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Heads We Win, Tails You Lose: The Fascist Philosophy Behind Private Equity’s Leveraged Buyout of Everything

It’s been the same head­line for months now:

* April of 2020: Amer­i­can bil­lion­aires have got­ten $280 bil­lion rich­er since the start of the COVID-19 pan­dem­ic

* May of 2020: Amer­i­can bil­lion­aires got $434 rich­er dur­ing the pan­dem­ic

* August of 2020: Amer­i­can bil­lion­aires got $637 rich­er dur­ing the pan­dem­ic

* Sep­tem­ber of 2020: U.S. bil­lion­aires got $845 bil­lion rich­er since the start of the pan­dem­ic/Wealth of US bil­lion­aires ris­es by near­ly a third dur­ing pan­dem­ic.

* Octo­ber of 2020: US bil­lion­aires saw their net worth rise by almost $1 tril­lion between March and Octo­ber — Jeff Bezos remains the rich­est, a study says.

From near­ly the start of the COVID-19 pan­dem­ic it’s been clear that the pub­lic health dis­as­ter was­n’t a dis­as­ter for every­one, with the wealth­i­est indi­vid­u­als being not only large­ly insu­lat­ed from the eco­nom­ic lock­down but in many cas­es well posi­tioned to prof­it from it. The pan­dem­ic was turn­ing into a giant trans­fer of wealth. But get­ting a sense of the scale of the mas­sive trans­fer of wealth was going to take time. And time has indeed passed, with the wealth of US bil­lion­aires hav­ing risen by near­ly a third since the start of the pan­dem­ic.

And that’s only as of Sep­tem­ber. At this rate the bil­lion­aires are on track to be tril­lion dol­lars rich­er by the end of the year. What kind of wealth gains are in store for the bil­lion­aires in 2021? Only time will tell. Time and the inevitable reports of tril­lions more dol­lars in bil­lion­aire wealth. It’s an absurd gen­uine soci­etal cat­a­stro­phe on top of all the oth­er cat­a­stro­phes. And that’s what it’s going to be cru­cial to keep in mind as this pan­dem­ic plays out that the emer­gence of a ‘heads we win, tails you lose’ bil­lion­aire class was nev­er actu­al­ly inevitable. There’s no law of nature that dic­tates we tol­er­ate an ever increas­ing wealth gap. It’s a pol­i­cy choice.

That’s why one of the major ques­tions fac­ing not just the US but the world at this point is what should be done about this egre­gious cap­ture of wealth by a tiny sliv­er of the pop­u­la­tion. A tiny sliv­er that was already egre­gious­ly wealthy. And as the fol­low­ing arti­cle excerpts make clear, if we’re going to final­ly begin to ask the ques­tion of how to cor­rect this yawn­ing wealth gap there’s a very obvi­ous tar­get: the pri­vate equi­ty indus­try, which has gone from a rel­a­tive­ly tiny and obscure sec­tor of finance pre-1980 to a behe­moth that today pow­ers the “shad­ow bank­ing” sec­tor of the econ­o­my using mas­sive debt and bru­tal cost-cut­ting mea­sures that often cross into the ter­ri­to­ry of cor­po­rate loot­ing. Includ­ing the loot­ing of a num­ber of cor­po­rate pen­sions. In terms of address­ing the gross and grow­ing lev­els of inequal­i­ty this seems like a good place to start.

As we’re going to see...

1. The long-hoped for “V‑shape” eco­nom­ic recov­ery from the pan­dem­ic is increas­ing­ly look­ing like a “K‑shaped” recov­ery where some sec­tors of the econ­o­my do well while oth­ers lag or lan­guish. Guess who owns the bulk of the sec­tors of the econ­o­my poised to do well.

2. Back in March, when the eco­nom­ic lock­down was first wreak­ing hav­oc, the pri­vate equi­ty was lob­by­ing to get access to the US fed­er­al gov­ern­men­t’s Pay­check Pro­tec­tion Pro­gram (PPP) loan pro­gram that was explic­it­ly set up for small busi­ness­es. Pub­licly, pri­vate equi­ty lob­bies for decry­ing the lack of access to the fed­er­al loans for small busi­ness own by pri­vate equi­ty firms (which would­n’t real­ly make them small busi­ness­es). Pri­vate­ly, pri­vate equi­ty firms were report­ed­ly inform­ing Con­gress that if they don’t get access to the loans they will be forced to engage in mass lay­offs. The pri­vate equi­ty indus­try was sit­ting on $2 tril­lion in cash at the time they were mak­ing this threat. Heads we win, tails you lose. Again and again.

3. At the same time the pri­vate equi­ty lob­by was threat­en­ing to engage in mass lay­offs if it did­n’t get access to the PPP loans it was also rais­ing a dis­turbing­ly valid point for why the pri­vate equi­ty indus­try should be bailed out by the fed­er­al gov­ern­ment: pub­lic pen­sion funds have become major investors in a num­ber of pri­vate equi­ty funds. For exam­ple, the Cal­i­for­nia Pub­lic Employ­ees’ Retire­ment Sys­tem (CalPERS), put 27% of its assets in pri­vate equi­ty firms in 2018–2019, amount­ing to almost $7 bil­lion dol­lars that year alone. As we should expect, if we com­pare the annu­al returns of pri­vate equi­ty-run invest­ments the per­for­mance of pri­vate equi­ty has­n’t remote­ly jus­ti­fied the often exor­bi­tant pri­vate equi­ty fees.

4. While Con­gress even­tu­al­ly put in place lim­its (with some excep­tions) to pri­vate equi­ty’s par­tic­i­pa­tion in the PPP, numer­ous pri­vate equi­ty firms found var­i­ous loop­holes or arrange­ments used to jus­ti­fy tak­ing loans any­way.

5. In June of this year, the Trump admin­is­tra­tion expand­ed the role of pri­vate equi­ty in US retire­ment sav­ings beyond pen­sion funds when the Depart­ment of Labor announced that it would allow pri­vate equi­ty firms to sell retire­ment prod­ucts to indi­vid­ual 401k retire­ment accounts.

6. Just days ago, we learned that CalPERS is plan­ning on depend­ing even more on pri­vate equi­ty invest­ments in the future. Why? Well, as the chief exec­u­tive of CalPERS put it, a study from CalPERS and its out­side con­sul­tants showed that only pri­vate equi­ty and oth­er high risk invest­ments like dis­tressed debt were like­ly to yield the 7 per­cent annu­al­ized returns that CalPERS needs to meet its future oblig­a­tions. Now, as we’ll see, this sit­u­a­tion was arrived at in part due to the deeply unre­al­is­tic expec­ta­tions of future stock mar­ket per­for­mance that not just CalPERS but a num­ber of oth­er pen­sion funds have tra­di­tion­al­ly used for deter­min­ing how much mon­ey needs to actu­al­ly be invest­ed to meet pen­sion oblig­a­tions, so rely­ing on pri­vate equi­ty and dis­tressed debt is basi­cal­ly a gam­bit to cor­rect for those unre­al­is­tic expec­ta­tions. So the pub­lic is increas­ing­ly turn­ing to pri­vate equi­ty to address pen­sion short­falls instead of oth­er far more sen­si­ble approach­es like sim­ply tax­ing the rich more to pay for those pen­sions.

7. Final­ly, we’ll take a look at a piece by econ­o­mist Matt Stoller about the his­to­ry and phi­los­o­phy behind the rise of pri­vate equi­ty. A his­to­ry where load­ing com­pa­nies with debt was char­ac­ter­ized as ben­e­fi­cial because it would force man­agers to focus on cut­ting costs. And a his­to­ry where the rise of the pri­vate equi­ty move­ment in the 1980s was seed­ed by fig­ures like Bill Simon and the nascent “law and eco­nom­ics move­ment” that rep­re­sent­ed the con­ser­v­a­tive back­lash against the New Deal. As we’ll see, Simon viewed ruth­less­ness as a virtue and though the Repub­li­can Par­ty of Richard Nixon and Ger­ald Ford was too ‘soft’. Not sur­pris­ing­ly, Simon’s views were quite pop­u­lar with the bud­ding “New Right” Repub­li­can class of 1978. Today’s Repub­li­can Par­ty is almost entire­ly of the “New Right” strain. So when we look at the his­to­ry of the rise of pri­vate equi­ty we’re also look­ing at the his­to­ry of the rise of the con­tem­po­rary Repub­li­can Par­ty’s extrem­ist eco­nom­ic poli­cies run almost exclu­sive­ly for the ben­e­fit of big cor­po­ra­tions and the super rich.

The K‑Shaped Recov­ery: The Lat­est Exam­ple of the “Heads I Win, Tails You Lose” Econ­o­my Run By and For the Rich

Ok, first, let’s start with a look at the emerg­ing “K‑shaped” nature of the ongo­ing eco­nom­ic recov­ery. A ‘recov­ery’ in cer­tain seg­ments of the econ­o­my — in par­tic­u­lar the tech­nol­o­gy sec­tor, big banks, and big-box retail — and a gen­er­al recov­ery in the stock mar­ket — which is almost entire­ly owned by the wealth — while mom-and-pop stores and ser­vice pro­fes­sion­als lag. So it’s a “K‑shaped” recov­ery that pri­vate equi­ty is extreme­ly well poised to cap­i­tal­ize on. After all, pri­vate equi­ty has been one of the major play­ers in the big-box retail sec­tor for yeas — often to the detri­ment of those stores as their new pri­vate equi­ty own­ers loaded up on debt and a major investor in tech­nol­o­gy ...not so much mom-and-pop shops. So this real­ly is turn­ing into the kind of ‘recov­ery’ opti­mized to ensure the grow­ing influ­ence of pri­vate equi­ty on the econ­o­my is going to not just con­tin­ue grow­ing but accel­er­at­ing too. And as econ­o­mist point out, it’s not like this K‑shaped recov­ery is a nov­el phe­nom­e­na. The US econ­o­my has been increas­ing K‑shaped since the 1980s, with the real econ­o­my of reg­u­lar work­ers com­pris­ing the low­er half of the “K”, and finan­cial mar­kets mak­ing up the top half. So this just the lat­est K‑shaped recov­ery in an increas­ing­ly K‑shaped econ­o­my:

CNBC

Wor­ries grow over a K‑shaped eco­nom­ic recov­ery that favors the wealthy

* As the econ­o­my strug­gles to shake off the pan­dem­ic effects, wor­ries are grow­ing that the recov­ery could look like a K.
* That would be one where growth con­tin­ues but is uneven, split between sec­tors and income groups.
* One obvi­ous area of con­cern is the dichoto­my of the stock mar­ket vs the real econ­o­my, espe­cial­ly con­sid­er­ing that 52% of the mar­ket is owned by the top 1% of earn­ers.
* “Let’s not get lost on dif­fer­ent let­ters of the alpha­bet,” Trea­sury Sec­re­tary Steven Mnuchin said. “There are cer­tain­ly parts of the econ­o­my that need more work.”

Jeff Cox
Pub­lished Fri, Sep 4 2020 1:41 PM EDT
Updat­ed Sat, Sep 5 2020 5:35 PM EDT

The sto­ry for much of the past gen­er­a­tion has been a famil­iar one for the U.S. econ­o­my, where the ben­e­fits of expan­sion flow most­ly to the top and those at the bot­tom fall fur­ther behind.

Some experts think the coro­n­avirus pan­dem­ic is only going to make mat­ters worse.

Wor­ries of a K‑shaped recov­ery are grow­ing in the alpha­bet-obsessed eco­nom­ics pro­fes­sion. That would entail con­tin­ued growth, but split sharply between indus­tries and eco­nom­ic groups.

It’s a sce­nario where big-box retail and Wall Street banks ben­e­fit and mom-and-pop shops and restau­rants and oth­er ser­vice pro­fes­sion work­ers lag. Though not read­i­ly vis­i­ble in GDP num­bers for the next sev­er­al quar­ters that will look gaudy in his­tor­i­cal terms, the uneven ben­e­fits of the recov­ery pose longer-term risks for the nation­al eco­nom­ic health.

“The K‑shaped recov­ery is just a reit­er­a­tion of what we called the bifur­ca­tion of the econ­o­my dur­ing the Great Finan­cial Cri­sis. It real­ly is about the grow­ing inequal­i­ty since the ear­ly 1980s across the coun­try and the econ­o­my,” said Joseph Brusue­las, chief econ­o­mist at RSM. “When we talk K, the upper path of the K is clear­ly finan­cial mar­kets, the low­er path is the real econ­o­my, and the two are sep­a­rat­ed.”

Indeed, one of the sim­plest ways to envi­sion the cur­rent K pat­tern is by look­ing at the mete­oric surge of the stock mar­ket since late March, com­pared to the rest of the econ­o­my. While the mar­ket soared to new heights, GDP plunged at its most ever at an annu­al­ized rate, unem­ploy­ment, while falling, remains a prob­lem par­tic­u­lar­ly in low­er income groups, and thou­sands of small busi­ness­es have failed dur­ing the pan­dem­ic.

That in itself exac­er­bates inequal­i­ty at a time when 52% of stocks and mutu­al funds are owned by the top 1% of earn­ers.

But it’s not just about asset own­er­ship, it’s the nature of those assets.

The stock mar­ket gains have been large­ly the result of a hand­ful of stocks. Exclud­ing new­com­er Salesforce.com, Apple, Microsoft and Home Depot have con­tributed more points to the Dow Jones Indus­tri­al Aver­age this year than the oth­er 27 stocks on the index com­bined.

That’s why Wall Street when look­ing for the prop­er let­ter — V, W, U or vari­a­tions there­of — is begin­ning to see K as more of a pos­si­bil­i­ty.

“The K‑shaped nar­ra­tive is gain­ing trac­tion as the tale of two recov­er­ies con­forms well with the ongo­ing out­per­for­mance of risk assets and real estate while front-line ser­vice sec­tor jobs risk per­ma­nent elim­i­na­tion,” Ian Lyn­gen, head of U.S. rates strat­e­gy at BMO Cap­i­tal Mar­kets, said in a note.

The dom­i­nat­ing stocks, in fact, help tell a sto­ry about a shift­ing econ­o­my that is leav­ing those behind with less access to the tech­nol­o­gy that will shape the recov­ery.

“We believe this is now set­tled and that we are see­ing a ‘K‑shaped’ recov­ery,” wrote Marko Kolanovic, glob­al head of macro quan­ti­ta­tive and deriv­a­tives research at JPMor­gan Chase.

Kolanovic, who has fore­seen a num­ber of major mar­ket changes, said the rapid evo­lu­tion of soci­ety dur­ing the pan­dem­ic has trig­gered move­ments that have exac­er­bat­ed inequal­i­ty.

“The use of devices, cloud and inter­net ser­vices was bound to sky­rock­et while the rest of the econ­o­my took a nose dive (air­lines, ener­gy, shop­ping malls, offices, hos­pi­tal­i­ty, etc.),” he said. “This has cre­at­ed enor­mous inequal­i­ty not just in the per­for­mance of eco­nom­ic seg­ments, but in soci­ety more broad­ly. On one side, tech for­tunes reached all-time highs, while low­er income, blue col­lar work­ers and those that can­not work remote­ly suf­fered the most.”

Fed­er­al Reserve Chair­man Jerome Pow­ell has bemoaned the momen­tum that low­er earn­ers had just begun to see pri­or to the pan­dem­ic.

That’s one of the rea­sons the cen­tral bank last week adopt­ed a major pol­i­cy shift in which it will allow infla­tion to run above the Fed’s 2% goal for a peri­od of time after it has run below the mark. More than just a philo­soph­i­cal state­ment about infla­tion, cod­i­fy­ing the approach allows the Fed to keep inter­est rates low even after the job­less rate drops below what had once been con­sid­ered full employ­ment.

Fed offi­cials believe that keep­ing pol­i­cy loose when the unem­ploy­ment rate hit a 50-year low over the past year helped con­tribute to the wider dis­tri­b­u­tion of income gains, and should be the approach going for­ward.

“It’s a good start that the Fed­er­al Reserve, based on two decades of struc­tur­al change in the econ­o­my and a rapid­ly chang­ing demo­graph­ic struc­ture in the Unit­ed States, decid­ed to walk back its long-held pref­er­ence to act to pre­ven­ta­tive­ly against infla­tion, when expec­ta­tions were clear­ly anchored,” Brusue­las said.

The Fed, though, has tak­en some of the blame for the inequal­i­ty by imple­ment­ing poli­cies that seem to ben­e­fit asset hold­ers and ignore the rest of the pop­u­la­tion. While loans to small­er busi­ness­es have been slow to get out, the cen­tral bank has been buy­ing junk bonds and debt of big com­pa­nies like Apple and Microsoft to sup­port mar­ket func­tion­ing. The infla­tion piv­ot and an accom­pa­ny­ing change on the approach to the unem­ploy­ment rate, then, is seen as a way to focus pol­i­cy more broad­ly.

A vari­ety of paths

To be sure, the actu­al shape of the recov­ery depends on a num­ber of fac­tors, high among them the direc­tion of the virus and the extent to which Con­gress and the White House come through with more fis­cal aid.

This down­turn is unique in that it did not fol­low one of the usu­al paths low­er, such as a cred­it crunch or an asset bub­ble. Instead, this was a gov­ern­ment-induced reces­sion, a byprod­uct of efforts to con­tain the pan­dem­ic by pur­pose­ly keep­ing peo­ple away from their jobs and sub­se­quent­ly great­ly reduc­ing the abil­i­ty of busi­ness­es to oper­ate.

That’s why pre­dict­ing the path of recov­ery is dif­fi­cult.

“Every busi­ness cycle since 1990 has been one where there’s been some ‘K’ char­ac­ter­is­tics to it,” said Steven Ric­chi­u­to, U.S. chief econ­o­mist at Mizuho Secu­ri­ties. “Because they’ve been cred­it cycles, ris­ing waters don’t always lift all boats the same way. Some boats are tiny lit­tle lifeboats with­out much bag­gage, and some oth­er boats have heav­ier bags that need more ener­gy to lift. Those are the ones that have cred­it prob­lems.”

In the cur­rent sit­u­a­tion, cred­it is not the prob­lem and the Fed has back­stopped any of those issues that may arise through its myr­i­ad lend­ing and liq­uid­i­ty facil­i­ties.

Ric­chi­u­to sees a “more tra­di­tion­al recov­ery envi­ron­ment” that will turn into a “swoosh,” or one where an ini­tial burst lev­els off. That also is a pop­u­lar view.

“Clear­ly some areas are going to be slow­er to come back. That’s going to be true even when the vac­cine comes about,” said Yung-Yu Ma, chief invest­ment strate­gist at BMO Wealth Man­age­ment. “I don’t buy into the K shape so much. I think it’s more a mat­ter where there will be some indus­tries that take an extra six to nine months to real­ly pick up eco­nom­ic momen­tum. But once that hap­pens, every­thing will go togeth­er in the same gen­er­al tra­jec­to­ry.”

...

———-

“Wor­ries grow over a K‑shaped eco­nom­ic recov­ery that favors the wealthy” by Jeff Cox; CNBC; 09/04/2020

““The K‑shaped recov­ery is just a reit­er­a­tion of what we called the bifur­ca­tion of the econ­o­my dur­ing the Great Finan­cial Cri­sis. It real­ly is about the grow­ing inequal­i­ty since the ear­ly 1980s across the coun­try and the econ­o­my,” said Joseph Brusue­las, chief econ­o­mist at RSM. “When we talk K, the upper path of the K is clear­ly finan­cial mar­kets, the low­er path is the real econ­o­my, and the two are sep­a­rat­ed.””

Here we go again. Again. Anoth­er K‑shaped eco­nom­ic recov­ery in a K‑shaped econ­o­my increas­ing­ly dom­i­nate by a finan­cial sec­tor that has explod­ed in size since the 1980s, the decade when Pres­i­dent Rea­gan sent the US down the path of ‘sup­ply-side’ eco­nom­ics and pri­vate equi­ty explod­ed on the scene with debt-dri­ven lever­aged buy outs (LBOs). LBOs that, in many cas­es, destroyed and gut­ted the bought out com­pa­nies. Four decades lat­er pri­vate equi­ty’s grip on the econ­o­my is big­ger than ever, with a sig­nif­i­cant pres­ence in the tech­nol­o­gy sec­tor that hap­pens to be the hot sec­tor in the midst of this pan­dem­ic. The “top half of the K” is tech­nol­o­gy and finance, two pil­lars of today’s pri­vate equi­ty indus­try:

...
The dom­i­nat­ing stocks, in fact, help tell a sto­ry about a shift­ing econ­o­my that is leav­ing those behind with less access to the tech­nol­o­gy that will shape the recov­ery.

“We believe this is now set­tled and that we are see­ing a ‘K‑shaped’ recov­ery,” wrote Marko Kolanovic, glob­al head of macro quan­ti­ta­tive and deriv­a­tives research at JPMor­gan Chase.

Kolanovic, who has fore­seen a num­ber of major mar­ket changes, said the rapid evo­lu­tion of soci­ety dur­ing the pan­dem­ic has trig­gered move­ments that have exac­er­bat­ed inequal­i­ty.

“The use of devices, cloud and inter­net ser­vices was bound to sky­rock­et while the rest of the econ­o­my took a nose dive (air­lines, ener­gy, shop­ping malls, offices, hos­pi­tal­i­ty, etc.),” he said. “This has cre­at­ed enor­mous inequal­i­ty not just in the per­for­mance of eco­nom­ic seg­ments, but in soci­ety more broad­ly. On one side, tech for­tunes reached all-time highs, while low­er income, blue col­lar work­ers and those that can­not work remote­ly suf­fered the most.”
...

And note that one of the side effect of the Fed­er­al Reserve’s his­tor­i­cal­ly low rates and plans to keep them low for an extend­ed peri­od of time is obvi­ous­ly going to be to make debt-based takeovers of com­pa­nies even more capa­ble of buy up com­pa­nies. Low rates remain the right pol­i­cy at this time but there’s going to be side-effects and one of those side-effects is like­ly to be pri­vate equi­ty get­ting a much larg­er slice of ‘the pie’:

...
Fed­er­al Reserve Chair­man Jerome Pow­ell has bemoaned the momen­tum that low­er earn­ers had just begun to see pri­or to the pan­dem­ic.

That’s one of the rea­sons the cen­tral bank last week adopt­ed a major pol­i­cy shift in which it will allow infla­tion to run above the Fed’s 2% goal for a peri­od of time after it has run below the mark. More than just a philo­soph­i­cal state­ment about infla­tion, cod­i­fy­ing the approach allows the Fed to keep inter­est rates low even after the job­less rate drops below what had once been con­sid­ered full employ­ment.

Fed offi­cials believe that keep­ing pol­i­cy loose when the unem­ploy­ment rate hit a 50-year low over the past year helped con­tribute to the wider dis­tri­b­u­tion of income gains, and should be the approach going for­ward.

“It’s a good start that the Fed­er­al Reserve, based on two decades of struc­tur­al change in the econ­o­my and a rapid­ly chang­ing demo­graph­ic struc­ture in the Unit­ed States, decid­ed to walk back its long-held pref­er­ence to act to pre­ven­ta­tive­ly against infla­tion, when expec­ta­tions were clear­ly anchored,” Brusue­las said.
...

It’s one of the many exam­ples of the “heads we win, tails you lose” nature of the increas­ing­ly unequal US econ­o­my. In order to facil­i­tate job cre­ation to help peo­ple find jobs inter­est rates are going to have to be kept at lev­els that mak­ing buy up com­pa­nies eas­i­er than ever. Too bad for those work­ers that pri­vate equi­ty is noto­ri­ous for inflict­ing vicious lay­offs on the com­pa­nies they buy.

Lend Us the Mon­ey or the Lit­tle Guy Gets It

As the fol­low­ing Finan­cial Times arti­cle from March 31 of this year, right when the scale of the pan­dem­ic lock­down’s eco­nom­ic impact was being acknowl­edged and the US fed­er­al gov­ern­ment was set­ting up the Pay­check Pro­tec­tion Pro­gram (PPP) designed specif­i­cal­ly to assist small busi­ness, the “heads we win, tails you lose” nature of pri­vate equi­ty’s posi­tion in the econ­o­my was on full dis­play. The res­cue pack­age explic­it­ly banned small busi­ness from par­tic­i­pat­ing if they are back by a pri­vate equi­ty firm that col­lec­tive­ly employs more than 500 peo­ple across their busi­ness hold­ings. So a small busi­ness backed by a small pri­vate equi­ty firm could poten­tial­ly apply for those loans but not if it’s backed by a giant like the Car­lyle Group or Bain Cap­i­tal.

In response, the pri­vate equi­ty indus­try’s lob­by pub­licly threat­ened mass lay­offs of pri­vate equi­ty-owned com­pa­nies unless those com­pa­nies — at least those with few­er than 500 employ­ees — were also made eli­gi­ble for the loans. Yep. The indus­try best known for hos­tile lever­aged buy­outs fol­lowed by gut­ting the debt-laden com­pa­ny and fir­ing every­one want­ed in on the small busi­ness emer­gency loans set up to pre­vent mass lay­offs. As the arti­cle notes, the pri­vate equi­ty indus­try was sit­ting on $2 tril­lion in unspent cash right at that time.

But that was­n’t the only “heads we win, tails you lose” argu­ment made by the indus­try as the time. As one top pri­vate equi­ty fund man­ag­er put it, “We need to act in the best inter­est of our own investors, which include pen­sion funds.” And he had a point. The pri­vate equi­ty indus­try is no longer just the a tool for the super-rich to cap­ture the econ­o­my. It’s increas­ing­ly being used by pen­sion funds — espe­cial­ly pub­lic pen­sion funds — to earn the nec­es­sary yields that are no longer avail­able from safer-invest­ments like bonds due to the pre­vail­ing low inter­est rate envi­ron­ment.

It’s worth recall­ing at this point the var­i­ous reports about pri­vate equi­ty funds basi­cal­ly fleec­ing pub­lic pen­sion investors in hid­den fees an unusu­al prof­it-shar­ing arrange­ments. That’s who this indus­try group is using as their pub­lic face: the pen­sion funds they’re screw­ing. The episode was a chill­ing a reminder that the pri­vate equi­ty indus­try mak­ing these mass lay­off black­mail threats are shame­less in addi­tion to ruth­less. And shame­less ruth­less­ness is a pret­ty potent com­bo for get­ting your way, at least in con­tem­po­rary Amer­i­ca, espe­cial­ly when com­bined with disin­gen­u­ous griev­ances:

The Finan­cial Times

Pri­vate equi­ty groups seek US small busi­ness res­cue loans
Exclu­sive: Indus­try warns of mass job cuts if port­fo­lio com­pa­nies are denied assis­tance

James Fontanel­la-Khan, Mark Van­de­velde and Sujeet Indap in New York and James Poli­ti in Wash­ing­ton
March 31, 2020, 10:13 pm

Some of the most pow­er­ful groups on Wall Street are press­ing the Trump admin­is­tra­tion to allow pri­vate equi­ty-owned com­pa­nies to access hun­dreds of bil­lions of dol­lars in loan funds ear­marked for US small busi­ness­es hit by the coro­n­avirus pan­dem­ic.

