Attack of the Zombie Debtors

In financial lingo, zombies are debtors that have little hope of recovery but manage to avoid being wiped out thanks to support from their lenders or the government. Zombies suck life out of an economy by consuming tax money, capital, and labor that would be better deployed in growing companies and sectors. Meanwhile, by slashing prices to generate sales, zombie companies can drag healthier rivals into insolvency.

—BusinessWeek

You would think that once was enough, that the failure of the first round was obvious, but no, Congress has done it again. They have released the second half of Paulson’s $700 billion and that shuffling sound you are hearing is the sound of zombies, coming at the smell of freshly-spilled money.

According to Peter Coy, writing for BusinessWeek: “The Bush Administration has already ladled out billions of dollars in assistance to weak banks and automakers. As the economy goes into what may become the worst economic downturn since the Great Depression, the Obama Administration will come under even more pressure to prop up sick financial and nonfinancial companies to save jobs. The debate will center on wounded giants such as Citigroup (C), General Motors (GM), and insurer American International Group (AIG). Other sectors with their hands out include steel, airlines, retail—and homeowners, who may be the scariest zombies of all.”

Creating Zombies

So far, what we have seen is the government propping up failed or failing businesses with little regard to whether those firms are strong enough to recover once the economic hard times are over. The general rule should be: If the company has a strong core but its finances have been compromised, then help them. If they don’t have the strength, then let them go.

Without that kind of hard assessment, you end up building zombies that suck the life out of the economy, and right now, the economy does not have that much life left in it to begin with.

Residence Evil

I can see the movie now, we can call it Residence Evil with Hank Paulson as the mad scientist who brings the Zombie King and Queen (played by Nancy Pelosi and Barney Frank) to life and Ben Bernanke as his loyal assistant, Igor.

Ok, that may be a little over the top, but as Coy points out, the biggest group of zombies could easily arise from the graves of the subprime mortgage fiasco.

Right now, the biggest zombie problem may lie in housing. Millions of homeowners are juggling mortgages they can't afford to pay alongside other debts: credit cards, auto loans, and so forth. In struggling to keep their heads above water, they're slashing consumer spending, which is harming economic growth.

Coy goes on to point out that up to 2005, bankruptcy would have been the answer for these people, but with the change in the bankruptcy law that year, discharging bad debt is much harder and that just makes the zombie problem worse.

According to a new study by Alan M. White, a ValparaisoUniversitySchool of Law professor, only one-third of modifications of subprime and near-subprime mortgages in November 2008 involved reductions in the monthly payment, often because late fees got tacked onto principal. As a result, he writes, "many modifications are temporary." That's the zombie condition.

Killing the Zombies

The financial equivalent to the requisite headshot needed to take down a zombie is the last thing that our lawmakers—especially those who are ideologically pro-zombie or whose states are already overrun with zombies—are willing to consider: Bankruptcy.

True, it is harder for individuals—mostly thanks to hard-lobbying credit card issuers—but it is still a viable weapon against zombie businesses. Bankruptcy takes the life or death of a company out of the hands of politicians and places into the hands of people far more likely to do the right thing for the right reasons—judges and trustees. Their job is to liquidate a company too far gone to recover (killing the zombie) to restructure things so a company can recover and become profitable again. This was at the heart of the discussions people were having as the Detroit automakers became zombies by taking their first, real bites out of the taxpayers. Now they are back for another mouthful.

The Bottom Line

That is the issue—zombies don’t stop. They don’t suddenly decide to make the changes necessary for independent survival and they don’t go off somewhere to die. They are, to quote the Red Queen, driven by the most primal of urges: The Need to Feed. We look at these companies and feel as though we are helping them, but are we? Or, are we merely perpetuating the problem by allowing the zombies to feed. If we are to recover from this recession, we have to change the way we look at zombies. They must be dealt with once and for all and under current law, that means—for good or ill—bankruptcy.