A Win for Capitalism, a Loss for State Capitalism

Published August 17, 2012

In the span of two weeks we have seen a success of capitalism and a growing failure of state capitalism. On August 1 came news that computers at Knight Capital went nuts, automatically buying more than $4 billion of securities the company had not meant to buy. In less than one hour Knight Capital’s glitchy computers had cost the company $440 million in losses. Now comes news the U.S. Treasury Department has revised up its estimate of the federal government’s probable loss from its auto company bailouts. The loss is estimated at $25.1 billion, up more than $3 billion from the last estimate. More losses are possible. The Knight Capital losses could have ruined the company, which until that day was the nation’s largest trader in U.S. equities. Company executives went begging to Securities and Exchange Commission Chairman Mary Schapiro for permission to back out of the trades. She said no. But Knight Capital did not fail, even though failure would have been fine in a capitalist system. Companies that mess up big time should pay a price. But it’s also fine in a capitalist system for investors to take advantage of the mistakes of others, and this they have done. A group of companies has put up $400 million to keep Knight Capital in business. The new investors receive stakes in the company and seats on its board of directors. So we have here a private company on the brink of ruin rescued by other private companies backed by their private investors. If Knight Capital succeeds, those investors reap the rewards. If Knight Capital fails, they take the losses. That’s capitalism. Then there’s the federal government’s bailout of Chrysler and General Motors. Some people call it state capitalism, crony capitalism, or corporate capitalism. There are other cruder names for it, too. Capitalism it is not. Heritage Foundation experts estimate the Obama administration “redistributed $26.5 billion more to the UAW than it would have received had it been treated as it usually would in bankruptcy proceedings. … Thus, the entire loss to the taxpayers from the auto bailout comes from the funds diverted to the UAW.” It wasn’t so much an auto company bailout as a bailout of a union whose workers were averaging $70 an hour in wages and lavish vacation, pension, and health insurance benefits—which played a big part in nearly destroying the companies. The UAW members have given up none of their pay and perks. They didn’t need to, with the bailouts paid for by taxpayers whose wages and benefits come nowhere near those of Detroit’s unionized workforce. The government’s bailouts also shredded bankruptcy law and forced first secured lenders to take major losses on loans they had made to the automakers with the legal assurance they would be first to recover assets from the companies. John Berlau of the Competitive Enterprise Institute has noted the government’s claimed number of “jobs created” by the bailouts includes those at domestic auto plants of foreign automakers such as Toyota and Hyundai in right-to-work states far from unionized Detroit. There is good reason to believe there would not have been many job losses absent a bailout. People forget Chrysler’s popular Jeep line used to be owned by American Motors Corp., once known as a Big Four automaker. AMC went out of business in the 1980s, and Chrysler bought Jeep. This was just a few years after an earlier government rescue of Chrysler, causing at least two questions: (1) Why wasn’t AMC bailed out? and (2) How many times must the taxpayers be forced to bail out Chrysler? Other automakers no doubt would have bought Chrysler’s and GM’s assets if those companies had gone under, just as Chrysler bought Jeep. Entirely new auto companies might have been started from the remains of the two failed automakers. But those would have been capitalist responses. Too few people in the federal government favor capitalism, where individuals acting on their own receive rewards or take losses. They prefer government steering rewards to certain people and losses to everyone. We can only hope some of them take note of the lesson in Knight Capital. Steve Stanek ([email protected]) is a research fellow at The Heartland Institute in Chicago.