White House and Trea­sury offi­cials have been con­tact­ed about the issue by indus­try lob­by­ists and exec­u­tives from major invest­ment firms, accord­ing to sev­en peo­ple who advised on the dis­cus­sions, or have spo­ken direct­ly with the par­tic­i­pants.

Con­gress last week autho­rised the Small Busi­ness Admin­is­tra­tion to dis­pense $350bn worth of res­cue loans to com­pa­nies with few­er than 500 work­ers that have been affect­ed by the coro­n­avirus pan­dem­ic.

The Wall Street groups are tak­ing aim at the so-called affil­i­a­tion rule, under which small busi­ness­es can be barred from access­ing the res­cue funds if they are backed by a pri­vate equi­ty firm whose port­fo­lio com­pa­nies col­lec­tive­ly have a work­force that exceeds the 500-per­son lim­it.

In a let­ter to Trea­sury Sec­re­tary Steven Mnuchin, seen by the Finan­cial Times, one indus­try body said fed­er­al “reg­u­la­tions effec­tive­ly pre­vent the small busi­ness port­fo­lio com­pa­nies owned by ven­ture cap­i­tal or pri­vate equi­ty funds from access­ing” the res­cue pro­gramme.

“We see no rea­son why being owned in a fund struc­ture should result in these busi­ness­es hav­ing less access to the cap­i­tal need­ed to keep their employ­ees on the pay­roll,” said the let­ter from Steve Nel­son, chief exec­u­tive of the Insti­tu­tion­al Lim­it­ed Part­ners Asso­ci­a­tion, whose mem­bers include pub­lic pen­sion funds that have invest­ed in funds run by Apol­lo, Black­stone, and oth­er big Wall Street firms.

The pleas echo a warn­ing that pri­vate equi­ty exec­u­tives have deliv­ered to offi­cials at the Trea­sury and the White House, accord­ing to peo­ple famil­iar with the con­ver­sa­tions: if their port­fo­lio com­pa­nies are locked out from the $2tn stim­u­lus pack­age agreed last week, they will be forced to dis­miss mil­lions of work­ers to sal­vage their own invest­ments.

“We need to act in the best inter­est of our own investors, which include pen­sion funds,” said an advis­er to one large pri­vate equi­ty firm. “If the gov­ern­ment wants to lim­it fund­ing for com­pa­nies we own just to pun­ish the pri­vate equi­ty indus­try, we will have to take dras­tic measures...That means cut­ting costs aggres­sive­ly, and restruc­tur­ing.”

The Amer­i­can Invest­ment Coun­cil, which rep­re­sents many lead­ing pri­vate equi­ty firms, said it would “con­tin­ue to work with the admin­is­tra­tion, the Fed­er­al Reserve and Con­gress to request that fed­er­al pro­grammes sup­port all busi­ness­es, regard­less of own­er­ship struc­ture, and their work­ers”.

Democ­rats have large­ly been opposed to help­ing out pri­vate equi­ty firms as part of the coro­n­avirus res­cue. Crit­ics say funds aimed at sav­ing mom-and-pop com­pa­nies should not be divert­ed to com­pa­nies backed by invest­ment firms that are sit­ting on more than $2tn in unspent cash.

But Nan­cy Pelosi, the Cal­i­for­nia Demo­c­rat who serves as Speak­er of the US House of Rep­re­sen­ta­tives, wrote to Mr Mnuchin on Tues­day to express con­cerns about help­ing small busi­ness­es backed by ven­ture cap­i­tal investors.

“Many small busi­ness­es in our dis­trict that employ few­er than 500 employ­ees, par­tic­u­lar­ly start-up com­pa­nies with equi­ty investors, have expressed con­cerns that an over­ly strict appli­ca­tion of the Small Busi­ness Administration’s affil­i­a­tion rule may exclude many from eli­gi­bil­i­ty” for the so-called pay­roll pro­tec­tion loans, wrote Ms Pelosi.

...

—————

“Pri­vate equi­ty groups seek US small busi­ness res­cue loans” by James Fontanel­la-Khan, Mark Van­de­velde and Sujeet Indap and James Poli­ti; Finan­cial Times; 03/31/2020

“The Wall Street groups are tak­ing aim at the so-called affil­i­a­tion rule, under which small busi­ness­es can be barred from access­ing the res­cue funds if they are backed by a pri­vate equi­ty firm whose port­fo­lio com­pa­nies col­lec­tive­ly have a work­force that exceeds the 500-per­son lim­it.”

It’s dis­crim­i­na­tion against real­ly, real­ly, real­ly big big com­pa­nies that own lots of oth­er com­pa­nies. That’s how the pri­vate equi­ty giants are react­ing to the small busi­ness res­cue pack­age that they could­n’t tap. As one let­ter sent to Steve Mnuchin put it, “We see no rea­son why being owned in a fund struc­ture should result in these busi­ness­es hav­ing less access to the cap­i­tal need­ed to keep their employ­ees on the pay­roll.” This is, again, a group that was sit­ting on $2 tril­lion in unspent cash fight­ing for a chunk of the $350 bil­lion small busi­ness res­cue loans:

...
In a let­ter to Trea­sury Sec­re­tary Steven Mnuchin, seen by the Finan­cial Times, one indus­try body said fed­er­al “reg­u­la­tions effec­tive­ly pre­vent the small busi­ness port­fo­lio com­pa­nies owned by ven­ture cap­i­tal or pri­vate equi­ty funds from access­ing” the res­cue pro­gramme.

“We see no rea­son why being owned in a fund struc­ture should result in these busi­ness­es hav­ing less access to the cap­i­tal need­ed to keep their employ­ees on the pay­roll,” said the let­ter from Steve Nel­son, chief exec­u­tive of the Insti­tu­tion­al Lim­it­ed Part­ners Asso­ci­a­tion, whose mem­bers include pub­lic pen­sion funds that have invest­ed in funds run by Apol­lo, Black­stone, and oth­er big Wall Street firms.

...

Democ­rats have large­ly been opposed to help­ing out pri­vate equi­ty firms as part of the coro­n­avirus res­cue. Crit­ics say funds aimed at sav­ing mom-and-pop com­pa­nies should not be divert­ed to com­pa­nies backed by invest­ment firms that are sit­ting on more than $2tn in unspent cash.
...

As shame­less as the pub­lic lob­by­ing cam­paign was, far more insid­i­ous was the pri­vate threats the indus­try was report­ed­ly mak­ing to Con­gress. The threat to lay­off mil­lions of work­ers to pro­tect their invest­ments. And part of that threat involved the counter-threat: if they did­n’t lay off the mil­lions of employ­ees the pen­sion funds invest­ed in pri­vate equi­ty would suf­fer. Heads we win, tails you lose, again and again:

...
The pleas echo a warn­ing that pri­vate equi­ty exec­u­tives have deliv­ered to offi­cials at the Trea­sury and the White House, accord­ing to peo­ple famil­iar with the con­ver­sa­tions: if their port­fo­lio com­pa­nies are locked out from the $2tn stim­u­lus pack­age agreed last week, they will be forced to dis­miss mil­lions of work­ers to sal­vage their own invest­ments.

“We need to act in the best inter­est of our own investors, which include pen­sion funds,” said an advis­er to one large pri­vate equi­ty firm. “If the gov­ern­ment wants to lim­it fund­ing for com­pa­nies we own just to pun­ish the pri­vate equi­ty indus­try, we will have to take dras­tic measures...That means cut­ting costs aggres­sive­ly, and restruc­tur­ing.
...

Also note that when the indus­try trum­pets its comitt­ment to act only in the best inter­ests of its investors, that idea — that cor­po­ra­tions should ONLY have the inter­ests of investors in mind to the exclu­sion of all oth­er inter­ests includ­ing the pub­lic inter­est — was one of the found­ing philoso­phies of the pri­vate equi­ty move­ment in the 70s and 80s, as we’ll see below. It is lit­er­al­ly a move­ment ded­i­cat­ed to under­min­ing the idea of the pub­lic good. It’s part of the rea­son the grow­ing reliance of pen­sions on pri­vate equi­ty is so per­verse.

So what are the odds that the pri­vate equi­ty indus­try pre­vails and gets to scoop up those small busi­ness loans? Well, while Democ­rats are the ones oppos­ing allow­ing pri­vate equi­ty to get those loans in the first place, there’s one par­tic­u­lar Demo­c­rat who was on board with the idea of chang­ing the eli­gi­bil­i­ty rule and giv­ing pri­vate equi­ty-own small busi­ness access to the funds: House Speak­er Nan­cy Pelosi, whose dis­trict includes Sil­i­con Val­ley, a city filled with pri­vate equi­ty-backed tech­nol­o­gy start-up com­pa­nies. And note that the let­ter Pelosi wrote to the Small Busi­ness Admin­is­tra­tion argu­ing for giv­ing pri­vate equi­ty access to the PPP loans was co-signed by fel­low Sil­i­con Val­ley Demo­c­rat Ro Khan­na, one of the most pro­gres­sive mem­bers of Con­gress. It’s a sign of increas­ing­ly inter­twined rela­tion­ship between pri­vate equi­ty and the tech­nol­o­gy sec­tor:

...
But Nan­cy Pelosi, the Cal­i­for­nia Demo­c­rat who serves as Speak­er of the US House of Rep­re­sen­ta­tives, wrote to Mr Mnuchin on Tues­day to express con­cerns about help­ing small busi­ness­es backed by ven­ture cap­i­tal investors.

Many small busi­ness­es in our dis­trict that employ few­er than 500 employ­ees, par­tic­u­lar­ly start-up com­pa­nies with equi­ty investors, have expressed con­cerns that an over­ly strict appli­ca­tion of the Small Busi­ness Administration’s affil­i­a­tion rule may exclude many from eli­gi­bil­i­ty” for the so-called pay­roll pro­tec­tion loans, wrote Ms Pelosi.
...

Also keep in mind that when the indus­try pri­vate­ly threat­ened Con­gress that it would engage in mass lay­offs if it did­n’t get access to those loans, that was implic­it­ly a threat to lay off large num­bers of the tech­nol­o­gy work­ers who hap­pened to be Pelosi and Khan­na’s con­stituents. So they real­ly were doing their jobs rep­re­sent­ing their con­stituents when they wrote that let­ter, which is an exam­ple of the pow­er of the “heads we win, tails you lose” nature of pri­vate equi­ty’s con­trol over the econ­o­my.

Head We Win, and Heads It Will Be. Because We are Too Big to Fail

But as we’ll see in the fol­low­ing Van­i­ty Fair piece by Bethany McLean from April of this year, there’s anoth­er major rea­son Cal­i­for­nia Democ­rats like Nan­cy Pelosi, Ro Khan­na, and Max­ine Waters sup­port­ed the pri­vate equi­ty indus­try’s calls for par­tic­i­pa­tion in the PPP: the Cal­i­for­nia Pub­lic Employ­ees’ Retire­ment Sys­tem (CalPERS), has bil­lions of dol­lars invest­ed in pri­vate equi­ty funds. And CalPERS is just the biggest of the grow­ing num­ber of pen­sion sys­tems that are becom­ing increas­ing­ly reliant pri­vate equi­ty, which is the kind of sit­u­a­tion that puts pri­vate equi­ty in the same kind of sys­temic posi­tion as the behe­moth banks that received bil­lions in bailouts dur­ing the 2008 finan­cial cri­sis: the ‘Too Big to Fail’ sys­temic posi­tion:

Van­i­ty Fair

Too Big to Fail, COVID-19 Edi­tion: How Pri­vate Equi­ty Is Win­ning the Coro­n­avirus Cri­sis

Pri­vate equi­ty has made multi­bil­lion­aires of exec­u­tives like Blackstone’s Steve Schwarz­man (net worth: $17.5 bil­lion) and Apollo’s Leon Black ($7.5 bil­lion). Thanks to the $2 tril­lion bipar­ti­san bailout bill, the industry’s coro­n­avirus loss­es will belong to all of us.

By Bethany McLean
April 9, 2020

Ever since Con­gress vot­ed to hand out $2 tril­lion in tax­pay­er mon­ey to those hard­est hit by the coro­n­avirus pan­dem­ic, Amer­i­can busi­ness­es have been scram­bling for a piece of the action. Air­lines, hotels, and restaurants—all of whose rev­enues have cratered in the wake of sweep­ing stay-home orders—have engaged in Hunger Games–like lob­by­ing to cash in on the CARES Act, mak­ing their case for a share of the dis­as­ter relief. But among those angling for a fed­er­al hand­out is one of the wealth­i­est sec­tors of the Amer­i­can econ­o­my: pri­vate equi­ty. These firms not only have a record $1.5 tril­lion in cash on the side­lines, wait­ing to be invest­ed, but their CEOs are among America’s rich­est exec­u­tives. So why should they be per­mit­ted to raid the fed­er­al Trea­sury in a time of cri­sis?

The rea­son is as sim­ple as it is galling: while great pri­vate for­tunes, such as that of Blackstone’s Stephen Schwarz­man (net worth: $17.5 bil­lion and Apollo’s Leon Black ($7.5 bil­lion), have been made from pri­vate equity’s march through the world, its loss­es, to a remark­able degree, will belong to all of us. That’s because some of the major investors in pri­vate-equi­ty funds are pub­lic pen­sion plans; at Black­stone, rough­ly one-third of the firm’s mon­ey comes from retire­ment plans set up to pro­vide for over 30 mil­lion work­ing-class Amer­i­cans, accord­ing to some­one with knowl­edge of its port­fo­lio. So if Blackstone’s invest­ments crater, the teach­ers, fire­fight­ers, and health care work­ers who are count­ing on those invest­ments to gen­er­ate the returns nec­es­sary to pay their pen­sions will suf­fer. Think of pri­vate-equi­ty firms as the banks of the coro­na cri­sis: They are, for bet­ter or worse, too big to fail.

...

Even before the COVID cri­sis, there were ques­tions about how well pri­vate-equi­ty invest­ments were actu­al­ly per­form­ing. But that didn’t seem to mat­ter, because low inter­est rates facil­i­tat­ed pri­vate equi­ty in anoth­er way. Belea­guered pen­sion funds, which suf­fered big loss­es in the finan­cial cri­sis, could no longer count on decent returns from fixed invest­ments, giv­en how low inter­est rates have been kept by the Fed. Increas­ing­ly des­per­ate to boost the port­fo­lios of retir­ing work­ers, they too turned to pri­vate equi­ty as their savior—urged on by pri­vate equity’s promis­es that it alone could deliv­er the nec­es­sary returns. In 2019, the Amer­i­can Invest­ment Coun­cil (AIC), a lob­by­ing group which rep­re­sents pri­vate-equi­ty giants like Black­stone, the Car­lyle Group, Apol­lo Glob­al Man­age­ment, and KKR, declared that “in order to con­tin­ue to pro­vide the ben­e­fits they guar­an­tee, pen­sions must con­tin­ue to invest in pri­vate equi­ty.”

In 2018, accord­ing to ana­lyt­ics firm eVest­ment, pen­sion funds in the U.S. and the U.K. pumped 27% of their fresh allo­ca­tions of mon­ey into pri­vate-equi­ty funds, up from 25% the year before. America’s largest pub­lic pen­sion plan, the Cal­i­for­nia Pub­lic Employ­ees’ Retire­ment Sys­tem, or CalPERS, put almost $7 bil­lion into pri­vate equi­ty dur­ing the 2018–2019 fis­cal year, accord­ing to Insti­tu­tion­al Investor. “We need pri­vate equi­ty, we need more of it, and we need it now,” chief invest­ment offi­cer Ben Meng said in ear­ly 2019—right before CalPERS hired a for­mer pri­vate-equi­ty guy, who began his career at Gold­man Sachs, to head its pri­vate-equi­ty efforts.

Dri­ven part­ly by pub­lic pen­sions, the pri­vate-equi­ty indus­try has mush­roomed. In each of the past four years, accord­ing to data-provider Pre­qin, pri­vate-cap­i­tal man­agers raised over $500 bil­lion of new mon­ey to invest. The industry’s total assets under man­age­ment have hit a record $4.1 tril­lion. The industry’s $1.5 tril­lion in cash on hand is also the high­est on record—and more than dou­ble what it was five years ago, accord­ing to Pre­qin. The half decade from 2013 to 2018 saw the most pri­vate-equi­ty deals over any five-year peri­od in Amer­i­can his­to­ry.

“Pri­vate-equi­ty man­agers won the finan­cial cri­sis,” as Bloomberg put it last fall. “Almost every­thing that’s hap­pened since 2008 has tilt­ed in their favor.” As a result, pri­vate equi­ty is now wound into the very fab­ric of our econ­o­my. Accord­ing to the Insti­tu­tion­al Lim­it­ed Part­ners Asso­ci­a­tion (ILPA), a lob­by­ing group which rep­re­sents CalPERs and oth­er pub­lic investors, busi­ness­es backed by pri­vate equi­ty employ more than 8.8 mil­lion Amer­i­cans at over 35,000 com­pa­nies, account­ing for a stag­ger­ing 5% of the Unit­ed States’ GDP. What’s more, the Milken Insti­tute report­ed, even by mid-2018, pri­vate equi­ty owned more com­pa­nies than the num­ber of busi­ness­es list­ed on all of the U.S. stock exchanges com­bined, and have account­ed for a more sig­nif­i­cant source of financ­ing than ini­tial pub­lic offer­ings in many recent years. If pri­vate equi­ty suf­fers, the blow will rever­ber­ate through­out the entire econ­o­my.

Which explains why ILPA wrote to Trea­sury Sec­re­tary Steven Mnuchin and Fed Chair­man Jerome Pow­ell last week, argu­ing that com­pa­nies backed by pri­vate equi­ty should be allowed to access the relief funds pro­vid­ed in the CARES Act. Oth­er­wise, the ILPA warned in a pre­vi­ous let­ter, there would be “sig­nif­i­cant harm not only to employ­ees that see their hours reduced or jobs elim­i­nat­ed, but also sig­nif­i­cant­ly reduced returns to the insti­tu­tions pro­vid­ing retire­ment secu­ri­ty through pen­sions, insur­ance poli­cies and oth­er invest­ments that serve hun­dreds of thou­sands of Amer­i­cans.” To make mat­ters worse, ILPA added, pro­vi­sions in many pri­vate-equi­ty invest­ments allow pri­vate-equi­ty firms to make addi­tion­al cap­i­tal calls when times are tough. That means pub­lic pen­sions might be forced to dump their hold­ings in pub­lic-backed invest­ments to pro­vide pri­vate-equi­ty firms with emer­gency cash—a move that could depress the stock mar­ket even fur­ther.

There are sev­er­al pots of fed­er­al mon­ey that the pri­vate-equi­ty indus­try is lob­by­ing to access. (And not all pri­vate-equi­ty firms care equal­ly about all of the pro­grams.) One is the so-called Pay­check Pro­tec­tion Pro­gram (PPP), set up to make $349 bil­lion in gov­ern­ment-guar­an­teed loans avail­able to busi­ness­es with few­er than 500 employ­ees. The prob­lem is, exist­ing rules at the Small Busi­ness Admin­is­tra­tion, which is over­see­ing the pro­gram, have been wide­ly inter­pret­ed as exclud­ing loan­ing mon­ey to most mom-and-pop busi­ness­es that are con­trolled by large par­ent companies—including pri­vate-equi­ty firms. So pri­vate equi­ty is push­ing to waive those rules, argu­ing that small firms should not be penal­ized for hav­ing been bought out by big investors. (Many of the com­pa­nies owned by mam­moth pri­vate-equi­ty firms like Black­stone are too big on their own to qual­i­fy for this buck­et of mon­ey.)

The pri­vate-equi­ty indus­try also wants the com­pa­nies they have invest­ed in to have access to the $454 bil­lion being doled out through the Trea­sury, an amount that the Fed said could be lever­aged into over $2 tril­lion. Because rules for access to this mon­ey weren’t spec­i­fied in the CARES Act, as ILPA notes, the exec­u­tive branch will have a fair amount of dis­cre­tion over who gets access to the money—and pri­vate-equi­ty firms want to take full advan­tage of that open­ing. “We’ll con­tin­ue to work with the admin­is­tra­tion and Con­gress to request that fed­er­al pro­grams sup­port all busi­ness­es, regard­less of own­er­ship struc­ture, and their work­ers,” says the AIC’s CEO, Drew Mal­oney.

The pol­i­tics dic­tat­ing whether the pri­vate-equi­ty indus­try will get its wish­es are sur­pris­ing. Mnuchin is a for­mer Gold­man Sachs exec­u­tive and hedge fund guy; Blackstone’s Schwarz­man has ties to Trump; Jared Kush­n­er ’s fam­i­ly busi­ness has got­ten loans from Apol­lo, accord­ing to the Wash­ing­ton Post. Yet an exemp­tion for the pri­vate-equi­ty indus­try did not make its way into the CARES Act; accord­ing to Bloomberg, Sen­ate Major­i­ty Leader Mitch McConnell is try­ing to pass a $250 bil­lion boost to the PPP—without pro­vi­sions open­ing it to pri­vate-equi­ty-backed com­pa­nies. On the oth­er hand, Democ­rats, includ­ing House Speak­er Nan­cy Pelosi and pow­er­ful Rep­re­sen­ta­tive Max­ine Waters, have weighed in loudly—on the industry’s behalf. “It is absolute­ly imper­a­tive,” Waters recent­ly wrote in sup­port of pri­vate equi­ty, “that the relief…be extend­ed to pro­tect all work­ers, irre­spec­tive of the affil­i­a­tions of their employ­ers.” Trans­la­tion: Work­ers shouldn’t suf­fer just because their boss­es sold a con­trol­ling stake in their busi­ness­es to a bunch of greedy fat cats. As for Pelosi, she doesn’t want to see com­pa­nies backed by ven­ture cap­i­tal exclud­ed from fed­er­al relief, giv­en her Sil­i­con Val­ley con­stituents.

Restau­rants and hotels owned by big chains have already received exemp­tions grant­i­ng them access to the relief funds, regard­less of how many peo­ple their par­ent com­pa­nies employ. The allies of pri­vate equi­ty hope that sim­i­lar exemp­tions will soon be forth­com­ing for their firms.“We are in a wait-and-see mode,” Chris Hayes, the ILPA’s senior pol­i­cy coun­sel, told me.

The fear, of course, is that pri­vate equi­ty will do what pri­vate equi­ty does best, which is pock­et the mon­ey them­selves rather than devot­ing it to the busi­ness­es they’ve invest­ed in. The typ­i­cal fee struc­ture in pri­vate equi­ty is the so-called 2 and 20, which means that a fund col­lects a fee of 2% of the total assets it man­ages, as well as 20% of any gains on its invest­ments after a cer­tain return is achieved. The indus­try also qui­et­ly helps itself to yet more mon­ey by hav­ing port­fo­lio com­pa­nies pay fees for con­sult­ing and financ­ing ser­vices pro­vid­ed by, of course, their pri­vate-equi­ty back­ers. If pri­vate equi­ty is hand­ed bil­lions in tax­pay­er mon­ey, it could use some of it to pay them­selves hefty fees today, then pock­et even more of it down the road, when they sell their port­fo­lio com­pa­nies and col­lect their 20% of the tax­pay­er-enabled gains. The tax­pay­er hand­outs will also help pri­vate equi­ty con­tin­ue its relent­less march through the glob­al econ­o­my, snap­ping up trou­bled com­pa­nies at bar­gain prices or extend­ing high-priced cred­it as oth­er investors, includ­ing hedge funds, are forced to sell off their hold­ings in the post-coro­na land­scape.

Unfor­tu­nate­ly, there isn’t real­ly an alter­na­tive to pro­vid­ing pri­vate equi­ty with fed­er­al funds. Like the big banks in 2008, pri­vate equi­ty is hold­ing us all hostage. But there are ways to make it work bet­ter. Accord­ing to the CARES Act, com­pa­nies can only receive loans from the Small Busi­ness Admin­is­tra­tion if they com­mit to pre­serv­ing jobs. Waters, in her let­ter, argues for plac­ing even more strings on the mon­ey tak­en by pri­vate-equi­ty-backed com­pa­nies. Not only should tax­pay­er funds not be used to pay man­age­ment or con­sult­ing firms, she says, but com­pa­nies that take the mon­ey should also, for instance, be required to include work­ers on their cor­po­rate boards and grad­u­al­ly increase their min­i­mum wage to at least $15 an hour.

We could go even fur­ther. A loop­hole in the tax code cur­rent­ly allows pri­vate-equi­ty financiers to pay tax­es on their returns at the low­er rate for cap­i­tal gains, rather than the high­er rate for per­son­al income. We could close that, once and for all. We could also lim­it the deductibil­i­ty of inter­est pay­ments for tax pur­pos­es even more than Pres­i­dent Don­ald Trump ’s new tax law already did, so com­pa­nies aren’t encour­aged to load up on debt. Ras­mussen points out that after the finan­cial cri­sis in 2008, the Fed­er­al Reserve set a lim­it on the amount of debt it con­sid­ered pru­dent. Even so, he told me, a “large num­ber of pri­vate-equi­ty firms ignored that guid­ance and decid­ed to put very high lev­els of lever­age on their port­fo­lio com­pa­nies.” Maybe those firms should now be required to con­tribute more equi­ty from their cash stock­piles, he sug­gests.

The big banks emerged from the finan­cial cri­sis vic­to­ri­ous, but also sub­ject to a host of new reg­u­la­tions designed to reduce lever­age and sta­bi­lize the econ­o­my. It’s essen­tial that we do the same today. Giv­en how much of the econ­o­my will rise and fall on the invest­ments that pri­vate-equi­ty funds man­age, we may be forced to let them share the fed­er­al hand­out. But it doesn’t have to be a blank check.

———-

“Too Big to Fail, COVID-19 Edi­tion: How Pri­vate Equi­ty Is Win­ning the Coro­n­avirus Cri­sis” by Bethany McLean; Van­i­ty Fair; 04/09/2020

“Pri­vate-equi­ty man­agers won the finan­cial cri­sis,” as Bloomberg put it last fall. “Almost every­thing that’s hap­pened since 2008 has tilt­ed in their favor.” As a result, pri­vate equi­ty is now wound into the very fab­ric of our econ­o­my. Accord­ing to the Insti­tu­tion­al Lim­it­ed Part­ners Asso­ci­a­tion (ILPA), a lob­by­ing group which rep­re­sents CalPERs and oth­er pub­lic investors, busi­ness­es backed by pri­vate equi­ty employ more than 8.8 mil­lion Amer­i­cans at over 35,000 com­pa­nies, account­ing for a stag­ger­ing 5% of the Unit­ed States’ GDP. What’s more, the Milken Insti­tute report­ed, even by mid-2018, pri­vate equi­ty owned more com­pa­nies than the num­ber of busi­ness­es list­ed on all of the U.S. stock exchanges com­bined, and have account­ed for a more sig­nif­i­cant source of financ­ing than ini­tial pub­lic offer­ings in many recent years. If pri­vate equi­ty suf­fers, the blow will rever­ber­ate through­out the entire econ­o­my.

