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Deutsche Bank Estimates 18 Percent of U.S. Companies Are 'Zombies'

Chris Gaetano
Published Date:
Jun 24, 2020
Analysts from Deutsche Bank estimate that roughly 18 percent of U.S. companies can be classified as "zombies," that is, businesses that do not make enough to service their debt interest and so can survive only through constant injections of new credit, according to the Washington Post.

Zombie companies are hardly a new phenomena, as a report last year estimated that roughly 12 percent of all companies on earth are financially undead. While such firms consistently underperform (hence the lack of earnings to cover debt interest), banks nonetheless continue to lend to them because it's easier to keep failing companies on life support and hope that they will recover than it is to watch them collapse, which would then force them to write off the loan.

The rise of the collateralized loan obligation
is likely another factor, as the multibillion-dollar market gives banks an incentive to make easy loans which they can then package into securities that are then sold to investors. Unlike the collateralized mortgage obligations that made headlines in the 2008 crisis, CLOs have credit standards that mean that borrowers whose credit quality dips too low must be ejected from the security and usually sold at a deep discount somewhere else. Generally issuers of CLOs would prefer this not happen, and so also have an incentive against cutting off borrowers.

However, while zombie companies did not begin with the pandemic, the economic chaos they have introduced has provided fertile ground for them to proliferate as never before. Deutsche Bank's report largely laid this at the feet of the Federal Reserve, saying that ultra-low interest rates mean that credit remains dirt cheap, which enables failing companies to keep borrowing with little cost or consequence. It added that the central bank's further pledge to buy corporate debt on both the primary and secondary market likely did not help either. While Deutsche Bank does not believe the Fed shouldn't have acted in response to the pandemic, it noted that these short-term fixes could lead to long-term problems down the road. The Post compared it to someone injured taking painkillers: While in the hospital that may be fine, but the patient risks addiction once they're out in the real world.

The problem with zombie companies is that they take up resources that might have gone to more efficient firms, thus depressing overall economic competitiveness. One 2018 study found, after controlling for cyclical effects, that within industries over the period 2003–13, a higher share of industry capital sunk in zombie firms is associated with lower investment and employment growth of the typical non-zombie firm and less productivity-enhancing capital reallocation. This is due, said the paper, to market congestion, which limits the expansion possibilities of healthy incumbent firms, creates barriers to entry for new players and constrains the post-entry growth of young firms.

Another study from that same year found that the easy access to credit that creates zombie firms can allow "less efficient incumbent firms to remain longer on the market, thereby discouraging entry of new and potentially more efficient innovators." Even though easy credit also helps entrepreneurs innovate, the researchers believe it can, and has, done long-term economic damage, saying that the "decline in productivity growth in most advanced countries since the 1970s may indeed be partly related to an overall easier access to credit due to financial liberalization over the period" and that "This mechanism may have been amplified by the decrease of interest rates and the capital abundance observed in the last decade." 

While killing a movie zombie is easy enough (destroy the brain, provided you're dealing with classic Romero zombies and not the super-durable examples in the cult classic Dead Alive), addressing zombie companies is a little more dicey because it would involve cutting off credit, which in turn could lead to major job losses as these companies shrivel up and die. Therefore, dealing with zombie companies will likely be a complex task requiring subtle measures.

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