I first ran into the idea of zombie firms–and the need to kill them–back in the late 1980s, when the US savings and loan industry was melting down. Here’s an explanation from that time from Edward Kane (“The High Cost of Incompletely Funding the FSLIC Shortage of Explicit Capital.” Journal of Economic Perspectives, 1989, 3:4, 31-47).

“The events of the early 1980s broke the savings and loan industry into two divergent parts: the living and the living dead. This terminology portrays firms whose enterprise-contributed capital has been lost as soulless “zombie” institutions. … Zombie firms now constitute roughly 25 percent of the FSLIC-insured thrift industry. As in a George Romero zombie movie, capital forbearance brings dead firms back to a malefic form of quasi-life in which they attack the living, turning the prey they feed on into zombies, too. In a kind of Gresham’s Law scenario (an analogy suggested by Joseph Stiglitz), “bad” zombie thrifts tend to drive out healthy competition. Zombie institutions do this by sucking deposits away from their competitors by offering high interest rates and by bidding down loan rates on high-risk projects. This squeezes profit margins and the proliferation of weak competitors and risky positions ultimately raises deposit-insurance premiums for everyone.”

The key insight is that when governments show restraint in killing the zombies, they soak up capital and slash prices in a way that makes it hard for other firms to compete, thus creating more zombies. Frank Borman, an astronaut who commanded Apollo 8 and later ran Eastern Air Lines, liked to say: “Capitalism without bankruptcy is like Christianity without hell” (for example, see Time magazine, “The Growing Bankruptcy Brigade,” October 18, 1982, p. 104).

Zombie firms were also sighted in Japan after its economic meltdown in the early 1990s. For example, Takeo Hoshi and Anil K. Kashyap wrote (“Japan’s Financial Crisis and Economic Stagnation .” Journal of Economic Perspectives, 2004, 18:1, 3-26):