Hello and welcome you are listening to Patrick Boyle on
Finance, a podcast exploring ideas from quantitative finance,
examining events occurring in markets right now and financial
history to see what lessons can be taken away, including
interviews with some of the most interesting people in the world
of finance. To learn more about the podcast,
visit on finance.org. After a decade of decline,
bankruptcy filings around the world are on the rise.
In the United States, business bankruptcy filings rose more
than 40% last year and non business bankruptcy filings rose
by 16%. Bankruptcies in England and
Wales just hit a 30 year high according to the latest figures.
In Japan, corporate bankruptcies involving a total liability of
¥10,000,000 or more increased year on year by more than 35%.
Germany's Federal Statistics Office announced that
bankruptcies were up over 23% last year and that they're
seeing a growing number of business and individual
applications for insolvency and bankruptcy.
Since June, monthly double digit growth rates have been
consistently observed compared to the previous year, according
to the Federal Statistics Office.
In Russia, bankruptcies are 60% higher than a year ago, while in
China, where we hear about all sorts of economic distress, the
bankruptcy rate is still about 1/4 of the rate in the United
States. The reason for this is not that
the economy is doing better, but that the barriers to bankruptcy
in China are so high that struggling firms have no choice
but to constantly refinance their loans, replacing old debts
with new ones. The difficulties associated with
bankruptcy in China mean that the situation tends to get
really desperate there before being eventually resolved. 83%
of the companies that end up at bankruptcy court in China end up
being liquidated, compared with just 5% in the United States,
according to a recent OECD report.
Corporate bankruptcy rates in Norway, Finland, Spain, Britain,
Sweden and Denmark have now exceeded the levels hit during
the global financial crisis, According to Eurostat.
Hospitality, transportation and professional services were the
hardest hit sectors, with trade, industry and construction being
the least affected sectors. In the United States, S&P Global
recorded 50 new corporate bankruptcy filings in February,
with healthcare being at the sector with the greatest number
of bankruptcies. Geographically, California and
Texas combined made-up nearly half of the month's
bankruptcies. So why is all of this happening?
Well, financial conditions for businesses and households have
tightened significantly since central banks began hiking
interest rates in March 2022 to combat inflation.
Rates on mortgage loans, for instance, in the second-half of
last year reached their highest level since the start of the
century. The higher cost of debt
servicing, the rollback of pandemic support, combined with
higher energy costs, particularly in Europe, have put
the squeeze on businesses and households.
The massive government support schemes rolled out globally
during the pandemic for both businesses and households, which
are estimated to have cost $12 trillion, meant that shaky
businesses were able to scrape by during the pandemic and only
began filing for bankruptcy once government support was taken
away. Unemployment rates in most large
economies are near their historic lows, and economists
are predicting that the global economy will continue to grow.
So do we need to worry about the rising global bankruptcies?
An example of an industry that experienced a boom bust cycle in
recent years is the logistics and trucking industry.
Beginning in 2020, American consumers, who were working from
home and flush with stimulus checks and the money they were
saving from, no longer commuting or taking expensive holidays,
started to splurge on goods. Webcams, office desks, computers
and appliances overwhelmed ports, warehouses and shipping
companies. Online purchases exploded as
shoppers avoided physical contact at stores as consumers
complained about slow delivery times.
The logistics industry boomed due to the high demand.
The cost of freight went up 70% and the cost of running a
freight business fell with the price of diesel fuel.
According to The Economist, logistics firms hired 1,000,000
workers and built 1.8 billion square feet of new storage space
in order to cash in on the boom. By July 2023, the number of
trucks for hire in the United States had almost doubled.
When the pandemic ended, Americans reduced their online
purchases and returned to their old spending habits, so lavish
weddings and luxury pickup trucks.
As demand fell, so did freight prices.
Last summer, as the boom turned to bust yellow, one of America's
biggest trucking companies, declared bankruptcy after 99
years in business. Joseph Shumter coined the term
creative destruction in 1942 to describe the constant industrial
mutation that incessantly revolutionizes the economic
structure from within. He argued that lost jobs,
bankrupt companies, and vanishing industries are
inherent parts of the growth system and that, as unpleasant
as it may sound, a lot of good comes from all of this economic
turmoil. Creative destruction, Schumpter
explained, is the free markets messy way of moving forward and
delivering progress, and societies that allow this to
happen grow more productive and richer over time.
