As I watch the Big Three bailout saga unfold in Washington from halfway around the world here in Hong Kong, a phrase comes to mind that used to be commonly heard in Asia: "Too big to fail." There was a time when politicians, bankers and bureaucrats in Asian countries thought that certain large enterprises were simply too important to go bankrupt, no matter how miserable their performance. The resulting unemployment would be unacceptable, the impact on the financial sector and economic growth too great. That, in effect, is the same argument being used today by supporters of a government rescue for the cash-burning U.S. auto industry. The consequences of allowing a manufacturing giant like GM to collapse would, their thinking goes, be too onerous for an economy already in recession to stomach. (See the 10 worst business deals of 2008.)
But the experience in Asia over the past decade shows that no company is too big to fail, the fallout is often not as painful as the dire predictions and, in the medium to long term, economies may actually benefit by permitting their deadweight to die.
Take, for example, the 1999 collapse of South Korea's gargantuan Daewoo Group in the wake of the Asian financial crisis. The end of Daewoo, one of the country's four largest industrial conglomerates, was a shocker, but not because anyone was surprised by Daewoo's abysmal financial condition. That was obvious. The group was amassing dizzying amounts of debt in an ill-conceived global expansion (especially at its car company). A year earlier, I had called Daewoo's madcap strategy "corporate suicide" in the Wall Street Journal. The surprise was that policymakers and bankers had the guts to allow Daewoo to collapse. Daewoo was an icon of Korea's astounding economic miracle. Aside from cars, group companies made trucks, ships and TV sets, brokered stocks and built buildings. The Daewoo-owned Hilton Hotel in Seoul even had a pretty good Italian restaurant. More important, Daewoo invested in industries, like cars, perceived as core to the Korean economy. (See the 50 worst cars of all time.)
And the consequences of a Daewoo failure looked catastrophic. Daewoo, it turned out, had about $75 billion in debt and other liabilities a hit the Korean banking sector could ill afford. The banks had just been yanked from the abyss by a government bailout (sound familiar?) made necessary by the 1997-98 Asian financial crisis. And the timing also could not have been worse: the economy was emerging from its deepest recession since Korea's accelerated growth began in the early 1960s. Arguably, a Daewoo collapse was more threatening to Korea than, say, a GM bankruptcy would be to the U.S., simply because the Korean economy is so much smaller. Daewoo had about $50 billion in revenues. The entire South Korean gross domestic product in 1999 was only $450 billion. (GM, by comparison, had $181 billion in revenues in 2007, while U.S. GDP reached $13.8 trillion.) Daewoo seemed too big to fail.
Well, not really. The Korean economy didn't fall into the Pacific after Daewoo's tumble as many had feared. Korea's GDP grew 9.5% the year Daewoo failed, and 8.5% the next. (See pictures of the global financial crisis.)
That isn't to say Daewoo's demise wasn't painful. The government and banks stage-managed Daewoo's unwinding to soften the blow to the economy. The group was broken apart. Some assets were sold. (Ironically, GM acquired some of Daewoo's car company.) Other affiliates got debt restructurings; a government agency bought up Daewoo loans from the financial sector at a discount. Billions were lost. But the whole concept that Daewoo was too big to fail proved false. The reality was that Daewoo had become more burden than boon. Many of the loans it had gobbled up were effectively bad, however they were characterized on banks' balance sheets, because it was unlikely that Daewoo could have paid them off. Government officials and bank executives were simply acknowledging reality.
In fact, it's not hard to argue that the Korean economy was better off with Daewoo out of the way. The persistence of the belief that Daewoo and the other giant Korean conglomerates were too big to fail led many bankers and bond investors to toss billions at them no matter how loony their business plans or unprofitable their projects. Money was wasted in unproductive ways. Once the too-big-to-fail perception was finally dispelled and the large conglomerates were no longer considered the safest investments, bankers and investors, looking for new opportunities, more readily financed small firms, entrepreneurs and consumers, who had been starved of capital.
Japan learned a similar lesson during the economy's Lost Decade after a stocks-and-real-estate bubble burst in the early 1990s. In a pathetic attempt to avoid losses, Japanese banks kept pumping fresh funds into debt-ridden, unprofitable firms to keep them afloat. These companies came to be known as zombie firms they appeared to be living but were actually dead, too burdened by debt to do much more than live off further handouts. One economist called Japan a "loser's paradise." The classic zombie was retail chain Daiei, which limped along for years, crushed by debt and multibillion-dollar losses, as banks kept bailing out the firm. Daiei, with nearly 100,000 employees at the time, was considered by politicians too big to fail. It was only after Japan began solving its zombie problem, rather than perpetuating it, that the country's financial crisis was finally resolved. (Daiei eventually was pushed by its creditors into a workout plan sponsored by a state-linked restructuring agency in 2004.)
Now, I'm not calling GM and Chrysler zombies. Nor am I predicting that the U.S. economy will glide effortlessly through a crisis at the Big Three. But history tells us that no firm is completely indispensable to a national economy, no matter how much of an institution it appears to be. Nor do firms need to be preserved in exactly the form in which we all know them. Any time a giant, money-losing corporation fails, the results are ugly. But the outcome may still look better than a zombie.