1. How to use GuruFocus - Tutorials
  2. What Is in the GuruFocus Premium Membership?
  3. A DIY Guide on How to Invest Using Guru Strategies
Stepan Lavrouk
Stepan Lavrouk
Articles (514) 

Howard Marks: Why We Need Recessions and Bankruptcies

Economies need to shed the dead weight now and again

May 21, 2020

Yesterday, I wrote about some recent comments made by Howard Marks (Trades, Portfolio) that addressed the troubling long term implications of the government getting overly involved in the financial markets. Today, I want to examine a related topic that Marks wrote about: why recessions are useful and natural parts of the economic cycle and will help the economy overall.

Like Catholicism without hell

The U.S. Federal Reserve, as well as the Treasury department, are doing everything that they can in order to support the economy by injecting liquidity. On the face of things, this might seem like a good thing. After all, companies don't want to go bankrupt.

However, bankruptcies and recessions are a natural part of the business cycle. There’s a saying that has been variously attributed to different sources: “capitalism without bankruptcy is like Catholicism without hell.” For the capitalistic system of incentives to operate, poor performance needs to be punished just as much as good performance needs to be rewarded in the business world. As Marks once said:

“There is a concept called moral hazard, when people who engage in risky behaviour, and bad things happen which could cause them to pay for their risky behaviour, are supported and sheltered... In order for business and investment to function as it should, there has to be a fear factor. I am afraid of losing money for my clients. That causes me to be conservative and has shaped my career...It has caused us [Oaktree Capital] to stay high in the capital structure and try to invest in companies with better futures - even if they are financially distressed.”

If our incentive system does not punish excessive risk taking, then it is only a matter of time before we end up in a situation where prudence is punished and cavalier decision making is lauded. Indeed, this is arguably the position we were in before the latest market downturn, and it was the mindset that created the conditions for the collapse in the first place. Bankruptcies help weed out the industry players that operate inefficiently and rebalance investor psychology.

There is a further and very important aspect to this argument. It has become fashionable to argue that the government needs to bail out businesses to stop bankruptcies in order to protect workers. Nothing could be further from the truth. In reality, a company can hold on to parts of its workforce while it goes through an orderly restructuring. Even in cases where workers are laid off, they are entitled to unemployment benefits (although these social guarantees could afford to be made stronger and more extensive).

It is simply not true that the government needs bail out shareholders and managers of large corporations to protect the rank and file workers, and the suggestion of this is meant only to protect shareholders and management who allocated their capital unwisely. Those who stand to gain the most should also stand to lose the most.

Disclosure: The author owns no stocks mentioned.

Read more here:

Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.

About the author:

Stepan Lavrouk
Stepan Lavrouk is a financial writer with a background in equity research and macro trading. Specific investing interests include energy, fundamental geoeconomic analysis and biotechnology. He holds a bachelor of science degree from Trinity College Dublin.

Rating: 0.0/5 (0 votes)


Please leave your comment:

Performances of the stocks mentioned by Stepan Lavrouk

User Generated Screeners

pascal.van.garsseHigh FCF-M2
kosalmmuseBest one1
DBrizanall 2019Feb26
kosalmmuseBest one
DBrizanall 2019Feb25
MsDale*52-Week Low
Get WordPress Plugins for easy affiliate links on Stock Tickers and Guru Names | Earn affiliate commissions by embedding GuruFocus Charts
GuruFocus Affiliate Program: Earn up to $400 per referral. ( Learn More)