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April 12, 2012 9:35 AM   Subscribe

Robert Reich explains Private Equity Partnerships (or, "How Mitt Romney Got Obscenely Rich") in 8 easy steps.
posted by flapjax at midnite (51 comments total) 29 users marked this as a favorite

 
Here's his blog post about this.
posted by Burhanistan at 9:38 AM on April 12, 2012 [2 favorites]


Thanks, B-stan!
posted by flapjax at midnite at 9:40 AM on April 12, 2012


eh I don't think campaigning agains the tax deductibility of interest is a real winner here guys. Not to mention it would have some pretty deflationary impacts on the larger economy at a time when we really don't need deflation.

Besides just pound him on the totally indefensible carried-interest loophole and how most mature private equity buyouts are about job losses and cost cutting.

Don't start trying to make cap structure arguments - as correct as they may be.
posted by JPD at 9:43 AM on April 12, 2012


I think focusing on the record of companies post takeover and post debt issuance is something that could definitely be used to hammer on Romney as a "Job Creator". Certainly operations at some firms can be streamlined and efficiencies can be reached but coming into a profitable enterprise, laying off a ton of workers, saddling it with unsustainable debt loads and pocketing the difference could definitely be a worthwhile.

It seems like someone could definitely look at the net loss in jobs at the firms that Bain capital took over + any losses due to the firm later going bankrupt and generate a pretty hard number that would skewer the "Job Creator" rhetoric.
posted by vuron at 9:49 AM on April 12, 2012 [2 favorites]


Mitt who?
posted by Wilder at 9:50 AM on April 12, 2012 [2 favorites]


Can someone explain to me how Step Four works, please? I don't get how making the company pay interest on new debt increases the company's profits.
posted by BigLankyBastard at 9:51 AM on April 12, 2012 [1 favorite]


BigLankyBastard: Someone loans you ten bucks. Now you've got 10 in your pocket and an anti-10 in someone else's pocket. If you can turn the 10 into 20 before the -10 becomes -20, you've made more money than you would have without taking the loan, thus increasing your profits.
posted by kaibutsu at 9:55 AM on April 12, 2012


(I'm learning all about this right now playing this game.)
posted by kaibutsu at 9:56 AM on April 12, 2012 [5 favorites]


JPD - I don't think the complaint here is about the tax deductibility of interest. It is that these firms make huge profits while assuming little or no financial risk (they instead often risk the pooled money of the middle-class), AND pay reduced taxes on this windfall — not to mention leaving withered, debt-ridden companies behind which further burden the financial system.

It is a dangerous, parasitic process.
posted by dickyvibe at 9:56 AM on April 12, 2012 [7 favorites]


BigLankyBastard: "Can someone explain to me how Step Four works, please? I don't get how making the company pay interest on new debt increases the company's profits."

Corporate Income Tax Interest Deduction produces a negative tax on debt-financed investments. In theory these debt-financed investments are supposed to cover capital expenditures but really they are being used to finance outlandish profits for the takeover specialists.
posted by vuron at 9:57 AM on April 12, 2012


So, the owning firm takes the loan, makes the owned company pay the interest, and the firm reinvests that loaned money which is free to the firm... is that right?
posted by BigLankyBastard at 9:58 AM on April 12, 2012


they instead often risk the pooled money of the middle-class

This is wrong, investors must meet certain criteria to invest in these funds. This video is also a very simplified version that probably only represents a small part of "Private Equity" and probabaly doesnt even hold true for all of the partnerships Romney was a part of.
posted by Busmick at 9:59 AM on April 12, 2012 [1 favorite]


It seems like someone could definitely look at the net loss in jobs at the firms that Bain capital took over + any losses due to the firm later going bankrupt and generate a pretty hard number that would skewer the "Job Creator" rhetoric.

I don't know if anyone has conclusively run the numbers for Bain, but:
The jobs track record for private-equity firms in general appears to be a wash. In an analysis issued in September, five economists, using US Census Bureau data from 1980 to 2003, examined what effect private-equity firms had on job creation two years after they had acquired a company. They found that employment at an acquired firm was down 2 percent.
(source). And I suspect that the remaining workers (as opposed to management) found their wages and benefits cut.