Pri­vate Equi­ty “won” the 2008 finan­cial cri­sis and now own more com­pa­nies than the num­ber of busi­ness­es list­ed on all of the US stock exchanges com­bined. It’s anoth­er way of mea­sur­ing the extent of the pri­vate equi­ty indus­try’s cap­ture of the econ­o­my over the last four decades. And now, thanks in part to the ultra-low inter­est rates that result­ed from the 2008 finan­cial cri­sis that pri­vate equi­ty won, pen­sion funds are increas­ing­ly reliant on pri­vate equi­ty to ful­fill their pen­sion oblig­a­tions. In oth­er words, in addi­tion to cap­tur­ing more com­pa­nies than are list­ed on all of the US stock mar­kets, pri­vate equi­ty cap­tured the pen­sion sys­tem too:

...
In 2018, accord­ing to ana­lyt­ics firm eVest­ment, pen­sion funds in the U.S. and the U.K. pumped 27% of their fresh allo­ca­tions of mon­ey into pri­vate-equi­ty funds, up from 25% the year before. America’s largest pub­lic pen­sion plan, the Cal­i­for­nia Pub­lic Employ­ees’ Retire­ment Sys­tem, or CalPERS, put almost $7 bil­lion into pri­vate equi­ty dur­ing the 2018–2019 fis­cal year, accord­ing to Insti­tu­tion­al Investor. “We need pri­vate equi­ty, we need more of it, and we need it now,” chief invest­ment offi­cer Ben Meng said in ear­ly 2019—right before CalPERS hired a for­mer pri­vate-equi­ty guy, who began his career at Gold­man Sachs, to head its pri­vate-equi­ty efforts.
...

And note one of the mech­a­nis­tic ways the pen­sion sys­tem’s reliance on pri­vate equi­ty makes the threat of not bail­ing out pri­vate equi­ty an even more potent threat: many pri­vate-equi­ty funds have cap­i­tal call pro­vi­sions that could force pen­sions to dump oth­er invest­ments (includ­ing stocks) in order to shore up ail­ing pri­vate equi­ty funds. So if those funds get dis­tressed they can basi­cal­ly trans­fer that dis­tress into dif­fer­ent asset class­es includ­ing the stock mar­ket:

...
Which explains why ILPA wrote to Trea­sury Sec­re­tary Steven Mnuchin and Fed Chair­man Jerome Pow­ell last week, argu­ing that com­pa­nies backed by pri­vate equi­ty should be allowed to access the relief funds pro­vid­ed in the CARES Act. Oth­er­wise, the ILPA warned in a pre­vi­ous let­ter, there would be “sig­nif­i­cant harm not only to employ­ees that see their hours reduced or jobs elim­i­nat­ed, but also sig­nif­i­cant­ly reduced returns to the insti­tu­tions pro­vid­ing retire­ment secu­ri­ty through pen­sions, insur­ance poli­cies and oth­er invest­ments that serve hun­dreds of thou­sands of Amer­i­cans.” To make mat­ters worse, ILPA added, pro­vi­sions in many pri­vate-equi­ty invest­ments allow pri­vate-equi­ty firms to make addi­tion­al cap­i­tal calls when times are tough. That means pub­lic pen­sions might be forced to dump their hold­ings in pub­lic-backed invest­ments to pro­vide pri­vate-equi­ty firms with emer­gency cash—a move that could depress the stock mar­ket even fur­ther.
...

Also note how the $1.5–2 tril­lion in cash that the indus­try had on on hand back in April was not just a record lev­el for the sec­tor but dou­ble what it was five years ago. It’s the kind of cash pile that sug­gests the sec­tor was wait­ing for the next inevitable reces­sion, when all sorts of com­pa­nies would become avail­able for pur­chase at fire sale prices:

...
Dri­ven part­ly by pub­lic pen­sions, the pri­vate-equi­ty indus­try has mush­roomed. In each of the past four years, accord­ing to data-provider Pre­qin, pri­vate-cap­i­tal man­agers raised over $500 bil­lion of new mon­ey to invest. The industry’s total assets under man­age­ment have hit a record $4.1 tril­lion. The industry’s $1.5 tril­lion in cash on hand is also the high­est on record—and more than dou­ble what it was five years ago, accord­ing to Pre­qin. The half decade from 2013 to 2018 saw the most pri­vate-equi­ty deals over any five-year peri­od in Amer­i­can his­to­ry.
...

Yes, this ‘Too Big to Fail’ sec­tor of the econ­o­my was at his­tor­i­cal­ly high lev­els of pre­pared­ness to cap­i­tal­ize on a fail­ing econ­o­my when the pan­dem­ic hit. It’s anoth­er rea­son we should expect pri­vate equi­ty’s grip over the econ­o­my to be a his­toric highs too when this pan­dem­ic is over.

CalPERS to Pri­vate Equi­ty: We’d Like to Dou­ble Down on Our Des­per­a­tion Play Please

And as the fol­low­ing New York Times arti­cle from just days ago makes clear, anoth­er rea­son we should expect pri­vate equi­ty to own even more of the econ­o­my at the end of this pan­dem­ic is sim­ply because pen­sion sys­tems show no sign of shy­ing away from pri­vate equi­ty. And in the case pen­sion giant CalPERS, the new­ly announced plan for the decade is to invest even more in pri­vate equi­ty funds for the next decade. Dou­bling down on des­per­a­tion. That’s the plan.

As the arti­cle describes, this is CalPER­S’s plan despite the fact that a num­ber of trustees have deep mis­giv­ings about the strat­e­gy and sus­pect they are being sold a bill of goods. Beyond that, the last CalPERS chief invest­ment offi­cer, Ben Meng, resigned in August after it was dis­cov­ered he holds per­son­al stakes in some of the same pri­vate equi­ty funds CalPERS was invest­ing in. And data shows that CalPERS’s pri­vate equi­ty returns are con­sis­tent­ly low­er than indus­try bench­marks. But CalPERS is pro­ceed­ing with the plan because they argue they have no choice. Pri­vate equi­ty — or oth­er risky invest­ments like dis­tressed debt — are the only invest­ments that might be able to return to CalPERS the ~7% annu­al­ized returns it needs to meet its oblig­a­tions. That’s what a study by CalPERS and an out­side con­sul­tant con­clud­ed. Pri­vate equi­ty has effec­tive­ly cap­tured CalPERS.

Also keep in mind that we can already pre­dict the ongo­ing era of his­tor­i­cal­ly low inter­est rates that pushed CalPERS and oth­er pen­sion plans towards risky invest­ments like pri­vate equi­ty is prob­a­bly going to con­tin­ue for years to come. So when we see CalPERS active­ly plan on invest­ing even more in pri­vate equi­ty over this next decade of low inter­est rates because they feel they have no choice there’s prob­a­bly quite a few more pen­sion funds that will fol­low suit, if they aren’t already:

The New York Times

March­ing Orders for the Next Invest­ment Chief of CalPERS: More Pri­vate Equi­ty

The nation’s biggest pub­lic pen­sion fund is con­sis­tent­ly short of the bil­lions of dol­lars it needs to pay all retirees their pen­sions. It seeks high­er returns.

By Mary Williams Walsh
Oct. 19, 2020, 5:00 a.m. ET

Ben Meng got the job of chief invest­ment offi­cer of CalPERS by con­vinc­ing the trustees of the nation’s largest pub­lic pen­sion fund that he could hit their tar­get of a 7 per­cent annu­al return on invest­ment by direct­ing more of the fund’s bil­lions into pri­vate equi­ty.

Now, Mr. Meng is gone — only a year and a half after he start­ed — and CalPERS, as the $410 bil­lion Cal­i­for­nia Pub­lic Employ­ees’ Retire­ment Sys­tem is known, is no clos­er to that goal. The fund is con­sis­tent­ly short of the bil­lions of dol­lars it needs to pay all retirees their pen­sions. And it con­tin­ues to cal­cu­late that it can meet those oblig­a­tions only if it gets the kind of big invest­ment gains promised by pri­vate equi­ty.

The strat­e­gy involves putting mon­ey into funds man­aged by firms such as the Black­stone Group and Car­lyle, which buy com­pa­nies and retool them with the goal of sell­ing them or tak­ing them pub­lic. Even as some of the fund’s trustees have mis­giv­ings — they say the pri­vate equi­ty busi­ness is opaque, illiq­uid and car­ries high fees — they say they have lit­tle choice.

“Pri­vate equi­ty isn’t my favorite asset class,” There­sa Tay­lor, the chair of the CalPERS board’s invest­ment com­mit­tee, said at a recent meet­ing. “It helps us achieve our 7 per­cent solu­tion,” she said. “I know we have to be there. I wish we were 100 per­cent fund­ed. Then, maybe we wouldn’t.”

CalPERS, like many oth­er pen­sion funds, began putting mon­ey into pri­vate equi­ty funds decades ago. But its reliance on such funds has increased in recent years, as low inter­est rates have made bonds less attrac­tive and stocks have proven too volatile. Adding to the urgency are an aging pop­u­la­tion, expan­sive pen­sion ben­e­fits that can’t be reduced and a major fund­ing short­fall.

Mr. Meng’s abrupt depar­ture in August, and CalPERS’s slow-mov­ing search for a replace­ment, are delay­ing its plans to increase its pri­vate equi­ty invest­ments. Mr. Meng resigned after com­pli­ance staff noticed that he had per­son­al stakes in some of the invest­ment firms that he was com­mit­ting CalPERS’s mon­ey to, most notably Black­stone. Cal­i­for­nia state offi­cials in that sit­u­a­tion are sup­posed to recuse them­selves, but Mr. Meng did not.

Some of the fund’s stake­hold­ers, includ­ing cities, school dis­tricts and oth­er pub­lic employ­ers, wor­ry that in the mean­time, CalPERS’s trustees could react by putting new restric­tions on invest­ment chiefs, dis­cour­ag­ing top can­di­dates from apply­ing for the job or oth­er­wise mak­ing it hard­er for CalPERS to achieve its tar­get rate of return. If invest­ment returns fall short, local offi­cials know they’ll have to make up the dif­fer­ence, dip­ping into their bud­gets to free up more mon­ey to send to the fund.

“It gets hard­er and hard­er each year,” said Brett McFad­den, the super­in­ten­dent of a large school dis­trict north­east of Sacra­men­to. He has cut art, music and guid­ance coun­selors to get more mon­ey for the state pen­sion sys­tems every year. “These poli­cies are being made in Sacra­men­to, and I’m the one left hold­ing the bag,” he said.

Mar­cie Frost, the chief exec­u­tive of CalPERS, said that Mr. Meng’s depar­ture would not prompt the board to change CalPERS’s invest­ment strat­e­gy. She said a study by CalPERS and its out­side con­sul­tants showed that pri­vate equi­ty and dis­tressed debt were the only asset class­es pow­er­ful enough to boost the fund’s over­all aver­age gains up to 7 per­cent a year, over time.

“So we have to have a mean­ing­ful allo­ca­tion to those,” she said, adding: “There are no guar­an­tees that we’re going to be able to get 7 per­cent in the short term or, frankly, in the long term.”

Data show that CalPERS’s pri­vate equi­ty returns are con­sis­tent­ly low­er than indus­try bench­marks, but pri­vate equi­ty has still per­formed bet­ter than oth­er assets and “has gen­er­at­ed bil­lions of dol­lars in addi­tion­al returns as a result of our invest­ments,” said Greg Ruiz, CalPERS’s man­ag­ing invest­ment direc­tor for pri­vate equi­ty.

Mr. Meng was a big pro­po­nent of pri­vate equi­ty, telling trustees that “only one asset class” would deliv­er the returns they sought and that the fund would need to direct more mon­ey into it. But while CalPERS sought, under him, to increase its pri­vate equi­ty allo­ca­tion to 8 per­cent of total assets, the hold­ings fell to 6.3 per­cent, in part because the pri­vate equi­ty man­agers were return­ing mon­ey from pre­vi­ous invest­ments and CalPERS did not jump to rein­vest it. Over­all, the fund had about $80 bil­lion — or 21 per­cent of its assets — in pri­vate equi­ty, real estate and oth­er illiq­uid assets as of June 30, the end of its last fis­cal year.

CalPERS has some­times moved slow­ly on pri­vate equi­ty part­ly because of its trustees’ qualms.

At one recent meet­ing, Ms. Tay­lor, the invest­ment com­mit­tee chair and for­mer­ly a senior union offi­cial, recalled that some of CalPERS’s pri­vate equi­ty part­ners had bought Toys ‘R’ Us in 2005. The trans­ac­tion loaded it up with $5 bil­lion in debt just as the retailer’s bricks-and-mor­tar sales strat­e­gy was becom­ing anti­quat­ed, and the com­pa­ny went into a long, slow col­lapse that end­ed in liq­ui­da­tion and cost more than 30,000 jobs. “I’m hop­ing that we can get to a bet­ter strat­e­gy of mit­i­gat­ing some of these prob­lems,” she said.

Oth­er trustees ques­tioned the valid­i­ty of the inter­nal bench­mark CalPERS uses to eval­u­ate its pri­vate equi­ty invest­ments, say­ing they didn’t believe the returns were all that good after fees were deduct­ed.

“We’re going to be sold a bill of goods, and we’re going to believe what they say, because we want to believe it and we want to make high­er returns,” said Mar­garet Brown, a trustee and retired cap­i­tal invest­ments direc­tor for a school dis­trict south­east of Los Ange­les.

Still, the march­ing orders for CalPERS’s next invest­ment chief are appar­ent: find ways to increase the pen­sion giant’s invest­ments in pri­vate equi­ty funds.

Inde­pen­dent ana­lysts have long urged pub­lic pen­sion trustees to stop chas­ing high­er returns and instead take a deep, hard look at how they got to be so under­fund­ed in the first place. A grow­ing school of thought blames the way they cal­cu­late their total oblig­a­tions to retirees for under­stat­ing the true num­ber — specif­i­cal­ly, how they trans­late the val­ue of pen­sions due in the future into today’s dol­lars.

To do that, CalPERS uses the rou­tine prac­tice of dis­count­ing, which all finan­cial insti­tu­tions use and is based on the prin­ci­ple that mon­ey is worth more today than in the future. It requires the selec­tion of an appro­pri­ate dis­count rate. CalPERS uses its tar­get return on invest­ment of 7 per­cent as its dis­count rate — a prac­tice flat­ly reject­ed by finan­cial econ­o­mists, because 7 per­cent is asso­ci­at­ed with a high degree of risk, and CalPERS’s pen­sions are risk free. Econ­o­mists say that CalPERS, and oth­er pub­lic pen­sion sys­tems, should be using the rate asso­ci­at­ed with risk-free bonds like U.S. Trea­sury bonds. Doing it that way shows the tremen­dous intrin­sic val­ue of risk-free retire­ment income.

But by assum­ing a high so-called dis­count rate that match­es its assumed rate of return, CalPERS makes its short­fall look much small­er on paper — which allows the fund to bill the state of Cal­i­for­nia and its cities for small­er annu­al con­tri­bu­tions than it would oth­er­wise have to. That helps every­body bal­ance their bud­gets more eas­i­ly, but it has left the pen­sion sys­tem chron­i­cal­ly under­fund­ed.

Pub­lic pen­sion sys­tems in Cal­i­for­nia, includ­ing CalPERS, report­ed a com­bined short­fall of $352.5 bil­lion as of 2018, using their high invest­ment assump­tions as dis­count rates, accord­ing to a com­pi­la­tion by the Stan­ford Insti­tute for Eco­nom­ic Pol­i­cy Research. But by replac­ing just that one assump­tion with what econ­o­mists con­sid­er a valid dis­count rate, the insti­tute showed that the funds were real­ly $1 tril­lion short that year. If CalPERS sud­den­ly start­ed billing local gov­ern­ments accord­ing­ly, it would cause a cri­sis.

CalPERS stepped into this trap in 1999, at the end of a pow­er­ful bull mar­ket. On paper, it appeared to have far more mon­ey than it need­ed, and state law­mak­ers decid­ed to increase pub­lic pen­sions after hear­ing from CalPERS offi­cials it would not cost any­thing so long as the fund’s invest­ments could pro­duce 8.25 per­cent aver­age annu­al gains.

Then the dot-com bub­ble burst, and the invest­ment gains on paper that CalPERS had amassed melt­ed away, leav­ing a short­fall. But the big pen­sion increase was locked in because Cal­i­for­nia law bars any reduc­tion in pub­lic pen­sions. Sim­i­lar things hap­pened in many oth­er states. Before long, the race was on for high­er invest­ment returns.

“Over the past 20 years, U.S. pen­sion funds have set aggres­sive tar­gets and failed to meet them,” said Kurt Winkel­mann, a senior fel­low for pen­sion pol­i­cy design at the Uni­ver­si­ty of Minnesota’s Heller-Hur­wicz Eco­nom­ics Insti­tute.

He recent­ly com­piled the invest­ment returns of the 50 states’ pen­sion sys­tems from 2000 to 2018 and com­pared them with the states’ aver­age tar­gets dur­ing that peri­od. It turned out that the actu­al returns were 1.7 per­cent­age points per year less.

CalPERS’s invest­ment results were even more off the mark, Mr. Winkel­mann found. Its tar­get aver­aged 7.7 per­cent over the 18-year time frame. But actu­al aver­age returns were only 5.5 per­cent over that peri­od, Mr. Winkel­mann said.

...

———–

“March­ing Orders for the Next Invest­ment Chief of CalPERS: More Pri­vate Equi­ty” by Mary Williams Walsh; The New York Times; 10/19/2020

“The strat­e­gy involves putting mon­ey into funds man­aged by firms such as the Black­stone Group and Car­lyle, which buy com­pa­nies and retool them with the goal of sell­ing them or tak­ing them pub­lic. Even as some of the fund’s trustees have mis­giv­ings — they say the pri­vate equi­ty busi­ness is opaque, illiq­uid and car­ries high fees — they say they have lit­tle choice.

There’s no choice. That’s the con­clu­sion CalPERS grim­ly arrived. And arrived at in the face of data show­ing the returns from pri­vate equi­ty are con­sis­tent­ly low­er than indus­try bench­marks. It’s one thing to miss your bench­marks every few years but if the annu­al­ized aver­age returns are low­er that’s a giant fail. Com­pound inter­est works in the neg­a­tive direc­tion too. And accord­ing to a study of CalPERS’ pri­vate equi­ty returns from 2000–2018, the tar­get ben­chark of 7.7% annu­al returns actu­al­ly came in at 5.5%. That adds up...or maybe ‘sub­tracts up’ is a bet­ter way to put it:

...
Data show that CalPERS’s pri­vate equi­ty returns are con­sis­tent­ly low­er than indus­try bench­marks, but pri­vate equi­ty has still per­formed bet­ter than oth­er assets and “has gen­er­at­ed bil­lions of dol­lars in addi­tion­al returns as a result of our invest­ments,” said Greg Ruiz, CalPERS’s man­ag­ing invest­ment direc­tor for pri­vate equi­ty.

...

At one recent meet­ing, Ms. Tay­lor, the invest­ment com­mit­tee chair and for­mer­ly a senior union offi­cial, recalled that some of CalPERS’s pri­vate equi­ty part­ners had bought Toys ‘R’ Us in 2005. The trans­ac­tion loaded it up with $5 bil­lion in debt just as the retailer’s bricks-and-mor­tar sales strat­e­gy was becom­ing anti­quat­ed, and the com­pa­ny went into a long, slow col­lapse that end­ed in liq­ui­da­tion and cost more than 30,000 jobs. “I’m hop­ing that we can get to a bet­ter strat­e­gy of mit­i­gat­ing some of these prob­lems,” she said.

Oth­er trustees ques­tioned the valid­i­ty of the inter­nal bench­mark CalPERS uses to eval­u­ate its pri­vate equi­ty invest­ments, say­ing they didn’t believe the returns were all that good after fees were deduct­ed.

“We’re going to be sold a bill of goods, and we’re going to believe what they say, because we want to believe it and we want to make high­er returns,” said Mar­garet Brown, a trustee and retired cap­i­tal invest­ments direc­tor for a school dis­trict south­east of Los Ange­les.

...

“Over the past 20 years, U.S. pen­sion funds have set aggres­sive tar­gets and failed to meet them,” said Kurt Winkel­mann, a senior fel­low for pen­sion pol­i­cy design at the Uni­ver­si­ty of Minnesota’s Heller-Hur­wicz Eco­nom­ics Insti­tute.

He recent­ly com­piled the invest­ment returns of the 50 states’ pen­sion sys­tems from 2000 to 2018 and com­pared them with the states’ aver­age tar­gets dur­ing that peri­od. It turned out that the actu­al returns were 1.7 per­cent­age points per year less.

CalPERS’s invest­ment results were even more off the mark, Mr. Winkel­mann found. Its tar­get aver­aged 7.7 per­cent over the 18-year time frame. But actu­al aver­age returns were only 5.5 per­cent over that peri­od, Mr. Winkel­mann said.
...

Even with that lev­el of under­per­for­mance, pri­vate equi­ty is still deemed to be bet­ter than the low­er-yield­ing alter­na­tives. It’s the kind of dynam­ic that only points to more and more pen­sion mon­ey head­ing into pri­vate equi­ty, and not just CalPER­S’s mon­ey.

But also note the oth­er fac­tor that has cre­at­ed this per­ceived need for pri­vate equi­ty invest­ments: pen­sions are con­sis­tent­ly under­fund­ed, which is the fun­da­men­tal fac­tor dri­ving the need for the rel­a­tive­ly high returns pri­vate equi­ty promis­es to deliv­er. And while the pri­vate equi­ty indus­try can’t be blamed entire­ly for that sit­u­a­tion, it’s not blame­less either. Those con­sis­tent promis­es of 7%+ pro­ject­ed returns allow CalPERS to col­lect less mon­ey from the state and cities than is real­is­ti­cal­ly required, result­ing in a com­bined short­fall of $352.5 bil­lion as of 2018 for Cal­i­for­ni­a’s pub­lic pen­sion sys­tems:

...
“Pri­vate equi­ty isn’t my favorite asset class,” There­sa Tay­lor, the chair of the CalPERS board’s invest­ment com­mit­tee, said at a recent meet­ing. “It helps us achieve our 7 per­cent solu­tion,” she said. “I know we have to be there. I wish we were 100 per­cent fund­ed. Then, maybe we wouldn’t.”

CalPERS, like many oth­er pen­sion funds, began putting mon­ey into pri­vate equi­ty funds decades ago. But its reliance on such funds has increased in recent years, as low inter­est rates have made bonds less attrac­tive and stocks have proven too volatile. Adding to the urgency are an aging pop­u­la­tion, expan­sive pen­sion ben­e­fits that can’t be reduced and a major fund­ing short­fall.

...

Inde­pen­dent ana­lysts have long urged pub­lic pen­sion trustees to stop chas­ing high­er returns and instead take a deep, hard look at how they got to be so under­fund­ed in the first place. A grow­ing school of thought blames the way they cal­cu­late their total oblig­a­tions to retirees for under­stat­ing the true num­ber — specif­i­cal­ly, how they trans­late the val­ue of pen­sions due in the future into today’s dol­lars.

To do that, CalPERS uses the rou­tine prac­tice of dis­count­ing, which all finan­cial insti­tu­tions use and is based on the prin­ci­ple that mon­ey is worth more today than in the future. It requires the selec­tion of an appro­pri­ate dis­count rate. CalPERS uses its tar­get return on invest­ment of 7 per­cent as its dis­count rate — a prac­tice flat­ly reject­ed by finan­cial econ­o­mists, because 7 per­cent is asso­ci­at­ed with a high degree of risk, and CalPERS’s pen­sions are risk free. Econ­o­mists say that CalPERS, and oth­er pub­lic pen­sion sys­tems, should be using the rate asso­ci­at­ed with risk-free bonds like U.S. Trea­sury bonds. Doing it that way shows the tremen­dous intrin­sic val­ue of risk-free retire­ment income.

But by assum­ing a high so-called dis­count rate that match­es its assumed rate of return, CalPERS makes its short­fall look much small­er on paper — which allows the fund to bill the state of Cal­i­for­nia and its cities for small­er annu­al con­tri­bu­tions than it would oth­er­wise have to. That helps every­body bal­ance their bud­gets more eas­i­ly, but it has left the pen­sion sys­tem chron­i­cal­ly under­fund­ed.

Pub­lic pen­sion sys­tems in Cal­i­for­nia, includ­ing CalPERS, report­ed a com­bined short­fall of $352.5 bil­lion as of 2018, using their high invest­ment assump­tions as dis­count rates, accord­ing to a com­pi­la­tion by the Stan­ford Insti­tute for Eco­nom­ic Pol­i­cy Research. But by replac­ing just that one assump­tion with what econ­o­mists con­sid­er a valid dis­count rate, the insti­tute showed that the funds were real­ly $1 tril­lion short that year. If CalPERS sud­den­ly start­ed billing local gov­ern­ments accord­ing­ly, it would cause a cri­sis.
...

Also keep in mind that we can’t real­ly sep­a­rate the issue of pen­sion fund­ing short­falls and the strug­gling finances of states and cities from the US’s 40 year infat­u­a­tion with sup­ply-side eco­nom­ic phi­los­o­phy cel­e­brat­ed tax cuts for the wealthy as a pol­i­cy cure-all that cre­at­ed a decades-long tax rate race to the bot­tom for the wealth­i­est. A 40 year infat­u­a­tion with sup­ply-side eco­nom­ic poli­cies that hap­pened to fuel the rise of pri­vate equi­ty.

Too Big to Lose Even When It Los­es

So how was this fight over whether or not pri­vate equi­ty could access the fed­er­al bailouts resolved? Well, in late April, the Small Busi­ness Admin­is­tra­tion (SBA) announced that pri­vate equi­ty would not be allowed to tap those funds. But as the fol­low­ing Bloomberg arti­cle from July describes, while some of the biggest and most high profile/notorious pri­vate equi­ty firms like Black­stone did indeed decide to for­go the fed­er­al funds, numer­ous pri­vate equi­ty firms did so any­way. And while some pri­vate equi­ty-owned busi­ness did have an excep­tion and were allowed to access the funds — like food-ser­vice busi­ness­es — most pri­vate equi­ty-owned busi­ness don’t have this loop­hole avail­able. And yet numer­ous firms took the mon­ey any­way. How? Trick­ery and workarounds, more or less. Workarounds like ced­ed seats on the com­pa­ny board. In oth­er words, the pri­vate equi­ty firms effec­tive­ly pre­tend­ed to no longer con­trol their own com­pa­nies:

Bloomberg

Res­cue Cash Too Hot for KKR Proves Irre­sistible to Many PE Peers

By Heather Perl­berg
July 2, 2020, 3:00 AM CDT
Updat­ed on July 2, 2020, 10:55 AM CDT
* Dozens of buy­out firms are said to ben­e­fit from SBA’s lend­ing
* Some may soon face scruti­ny as gov­ern­ment iden­ti­fies bor­row­ers

Even inside bat­tle-scarred KKR & Co., enter­ing the polit­i­cal fray was enough to stoke unease.

