Here is a classic private-equity deal. It’s not one of Mitt Romney’s, but I use it because it has been well documented. In 2006, near the end of the bubble, the Blackstone firm and a partner bought a travel company for $4.3 billion. They put up $1 billion of their fund monies and borrowed the rest—but on the books of the travel company, not their own. The first year, the new owners laid off 846 employees, at an annual savings of about $100 million. A little while later, they borrowed another $1.1 billion on the travel company’s books and paid it to themselves as a “special dividend.” Within a few months, that is, they completely recovered their initial investment, and pocketed substantial deal fees and management fees besides.
Private-equity barons like to say they “create wealth.” But more frequently they merely redistribute it. The employees laid off by Blackstone had lost considerable wealth in the form of job security and health insurance, and the company was riskier, but those losses were matched by the private-equity investors’ gains.
Few people complain about the great wealth of a Bill Gates, even though Gates is richer than almost anyone in finance, and his products have eliminated many precomputer jobs. That’s because software moguls are truly engaged in “creative destruction,” creating new technologies that radically transform whole industries and national lifestyles. While venture-capital firms support transformational new companies, private-equity firms look for cash-flow stability to support leverage. Their major goal is not to invent things or create jobs, but to funnel money to the partners.
The current cycle in private equity dates from the leveraged-buyout boom of the 1980s. After the dreadful ’70s, the stock market was at one of its lowest ebbs relative to company value in the entire postwar era. But once Paul Volcker quelled inflation, there was a golden opportunity for the savviest, richest investors. Borrow shiploads of money, buy up the stock of good companies, and wait for the market to catch up. The late buyout king Ted Forstmann bragged mid-decade that his investors had made 80 percent annual returns. But if you had just bought the S&P 500 Index in 1982 with 90 percent borrowed money, your equity would have returned more than 100 percent a year through 1986.
Private equity is really about leverage. Returns on equity are high because private equity owners fund their companies almost entirely with debt. Highly leveraged companies do fine as long as markets are rising, but, as Warren Buffett has remarked, when the tide goes out you find out who’s been swimming naked.
Investors in public companies expect dividends to be paid out of earnings. Private equity owners pay themselves dividends by borrowing against future earnings. That is an inherently dangerous game—the kind that canny stock-market investors flee like the plague.
The authors of a recent admiring book on Blackstone concede that the firm’s outsized earnings primarily stem from leveraged bets on the stock market. Mitt Romney headed Bain Capital from 1984 to 1999, years of very strong average market growth, when highly leveraged players generally did very well indeed.
Romney’s Bain did smaller deals than Blackstone, but followed the same pattern of paying out very large dividends with borrowed money. Dade-Behring was a successful medical-equipment company. In 1999, Bain increased the company’s debt by $450 million, and paid three-quarters of it to themselves, requiring a “strategic bankruptcy” when markets turned down a couple of years later. A number of other mid-size companies—Georgetown Steel, American Pad & Paper—followed a similar pattern.
Private-equity firms are not inherently evil. They want to keep the milk cows healthy, and they welcome job growth so long as it increases profits. But jobs are incidental; their core objective is to extract money.
There is little question that private equity has been a factor in the sharp upward ratchet in income inequality over the past thirty years. So it is absurd to give private equity a special tax break. All investors are entitled to have investment gains taxed at the current capital-gains rate of 15 percent. But private-equity partners pay the same low rate on the incentive fees they take, which are usually 20 percent of their fund investors’ gains. There is no conceivable justification for such special treatment.
Mitt Romney’s record as head of Bain Capital is a good one, but it was during a period when most firms did very well. He is clearly intelligent, with a high order of a specific kind of analytic ability. By itself that is hardly a qualification for the presidency.