As COVID Rages, Bankruptcy Cases Fall…..For Now

Yves here. This post explains the seeming contradiction of severe Covid-induced distress in many sectors of the economy, such as restaurants, retail stores in central city office districts, hotels, personal services, with a decline in the number of bankruptcy filings. The authors attribute the disconnect to government support, which they argue will decline before there’s enough improvement in fundamentals to get business owners out of their hole. Remember also some US states and cities have imposed rent and/or eviction moratoriums. That does not make the payments away, but merely defers when they have to be paid. And when those stays of execution end or are about to end, it’s not hard to think that that alone will trigger additional bankruptcies.

Another factor that some have argued is working in the US is that a higher proportion of businesses than normal are closing not by using the bankruptcy process but by simply shuttering their operations. The argument is that for small businesses, bankruptcy almost always means a personal bankruptcy too, since most lenders require the owner to guarantee the obligation personally. A personal bankruptcy makes it hard to get credit or a new job, so it’s better if possible to wind up a business rather than resort to bankruptcy. And as much as it is draining to shutter a company, bankruptcy is even more so.

Can readers provide any intelligence about the fragility of businesses in your area, and if waning government support is increasing distress?

By Simeon Djankov,Policy Director, Financial Markets Group, London School of Economics and Eva (Yiwen) Zhang, Researcher, Peterson Institute for International Economics. Originally published at VoxEU<

Bankruptcies have fallen sharply in OECD economies because of the array of COVID-related support available to businesses, as well as imposed moratoria on bankruptcy filings. This column argue that this situation won’t last, and that governments should start planning for a surge by the end of 2021 – ideally by reforming their bankruptcy laws, as the UK has done, and lessening the burden on courts.

Bankruptcies have fallen sharply in OECD economies because of the array of COVID-related support available to businesses, as well as imposed moratoria on bankruptcy filings. This column argue that this situation won’t last, and that governments should start planning for a surge by the end of 2021 – ideally by reforming their bankruptcy laws, as the UK has done, and lessening the burden on courts.

Economic crises bring an upturn in bankruptcies. Companies suffering losses struggle to survive, and many fail. A wave of bankruptcy filings was expected in the wake of COVID-19 too (Bailey et al. 2021). Yet during 2020, the number of corporate bankruptcy filings in most advanced economies – members of the OECD – fell by 17% relative to 2019, and by even more relative to previous years (Figure 1). This decline in bankruptcy cases demonstrates the success of the initial COVID-19 response measures. On second glance, however, it brings worries too (Blanchard et al. 2020).

Figure 1 Average 2020 bankruptcy filings are 17% lower than in 2019

Note: The index is based on total number of bankruptcies in 25 advanced economies (Australia, Austria, Belgium, Canada, the Czech Republic, Denmark, Estonia, Finland, France, Germany, Iceland, Japan, Luxembourg, the Netherlands, New Zealand, Norway, Poland, Portugal, South Korea, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States. For 12 economies (Australia, Belgium, Canada, Estonia, Finland, Germany, Iceland, Norway, Spain, Sweden, Turkey and the United Kingdom), the latest available data (most often to November 2020) are annualized to 2020 annual aggregates.
Source: Authors’ calculation using national data (accessed through Macrobond on 26 January 2021).

Bankruptcy Filings Have Declined in 24 of 25 Advanced Economies

Data for 2020 are available on bankruptcy filings in 25 OECD economies. In the US, these fell by 16% relative to last year. The other major economies show the same pattern of decline. In Japan and Germany the falls are 7% and 13%, respectively; in Canada and the UK, bankruptcies fell by around a quarter (Figure 2). The largest decline is in Australia and France (40%), while Poland is the only country that shows no change relative to 2019.

Figure 2 Bankruptcy cases decline across advanced economies

Note: The index is based on total number of bankruptcies in 25 advanced economies (Australia, Austria, Belgium, Canada, the Czech Republic, Denmark, Estonia, Finland, France, Germany, Iceland, Japan, Luxembourg, the Netherlands, New Zealand, Norway, Poland, Portugal, South Korea, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States. For 12 economies (Australia, Belgium, Canada, Estonia, Finland, Germany, Iceland, Norway, Spain, Sweden, Turkey and the United Kingdom), the latest available data (most often to November 2020) are annualized to 2020 annual aggregates.
Source: Authors’ calculation using national data (accessed through Macrobond on 26 January 2021).

The reasons for this decline are twofold. The COVID-19 pandemic has induced governments in many advanced economies to finance job support programmes to assist workers and to temporarily halt bankruptcy procedures – providing lifelines to keep firms alive through the crisis, at a time when premature bankruptcy can worsen the recession. The job support programmes have been updated and expanded in most OECD countries, while the bankruptcy moratoriums are expiring soon in many countries. Australia, for example, returned to normal bankruptcy procedures on 1 January 2021 (Australian Financial Security Authority 2021).

For many employers and businesses, the government programmes have worked. Businesses have reacted by keeping employees on board or hiring new ones when restrictions on business operations became less onerous. In turn, the support keeps businesses open, in the hope that the economy turns around.

This availability of plentiful financial support to businesses cannot continue for long. A large number of firms will need debt restructuring once government support programmes run out and the courts open up. Extensive reorganisation or liquidation procedures, which may work in normal times, will prove insufficient to service a large wave of insolvencies. Changes to existing regimes should be done now, before the wave on bankruptcies comes. In March 2019 – a year before COVID started closing down businesses – the European Parliament adopted a new directive on preventive restructuring, aiming to increase the efficiency of insolvency proceedings (Becker 2019). The Reform Directive specifies that a new procedure must be in place in all EU member countries by 2022. The UK has done just that and thus provides an example for other governments to follow.

The UK Has Added Three Features to Its Bankruptcy Law

The amendments to the UK insolvency law, adopted in June 2020, add three features (Balloch et al. 2020). First, these amendments introduce a two-month moratorium, during which the company benefits from a payment holiday from the majority of its debts. Second, the amendments allow the debtor to propose a rescue plan that can be forced onto every creditor if the majority of creditors agree. Third, suppliers are prevented from stopping deliveries once they find out that the debtor has trouble paying creditors, as long as the firm pays for its supplies on time – even ahead of bank creditors. Research on bankruptcy procedures around the world (Djankov et al. 2008) shows that the type of changes the UK has enacted increase the likelihood firms will survive, as they continue operating during their restructuring.

Some economists are concerned that keeping insolvent firms alive will drain resources from the healthy parts of the economy (Acharya 2020). These fears are fundamentally misguided. Policies to force businesses to shut down permanently risk slowing down the COVID recovery (Laeven et al 2020). As businesses shut down, they break a supply chain that affects other businesses, including in healthier sectors. Such breakage should be avoided as much as possible.

See original post for references