As sev­er­al of the pri­vate equi­ty titan’s port­fo­lio com­pa­nies got loans from an emer­gency U.S. pro­gram aimed at help­ing small busi­ness­es sur­vive the coro­n­avirus pan­dem­ic, exec­u­tives at the firm’s New York head­quar­ters issued a blunt mes­sage: Return the mon­ey to tax­pay­ers.

Yet across the cash-rich pri­vate equi­ty world, many firms pushed ahead, ben­e­fit­ing from the $669 bil­lion Pay­check Pro­tec­tion Pro­gram run by the Small Busi­ness Admin­is­tra­tion and Trea­sury Depart­ment, accord­ing to lawyers and lenders with knowl­edge of the strate­gies. Now, some of those firms face the prospect of tough pub­lic scruti­ny, as the Trump admin­is­tra­tion acqui­esces to pres­sure from law­mak­ers to name bor­row­ers who drew poten­tial­ly for­giv­able loans from tax­pay­ers.

After the gov­ern­ment broad­ly exclud­ed pri­vate equi­ty firms from the pro­gram, dozens found ways to steer around the restric­tions, often adjust­ing gov­er­nance or own­er­ship arrange­ments with port­fo­lio com­pa­nies in sec­tors includ­ing enter­tain­ment, fit­ness, sports and der­ma­tol­ogy, the peo­ple said, ask­ing not to be named dis­cussing con­fi­den­tial arrange­ments.

What’s more, some port­fo­lio com­pa­nies also ben­e­fit­ed from indi­rect tax­pay­er sup­port after help­ing scores of relat­ed busi­ness­es apply for PPP loans, keep­ing rev­enue flow­ing, the peo­ple said.

The industry’s secret suc­cess in tap­ping SBA mon­ey risks stok­ing a new uproar in Wash­ing­ton. Pub­licly trad­ed com­pa­nies and hedge funds already faced a back­lash for try­ing to lean on U.S. cof­fers, lead­ing them to add to more than $38 bil­lion in loans that have been returned or oth­er­wise can­celed. Unclear is how many pri­vate equi­ty firms may soon be out­ed.

Some have held meet­ings in recent days to dis­cuss return­ing SBA mon­ey, accord­ing to peo­ple with knowl­edge of the talks. Spokes­men for the SBA and Trea­sury declined to com­ment or didn’t respond to mes­sages seek­ing com­ment, includ­ing on whether com­pa­nies that repay loans will be includ­ed in data to be made pub­lic.

Though peo­ple close to the pri­vate equi­ty indus­try were will­ing to describe how firms accessed SBA loans, the iden­ti­ty of those that did so remains close­ly guard­ed because of the polit­i­cal sen­si­tiv­i­ties. More than a dozen pri­vate equi­ty firms declined to com­ment or didn’t respond to mes­sages seek­ing com­ment on whether their port­fo­lio com­pa­nies had sought or received loans. But rep­re­sen­ta­tives for some of the largest — KKR, Black­stone Group Inc., Apol­lo Glob­al Man­age­ment, Car­lyle Group Inc., TPG and Ares Man­age­ment — said com­pa­nies they con­trol did not use SBA mon­ey.

...

Broad­ly Dis­qual­i­fied

To be clear, Con­gress and the SBA inten­tion­al­ly stopped short of out­right ban­ning relief to com­pa­nies backed by pri­vate equi­ty investors. Author­i­ties carved out excep­tions for food-ser­vice and accom­mo­da­tion com­pa­nies hit espe­cial­ly hard by the pan­dem­ic. Fran­chisees and affil­i­ates of firms already licensed as Small Busi­ness Invest­ment Com­pa­nies also were allowed in.

But most com­pa­nies backed by buy­out firms appeared to be dis­qual­i­fied by rules against lend­ing to bor­row­ers with more than 500 employ­ees, unless they met SBA stan­dards for larg­er firms. Reg­u­la­tors tal­ly such fig­ures by adding all the head­count at busi­ness­es con­trolled by a pri­vate equi­ty firm. If two busi­ness­es each employ 300 peo­ple, they could both be dis­qual­i­fied.

Defin­ing whether a pri­vate equi­ty firm con­trols a com­pa­ny isn’t always sim­ple. Funds are known to take minor­i­ty stakes with out­size influ­ence over strat­e­gy. If a buy­out firm wields enough clout on a board of direc­tors to pre­vent a quo­rum or to block deci­sions, then that “neg­a­tive con­trol” can make the com­pa­ny inel­i­gi­ble for SBA sup­port.

That’s prompt­ed a vari­ety of workarounds, accord­ing to peo­ple famil­iar with the strate­gies. For exam­ple, buy­out firms ced­ed some board seats or gave up oth­er rights to loosen their grip.

Ample Cash

Evi­dence of the strate­gies emerged in April when the SBA, in con­sul­ta­tion with the Trea­sury, pub­lished guid­ance on a list of fre­quent­ly asked ques­tions. It not­ed share­hold­ers who for­feit “rights to pre­vent a quo­rum or oth­er­wise block action by the board of direc­tors or share­hold­ers” must do so “irrev­o­ca­bly” to sat­is­fy the rules.

In oth­er cas­es, buy­out firms have got­ten around the ban with more arcane steps, such as pledg­ing not to add any more debt or giv­ing up the pow­er to make hir­ing and fir­ing deci­sions, accord­ing to the peo­ple famil­iar with the arrange­ments.

The pri­vate equi­ty indus­try lob­bied to access the SBA pro­gram as it was being set up, but to lit­tle avail. “It shouldn’t mat­ter if the com­pa­nies are backed by invest­ment from cor­po­ra­tions, pen­sion funds or oth­ers,” Drew Mal­oney, the pres­i­dent of the Amer­i­can Invest­ment Coun­cil, pri­vate equity’s trade group, said at the time.

The pro­gram isn’t meant to help com­pa­nies that have access to oth­er sources of cash, Trea­sury Sec­re­tary Steven Mnuchin has said. SBA offi­cials have urged the pri­vate equi­ty indus­try — which cur­rent­ly has about $1.5 tril­lion in avail­able cash — to help their port­fo­lio com­pa­nies. There’s also the moral haz­ard: Some com­pa­nies were par­tic­u­lar­ly vul­ner­a­ble to the pan­dem­ic because pri­vate equi­ty own­ers had loaded them up with debt to max­i­mize prof­its.

Still, buy­out firms argue there are restric­tions on how much they can pump into trou­bled deals and pri­vate­ly lament that their busi­ness mod­el is mis­un­der­stood.

Den­tal Relief

Some firms were able to get indi­rect tax­pay­er sup­port because of the way they hap­pened to struc­ture invest­ments in high­ly reg­u­lat­ed indus­tries. Take den­tistry, for exam­ple.

Laws in most states pre­vent investors from own­ing den­tal prac­tices out­right, so buy­out funds own a sep­a­rate enti­ty that pro­vides relat­ed ser­vices. Ares and Leonard Green & Part­ners own Aspen Den­tal Man­age­ment Inc., a provider of busi­ness and admin­is­tra­tive sup­port to den­tists.

As the pan­dem­ic shut down den­tistry, almost every prac­tice affil­i­at­ed with Aspen qual­i­fied for SBA financ­ing, Chief Exec­u­tive Offi­cer Bob Fontana told staff in a mes­sage April 19. “Two weeks ago, we worked with prac­tice own­ers to sub­mit PPP loan appli­ca­tions,” he said at the time. “We’re thrilled to report that every loan request we sub­mit­ted has been accept­ed.”

The fund­ing helped reopen prac­tices and return staff to work, a spokes­woman for Aspen said in an emailed state­ment. Aspen Den­tal itself didn’t seek SBA fund­ing, she said. Aspen “pro­vid­ed cer­tain pay­roll and oper­a­tions data, as required in the loan appli­ca­tions, for those inde­pen­dent prac­tices who chose to apply for the PPP loans.”

Back in Wash­ing­ton, law­mak­ers are tak­ing a tough look at how the SBA mon­ey was deployed. They suc­cess­ful­ly pressed the Trump admin­is­tra­tion to reverse its posi­tion on with­hold­ing all data about com­pa­nies that received PPP financ­ing and agree to dis­close com­pa­ny names and data for loans of more than $150,000, as well as details about small­er loans with­out per­son­al­ly iden­ti­fi­able infor­ma­tion they con­sid­er to be pro­pri­etary.

...

————-

“Res­cue Cash Too Hot for KKR Proves Irre­sistible to Many PE Peers” by Heather Perl­berg; Bloomberg; 07/02/2020

“After the gov­ern­ment broad­ly exclud­ed pri­vate equi­ty firms from the pro­gram, dozens found ways to steer around the restric­tions, often adjust­ing gov­er­nance or own­er­ship arrange­ments with port­fo­lio com­pa­nies in sec­tors includ­ing enter­tain­ment, fit­ness, sports and der­ma­tol­ogy, the peo­ple said, ask­ing not to be named dis­cussing con­fi­den­tial arrange­ments.”

Yes, all of a sud­den all sorts of pri­vate equi­ty-owned and con­trolled com­pa­nies ‘ced­ed con­trol’ of the com­pa­nies and that made the com­pa­nies eli­gi­ble for the funds. At least that was appar­ent­ly what numer­ous pri­vate equi­ty-owned firms con­clud­ed:

...
Defin­ing whether a pri­vate equi­ty firm con­trols a com­pa­ny isn’t always sim­ple. Funds are known to take minor­i­ty stakes with out­size influ­ence over strat­e­gy. If a buy­out firm wields enough clout on a board of direc­tors to pre­vent a quo­rum or to block deci­sions, then that “neg­a­tive con­trol” can make the com­pa­ny inel­i­gi­ble for SBA sup­port.

That’s prompt­ed a vari­ety of workarounds, accord­ing to peo­ple famil­iar with the strate­gies. For exam­ple, buy­out firms ced­ed some board seats or gave up oth­er rights to loosen their grip.
...

It all rais­es a dis­turb­ing ques­tion: so giv­en that pri­vate equi­ty’s busi­ness mod­el is heav­i­ly reliant on load­ing the com­pa­nies they buy with debt, how many of the pri­vate equi­ty-owned busi­ness that sought the PPP funds sought them in part because of the high debt loads their pri­vate equi­ty-own­ers inflict­ed upon the com­pa­nies made them high­ly frag­ile once the pan­dem­ic hit:

...
The pro­gram isn’t meant to help com­pa­nies that have access to oth­er sources of cash, Trea­sury Sec­re­tary Steven Mnuchin has said. SBA offi­cials have urged the pri­vate equi­ty indus­try — which cur­rent­ly has about $1.5 tril­lion in avail­able cash — to help their port­fo­lio com­pa­nies. There’s also the moral haz­ard: Some com­pa­nies were par­tic­u­lar­ly vul­ner­a­ble to the pan­dem­ic because pri­vate equi­ty own­ers had loaded them up with debt to max­i­mize prof­its.
...

It also rais­es the ques­tion of how much of the cash these pri­vate equi­ty-own­ers had on hand came direct­ly or indi­rect­ly from teh act of load­ing these com­pa­nies up with debt.

Pri­vate Equi­ty: It’s Not Just For Pen­sions. Any­more. Thanks to Trump’s Depart­ment of Labor

Well, at least this grow­ing pri­vate equi­ty pen­sion night­mare — a night­mare where pen­sions seem to con­sis­tent­ly under­per­form indus­try bench­marks — is lim­it­ed to pen­sion plans and has­n’t bled into the US’s 401k per­son­al retire­ment accounts. Right? Well, not as of June, when the Depart­ment of Labor just issued an order that allows 401ks to invest in pri­vate equi­ty funds for the first time ever. Pri­vate equi­ty for the ‘lit­tle guy’. What could go wrong?

So what was the rea­son­ing behind this move? The Labor Depart­ment asserts that pri­vate equi­ty funds per­form well and point­ed to the fact that pri­vate equi­ty funds have per­formed as well as pub­lic equi­ty indices since at least 2006. What that rea­son­ing did­n’t fac­tor in is the fact that pri­vate equi­ty funds have high fees that can range any­where from 7–20 per­cent. Again, that adds up. Low fees in the range of 0.21 to 0.6 per­cent are one of the main fea­tures of pub­lic equi­ty indices. So the Depart­ment of Labor basi­cal­ly passed a rule that allows indi­vid­ual retirees to give pri­vate equi­ty a bunch of fees:

The Amer­i­can Prospect

Let­ting Pri­vate Equi­ty Bil­lion­aires Rob Work­er Retire­ment Funds

A new Depart­ment of Labor rule allows pri­vate equi­ty to get into 401(k) plans. One expert esti­mates a $13.7 bil­lion annu­al wealth trans­fer from work­ers to Wall Street tycoons.

by Robin Kaiser-Schat­zlein

June 18, 2020

On June 3, under the cov­er of viral chaos and civ­il unrest, the Depart­ment of Labor announced that it would allow pri­vate equi­ty firms to sell prod­ucts to indi­vid­ual retire­ment accounts, includ­ing 401(k)s. The impe­tus was Pres­i­dent Trump’s vague, blus­tery, and dereg­u­la­to­ry exec­u­tive order to “remove bar­ri­ers” to the “inno­va­tion, ini­tia­tive, and dri­ve of the Amer­i­can peo­ple.” But the Labor Department’s rule will do the oppo­site, exac­er­bat­ing wealth inequal­i­ty by suck­ing a huge pile of mon­ey out of the pock­ets of work­ers sav­ing for retire­ment and shep­herd­ing it to the few fab­u­lous­ly wealthy own­ers of pri­vate equi­ty firms.

By open­ing the flood­gates to pri­vate equi­ty, the Depart­ment of Labor will sub­ject indi­vid­ual retire­ment accounts to pri­vate equity’s exor­bi­tant­ly high fees, while pro­vid­ing rough­ly the same returns as low- and no-fee mutu­al funds. Experts sug­gest that this point­less pay­out to pri­vate equi­ty from these fees––borne entire­ly by workers––might be in the ball­park of $13.7 bil­lion per year.

Work­er mon­ey already props up the pri­vate equi­ty busi­ness mod­el. CalPERS, one of the largest pen­sion funds in the world, has been invest­ing heav­i­ly in pri­vate equi­ty firms that buy and sell dis­tressed assets for years. Now, Trump’s Labor Depart­ment has giv­en the green light for even more work­er mon­ey to flow into an indus­try that fre­quent­ly harms work­ers, by load­ing com­pa­nies with debt, forc­ing them to cut labor costs to the bone, and fre­quent­ly bank­rupt­ing them, while extract­ing the last bits of val­ue.

The Department’s ratio­nale for allow­ing retire­ment savers to buy prod­ucts from pri­vate equi­ty firms was that these funds per­form well. Sec­re­tary of Labor Eugene Scalia said in a press state­ment that let­ting pri­vate equi­ty funds devel­op prod­ucts for retire­ment savers was to allow them to “gain access to alter­na­tive invest­ments that often pro­vide strong returns.” But experts dis­agree. Pro­fes­sor Ludovic Phalip­pou at the Uni­ver­si­ty of Oxford ana­lyzed pri­vate equi­ty funds from 2006 to 2015, and found that they don’t earn back the leg­endary sky-high returns. Rather, the “funds have returned about the same as pub­lic equi­ty indices since at least 2006.” One main prob­lem is that the high fees that pri­vate equi­ty firms charge, which can range any­where from 7 per­cent on the low end to 20 per­cent for pri­vate clients, dimin­ish the returns to investors. These per­for­mance fees totaled about $230 bil­lion over the peri­od stud­ied.

If pri­vate equi­ty was to sell prod­ucts to indi­vid­ual investors, their fees would like­ly be in the range that they charge California’s pub­lic-employ­ee pen­sion fund CalPERS, which Phalip­pou notes is about 7 per­cent. Eileen Appel­baum, co-direc­tor at the Cen­ter for Eco­nom­ic and Pol­i­cy Research and an expert on pri­vate equi­ty, told me she thinks 7 per­cent is at best a con­ser­v­a­tive esti­mate. The invest­ments allowed by the gov­ern­ment in 401(k) plans would be a “fund of funds,” or an invest­ment fund com­posed of oth­er pri­vate equi­ty funds. This would like­ly tack on an extra per­cent­age point. Then you add in the stan­dard fee that a bro­ker­age like Fideli­ty or Van­guard takes for man­ag­ing the over­all 401(k) (which are small and range from 0.21 per­cent to 0.6 per­cent, accord­ing to Investo­pe­dia), and the fees for a pri­vate equi­ty prod­uct would be in the range of 8.2 to 8.6 per­cent. Com­pare this to the more stan­dard index fund, which would have only a minus­cule 0.21 to 0.6 per­cent fee.

The 401(k) mar­ket is cur­rent­ly a mas­sive $6.2 tril­lion, and Appel­baum notes that only a lit­tle more than half of that mar­ket is invest­ed in the kind of tar­get-date funds and bal­ance funds that the Labor Depart­ment made pri­vate equi­ty firms cur­rent­ly eli­gi­ble to sell into. (Tar­get-date funds are often the default option for work­ers, mak­ing that a big poten­tial prize for pri­vate equi­ty.) She thinks that for the time being, most finan­cial advis­ers will not feel com­fort­able sell­ing pri­vate equi­ty prod­ucts to their clients. Sources indi­cate that Van­guard and Fideli­ty, two of the biggest advis­ers, have thus far declined to move retire­ment funds into pri­vate equi­ty.

But even a small stake in such a giant mar­ket would be a wind­fall for pri­vate equi­ty man­agers. Even if the mar­ket set­tles in at around 5 per­cent of all 401(k) funds, that would rep­re­sent a still-giant pool of $171 bil­lion. If 8 per­cent of this goes to pri­vate equi­ty firm fees (less the bro­ker fees), pri­vate equi­ty will have charged work­ers $13.7 bil­lion to deliv­er returns equal to or less than pub­lic equi­ty mar­kets. As Appel­baum notes, retire­ment savers will suf­fer from “hav­ing all this mon­ey tak­en out that they didn’t have tak­en out before.”

There are oth­er dis­ad­van­tages, says Appel­baum. Pri­vate equi­ty invest­ments are noto­ri­ous­ly risky, lack the finan­cial trans­paren­cy of pub­lic firms, and typ­i­cal­ly force investors to com­mit their mon­ey for a decade. “There are a lot of down­sides,” Appel­baum said. “For the extra risk you’re sup­posed to get extra reward. But here there is no extra reward.”

Anoth­er prob­lem is that, even if the top quar­tile of glitzy pri­vate equi­ty firms per­form well (which Appel­baum sug­gests they often do), any retire­ment prod­uct would fea­ture a blend of pri­vate equi­ty funds, which like­ly would include the mid­dling and los­er funds, bring­ing down the prospec­tive return with­out bring­ing down the indus­try-stan­dard, sky-high fees. And as Bar­bara Rop­er of the Con­sumer Fed­er­a­tion of Amer­i­ca indi­cat­ed to me, with­out strong pro­tec­tions for work­ers from being ripped off by finan­cial advis­ers, they could eas­i­ly be talked into these haz­ardous invest­ments.

Appel­baum stress­es that the cre­ation and imple­men­ta­tion of the pri­vate equi­ty prod­ucts is like­ly a lit­tle ways off. Finan­cial firms aren’t like­ly to feel con­fi­dent sell­ing them right away. Pri­vate equi­ty funds also need upfront invest­ments of $5 mil­lion to $10 mil­lion, which will require asset man­agers to some­how pool 401(k)s into big invest­ments; this is espe­cial­ly dif­fi­cult giv­en the speed with which work­ers change jobs and will need to with­draw funds that pri­vate equi­ty firms want to lock up. “Fre­quent turnover in retire­ment plan invest­ments makes pri­vate equi­ty a par­tic­u­lar­ly poor choice for most retire­ment savers,” Rop­er said. And cur­rent­ly, the eco­nom­ic shut­down has dis­tract­ed pri­vate equi­ty with a per­verse prob­lem: They have over $1.4 tril­lion in unde­ployed cap­i­tal (known as “dry pow­der”) that they need to spend.

Nonethe­less, pri­vate equi­ty firms have been drool­ing over the tan­ta­liz­ing 401(k) mar­ket since at least 2013, Appel­baum says. (She wrote an orac­u­lar arti­cle in 2014 called “Pri­vate Equi­ty Is Com­ing for Your Nest Egg.”) The Trump Labor Depart­ment rule is the ful­fill­ment of a long-deferred dream.

...

Democ­rats are start­ing to speak out about the Labor Department’s deci­sion. Michael Gwin, spokesper­son for Demo­c­ra­t­ic pres­i­den­tial nom­i­nee Joe Biden, gave the Prospect this state­ment: “While Joe Biden stead­fast­ly sup­ports more equal access to retire­ment sav­ing incen­tives and oppor­tu­ni­ties for wealth build­ing, he staunch­ly oppos­es reg­u­la­to­ry changes that will lead to sky­rock­et­ing fees and dimin­ished retire­ment secu­ri­ty for savers. This reg­u­la­to­ry action is anoth­er exam­ple of Pres­i­dent Trump putting the inter­ests of Wall Street ahead of Amer­i­can work­ers and fam­i­lies.”

If pri­vate equi­ty prod­ucts won’t bring in extra returns for work­ers, what is the Trump admin­is­tra­tion after? It looks like they want to use work­ers’ mon­ey to pam­per and fash­ion a new class of bil­lion­aires. Many of them, after all, are friends and donors of the admin­is­tra­tion.

This mod­el has already been proven. Phalip­pou finds that as they got increas­ing­ly involved with pen­sion funds, the num­ber of pri­vate equi­ty multi­bil­lion­aires rose from three in 2005 to 22 in 2020. From study­ing the pri­vate equi­ty indus­try, he sug­gests that the use of pri­vate equi­ty is a wealth trans­fer that “might be one of the largest in the his­to­ry of mod­ern finance: from a few hun­dred mil­lion pen­sion scheme mem­bers … to a few thou­sand peo­ple work­ing in pri­vate equi­ty.” Under the guid­ance of the Trump admin­is­tra­tion, it seems it can only get worse.

————

“Let­ting Pri­vate Equi­ty Bil­lion­aires Rob Work­er Retire­ment Funds” by Robin Kaiser-Schat­zlein; The Amer­i­can Prospect; 06/18/2020

By open­ing the flood­gates to pri­vate equi­ty, the Depart­ment of Labor will sub­ject indi­vid­ual retire­ment accounts to pri­vate equity’s exor­bi­tant­ly high fees, while pro­vid­ing rough­ly the same returns as low- and no-fee mutu­al funds. Experts sug­gest that this point­less pay­out to pri­vate equi­ty from these fees––borne entire­ly by workers––might be in the ball­park of $13.7 bil­lion per year.”

The same returns as before but now with extra fees! That’s basi­cal­ly what Trump’s Depart­ment of Labor just unleashed upon US work­ers. No longer will work­ers be bur­dened with the ultra-low 0.21–0.6 per­cent fees charged by equi­ty index funds:

...
The Department’s ratio­nale for allow­ing retire­ment savers to buy prod­ucts from pri­vate equi­ty firms was that these funds per­form well. Sec­re­tary of Labor Eugene Scalia said in a press state­ment that let­ting pri­vate equi­ty funds devel­op prod­ucts for retire­ment savers was to allow them to “gain access to alter­na­tive invest­ments that often pro­vide strong returns.” But experts dis­agree. Pro­fes­sor Ludovic Phalip­pou at the Uni­ver­si­ty of Oxford ana­lyzed pri­vate equi­ty funds from 2006 to 2015, and found that they don’t earn back the leg­endary sky-high returns. Rather, the “funds have returned about the same as pub­lic equi­ty indices since at least 2006.” One main prob­lem is that the high fees that pri­vate equi­ty firms charge, which can range any­where from 7 per­cent on the low end to 20 per­cent for pri­vate clients, dimin­ish the returns to investors. These per­for­mance fees totaled about $230 bil­lion over the peri­od stud­ied.

If pri­vate equi­ty was to sell prod­ucts to indi­vid­ual investors, their fees would like­ly be in the range that they charge California’s pub­lic-employ­ee pen­sion fund CalPERS, which Phalip­pou notes is about 7 per­cent. Eileen Appel­baum, co-direc­tor at the Cen­ter for Eco­nom­ic and Pol­i­cy Research and an expert on pri­vate equi­ty, told me she thinks 7 per­cent is at best a con­ser­v­a­tive esti­mate. The invest­ments allowed by the gov­ern­ment in 401(k) plans would be a “fund of funds,” or an invest­ment fund com­posed of oth­er pri­vate equi­ty funds. This would like­ly tack on an extra per­cent­age point. Then you add in the stan­dard fee that a bro­ker­age like Fideli­ty or Van­guard takes for man­ag­ing the over­all 401(k) (which are small and range from 0.21 per­cent to 0.6 per­cent, accord­ing to Investo­pe­dia), and the fees for a pri­vate equi­ty prod­uct would be in the range of 8.2 to 8.6 per­cent. Com­pare this to the more stan­dard index fund, which would have only a minus­cule 0.21 to 0.6 per­cent fee.
...

How will inde­pen­dent investors fair with this grand new retire­ment invest­ment oppor­tu­ni­ty? Pre­sum­ably about as well as pen­sion funds...with con­sis­tent­ly under­per­form­ing results that lag the indus­try bench­marks. Lucky them.

Pri­vate Par­a­sites Tak­ing Over the World

But as the fol­low­ing Bloomberg arti­cle from Octo­ber of 2019 — right before the start of the coro­n­avirus pan­dem­ic — makes clear, there’s anoth­er major rea­son we should be con­cerned about 401k invest­ments in pri­vate equi­ty fund: pri­vate equi­ty is bad for busi­ness. Yes, it’s great of earn­ing mas­sive prof­its for the exec­u­tives in the pri­vate equi­ty firms. But as stud­ies have shown, the busi­ness bought out by pri­vate equi­ty are more frag­ile than their pub­licly held counter-parts, large­ly because they are typ­i­cal­ly pur­chased in a lever­aged buy out that loads the com­pa­ny with debt. Addi­tion­al­ly, the incen­tives for the new pri­vate equi­ty own­ers to effec­tive­ly gut a busi­ness and sell off its most valu­able assets in the inter­est of mak­ing a quick prof­it is exceed­ing­ly high, in large part because of the mas­sive lever­age used to make the pur­chase. Beyond that, pri­vate equi­ty can treat the busi­ness­es it owns effec­tive­ly like vir­tu­al ATM, where they force the com­pa­ny to bor­row mon­ey to pay its pri­vate equi­ty own­er spe­cial div­i­dends. As the arti­cle also points out, the cor­po­rate debt lev­els a year ago were look­ing scar­i­ly high should anoth­er reces­sion hit thanks in large part to pri­vate equi­ty’s grow­ing role in the econ­o­my over the last decade after it ‘won’ the 2008 finan­cial cri­sis. And then, of course, the coro­n­avirus pan­dem­ic hit and an even eco­nom­ic night­mare sce­nario we find our­selves in today emerged. So the more pen­sions and 401ks pile into pri­vate equi­ty, the more cash pri­vate equi­ty has on hand to effec­tive­ly loot the econ­o­my even more than the present-day loot­ing lev­els:

Bloomberg Busi­ness­week

Every­thing Is Pri­vate Equi­ty Now
Spurred by cheap loans and investors des­per­ate to boost returns, buy­out firms roam every cor­ner of the cor­po­rate world.

