Poetic Justice

AP Photo/Scott Gries

Thomas Monaghan, founder of Domino's Pizza, sold a "significant portion" of his stake in the company to Mitt Romney's Bain Capital in 1998.

A splendid accidental benefit of this year’s Republican presidential primary is that one of the most abusive dark corners of American capitalism, so-called private equity, is coming in for belated scrutiny and scorn. Delectably, the disclosures and criticisms are coming from leading Republicans, in a blatant undermining of cherished Republican ideology. Even before Democrats lay a glove on Romney, he will be assaulted by an investigative documentary that is more Michael Moore than Adam Smith. In politics, it doesn’t get much better than this.

“Private equity” was rebranded in the 1990s. It used to be called, more honestly, leveraged buyouts. While the job-killing aspect of many of the deals done by Mitt Romney’s Bain Capital and kindred financial engineers has come in for withering criticism, that is only one part of the mischief.

The phrase “private equity” conjures up images of venture capitalists pooling their funds and backing promising new ventures or contributing new equity and new management to companies in need of restructuring. But that is not how the game really works most of the time. Typically, private-equity companies borrow a ton of money, sometimes in collusion with incumbent management and sometimes in opposition to it, and take a company private. That is, the company’s shares are no longer publicly traded.

This maneuver has several advantages to the new owners. First, despite the picture of investors putting in equity, most of the money is usually borrowed. That produces a huge tax break, since the interest is tax-deductible. Second, the new owners can pay themselves large management fees as well as “special dividends.” Typically, they take out far more than they put in, by incurring debts carried on the books of the operating company.

For instance, when Bain masterminded a private-equity deal for HCA, one of America’s largest for-profit hospital chains (which has gone from private to public twice and which paid a multibillion-dollar fine for defrauding Medicare), Bain paid itself a management fee of $58 million, even though it had only put up 6.3 percent of the buyout fund.

Another big plus: The main regulatory principle protecting investors and by extension, the system as a whole, is disclosure. Under the securities laws administered by the Securities and Exchange Commission, management must disclose information deemed “material” to the interests of the investing public, including salaries, earnings, losses, assets, liabilities, and risks. But these laws flow from the fact that a corporation’s shares are publicly traded. A company owner by a private-equity outfit like Bain can operate completely in the shadows.

Then, there are three possible ways to cash in.  If the company turns out to be a success, like Staples (one of Bain’s big winners), the private-equity owners can take their legitimate share of the reward. But that turns out to be the exception. If the company, newly loaded up with debt, starts to falter, it can be broken up, with massive layoffs and cuts in health and pension benefits, and resold, usually at a profit for the private-equity owners.

Or the company can simply declare bankruptcy under Chapter 11 and shed its debts. Normally, shareholders think twice about incurring risks that could result in  bankruptcy, because one of the consequences is that the stock becomes worthless. But private-equity owners typically have already made their bundle on management fees and special dividend payouts, so even if the operating company goes bankrupt, they are still in the money. 

And all of this is legal.

Oddly, as one abuse after another was exposed following the financial collapse, the predations of private equity have sailed merrily on. There is a terrific 2009 book on the subject, which I reviewed for the Prospect, Josh Kosman’s The Buyout of America. Read Kosman, and you will learn chapter and verse about how Bain, Carlyle, Blackstone, Texas Pacific Group, and the others plunder operating companies with taxpayer subsidies thanks to the borrowed money.

Among the tales Kosman tells: Thomas H. Lee Partners buys Warner Music, the world's fourth-biggest music company, and loads up the company with debt to finance the buyout and to pay itself $1.2 billion in dividends. One-third of the workforce is fired. CD&R, The Carlyle Group, and Merrill Lynch buy Hertz, the nation's largest auto-rental company, putting up just $2.3 billion in cash out of a $15 billion deal. The private-equity owners quickly recoup more than half of their down payment by loading up the company with even more debt. Funds for rental operations are cut by 39 percent, and Hertz's market share falls. In another example, Bain Capital, the company that made Mitt Romney rich, invests just $18.5 million in KB Toys, extracts $85 million in dividends, then takes the company into bankruptcy, stiffing employees, investors, and creditors.

In their tactical attack on Mitt Romney, the other Republicans have painted themselves into a corner. They owe it to the public to explain just what is improper about what private-equity operators do, what should be illegal, and what should be subject to disclosure. One awaits details from such aspiring working-class heroes as Rick Santorum and Newt Gingrich.

Comments

Let's face the dire truth. The US is founded on vulture capitalism. What else is slavery?

It is a myth that capitalism is pure and good by itself and must not be regulated. It is now time to stand up for true righteousness and expose the hypocrisy. 

Remember the civil war and how unwillingness and stubborness led to the bloodiest war in the history of the US. Great Britain got rid of slavery in a peaceful way. The United States, where all men are created equal on paper, had to have it pried out of their fingers.

What would happen if the rich, who profit from vulture capitalism, and their powerful friends in the media and in Washington, are as stubborn and unwilling to acknowledge the evil of vulture capitalism. Why would God not bring justice to those oppressed by this selfish system as He did for the slaves?

Watch my video: A German's preachers thoughts on 2012.
http://www.youtube.com/watch?v=gpLYq525SpM 

«The Buyout of America. Read Kosman, and you will learn chapter and verse about how Bain, Carlyle, Blackstone, Texas Pacific Group, and the others plunder operating companies with taxpayer subsidies thanks to the borrowed money.»

But the whole USA has been arguably LBOed, and not just a lot of individual companies. Just look at the colossal increase of USA public debt in recent years and decades. Reagan wrote that the debt increase was deliberate to make for a later case in cuts in spending, that's how LBOs work.

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