June 3, 2012 |
Photo Credit: ShutterStock.com
Were it not such a sad statement about how superficial
our political discourse has become, the indignant defenses of Bain
Capital by self-flattering “centrists” in the media would be almost
comical.
The simple reality that has been totally obscured in most of the
coverage of what has been reduced to a “political flap,” is that finance
is what's known as an “intermediary good” – it doesn't produce anything
directly. It can -- and does -- stimulate the larger economy. But the
financial sector can also extract wealth from the real economy, at a
cost.
The lion's share of Mitt Romney's fortune was made doing the latter
through leveraged buy-outs (LBOs), a reality that Romney doesn't like to
talk about on the campaign trail. Instead, he wants to talk about
Staples, or Sports Authority -- two among a small handful of his venture
capital deals -- and just about every mainstream media report elides
the distinction between those very different things.
Perhaps the media, like much of the American public, doesn’t
understand what LBO artists like Romney really do. Here’s a quick
refresher.
Venture capital deals represent a very basic free-market transaction.
Investors put money into a company at its early stages in exchange for a
share of the company. If the start-up doesn't pan out, the investors
lose their stake; if it grows and matures, they make a healthy profit.
In venture capital deals, investors only make a profit when the company
they put their cash into does well.
Leveraged buy-outs are a different creature entirely. LBO firms also
deal with risky companies – usually those struggling to stay afloat –
but they don't actually take on much risk themselves as they structure
the deals so that they profit whether the target company becomes healthy
and grows, or collapses, often under the weight of debt piled onto it
by the private equity firm itself.
Here's how the deal works. The leveraged buy-out firm will put down a
fraction of the cost of buying an ailing company. The balance of the
transaction is borrowed, but the debt goes onto the books of the target
company, not the private equity firm – the struggling company basically
finances the lion's share of its own sale.
The target company's debt payments then increase significantly, and
that debt service is written off, reducing its tax burden a great deal.
This subsidy increases short-term revenues (at the expense of long-term
debt) and that, in turn, is paid out to the firm's investors along with
a fat stream of management fees that Romney and his partners skimmed
off the top.
(The industry-standard structure of these deals is known as “2 and
20.” Management gets 2 percent of the capital they invest as a fee, and
20 percent of the profits that the fund realizes. That 2 percent
represents between two to four times what the average management fees
for a mutual fund usually run, and is collected regardless of how the
fund does.)
This is a win-win deal for the leveraged buyout firm. A recent study
by researchers at the University of Chicago estimated that the average
tax benefit of these companies' increased debt-loads in 1980s equaled
“10 to 20 percent of firm value,” which, as Mike Konczai
noted recently, “is value that comes from taxpayers to private equity as a result of the tax code.
Now look at how this story has been covered. Let's focus on CNN,
which is supposedly the most “neutral” of the cable news outlets.
Consider a remarkably obtuse “
Letter to the President”
penned by CNN political correspondent Tom Foreman – “an Emmy
award-winning journalist whose experience spans more than three
decades.” The thrust of it was that Newark Mayor Cory Booker “spoke
truth to power” when he said he was “nauseated” by Democrats' criticism
of Bain. Of course, nobody knows what was in Booker's heart, but we do
know that he got $565,000 in campaign funds from Wall Street to get
elected, with at least $36,000 coming from Bain and its employees, and
in that context one has to be willfully naïve to jump to the conclusion
that he was just speaking the truth as he sees it.
Then there was host Christina Romans saying that “what private equity
does” is “comes in, cleans up a company, sells it, or moves it
forward.” When Bain “cleans up” companies, more often than not it means
looting pension funds, laying off workers, and saddling the firms with
huge amounts of debt before flipping them.
Another anchor, Ashleigh Banfield, attacked Ben La Bolt, the Obama
campaign's press secretary, saying, “Ben, come on, you and I also know
that he had plenty of success, as the
Washington Post has outlined many successes... that Bain Capital has had in creating jobs, in saving people's companies from going under.”
