It is conventional wisdom by now that the major players in the airline industry, the hotel industry, the gaming industry, and multiple other industries hit hard by the pandemic should be “rescued,” meaning, the government should send them tens of billions.
But what if that logic is wrong-headed?
What if a better path — with better results for the economy — would be letting them all fail?
Chamath Palihapitiya, a billionaire venture capitalist known for blunt talk and controversial views, made this argument on CNBC last week. He even took it further, suggesting many such companies “deserve to get wiped out.”
Scott Wapner, the CNBC anchor conducting the interview, appeared visibly stunned. But Palihapitiya made some very good points.
His first point was that, when a major business fails, employees don’t actually take the brunt of it — the executives, shareholders, and money managers do.
The total collapse of big companies “is a lie purported by Wall Street,” the VC said.
He then went on to add:
“When a company fails, it does not fire their employees, it goes through a prepackaged bankruptcy. If anything, what happens is the people who have the pensions inside the companies, the employees of the companies, end up owning more of the company. The people that get wiped out are the speculators that own the unsecured tranches of debt or the folks that own the equity. And by the way, those are the rules of the game. That’s right. These are the people that purport to be the most sophisticated investors in the world. They deserve to get wiped out.”
The airline industry is a perfect example of what Palihapitiya is talking about.
Since 1978, there have been more than 100 bankruptcy filings for airlines in the United States. More than 60 of them occurred in the past 20 years. And yet, can you recall any point where the planes stopped flying?
A large, publicly traded business can be divided into at least three parts. You’ve got the assets, the employees, and the financing.
- The assets account for infrastructure and equipment and “stuff.” For airlines, this would be the planes, the runway slots, the fuel hedges, and so on.
- The employees are the people that make the business run, not at the executive level but the actual day-to-day. For airlines this would be the pilots, the flight attendants, the mechanics, the baggage handlers, the ticket agents, and so on.
- The financing is the paper-shuffling side of the business — the accounting of who owns what, the relative amounts of debt versus equity, the interest rate payments owed on the debt, and so on.
As Palihapitiya points out — and the airline industry shows — when a company “fails,” the assets and the employees can turn out fine.
A change of ownership via bankruptcy primarily impacts the finance side, which means a bunch of executives get fired and a bunch of shareholders get wiped out. If the new owner of the assets is a “stronger hand,” the employees can actually wind up better off than before.
To sum up, a public company bailout is all too often a rescue of CEOs and shareholders. The employees and the public — those who want to fly the airplanes, or stay in the hotels — can still do fine in the event of a bankruptcy event.
In terms of saving the finance guys, Palihapitiya put it like this: “A hedge fund that serves a bunch of family offices? Who cares? They don’t get to summer in the Hamptons? Who cares?”
There is another argument, in favor of saving these big companies: They aren’t to blame for a pandemic-related shutdown.
Why should the big airline and hotel chains be penalized, in other words, due to an event they had no control over (a pandemic), as a result of forced shutdown by the government?
And yet, the problem with the “it wasn’t their fault” argument is that tens of millions of small and medium-sized businesses were just as exposed to the pandemic, and many will be crippled or will fail — and none will be saved.
That is to say: Why should a wealthy CEO and a crew of wealthy financiers get tens of billions in bailout money, when tens of millions of small and medium-sized business owners will get virtually nothing?
In many ways capitalism isn’t fair — but that is part of the point.
A capitalist system exposes a business owner to “fat tails” on both sides of the bell curve.
If an entrepreneur starts a business, and happens to have just the right business model at just the right time, and serves the public well and makes a fortune in result — well, that is great. Capitalism says those gains were earned.
But if that same entrepreneur has a bad break instead of a good one, due to tough competition or a change of consumer preference or any one of a zillion other things — capitalism says “that’s how it goes.” The optionality of wealth implies the consequences of failure.
But for a whole class of well-connected players at the top, the logic of capitalism doesn’t apply in full.
Instead it is “socialism for the rich, capitalism for the rest,” in the sense that, if an industry player is big enough, that player will get bailed out — no matter how dumb or questionable the decisions at the top — whereas, for smaller players facing troubles, it’s “survival of the fittest” all the way.
Then, too, a healthy economy requires business failures in the same way a healthy forest requires forest fires.
Under normal circumstances, the occasional forest fire is a feature, not a bug, for the overall forest ecosystem. The fire clears out underbrush and dead growth, kills off pests and invasive species, and clears room for new saplings to grow from the ash.
In the same way, business failures can make industries and economies stronger. If a business was mismanaged, or if management was poor, the bankruptcy process can transfer control to smarter and wiser managers. Or, if the old management was stuck on a business model that is no longer viable, new management might have the courage and vision to change it for the better.
This is the part of the process Joseph Schumpeter called “creative destruction,” and it is one of the ways an economy renews itself.
When tens of billions of dollars are thrown at existing industry players, to reward existing financiers and CEOs for the benefit of being well connected and “too big to fail,” the renewal process gets stopped in its tracks or even reversed.
In a smarter world, the typical Wall Street logic would be turned on its head.
If things made more sense, big companies with well-staffed legal departments would be allowed to fail more often, not less often. The planes would not stop flying, and the hotel doors would not close.
If done this way, shareholders would get burned when a big name occasionally fails. But again, as Palihapitiya says: “So what?”
Then, too, even shareholders would be better off with more failures at the top, because there would be far more “young saplings” — exciting new companies rising up from the ash — to invest in at the publicly traded level.
And the tens to hundreds of billions saved on the equivalent of “crony capitalism” bailouts — because that is really what we’re talking about here — could then be redirected toward shoring up the little guys, providing more of a safety net for small and medium-sized businesses — the players with no “connections” at all — in a way that strengthens the real economy and makes it more resilient.