Octo­ber 3, 2019, 3:00 AM CDT
Cor­rect­ed Octo­ber 8, 2019, 3:10 PM CDT

Pri­vate equi­ty man­agers won the finan­cial cri­sis. A decade since the world econ­o­my almost came apart, big banks are more heav­i­ly reg­u­lat­ed and scru­ti­nized. Hedge funds, which live on the volatil­i­ty cen­tral banks have worked so hard to quash, have most­ly lost their flair. But the firms once known as lever­aged buy­out shops are thriv­ing. Almost every­thing that’s hap­pened since 2008 has tilt­ed in their favor.

Low inter­est rates to finance deals? Check. A friend­ly polit­i­cal cli­mate? Check. A long line of clients? Check.

The PE indus­try, which runs funds that can invest out­side pub­lic mar­kets, has tril­lions of dol­lars in assets under man­age­ment. In a world where bonds are pay­ing next to nothing—and some have neg­a­tive yields—many big investors are des­per­ate for the high­er returns PE man­agers seem to be able to squeeze from the mar­kets.

The busi­ness has made bil­lion­aires out of many of its founders. Funds have snapped up busi­ness­es from pet stores to doc­tors’ prac­tices to news­pa­pers. PE firms may also be deep into real estate, loans to busi­ness­es, and start­up investments—but the heart of their craft is using debt to acquire com­pa­nies and sell them lat­er.

In the best cas­es, PE man­agers can nur­ture fail­ing or under­per­form­ing com­pa­nies and set them up for faster growth, cre­at­ing out­size returns for investors that include pen­sion funds and uni­ver­si­ties. But hav­ing once oper­at­ed on the com­fort­able mar­gins of Wall Street, pri­vate equi­ty is now fac­ing tougher ques­tions from politi­cians, reg­u­la­tors, and activists. One of PE’s super­pow­ers is that it’s hard for out­siders to see and under­stand the indus­try, so we set out to shed light on some of the ways it’s chang­ing finance and the econ­o­my itself. —Jason Kel­ly

The Mag­ic For­mu­la Is Lever­age ... and Fees

PE invests in a range of dif­fer­ent assets, but the core of the busi­ness is the lever­aged buy­out

The basic idea is a lit­tle like house flip­ping: Take over a com­pa­ny that’s rel­a­tive­ly cheap and spruce it up to make it more attrac­tive to oth­er buy­ers so you can sell it at a prof­it in a few years. The tar­get might be a strug­gling pub­lic com­pa­ny or a small pri­vate busi­ness that can be combined—or “rolled up”—with oth­ers in the same indus­try.

1. A few things make PE dif­fer­ent from oth­er kinds of invest­ing. First is the lever­age. Acqui­si­tions are typ­i­cal­ly financed with a lot of debt that ends up being owed by the acquired com­pa­ny. That means the PE firm and its investors can put in a com­par­a­tive­ly small amount of cash, mag­ni­fy­ing gains if they sell at a prof­it.

2. Sec­ond, it’s a hands-on invest­ment. PE firms over­haul how a busi­ness is man­aged. Over the years, firms say they’ve shift­ed from brute-force cost-cut­ting and lay­offs to McK­in­sey-style oper­a­tional con­sult­ing and reor­ga­ni­za­tion, with the aim of leav­ing com­pa­nies bet­ter off than they found them. “When you grow busi­ness­es, you typ­i­cal­ly need more peo­ple,” said Black­stone Group Inc.’s Stephen Schwarz­man at the Bloomberg Glob­al Busi­ness Forum in Sep­tem­ber. Still, the busi­ness mod­el has put PE at the fore­front of the finan­cial­iza­tion of the economy—any busi­ness it touch­es is under pres­sure to real­ize val­ue for far-flung investors. Quick­ly.

3. Final­ly, the fees are huge. Con­ven­tion­al mon­ey man­agers are lucky if they can get investors to pay them 1% of their assets a year. The tra­di­tion­al PE struc­ture is “2 and 20”—a 2% annu­al fee, plus 20% of prof­its above a cer­tain lev­el. The 20 part, known as car­ried inter­est, is espe­cial­ly lucra­tive because it gets favor­able tax treat­ment. —J.K.

The Returns Are Spec­tac­u­lar. But There Are Catch­es

For investors the draw of pri­vate equi­ty is sim­ple: Over the 25 years end­ed in March, PE funds returned more than 13% annu­al­ized, com­pared with about 9% for an equiv­a­lent invest­ment in the S&P 500, accord­ing to an index cre­at­ed by invest­ment firm Cam­bridge Asso­ciates LLC. Pri­vate equi­ty fans say the funds can find val­ue you can’t get in pub­lic mar­kets, in part because pri­vate man­agers have more lee­way to over­haul under­val­ued com­pa­nies. “You can­not make trans­for­ma­tion­al changes in a pub­lic com­pa­ny today,” said Neu­berg­er Berman Group LLC man­ag­ing direc­tor Tony Tutrone in a recent inter­view on Bloomberg TV. Big insti­tu­tion­al investors such as pen­sions and uni­ver­si­ty endow­ments also see a diver­si­fi­ca­tion ben­e­fit: PE funds don’t move in lock­step with broad­er mar­kets.

But some say investors need to be more skep­ti­cal. “We have seen a num­ber of pro­pos­als from pri­vate equi­ty funds where the returns are real­ly not cal­cu­lat­ed in a man­ner that I would regard as hon­est,” said bil­lion­aire investor War­ren Buf­fett at Berk­shire Hath­away Inc.’s annu­al meet­ing ear­li­er this year. There are three main con­cerns.

• The val­ue of pri­vate invest­ments is hard to mea­sure

Because pri­vate com­pa­ny shares aren’t being con­stant­ly bought and sold, you can’t look up their price by typ­ing in a stock tick­er. So pri­vate funds have some flex­i­bil­i­ty in valu­ing their hold­ings. Andrea Auer­bach, Cambridge’s head of glob­al pri­vate invest­ments, says a mea­sure that PE firms often use to assess a company’s performance—earnings before inter­est, tax­es, depre­ci­a­tion, and amor­ti­za­tion, or Ebitda—is often over­stat­ed using var­i­ous adjust­ments. “It’s not an hon­est num­ber any­more,” she says. Ulti­mate­ly, though, there’s a lim­it to how much these val­u­a­tions can inflate a PE fund’s returns. When the fund sells the invest­ment, its true val­ue is exact­ly what­ev­er buy­ers are will­ing to pay.

Anoth­er con­cern is that the lack of trad­ing in pri­vate invest­ments may mask a fund’s volatil­i­ty, giv­ing the appear­ance of smoother returns over time and the illu­sion that illiq­uid assets are less risky, accord­ing to a 2019 report by asset man­ag­er AQR Cap­i­tal Man­age­ment, which runs funds that com­pete with pri­vate equi­ty.

• Returns can be gamed

Pri­vate equi­ty funds don’t imme­di­ate­ly take all the mon­ey their clients have com­mit­ted. Instead, they wait until they find an attrac­tive invest­ment. The inter­nal rate of return is cal­cu­lat­ed from the time the investor mon­ey comes in. The short­er the peri­od the investor cap­i­tal is put to work, the high­er the annu­al­ized rate of return. That opens up a chance to juice the fig­ures. Funds can bor­row mon­ey to make the ini­tial invest­ment and ask for the clients’ mon­ey a bit lat­er, mak­ing it look as if they pro­duced prof­its at a faster rate. “Over the last sev­er­al years, more pri­vate equi­ty funds have pur­sued this as a way to ensure their returns keep up with the Jone­ses,” Auer­bach says. The Amer­i­can Invest­ment Coun­cil, the trade group for PE, says short-term bor­row­ing allows fund man­agers to react quick­ly to oppor­tu­ni­ties and sophis­ti­cat­ed investors to use a vari­ety of mea­sures besides inter­nal rate of return to eval­u­ate PE per­for­mance.

• The best returns might be in the rearview mir­ror

Two decades ago an investor could pick a pri­vate equi­ty fund at ran­dom and have a bet­ter than 75% chance of beat­ing the stock mar­ket, accord­ing to a report by finan­cial data com­pa­ny Pitch­Book. Since 2006 those odds have dropped to worse than a coin flip. “Not only are few­er man­agers beat­ing the mar­ket but their lev­el of out­per­for­mance has shrunk, too,” the report says.

One like­ly rea­son will be famil­iar to investors in mutu­al funds and hedge funds. When strate­gies suc­ceed, more peo­ple pile in—and it gets hard­er and hard­er to find the kinds of bar­gains that fueled the ear­ly gains. There are now 8,000-plus PE-backed com­pa­nies, almost dou­ble the num­ber of their pub­licly list­ed coun­ter­parts. The PE play­book informs activist hedge funds and has been mim­ic­ked by pen­sions and sov­er­eign funds. Some of PE’s secret sauce has been shared lib­er­al­ly in busi­ness school sem­i­nars and man­age­ment books.

A deep­er prob­lem could be that the first gen­er­a­tion of buy­out man­agers wrung out the eas­i­est prof­its. PE think­ing per­vades the cor­po­rate suite—few chief exec­u­tive offi­cers are now sit­ting around wait­ing for PE man­agers to tell them to sell under­per­form­ing divi­sions and cut costs. Auer­bach says there are still good PE man­agers out there and all these changes have “forced evo­lu­tion and inno­va­tion.” But it’s pos­si­ble that a cos­mic align­ment of lax cor­po­rate man­age­ment, cheap debt, and des­per­ate-for-yield pen­sions cre­at­ed a moment that won’t be repeat­ed soon.Hema Par­mar and Jason Kel­ly

Buy­outs Push Com­pa­nies to the Lim­it. Or Over It

If your com­pa­ny finds itself part of a PE port­fo­lio, what should you expect? Research has shown that com­pa­nies acquired through lever­aged buy­outs (LBOs) are more like­ly to depress work­er wages and cut invest­ments, not to men­tion have a high­er risk of bank­rupt­cy. Pri­vate equi­ty own­ers ben­e­fit through fees and div­i­dends, crit­ics say, while the com­pa­ny is left to grap­ple with often debil­i­tat­ing debt.

Kristi Van Beck­um worked as an assis­tant man­ag­er for Shop­ko Stores Inc. in Wis­con­sin when the chain of rur­al depart­ment stores was bought by PE firm Sun Cap­i­tal Part­ners Inc. in a 2005 LBO. “When they took over, our pay­roll got dras­ti­cal­ly cut, our retire­ment plan got cut, and we saw a lot of turnover among exec­u­tives,” she says.

One of Sun Capital’s first moves as own­er was to mon­e­tize Shopko’s most valu­able asset, its real estate, by sell­ing it for about $800 mil­lion and leas­ing back the space to its stores. That gen­er­at­ed a short-term wind­fall but added to Shopko’s long-term rent costs. “A lot of stores that were once prof­itable start­ed to show low­er prof­its because they had to start pay­ing rent,” Van Beck­um says.

In 2019, Shop­ko said it could no longer ser­vice its debt and filed for bank­rupt­cy, ulti­mate­ly shut­ter­ing all of its more than 360 stores. Van Beck­um was asked to stay on as a man­ag­er dur­ing her store’s liq­ui­da­tion and was promised sev­er­ance and a clos­ing bonus in return, she says. Weeks lat­er, she received an email telling her that her sev­er­ance claim wouldn’t be paid. Sun Cap­i­tal has said mon­ey has been con­tributed to the bank­rupt­cy plan that can pay such claims.

Pri­vate equi­ty and hedge funds gained con­trol of more than 80 retail­ers in the past decade, accord­ing to a July report by a group of pro­gres­sive orga­ni­za­tions includ­ing Amer­i­cans for Finan­cial Reform and Unit­ed for Respect. And PE-owned mer­chants account for most of the biggest recent retail bank­rupt­cies, includ­ing those of Gym­boree, Pay­less, and Shop­ko in the past year alone. Those bank­rupt­cies wiped out 1.3 mil­lion jobs—including posi­tions at retail­ers and relat­ed jobs, such as at ven­dors—accord­ing to the report, which esti­mates that “Wall Street firms have destroyed eight times as many retail jobs as they have cre­at­ed in the past decade.”

Whether LBOs per­form poor­ly because of debt, busi­ness strat­e­gy, or com­pe­ti­tion from Amazon.com Inc., research shows they fare worse than their pub­lic coun­ter­parts. A July paper by Bri­an Ayash and Mah­di Ras­tad of Cal­i­for­nia Poly­tech­nic State Uni­ver­si­ty exam­ined almost 500 com­pa­nies tak­en pri­vate from 1980 to 2006. It fol­lowed both the LBOs and a sim­i­lar num­ber of com­pa­nies that stayed pub­lic for a peri­od of 10 years. They found about 20% of the PE-owned com­pa­nies filed for bankruptcy—10 times the rate of those that stayed pub­lic. Pile on debt, and employ­ees lose, Ayash says. “The com­mu­ni­ty los­es. The gov­ern­ment los­es because it has to sup­port the employ­ees.” Who wins? “The funds do.”

Research by Eileen Appel­baum, co-direc­tor of the Cen­ter for Eco­nom­ic and Pol­i­cy Research, says the prob­lem isn’t lever­age per se but too much of it. She points to guid­ance issued by the Fed­er­al Deposit Insur­ance Corp. in 2013 say­ing debt lev­els of more than six times earn­ings before inter­est, tax­es, depre­ci­a­tion, and amor­ti­za­tion, or Ebit­da, “rais­es con­cerns for most indus­tries.” A 2019 McK­in­sey report shows that medi­an debt in pri­vate equi­ty deals last year was just under the six times Ebit­da thresh­old at 5.5, up from five in 2016.

...

The retail indus­try was long a prime tar­get for buy­outs because of its reli­able cash flow and the val­ue of the real estate it owned. But the sec­tor is no longer as suit­ed to PE own­er­ship amid ever-chang­ing cus­tomer whims and the mas­sive upheaval brought by Ama­zon, says Per­ry Man­dari­no, head of restruc­tur­ing and co-head of invest­ment bank­ing at B. Riley FBR. “Pri­vate equi­ty has suc­cess­ful­ly pre­served com­pa­nies across a num­ber of sec­tors,” he says, “but the dis­rup­tion in retail has proven dif­fi­cult for even some of the most savvy investors to nav­i­gate. High lever­age, espe­cial­ly in this dif­fi­cult envi­ron­ment, can be fatal.”

The most notable recent exam­ple of that is Toys “R” Us Inc. When the children’s toy retail­er filed for bank­rupt­cy in 2017, it was pay­ing almost $500 mil­lion a year to ser­vice the debt from its 2005 takeover by Bain Cap­i­tal LP, Vor­na­do Real­ty Trust, and Kohlberg Kravis Roberts & Co. After it was liq­ui­dat­ed in March fol­low­ing poor hol­i­day sea­son sales, its own­ers became the tar­get of protests by laid-off work­ers, as well as scruti­ny from investors and crit­i­cism from elect­ed offi­cials. Lat­er that year, KKR and Bain said they’d each con­tribute $10 mil­lion to a fund for work­ers who lost their jobs when the retail­er col­lapsed. Sen­a­tor Eliz­a­beth War­ren (D‑Mass.) intro­duced a bill in July that would lim­it pay­outs pri­vate equi­ty own­ers could receive from trou­bled com­pa­nies.

That kind of impact isn’t unique to retail, says Heather Slavkin Cor­zo, senior fel­low at Amer­i­cans for Finan­cial Reform and direc­tor of cap­i­tal mar­ket poli­cies at the union fed­er­a­tion AFL-CIO. “The mas­sive growth of pri­vate equi­ty over the past decade means that this industry’s influ­ence, eco­nom­ic and polit­i­cal, has mush­roomed,” she says. “It’s hard­ly an exag­ger­a­tion to say that we are all stake­hold­ers in pri­vate equi­ty these days, one way or anoth­er.”Lau­ren Cole­man-Lochn­er and Eliza Ronalds-Han­non

After the Cri­sis, Rental Homes Became an Asset Class

Rent­ing out hous­es used to be a rel­a­tive­ly small-time busi­ness. Now rentals are what Wall Street calls an asset class—another invest­ment like stocks or tim­ber­land, with ten­ants’ month­ly checks show­ing up as yield in someone’s port­fo­lio. About 1 mil­lion peo­ple may now live in homes owned by large land­lords. This tec­ton­ic shift can be traced to the U.S. hous­ing cri­sis.

Pri­vate equi­ty com­pa­nies includ­ing Black­stone Group Inc. had the mon­ey to gorge on fore­closed hous­es in the years after the crash and quick­ly applied their mod­el to a whole new busi­ness. They used economies of scale, cost-cut­ting, and lever­age to max­i­mize prof­its on under­val­ued assets. The key was to cre­ate a stan­dard­ized way to man­age sin­gle-fam­i­ly homes, scat­tered from Atlanta to Las Vegas, almost as effi­cient­ly as apart­ment build­ings. PE-backed land­lords set up cen­tral­ized 24/7 cus­tomer ser­vice cen­ters and auto­mat­ed sys­tems for rent col­lec­tion and main­te­nance calls.

Black­stone-backed rental com­pa­ny Invi­ta­tion Homes Inc. even­tu­al­ly went pub­lic, then merged with a land­lord seed­ed by Star­wood Cap­i­tal Group and Colony Cap­i­tal Inc. to cre­ate the U.S.’s largest sin­gle-fam­i­ly rental com­pa­ny, with more than 80,000 units. Invi­ta­tion Homes owns less than 1% of the sin­gle-fam­i­ly rental stock, says Ken Caplan, Blackstone’s glob­al co-head of real estate. “But it has raised the bar for pro­fes­sion­al ser­vice for the indus­try,” he says.

The aims of the land­lords and the needs of their ten­ants often diverge, says Leilani Farha, the Unit­ed Nations’ spe­cial rap­por­teur on the right to hous­ing. Steady rent increas­es that make investors hap­py come out of ten­ants’ pay­checks, strain­ing house­hold finances and mak­ing it hard­er to save for a down pay­ment. Mean­while, PE-backed com­pa­nies’ sprawl­ing port­fo­lios of rental prop­er­ties may lim­it the avail­abil­i­ty of entry-lev­el hous­es that could be occu­pied by home­own­ers. Insti­tu­tion­al land­lords were 66% more like­ly than oth­er oper­a­tors to file evic­tion notices, accord­ing to Geor­gia Insti­tute of Tech­nol­o­gy pro­fes­sor Elo­ra Ray­mond, whose 2016 study of Ful­ton Coun­ty, Ga., court records was pub­lished by the Fed­er­al Reserve Bank of Atlanta. Invi­ta­tion Homes was less like­ly to file notices than its largest peers, accord­ing to the paper. A com­pa­ny spokesman says it works with ten­ants to avoid evic­tion and that its high renew­al rates indi­cate cus­tomer sat­is­fac­tion.

From Wall Street’s point of view, the mod­el has worked beau­ti­ful­ly. Invi­ta­tion Homes has con­vinced stock mar­ket investors that it can man­age oper­at­ing costs. It also bought shrewd­ly, swal­low­ing up starter homes in good school dis­tricts, antic­i­pat­ing that tight cred­it and ane­mic con­struc­tion rates would push the U.S. toward what one indus­try ana­lyst dubbed a renter­ship soci­ety. Sure enough, U.S. home­own­er­ship is near its low­est point in more than 50 years, allow­ing Invi­ta­tion Homes to raise rents by more than 5%, on aver­age, when ten­ants renew leas­es.

“The sin­gle-fam­i­ly rental com­pa­nies have a per­fect recipe,” says John Pawlows­ki, an ana­lyst at Green Street Advi­sors LLC. “It’s a com­bi­na­tion of sol­id eco­nom­ic growth in these Sun Belt mar­kets and very few options out there on the own­er­ship front.” Shares of Invi­ta­tion Homes have gained almost 50% since the start of 2019. Black­stone has sold more than $4 bil­lion in shares of it this year. Its remain­ing stake is worth about $1.7 bil­lion. —Prashant Gopal and Patrick Clark

As Prof­its Grow, So Does Inequal­i­ty

In July, Demo­c­ra­t­ic pres­i­den­tial can­di­date Eliz­a­beth War­ren of Mass­a­chu­setts likened the pri­vate equi­ty indus­try to vam­pires. She struck a nerve: Even among Wall Street com­pa­nies, PE stands out as a sym­bol of inequal­i­ty in the U.S. “There’s this con­cen­tra­tion of extreme wealth, and pri­vate equi­ty is a huge part of that sto­ry,” says Char­lie Eaton, an assis­tant pro­fes­sor of soci­ol­o­gy at the Uni­ver­si­ty of Cal­i­for­nia at Merced.

Income gains for the top 1% in the U.S. have been ris­ing at a faster clip than for low­er groups since 1980. Since that time, PE man­agers have steadi­ly tak­en up a larg­er share of the high­est income groups, includ­ing the rich­est 400 peo­ple, accord­ing to sev­er­al research papers from the Uni­ver­si­ty of Chicago’s Steven Kaplan and Stanford’s Joshua Rauh. There are more pri­vate equi­ty man­agers who make at least $100 mil­lion annu­al­ly than invest­ment bankers, top finan­cial exec­u­tives, and pro­fes­sion­al ath­letes com­bined, they found. The very struc­ture of PE firms is par­tic­u­lar­ly prof­itable for man­agers at the top; not only do they earn annu­al man­age­ment fees, but they also get a cut of any prof­its.

Beyond that, PE may con­tribute to inequal­i­ty in sev­er­al ways. First, it offers investors high­er returns than those avail­able in pub­lic stocks and bonds mar­kets. Yet, to enjoy those returns, it helps to already be rich. Pri­vate equi­ty funds are open sole­ly to “qual­i­fied” (read: high-net-worth) indi­vid­ual investors and to insti­tu­tions such as endow­ments. Only some work­ers get indi­rect expo­sure via pen­sion funds.

Sec­ond, PE puts pres­sure on the low­er end of the wealth divide. Com­pa­nies can be bro­ken up, merged, or gen­er­al­ly restruc­tured to increase effi­cien­cy and pro­duc­tiv­i­ty, which inevitably means job cuts. The result is that PE accel­er­ates job polar­iza­tion, or the growth of jobs at the high­est and low­est skill and wage lev­el while the mid­dle erodes, accord­ing to research from econ­o­mists Mar­tin Ols­son and Joacim Tag.

The imper­a­tive to make high­ly lever­aged deals pay off may also encour­age more preda­to­ry busi­ness prac­tices. A study co-authored by UC Merced’s Eaton, for exam­ple, found that buy­outs of pri­vate col­leges lead to high­er tuition, stu­dent debt, and law enforce­ment action for fraud, as well as low­er grad­u­a­tion rates, loan-repay­ment rates, and grad­u­ate earn­ings. But the deals did increase prof­its.

...

Crit­ics and advo­cates of PE gen­er­al­ly agree on at least one thing: When peo­ple are hurt by deals that turn com­pa­nies upside down, there should be sys­tems in place to assist them. “You don’t want to stand in the way of eco­nom­ic inno­va­tion,” says Gre­go­ry Brown, a finance pro­fes­sor at UNC Kenan-Fla­gler Busi­ness School. “But you would hope that peo­ple who get run over are helped.” —Katia Dmitrie­va

Bar­bar­ians at the Gate Become the New Estab­lish­ment

1970s
The U.S. Depart­ment of Labor relax­es reg­u­la­tions to allow pen­sion funds to hold riski­er invest­ments. This opens up a new pool of mon­ey for buy­out artists. Cousins Hen­ry Kravis and George Roberts leave Bear Stearns with their men­tor Jerome Kohlberg to form Kohlberg Kravis Roberts & Co.

1980s
L.A. financier Michael Milken (above, sec­ond from left) turns junk bonds into a hot invest­ment, which makes get­ting lever­age eas­i­er. For­mer Lehman Broth­ers part­ners Pete Peter­son and Stephen Schwarz­man found Black­stone Group. KKR takes con­trol of RJR Nabis­co in a stun­ning $24 bil­lion deal.

1990s
Milken goes to jail for secu­ri­ties vio­la­tions, and his firm, Drex­el Burn­ham Lam­bert, col­laps­es. But takeover artists are find­ing more tools for financ­ing deals, as banker Jim­my Lee (pic­tured, third from left) pop­u­lar­izes lever­aged loans at what’s now JPMor­gan Chase & Co.

2000s
Pen­sions for Cal­i­for­nia state employ­ees and Mid­dle East sov­er­eign funds pour mon­ey into record-set­ting funds that rou­tine­ly sur­pass $15 bil­lion apiece. Big deals of the era include Dol­lar Gen­er­al Corp. and Hilton Hotels. Sev­er­al pri­vate equi­ty firms them­selves go pub­lic.

2010s
After the finan­cial cri­sis, Black­stone, Ares Cap­i­tal, and Apol­lo Glob­al expand their pri­vate cred­it busi­ness­es, pro­vid­ing financ­ing to com­pa­nies no longer served by big banks. Vet­er­an PE exec­u­tive Mitt Rom­ney is the 2012 Repub­li­can pres­i­den­tial nom­i­nee. —J.K.

Pri­vate Equi­ty Is Get­ting Com­pa­nies Hooked on Debt

Pri­vate equi­ty couldn’t exist with­out debt. It’s the jet fuel that makes a cor­po­rate acqui­si­tion so lucra­tive for a turn­around investor. The more debt you can raise against a tar­get com­pa­ny, the less cash you need to pay for it, and the high­er your return on that cash once you sell.

Ultralow inter­est rates have made this fuel espe­cial­ly potent and easy to obtain. The mar­ket for lever­aged loans—industry jar­gon for loans made to com­pa­nies with less-than-stel­lar credit—has dou­bled in the past decade. Almost 40% of all such loans out­stand­ing are to com­pa­nies con­trolled by pri­vate equi­ty, accord­ing to data from Dealog­ic.

Some lever­aged loans are arranged by banks. But there’s also been a boom in pri­vate lenders, who may be will­ing to pro­vide financ­ing when banks or pub­lic debt mar­kets won’t. All the while, bond and loan investors des­per­ate for yield have accept­ed high­er risks. As buy­out titans have chased big­ger and riski­er deals, their tar­get com­pa­nies have been left with more frag­ile bal­ance sheets, which gives man­age­ment less room for error. This could set the stage for a rude awak­en­ing dur­ing the next reces­sion.

“We’re see­ing scary lev­els of lever­age,” says Dan Zwirn, chief invest­ment offi­cer of alter­na­tive asset man­ag­er Are­na Investors. “Pri­vate equi­ty spon­sors are all slam­ming against each oth­er to get deals done.” Loans to com­pa­nies with espe­cial­ly high debt loads now exceed peaks in 2007 and 2014, accord­ing to the U.S. Fed­er­al Reserve. And com­pa­nies owned by pri­vate equi­ty typ­i­cal­ly car­ry a high­er debt load rel­a­tive to their earn­ings and offer less trans­paren­cy on their finan­cial posi­tion than oth­er cor­po­rate bor­row­ers.

...

