COLLATERAL DAMAGE: The Rise of Insolvent Zombie Firms By Lynette Zang
“The Financial Crisis of 2007-2008 was not the result of an unfortunate convergence of a number of bad factors, but was the result of a long-term, permanent, transformation of the U.S. financial system into one involving significant amounts of wholesale funding, which is vulnerable to runs. This vulnerability has not been solved.†Excerpt from the 2016 NBER working paper, “OPTIMAL MONETARY POLICY IN A COLLATERALIZED ECONOMY†https://www.nber.org/papers/w22599.pdf
One look at global financial plumbing (which we do in Part 2 of this series) verifies this fact. What is wholesale funding you ask? Simply put, short-term debt provided by private corporations. This debt is based on collateral. Can you guess which one is vulnerable to runs?
Basically, there three collateral types;
- Intangible Financial Assets (stock, bond, derivative contracts, fiat currency held on account, etc.)
- Contracts That Run Counterparty Risk
- Default
- Abundant Supply Tailored to Demand
- Easy and Cheap to Create
- Can Be Easily Duplicated (Hypothecated and Rehypothecated)
- Infinitely Leveraged By Many Counterparties
- Limited Buyer Base
- Useful Only In Financial System
- As Collateral
- To Trade
- For Control
- Can Lose All Value
- YOU Have No Options Of Where to Hold Intangible Wealth
- Useful Only In Financial System
- Tangible Assets (physical gold, silver, real estate, oil etc.)
- Physical Assets Than You Can Hold and Own
- Gold and Silver Run No Counterparty Risk, Is Easily and Invisibly Moveable and Has Global Value
- Anything Physical Is Limited In Supply
- Gold and Silver Take Labor and Energy to Pull From the Ground
- Is Impossible To Completely Duplicate
- Gold and Silver Possess Unique Qualities So Far Proving Impossible To Duplicate
- Broadest Buyer Base
- Gold and Silver Are Used In the Financial System, Manufacturing, Electronics, Medicine, Art, Jewelry, in Food Globally
- Gold and Silver Have Never Gone To Zero Because There Is ALWAYS A BUYER
- Gold and Silver Are An Easily Moveable Asset
- Gold Enables You To Hold A Lot Of Wealth In a Small Package That Is Globally Valued
- YOU As The Asset,
- The ability to repay the debt (in a normal economic environment)
- From Your Time (Labor)
- Savings (Equity)
- The ability to repay the debt (in a normal economic environment)
- Physical Assets Than You Can Hold and Own
- Contracts That Run Counterparty Risk
- Investment (Growth of Equity)
If you think the collateral most subject to runs are those that are intangible, you’d be correct. That’s because the wall street market alone, determines the market price, so if they get spooked, like 2007, market prices evaporate along with trading demand.
Because of the 2008 stock market crash, central bank easy money policies (zero bound interest rates along with bond buying) spawned the rise of zombie firms. Typically these are older, well-known companies whose gross annual earnings do not cover annual interest expenses for at least 3 years in a row and without the probability of a better financial future. Bottom line, they are insolvent and should be out of business. As more fiat collateral is created for and by these zombies, the less real value it has, regardless of the current trading value in the markets.
The problem lies with the banks. If taking the losses, as these companies default on their debts, would push the bank into insolvency, it becomes beneficial for the bank to continuously roll these loans over, funding deficits along the way. That hides the insolvency of all those zombie corporations (banks and non-banks). Crisis averted for now, in a doom loop between bank and non-bank, that becomes ever more vulnerable to interest rate shocks. Could this be why central bankers cannot raise rates?
But there are additional vulnerabilities as well because central bank QE has inflated fiat asset prices, and corporations have used these inflated assets as collateral for those additional loans. A shock anywhere in this fiat collateral could be catastrophic for this debt house of cards.
Central bankers understand all that I’ve shown you here and much more. 2010 saw the first positive cumulative gold buying by global central bankers since 1971, when Nixon closed the gold window, and they been accumulating ever since with the highest annual level of gold buying since the 1940s, in 2018.
That is because physical gold is the soundest collateral with the longest continuous value in history. Ask yourself, when the financial house of card falls, what collateral do I want to be holding? Real or Imagined, the choice is yours.
Slides and Links:
https://www.nber.org/papers/w22599
https://www.nber.org/papers/w22599.pdf
https://www.bloomberg.com/graphics/2019-decade-of-debt/?srnd=fixed-income
https://theotrade.com/global-central-banks-cut-rates-fed-in-a-mid-cycle-pause/
https://www.bloomberg.com/graphics/2018-almost-junk-credit-ratings/
https://www.bloomberg.com/graphics/2019-decade-of-debt/?srnd=fixed-income
https://www.leveragedloan.com/primer/#!second-lien-loans
https://www.reuters.com/article/us-bis-markets-zombie-idUSKCN1M30PC
https://www.bis.org/publ/qtrpdf/r_qt1809g.pdf
https://www.wsj.com/articles/steinhoff-says-probe-found-accounting-irregularities-11552680095
https://www.nbc-2.com/story/40225074/13-of-the-worlds-companies-are-zombies-thats-not-healthy
https://voxeu.org/article/zombie-firms-weak-banks-and-restructuring
http://www.oecd.org/officialdocuments/publicdisplaydocumentpdf/?cote=ECO/WKP(2017)31&docLanguage=En
https://gnseconomics.com/en_US/2019/03/11/the-dangerous-zombie-infestation-of-the-world-economy/
https://www.wsj.com/articles/accounting-blowup-at-steinhoff-was-hiding-in-plain-sight-1512585579
YouTube Short Description:
One look at global financial plumbing (which we do in Part 2 of this series) verifies that, short-term debt provided by private corporations is providing the propellent for emerging market and developing country economies. This debt is based on collateral that is vulnerable to runs.
Because of the 2008 stock market crash, central bank easy money policies (zero bound interest rates along with bond buying) spawned the rise of zombie firms. The problem lies with the banks. If taking the losses, as these companies default on their debts, would push the bank into insolvency, it becomes beneficial for the bank to continuously roll these loans over, funding deficits along the way.
As more fiat collateral is created by these zombies, the less real value it has, regardless of the current trading value in the markets.
Physical gold is the soundest collateral with the longest continuous value in history. Ask yourself, when the financial house of card falls, what collateral do I want to be holding? Real or Imagined, the choice is yours.
