Real Capitalism at Work? The Knight Capital Example

Capitalism is superior to crony capitalism in every way, for nearly everyone, except the cronies.

Capitalism is a system of reward and failure, buyers and sellers, opportunity and missed opportunity. The recent example of Knight Capital’s meltdown and then continued survival is a good case study of what should happen in the marketplace.

(From IBD)

“The Knight Capital losses could have ruined the company, which until that day was the nation’s largest trader in U.S. equities. Company executives went begging to Securities and Exchange Commission Chairman Mary Schapiro for permission to back out of the trades. She said no.

But Knight Capital did not fail, even though failure would have been fine in a capitalist system. Companies that mess up big time should pay a price.

But it’s also fine in a capitalist system for investors to take advantage of the mistakes of others, and this they have done. A group of companies has put up $400 million to keep Knight Capital in business. The new investors receive stakes in the company and seats on its board of directors.

So we have here a private company on the brink of ruin rescued by other private companies backed by their private investors. If Knight Capital succeeds, those investors reap the rewards. If Knight Capital fails, they take the losses. That’s capitalism.”

Click here for the story.

Capitalism has a weird karma associated with it. If one does business the right way one is likely to have others do business with you the right way (though this is certainly not always true.) In an op-ed entitled Why Knight Capital Was Saved And Lehman Brothers Failed, John G. Taft CEO of RBC Capital Markets, argues that the character and integrity of of Knight’s CEO, Thomas Joyce had much to with Knight’s survival.

I don’t know either man, and I am sure there are plenty of other reasons why Knight’s fellow companies came to its aid besides the high quality of Joyce’s character. But it sounds like it was at least a factor.

A good lesson for would be CEOs.

Just to be clear I am not giving a pass to Knight. They messed up big time. They caused a lot of pain. Additionally Knight did try to get out of bad trades by leveraging their special status, and they were rebuffed (surprisingly). So there are no angels here.

However the nastiness of earlier this month appears to have been settled in short order without the involvement of the state, and that, even if Knight did try to play the crony card, is still a very good thing.

(IBD,8-20-2012) (Forbes, 8-20-2012)