PE firms can use some of the com­pa­nies they own as vir­tu­al ATMs—having the com­pa­ny bor­row mon­ey to pay its own­er spe­cial div­i­dends. That allows the funds to recov­er their invest­ment soon­er than they typ­i­cal­ly would through a sale or an ini­tial pub­lic offer­ing. Sycamore Part­ners LLC, known for its aggres­sive bets in the retail indus­try and relat­ed run-ins with cred­i­tors, has already recov­ered about 80% of the mon­ey it put down to acquire Sta­ples Inc. in 2017 through div­i­dends most­ly fund­ed by debt. Car­lyle Group, Hell­man & Fried­man, and Sil­ver Lake have also sad­dled their port­fo­lio com­pa­nies with new debt to extract div­i­dends this year. Rep­re­sen­ta­tives for the four pri­vate equi­ty firms declined to com­ment.

Lit­tle bub­bles have already start­ed to pop, giv­ing debt investors a glimpse of how quick­ly things can dete­ri­o­rate. Bonds issued last year to finance Kohlberg Kravis Roberts & Co.’s deal to take pri­vate Envi­sion Health­care, a hos­pi­tal staffing com­pa­ny, have already lost almost half their face val­ue after ini­tia­tives in Wash­ing­ton to stop sur­prise med­ical bills spooked investors. (A rep­re­sen­ta­tive for KKR declined to com­ment.) The debt of some oth­er pri­vate equi­ty-owned com­pa­nies, includ­ing the largest Piz­za Hut fran­chisee in the world and a phone recy­cling com­pa­ny, has also fall­en in mar­ket val­ue in recent months. “When you have peo­ple des­per­ate for yield, buy­ing low­er-rat­ed, poor-qual­i­ty debt, the ques­tion is what’s going to make this stuff blow out,” says Zwirn. “And it will.” —Davide Scigli­uz­zo, Kelsey But­ler, and Sal­ly Bakewell

————

“Every­thing Is Pri­vate Equi­ty Now”; Bloomberg Busi­ness­week; 10/03/2019

“Two decades ago an investor could pick a pri­vate equi­ty fund at ran­dom and have a bet­ter than 75% chance of beat­ing the stock mar­ket, accord­ing to a report by finan­cial data com­pa­ny Pitch­Book. Since 2006 those odds have dropped to worse than a coin flip. “Not only are few­er man­agers beat­ing the mar­ket but their lev­el of out­per­for­mance has shrunk, too,” the report says.”

You can only keep re-loot­ing an econ­o­my so many times before your loot­ing-returns start declin­ing. That’s the trag­ic les­son we appear to be watch­ing play out. The ‘low hang­ing loot fruit’ has already been loot­ed:

...
One like­ly rea­son will be famil­iar to investors in mutu­al funds and hedge funds. When strate­gies suc­ceed, more peo­ple pile in—and it gets hard­er and hard­er to find the kinds of bar­gains that fueled the ear­ly gains. There are now 8,000-plus PE-backed com­pa­nies, almost dou­ble the num­ber of their pub­licly list­ed coun­ter­parts. The PE play­book informs activist hedge funds and has been mim­ic­ked by pen­sions and sov­er­eign funds. Some of PE’s secret sauce has been shared lib­er­al­ly in busi­ness school sem­i­nars and man­age­ment books.

A deep­er prob­lem could be that the first gen­er­a­tion of buy­out man­agers wrung out the eas­i­est prof­its. PE think­ing per­vades the cor­po­rate suite—few chief exec­u­tive offi­cers are now sit­ting around wait­ing for PE man­agers to tell them to sell under­per­form­ing divi­sions and cut costs. Auer­bach says there are still good PE man­agers out there and all these changes have “forced evo­lu­tion and inno­va­tion.” But it’s pos­si­ble that a cos­mic align­ment of lax cor­po­rate man­age­ment, cheap debt, and des­per­ate-for-yield pen­sions cre­at­ed a moment that won’t be repeat­ed soon. —Hema Par­mar and Jason Kel­ly
...

But declin­ing returns don’t mean we should expect pri­vate equi­ty to shrink. It can still be plen­ty profitable...thanks to the prof­it-mul­ti­ply­ing pow­er of lever­aged buy­outs. Prof­itable to the pri­vate equi­ty investors...not so much for soci­ety at large which ends up with job loss­es, debt-bloat­ed com­pa­nies that tend to fare worse than their pub­licly-held coun­ter­parts, and an exac­er­ba­tion of eco­nom­ic inequal­i­ty as new low­er-paid employ­ees replace the laid-off work­ers, assum­ing the com­pa­ny isn’t dri­ven into bank­rupt­cy from all the debt:

...
If your com­pa­ny finds itself part of a PE port­fo­lio, what should you expect? Research has shown that com­pa­nies acquired through lever­aged buy­outs (LBOs) are more like­ly to depress work­er wages and cut invest­ments, not to men­tion have a high­er risk of bank­rupt­cy. Pri­vate equi­ty own­ers ben­e­fit through fees and div­i­dends, crit­ics say, while the com­pa­ny is left to grap­ple with often debil­i­tat­ing debt.

...

Pri­vate equi­ty and hedge funds gained con­trol of more than 80 retail­ers in the past decade, accord­ing to a July report by a group of pro­gres­sive orga­ni­za­tions includ­ing Amer­i­cans for Finan­cial Reform and Unit­ed for Respect. And PE-owned mer­chants account for most of the biggest recent retail bank­rupt­cies, includ­ing those of Gym­boree, Pay­less, and Shop­ko in the past year alone. Those bank­rupt­cies wiped out 1.3 mil­lion jobs—including posi­tions at retail­ers and relat­ed jobs, such as at ven­dors—accord­ing to the report, which esti­mates that “Wall Street firms have destroyed eight times as many retail jobs as they have cre­at­ed in the past decade.”

Whether LBOs per­form poor­ly because of debt, busi­ness strat­e­gy, or com­pe­ti­tion from Amazon.com Inc., research shows they fare worse than their pub­lic coun­ter­parts. A July paper by Bri­an Ayash and Mah­di Ras­tad of Cal­i­for­nia Poly­tech­nic State Uni­ver­si­ty exam­ined almost 500 com­pa­nies tak­en pri­vate from 1980 to 2006. It fol­lowed both the LBOs and a sim­i­lar num­ber of com­pa­nies that stayed pub­lic for a peri­od of 10 years. They found about 20% of the PE-owned com­pa­nies filed for bankruptcy—10 times the rate of those that stayed pub­lic. Pile on debt, and employ­ees lose, Ayash says. “The com­mu­ni­ty los­es. The gov­ern­ment los­es because it has to sup­port the employ­ees.” Who wins? “The funds do.”

...

Beyond that, PE may con­tribute to inequal­i­ty in sev­er­al ways. First, it offers investors high­er returns than those avail­able in pub­lic stocks and bonds mar­kets. Yet, to enjoy those returns, it helps to already be rich. Pri­vate equi­ty funds are open sole­ly to “qual­i­fied” (read: high-net-worth) indi­vid­ual investors and to insti­tu­tions such as endow­ments. Only some work­ers get indi­rect expo­sure via pen­sion funds.

Sec­ond, PE puts pres­sure on the low­er end of the wealth divide. Com­pa­nies can be bro­ken up, merged, or gen­er­al­ly restruc­tured to increase effi­cien­cy and pro­duc­tiv­i­ty, which inevitably means job cuts. The result is that PE accel­er­ates job polar­iza­tion, or the growth of jobs at the high­est and low­est skill and wage lev­el while the mid­dle erodes, accord­ing to research from econ­o­mists Mar­tin Ols­son and Joacim Tag.
...

And check out the new method of fleec­ing the pub­lic that emerged as a direct con­se­quence of the 2008 finan­cial cri­sis and flood of dis­tressed real estate avail­able for pri­vate equi­ty to scoop up at fire sale prices: Pri­vate equi­ty has such a large stake in the home rental mar­kets it now has the mar­ket pow­er to just keep rais­ing rents every year:

...
Pri­vate equi­ty com­pa­nies includ­ing Black­stone Group Inc. had the mon­ey to gorge on fore­closed hous­es in the years after the crash and quick­ly applied their mod­el to a whole new busi­ness. They used economies of scale, cost-cut­ting, and lever­age to max­i­mize prof­its on under­val­ued assets. The key was to cre­ate a stan­dard­ized way to man­age sin­gle-fam­i­ly homes, scat­tered from Atlanta to Las Vegas, almost as effi­cient­ly as apart­ment build­ings. PE-backed land­lords set up cen­tral­ized 24/7 cus­tomer ser­vice cen­ters and auto­mat­ed sys­tems for rent col­lec­tion and main­te­nance calls.

Black­stone-backed rental com­pa­ny Invi­ta­tion Homes Inc. even­tu­al­ly went pub­lic, then merged with a land­lord seed­ed by Star­wood Cap­i­tal Group and Colony Cap­i­tal Inc. to cre­ate the U.S.’s largest sin­gle-fam­i­ly rental com­pa­ny, with more than 80,000 units. Invi­ta­tion Homes owns less than 1% of the sin­gle-fam­i­ly rental stock, says Ken Caplan, Blackstone’s glob­al co-head of real estate. “But it has raised the bar for pro­fes­sion­al ser­vice for the indus­try,” he says.

The aims of the land­lords and the needs of their ten­ants often diverge, says Leilani Farha, the Unit­ed Nations’ spe­cial rap­por­teur on the right to hous­ing. Steady rent increas­es that make investors hap­py come out of ten­ants’ pay­checks, strain­ing house­hold finances and mak­ing it hard­er to save for a down pay­ment. Mean­while, PE-backed com­pa­nies’ sprawl­ing port­fo­lios of rental prop­er­ties may lim­it the avail­abil­i­ty of entry-lev­el hous­es that could be occu­pied by home­own­ers. Insti­tu­tion­al land­lords were 66% more like­ly than oth­er oper­a­tors to file evic­tion notices, accord­ing to Geor­gia Insti­tute of Tech­nol­o­gy pro­fes­sor Elo­ra Ray­mond, whose 2016 study of Ful­ton Coun­ty, Ga., court records was pub­lished by the Fed­er­al Reserve Bank of Atlanta. Invi­ta­tion Homes was less like­ly to file notices than its largest peers, accord­ing to the paper. A com­pa­ny spokesman says it works with ten­ants to avoid evic­tion and that its high renew­al rates indi­cate cus­tomer sat­is­fac­tion.

From Wall Street’s point of view, the mod­el has worked beau­ti­ful­ly. Invi­ta­tion Homes has con­vinced stock mar­ket investors that it can man­age oper­at­ing costs. It also bought shrewd­ly, swal­low­ing up starter homes in good school dis­tricts, antic­i­pat­ing that tight cred­it and ane­mic con­struc­tion rates would push the U.S. toward what one indus­try ana­lyst dubbed a renter­ship soci­ety. Sure enough, U.S. home­own­er­ship is near its low­est point in more than 50 years, allow­ing Invi­ta­tion Homes to raise rents by more than 5%, on aver­age, when ten­ants renew leas­es.
...

Final­ly, keep in mind this Bloomberg arti­cle was writ­ten in Octo­ber of 2019 and warn­ing about already scary lev­els of cor­po­rate debt thanks in large part to pri­vate equi­ty. “Lever­aged loans” (loans to com­pa­nies with low­er qual­i­ty cred­it) have dou­bled over the past decade and almost 40% of that is held by pri­vate equi­ty-owned com­pa­nies:

...
Ultralow inter­est rates have made this fuel espe­cial­ly potent and easy to obtain. The mar­ket for lever­aged loans—industry jar­gon for loans made to com­pa­nies with less-than-stel­lar credit—has dou­bled in the past decade. Almost 40% of all such loans out­stand­ing are to com­pa­nies con­trolled by pri­vate equi­ty, accord­ing to data from Dealog­ic.

Some lever­aged loans are arranged by banks. But there’s also been a boom in pri­vate lenders, who may be will­ing to pro­vide financ­ing when banks or pub­lic debt mar­kets won’t. All the while, bond and loan investors des­per­ate for yield have accept­ed high­er risks. As buy­out titans have chased big­ger and riski­er deals, their tar­get com­pa­nies have been left with more frag­ile bal­ance sheets, which gives man­age­ment less room for error. This could set the stage for a rude awak­en­ing dur­ing the next reces­sion.

“We’re see­ing scary lev­els of lever­age,” says Dan Zwirn, chief invest­ment offi­cer of alter­na­tive asset man­ag­er Are­na Investors. “Pri­vate equi­ty spon­sors are all slam­ming against each oth­er to get deals done.” Loans to com­pa­nies with espe­cial­ly high debt loads now exceed peaks in 2007 and 2014, accord­ing to the U.S. Fed­er­al Reserve. And com­pa­nies owned by pri­vate equi­ty typ­i­cal­ly car­ry a high­er debt load rel­a­tive to their earn­ings and offer less trans­paren­cy on their finan­cial posi­tion than oth­er cor­po­rate bor­row­ers.

...

PE firms can use some of the com­pa­nies they own as vir­tu­al ATMs—having the com­pa­ny bor­row mon­ey to pay its own­er spe­cial div­i­dends. That allows the funds to recov­er their invest­ment soon­er than they typ­i­cal­ly would through a sale or an ini­tial pub­lic offer­ing. Sycamore Part­ners LLC, known for its aggres­sive bets in the retail indus­try and relat­ed run-ins with cred­i­tors, has already recov­ered about 80% of the mon­ey it put down to acquire Sta­ples Inc. in 2017 through div­i­dends most­ly fund­ed by debt. Car­lyle Group, Hell­man & Fried­man, and Sil­ver Lake have also sad­dled their port­fo­lio com­pa­nies with new debt to extract div­i­dends this year. Rep­re­sen­ta­tives for the four pri­vate equi­ty firms declined to com­ment.
...

How many of the pri­vate equi­ty-owned com­pa­nies that took those PPP loans in 2020 were com­pa­nies that were treat­ed like vir­tu­al ATMS in 2019? It’s one of the many ques­tions we should all be ask­ing about the grow­ing role pri­vate equi­ty is place across soci­ety.

We Already Invit­ed the Vam­pire Into the House. It Did­n’t Go Well. How About We Kick Them Out?

And of all the ques­tions we should be ask­ing about pri­vate equi­ty, per­haps the most impor­tant, and press­ing, ques­tion is why on earth this is being allowed to hap­pen? It’s lit­er­al­ly an indus­try where the pri­ma­ry prod­uct they pro­duce is cor­po­rate debt that get trans­ferred into pri­vate prof­its. Why is this even allowed to exist? It’s a ques­tion econ­o­mist Matt Stoller asked and answered in a piece that not only describes what pri­vate equi­ty does but why. Why, philo­soph­i­cal­ly, did such a destruc­tive indus­try emerge in the first place. As Stoller describes, the rise if pri­vate equi­ty was in part a reflec­tion of the polit­i­cal rise of a par­tic­u­lar indi­vid­ual who held an espe­cial­ly ruth­less world­view that equat­ed ruth­less­ness with moral­i­ty: William (Bill) Simon, the top exec­u­tive and bond trad­er as Salomon Broth­ers in the 1960s and 70s who went on to become a leader at the Trea­sury Depart­ment under Richard Nixon and Ger­ald Ford. Simon was so ruth­less he was con­vinced the Repub­li­can Par­ty of that era was too lib­er­al and “soft”. Simon went on to become pres­i­dent of the hard right Olin Foun­da­tion, the key con­ser­v­a­tive foun­da­tion that was pro­vid­ing mon­ey to the nascent “law and eco­nom­ics” move­ment that arose as the con­ser­v­a­tive back­lash against New Deal restric­tions on finan­cial and cor­po­rate pow­er. A move­ment that cham­pi­oned the idea that busi­ness should sole­ly respon­si­ble to share­hold­er inter­ests, for­get the rest of soci­ety. It was a move­ment that also cham­pi­oned the idea that load­ing cor­po­ra­tions with debt would dis­ci­pline waste­ful cor­po­rate man­agers and end up plac­ing own­er­ship in the hands of those who would force man­agers to be atten­tive to effi­cient oper­a­tion of the cor­po­ra­tion. In oth­er words, cor­po­rate debt could force the simul­ta­ne­ous ‘race to the bot­tom’ for things like work­er pay and employ­ment and ‘race to the top’ of soci­ety’s wealth, which is real­ly a race for dom­i­na­tion.

So pri­vate equi­ty is basi­cal­ly the man­i­fes­ta­tion of the “law and eco­nom­ics” move­ment. Bill Simon even car­ried out the first large scale lever­aged buy­out in 1982 when he and two oth­er investors bor­rowed heav­i­ly to buy Gib­son from a strug­gling RCA for $80 mil­lion. The three put up $1 mil­lion them­selves and bor­rowed the oth­er $79 mil­lion. They imme­di­ate­ly had Gib­son issue a $900,000 “spe­cial div­i­dend” to them­selves. They then sold off Gib­son’s real estate assets, gave the man­agers 20% of the shares (so they would be focused pri­mar­i­ly on the stock price) and eigh­teen months lat­er they took Gib­son pub­lic dur­ing a bull mar­ket for $270 mil­lion. Simon him­self made $70 mil­lion on a per­son­al invest­ment of $330,000. The lever­aged buy now the ‘hot’ invest­ment strat­e­gy and a new par­a­digm for cor­po­rate Amer­i­ca was born. A par­a­digm that has almost exclu­sive­ly ben­e­fit­ted a tiny per­cent of soci­ety and helped pro­pel the Unit­ed States into the cor­po­rate hell hole it is today:

mattstoler.substack

Why Pri­vate Equi­ty Should Not Exist
(Big issue 7-30-2019)
Matt Stoller
Jul 30, 2019

Hi,

Wel­come to Big, a newslet­ter about the pol­i­tics of monop­oly. If you’d like to sign up, you can do so here. Or just read on…

Today I’m going to dis­cuss address the nascent polit­i­cal attack on pri­vate equi­ty, the finan­cial mod­el in com­merce which more than any oth­er defines the West­ern polit­i­cal land­scape. The most impor­tant sig­nal of this attack is in the Demo­c­ra­t­ic Pres­i­den­tial cam­paign, where can­di­dates are being pres­sured on what they will do about PE. Sure enough, Sen­a­tor Eliz­a­beth War­ren, the stan­dard bear­er for sophis­ti­cat­ed pol­i­cy think­ing, recent­ly announced a plan to rein in PE. And Bernie Sanders is lead­ing protests against PE acqui­si­tions. Per­haps as impor­tant are rum­blings on the right; Repub­li­can Sen­a­tor Mar­co Rubio’s released a report in March attack­ing the con­trol of the econ­o­my by financiers.

In oth­er words, PE is start­ing to face some of the same head­winds that big tech is expe­ri­enc­ing. I’m going to explain what pri­vate equi­ty is and why it is fac­ing these attacks. I’ll also go into a bit of his­to­ry, how pri­vate equi­ty, which used to be called the lever­aged buy-out indus­try (LBO), was start­ed by a Nixon admin­is­tra­tion offi­cial who over­saw the both the bank­rupt­cy of New York City and the intel­lec­tu­al attack on antitrust in the 1970s. Final­ly I’ll also dis­cuss what it would mean to elim­i­nate PE from our econ­o­my and pol­i­tics.

...

Why Pri­vate Equi­ty Should Not Exist

Ear­li­er this month, a for­mer Toys “R” Us employ­ee named Sarah Wood­hams con­front­ed Demo­c­ra­t­ic Pres­i­den­tial can­di­date Julian Cas­tro. Wood­hams told Cas­tro about her expe­ri­ence at the cor­po­ra­tion. She worked there for sev­en years, and then was laid off with no sev­er­ance because a set of pri­vate equi­ty firms bought the com­pa­ny and loot­ed it. What she described is not an iso­lat­ed instance, but an increas­ing­ly com­mon one in Amer­i­ca. Wood­hams told Cas­tro that “dozens of retail com­pa­nies con­trolled by Wall Street have gone into bank­rupt­cy, includ­ing RadioShack, Pay­less, and Kmart,” with 15,000 jobs alone in Penn­syl­va­nia hav­ing dis­ap­peared.

“Bil­lion­aires buy up these com­pa­nies, make huge prof­its on our backs, and get away with it because there’s no finan­cial reg­u­la­tion,” Sarah Wood­hams explained. “As pres­i­dent, what will you do to hold pri­vate equi­ty firms and hedge funds account­able for the destruc­tion of our com­mu­ni­ties and liveli­hoods?”

Part­ly because of orga­niz­ing by work­ers like Wood­hams, part­ly because of the scale of the indus­try, pri­vate equi­ty is becom­ing an impor­tant part of the polit­i­cal dia­logue. Mil­lions of work­ers work­ing for com­pa­nies con­trolled by PE funds. As I not­ed above, the debate is now hot; Eliz­a­beth War­ren released a plan specif­i­cal­ly on pri­vate equi­ty, par­al­leled by a report on finan­cial pow­er by Repub­li­can Mar­co Rubio in March. More impor­tant­ly, Cas­tro was con­front­ed by an activist. Cas­tro was embar­rassed because he did not seem to know what PE was, so you can be sure the oth­er Pres­i­den­tial can­di­dates are prepar­ing talk­ing points on PE for their boss­es. That’s a big deal, when even the mediocre politi­cians start to get it.

So what is pri­vate equi­ty? In one sense, it’s a sim­ple ques­tion to answer. A pri­vate equi­ty fund is a large unreg­u­lat­ed pool of mon­ey run by financiers who use that mon­ey to invest in and/or buy com­pa­nies and restruc­ture them. They seek to recoup gains through div­i­dend pay-outs or lat­er sales of the com­pa­nies to strate­gic acquir­ers or back to the pub­lic mar­kets through ini­tial pub­lic offer­ings. But that doesn’t cap­ture the scale of the mod­el. There are also pri­vate equi­ty-like busi­ness­es who scour the land­scape for com­pa­nies, buy them, and then use extrac­tive tech­niques such as price goug­ing or legal­ized forms of com­plex fraud to gen­er­ate cash by mov­ing debt and assets like real estate among shell com­pa­nies. PE funds also lend mon­ey and act as bro­kers, and are mor­ph­ing into invest­ment bank-like insti­tu­tions. Some of them are pub­lic com­pa­nies.

While the move­ment is couched in the lan­guage of busi­ness, using terms like strat­e­gy, busi­ness mod­els returns of equi­ty, inno­va­tion, and so forth, and pro­po­nents refer to it as an indus­try, pri­vate equi­ty is not busi­ness. On a deep­er lev­el, pri­vate equi­ty is the ulti­mate exam­ple of the col­lapse of the enlight­en­ment con­cept of what own­er­ship means. Own­er­ship used to mean domin­ion over a resource, and respon­si­bil­i­ty for care­tak­ing that resource. PE is a polit­i­cal move­ment whose goal is extend deep man­age­r­i­al con­trols from a small group of financiers over the pro­duc­ers in the econ­o­my. Pri­vate equi­ty trans­forms cor­po­ra­tions from insti­tu­tions that house peo­ple and cap­i­tal for the pur­pose of pro­duc­tion into extrac­tive insti­tu­tions designed sole­ly to shift cash to own­ers and leave the rest behind as trash. Like much of our polit­i­cal econ­o­my, the ideas behind it were devel­oped in the 1970s and the actu­al imple­men­ta­tion was oper­a­tional­ized dur­ing the Rea­gan era.

Now what I just described is of course not the ratio­nale that pri­vate equi­ty guys give for their mod­el. Accord­ing to them, PE takes under­per­form­ing com­pa­nies and restruc­tures them, deliv­er­ing need­ed inno­va­tion for the econ­o­my. PE can also invest in ear­ly stages, help­ing to build new busi­ness­es with risky cap­i­tal. There is some mer­it to the argu­ment. Pools of cap­i­tal can invest to improve com­pa­nies, and many funds have built a com­pa­ny here and there. But only small-scale funds real­ly do that, or such exam­ples are excep­tions to the rule or involve build­ing high­ly finan­cial­ized scal­able busi­ness­es, like chain stores that roll up an indus­try (such as Sta­ples, financed by Bain in the 1980s). At some lev­el, hav­ing a pool of funds means being able to invest in any­thing, includ­ing build­ing good busi­ness­es in a dynam­ic econ­o­my where cre­ative destruc­tion leads to bet­ter prod­ucts and ser­vices. Unfor­tu­nate­ly, these days PE empha­sizes the “destruc­tion” part of cre­ative destruc­tion.

The takeover of Toys “R” Us is a good exam­ple of what pri­vate equi­ty real­ly does. Bain Cap­i­tal, KKR, and Vor­na­do Real­ty Trust bought the pub­lic com­pa­ny in 2005, load­ing it up with debt. By 2007, though Toys “R” Us was still an immense­ly pop­u­lar toy store, the com­pa­ny was spend­ing 97% of its oper­at­ing prof­it on debt ser­vice. Bain, KKR, and Vor­na­do were tech­ni­cal­ly the ‘own­ers’ of Toys “R” Us, but they were not liable for any of the debts of the com­pa­ny, or the pen­sions. Peri­od­i­cal­ly, Toys “R” Us would pay fees to Bain and com­pa­ny, rough­ly $500 mil­lion in total. The toy store stopped inno­vat­ing, stopped tak­ing care of its stores, and cut costs as aggres­sive­ly as pos­si­ble so it could con­tin­ue the pay­out. In 2017, the com­pa­ny final­ly went under, liq­ui­dat­ing its stores and fir­ing all of its work­ers with­out sev­er­ance. A lot of peo­ple assume Ama­zon or Wal­mart killed Toys “R” Us, but it was sell­ing mas­sive num­bers of toys until the very end (and toy sup­pli­ers are going to suf­fer as the mar­ket con­cen­trates). What destroyed the com­pa­ny were financiers, and pub­lic poli­cies that allowed the divorc­ing of own­er­ship from respon­si­bil­i­ty.

The Ori­gins of the Mod­el: Build­ing a “Counter-intel­li­gentsia”

If there is a father to the pri­vate equi­ty indus­try, it is a man named William Simon. Simon is per­haps one of the most impor­tant Amer­i­can polit­i­cal fig­ures of the 1970s and ear­ly 1980s, a bril­liant inno­va­tor in pol­i­tics, finan­cial, and in how ideas are pro­duced in Amer­i­can pol­i­tics. Simon was an accoun­tant, a nerd, but also an apoc­a­lyp­ti­cal­ly ori­ent­ed con­ser­v­a­tive financier who was a bond trad­er and top exec­u­tive at Salomon Broth­ers in the 1960s and 1970s. Beyond ruth­less, Simon believed in ruth­less­ness as a moral phi­los­o­phy. He was, accord­ing to a friend, “a mean, nasty, tough bond trad­er who took no BS from any­one,” and would appar­ent­ly wake up his chil­dren on week­end morn­ings with buck­ets of cold water. He was such a dif­fi­cult per­son that he was invit­ed onto the Citibank board of direc­tors, and short­ly there­after, essen­tial­ly kicked off.

