companies are taking on debts that they probably

can't repay.

Economists call these unviable companies zombie

firms.

They crowd out capital that would otherwise be available

to healthy firms.

Zombie firms are a growing problem around the world.

The share of zombie firms has been increasing over

time. This has detrimental effects to the healthy firms

that compete in the same sector.

Banks and governments keep zombie firms alive when they

bail out unviable businesses.

I actually don't want the government to prop up zombie

companies anymore.

If a company has to die because the world has

changed permanently, let it die.

The Fed's swift interest rate hikes are making

long-suspected zombie firms go bankrupt.

The stance of policy is restrictive, meaning that

tight policy is putting downward pressure on

economic activity and inflation.

As these rates rise, it's becoming more expensive to

do a lot of things, including operating a

business.

There are some firms that actually really should no

longer exist, but there are other times that you have

firms where the underlying business model still has a

potential to create real value.

The fed doesn't see zombie firms as a problem in the

United States, at least not yet.

So we might have come into this year thinking zombie

firms are a small problem and one that will quickly go

away as things normalize.

But if this is the new normal, the problem of

zombie firms, zombie banks and even slower growth for

the whole economy will only become a bigger challenge.

Is the U.S. financial system propping up zombie firms and

how many are left after the pandemic?

Zombie firms are failing businesses that manage to

stay open for years due to cheap credit.

There is no single accepted definition of zombie firms,

but there are common characteristics that we look

for. Usually it's an older firm.

It's not a new firm.

So this is an overly indebted firm.

And on top of that, it's consistently displaying

negative sales growth.

Roughly 10% of publicly listed companies in the

United States are zombies, according to the Fed's most

recent estimate, which was collected before the

pandemic began.

Which is almost twice as large relative to the share

20 years ago.

So there is really a trend here.

Other accounts estimate higher levels of

unprofitable firms weighing on the economy.

One of the more aggressive accounts come from Credit

Risk Monitor, which says that as many as 40% of

publicly listed U.S. companies are actually

unviable. Zombie firms can appear in any sector where

debt is involved.

Like real estate, energy.

These are sectors that traditionally are less

exposed to competition and also tend to be more

financially vulnerable and more prone to swings in

demand.

A big chunk of the universe of unprofitable companies in

the U.S. are actually growth companies.

They're also oftentimes companies that are

under-leveraged. They don't have a lot of debt on

balance sheets and that's a really key difference with

the typical zombie.

It's really important to sort of separate them.

When compared to their peers, zombie firms are

smaller in size, have lower returns on assets, hold less

cash and have lower investment opportunities

than their non-zombie counterparts. Those weak

financials set zombies up for failure if they can't

find a new creditor to bridge the gap.

That's what's happening in 2023.

516 corporations have filed for bankruptcy through

September. That's a huge surge from recent levels.

Companies that used to borrow at zero to invest or

grow their business are now paying, in some cases,

upwards of 9% and 10%.

So if your cost of doing business goes way up and

your sales are growing way less than they used to,

that's a huge problem that's making a lot of

businesses simply not profitable.

Businesses like the trucking giant Yellow.

It filed for bankruptcy in August.

Some 30,000 workers were laid off in the process.

This company had really been in trouble for over a

decade, and what they did in order to make a go of it

was continue to borrow money, use private equity at

times to find new ways of funding themselves, and hope

for new growth options.

But none of those really panned out.

Yellow stayed afloat in its final years with a $700

million bailout loan from the government.

Yellow repaid $54.8 million in interest on that loan,

but just $230 of the loan principal was repaid before

the business shuttered.

The company did not respond to CNBC's request for a

comment.

It was very important during the pandemic that

governments stepped up.

One of the unintended effects could be that the

support was initially mostly untargeted.

So if it's not well calibrated, it might have

kept pre-pandemic zombie firms alive for longer.

And the era of cheap money went away.

And they have to pay market rates to borrow.

Suddenly they don't have as much traffic as they used

to. Their business model doesn't work, and worse,

they're left with the legacy of all the debt they

took on during the zero rate era.

And that's what a lot of other companies share.

It's really raising the bar for what companies have to

achieve. At the same time, we're realizing companies

take a lot longer to achieve profitability than a

lot of people had hoped.

There are people like Sheila Bair, the former head

of the FDIC, who think that these bankruptcies are what

we need to get back to a healthy economy.

I'm hoping we can pull off the proverbial soft landing

and make this transition not too painful.

But once we do get to the other side, it's going to be

better for the economy.

There are some firms that actually really should no

longer exist. There can be a tendency of those weak

banks to continue to extend new loans, because that

helps those firms stay afloat and allows those weak

banks to avoid having to recognize the losses on the

loans that they've already made.

Economists studied the lost decade of the 1990s and

Japan to learn the full effects of zombie firms.

Japan was an early example of this concern that zombie

firms could cause a lost decade of economic growth.

And it's not out of the question that we could face

a similar problem today.

So the issue in Japan was at the time, the combination of

undercapitalized banks and weak supervision.

So they had an incentive to keep these zombie firms

alive under the expectation that the government would

bail them out.

The effect: the share of zombie firms in Japan shot

up after 1994 and a decade of slow growth followed.

Well, what's happening with the U.S.

banks now? They have big losses on their portfolios

while they're hoping that they can continue to make a

nice spread on interest rates. It's not so much a

question of earnings season right now and whether the

banks can get through it. It's really a question of

how much capital do the banks really have to lend

into the economy over the next decade?

And if they don't have as much as we previously

thought, there's a risk that for the broader

economy, we experience a lost decade here, too.

Economists say key U.S.

industries, like airlines and autos, appear to operate

on high debt and potentially an expectation

of government bailouts.

What's happening now is that even if the economy weakens

substantially, the government is constrained.

It can't borrow and come to the rescue the way that it

once did. It's almost a luxury to be able to debate

the idea of whether the government would step in and

lead to a Japanese-style lost decade.

It's not a secret.

And about all I can say is we know that we're on an

unsustainable path fiscally.

It's not that the level of the debt is unsustainable.

It's not. It's that the path we're on is

unsustainable, and we'll have to get off that path

sooner rather than later.

Even in the face of growing debt nationwide, some

investors see this economy as unusually resilient.

I don't think the parallel with Japan holds at all.

The supply side of the economy continues to sort of

grow a little bit.

You're bringing more supply to the labor market.

You're taking down the pressure on wages.

You have the differences that we went through a

massive shock in 2008.

A lot of things have been put in place to reduce the

risk of financial instability.

I think one of the challenges that the Fed and

other bank regulators are having to pay attention to

is have the assumptions that we've traditionally

used when assessing the healthiness of banks.

Do those still hold?

This is where supervision comes in, filling the

inevitable gaps in the rule system.

The Fed's interest rate hikes are expected to rid

the economy of weak performers.

We've raised our policy interest rate by five and a

quarter percentage points, and have continued to reduce

our securities holdings at a brisk pace.

We've covered a lot of ground, and the full effects

of our tightening have yet to be felt.

The biggest implication of the rapid rise in interest

rates that we've seen is that reintroduced the value

proposition of cash as an asset class, and that

actually, you know, puts some constraints on risk

assets.

I think we're only just beginning to see the toll

that high rates are taking.

If rates stay where they are, it's going to reshape

business banks and the U.S.

economy as we know it.

It's aversion to losses.

You might have made a bad loan with information you

had at the time. You know, maybe the firm was like

potentially promising, but it never paid off.

And I don't want to recognize that I, the

investor, or the bank, I was wrong.

And that's human behavior.