Is it Cronyism to Ride the Boom? (Douglas French)
Tuesday October 23rd, 2012
After the bust of 2008, well-connected corporations and banks lobbied for and received many billions in bailouts from the government. The public was outraged. The term "crony capitalism" came into new prominence as a designation for capitalists who live off the taxpayer.
But how far do we want to take this language? In a mixed economy, no one is untainted by some association with government. And in a paper-money economy, every existing enterprise is compelled to ride the waves of economic cycles.
Does getting rich in the boom make you a crony? If you are good at playing the markets, does that make you corrupt, because the system itself is distorted by central bank intervention and a million other impositions? If you buy low and sell high, do you deserved to be demonized?
The critics of Bain Capital, Mitt Romney's one-time employer, seem to think so. Let's examine the claim.
The Federal Reserve has flooded the world with money since the last ties to the gold standard were snipped back in 1971, by Richard Nixon, of all people. Interest rates are lower in the unrestricted Fed printing world than they would be in a laissez-faire Shangri-La. In the 2000s, low interest rates and the oceans of liquidity sloshing around in Greenspan's bathtub led to speculation.
Every old Austrian economist figured this out. And the proprietors at Bain Capital figured it out as well. Buy companies on the cheap with cheap money, make them more efficient, and sell them as quickly as possible for a higher price. Sounds like good work if you can find it, except for one thing: It's not easy to turn a failing company around. It takes expertise, and when you are dealing with high leverage, timing is everything.
Let's look at David Stockman's The Great Deformation: How Crony Capitalism Corrupts Free Markets and Democracy. The book is the cause celebre of the supporters of Obama for president because it labels Romney a deformer and a crony in the attempt to strip him of his main private-sector claim to fame. This book excerpt matters not only because it is now top fodder in the political war, but also because it ramps up the attacks on anyone who makes it big in the markets, and thereby opens up a new front against private wealth.
Mr. Stockman's had some great things to say in the past couple years, and crony capitalism is rampant for sure, but taking the private equity business to task as if it were the nation's greatest threat is painting with too broad a brush.
He writes that "the waxing and waning of the artificially swollen LBO business has been perfectly correlated with the bubbles and busts emanating from the Fed." Well, sure it has. The same goes for the homebuilding business and a number of other business-cycle dependent industries.
Easy money distorts the economy and makes average businessmen look like geniuses. The social value of crashes, recessions, and depressions is to let capital providers know who, in Warren Buffett's words, "has been swimming without a suit." As for Romney, he left the party on time. Good for him. We should all be so lucky.
Is this crony capitalism? No. Compare with Citicorp and Goldman Sachs lining up for TARP money and dozens of other government giveaways that saved them from the clutches of capitalism's death grip. Crony capitalism is creating money out of nowhere to pay 100 cents on the dollar for AIG's obligations, saving not only the insurance giant, but dozens of other financial firms foreign and domestic.
Bain Capital did not receive a bailout. Bain continually bought low and sold high. Most of the time, the firm earned a return lower than a passive investor in the S&P 500. But there were 10 deals that amounted to 75% of the firm's earnings during Romney's tenure.
Stockman offers this up as proof that some sort of skullduggery went on, but anyone who has invested in private partnerships knows that all successful investors strike out occasionally, hit mainly singles and doubles, and a small percentage of the time hit home runs. It's the home runs that make the money managers worth their money.
Stockman further kvetches that "four of the 10 Bain Capital home runs ended up in bankruptcy." The company had the bad form to sell out before the companies became victim to the 2000-02 downturn. Was Romney really so clairvoyant as to do this using sheer business acumen? If so, he probably should be president. Hardly anyone predicted that 2000-02 recession.
(By the way, the other guy under consideration on Nov. 6 has displayed the bad timing of funneling taxpayer money to companies like Solyndra and A123 Systems just before each firm filed for bankruptcy. If we must fill the Oval Office, I'll take the guy with good timing any day.)
Stockman further takes Romney to task for rebranding Stage Stores Inc. to make it appealing to investors. The company's stock price doubled, and again, Bain had the good sense to sell out, for an 1,800% gain. Bain was able to put little money down toward these purchases and occasionally had big winners. But the key point here is that Bain was investing its own money. The other guy on the ballot has been "investing" taxpayer money.
And as distressed as Stockman is about LBO debt, it's nothing compared with the $16 trillion that Uncle Sam has racked up. Borrowing money at low interest rates to turn businesses around and turn quick profits can only be considered good business.
What Bain did was no different than the person who buys a fixer-upper, does the repairs, obtains a cash-out refi based on the appreciated value, and then sells the house at the top of the market. Would that seller be vilified if the buyer of the house lost it to foreclosure because they paid and borrowed too much? Stockman's piece seems to indict anyone who has refinanced their home or business at a lower rate and eventually sold out for a profit.
LBOs "are dangerous because when they fail, they leave needless economic disruption and job losses in their wake," writes Stockman. But these businesses were failing to begin with. Some were using poor business plans, others outmoded technology, some had bloated managements. Either way, what's the disruption? The bankruptcies redistributed the assets (including labor) to more efficient uses, unlike, say, the GM or Wall Street bailouts.
Stockman claims that LBOs "would be rare in an honest free market — it's only cheap debt, interest deductions, and ludicrously low capital gains taxes that artificially fuel them." In an honest free market, the debt would be cheap because the money would be stable like gold or silver. There would be no capital gains taxes at all, so interest deductions wouldn't matter.
(And what is this about low capital gains taxes? Fact: "U.S. corporations face long-term capital gains tax rates almost 80% higher than those of their competitors in other countries. The U.S. tax rate on long-term corporate capital gains is higher than that of all but two of the other countries surveyed.")
One 50-1 home run for Bain was due to "massive leverage, fancy accounting, and bubble finance, not entrepreneurial prowess," Stockman sniffs. Wait just a minute. Buying a company that's undervalued, using every tax loophole the government allows, and marketing and selling the stock at the market price is the definition of entrepreneurship: whether it's the Hayekian processes of discovery, Kirznerian alertness, Schumpeterian innovation, Schultzian adaptation, or Misesian foresight of consumer wants.
The U.S. economy is anything but a free market. It's absurd to judge the Republican candidate's entrepreneurial acumen in a mythical free-market world that doesn't exist. Mitt Romney and Bain Capital played the hand they were dealt, and they played it spectacularly well. Election or not, it's deeply dangerous to blame entrepreneurs for the statist environment they must operate in.
Douglas E. French is senior editor of the Laissez Faire Club. He received his master's degree under the direction of Murray N. Rothbard at the University of Nevada, Las Vegas, after many years in the business of banking. He is the author of two books, Early Speculative Bubbles and Increases in the Supply of Money, the first major empirical study of the relationship between early bubbles and the money supply, and Walk Away, a monograph assessing the philosophy and morality of strategic default. He is founder and editor of LibertyWatch magazine. Write him.