On many street corners this Halloween, you'll spot zombies stiff with rigor mortis ambling about in search of human flesh, another place to drink, or a bowl of sweets.
As most people know, a bad run in with a zombie can be fatal and ideally should be avoided at all costs.
Many people believe zombies to be the thing of myth, legend, and Halloween dress-up games but chances are you might have more to do with them than you'd think. Heck, you may own shares in one.
So here comes the term "zombie company" — an organisation stumbling around, unwashed and potentially beyond its use-by date, desperately looking to devour more debt.
"The basic idea is that it's a company that's really not doing well enough to survive in normal times, if money wasn't free," said Sharon Zollner, ANZ's chief economist.
The wage subsidy, which indiscriminately poured money into all kinds of businesses throughout the country, has allowed many firms to live past their expected life span.
Interest rates, which are getting dangerously close to negative territory, makes debt cheaper than ever. These two factors culminate in the perfect storm for the undead.
How to identify a zombie company
For investors, particularly more fresh-faced retail ones, the obvious question is how to spot these zombie companies. Unlike the dressed-up zombies lurching around town this weekend, there aren't a million giveaways, just one big one: debt.
First, you need to understand how much debt a firm is carrying, then, what it's used for. Is it debt towards innovation, or debt just to keep their heads above board?
Then, you need to understand if they're generating sufficient cash to not only cover costs and interest charges, but to repay the debt itself. If they're 'hooked' on cheap debt, you may wish to start running.
Some of the lowest interest rates ever are responsible for creating these zombie firms. In the United States for example, we've been seeing a record number of investors piling into assets aptly known as "junk bonds" in the hunt for a better yield. These high risk, high reward securities are issued by companies who run a strong likelihood of not being able to pay it back.
This "toxic debt" is offloaded often to people still clinging to the paradigm of "living off interest". This may end poorly.
Are they worth keeping alive?
Historically in New Zealand, we've seen a natural inclination from policy makers to keep these debt-ridden companies alive. The art is in not allowing them to all hit the wall at once. In the medium to longer term however, zombies are harmful to the economy.
"The cost of them failing can be measured, but the cost of firms never starting up because those incumbents are sucking up the resources, that cost is unmeasurable; but it's real," said Zollner.
If I was to go zombie hunting here in New Zealand, I'd probably start in our tourism sector. When our borders closed, we watched an entire industry come to grips with a serious oversupply issue. There's no way that excitable Aucklanders could ever make up for the shortfall of international visitors we would usually expect over our peak summer months.
In an efficient, free and productive market, companies should be allowed to die out. With death, we allow for other companies to grow in their place - it's survival of the fittest and yes, it's unpleasant at times to watch businesses die. To avoid mass unemployment, I'd be hard-pressed to criticise the way the Reserve Bank has responded initially to this crisis too, but at some stage, we need to call the funeral director. This is the "we-can-still-be-friends" method of breaking up with inefficient business.
What could a mass cull mean for everyone?
Debt is cheap as chips, wage subsidies have mostly run their course but have also given millions to unproductive sectors of the economy. The greatest fear now is that all of these zombies will meet their maker at once.
"If we saw a sustained rise of inflation, we'd see a rise in interest rates, no matter what the banks do. Either way, zombies could all hit the wall at the same time," said Zollner.
And this is where I'm scratching my head - what happens when interest rates increase? If money is cheap, and made readily available, it makes sense to take advantage of this as a firm and as an individual, especially when low rates seem to be highly correlated to rising asset prices.
I can only really see a few possibilities when government support tapers off and interest rates increase:
• Firms all hit the wall at once. This wouldn't be pretty especially if we're already in a recession.
• Firms have to sell assets or downsize to reduce debt - even though they trade through, jobs are still lost in the transition and output suffers.
• Debt-deletion occurs via some jubilee event orchestrated by the government and the central bank. A black hole is created to suck up and destroy the debt at the same time as some sort of monetary-system reset.
Sound far fetched? Hey, we're in a world where the ridiculous is now mainstream.
The forces of creative-destruction should be left to play out - but this time, due to the synchronised nature of the situation we now find ourselves in, what's more valuable: allowing the efficient reallocation of capital, or allowing businesses and employees time for a safe transition?
- Darcy Ungaro is an authorised financial adviser and host of the NZ Everyday Investor Podcast.