But Bain Capital was not in the business of creating jobs, or even
saving companies over the long-term. Its model had a relatively low rate
of success. A study by Deutche Bank
found
that 33 out of 68 major deals cut on Romney's watch lost money for the
firm's investors. Its richest deals made up for the flops, however, and
Bain's partners were guaranteed hefty fees regardless of how the
businesses they “restructured” ultimately performed.
That gets to a crucial difference between venture capital and
leveraged buy-outs. With the former, the private equity firm only makes
money if the companies it invests in succeed. By using loopholes in the
tax code, LBO firms are essentially guaranteed to make money – for
their partners, if not always their investors – regardless of how their
investments do. Yet David Gergen suggested on “Out Front with Erin
Burnett” that attacks on Bain are attacks on “free enterprise.” “There
has been, as you know, an anxiety, a fear and anger on the part of many
in the business community by what they regard as a hostility toward
private enterprise, toward business,” he said. “And the messages to --
that many are taking away from the president's campaign right now is not
just about Bain Capital. It's about people who are in private sector.”
Erin Burnett crowed about a study, which found that “companies bought
out by private equity firms lose about one percent of their workforce.”
For Burnett, those layoffs “support the more positive view of private
equity which is that firms like Bain take over weak or faltering
companies where everyone might lose their jobs, build a stronger company
where the remaining jobs are more stable.” But as Paul Krugman
noted, “The real complaint about Mr. Romney and his colleagues isn’t that they destroyed jobs, but that they destroyed
good jobs.”
When the dust settled after the companies that Bain restructured were
downsized — or, as happened all too often, went bankrupt — total U.S.
employment was probably about the same as it would have been in any
case. But the jobs that were lost paid more and had better benefits than
the jobs that replaced them. Mr. Romney and those like him didn’t
destroy jobs, but they did enrich themselves while helping to destroy
the American middle class.
And Burnett was echoing Bain's own talking points. The firm has
claimed that only 5 percent of the companies it acquired went bankrupt
“while under our control.” As the
Washington Post pointed out, those were “the operative words in the Bain statement” That's because, as the
Wall Street Journal discovered,
once saddled with mountains of debt, more than four times as many
companies with which Bain was involved – 22 percent – “either filed for
bankruptcy or liquidated by the end of the eighth year after Bain
invested.”
We hear a lot about how this is a good debate for the American people
to have. And it should be. We should consider how our financial sector
has become bloated, swimming in capacity the larger economy doesn’t
need. Historically, it’s grown and contracted along with the business
cycle. When the economy was going gang-busters and businesses were
expanding, it was there to provide capital and insurance and connect
investors with entrepreneurs and innovators. Then, when the business
cycle took its inevitable turn and the economy slowed down, it would
contract. But as the Associated Press noted, "when the Internet bubble
burst in 2000, the sector never stopped growing. Instead, it ballooned
over the past eight years to around 10 percent of the U.S. economy,
puzzling economists."
We should also have a discussion of the influence the financial
sector has on the behavior of the rest of the corporate economy. The
original function of the financial markets -- to link investors’ capital
with innovative firms -- has been turned on its head by Wall Street.
Today, corporate behavior is very much dictated by the markets --
quarterly earnings, stock prices and the like -- and not the other way
around. That’s not a good thing.
Lawrence Mitchell, a professor of business law at George Washington University, notes in his book,
The Speculation Economy,
that a survey of CEOs running major American corporations found that
almost 80 percent would have "at least moderately mutilated their
businesses in order to meet [financial] analysts’ quarterly profit
estimates."
Cutting the budgets for research and development, advertising and
maintenance and delaying hiring and new projects are some of the
long-term harms they would readily inflict on their corporations. Why?
Because in modern American corporate capitalism, the failure to meet
quarterly numbers almost always guarantees a punishing hit to the
corporation’s stock price.
These dynamics are epitomized by leveraged buy-out artists like Mitt
Romney. So, yes, this would be a very valuable discussion to have, but
the traditional media's mewling about people daring to criticize Bain,
and their instinctive deference to Big Finance, are doing more to
obscure the issue than illuminate it. And that's preventing us from
having a real debate.
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