Why corporate bankruptcies were up in 2023 despite the improving economy
Imagine taking a Bird scooter to Rite Aid before heading to a WeWork, where you read a news article on Vice and then buying a gift on Bed Bath & Beyond's website.
What is this, 2018?
No, this is 2023, and you've just interacted with five of the hundreds of companies that filed for bankruptcy this year. Most of these companies have not completely collapsed, but they are limping along.
While most major indicators, like inflation finally cooling off and consumer confidence improving, show the economy turning the corner, corporate bankruptcies this year have moved in the opposite direction.
A confluence of forces including rising interest rates, stubborn inflation earlier in the year and companies dealing with crushing debt piled up during an era of easy money have resulted in one of the busiest years for corporate bankruptcies in more than a decade.
According to S&P Global Intelligence, there were 591 corporate bankruptcies in 2023, one of the highest bankruptcy totals since 2011. Only 2020, with 639 corporate bankruptcies, witnessed more.
"This is the market swing we've been expecting for some time," said Brook Gotberg, a professor at Brigham Young University who specializes in bankruptcy law.
Government aid during Covid delayed bankruptcy uptick
Gotberg said bankruptcy watchers have long been expecting a surge in bankruptcies following the boom in corporate borrowing that accompanied the Fed's years of near-zero interest-rate policies.
Rates began creeping up right before the pandemic, but then they were slashed during Covid-19 to prevent the economy from cratering. Businesses capitalized on the moment. Enjoying historically low interest rates, companies borrowed trillions of dollars and spent freely, some plowing ahead with overly ambitious growth plans that loaded the companies up with debt.
In recent years, those same companies started to run out of cash, and they were unable to secure new financing, leading to a wave of bankruptcies.
"Bankruptcies are cyclical," Gotberg said. "There are periods of prosperity. Companies borrow. Then a spike in interest rates, and companies can't refinance, and bankruptcies suddenly surge," she said.
Companies turn to Chapter 11 for breathing room, re-organization
For many companies this year, like Bed Bath & Beyond, Rite Aid, Party City, WeWork, Bird, Envision Healthcare, Lordstown Motors, and many more, the bankruptcies were under Chapter 11, which is a type of court proceeding aimed at restructuring a firm, not totally shutting down.
"Chapter 11 gives a little bit of time for a company to get their act together and fix their problems," said Edward Altman, a bankruptcy expert at New York University.
The process allows a company to put debt payments on hold; a chance to sell off parts of the company that are not doing well; the ability to renegotiate lease commitments or escape them altogether. Chapter 11 also makes it easier to get new loans to try to find firmer financial footing. Basically, it's a way to hit the pause button and try to cut expenses enough to survive.
Some major companies, or entire industries, have gone through the Chapter 11 process. Nearly every airline in the U.S. has gone bankrupt and re-organized in Chapter 11. And, in 2009, General Motors did the same, cutting its debt and expenses and emerged a profitable company.
"And General Motors is seen as the playbook for many companies today," Altman said.
'Zombie companies' also on the rise, which could mean more bankruptcies
Altman also studies what are known as "zombie companies," which are firms that do not make enough money to pay the interest on their debt. They are called zombies because despite not doing the very minimum on their debt obligations, they still exist, even if their fundamentals are essentially dead.
Altman said the number of zombies has been skyrocketing in recent years, which creates a major drag on the economy. That's because the ambling corpse-like companies are using money that could be put toward other parts of the economy, like more innovative and productive companies.
The number of zombie companies, Altman's research has shown, has grown from 1.5% in the 1990s to nearly 10% today among publicly traded companies in the world's 20 largest economies.
"Corporate zombies are on the rise, and I predict it is going to get worse in 2024, when an enormous amount of corporate debt is coming due and companies are facing difficulties trying to refinance or pay off that debt," Altman said, pointing out that for many of the companies, insolvency will be their likely fate.
"For now, those companies are somehow surviving," he said. "But many will eventually go bankrupt."
Stephanie Kelton, an economics professor at Stony Brook University, said banks are not extending as many lifelines to struggling companies as they once did since credit is no longer cheap. Companies cannot afford it, and banks view debt-saddled firms with cash flow problems as risky borrowers.
One possible result of this next year? Perhaps a surge in zombie companies being acquired or merging with other firms, Kelton said, "as many of these on-the-precipice firms may prefer to be taken over versus filing for bankruptcy."
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