Keeping zombie companies alive is the right call

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Companies that would have gone bankrupt regardless of the pandemic have been kept alive thanks to the unprecedented stimulus measures carried out in the past year to support the global economy, IMF data suggest. There is a case for sparing them a little longer.

Usually bankruptcy rates rise in the quarters after gross domestic product begins to fall. But the opposite happened when the pandemic first hit the global economy last spring, according to the IMF index that documents insolvencies across 13 advanced economies in the run-up to, and in the aftermath of, major recessions including last year’s historic contraction. The number of bankruptcies began to drop sharply — and has continued to do so.

Stimulus measures — such as furlough schemes to cover workers’ wages, loan guarantees to protect companies’ borrowings and moratoria on bankruptcy filings — are “keeping some unviable firms afloat”, the DC-based financial institution said.

The figures are “incredible and absolutely unprecedented”, said David Owen, an economist at Jefferies.

Line chart of Number of bankruptcies*, index (last pre-recession quarter = 100) showing Stimulus keeps zombie companies alive

This unusual trend has arisen because of the peculiar nature of the crisis, according to Karen Dynan, senior fellow at the Peterson Institute and a former chief economist at the US Treasury department. “Most recessions occur because of some imbalance in the structure of the economy and therefore the shape of the economy needs to change,” she said. “This shock came from outside the economy [so] you want to be able to wake the economy up in the same shape as it was when you put it to sleep.”

But these measures “likely only forestalled the failure of some companies facing insolvency”, according to Karen Harris, managing director of the macro trends group at consultancy Bain. “The full magnitude of the distortions will emerge once these emergency measures have been lifted.”

The support postpones the need to address questions we simply cannot yet answer: which of the hardest-hit sectors — such as travel, entertainment, physical retail and hospitality — will revive, and to what extent? Will companies go back to the office, and how will economic clusters such as downtown cityscapes change as a result?

It is also keeping millions of people in work who would otherwise face life-changing financial difficulties. The longer people are out of work, the more likely it becomes that their skills deteriorate, and the harder they find it to secure a new job.

This is a compelling argument for postponing the wave of bankruptcies, for the short-term at least. But as the global economy moves into its recovery phase this year, politicians will ponder the best moment to switch off the support.

A rapid scaling-back risks triggering a mass extinction, as the forces of corporate gravity catch up with firms that had been kept in suspended animation. Jobs protected through the worst of the crisis could then be lost en masse.

The number of new companies being set up is also running at an unusually high level in several major economies, suggesting some parts of the global economy at least are already experiencing a vigorous recovery. But, Mr Owen said, it was “unlikely that these new companies will sufficiently rapidly soak up all the workers who could be laid off”.

There is also a risk that mass bankruptcies could lead banks to face a reckoning in the form of rising non-performing loans and defaults. “Stress testing means we can be fairly sure that banks are more robust than they used to be, but if there is a wave of corporate defaults then banks will take a large part of the hit,” Mr Owen said. “We need to consider how to wind down those companies without doing damage to the overall economic recovery.”

As a result “the recovery is not going to be quite as easy as some people think”, according to Ms Dynan. “There is a sense in which we are putting off decisions that need to be made — but we are doing the right thing for now.”

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