Anyway, even if Bain created lots of jobs, "number of jobs created" is a pretty useless statistic. I want to see "net number of jobs created with total compensation equal to or greater to the worker's prior job." I also want to see "number of workers whose total compensation was reduced as part of cost cutting." In other words, I want to see evidence that private equity actually resulted in a net transfer of wealth to workers rather than to private equity and management. Otherwise it's just the usual conservative trick of convincing workers to vote against their own interests.
posted by jedicus at 10:02 AM on April 12, 2012 [11 favorites]



This is wrong, investors must meet certain criteria to invest in these funds. Yes and a DB plan by definition meets those criteria. CALPERS is the single largest Private Equity investor in the US. I think the Oregon State Treasury is widely considered the firm that gave birth to PE as an institutional asset class when the gave KKR money in '81
posted by JPD at 10:03 AM on April 12, 2012




JPD - I don't think the complaint here is about the tax deductibility of interest.

Watch the two minute mark again.
posted by JPD at 10:04 AM on April 12, 2012


Just out of curiosity, how does Romney's fortune compare to John Kerry's when he ran?

(I assume Perot was worth both of them put together.)
posted by Trurl at 10:05 AM on April 12, 2012 [1 favorite]


Let Us Now Praise Private Equity by Reihan Salam.
posted by John Cohen at 10:05 AM on April 12, 2012


Not exactly, it's more that the controlling firm has the owned firm issue a ton of debt. Some of that in theory could be used to expand the business but in reality the debt is just being used to pay the controlling firm a ton of money that is used to payback the investors in in the purchasing firm + profits.

The controlled firm now has x amount of new debt but in the short term at least the tax deductability of interest for those debt payments actually produces a negative tax rate of -6.4%. This reduces the corporate income taxes paid and makes the firm seem more profitable.

The major problem being that suddenly the firm has a massive amount of debt that they can barely service and in effect we are paying for that negative tax rate. Long term a lot of these companies struggle to survive but firms like Bain cash out way before that happens.
posted by vuron at 10:06 AM on April 12, 2012 [4 favorites]


And I think the video is a vast oversimplification and is far more black and white than reality - but hey - Its Politics!!!

(Also I'd argue there is a pretty big factual error in that the money gets borrowed to buy the business. The Leveraged Re-cap really only became big during the credit-bubble after Romney was retired)
posted by JPD at 10:07 AM on April 12, 2012


Yes and a DB plan by definition meets those criteria. CALPERS is the single largest Private Equity investor in the US.
I agree but this isnt a case of peoples money being taken from them or mis-allocated ...everyone involved has their eyes open. My point is that this video is an over-simplification and not universally true.
posted by Busmick at 10:08 AM on April 12, 2012


Just out of curiosity, how does Romney's fortune compare to John Kerry's when he ran?

(I assume Perot was worth both of them put together.)


Without looking up any of this, both Kerry and Romney are estimated to be worth a few hundred million dollars each, so they're in the same ballpark. McCain had less at around $50 million. Ross Perot is generally described as a billionaire, so I'm sure you're right about him. Barack Obama or anyone else who ends up being president has pretty much got it made, not because of the president's salary but because of their lifelong potential to get paid exorbitant amounts for whatever they do.
posted by John Cohen at 10:09 AM on April 12, 2012


Long term a lot of these companies struggle to survive but firms like Bain cash out way before that happens.

Right you could making a living betting against levered companies IPO'd as exits for the PE guys during economic upcycles.
posted by JPD at 10:09 AM on April 12, 2012 [3 favorites]


From Wikipedia:

Romney: As a result of his business career, by 2007, Romney and his wife had a net worth of between $190 and $250 million, most of it held in blind trusts.[73] An additional blind trust existed in the name of the Romneys' children and grandchildren that was valued at between $70 and $100 million as of 2007.[74] The couple's net worth remained in the same range as of 2011, and was still held in blind trusts.

