In a short Twitter thread last month, Olivier Blanchard, former chief economist of the IMF and past president of the American Economic Association, reassessed how the economic effects of the pandemic had played out compared with what he had expected. One striking observation was: “I expected a lot of inefficient bankruptcies, due to high debt rather than lack of viability post covid. This . . . does not seem to be the case. The proportion of low productivity firms in bankruptcies appears to be roughly the same as usual.”
Blanchard is, of course, right. Despite the deepest economic hit in our lifetimes, the rate of companies going bankrupt is markedly lower than last year and has kept falling since the onset of the first lockdowns. And this phenomenon seems universal across advanced economies.
Here is the pattern in Germany, where the number of insolvencies was down 17 per cent year on year in July, and provisional numbers show a 35 per cent year-on-year fall in September:
Here is the UK, where (England and Wales) insolvencies were down 42 per cent year on year in October:
In the US, Chapter 11 restructurings have gone up, but liquidations under Chapter 7 fell 32 per cent in the year to October compared with the same period last year. And in France, the number of corporate bankruptcies in the 12 months to September was 30 per cent lower than one year earlier (the chart below shows 12-month running totals of bankruptcies).
This is good news, for now. We cannot exaggerate how unusual this is; Blanchard and the rest of us were right to fear a bankruptcy wave. That is the normal pattern in any downturn, let alone as big as this.
The European Central Bank’s latest Financial Stability Review includes the chart below, which traces corporate insolvencies alongside economic growth and is an indicator of companies’ financial vulnerability. It shows that these economic phenomena have followed each other closely — until this year.
This immediately raises two questions: why have bankruptcies been subdued and can it last?
The reason companies are surviving is not, as the ECB chart shows, that businesses are in good shape; financial vulnerability is at a record high. Instead, it is, at least in part, that governments have gone all out to prevent bankruptcies, or at least to delay them. One thing they have done is to put to work a large battery of measures for liquidity support. Central banks have poured money into financial markets and set up or enhanced facilities to ensure these measures improve companies’ access to credit. Governments have put in place guarantees to banks that lend to corporations. And there has been direct financial support to subsidise wage costs or compensate for companies’ hard-to-avoid running costs, thereby improving their liquidity position.
These offers of liquidity have been taken up, as the IMF’s latest Global Financial Stability Report makes clear. Corporate indebtedness has increased — partly because strong companies have borrowed to build up cash chests, but partly, too, because harder-hit companies have had to substitute loans for business income in order to survive.
Another type of policy has been regulatory measures to forestall bankruptcy filings. Germany and France, for example, have postponed the requirement to file for insolvency. Sometimes such steps have made a virtue of necessity: the pandemic also hit courts and caused the work of the judiciary, including insolvency procedures, to slow down dramatically. So we can chalk up some, but only some, of the unexpectedly low level of bankruptcies as a policy success.
All the reasons why companies’ survival rates have been higher than we may have feared are, unfortunately, reasons to think this will not last. Eventually, both policy-imposed and involuntary delays to the insolvency procedure will catch up with companies weakened by the pandemic.
In the best-case scenario, new vaccines prove reliable and are rolled out fast, business returns to normal and companies’ cash flow is restored. But that does not undo the severe damage many corporate balance sheets have already suffered. They will remain vulnerable for a long time. And if the pandemic retreats and the economy recovers strongly, it could, perversely enough, tempt governments to end support and stimulus policies prematurely. That would leave financially weak companies even more vulnerable.
In other words, we should think of the missing bankruptcy wave as delayed, not avoided. That poses a double danger. One is that without preparation, a cascade of bankruptcies causes deeper economic damage than it needs to. The other is that policymakers delay bankruptcies for too long, tying up labour and capital in “zombie” companies and activities that will never be viable again.
The solution to both problems is the same: it is to create bankruptcy procedures that allow viable activities to go on rather than be dragged down by unpayable debts. The US is ahead of Europe on this (if Chapter 11 reorganisations are the exception from the general trend of falling bankruptcy numbers, it is probably for the right reason). And the trend in many countries has been towards more streamlined insolvency processes that avoid liquidation where it is not necessary.
But all economies, especially in Europe, can and must do better. Zombies with debt overhangs and liquidation are both threats to the recovery and to long-term productive capacity. The unusual but welcome delay in bankruptcies gives us the breathing room to upgrade bankruptcy rules, boost the staff and budgets of institutions dealing with insolvent companies and, above all, make it a political priority that debts should be restructured early and quickly so as not to drag down valuable economic activity.
Perhaps this is too pessimistic. Perhaps insolvency problems will remain low, or the recovery will be so strong as to make them manageable. It still makes sense to prepare for the worst, and allow ourselves to be pleasantly surprised.
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