In the ear­ly 1970s, Simon went into pol­i­tics, a leader at the Trea­sury Depart­ment under Nixon and Ford. He over­saw not just Trea­sury but became the the ‘Ener­gy Czar’ in charge of the oil cri­sis, and a key play­er in reject­ing New York City’s 1975 request for funds to ward off bank­rupt­cy. Simon, along with a few oth­ers like Pete Peter­son, came out of the Nixon admin­is­tra­tion with a bet­ter rep­u­ta­tion than he had going in, per­ceived as a neu­tral and com­pe­tent tech­no­crat. Simon saw both pros­per­i­ty and poi­son in Nixon and Ford. He sup­port­ed the attacks on New York City’s and the forced aus­ter­i­ty by the Fed­er­al gov­ern­ment, but he also despised Nixon’s attempt­ed econ­o­my-wide price con­trols to deal with infla­tion.

After his time at the Trea­sury, Simon turned to intel­lec­tu­al orga­niz­ing, because he believed that the Repub­li­cans were soft. Simon though Repub­li­cans, even when they had pow­er, as Nixon or Ford of Gov­er­nors like Nel­son Rock­e­feller of New York, were still lib­er­al, oper­at­ing as con­ser­v­a­tive Phyl­lis Schafly put it, mere­ly “an echo” of the Democ­rats. So he sought to finance thinkers in acad­e­mia to restruc­ture how elites did pol­i­cy, or as he put it, a “counter-intel­li­gentsia.” He became the Pres­i­dent of the Olin Foun­da­tion, the key con­ser­v­a­tive foun­da­tion pro­vid­ing mon­ey to the nascent law and eco­nom­ics move­ment, the con­ser­v­a­tive intel­lec­tu­al back­lash against New Deal con­trols on finance and cor­po­rate pow­er. Law and eco­nom­ics wasn’t per­ceived of as a right-wing insti­tu­tion­al frame­work, but a sci­en­tif­ic one. Olin gave to Har­vard Law to build out a law and eco­nom­ics pro­gram, and finan­cial suprema­cy over cor­po­ra­tions was accept­ed quick­ly in lib­er­al citadels.

The law and eco­nom­ics move­ment helped build the intel­lec­tu­al edi­fice for PE, a mod­el designed to restruc­ture the Amer­i­can econ­o­my from the very begin­ning. In 1965, Hen­ry Manne, a law and eco­nom­ics orga­niz­er, wrote about the “mar­ket for cor­po­rate con­trol,” putting forth finan­cial mar­kets where cor­po­ra­tions were bought and sold as the essen­tial mech­a­nisms for fir­ing inef­fi­cient man­agers and replac­ing them with ones who would look out for the own­ers.

In 1965, Manne was ahead of his time, because most peo­ple thought Amer­i­can busi­ness­es were well-run. But in the 1970s, in an infla­tion­ary envi­ron­ment and as for­eign imports began com­ing into the U.S. in force, this belief col­lapsed. In 1970, Mil­ton Fried­man put for­ward the share­hold­er val­ue of the firm, a the­o­ry that the only rea­son for the cor­po­ra­tion to exist is to max­i­mize share­hold­er val­ue. In 1976, Michael Jensen, the intel­lec­tu­al patron saint of PE, refined these con­cepts into a paper titled “The­o­ry of the firm: Man­age­r­i­al behav­ior, agency costs and own­er­ship struc­ture,” argu­ing that load­ing up firms with debt would dis­ci­pline waste­ful man­age­ment, and that plac­ing own­er­ship in the hands of a few would force man­agers to be atten­tive to effi­cient oper­a­tion of the cor­po­ra­tion.

The increas­ing­ly wide­spread belief that Amer­i­can cor­po­ra­tions were mis­man­aged, infla­tion­ary chaos, and a cri­sis of con­fi­dence among lib­er­als com­bined into what was a polit­i­cal rev­o­lu­tion in com­merce. William Simon was both both a par­tic­i­pant in and a moral light for this rev­o­lu­tion. In the mid-1970s, he (or his ghost­writer) put pen to paper, and wrote a book pop­u­lar among mem­bers of “the new right” as the large class of 1978 Con­gres­sion­al Repub­li­cans (which includ­ed a young Newt Gin­grich) was known. His book was called A Time for Truth, and along with Robert Bork’s Antitrust Para­dox, it gave the New Right a lan­guage to mar­ry moral­i­ty and polit­i­cal eco­nom­ics. Rea­gan would run on New Right themes in 1980.

A Time for Truth reflect­ed Simon’s hard­core atti­tude. It was a jere­mi­ad, with terms tossed around like ‘eco­nom­ic dic­ta­tor­ship’, charges of Com­mu­nism and fas­cism, and a screed about the per­ils of gov­ern­ment. The book was intro­duced by the intel­lec­tu­al god­fa­ther of the right-wing, the Aus­tri­an econ­o­mist, F.A. Hayek, who laud­ed it as “a bril­liant and pas­sion­ate book by a bril­liant and pas­sion­ate man.” Simon pop­u­lar­ized the pseu­do-sci­en­tif­ic term, ‘cap­i­tal short­age,’ or the the idea that busi­ness­es sim­ply didn’t have the incen­tive to invest in fac­to­ries because of gov­ern­ment rules or fear of infla­tion. This led to infla­tion, low­er pro­duc­tiv­i­ty, and stag­na­tion. The solu­tion would be sim­ple: cut cap­i­tal gains tax­es, cut gov­ern­ment spend­ing, reduce antitrust enforce­ment, and stop reg­u­lat­ing through pub­lic insti­tu­tions.

The Carter admin­is­tra­tion and Con­gres­sion­al Democ­rats took Simon’s advice, and slashed cap­i­tal gains tax­es, cut­ting the max­i­mum rate to 28% from 49% in 1978. They dereg­u­lat­ed truck­ing, finance, air­planes, and rail­roads. In addi­tion, changes in pen­sion laws enabled Amer­i­can retire­ment sav­ings to flood into new vehi­cles, like ven­ture cap­i­tal and its cousin, what would first be known as lever­aged buy-outs and then pri­vate equi­ty. The Rea­gan administration’s fur­ther dereg­u­la­tion of finance enabled a long bull mar­ket in the 1980s as spec­u­la­tors took con­trol of the econ­o­my. Share­hold­ers no longer were con­tent to leave their mon­ey in stocks that paid div­i­dends, because they could now keep most of their cap­i­tal gains. And the chaos unleashed by dereg­u­la­tion opened up the door to cor­po­rate restruc­tur­ing of cor­po­ra­tions who had been tight­ly con­trolled by pub­lic rules, but were now free to enter and exit new busi­ness­es.

In 1982, William Simon turned into a leader of the finan­cial rev­o­lu­tion. He pulled off the first large scale lever­aged buy­out, of a com­pa­ny called Gib­son Greet­ing cards, a deal that shocked Wall Street. He and his part­ner paid $80 mil­lion for Gib­son, buy­ing the com­pa­ny from the strug­gling con­glom­er­ate RCA. The key was that they didn’t use their own mon­ey to buy the com­pa­ny, instead using Simon’s polit­i­cal cred­i­bil­i­ty and con­nec­tions to bor­row much of the nec­es­sary $79 mil­lion from Bar­clays Bank and Gen­er­al Elec­tric, only putting down $330,000 apiece. They imme­di­ate­ly paid them­selves a $900,000 spe­cial div­i­dend from Gib­son, made $4 mil­lion sell­ing the company’s real estate assets, and gave 20% of the shares to the man­agers of the com­pa­ny as an incen­tive to keep the stock price in mind. Eigh­teen months lat­er, they took Gib­son pub­lic in a bull mar­ket, sell­ing the com­pa­ny at $270 mil­lion. Simon cleared $70 mil­lion per­son­al­ly in a year and a half off an invest­ment of $330,000, an insane­ly great return on such a small invest­ment. Eyes popped all over Wall Street, and Gib­son became the start­ing gun for the merg­ers and acqui­si­tions PE craze of the 1980s.

Anoth­er busi­ness trend inter­sect­ed with changes in pol­i­cy encour­ag­ing finan­cial dom­i­nance: the rise of man­age­ment con­sult­ing. Like law and eco­nom­ics, man­age­ment con­sul­tants rose in the late 1960s with pseu­do-sci­en­tif­ic the­o­ries about busi­ness, and they began treat­ing cor­po­ra­tions as finan­cial port­fo­lios, with sub­sidiaries of assets. Many of the orga­niz­ers of pri­vate equi­ty firms in the 1980s came from man­age­ment con­sult­ing firms like the Boston Con­sult­ing Group and McK­in­sey. Mitt Rom­ney was an ear­ly inno­va­tor around PE. He came from Bain, which was a con­sult­ing firm. To give you a sense of what that meant in terms of the phi­los­o­phy of com­merce, here’s Bain Con­sult­ing today, help­ing com­pa­nies find ways to inno­vate around rais­ing prices instead of pro­duc­tive tech­niques.

PE firms serve as trans­mit­ters of infor­ma­tion across busi­ness­es, sort of dis­ease vec­tors for price goug­ing and legal arbi­trage. If a cer­tain kind of price goug­ing strat­e­gy works in a phar­ma­ceu­ti­cal com­pa­ny, a pri­vate equi­ty com­pa­ny can roll through the indus­try, buy­ing up every pos­si­ble can­di­date and quick­ly forc­ing the price goug­ing every­where. In the defense sec­tor, Trans­digm serves this role, buy­ing up aero­space spare parts mak­ers with pric­ing pow­er and jack­ing up prices, in effect spread­ing cor­rupt con­tract­ing arbi­trage against the Pen­ta­gon much more rapid­ly than it would have spread oth­er­wise.

More fun­da­men­tal­ly, pri­vate equi­ty was about get­ting rid of the slack that Amer­i­can man­agers had to look out for the long-term, slack that allowed them to fund research and exper­i­ment with pro­duc­tive tech­niques. PE replaced slack with bru­tal debt sched­ules and mas­sive upside for high­er stock prices, and no down­side for the own­er-financiers should the com­pa­ny fail. The goal is to elim­i­nate pro­duc­tion in favor of scal­able prof­itable things like brands, patents, and tax loop­holes, because pro­duc­ers — engi­neers, artists, work­ers — are cost cen­ters. Pro­duc­tion can also be elim­i­nat­ed by fis­sur­ing the work­place, such as the mass move to off­shore pro­duc­tion to low­er cost coun­tries in the 1980s onward. When I report­ed on the prob­lem of finan­cial­iza­tion destroy­ing our nation­al secu­ri­ty capac­i­ty, one of the man­u­fac­tur­ers I talked to told me about how the “LBO boys” — or Lever­aged Buy Out Boys — took apart fac­to­ries in the mid­west and shipped them to Chi­na.

There hasn’t been a lot of analy­sis of just how prof­itable pri­vate equi­ty real­ly is for investors or lenders, and I’m only touch­ing on part of what is a very com­plex phe­nom­e­non. There are ways PE funds orga­nize fees against pen­sion funds, there’s self-deal­ing among banks and mid­dle­men, and at this point large PE firms are buy­ing insur­ance com­pa­nies and ded­i­cat­ing their insur­ance port­fo­lios to PE deals. But I found this paper by Bri­an Ayash and Mah­di Ras­tad quite use­ful. What Ayash and Ras­tad not­ed is that com­pa­nies bought by pri­vate equi­ty are ten times more like­ly than com­pa­ra­ble com­pa­nies to go bank­rupt. And this makes sense. The goal in PE isn’t to cre­ate or to make a com­pa­ny more effi­cient, it is to find legal loop­holes that allow the orga­niz­ers of the fund to max­i­mize their return and shift the risk to some­one else, as quick­ly as pos­si­ble. Bank­rupt­cies are a nat­ur­al result if you load up on risk, and because the bank­rupt­cy code is com­plex, bank­rupt­cy can even be an oppor­tu­ni­ty for the financier to restruc­ture his/her invest­ment and push the cost onto employ­ees by seiz­ing the pen­sion.

Eliz­a­beth War­ren just put for­ward a fair­ly rea­son­able plan to address the prob­lem. Under her plan, pri­vate equi­ty funds who buy com­pa­nies would them­selves respon­si­ble for any debt those com­pa­nies bor­row, as well as the pen­sion funds of their sub­sidiaries. PE firms could no longer pay them­selves spe­cial fees and div­i­dends, they would lose their spe­cial advan­tages in bank­rupt­cy and in the tax code, and would have to dis­close what they charge to investors. Effec­tive­ly she reuni­fies own­er­ship with respon­si­bil­i­ty. Invest­ing would basi­cal­ly become once again about tak­ing mod­est risks and reap­ing mod­est returns, rather than pil­lag­ing good com­pa­nies. (I’d pro­pose a cou­ple of oth­er changes as well, like rais­ing cap­i­tal gains tax­es quite rad­i­cal­ly, and gut­ting gold­en para­chutes. We also need to replace cap­i­tal pro­vid­ed by PE with small busi­ness lend­ing by gov­ern­ment, as Mar­co Rubio is orga­niz­ing. But I don’t want to demand too many pol­i­cy changes. After all no sense in get­ting… greedy.)

Warren’s plan has gen­er­at­ed some back­lash, because she’s mak­ing a philo­soph­i­cal point about what kind of soci­ety we want to live in. I’ll focus on two quotes from War­ren crit­ics.

Steven Pearl­stein in the Wash­ing­ton Post not­ed:

“Unfor­tu­nate­ly, Warren’s fix­es for these prob­lems... would pret­ty much guar­an­tee that nobody invests in or lends to pri­vate equi­ty firms.”

Aaron Brown in Bloomberg said:

A 100% tax on fees doesn’t mean PE funds will work for free; in fact, they won’t work at all… If you strip doc­tors of all assets if a patient dies, you won’t improve health­care; you’ll make sur­geons and oncol­o­gists switch to cos­met­ic der­ma­tol­ogy.”

Of course, Pearl­stein and Brown are both in one sense right. Warren’s plan will large­ly elim­i­nate pri­vate equi­ty, or at least that which is based on legal arbi­trage, which is near­ly all of it. In anoth­er sense they are entire­ly miss­ing the point. Brown calls PE firms doc­tors sav­ing patients. But pri­vate equi­ty, for War­ren, is bad, a form of legal­ized fraud shift­ing mon­ey from the pock­ets of investors and work­ers to the pock­ets of financiers. It is also, as she knows, the mod­el that best rep­re­sents the destruc­tive direc­tion of Amer­i­can polit­i­cal econ­o­my over the past four decades.

And though it is not real­ly on stage that often, pri­vate equi­ty is an impor­tant part of our polit­i­cal debate, though the sup­port­ers of pri­vate equi­ty in pol­i­tics are so far qui­et. And that is because pri­vate equi­ty funds are impor­tant vec­tors for polit­i­cal dona­tions.

In the sec­ond quar­ter, Joe Biden, Cory Book­er, Pete Buttigieg, and Kamala Har­ris have all received dona­tions from one or both of the lead­ers of the country’s top two pri­vate-equi­ty firms, Black­stone and the Car­lyle Group. Buttigieg received max dona­tions from 11 high-lev­el Black­stone employ­ees, as well as mon­ey from Bain Cap­i­tal and Neu­berg­er Berman. Biden, Book­er, and Gilli­brand nabbed dona­tions from employ­ees at at least three of the top 15 pri­vate-equi­ty firms.

PE funds are job sinecures for out of pow­er elite Democ­rats and Repub­li­cans, a sort of shad­ow gov­ern­ment of financiers who actu­al­ly do the man­ag­ing of Amer­i­can cor­po­ra­tions while the gov­ern­ment futzes around, par­a­lyzed by the cor­rup­tion PE barons orga­nize.

What crit­ics of PE are propos­ing is a pro­found restruc­tur­ing of the phi­los­o­phy of the Amer­i­can polit­i­cal econ­o­my, a return to excel­lence in pro­duc­tion as the goal instead of excel­lence in manip­u­la­tion. If crit­ics suc­ceeds, those who make and cre­ate will have their bar­gain­ing pow­er increase rad­i­cal­ly, which will mean wage growth across the bot­tom and mid­dle tier. Swaths of elite pow­er­ful peo­ple will lose pow­er. It’ll be real­ly jar­ring, because we aren’t used to a pro­duc­er-focused eco­nom­ic order any­more. But it is what we need to do.

...

———–

“Why Pri­vate Equi­ty Should Not Exist” by Matt Stoller; mattstoler.substack; 07/30/2019

More fun­da­men­tal­ly, pri­vate equi­ty was about get­ting rid of the slack that Amer­i­can man­agers had to look out for the long-term, slack that allowed them to fund research and exper­i­ment with pro­duc­tive tech­niques. PE replaced slack with bru­tal debt sched­ules and mas­sive upside for high­er stock prices, and no down­side for the own­er-financiers should the com­pa­ny fail. The goal is to elim­i­nate pro­duc­tion in favor of scal­able prof­itable things like brands, patents, and tax loop­holes, because pro­duc­ers — engi­neers, artists, work­ers — are cost cen­ters. Pro­duc­tion can also be elim­i­nat­ed by fis­sur­ing the work­place, such as the mass move to off­shore pro­duc­tion to low­er cost coun­tries in the 1980s onward. When I report­ed on the prob­lem of finan­cial­iza­tion destroy­ing our nation­al secu­ri­ty capac­i­ty, one of the man­u­fac­tur­ers I talked to told me about how the “LBO boys” — or Lever­aged Buy Out Boys — took apart fac­to­ries in the mid­west and shipped them to Chi­na.”

PE replaced slack with bru­tal debt sched­ules and mas­sive upside for high­er stock prices, and no down­side for the own­er-financiers should the com­pa­ny fail. Heads we win. Tails you lose. To the most ruth­less goes the spoils. The only thing should mat­ter to com­pa­ny man­age­ment is max­i­miz­ing short-term returns for share­hold­ers. Plan­ning for the long-term or fac­tor­ing in the pub­lic good was seen as bad. And the best way to ensure man­age­ment would abide by these prin­ci­ples is to load the cor­po­ra­tion up with debt so man­agers would have no choice but to focus on cut­ting costs (as opposed to cut­ting yields to the own­ers that forced all the new debt). That’s the phi­los­o­phy that has tak­en over cor­po­rate Amer­i­ca and it’s the philo­soph­i­cal foun­da­tion for the entire pri­vate equi­ty move­ment:

...
In the ear­ly 1970s, Simon went into pol­i­tics, a leader at the Trea­sury Depart­ment under Nixon and Ford. He over­saw not just Trea­sury but became the the ‘Ener­gy Czar’ in charge of the oil cri­sis, and a key play­er in reject­ing New York City’s 1975 request for funds to ward off bank­rupt­cy. Simon, along with a few oth­ers like Pete Peter­son, came out of the Nixon admin­is­tra­tion with a bet­ter rep­u­ta­tion than he had going in, per­ceived as a neu­tral and com­pe­tent tech­no­crat. Simon saw both pros­per­i­ty and poi­son in Nixon and Ford. He sup­port­ed the attacks on New York City’s and the forced aus­ter­i­ty by the Fed­er­al gov­ern­ment, but he also despised Nixon’s attempt­ed econ­o­my-wide price con­trols to deal with infla­tion.

After his time at the Trea­sury, Simon turned to intel­lec­tu­al orga­niz­ing, because he believed that the Repub­li­cans were soft. Simon though Repub­li­cans, even when they had pow­er, as Nixon or Ford of Gov­er­nors like Nel­son Rock­e­feller of New York, were still lib­er­al, oper­at­ing as con­ser­v­a­tive Phyl­lis Schafly put it, mere­ly “an echo” of the Democ­rats. So he sought to finance thinkers in acad­e­mia to restruc­ture how elites did pol­i­cy, or as he put it, a “counter-intel­li­gentsia.” He became the Pres­i­dent of the Olin Foun­da­tion, the key con­ser­v­a­tive foun­da­tion pro­vid­ing mon­ey to the nascent law and eco­nom­ics move­ment, the con­ser­v­a­tive intel­lec­tu­al back­lash against New Deal con­trols on finance and cor­po­rate pow­er. Law and eco­nom­ics wasn’t per­ceived of as a right-wing insti­tu­tion­al frame­work, but a sci­en­tif­ic one. Olin gave to Har­vard Law to build out a law and eco­nom­ics pro­gram, and finan­cial suprema­cy over cor­po­ra­tions was accept­ed quick­ly in lib­er­al citadels.

The law and eco­nom­ics move­ment helped build the intel­lec­tu­al edi­fice for PE, a mod­el designed to restruc­ture the Amer­i­can econ­o­my from the very begin­ning. In 1965, Hen­ry Manne, a law and eco­nom­ics orga­niz­er, wrote about the “mar­ket for cor­po­rate con­trol,” putting forth finan­cial mar­kets where cor­po­ra­tions were bought and sold as the essen­tial mech­a­nisms for fir­ing inef­fi­cient man­agers and replac­ing them with ones who would look out for the own­ers.

In 1965, Manne was ahead of his time, because most peo­ple thought Amer­i­can busi­ness­es were well-run. But in the 1970s, in an infla­tion­ary envi­ron­ment and as for­eign imports began com­ing into the U.S. in force, this belief col­lapsed. In 1970, Mil­ton Fried­man put for­ward the share­hold­er val­ue of the firm, a the­o­ry that the only rea­son for the cor­po­ra­tion to exist is to max­i­mize share­hold­er val­ue. In 1976, Michael Jensen, the intel­lec­tu­al patron saint of PE, refined these con­cepts into a paper titled “The­o­ry of the firm: Man­age­r­i­al behav­ior, agency costs and own­er­ship struc­ture,” argu­ing that load­ing up firms with debt would dis­ci­pline waste­ful man­age­ment, and that plac­ing own­er­ship in the hands of a few would force man­agers to be atten­tive to effi­cient oper­a­tion of the cor­po­ra­tion.
...

And note how Simon’s book, A Time for Truth, that laid out his ruth­less phi­los­o­phy was so extreme that Aus­tri­an school econ­o­mist Friedrich von Hayek wrote the intro­duc­tion. It was a book that pop­u­lar­ized the ‘sup­ply-side’ ideas that have been used to jus­ti­fy all forms of tax and reg­u­la­tion cuts over the past four decades and look who just hap­pened loved the book: the rad­i­cal “New Right” wing of the Repub­li­can Par­ty from the class of 1978. The New Right that is the over­whelm­ing dom­i­nant force in the Repub­li­can Par­ty today (it’s not so new any­more). It’s a reminder that the phi­los­o­phy behind pri­vate equi­ty did­n’t just cap­ture the minds of cor­po­rate board rooms. It also cap­tured the Repub­li­can Par­ty and pro­pelled the par­ty into the mon­strous enti­ty it is today:

...
The increas­ing­ly wide­spread belief that Amer­i­can cor­po­ra­tions were mis­man­aged, infla­tion­ary chaos, and a cri­sis of con­fi­dence among lib­er­als com­bined into what was a polit­i­cal rev­o­lu­tion in com­merce. William Simon was both both a par­tic­i­pant in and a moral light for this rev­o­lu­tion. In the mid-1970s, he (or his ghost­writer) put pen to paper, and wrote a book pop­u­lar among mem­bers of “the new right” as the large class of 1978 Con­gres­sion­al Repub­li­cans (which includ­ed a young Newt Gin­grich) was known. His book was called A Time for Truth, and along with Robert Bork’s Antitrust Para­dox, it gave the New Right a lan­guage to mar­ry moral­i­ty and polit­i­cal eco­nom­ics. Rea­gan would run on New Right themes in 1980.

A Time for Truth reflect­ed Simon’s hard­core atti­tude. It was a jere­mi­ad, with terms tossed around like ‘eco­nom­ic dic­ta­tor­ship’, charges of Com­mu­nism and fas­cism, and a screed about the per­ils of gov­ern­ment. The book was intro­duced by the intel­lec­tu­al god­fa­ther of the right-wing, the Aus­tri­an econ­o­mist, F.A. Hayek, who laud­ed it as “a bril­liant and pas­sion­ate book by a bril­liant and pas­sion­ate man.” Simon pop­u­lar­ized the pseu­do-sci­en­tif­ic term, ‘cap­i­tal short­age,’ or the the idea that busi­ness­es sim­ply didn’t have the incen­tive to invest in fac­to­ries because of gov­ern­ment rules or fear of infla­tion. This led to infla­tion, low­er pro­duc­tiv­i­ty, and stag­na­tion. The solu­tion would be sim­ple: cut cap­i­tal gains tax­es, cut gov­ern­ment spend­ing, reduce antitrust enforce­ment, and stop reg­u­lat­ing through pub­lic insti­tu­tions.
...

And that’s all why we real­ly need to ask our­selves: should the pri­vate equi­ty indus­try even be allowed to exist? Does the gen­er­al pub­lic share Bill Simon’s world­view? Do peo­ple real­ly want a world where cor­po­ra­tions care ONLY about short-term share­hold­er returns? Do peo­ple real­ly want a world where lever­aged buy­outs are the tool of choice to allow the rich turn a quick prof­it buy effect­ing loot­ing com­pa­nies and prof­it­ing from their down­fall? Do peo­ple real­ly want a ‘Heads We Win. Tails You Lose” soci­ety? Because if not, pri­vate equi­ty has to go, at least in its cur­rent form. And this is no longer just a ques­tion for the Amer­i­can pub­lic. This is now the glob­al cor­po­rate phi­los­o­phy.

Or we can just con­tin­ue down our cur­rent path and allow pri­vate equi­ty to take over effec­tive­ly every­thing. Which will hap­pen if it’s allowed to. That’s the nature of preda­to­ry sys­tems. They will take it all if they can. That’s the phi­los­o­phy. A phi­los­o­phy where ruth­less­ness is a virtue. And that’s why the ques­tion of whether or not pri­vate equi­ty should even be allowed to exist is also the ques­tion of whether or not we’ll final­ly address the pan­dem­ic of awful ideas that are con­tin­u­ing to loot the future or if we all just want to role over and let the most ruth­less peo­ple on the plan­et con­tin­ue tak­ing it all. In oth­er words, which one is real­ly ‘too big to fail’: pri­vate equi­ty or every­one else?

Discussion

19 comments for “Heads We Win, Tails You Lose: The Fascist Philosophy Behind Private Equity’s Leveraged Buyout of Everything”

  1. @Pterrafractyl–

    Indeed!

    Great work.

    This antic­i­pates the shows I will be doing in the near future.

    SARS Cov‑2 is, among oth­er things, “The Wealth Con­cen­tra­tion Virus”!

    This is delib­er­ate and pre-planned.

    Details to fol­low.

    Again, mag­nif­i­cent work!

    Best,

    Dave

    Posted by Dave Emory | October 22, 2020, 6:43 pm
  2. Here’s a pair of arti­cles that point towards what real­ly should be a grow­ing scan­dal for the Trump admin­is­tra­tion regard­ing the admin­is­tra­tion of the Pay­check Pro­tec­tion Pro­gram (PPP):

    First, here’s a Forbes piece from back in July that gives us a sense of just how much mon­ey as being made the Wall Street banks that actu­al­ly issued most of the PPP loans to small busi­ness: bil­lions of dol­lars in fees were col­lect­ed, with the biggest loan issuer, JP Mor­gan Chase, mak­ing over $800 mil­lion as of June 30. The bank told Forbes, “We will not make a prof­it from the pro­gram and remain ful­ly com­mit­ted to sup­port­ing under­served com­mu­ni­ties that have been eco­nom­i­cal­ly impact­ed by the pan­dem­ic,” but then declined to elab­o­rate.

