With Zero Interest Rates and Massive Liquidity, The Percentage of Zombie Companies Has Soared. Promoting Excess Debt, Malinvestment and Overcapacity.
(Source BIS)
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The defaults and currency crises in the periphery will then move into the core.
It’s funny how unintended consequences so rarely turn out to be good. The intended consequences of central banks’ unprecedented tsunami of stimulus (quantitative easing, super-low interest rates and easy credit / abundant liquidity) over the past decade were:
1. Save the banks by giving them credit-money at near-zero interest that they could loan out at higher rates. Savers were thrown under the bus by super-low rates (hope you like your $1 in interest on $1,000…) but hey, bankers contribute millions to politicos and savers don’t matter.
2. Bring demand forward by encouraging consumers to buy on credit now.Nothing like 0% financing to incentivize consumers to buy now rather than later. Since a mass-consumption economy depends on “growth,” consumers must be “nudged” to buy more now and do so with credit, since that sluices money to the banks.
3. Goose assets based on interest rates by lowering rates to near-zero. Bonds, stocks and real estate all respond positively to declining interest rates. Corporations that can borrow money very cheaply can buy back their shares, making insiders and owners wealthier. Housing valuations go up because buyers can afford larger mortgages as rates drop, and bonds go up in value with every notch down in yield.
This vast expansion of risk-assets valuations was intended to generate a wealth effectthat made households feel wealthier and thus more willing to binge-borrow and spend.
All those intended consequences came to pass: the global economy gorged on cheap credit, inflating asset bubbles from Shanghai to New York to Sydney to London. Credit growth exploded higher as everyone borrowed trillions: nation-states, local governments, corporations and households.
While much of the hot money flooded into assets, some trickled down to the real economy, enabling enough “growth” for everyone to declare victory.
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Earlier today a friend pinged me with this story: U.S.Personal Spending Outpaces Income Growth For 26th Straight Month.
He commented: “Hey, a lot of good bankruptcies are coming.”
I replied: “Yes – the killer will actually be corporate! Many Zombie firms are on life support – low interest rates.”
Roughly three hours later, a second friend pinged me with this headline: GE warns its subprime mortgage unit could file for bankruptcy.
GE shut down WMC, its mortgage business, in 2007 after the market for lending to risky borrowers collapsed. But the business still faces legal trouble, including lawsuits from investors and an investigation by the Justice Department.
GE warned in a filing on Tuesday evening that WMC could file for bankruptcy if it loses one of those lawsuits.
Investors lost billions of dollars when subprime loans went bust across the country during the foreclosure crisis. Federal bank regulators ranked WMC as one of the worst subprime mortgage lenders in major metro areas, with more than 10,000 foreclosures between 2005 and 2007.
The investors who are suing claim that WMC misrepresented the quality of the mortgages it sold. The investors are demanding that WMC buy the mortgages back.
Story Irony
The irony in this story is that I was not at all referring to legacy businesses, but rather more recent corporate actions. This Tweet explains.
A “zombie” corporation is one that needs constant refinancing at low interest rates or repetitive debt offerings to survive. Zombies are unable to pay down debt.
With rising interest rates, it gets increasingly harder for zombies to survive.
Here is another interesting Tweet:
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Bank of America says 9% of European firms have subpar interest coverage. Bloomberg covers the story in its report Zombie Companies Littering Europe May Tie the ECB’s Hands for Years.
Watch out for the zombies.
The plethora of companies propped up by the European Central Bank will limit policy makers’ ability to withdraw monetary stimulus that’s been supporting the continent’s bond market since the financial crisis, according to strategists at Bank of America Corp. About 9 percent of Europe’s biggest companies could be classified as the walking dead, companies that risk collapse if the support dries up, according to the analysts.
“Monetary support in Europe over the last five years has allowed companies with weak profitability to continue to refinance their debt and stave off defaults,” analysts led by Barnaby Martin wrote in a note Monday. “This supports the point that our economists have been making: that the ECB will likely be very slow and patient in removing their extraordinary stimulus over the next year and a half.”
The strategists classify zombies as non-financial companies in the Euro Stoxx 600 with interest-coverage ratios — earnings relative to interest expenses — at 1 or less. The thinking goes that companies in this category are particularly vulnerable to rising interest rates.
The ECB’s dovish tone last week — pushing back the timing for a decision on the future of its bond-buying program until possibly October — confirms it will embark on a gradual pace of tightening in order to juice the economic recovery, according to Bank of America. It reckons the ECB’s taper will start in January 2018, with the first increase to the deposit rate projected in the spring of 2019, compared with consensus expectations for a hike in October 2018, according to overnight index swap contracts compiled by Bloomberg.
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This week John Hussman’s pondering about the state of our markets is as clear and concise as it’s ever been. He starts off by describing the difference between an economy operating at a low level versus a high level. He’s essentially describing a 2% GDP economy versus a 4% GDP economy. We have been stuck in a low level economy since 2008. And there is one primary culprit for the suffering of millions – The Federal Reserve and their Wall Street Bank owners. They are the reason incomes are stagnant, the labor participation rate is at 40 year lows, savers can only earn .25% on their savings, and consumers have been forced further into debt to make ends meet. Meanwhile, corporate America and the Wall Street banks are siphoning off record profits, paying obscene pay packages to their executives, buying off the politicians in Washington to pass legislation (TPP) designed to enrich them further, and arrogantly telling the peasants to work harder.
In economics, we often describe “equilibrium” as a condition where demand is equal to supply. Textbooks usually depict this as a single point where a demand curve and a supply curve intersect, and all is right with the world.
In reality, we know that economies often face a whole range of possible equilibria. One can imagine “low level” equilibria where producers are idle, jobs are scarce, incomes stagnate, consumers struggle or go into debt to make ends meet, and the economy sits in a state of depression – which is often the case in developing countries. One can also imagine “high level” equilibria where producers generate desirable goods and services, jobs are plentiful, and household income is sufficient to demand all of that output.
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