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Peter Crabb: Some industries seeking government aid have too much market power

Why so much and why is everyone saying more is to come? The $700 billion financial rescue package of October 2008 is apparently not enough.

On Monday, the government decided to add $40 billion to the American Insurance Group (AIG) takeover. Apparently the government’s original plan is too cumbersome for the company, preventing other investors from inputting more cash.

AIG continues to operate, and no policy holders have lost out, but more cash is needed to meet obligations. The government continues to worry how that the banking system will falter if AIG fails because the company has issued so many credit default swaps.

Continuing declines in economic activity suggest it’s time for others to get help. Congressional leaders are calling for emergency legislation to help the U.S. auto industry, especially General Motors (GM). Congress will need new laws as the Bush administration is resisting the use of funds for automakers under the current bailout plan.

On Wednesday Treasury Secretary Paulson said Treasury would continue to use funds from the $700 billion program to purchase stock in banks in the hope banks will resume more normal lending. He also said he would look at other kinds of financial institutions but said nothing of other industries. The Treasury is not running any auctions to purchase bad loans as originally written in the bank rescue plan. Direct purchase of company stock looks to be the only plan today.

But more and more industries want help. The New York Times reported Wednesday that the National Marine Manufacturers Association is asking whether boat financing companies might be eligible for aid. The cost of credit in this market has risen, and fewer loans are approved.

What makes large insurance companies (AIG) and large automakers (GM) so important? The economic answer is concentration. Relative to others, these industries are characterized by a few dominant firms. According to 2002 Census data, the insurance industry is one of the most concentrated in all of finance - much more than banks or securities brokerages.

The U.S. Department of Justice tracks industry concentration and is charged with breaking up industries where it becomes a problem. The Herfindahl-Hirschman Index (HHI), is the accepted measure of market concentration in manufacturing industries like motor vehicles.

The HHI is calculated by squaring the market share of each firm competing in the market and then summing the resulting numbers. Markets with an HHI between 1,000 and 1,800 points are labeled “moderately concentrated,” and those in which the HHI is in excess of 1,800 points are considered concentrated.

The HHI for automobile manufacturing is 2,754. Perhaps more problematic is the fact that auto parts manufacturing is also concentrated. Most auto part industries, like powertrains and transmissions, have HHIs in excess of 1,000.

The Detroit News reported this week that even Japanese car makers would face hardship if one of the U.S. carmakers failed. These firms rely on the same parts suppliers as the U.S. auto makers. Thus, these industries both contain the proverbial “too big to fail” companies. But more to the point, industry concentration is too high.

If there are any strings attached to more bailout legislation, policymakers should consider methods to reduce the level of concentrated power. More active enforcement from the Department of Justice and more open trade with other countries are two valid considerations.

Since 2000, Peter R. Crabb has been a professor of finance and economics at Northwest Nazarene University in Nampa. He earned his doctorate in international and financial economics from the University of Oregon.