Perot: With an estimated net worth of about US$3.4 billion in 2011, he is ranked by Forbes as the 99th-richest person in the United States.

Kerry: The Forbes 400 survey estimated in 2004 that Teresa Heinz Kerry had a net worth of $750 million. However, estimates have frequently varied, ranging from around $165 million to as high as $3.2 billion, according to a study in the Los Angeles Times. Regardless of which figure is correct, Kerry is the wealthiest U.S. Senator. Kerry is wealthy in his own name, and is the beneficiary of at least four trusts inherited from Forbes family members, including his mother, who died in 2002. Forbes magazine (a major business magazine named for an unrelated Forbes family) estimated that if elected, Kerry would have been the third-richest U.S. President in history when adjusted for inflation.[15] This assessment was based on the couple's combined assets, but Kerry and Heinz signed a prenuptial agreement that keeps their assets separate.[16] Kerry's financial disclosure form for 2002 put his personal assets in the range of $409,000 to $1.8 million, with additional assets held jointly by Kerry and his wife in the range of $300,000 to $600,000.
posted by monju_bosatsu at 10:11 AM on April 12, 2012 [5 favorites]


A sufficiently trenchant critique of what private equity has done to U.S. manufacturing becomes a critique of the underpinnings of Bill Clinton's "New Economy." So, Reich trots out some talking points against Romney in time for the election, but this hollowing out has been going on for decades and there's no desire to see that you have an economy which is an increasingly thin shell covering empty wasteland of human lives...

Any policy, given enough lawyers and lobbyists develops loopholes. Without regulatory oversight over Wall Street that has the power and political will to bankrupt people, any specific reform is totally fruitless: interest, carried-interest whatever...
posted by ennui.bz at 10:12 AM on April 12, 2012 [3 favorites]


ennui.bz has it right. I love Robert Reich, and I'm not a Romney supporter, but the distortion field has already begun to take hold. Why, for example, didn't Obama and the Dems take on the capital gains tax issue when they had votes? Same with health care. Same with campaign financing. Same with war in the Middle East. As regards the capital gains issue, might that have something to do with the fact that Goldman Sachs was Obama's largest corporate bundler in 2008, along with a bunch of other financial institutions?

Oh, and btw, a lot of companies that private equity takes on themselves pursue private equity as a solution because they have exhausted more traditional means of financing (banks, etc.). Many businesses that private equity groups take over are on their very last leg, and about to go under because they are poorly managed, or have not appropriately leverage intellectual and other kinds of capital.

Last, many of the problems that Reich points out have been permitted by BOTH parties.

So, here we go again - every four years both parties trot out their "hope and fear" agendas, all neatly packaged and paid for by their corporate sponsors. Every four years, Americans become a bunch of suckers.
posted by Vibrissae at 10:23 AM on April 12, 2012 [6 favorites]


Oh, and btw, a lot of companies that private equity takes on themselves pursue private equity as a solution because they have exhausted more traditional means of financing (banks, etc.). Many businesses that private equity groups take over are on their very last leg, and about to go under because they are poorly managed, or have not appropriately leverage intellectual and other kinds of capital.


No. this is a very small niche area of the industry - none of the huge private equity players do this. And oh you think the KKRs, Bains, and Apollos of the world are predators? Those guys are cuddly teddy bears compared to the "loan-to-own" and distressed guys. Not even teddy bears - fluffy white clouds of candy floss.
posted by JPD at 10:30 AM on April 12, 2012


every four years both parties trot out their "hope and fear" agendas

It's obvious that the best we can expect from a second Obama term is an ongoing slow decline, even with a Democratic Congress, as opposed to a full-speed 'race to the bottom' if Romney works with a Republican Congress. Now, some of us cynics believe that the USofA is not going to turn itself around until it hits rock bottom, so if you feel you can survive that crash yourself and want to build a better country for your very young or not-yet-born children (since it should take 10-20 years after the crash), then hurrying up the crash is not a bad idea. You'll know it's all over when the billionaires stop funding American politicians because the return-on-investment is no longer worth it.
posted by oneswellfoop at 10:39 AM on April 12, 2012 [5 favorites]


I think Reich overstates the focus on cutting jobs as the primary reason to do an LBO. That's certainly the case sometimes. But in the vast majority of deals I encountered during the boom years the real driver behind doing the deal was the availability of debt. It's the same dynamic that played out in the housing market. Most people who bought homes as investments did it because they could get a mortgage easily, not because they thought they could fix up the house. Some people did that and some LBOs are predicated on making major cuts but it's not the most popular reason.

