Good and Bad Capitalism

By Peter Galuszka

The Republican presidential primary season has taken on a peculiar wackiness, particularly when free market advocate Next Gingrich takes on front-runner Mitt Romney for his days as a private equity capitalist at Bain Capital.

The conservatives amongst us shudder at the very idea that something as precious as finance can be spotlighted (as they conveniently forget just how cravenly the finance industry nearly crashed our economy in 2008).

What raises my interest, however, is not that capitalism is inherently evil, but that there are different ways to go about it.

Harvard-trained Romney lead Bain Capital in the 1980s and 1990s and profited mightily. Bain was part of the leveraged buyout revolution of the 1980s in which financiers would target companies, amass takeover war chests, buy them and either sell them off or not. Proponents argue that this approach leads to greater efficiency and they cite the old Schumpeter saw that “creative destruction” is a necessary part of  boosting free market capitalism by chipping off dead wood and letting new sprouts grow.

Sounds good, but the fact is that the LBO raiders of the 1980s were not out for the betterment of mankind. They were out to make zillions of bucks, regardless of whomever paid the real price in layoffs, shattered lives and the like. This is apparently what Romney was up to, despite his unprovable claims that he “created” 100,000 jobs. NPR has knocked that one down, noting that Bain never kept track of such things, so how would Romney know?

Another point comes up in a Sunday Washington Post article by William D. Cohan a former finance executive with Merrill Lynch and Lazard Freres who wrote “Money and Power: How Goldman Sachs Came to Rule the World.” He says that Bain and Romney not only played the LBO game, they did so ruthlessly, even by private equity rules. “In my experience,” he writes,”Bain Capital did all it could to game the system by consistently offering the highest prices during the early rounds of bidding — only to try to low ball the price after it had weeded out the competitors.” This practice led to an industry-wide mistrust of Bain — that it couldn’t be held to its word.

If so, that suggests some bad things about Romney, who is devoutly religious. But this is not to put down entrepreneurship among aspiring politicians.

For another style look at U.S. Sen. Mark Warner. Back 30 or so years, he parlayed his experience as a young Capitol Hill aide and knowledge of federal communications law to rationalize the rising cellular telephone business. One thing he did was organize auctions of bandwidth needed for the telephones. That way, a company with rights to bandwidth in Phoenix could add to its local area by swapping its bandwidth in a place such as Buffalo to a firm that wanted to expend there.

Besides sorting out bandwidth, Warner also helped create telecom giant Nextel which is now part of Sprint. He also formed Columbia Capital, which financed the high tech boom in Northern Virginia in the late 1990s. He ended up with at least $200 million in personal wealth. He’s also a Democrat.

So, who do you think has created more jobs? Mark Warner? Or Mitt Romney?

Share this article


(comments below)


(comments below)


12 responses to “Good and Bad Capitalism”

  1. Venture capital and LBO capital address two very different types of situations.

    Venture capital underwrites start-up and early-phase businesses that require (a) money and (b) the expertise and connections that the venture capitalists can provide. While venture capitalists might augment the founding entrepreneur’s management team, their job is to provide guidance and oversight, not to run the company. It is worth noting that venture capitalists will not hesitate to shut down or unload a company that falls short of expectations.

    LBO capital, by contrast, is used to buy out established companies whose management is judged to be inadequate. Far from being growth companies, LBO candidates are under-performers, if not in danger of going out of business. In these cases, it is necessary for the LBO company to insert its own management to turn the company around — and often to make ruthless decisions to fend of disaster. (That’s not to excuse every action by every corporate raider like “Chainsaw Al” Dunlap, any more than to excuse the action of every venture capitalist.)

    Both types of capital are needed in a dynamic, market-driven economy. The alternative to LBOs, as you might recall, is to allow management of big, established companies to grow fat and happy, and to run the companies for their own benefit rather than that of the shareholders. While you dish the “corporate raiders” of the 1980s, they improved the performance of a lot of corporations they took over — and scared the managements of other companies to pick up their game.

    Liberals criticize the ’80s as an era of “greed and excess” and wax nostalgic over the venture-driven Internet boom — overlooking the how many peoples’ lives were dislocated when the Internet boom crashed. The corporate raiders were a phenomenon of the Reagan era, thus were evil. The Internet bubble occurred during the Clinton ear, hence was good.

    The fact is, our economy needs both LBO capital and venture capital. Here’s a more useful discussion: Do hedge funds have any social or economic utility. Let’s talk about John Corzine, former governor of New Jersey, and MFS Capital!

  2. I’m not sure where I am on this and I suspect many others are similarly situated.

    For instance, can you see LBO’s going after Microsoft or Google or Facebook or Twitter..?? why? why not?

    in terms of the bust.. name the top 3 or 5 failures and their business model and then compare that to similar companies with similar business models today… what changed? Why do they work today but they failed in the time?

  3. Peter Galuszka Avatar
    Peter Galuszka

    Puuh leez! I never said Clinton was “good” because of the Net bubble. Au contraire, I am one of the biggest critics of that period with its meaningless business plans, brand buying and BS overreach. The Warner example happened during Reagan and then Bush, so puuh-leez! The LBO period, however, does deserve scrutiny since it did not CREATE wealth it destroyed it.
    And thank you very much for the Econ 101 on LBOs and VCs. Who would have guessed?.