He argued that attempts to save jobs, industries or businesses
almost always go wrong. According to Schumpter,
interference to keep inefficient businesses in place comes at a
high societal cost as it prevents the movement of capital
and resources to new, more efficient industries, which can
lead to economic stagnation. Zombie firms is a term used to
describe companies that are economically unviable but
managed to survive either through bailouts or by
constantly raising funds from banks and capital markets.
They are Walking Dead businesses.
An EBRD paper estimates that pre pandemic, roughly 5% of the
companies in their sample could be classified as zombie firms.
When the pandemic struck in 2020, businesses found
themselves able to raise substantial amounts of external
financing, both by drawing down existing lines of credit from
banks and by accessing government support programs.
The EBRD analysis shows that in countries that introduced a
larger number of policy measures to help businesses during the
pandemic, zombie firms saw their borrowing grow at a faster rate
than healthy firms did. The meme stock mania during the
pandemic also had the effect of funding zombie firms that, even
without the pandemic, were on the path to bankruptcy.
A Goldman Sachs paper from 2022 and an IMF paper from 2023 both
estimate that the number of zombie firms doubled to 10% by
the end of the pandemic. The IMF paper by Albuquerque and
Iyer highlights the harm weak businesses on life support can
cause in an economy. These businesses reduce growth
and investment within an economy by affecting the operations of
otherwise healthy firms, be they direct competitors, suppliers or
off takers. Government aid and low interest
rates during the pandemic delayed the bankruptcy of many
unviable firms. A big reason for the spike in
bankruptcies that we're seeing around the world today is that
higher interest rates and the withdrawal of pandemic relief
programs has caused zombie firms to finally declare bankruptcy.
So how does bankruptcy work then?
Well, the rules are different in different countries.
But in the United States, when a business can no longer service
its debt or pay its creditors, the business itself or its
creditors can file with the federal bankruptcy court for
protection under either Chapter 7 or Chapter 11.
In Chapter 7, the business seizes operations.
A trustee sells all of its assets and then distributes the
proceeds to its creditors. If anything is left over after
that, it's returned to the owners of the company.
This is what's known as a liquidation scenario.
Chapter 11, on the other hand, is known as a reorganization
bankruptcy, which allows a business to keep running while
creating a plan to repay its lenders, with the goal of
emerging from bankruptcy as a viable business.
In Charter 11, the original debt provider usually remains in
control of the business as a debtor in possession and is
subject to the oversight of the court.
The process leads to three possible outcomes,
reorganization, conversion to Chapter 7, or dismissal.
In order to reorganize, the company must file and the court
must accept a plan of reorganization, which is
basically a compromise between the major stakeholders,
including the debtor, and its creditors.
In a Chapter 11 bankruptcy, the company is usually
recapitalized, meaning that more money is put in by either a new
or existing investor who expects to earn a return on this new
investment. The goal is that the company
emerges from bankruptcy as a viable business.
Chapter 11 gives a business time to negotiate with stakeholders
to fix their problems and hopefully move on.
The process allows a company to put debt payments on hold,
possibly sell off parts of the company, and renegotiate things
like debt and lease commitments, making it easier to get new
loans so that the business can keep running.
It involves investors and lenders recognizing their
losses, and can mean a court confirming a plan over the
objection of a class of creditors if necessary.
A combination of higher interest rates, stubborn inflation and
companies dealing with huge debt loads piled up during the easy
money era have resulted in one of the busiest periods for
corporate bankruptcies in quite some time.
NYU professor Edward Altman, who's best known for the Altman
Z Score popular tool for predicting bankruptcies,
recently told NPR in an interview that corporate zombies
are on the rise and that he predicts bankruptcies will get
worse in 2024 when an enormous amount of corporate debt comes
due and companies are facing difficulties trying to refinance
or pay off that debt. The reasons for rising
bankruptcies vary around the world.
Businesses in Europe are faced with the withdrawal of pandemic
era financial support along with higher interest rates, just like
in the United States. But they're also dealing with
higher energy prices due to the ongoing war in Ukraine.