Those guys are cuddly teddy bears compared to the "loan-to-own" and distressed guys.

I'd say Apollo is in the latter group and not the teddy bear group. It joined in with the teddy bears during the boom, but it's a distressed shop at the core.
posted by mullacc at 10:45 AM on April 12, 2012 [1 favorite]


"...Long term a lot of these companies struggle to survive"

I was in our MD's office one day in the early 2000s, just after the company had been broken up and different bits sold to different competitors. When he'd set things up at the beginning of the 90s, it had been a new division of one of the best, most profitable and most effective companies in its field, and for a while we followed most happily in that tradition.

Then the company - a family firm, privately held, brimming with cash - went public, official reason "we need stock to do deals". Real reason: the head of the firm had handed over to his sons, who fancied themselves as high financiers and wanted to Prove Themselves. They Proved Themselves by subsequently flogging off the company to a real, shark-skinned investment bank, who schooled the upstart sons by promptly selling it on at double the price to one of the original bidders. That (huge) price was paid through highly-leveraged debt, which ended up with us.

We were left managing a profitable business with a tradition of doing things the right way, with no money to do things the right way. Eventually, having been whittled down and sold on a few times, each time with false promises and more value lost (lost! No sir, not lost), the shitstorm of the dot com bubble threw the last bucket of rancid vomit over our heads and that was that.

I have never seen a man - a charismatic, capable, fair man - look so broken as my MD did that day. Despite offers (one I know about was to be CEO of a very respectable UK outfit, which would have been a big step up even when the good times were rolling), he retired from business altogether apart from charity work, I heard because he had been so sickened by the whole thing.

The one bit of our conversation that day that I remember was me asking him how what had happened could be legal, and him saying that he didn't know.

I know why it's legal now, because the people who set the rules are the ones that do best by them. The destruction of actual worth, of actual people and of immense potential, does not feature in their calculations, and I doubt it looms much larger in their awareness. But I have seen it and lived through it, and it is never far from mine.
posted by Devonian at 10:50 AM on April 12, 2012 [19 favorites]


Devonian, that's a interesting story, but I'm not sure what laws could be created to stop that from happening.
posted by rebent at 11:18 AM on April 12, 2012


I don't think I will be loading that moveon.org website again any time soon. I saw about a hundred scripts run before the video loaded and then before I could push the play button there was a screen filling ad. Couldn't be bothered to do anything but close their fucking tab.

Was Step One: choose good parents?
posted by bukvich at 11:23 AM on April 12, 2012


Rebent: sure, I know. How is it different from the heads of a company deciding on a big new project, going into debt for it and getting the numbers wrong? (what got two of the companies I worked for before that one: those were bad and upsetting, but this was worse.) How does capitalism even work if you can't use other people's capital on mutually-agreed terms?

But, in general, wanton destruction of people and property is illegal, and discouraged by passing on the consequences of such actions to the actors. Industries are regulated along much the same theory. Create a chain of responsibility and a mechanism for tugging it.

The companies I worked for which went down for internal reasons, well, the people that were responsible for making the decisions got a lot of the pain. The people who made the decisions in my story; they got all of the pie. The pain feedback loop needs to be there.
posted by Devonian at 11:42 AM on April 12, 2012 [2 favorites]


Of course they could create laws to introduce regulations. They existed for decades. Laws against capital flight. Laws against usury. Laws against tax evasion.

