Too Big to Fail

Imagine this: you are placed in charge of the federal government and given carte blanche to do whatever you seemed appropriate to fix what is broken and to solve problems.  The first item that lands on your desk is the following: you must decide which of two companies to assist financially, and which to let struggle and possibly fail.  They are ABC Corp and XYZ, Inc.  Both are manufacturing concerns who employ scores of thousands of people.  Both are in the same industry and are direct competitors with each other.

ABC Corp has burdensome contracts with labor unions, which has led to high labor costs, generous retirement benefits, and out of control health benefit obligations.  There are nearly 4 retirees for every current worker.  Because of these obligations, hourly labor costs per employee are 50% higher for ABC Corp than for XYZ.  To make matters worse, ABC Corp's credit rating has dropped over the past fews years to the point that it is having a hard time borrowing money.  And for good reason - it has a hard time paying its debts.  ABC's products have a reputation (whether it is valid or not) of being inferior to XYZ's, and sales have slipped.  It is considering filing bankruptcy.  In the past 15 years, ABC has shed more than 80,000 jobs to help stay afloat.

XYZ, Inc, on the other hand, is in sound financial condition, for a variety of reasons.  First, its reputation for quality is very good, given that the best 10 products in its field as rated by Consumer Reports are all made by XYZ.  This has led to solid sales, especially for repeat buyers.  Labor costs are under control.  While it pays its employees a comparable hourly rate to ABC, fringe benefits are more in line with other Fortune 500 companies, especially legacy costs (those paid to employees no longer working).  Its credit is good, and it has been expanding its manufacturing capacity to meet increased demand.  While ABC has been cutting its workforce, XYZ has added more than 90,000 people to its payroll in the US.

Given these facts, would company is worthy of assistance and which should be allowed to fend for itself?  Where would the money be better spent - on ABC Corp or XYZ?

This isn't merely an academic exercise.  ABC Corp is the American auto industry, while XYZ is the US component of the Japanese auto industry.  Our current administration is telling us that GM and Chrysler are "too big to fail", that we need to pour billions upon billions of dollars into these monstrosities.  What they fail to grasp is that lack of capital is not what got the US auto industry into this mess - a bad business model did.  The market is punishing Chrysler and GM for bad decisions they have made in the past.  Rather than trying to stave off the inevitable, our government needs to listen to what our free market is saying loud and clear: these companies are financially unsound.

But if GM and Chrysler stop making cars, what will happen to all those people who work for the auto industry and its related sub-industries?  That's really a red herring, a question meant to distract us from the fact that our money is being wasted on these poorly-managed institutions.  If GM stops making cars, the American public won't stop buying cars.  There will be just as much demand as before.  Toyota, Honda, Nissan, etc. will increase manufacturing capacity to meet this demand.  It makes much better financial sense to take all that money that we're throwing away on GM and lend it to Japanese auto makers so that they can build more factories and employ those people laid off by GM and Chrysler.  The only thing is - they don't need the federal government to lend them any money.   Their credit is strong enough that banks will lend them money, because they are confident that it will be repaid.

About this Entry

This page contains a single entry by Louis Core published on May 24, 2009 3:40 PM.

U2: The Best Rock Bad Ever? was the previous entry in this blog.

My Problem With Gay Marriage is the next entry in this blog.

Find recent content on the main index or look in the archives to find all content.