How Capitalism Will Save Us (18 page)

What free-market opponents fail to grasp is how bigness most often becomes a disadvantage in a marketplace that demands agility to compete. The investment research firm CommScan looked at stocks of the thirty biggest corporate mergers over five years during the late 1990s. On average, they underperformed the Standard & Poor’s 500 index.

Remember when Internet powerhouse AOL merged with Time Warner in 2000? People feared that the new company would dominate media markets. Instead, AOL–Time Warner is now considered one of the biggest failed mergers in history, a corporate behemoth burdened with debt. The synergies expected between the company’s old and new media divisions
failed to materialize and produce any new value for shareholders. The final blow: in spring 2009 Time Warner announced that it was getting rid of AOL.

All of this is not to imply that small companies are always capable of outstripping bigger ones. Smallness is a disadvantage when a start-up tries to do things pretty much the same way big companies do. After World War II, construction magnate Henry Kaiser invested considerable resources into developing a new auto company. But his foray into autos flopped because he offered no real technological breakthroughs. Nor were his models seen as any better than what was already in the marketplace. “Me too”–ism won’t work.

By contrast, a big company can give another big company a renewed run for its money. Microsoft, having badly trailed in the search-engine business, is making a rejuvenated and innovative run at Google with its new search engine,
Bing.com
.

Ironically, companies with the greatest control over their markets are those whose power is enforced by government fiat. Few question the “market power” of their local utility. When government creates a monopoly, no one complains.

I
n 2008, many people were incensed when the federal government passed a $700 billion bailout of financial companies on the verge of imploding from the subprime-mortgage collapse. Opposition was voiced not only by those ordinarily hostile to business, but also by many who saw the bailout as a betrayal of Schumpeter’s principles. After all, they insisted, isn’t this supposed to be a free-market economy? Aren’t companies
that make bad decisions—in this case, investing in high-risk mortgage-backed securities and derivatives—supposed to suffer the consequences? Shouldn’t they be allowed to fail?

Most of the time we’d say yes. But, as we’ve noted, by fall 2008, a series of government errors had put the whole financial system on the verge of collapse. That’s why, in the Real World, the bailout was critical. Very simply: had the government not stepped in, the impact on the worldwide economy, on billions of people, would have been cataclysmic.

The financial sector is not just another industry. It is the lifeblood of our system. Without banks and other credit providers you don’t have an economy. By September 2008 the U.S.—and global—financial system was on the verge of cardiac arrest. Allowing the financial sector to implode would have unleashed a cascade of calamity: People fearful of losing the money in their checking or money-market account would have withdrawn their cash. Banks would have stopped lending to one another and to solvent borrowers. Merchants wouldn’t have been able to get financing for inventories. Buyers wouldn’t have been able to get credit for their purchases. Entrepreneurs would have been denied capital for startups. There would have been no money available for business expansion. Capital and credit flows would have dried up. Companies everywhere would have liquidated their debts. Unemployment would have soared. Economic activity would have imploded.

Some of these events did unfold after the crash of 2008. But had Congress allowed AIG and other companies to go under, we would have suffered not just a serious recession but a worldwide depression of untold magnitude. Tens of millions would have seen their jobs destroyed. Countless solvent companies would have gone under. Beyond the devastation of the worldwide economy, the political repercussions would have been uglier than they were in 2009. The resulting government intrusion into the U.S. economy would have vastly exceeded anything the Obama administration will be able to do.

The repercussions would have been felt outside the United States. In some less stable countries, free markets and democracy itself would have been discredited. Tyrants would have had new opportunities to rise up. Let us not forget that Hitler would never have come to power had it not been for the Great Depression of the 1930s. Before that crisis, the Nazis had carried only 2 percent of the vote in 1928.

Another reason government had to intervene was that, as we explained in the first question in this chapter, this was not a disaster created by free markets. Companies did not melt down because of “natural causes”—i.e., losing out in the rough-and-tumble competition of the marketplace. This was government-made destruction. There was nothing “creative” about it.

Low interest rates and a too-abundant money supply, courtesy of the Federal Reserve Bank, stoked an overheated housing market. Government-created Fannie and Freddie helped promote low-interest lending to unqualified borrowers. Federally mandated mark-to-market accounting rules added fuel to the fire, making basically healthy banks and insurers appear in worse shape than they were, encouraging write-downs that set off maniacal short selling of financial stocks.

The bottom line is that bad government policies distorted the decision making and market behavior of these financial institutions. Thus, government intervention should be seen as
an effort to reestablish the normal functioning of the market
.

The cost of restoring bank balance sheets and of other emergency measures pales in comparison to the staggering multitrillion-dollar losses and unemployment that would have resulted if no steps had been taken.

In 2009 the Obama administration used this TARP money as a tool to micromanage institutions. Banks were forced to do things for political reasons, such as accept a reorganization of Chrysler and GM that harmed their true interests.

Some opponents of the bailout have characterized this massive intervention as socialism and it has come close. But socialism is permanent government ownership. The bailout was intended as temporary disaster relief. No one fears socialism when the government helps the victims of floods and hurricanes. The markets, in effect, suffered their version of Hurricane Katrina, affecting the lives and livelihoods of millions and threatening the collapse of the free-enterprise system.

It was not socialism when the government sent the citizens of Louisiana and other states relief after Hurricane Katrina. However, if the government had
continued
Katrina-level aid indefinitely, not letting people get back on their feet and rebuild businesses—then we would start to worry.