Gadfly

Zombies Will Die

Rising rates will inflict some Darwinistic pressure on weaker borrowers.
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Photographer: Matt Cowan/Getty Images

Undead companies that have been kept alive by the artificial life-support systems introduced by the world's central banks after the financial crisis may soon meet their unmakers.

In its most recent annual report, the Bank for International Settlements calculated that zombie firms—defined as companies more than 10 years old whose earnings don't even cover interest expenses—account for almost 10.5 percent of publicly traded companies across 13 countries including Germany, France, Italy, the U.S. and the U.K., up from fewer than 6 percent a decade ago.

What's sustaining those undead firms? Ultra-low interest rates have a lot to answer for. Central bank purchases of government and corporate bonds have driven down borrowing costs, enabling companies that would otherwise have gone to the wall to linger.

The era of easy money, however, is about to end.

Keeping zombie companies alive undermines productivity; capital is trapped in unproductive firms, and is in turn unavailable to nimbler companies that would make better use of it. The Organization for Economic Cooperation and Development estimates that more than 15 percent of capital in Italy and Spain, for example, is sunk in zombie enterprises; even in the U.K. and France, the estimate for dead capital is higher than 5 percent.

The euro zone seems particularly ripe for a killing spree. Italian banks, for example, have more than 200 billion euros ($228 billion) of domestic non-performing loans on their books, twice the total of five years ago.

While that's bad news for Italian banks, it's arguably worse for the wider economy. All that capital trapped in those ailing borrowers could otherwise be generating much-needed growth and employment.

The European Central Bank's announcement in 2012 that it planned to buy government bonds bolstered the region's banks, allowing them to sell debt to the central bank at a profit and boosting the value of the bonds they held on their balance sheets.

But economists Viral Acharya, Tim Eisert, Christian Eufinger and Christian Hirsch argue that while those banks that enjoyed the most benefit from the program increased their lending, they did so in favor of existing borrowers rather than new clients. The cash, moreover, was skewed toward keeping weaker creditors afloat.

“By continuing to lend to their impaired borrowers, distressed banks can avoid realizing losses on outstanding loans,” the economists argued in a paper they revised in May. “Instead, by ‘evergreening’ loans to their impaired borrowers, banks in distress can gamble for resurrection in the hope that their borrowers regain solvency, or, at least, they can delay taking a balance sheet hit.”

To be sure, a wave of Schumpeterian destruction that cleanses the system and rids the world of zombie companies will take a while yet. Central banks are still in the process of taking their collective foot off the accelerator rather than slamming on the brakes.

But as traders and investors become increasingly convinced that central bank balance sheets will become less swollen with bonds, higher borrowing costs will begin to inflict the Darwinistic pressure that the weaker borrowers have been able to avoid in recent years.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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