Last month, the European Commission reduced its forecasts
for eurozone growth in 2024 as high interest rates weigh on
economic activity, but said that inflation is expected to have
from last year's highs. While European companies are
struggling to adapt to the bloc's tougher business
environment and bankruptcies are rising, the number of new
business registrations have seen their 4th consecutive quarterly
increase. Bankruptcies in Russia are up
60% from a year ago, according to Russia's Federal Register for
bankruptcy. The Bank of Russia has hiked
interest rates to 16% to tame inflation, and companies that
need to refinance loans are really struggling.
In this environment, Russia has been hit hard by sanctions and
faces falling revenues from energy exports.
Gas prom profits have almost quartered since the first
quarter of 2022 as Europe slashed its imports of Russian
gas. Gazprom has tried to find new
energy buyers, but it's new deals will only compensate for
five to 10% of the lost European market, according to the FT
Earlier this month, Putin hinted at higher taxes for companies
during his State of the Nation address.
The Moscow Times reported that this may include a windfall tax
on businesses other than war related sectors like arms
production. The Russian economy is in rough
shape. So why is China experiencing a
much lower bankruptcy rate than the rest of the world when their
economy appears to be slowing rapidly?
A Hong Kong court recently ordered the liquidation of
Evergrand, the world's most indebted property developer,
which has more than $300 billion in liabilities and hundreds of
unfinished apartment complexes across China.
Even with this court order, it's unclear whether mainland Chinese
authorities will recognize the Hong Kong court's ruling or not.
It's not just Evergrande, either.
Chinese developer Country Garden, once China's largest
private developer in terms of sales, announced last month that
it had received a winding up petition from a creditor.
Firms like HNA and Anbang who had gone on debt fueled foreign
acquisition sprees saw their top executives being detained.
You don't really want to be the leader of a high profile Chinese
firm that finds itself in distress.
The Chinese government seized Anbang in 2018, while H and A
went into bankruptcy administration in 2021.
Despite all of this news, China's corporate bankruptcy
rate is still less than 1/4 of that seen in the United States.
This is surprising when the country is experiencing a wave
of corporate defaults, which includes half of the nation's
fifty largest property developers.
The reason for the low bankruptcy rate in China is that
significant barriers to bankruptcy exist, meaning that
struggling firms often no choice but to refinance on worse and
worse terms, replacing existing debts with new debts.
Local officials in China push lenders to extend the lives of
even the worst businesses. Most Chinese banks are state
owned or state controlled, meaning that the government is
on the hook for losses. A corporate bankruptcy in China
is extremely difficult, requiring the consent of courts,
creditors, local government, and often a regulator.
Personal bankruptcies in China are even more difficult.
Shenzhen is the only place in all of mainland China where
local residents can file for personal bankruptcy, as a pilot
scheme was launched there in March 2021.
According to a paper by Junfu and Dong.
These high barriers to bankruptcy mean that a large
number of enterprises exist in China that have not been
liquidated, even though they have gone out of business or had
their licences revoked, or are terminated without liquidation.
As Shunter explained, the purpose of an efficient
bankruptcy process is to return assets and resources as quickly
as possible to the productive economy, reducing the financial
distress costs associated with drawn out insolvency.
Although it may be politically difficult to recognise in China,
once a borrower is unable to pay its debts, the faster and
orderly bankruptcy process can occur, the less financial
distress costs pile up for the overall economy.
In many of the high profile cases, the business owners want
to cling on, hoping for the possible upside of recovery.
The banks don't want to book losses.
And politicians want to avoid the embarrassment of these
businesses announcing their inability to pay their
suppliers, their employees, or deliver finished homes to
customers who have already paid for them in full.
Unfortunately, the longer these bankruptcies are postponed, the
greater the losses will likely be, and the slower the economy
will be at redeploying assets and resources to more productive
uses. So should we panic, then, about
the rising number of bankruptcies around the world?
Probably not. Rising bankruptcies are part of
the business cycle and always occur at times of a slowdown or
at times of great change in an economy.
While bankruptcies are rising, many businesses also built up
good cash buffers and secured cheap financing deals when rates
were low. As I said earlier, economists
are forecasting that the global economy will continue to grow,
and right now, unemployment rates in most parts of the world
are near their historical lows. While bankruptcies have risen,
they're still modest by historical standards in big
economies including the US and Europe.
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