taken on long-term bond holdings whose market value had dropped as interest rates rose. It's a phenomenon regulators said had produced $620 billion in losses across the US banking sector at the end of 2022. Smaller banks also faced rising costs as money market funds, with their higher yields, took deposits from banks. That left regional banks, in particular, with a choice of either losing billions in funding or raising their own deposit rates and squeezing their profit.
6. How do zombie companies weigh on economies?
Trapped in a cycle of stagnant growth and productivity, zombie companies suck up capital that could otherwise be used by innovative companies to invest in new products and services. For example, business investment by an ordinary company would have been 2% higher in 2013 on average if the share of zombies had remained unchanged from its 2007 level, according to the Organization for Economic Co-operation and Development. It's not just investment that zombie companies undermine. Their sudden collapse could also cause job losses, reduced consumption and tighter lending, which could then push other firms closer to bankruptcy.
7. What can be done about zombies?
While the economically efficient thing to do with zombies is to put them out of their misery, the long persistence of the phenomenon is a sign of how hard shutting them down can be. The BIS study warns that there's an 85% chance of zombie companies staying zombies in the following year, up from about 70% in the late 1980s. Part of the problem is that the kind of economic downturn that brings zombies to light is exactly the kind of situation in which governments may want to limit bankruptcies or bank closings.
Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement. 02 April, 2023
