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. Thanks for tuning into this week's podcast. Don't forget to subscribe on your podcasting app if you want to be updated whenever a new podcast is released.
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