Call them "zombie" companies. Many more has-been companies will be feeding opposite to taxpayers, investors, and workers—sapping the lifeblood of healthier rivals

By Peter Coy

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Henrik Drescher

Zombies. Seen one lately? If not, you may soon, because they are about to intimidate the U.S. economy. In financial lingo, zombies are debtors that have little hope of recovery but that manage to avoid being wiped out thanks to support from their lenders or the government. Zombies swallow up life out of an economy by consuming assessment 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.

Sometime in the past not many months, zombies went from being a latent risk to a genuine threat—unit that is likely to augment in the months against us. The Bush Administration has even now ladled free from billions of dollars in alms to weak banks and automakers. As the system goes into what may become the crush household downturn since the Great Depression, the Obama Administration will tend hitherward under even more pressure to prop up sick pecuniary and nonfinancial companies to save jobs. The debate will center on wounded giants such as Citigroup (C), General Motors (GM), and underwriter American International Group (AIG). Other sectors with their hands out include steel, airlines, retail—and homeowners, who may be the scariest zombies of quite.

Hard choices lie ahead, so it’s prominent to have a sturdy framework conducive to making them. The right approach, say those who have studied the cause of distress, is to prop up a company if its core business is healthy but its financing sources have temporarily shut down. Otherwise, let it go. Postponing the decision by supporting sick and healthy in the same manner will merely issue the eventual misery greater and reduce growth. “If an institution is poorly managed and does not have a reasonable plan for acting out its problems, they ought to go ahead and shoot it,” says William M. Isaac, a former Federal Deposit Insurance Corp. presiding officer who now heads brink consultancy Secura Group.

Japan was plagued by the agency of zombies during its lost decade of slow growth in the 1990s. Weak Japanese borrowers used the proceeds from fresh loans to pay interest on old ones—a process called “evergreening” that kept banks from having to acknowledge losses. In the ’80s, the U.S. airline industry was pulled down by Eastern Airlines, which was allowed to keep flying (and charging low fares) while in insolvency flattering attention. That doesn’t lend aid anyone. “At more point, you indigence to wake up and accept the fact that, ‘Oops, that’s not going to work,’ ” says Stéphane Téral, an analyst with Infonetics Research who tracked the demise of scads of telecom carriers in the early 2000s.

Protecting zombies can stunt long-term growth by blocking what economist Joseph Schumpeter called “creative shipwreck”—the painful but necessary reallocation of resources from declining companies and sectors to rising ones. That turns out to be trying. In the U.S. manufacturing and retail sectors, a vast share of productivity gains have come from like reallocation, says economist Steven J. Davis of the University of Chicago Booth School of Business. Case in epigram: the growth of hyperefficient Wal-Mart (WMT) at the expense of mom-and-pop shops, which were allowed to draw the last breath. The default of such reallocation could slow productivity growth.

“LEMON SOCIALISM”

The problem with the common bailout is that the ruling power may be giving standard of value to companies that don’t have a long-term future: zombies. On paper, for example, the Treasury Dept. says it invests Troubled Asset Relief Program (TARP) money only in “healthy banks—banks that are considered viable without government investment” because “they are best positioned to increase the flow of credit in their communities.” That’s the right idea. In practice, notwithstanding that, the criteria aren’t so stringent.