The reason those laws aren't passed is because the criminals have written the new laws. While they are praised by our greed-based society for stealing billions, they simultaneously convince Americans through marketing firms masquerading as journalism that poor people who ask for food, shelter, and medical care from the government are the parasites.

The money that has been funneled out of the economy by Romney and his friends — which included a lot of Democrats — could have paid for the medical care and education of millions of people. It's no coincidence that jobs started disappearing as soon as the vultures were freed of the last protections that existed for American workers and small business owners.

The bottom line is that these individuals do not give a damn about you, or your grandma, or about your child's future. They want money and power, and if they have to destroy the entire economy to get it, that's "just business." Buying off politicians and destroying the government's ability to police corporate activity, while turning even the most solemn duties of government into for-profit operations, is just the beginning: they are already starting to throw people in jail for being in debt.

More poor people in prison. More cheap, uneducated, unorganized laborers. Higher profits. Happier Mitt Romney.
posted by deanklear at 11:53 AM on April 12, 2012 [2 favorites]


If "corporations are people, my friends", then couldn't we get the act of loading one up with highly-leveraged debt prosecuted as murder, my friends?
posted by benito.strauss at 12:06 PM on April 12, 2012 [1 favorite]


Just out of interest what law could reasonably be passed that prevents Private Equity deals?

I mean I'm a bit confused - usury? tax evasion? We don't even have laws against capital flight
posted by JPD at 12:11 PM on April 12, 2012


eh I don't think campaigning agains the tax deductibility of interest is a real winner here guys.

Tax deductibility is the crux of the problem with private equity firms, however, because it is precisely this factor that gives the partners in those firms the economic incentive to profit by eliminating other people's jobs.
posted by jonp72 at 12:18 PM on April 12, 2012 [1 favorite]


Tax deductibility is the crux of the problem with private equity firms, however, because it is precisely this factor that gives the partners in those firms the economic incentive to profit by eliminating other people's jobs.
Explain. Or are you conflating the lower carried interest tax rate with tax deductibility of corporate debt.


Ending the tax deductibility of corporate debt is inherently deflationary - the last thing the US needs is something like that right now.
posted by JPD at 12:26 PM on April 12, 2012


The tax deduction that needs to end is not corporate debt, its the differential taxation of capital gains and ordinary income. That differential makes working in finance and engaging in financial manipulations that generate capital gains extra-ordinarily attractive.
posted by RandlePatrickMcMurphy at 12:39 PM on April 12, 2012 [1 favorite]


That differential makes working in finance and engaging in financial manipulations that generate capital gains extra-ordinarily attractive.

Probably 95% of Wall Street employees don't benefit from the carried-interest tax loophole. (Note not 95% by dollars of comp tho)

Virtually none of the people most culpable for the global financial crisis benefitted from the loophole.

Its indefensible, and must be closed - but let's not make it into something it isn't.
posted by JPD at 12:47 PM on April 12, 2012


The tax deduction that needs to end is not corporate debt, its the differential taxation of capital gains and ordinary income

Although a tough break if you take a shit salary for years as you build up your business before selling it.
posted by MuffinMan at 12:50 PM on April 12, 2012 [1 favorite]


There is probably some solution that lies between ending the tax deductibility of corporate debt and the status quo. They could cap the deduction at some relevant ratio (debt/equity or some % of EBIT maybe?). I don't really know enough about corporate finance to know what the solution would be but it should be but it should be possible to take the advantage away for extreme situations but leave things the way they are for normal businesses conducting business as usual.
posted by VTX at 1:08 PM on April 12, 2012


Most days I bring a brown-bag lunch to work, but today I went out. The bill came to $11. I felt a pang of guilt for a moment, until I did some mental math and realized that I could easily spend $11 on lunch every single day and not really have to cut back on anything else.

Mitt could spend $25,000 on lunch every single day and not really have to cut back on anything else.
posted by miyabo at 1:09 PM on April 12, 2012


They could cap the deduction at some relevant ratio (debt/equity or some % of EBIT maybe?).

