The trouble with bailouts

Painful though it is for the corporations that fail, this is one of the most powerful justifications for capitalism, writes Don Pittis.

It has come to this. A firm that made its name, and its fortune, feeding off companies in their death throes is demanding a government bailout.

Cerberus Capital Management takes its name from the many-headed dog that, in Greek mythology, prevents the dead from leaving Hades. This week the company's chairman, former U.S. treasury secretary John Snow, asked the American president-elect for help to keep his own business from being plunged into the fires of economic damnation.

It seems only a blink of an eye since Cerberus was one of the poster children for the private-equity capitalism that saw tenuous financial deals strung together on borrowed billions. But now all that is forgotten.

Snow, whose company owns 80 per cent of the deeply troubled car maker Chrysler, has warned Barack Obama that "the collapse of the auto industry at this time would be devastating for a new president."

This is only the latest call for government bailouts from struggling industries. Ford and GM say they need help. In Canada, the banks say they need more government money to help them lend. Auto-parts makers have asked Canada's finance minister, Jim Flaherty, for money and been turned down. A group representing Canadian manufacturers has formally asked Prime Minister Stephen Harper for government help for new financing.          And why not ask?

The New York banks that got markets into the current mess are getting billions in government money. Surely if the banks can get cash, then the companies that actually make goods and services deserve help? Cerberus and its peers say now is a special time when governments need to step in and help out. Jobs are at stake, they say.

The apparent logic of that argument is what makes winning an election in a time of a struggling economy such a mixed blessing. There simply isn't enough government money to rescue everyone. Bailouts are a bit like a Sophie's choice.

And besides, saving everyone may not be a good thing.

At the end of my street is a cluster of restaurants. If, as in previous downturns, people start spending less on meals out, those restaurants will feel the pain. The ones with the best food, the best value and the best management are likely to limp through bad times. But inevitably, some of the restaurants at the end of my street won't survive. When the hard times are over, the best restaurants will still be there, perhaps to expand, perhaps sending their well-trained staff out to create new, good restaurants. 

Painful though it is for the corporations that fail, this is one of the most powerful justifications for capitalism.

Not many people would recommend bailing out failing restaurants, except for the owners and staff members of failing restaurants. It seems obvious that some should fail, and that the government should not use its limited funds to rescue some and not others.

The same holds for the bigger businesses. Painful though it is for the corporations that fail, this is one of the most powerful justifications for capitalism.

It's important to remember that the economy is constantly evolving. Economist Joseph Schumpeter called it creative destruction, a force that continually renews and refreshes the economy. As the CBC's Fred Langan is fond of pointing out, only one company listed on the Dow Jones industrial average was there at the beginning: General Electric. Other founding members of the Dow included The Distilling and Cattle Feeding Company and the U.S. Leather Company. They were once great. Now gone.

And while the process of creative destruction is happening all the time, the process of renewal is most active during recessions.

The difficulty for governments is that even if economic theory pays off eventually, the pain of failing businesses and lost jobs hurts now. That's why Japan allowed many companies to survive after the crash of 1989 when they really should have died, creating the so-called "zombie corporations" that staggered through a decade-long market slump.

That's also why, during the postwar period, the British government protected its auto manufacturing sector with tariffs, bailouts and government-backed mergers. In the process, what had once been a country with four of the world's best-known car companies now has no domestic automakers at all.

Don Pittis has reported on business for Radio Hong Kong, the BBC and the CBC. He is currently senior producer of CBC News Business.