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.
With Zero Interest Rates and Massive Liquidity, The Percentage of Zombie Companies Has Soared., Promoting Excess Debt, Malinvestment and Overcapacity.
(Source BIS) pic.twitter.com/22XJyCCg81
— Daniel Lacalle (@dlacalle_IA) April 29, 2018
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:
About one-fifth of consumer loans made on GS’s Marcus platform are to borrowers with subprime credit scores: analysts https://t.co/eYq8eerl09
— Lisa Abramowicz (@lisaabramowicz1) May 3, 2018
GE is a fitting place for a wave of corporate bankruptcies to begin.
Deflationary News
By the way, this is extremely deflationary news: For discussion, please see Speculative Bond Short Hits New High: Others Claim “Rates Headed to Zero”.
Mike “Mish” Shedlock
You’ve never seen a bear market or a crash, obviously. Almost everything gets smoked and for a number of reasons. Long/short strategies get unwound which causes the ‘dogs’ to outperform the ‘stars’ (those good companies you refer to). There is $650bn of margin debt to unwind — trust me, ALL stocks will be impacted by this action and once momentum kicks in to the downside it’s like the charge of the Light Brigade. But, be my guest, hang in there if you’re feeling confident.
Sachvik said: “companies selling services to the Top 1%? 5%? 10%? (take your pick) should do fine even if there is a recession…”.
I’m not sure what the issue is: zombie companies are those who are unable to grow but able to re-finance while rates are at (or close to) zero. Once rates start to rise these companies are toast. If you understand ‘finance’ you understand this ..
So the term ‘zombie company’ arose from Japanese banks keeping financially troubled corporations alive after the asset price bubble of the late 80’s. The question will be, will US banks do the same for US corporations. My guess is that they will not do the same, nor will the Fed. Well, unless you are an automaker. lol
You may be right but in my experience the Fed always is slow to react and causes the problems more than fixes the issue. One problem is even if they react more quickly, he markets have a tendency to drop quickly before recovering. Perhaps we are in a flat market though and we just drag along for a few years.
Perhaps he anticipates that short term yields will keep going up.
Corporate, especially high yield, bond investors will sell and rotate into short term treasuries.
And there will be a new QE where FED will be buying long term treasuries. Hence pushing long term interest rates down.
I think that is the only explanation that fits Mish’s prediction. So yeah, I guess corporate bond interest rates will decouple from treasury interest rates somehow in his prediction.
In 2007, the FED bailed out the banks and only the banks. Fannie and Freddie went under as did GM. GM was bailed out by the government. Not the FED. The FED will protect the banking system at all costs, but probably not much else.
Reading the definition of “zombie companies”, I immediately thought of Tesla.
so if subprime mortgage originators go broke what does that do to housing?
I’m confused. In this article you talk about how rising interest rates are going to push zombie corporations to bankruptcy. In another article you talk about how how you expect interest rates to fall. Are you expecting government interest rates to fall, while corporate rates rise? It seems unlikely that they will head in opposite directions.
@MorrisWR, IMO, the Fed pre-2008 and post-2008 are two different entities. They are more likely to move very quickly. The printing press will be on full throttle.
Remember 2008? When the psychology changes, the Fed will act too late as usual. In a large bear market, most stocks lose a large percentage but that does not mean they will not gain it back. I see a lot of comments about how the Fed will not allow the markets to drop. When credit tightens, the Fed is never able to stop it. The frenzy and panic in 2008 was palpable. Perhaps next time they will be able to stop it quickly but my money will not be on that happening.
Mish – I’ve been a long-time reader of your blog and like your thoughtful analysis – agree with you that automation (and outsourcing) impact employment heavily. However, I still don’t understand why you think share prices will decline so much.
The stock market does not reflect the entire economy – the consumer facing stocks do, but surely not all listed stocks. In any case, companies selling services to the Top 1%? 5%? 10%? (take your pick) should do fine even if there is a recession…
Finally, I don’t see why the Fed wouldn’t act (with even larger sums of money) to bail out the stock market (and asset prices) if there is a correction. I’m not sure there is any government body that will hold the Fed accountable or stop it from the bailout…
Turkey, Tesla, something in the area of Tianamen? It’s just waiting for some silly last thing that under normal circumstances would have no consequence. Something few if any have their eye on so not allowed for. A possibly weak but important linkage. The last Jenga piece pulled out.
What butterfly wings beating will cause reality to set in?
Since 2010 Mish has been bearish on stocks, long on gold, and I agree with Mish. Mish’s forcast of deflation was spot on. Is this time, the PIPER is paid for endless QE ? Time will tell. Bear Markets are normal, and difficult to predict with accuracy as the FED and PPT distort reality of Capitalism. Or maybe I am too conservative or just paranoid ? Again, time will tell.