There's too much variation by industry. For example, Kellogg is probably just fine at 70%+ debt/capital. But that would be wildly irresponsible for smaller companies in more cyclical industries. And any attempt to risk-adjust across industries would be horribly complex. The Basel capital rules for banks are a huge mess and that's just for banks.
posted by mullacc at 2:12 PM on April 12, 2012


weighted average by NAICS/SIC code.

Hey guys I've got a great idea for a consulting firm start-up. Anyone in?
posted by JPD at 2:15 PM on April 12, 2012


Hey guys I've got a great idea for a consulting firm start-up. Anyone in?

I think you want the JOBS Act thread.
posted by VTX at 3:14 PM on April 12, 2012


Can someone explain to me how Step Four works, please?

Resurrect Glass-Steagall on Planet Jupiter.
posted by dhartung at 4:41 PM on April 12, 2012


The only reason that I can see for bringing up John Kerry's wealth would be to make a political argument along the lines of "Democrats nominated a rich guy as their candidate eight years ago, so they have no right to criticize Romney for his riches."

But of course, there are huge differences between the two cases. First, it's not 2004 anymore. The Occupy Movement made income inequality an issue now, when it wasn't one eight years ago, so that theme can't be completely ignored now. Second, Kerry - or I should say his wife's family - made their money the old-fashioned way, by manufacturing and selling a product, and not by this newfangled confusing and somewhat suspicious financial hocus-pocus. Third, and most important, is that Romney has invited a critique of the manner in which he became wealthy by the very things he says in his campaign speeches.

Romney has portrayed himself in his speeches as a guy who can turnaround the economy. It's about the only thing he has been consistent about for the last five years and it's a welcome message for people desperate to see the economy turn around. Romney points to his time at Bain ("rescuing failed companies") and to his success managing the Salt Lake City Olympics ("rescuing the Olympics from extinction") and the implication is that he has some kind of superhuman savvy that allows him to jump into any bad financial situation and make it all better. But is that true? How exactly does his experience at a private equity firm translate to governing the economy of a country? To even understand his campaign message, we have to understand what private equity firms do, and therefore how Romney got his money.
posted by twoleftfeet at 5:20 PM on April 12, 2012 [3 favorites]


JPD Just out of interest what law could reasonably be passed that prevents Private Equity deals?

It's not the deals themselves that are the problem, it's a specific subset of these deals, where this occurs: the bad actor in the system causes a victim entity, ie a person or company or trust or whatever, to take on debt, some or all of the proceeds of which will be given to the bad actor, and where the value (if any) that accrues to the victim entity in exchange for taking on the debt does not match the costs that the victim entity pays. It's a win-lose deal: those are always ethically suspect, and are a sign of conduct that probably should be illegal.

If you're not doing win-win deals, you're not doing capitalism properly. The core essence of capitalism is the voluntary exchange of goods and services between parties who are all better off with what they received, than they were with what they gave up. An honest trader, whether buyer or seller in the transaction, satisfies him/herself that the other party has received fair value. (Bearing in mind that people's valuations of things honestly do differ.)

A dishonest trader doesn't do that; he/she only checks his/her own value received, and generally checks whether it is as much as could be gained, rather than whether it is fair. That's the difference, and that's what laws governing trading need to be crafted around: expectations of good faith and concern for the welfare of one's trade partners, and enforcement against those who do not deal in good faith.

If the state lets you get away with dishonest trading, however complicated the terms of it, they're not doing governance properly.
posted by aeschenkarnos at 8:23 PM on April 12, 2012


"More poor people in prison. More cheap, uneducated, unorganized laborers. Higher profits. Happier Mitt Romney."

Ahem, I'm no Romney fan, but I am a fan of keeping it real... Do you really think Romney thinks this way about the world? Really? That is a sad world if you are not joking.
posted by astrobiophysican at 10:03 PM on April 12, 2012


Do you really think Romney thinks this way about the world?

I'd say, essentially, yes. Really.

That is a sad world if you are not joking.

Well, it is a pretty sad world. There's some really awful people in it. That's a surprise?
posted by flapjax at midnite at 12:40 AM on April 13, 2012


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