  4. re: dot com flops

    1 Webvan Online shop – online grocery
    2 pet stuff
    3 Retail – promise 1hr delivery of stuff in cities
    4 – internet currency
    5EToys – online toys
    6 Retail – global online fashions – sports teams stuff – entertainment content portal – online community of teen girls
    10GovWorks.coml – help government clients track contracts and purchasing functions

    I would say that every single one of the above business models not only still exists in the world but many are wildly successful – like paypal, ebay, facebook, groupon, amazon, etc…

    so I’m always puzzled by this apparent dichotomy.

    Clearly the visionary ideas behind many if not most of the core business models of the dot.coms ultimately proved to be potent and powerful but they failed back then.


    any thoughts on why?

  5. They failed because they couldn’t make any money.

    At one time many of the co’s listed above had a market value that far excedded their true worth. The “market” figured this out and, well, the rest is history.

  6. DJRippert Avatar

    LarryG asks a profound question. The answer lies in an understanding of both the curve of technology innovation and the peculiarities of human behavior.

    The best source for an answer is economist Carlota Perez. Dr. Perez’s corpus of work is large. However, this link will provide a quick summary of her thinking:

    Pretty much every major technology – based innovation has gone through the same boom-bust-boom cycle as the internet.

    Dr. Perez is a neo-Schumpeterian who believes that the economy needs creative destruction. However, she also believes that the government has a very legitimate role to play in regulating free enterprise.

    All those who write, read and comment on this blog would be well advised to read Dr. Perez’s work. Whether you agree or not, her perspectives are based on empirical evidence and the lessons of history – not some political posturing.

    Here is another article to whet your appetite:

  7. The classifications of liberal vs. conservative and bad vs. good (respectively in the Republican lexicon) really are fatuous as applied to venture capital and buyout capital. There are in fact venture capitalists with a liberal bent. A better classification would be scrupulous vs unscrupulous. There are many instances of the latter, many of them well-known because they were found out, but of course there are probably many more that have not been found out. Balzac wrote something to the effect “behind every great fortune there is a crime.” Maybe not every one, but for many there is something unscrupulous.
    Many defenders of capitalism though think that if you can get away with it, it must be ok – like the old religious thought- if you have the cash, it must mean you are worthy; or to put it another way, capitalism is neither moral nor immoral, it’s just good!

    But hedge funds – I agree with Jim that they have little redeeming social value. You’ve got to think things are off-kilter with our financial system (which some now are equating with “capitalism”) when:

    Before the crash – depository banks made most of their money off investment banking and more money from fees (overdraft, etc.) than interest on deposits.
    Executives of government insured banks received (and still receive) amazing salaries.
    More of the day-to-day trade activity on our stock exchanges is computer-driven by hedge funds looking to shave a bit from short-term arbitrage than is derived from investors. On this, I think a”per share” tax on transactions, say 1 cent/share, would be helpful.

    The whole thing with Romney is ridiculous. It’s ridiculous for him to claim he was somehow being virtuous at Bain – that was hardly the point (the point is well-illustrated by the picture of him and his young associates with the Benjamins), it can’t be proven, and anyway what value is a Dominoes or Staples job except to investors? And it’s ridiculous for his detractors to say it was “unvirtuous” – it was what it was, neither virtuous or not – a way to make money, and he was very good at it, good enough to fund his family’s extravagant lifestyle for generations. Maybe his skills as a money-maker (and a person who enjoys firing unproductive employees) would be helpful in the White House; he certainly has a better background than any of his Republican rivals.

  8. re: dot com failures

    but.. if you look at most of them … that failed… their core business model not only exists today but many are big time winners…

    so ..why did they fail back then…but they are succeeding now?

    that’s what does not add up to me.

  9. I see Mitt concedes to apying a whopping 15% in taxes.

    Now, that is good capitalism.

  10. DJRippert Avatar

    The 15% debate over Romney’s taxes is absurd. Mitt Romney makes his money by investing his money. Since he holds those investments for over a year he qualifies for capital gains treatment under US federal tax law. The current tax rate for capital gains is 15%. This is not hard to understand. It is the same reason that the tax rates of wealthy investors are often lower than the rates paid by their receptionists.

    Now, do the liberals propose that we treat capital gains the same way that we treat ordinary income? If so, Mitt Romney’s tax rate would rise. If not, the liberals should just shut up about Romney’s 15% and secretaries paying a higher rate than their bosses.

    Calling all liberals, calling all liberals ….

    Should capital gains be treated the same way, for tax purposes, as ordnary income?

  11. I agree with liberals that it is unfair that Warren Buffett (Mitt Romney, or any other multimillionaire) gets taxed at a higher tax rate than his secretary. But where do we go from there? Two observations.

    First, raising the capital gains tax may be more socially “just,” as in “fair,” but let’s not kid ourselves that it will create lots more tax revenue. Capital gains is the ultimate discretionary tax. Warren Buffett and his buddies have total discretion over when they trigger capital gains and how much they pay. If the gains are taxed at a higher rate, they will trigger far fewer taxable events.

    Second, the solution to the injustice is to lower the income tax rate, not to increase the capital gains rate. If we eliminated tax expenditures (zillions of deductions, credits, deductions and other loopholes), we could bring down the top income tax rate to a level comparable to the capital gains tax rate.

    Would liberals find that to be a reasonable compromise? Or are they hard-wired to favor higher tax rates, period, end of story?

  12. TMT has suggested, and I agree that we have a teeny tiny but real transaction tax on all wall street transactions.

    every time someone moves money – the govt gets a cut.

    a very small cut… but a very real cut.

Leave a Reply