Darwinism, as used since the late 19th century, refers to the concept of natural selection in evolution. Based upon the studies of Charles Darwin, Darwinism promotes that the "fittest" of its species will survive and live to create the next generation. Applied to business, this theory makes a lot of sense. The fittest or most profitable businesses should survive, and others will follow their business models to eventual success themselves. But what happens when the system fails?
Survival Of The Poorest
Today, the bailout loans for the Big Three automakers, General Motors (NYSE:GM), Ford (NYSE:F) and privately held Chrysler, were announced by the Bush administration, throwing what many believe is "good money after bad". These companies have not been profitable for years, and in particular, General Motors hasn't made a net profit in the past three years, and lost almost $39 billion ($39 per share) over the past 12 months. How can a company that hasn't been profitable since 2004 blame its situation on the goings on of the past 24 months? The answer to this question is that it can't - General Motors is not a fit company. (To learn the difference between Chrysler's structure and the other two, be sure to read our frequently asked question What's the difference between publicly and privately-held companies?)
The loans were made to the troubled automakers with danger to the nation's economy through closures as the reason for the bailout. In exchange for the rescue, tough concessions are required from the companies and their workers (represented by the United Autoworkers Union or UAW). In addition, the government will have the right to become a shareholder - much like it did with many of the major banks that it also bailed out.
Under the conditions of the loan, GM and Chrysler would have to provide warrants to the government giving it the option to buy in at a specific price. Ford, whose CEO Alan Mulally said would not need the short-term financial assistance, will not be offering up any ownership as of now. Ford's hope is that the aid to the other companies should be enough to stabilize the industry and that Ford will not need to take advantage of the loans being offered. (Discover the advantages of warrants to see why the government might want to use them in our article: What Are Warrants?)
Automakers Are Different
In any other industry, in any other time, companies that are not profitable either close-up shop or are strategically acquired by other parties. So, why did the government feel it had to step in this time?
Given the current financial environment I agree that a failure of these businesses would be detrimental to the economy, but I wonder if artificially propping up these companies is going to change that. Investors (both at home and abroad) are aware of the aid, and this will not necessarily make them any more comfortable in pouring money back into the economy. Yes, the workers will continue to be employed for now, but the concessions required of these companies will result in pay cuts and layoffs - things that would have occurred in a pre-packaged and orderly bankruptcy process. As it stands, I wouldn't be surprised if General Motors still went belly up. Indeed, Fitch Ratings has downgraded GM and Chrysler's debt rating to C from CCC believing that a default is imminent.
Thanks to this act of government, these companies won't be able to just default on the billions in debt they already have, they will default on the tax payer's money now too. I wonder who gets paid first if and when a bankruptcy actually does occur. (Be sure to read our related article What Is A Corporate Credit Rating? to learn more about this concept and An Overview Of Corporate Bankruptcy to learn about chapter 11 and chapter 7 filings.)
I say let them fail. Darwinian pain has been necessary for many other species and industries to reform - take for example, the airline industry or the recent banking industry pains. If the banks can merge, file bankruptcy and arise better, then why can't the automakers? Darwinism must be dead.