In his seminal article on economic calculation under central planning, Mises showed that a central planner cannot allocate productive factors in a manner consistent with consumer demand because the planner does not have the ability to calculate in terms of market prices. Market prices come about as the result of a competitive bidding process among decentralized private property owners who are seeking to earn profits.
In some cases, firms are not just being bailed out, they are being nationalized. Nationalization means that the ownership of the firm changes from the private sector to the government. This puts the Fed, or the Treasury, or whoever becomes the de-facto owner of these firms, in charge of them.
While the nationalization of the health care sector, the coal industry, the airlines, or any other industry would be bad enough, the nationalization of a single industry mainly destroys the ability of that industry to allocate capital rationally. But even within that industry, they have access to external market prices for their inputs and their outputs. And nationalized firms can still adopt technological advances that are generated by the competitive part of the economy.
The role of financial institutions within a market economy is to allocate capital. Banks, for example, borrow from small depositors and lend to home buyers or small businesses. Investment banks invest the equity of the share holders in asset markets, facilitate the issuance of new securities, and manage the capital of private investors.
This is why the recent round of bailouts of financial institutions is so damaging. The impact of these nationalizations is multiplied compared to the takeover of an industrial sector because the capital allocation function is so critical to a market economy. Financial institutions do not produce a physical good, they act entrepreneurially within the total capital structure of the economy to allocate productive factors. In no sense can this entrepreneurial function be replicated by a central planner operating outside of the profit and loss system.
I usually try to link to a news story at the start of a blog post, but for this point, any of the hundreds of articles archived by GATA would serve just as well.