In the seven years since Lehman Brothers failed, tipping the world into a financial crisis, the U.S. government has enacted a plethora of regulations to prevent another one.
But trauma aside, there are some tangible benefits to such a crisis, from a Darwinian winnowing of weak businesses to curbing extreme risk-taking. Here are some:
1. They often provide investors willing to take a gamble with tremendous bargains. Just look at the deals available on stocks in March and April of 2009. Without the meltdown, when would you expect to buy at such reduced prices?
If you invested in the SPDR S&P 500 (SPY) exchange-traded fund, which tracks the Standard & Poor’s 500 index (^GSPC), at the beginning of March 2009, you’d have done well. It would now be worth three times as much, not including dividends. Not bad for 6.5 years. Of course, you needed the nerve to invest when the investing world seemed finished forever.
2. Financial crises often cull the weakest firms, forcing them out of business. OK, so that didn’t quite happen in 2008 and 2009 because the government decided to bail out some large financial firms and others to prevent further damage to the economy.
But a cleansing of companies that aren’t succeeding isn’t all bad. As has been said many times, the reason that Silicon Valley is so successful is that the investors there embrace the idea that many companies will fail. If an idea works, then they run with it.
If the new firm fails, then the funding is pulled and the people involved go find a more productive project on which to work. For every Facebook (FB) or Twitter (TWTR) that becomes a pop culture touchstone, there are hundreds or maybe thousands of startups on the scrap heap.
3. Meltdowns often highlight weaknesses in the system. Think about a 3-year-old child trying to destroy a piece of your furniture. All small children are budding engineers, and their antics often seem aimed at testing objects to the point of destruction. So if they succeed in breaking a chair, you know it wasn’t particularly robust.
Likewise, in a financial crisis, you can see where the weakness is because weak companies simply can’t hide.
One example is my former employer, General Motors (GM) , which went through a reorganization (aka bankruptcy) in 2009. I think it was clear to many that something needed to change at the automaker, and the financial crisis merely sped up the process. Ultimately, the Obama administration stepped in rather than allow the giant automaker to collapse.
4. Crises remind others to be prudent. Taking risks is important in capitalism, but it’s important to weight the potential danger to your company: Is the risk something that will simply curb next quarter’s earnings or one that might sink the company altogether?
Financial giant New York Life Insurance Co. uses the tag line, “The company you keep,” seemingly as a reminder that many others before it haven’t survived.
5. The alternative to crises can be worse. Financial meltdowns have a high cost in both money and social upheaval. I have friends who were at Lehman, and I know the hardship its collapse caused.
But avoiding the inevitable isn’t necessarily a better alternative over the long term.
Look at Japan, where the economy has stagnated for decades now. There are many reasons for that, but a significant part of the problem in Japan was the presence of so-called zombie companies, firms neither alive enough to do business nor dead enough to get liquidated. They simply take up space and resources.
It’s far better to take a company through the bankruptcy courts and let its resources be used more efficiently by new owners, than to be haunted by zombies. Countries that let firms fail tend to do better economically than those that don’t.
The United States is still by far the richest country in the world, and companies are frequently being either created or liquidated. Where the failure rate is high, the wealth created often is also — see my comments above about Silicon Valley.