Textbook Case: How Government Can Create A Depression

Have you ever heard of Republic Windows And Doors? Unless you live on the North Side of Chicago, you probably haven’t. But they’re at the heart of what is becoming a textbook case in government overreach and willingness to interfere in private business dealings. And no less than the Man of Destiny himself, Barack Obama, has waded into this swamp, with both feet.

Republic is a family-owned business that has been operating since 1965, and had 700 employees as recently as two years ago. On Friday, they closed their doors forever.

Republic is a small-business victim of the “credit crunch” I’ve been telling you about here for sixteen months now. Their business of making new and replacement windows fell off sharply, along with the collapse of the residential construction industry. This is a sad story, which sadly will be repeated many, many times across America in the months and years ahead.

Republic did their banking with Bank of America, which pulled a line of credit from the company late last week, forcing them to close down. That’s what happens in a credit crunch. Now there isn’t enough public information to give you a full picture on the negotiations and other dealings that led to this point, and the company’s website has vanished behind a firewall.

The bottom line is that Republic’s business has largely evaporated. That’s not their fault, nor is it BoA’s fault, but it does mean that it makes no sense whatsoever for the company to continue drawing on credit lines, and it means that it makes no sense for BoA or anyone else to continue extending the credit. You simply do not lend money when it’s not likely you’ll be repaid. If you were a shareholder of BoA, that’s the very last thing you’d want them to do. Banking isn’t charity.

(Side note for the lawyers: yes, I’m well aware that a bank line is a binding contractual obligation. If BoA chose to modify the terms of an existing agreement, they would have had to invoke a material-adverse-changes clause, or force majeure, or whatever. There’s not enough published information to answer these questions yet, although it does appear that this situation has been in negotation for nearly two months now. None of the reporting implies that BoA has broken a contract or acted in bad faith. A spokeswoman for Republic characterized it as an understandable business decision.)

Well, hold on a minute. When you’re forced to shut down a business in a hurry, you make life hell for your employees. And Republic find themselves in the evil position of having to dismiss 300 employees, right before the holidays.

Except that 260 of these employees are represented by the United Electrical, Radio and Machine Workers. Now looking back over the recent history of this company, which has included several recapitalizations and management changes, you have to figure that they had a lot of trouble matching costs to the realities of their business. This is more or less the natural state of affairs when you have a union, as the Big Three automakers could tell you.

Would this company still be in business if their workers weren’t organized? Good question, although their management don’t seem to have been prizewinners either. But leave that to the side.

What the union is doing now, is literally occupying Republic’s production facilities and refusing to allow themselves to be locked out. In effect, the company can’t shut down because their workers won’t let them.

The union is demanding 60 days’ severance and vacation pay for all the affected members of the union. They’re citing a Federal law that requires companies to give 60 days’ notice before closing a plant. But the law contains exceptions for unforseen circumstances, and I’m sure all of this will get thoroughly aired in the months of ugly legal proceedings to come.

Now, at long last, we come to the nut of the story, and why I’ve recited it all to you here.

The union has decided that Bank of America is to blame for the fact that Republic Windows And Doors is going out of business. Accordingly, they’re demanding that BoA lend enough money to Republic to pay out the 60 days’ severance and vacation pay to the unionized labor.

When I first heard this story a few days ago, I thought what you’re thinking now: boy, this is stupid. The bank isn’t liable for a business failure, and they can’t flush their own money down a rathole, for a large number of very good reasons.

But that wasn’t the end of the story. Illinois governor Rod Blagojevich said that his State does business with Bank of America that’s worth hundreds of millions of dollars in fees and commissions. And that the State of Illinois would pull their business from Bank of America unless they funded the union’s demands.

This is also incredibly stupid. You don’t poke your nose into the dealings of private businesses if no laws were broken. And Blagojevich knows that.

And then it got even more stupid yet. Barack Obama, no less, was asked about the situation in a press conference on Sunday. And he expressed support for the workers. He was quoted in various wire stories to the effect that his plans and programs would need to “get money out the door” and help ordinary people.

Fair enough, Mr. Obama. And I know as well as anyone that the ongoing efforts to stabilize the financial system have been mysteriously unsuccessful at getting banks to start lending again. (Well, it’s mysterious to some people, maybe. Not to anyone who’s ever seen the inside of a bank.)

But the President-elect of the United States has implicitly given his support to an attempt by the State of Illinois to blackmail a private corporation into modifying the way it makes business decisions.

Now this tells you one of two things about Barack Obama: either he’s incredibly unaware of the effect that his words have, now that he’s the President-elect. Or, which would be far worse, he actually believes that it’s appropriate for Illinois to strong-arm the Bank of America into flushing its depositors’ money down a toilet, in order to get an ugly but isolated situation out of the headlines.

The President-elect needs to stand up and clarify which of these two possibilities is the truth.

But still, all of this is in the realm of the stupid and un-noteworthy. I’m about to tell you why it’s not stupid at all. Instead, it’s something that should frighten the heck out of you.

The reason you need to be frightened about the behavior of a grandstanding Governor and a clueless President-elect, is to be found in the rationale being given for why Bank of America should be required to pay severance to the workers who lost their jobs.

It goes back to the TARP financial bailout plan. Bank of America is one of the companies who, on October 13, were informed by Treasury Secretary Paulson that they would be required to sell big chunks of preferred stock to the government. The point of this was to ensure that the key players in the banking system had adequate capital. (In fact, many of the biggest are now overcapitalized, far beyond historical norms.)

Bank of America was forced to take about $15 billion in new capital at that time, and had to submit to a raft of new restrictions on its business, including limits on executive pay. (According to a timeline published by Republic Windows and Doors, this was just two days before the negotiations began, that finally led to Republic’s failure.)

It’s the position of the State of Illinois that, because Bank of America has received taxpayer funding, they ought to make and/or modify ordinary business decisions according to the wishes of the State.

Ok, look. I’ve always been a strong proponent of free markets. But free markets are no longer something we should expect to continue in America. We had this debate during the Presidential election, and our side lost the debate.

Elections have consequences. Barack Obama promised so many times to interfere in free markets, that we simply have to live with the fact that free markets in America are a thing of the past, and perhaps of the future, but not of the present. This is what Americans voted for.

And what of the Bank of America, and all the other banks that have accepted Federal assistance and are watching this case with their eyes peeled?

Well, put yourself in their position. You base your whole business on decades of experience in managing risk. The cost (and therefore the price) of credit depends on the risk in each situation. But now, a new risk has appeared: the risk that entities of government will step up and tell you to extend credit to people you wouldn’t otherwise have done.

How do you react? No excrement, Sherlock! You raise the price of credit sharply to compensate you for the increased risk of loss. And at the margin, you’ll curtail your existing books of business, and you’ll stop expanding credit.

Go back and look at the history of the Great Depression. State legislatures enacted all kinds of statutes throughout the Thirties to make it harder for banks and other financial intermediaries to sieze collateral and do other normal things to manage their risk. There’s ample evidence that these statutes, well-intentioned as they were, exacerbated the fundamental problem that remained in the US economy after the financial crises of the early Thirties were quelled.

In short, from about 1933 until the war, credit formation by private banks ran well below historic and sustainable levels. That’s the true reason the Great Depression lasted as long as it did.

Again, the only word I can think of for Barack Obama’s response to this situation, is clueless. He’s supporting government behavior that, if sustained widely, is exactly the kind that can easily turn the current recession into something far, far worse.