Does Halloween lose a bit of magic because people have been wearing masks for 6 months already? Resoundingly, no. Sure, it may be more trick than treat this year, but Halloween itself is about the atmosphere - shorter days, cooler evenings, foggy mornings, zombies...yes, the zombies. We are in the middle of a zombie apocalypse - you see them every day and probably have no idea until they collapse and die right in front of you. One of the more recent ones to be decapitated and burned (take your pick of favored zombie disposal methods) is...Hertz.
That’s right, we’re talking about zombie companies! Zombie companies are those that should have gone out of business a long time ago, but have been reanimated through the Fed’s zero interest rate policies. Without going on another rant about how the Fed has destroyed the notion of productive capital allocation, here’s how zombie companies form:
Let’s say there’s a company called ZomB. ZomB used to be decent, but for whatever reason (maybe they manufacture compact discs, maybe competition with Amazon), they’re not making enough money. They’re still generating revenue, but it’s not enough to cover all the overhead, interest on their debt, dividends, etc. They’re losing money and need to get their hands on more. So they issue more debt. Is this debt at 10% or 12% interest, where it probably should be to justify the risk to the investor of pouring money into a failing company? No! It’s at maybe 5%. The reason it is so low is because 5% seems a fantastical return when the S&P and Treasury bond yields are all under 2%.
Zero-rate Fed policy has incentivized a grotesque yield-seeking behavior - "we all go a little mad sometimes", to quote Norman Bates. So investors give this ZomB money in exchange for pittance for a few years. When the bonds mature, ZomB of course can't pay, so it has to issue more debt and use the proceeds to pay off the old bonds.
This has been working brilliantly (brilliantly at keeping zombies alive anyway, not so much for the growth of the healthy population, er, we mean economy), but every zombie apocalypse comes to an end eventually (except perhaps for Bruce Campbell in Evil Dead).
A couple years ago, the Fed started hiking interest rates. Say interest rates rise 2% - the next time ZomB needs to refinance its debt, it will have to offer closer to 9% or 10% instead of 6%. The amount of interest starts piling up, requiring ever more debt to satisfy. Eventually, they can’t refinance because they are so obviously bankrupt that no investor will give them any money. And that's when these zombies finally get to die in bankruptcy.
But that was then. Now, we're back to 0% interest rates and will be for the foreseeable future (probably years). As a result, we have seen record issuance of below-investment-grade debt this year. In fact, there has been more junk bond issuance through the first two thirds of this year than in any other full year on record!
So we now have over $2 trillion (with a “t”) in below-investment-grade debt outstanding. A lot of that belongs to companies that should have been taken out behind the woodshed and shot years ago. But just like when your best friend/lover/whoever first gets infected/bitten/whatever and you know you should kill them before they turn into a zombie/vampire/whatever but can’t and then are forced into a life or death struggle for survival, it didn’t happen. So here we are.
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