    Now, the fact that banks were prof­it­ing from the loans isn’t par­tic­u­lar­ly sur­pris­ing or nec­es­sar­i­ly scan­dalous. They pre­sum­ably had to actu­al­ly do work vet­ting appli­cants to issue the loans since many of the appli­cants pre­sum­ably weren’t already clients with the banks.

    But that does­n’t mean there isn’t a scan­dal here. Because as we’re going to see in the sec­ond Forbes arti­cle from last week, a new report released by a House of Rep­re­sen­ta­tives select com­mit­tee that inves­ti­gat­ed how the eight largest banks issu­ing these loans were were actu­al­ly car­ry­ing out the PPP pro­gram dis­cov­ered that the Trump Trea­sury Depart­ment and Small Busi­ness Admin­is­tra­tion (SBA) gave guid­ance to the big banks to pro­vide loans from the PPP to their “wealthy exist­ing clients at the expense of tru­ly strug­gling small busi­ness­es in under­served com­mu­ni­ties.” Wealthy exist­ing clients that include pri­vate equi­ty-owned com­pa­nies. Wealthy exist­ing clients that are pre­sum­ably a lot eas­i­er to vet for the loans too.

    And note that we are told the Trump admin­is­tra­tion encour­aged, but did­n’t order, these banks to pri­or­i­tize wealthy exist­ing clients. So while the banks can’t be blamed for the Trump admin­is­tra­tion giv­ing them guid­ance to do the wrong thing, they can sure be blamed for fol­low­ing it. Or, at least, they can be blamed for fol­low­ing that advice if we hold cor­po­ra­tions up to a high­er moral stan­dard than blind­ly pur­su­ing max­i­mal prof­its for share­hold­ers, which, we’ll recall, hap­pens to be the cor­po­rate phi­los­o­phy behind the pri­vate equi­ty move­ment.

    Ok, first, here’s the Forbes piece from back in July that gives us an idea of just how much the largest banks pro­cess­ing PPP loans, along with some of the banks’ vague pledges to some­how not keep these prof­its:

    Forbes

    Banks Made Bil­lions On PPP Loans. Learn What They’re Doing With The Cash

    Robin Saks Frankel
    Forbes Staff
    Jul 10, 2020, 08:51pm EDT

    Banks earned bil­lions of dol­lars in fees from pro­cess­ing over 4.5 mil­lion Pay­check Pro­tec­tion Pro­gram (PPP) loans worth more than $511 bil­lion in the last sev­er­al months, with the largest haul going to the country’s biggest banks, accord­ing to a new U.S. Small Busi­ness Admin­is­tra­tion (SBA) report.

    The finan­cial insti­tu­tions pro­cess­ing coro­n­avirus res­cue loans earn fees on a slid­ing scale based on the total dol­lar amount approved. Lenders earn 5% on loans of $350,000 or less, 3% on loans between $350,000 and less than $2 mil­lion, and 1% for loans of at least $2 mil­lion. Addi­tion­al­ly, banks will earn a 1% inter­est rate on loans they hold that are not eli­gi­ble for for­give­ness under PPP rules.

    But faced with mount­ing crit­i­cism, some banks say they won’t keep any prof­its. Instead, they will donate what they have earned after fac­tor­ing in the cost to process the loans.

    Here’s where some of the largest U.S. lenders say their loan cuts will go to after account­ing for expens­es.

    Chase

    Loans issued as of June 30: 269,424

    Amount dis­bursed: $29,066,127,405

    Aver­age loan size: $107,882

    The largest bank in the U.S. by asset size, JPMor­gan Chase has issued the high­est total dol­lar amount in PPP loans of any bank. Chase’s $28.6 bil­lion in loans would have snagged the bank­ing giant over $800 mil­lion in loan pro­cess­ing fees, accord­ing to an esti­mate by S&P Glob­al Mar­ket Intel­li­gence. A spokesper­son for the bank said the bank won’t real­ize any gains from the loans.

    “We will not make a prof­it from the pro­gram and remain ful­ly com­mit­ted to sup­port­ing under­served com­mu­ni­ties that have been eco­nom­i­cal­ly impact­ed by the pan­dem­ic,” a Chase rep­re­sen­ta­tive told Forbes Advi­sor. They declined to elab­o­rate.

    Bank of Amer­i­ca

    Loans issued as of June 30: 334,761

    Amount dis­bursed: $25,203,076,316

    Aver­age loan size: $75,287

    As the sec­ond largest U.S. bank by asset size, Bank of Amer­i­ca has processed rough­ly 335,000 PPP loans worth $25.2 bil­lion. Over 80% of those loans were for busi­ness­es with 10 or few­er employ­ees.

    The bank has pledged to donate all earn­ings from PPP loan pro­cess­ing fees—esti­mat­ed to be $755 mil­lion accord­ing to an analy­sis by S&P Glob­al Mar­ket Intel­li­gence—to com­mu­ni­ty devel­op­ment finan­cial insti­tu­tions (CDFIs) to rein­vest and sup­port char­i­ta­ble pro­grams, includ­ing low- to mod­er­ate-income hous­ing and small-busi­ness assis­tance.

    “We will use the net pro­ceeds of fees from the Pay­check Pro­tec­tion Pro­gram to sup­port small busi­ness­es and the com­mu­ni­ties and non­prof­its we serve,” a Bank of Amer­i­ca spokesper­son said.

    Tru­ist

    Loans issued as of June 30: 78,669

    Amount dis­bursed: $13,075,965,877

    Aver­age loan size: $166,215

    Tru­ist has not indi­cat­ed that it plans to donate any net pro­ceeds from PPP loan pro­cess­ing. In an April earn­ings call, the bank said it paid out $65 mil­lion in coro­n­avirus-relat­ed bonus­es to employ­ees mak­ing under $100,000 a year dur­ing the quar­ter.

    In March, Tru­ist launched its Tru­ist Cares Ini­tia­tive which pro­vides phil­an­thropic funds to help those affect­ed by the COVID-19 cri­sis. Tru­ist, the third largest lender of PPP funds, is the result of the merg­er between the for­mer Sun­Trust and BB&T banks, com­plet­ed in Decem­ber 2019.

    PNC Bank

    Loans issued as of June 30: 72,908

    Amount dis­bursed: $13,038,347,212

    Aver­age loan size: $178,833

    In a press release, PNC high­light­ed its com­mit­ment to serv­ing low-to-mod­er­ate income areas as well as non­prof­it orga­ni­za­tions when it came to pro­cess­ing PPP loans. Accord­ing to the release, more than 14,500 of the loans processed by PNC went to bor­row­ers locat­ed in low-to-mod­er­ate income cen­sus tracts, and more than 4,500 of the reg­is­tered loans were for non­prof­it orga­ni­za­tions. Addi­tion­al­ly, the Pitts­burgh-based bank said they ear­marked funds to local com­mu­ni­ty devel­op­ment groups.

    “PNC has com­mit­ted more than $45 mil­lion to eight com­mu­ni­ty devel­op­ment finan­cial insti­tu­tions (CDFIs) since March 2020 to sup­port their own orig­i­na­tion of PPP loans in poten­tial­ly under­served geo­gra­phies and sec­tors,” accord­ing to a May state­ment by PNC.

    Wells Far­go

    Loans issued as of June 30: 185,598

    Amount dis­bursed: $10,470,396,296

    Aver­age loan size: $56,414

    Of Wells Fargo’s PPP loans, 84% went to com­pa­nies with few­er than 10 employ­ees, 60% were for $25,000 or less, and 90% of these appli­cants had $2 mil­lion or less in annu­al rev­enue, accord­ing to a bank press release.

    Wells Far­go has indi­cat­ed it will allo­cate near­ly $400 mil­lion in PPP loan pro­cess­ing fees to help busi­ness­es impact­ed by COVID-19.

    “By donat­ing approx­i­mate­ly $400 mil­lion in pro­cess­ing fees to assist small busi­ness­es in need, Wells Fargo’s Open for Busi­ness Fund cre­ates oppor­tu­ni­ties for near-term access to cap­i­tal and address­es the road ahead to mean­ing­ful eco­nom­ic recov­ery, espe­cial­ly for Black and African Amer­i­can entre­pre­neurs and oth­er minor­i­ty-owned busi­ness­es,” Wells Far­go CEO Char­lie Scharf said in a state­ment.

    TD Bank

    Loans issued as of June 30: 82,773

    Amount dis­bursed: $8,468,624,019

    Aver­age loan size: $102,311

    TD Bank has not pub­licly indi­cat­ed what it plans to do with its PPP loan pro­ceeds. The bank in April announced the for­ma­tion of the TD Com­mu­ni­ty Resilience Ini­tia­tive, which TD Bank is fund­ing with an ini­tial $25 mil­lion Cana­di­an dol­lars to go toward com­mu­ni­ty phil­an­thropy projects. TD-bank is a Cana­di­an-based bank.

    Citibank

    Loans issued: Unknown

    Amount dis­bursed: Unknown

    Aver­age loan size: Unknown

    Citibank was the last of the major banks to start accept­ing PPP appli­ca­tions, begin­ning April 9. As such, the bank has not had the same time span or capac­i­ty to process the vol­ume of loans its peers han­dled. Addi­tion­al­ly, it is only accept­ing loan appli­ca­tions from its exist­ing Small Busi­ness Clients and data on loans dis­bursed to date is not pub­licly avail­able.

    The bank released a state­ment at the end of June that it would use its net pro­ceeds from PPP loans—about $25 million—to fund the expan­sion of its COVID-19 U.S. Small Busi­ness Relief Pro­gram, which was launched in April with a $7.5 mil­lion ini­tial allo­ca­tion.

    The pro­gram is intend­ed to help CDFIs in assist­ing small­er busi­ness­es and entre­pre­neurs who may not oth­er­wise be eli­gi­ble for fed­er­al stim­u­lus pro­grams. Citibank said it’s allo­cat­ing up to $500,000 per CDFI up to $15 mil­lion total to sup­port small busi­ness­es owned by peo­ple of col­or and low­er-income indi­vid­u­als and com­mu­ni­ties.

    The remain­ing esti­mat­ed $10 mil­lion in PPP loan rev­enue is expect­ed to be fun­neled to the Local Ini­tia­tives Sup­port Corp. (LISC) to sup­port the New York For­ward Loan Fund, which helps CDFIs pro­vide loans to small busi­ness­es, non­prof­its and small land­lords for work­ing cap­i­tal.

    ————-

    “Banks Made Bil­lions On PPP Loans. Learn What They’re Doing With The Cash” by Robin Saks Frankel; Forbes; 07/10/2020

    “But faced with mount­ing crit­i­cism, some banks say they won’t keep any prof­its. Instead, they will donate what they have earned after fac­tor­ing in the cost to process the loans.”

    We’re not going to prof­it from this at all. Or at least not keep the prof­its we’ve already made. Trust us. That was the spin we were hear­ing from the banks back in July.

    So did the banks ulti­mate donate all of their prof­its? That’s unclear at this point. But those banks that did end up donat­ing their PPP prof­its are prob­a­bly rather relieved they did so after the release of the House report last week that revealed that not only did the Trump Trea­sury Depart­ment and SBA active­ly encour­aged big banks to pro­vide loans from the PPP to their “wealthy exist­ing clients at the expense of tru­ly strug­gling small busi­ness­es in under­served com­mu­ni­ties,” but also revealed that all but one of the eight largest banks appar­ent­ly took that advice, to the detri­ment of gen­uine small busi­ness­es which, in turn, result­ed in a dis­pro­por­tion­ate­ly neg­a­tive impact on minor­i­ty owned busi­ness­es:

    Forbes

    Big Banks Pri­or­i­tized Bil­lions In PPP Funds For Wealthy Clients At The Expense Of Strug­gling Small Busi­ness­es, House Report Finds

    Jonathan Pon­ciano
    Forbes Staff
    Oct 16, 2020, 04:36pm EDT
    Updat­ed Oct 16, 2020, 05:09pm EDT

    TOPLINE

    The Trea­sury Depart­ment and Small Busi­ness Admin­is­tra­tion encour­aged big banks to pro­vide loans from the $670 bil­lion Pay­check Pro­tec­tion Pro­gram (PPP) to their “wealthy exist­ing clients at the expense of tru­ly strug­gling small busi­ness­es in under­served com­mu­ni­ties,” a House sub­com­mit­tee said Fri­day as it announced the release of a 19-page report con­clud­ing a months-long inves­ti­ga­tion into the dis­burse­ment of PPP funds.

    KEY FACTS

    * Doc­u­ments obtained by the House Select Sub­com­mit­tee on the Coro­n­avirus Cri­sis show that the Trea­sury pri­vate­ly told lenders to “go to their exist­ing cus­tomer base” when issu­ing PPP loans, the report says, and all but one of the eight banks involved in the inves­ti­ga­tion fol­lowed the guid­ance.

    * At least one bank, Cit­i­group, did so while rec­og­niz­ing that this cre­at­ed “a height­ened risk of dis­parate impact on minor­i­ty- and women-owned busi­ness­es,” an inter­nal Citi pre­sen­ta­tion obtained by the Select Sub­com­mit­tee revealed.

    * The report also claims that the SBA and Trea­sury failed to imple­ment the PPP as Con­gress intend­ed because they pro­vid­ed no guid­ance (except for one “vague” tweet from an SBA admin­is­tra­tor) ask­ing lenders to pri­or­i­tize under­served mar­kets, includ­ing minor­i­ty- and women-owned busi­ness­es, despite the CARES Act’s lan­guage, which called for pri­or­i­ti­za­tion of under­served mar­kets.

    * The report con­clud­ed that sev­er­al banks—including JPMor­gan, the biggest PPP lender—processed larg­er PPP loans for wealthy cus­tomers at more than dou­ble the speed of small­er loans “for the need­i­est small busi­ness­es.”

    * In Sep­tem­ber, the Select Sub­com­mit­tee released pre­lim­i­nary find­ings that claimed bil­lions of dol­lars in PPP loans might have been divert­ed to fraud, waste and abuse, includ­ing more than $1 bil­lion in loans that went to com­pa­nies that had already received anoth­er PPP loan and $195 mil­lion that went to gov­ern­ment con­trac­tors pre­vi­ous­ly flagged by the fed­er­al gov­ern­ment for per­for­mance or integri­ty issues.

    * The Select Sub­com­mit­tee began inves­ti­gat­ing the Trump Administration’s imple­men­ta­tion of the PPP on June 15, fol­low­ing reports that the pro­gram favored large com­pa­nies over “the need­i­est” small busi­ness­es.

    KEY BACKGROUND

    In March, the $2.2 tril­lion CARES (Coro­n­avirus Aid, Relief and Eco­nom­ic Secu­ri­ty) Act estab­lished the PPP with $349 bil­lion in for­giv­able loans meant to go to small busi­ness­es and non­prof­its exac­er­bat­ed by the coro­n­avirus pan­dem­ic to cov­er pay­roll, rent and util­i­ty pay­ments. That first round of fund­ing was exhaust­ed in just 14 days, so the pro­gram received an addi­tion­al $321 bil­lion from Con­gress in April. Reports soon sur­faced that many small busi­ness­es claimed they strug­gled to get loans while dozens of bil­lion­aire-owned com­pa­nies and pri­vate equi­ty firms man­aged to secure fund­ing. The toll on minor­i­ty- and women-owned busi­ness­es has since become more clear with data that shows the num­ber of active busi­ness own­ers has fall­en the sharpest among Black and immi­grant com­mu­ni­ties.

    CRUCIAL QUOTE

    “The Administration’s imple­men­ta­tion fail­ures had con­se­quences,” the report states. “Forty-one per­cent of busi­ness­es owned by African Amer­i­cans failed between Feb­ru­ary and April 2020, high­er than any oth­er demo­graph­ic group and more than dou­ble the per­cent­age of white-owned busi­ness­es that closed over the same peri­od.” That fig­ure has since soft­ened to 19%, but Black busi­ness own­ers still account for the hard­est-hit demo­graph­ic, and immi­grants fol­low close­ly behind, with 18% of their busi­ness­es fail­ing through June.

    TANGENT

    The PPP closed to new appli­ca­tions on June 30, leav­ing near­ly $134 bil­lion unused. The Trump Admin­is­tra­tion has since pro­posed using at least some of the left­over PPP funds as a stop­gap for stim­u­lus fund­ing while nego­ti­a­tions for anoth­er round of coro­n­avirus relief con­tin­ue to play out. White House eco­nom­ic advi­sor, Lar­ry Kud­low, told Fox Busi­ness Net­work today that Con­gress should appro­pri­ate unused funds from the pre­vi­ous res­cue pack­age to help small busi­ness­es, but added that “it takes leg­isla­tive and polit­i­cal will to do it” and that law­mak­ers and nego­tia­tors are “bick­er­ing.”

    ...

    ————

    “Big Banks Pri­or­i­tized Bil­lions In PPP Funds For Wealthy Clients At The Expense Of Strug­gling Small Busi­ness­es, House Report Finds” by Jonathan Pon­ciano; Forbes; 10/16/2020

    “Doc­u­ments obtained by the House Select Sub­com­mit­tee on the Coro­n­avirus Cri­sis show that the Trea­sury pri­vate­ly told lenders to “go to their exist­ing cus­tomer base” when issu­ing PPP loans, the report says, and all but one of the eight banks involved in the inves­ti­ga­tion fol­lowed the guid­ance.”

    Well, at least one bank seemed to demon­strate an inkling of a con­science (or more like­ly real­ized fol­low­ing such guid­ance was going to blow up in their faces). It’s progress. Painful­ly slow progress.

    So which of those eight big banks decid­ed not to fol­low the Trump admin­is­tra­tion’s ‘guid­ance’? As the House report describes, the eight banks they inves­ti­gat­ed were JPMor­gan Chase (JPMor­gan), Citibank (Citi), PNC Bank (PNC), Bank of Amer­i­ca, U.S. Bank, Tru­ist, Wells Far­go, and San­tander. And while the part of the report that tells us sev­en of the eight banks fol­lowed the Trump admin­is­tra­tion’s guid­ance does­n’t say which bank was the odd man out, it’s clear from the rest of the report that this is U.S. Bank, which was the only one to allow non-cus­tomers to apply for loans on the first day of the PPP. Plus, the para­graph of the report that tells us sev­en of the eight banks fol­lowed the Trump admin­is­tra­tion’s guid­ance cites foot­note 18 and that foot­note cites let­ters giv­en to the House sub­com­mit­tee from the sev­en remain­ing banks but makes no men­tion of U.S. Bank.

    But there’s anoth­er high­ly note­wor­thy rev­e­la­tion in the House report: when ques­tioned about this ‘guid­ance’, the Trea­sury Depart­ment com­plete­ly denied it. So it looks like this scan­dal includes a cov­er up:

    coronavirus.house.gov

    UNDERSERVED AND UNPROTECTED

    How the TrumpAd­min­is­tra­tion Neglect­edthe Need­i­est Small Busi­ness­es in the PPP

    SELECT SUBCOMMITTEE ON THE CORONAVIRUS CRISIS
    STAFF REPORT / OCTOBER 2020

    ...
    Despite the lack of clear writ­ten guid­ance, doc­u­ments and infor­ma­tion obtained by the Select Sub­com­mit­tee show that Trea­sury pri­vate­ly encour­aged banks to lim­it their PPP lend­ing pro­grams to exist­ing cus­tomers, which had the impact of exclud­ing many minor­i­ty and women-owned busi­ness­es that did not have estab­lished rela­tion­ships with these banks.

    In an email obtained by the Select Sub­com­mit­tee dat­ed March 28, 2020, the head of the Amer­i­can Bankers Asso­ci­a­tion (ABA) described to ABA’s board of direc­tors a call with Trea­sury offi­cials on March 27, the day the CARES Act was enact­ed. He explained that “Trea­sury would like for banks to go to their exist­ing cus­tomer base.”14 The Amer­i­can Bankers Asso­ci­a­tion rep­re­sents “the entire bank­ing industry.”15

    In a brief­ing for Select Sub­com­mit­tee staff, JPMor­gan cor­rob­o­rat­ed this account, explain­ing, “From ear­ly on there was an under­stand­ing from Trea­sury that banks were work­ing with exist­ing clients.”16

    Yet when the Select Sub­com­mit­tee staff asked Trea­sury about this “under­stand­ing,” they denied it ever exist­ed. Trea­sury told the Select Sub­com­mit­tee that they “nev­er addressed any­thing about lenders pri­or­i­tiz­ing exist­ing customers.”17

    ...

    ———–

    “UNDERSERVED AND UNPROTECTED” SELECT SUBCOMMITTEE ON THE CORONAVIRUS CRISIS STAFF REPORT; coronavirus.house.gov; OCTOBER 2020

    That sure sounds like a cov­er up!

    And it’s not like this is the kind of thing the Trea­sury Depart­ment would­n’t be high­ly inter­est­ed in cov­er­ing up. Of course they denied this to Con­gress. It looks awful. Because it is awful. Espe­cial­ly the all the small busi­ness­es that could­n’t get a loan. Or, rather, for­mer small busi­ness­es. They’re pre­sum­ably not in busi­ness any­more.

    Posted by Pterrafractyl | October 22, 2020, 9:27 pm
  3. @Dave: Here’s an arti­cle from Jan­u­ary 3, of 2020, weeks before the glob­al nature of the coro­n­avirus pan­dem­ic was known, that points to anoth­er man­ner in which this pan­dem­ic was like man­na from heav­en for the pri­vate equi­ty indus­try:

    Thanks, in part, to the long-run­ning his­tor­i­cal­ly low inter­est rates that are a con­se­quence of the 2008 finan­cial cri­sis, record lev­els of cash had been flow­ing into pri­vate equi­ty funds since that’s one of the only invest­ment class­es remain­ing that has paid above aver­age yields in recent years. Even hedge funds were aver­ag­ing only 5.5% vs +14% for pri­vate equi­ty.

    But all of that mon­ey flow­ing into pri­vate equi­ty was cre­at­ing a prob­lem: Too much mon­ey in pri­vate equi­ty means too much com­pe­ti­tion and low­er yields. That was one of the big fears fac­ing the pri­vate equi­ty sec­tor head­ing into this pan­dem­ic. It was becom­ing a vic­tim of its own suc­cess. Beyond that, most pri­vate equi­ty funds have a 5 to 10 year invest­ment time frame. So while funds could sit on cash for a while to wait for the right oppor­tu­ni­ty to invest, they can’t wait for­ev­er. They HAVE to find some­where to invest.

    Also keep in mind that part of what makes pri­vate equi­ty appeal­ing as an invest­ment for things like pen­sion funds seek­ing a com­bi­na­tion of high­er-yields but also ‘safe’ invest­ments is that pri­vate equi­ty has the capac­i­ty to do well when the rest of the econ­o­my is doing poor­ly. Which makes sense...when economies weak­en that inevitably cre­ates all sorts of buy­ing oppor­tu­ni­ties for with cash to spend.

    So at the start of this year, the whole pri­vate equi­ty indus­try was sit­ting on a his­toric pile of cash but fac­ing the prospect of no great buy­ing oppor­tu­ni­ties and pos­si­bly very a dis­ap­point­ing upcom­ing decade if the indus­try is forced to spend all that cash on already-over­priced invest­ments....unless there’s a new reces­sion that cre­ates all sorts of new buy­ing oppor­tu­ni­ties. And that’s why the coro­n­avirus pan­dem­ic real­ly was like man­na from finan­cial heav­en for pri­vate equi­ty:

    CNBC

    Pri­vate equity’s record $1.5 tril­lion cash pile comes with a new set of chal­lenges

    * Pri­vate investors are sit­ting on a record $1.5 tril­lion in cash, accord­ing to new data from Pre­qin. That is the high­est on record and more than dou­ble what it was five years ago.
    * Ana­lysts say investors are flood­ing to pri­vate equi­ty thanks to low inter­est rates, hedge fund under­per­for­mance, and low­er expect­ed returns from pub­lic mar­kets.
    * The flush of cash means more com­pe­ti­tion for the same deals, how­ev­er, push­ing up val­u­a­tions. Some ana­lysts think returns will “dis­ap­point.”

    Kate Rooney
    Pub­lished Fri, Jan 3 2020 12:31 PM EST
    Updat­ed Fri, Jan 3 2020 2:40 PM EST

    Pri­vate-equi­ty firms are hold­ing on to a record pile of cash. Increased com­pe­ti­tion might make it hard­er to spend, how­ev­er, in order to get the same dou­ble-dig­it returns that have made the group so pop­u­lar.

    The indus­try — which includes ven­ture cap­i­tal — had a total $1.45 tril­lion in “dry pow­der,” or cash, to invest at the end of 2019, accord­ing to data from Pre­qin. That is the high­est on record and more than dou­ble what it was five years ago.

    Ini­go Fras­er-Jenk­ins, head of the port­fo­lio strat­e­gy team at Bern­stein Research, said the steady cash stream into pri­vate equi­ty has been dri­ven by more investors expect­ing low­er returns from pub­lic mar­kets. The flood of mon­ey is dri­ving up entry prices and could mean low­er future returns, he said.

    “We think that the returns are going to dis­ap­point,” Fras­er-Jenk­ins told CNBC. “We also do not believe that over the cycle that it can de-cor­re­late from pub­lic mar­kets.”

    Hedge funds are anoth­er pop­u­lar invest­ment vehi­cle that insti­tu­tion­al investors, such as endow­ments and pen­sion funds, are turn­ing to. But the hedge-fund industry’s returns are lag­ging by com­par­i­son. Over the past five years end­ing in June, hedge funds post­ed 5.5% returns, com­pared with 14.4% for pri­vate equi­ty, accord­ing to the lat­est data avail­able from Pre­qin.

    Search for yield

    Anoth­er rea­son investors are pour­ing into the pri­vate equi­ty asset class is low glob­al yields. As the 10-year Trea­sury yield sank below 2% this year, investors went look­ing for bet­ter invest­ment alter­na­tives, accord­ing to Nan­cy Davis, chief invest­ment offi­cer and founder of advi­so­ry firm Qua­drat­ic Cap­i­tal. But pri­vate equi­ty is still “not a gold­en goose,” she said.

    “There aren’t too many investors with dou­ble-dig­it per­cent­age gain — so, as has been the case for the last few years, many feel like they have no choice but to get long and try to catch up by chas­ing the pri­vate-equi­ty per­for­mance,” Davis said. The result is “a ner­vous eupho­ria.”

    Davis not­ed that sen­ti­ment has got­ten “ridicu­lous­ly pos­i­tive” and is con­tribut­ing to a rise in val­u­a­tions. The idea that pri­vate equi­ty could con­tin­ue to pro­duce an inter­nal rate of return, or IRR, of 20% to 25% is “laugh­able” with bond yields as low as they are, she said.

    It’s not just pri­vate equi­ty sit­ting on cash. Revered investor War­ren Buf­fett — a vocal crit­ic of the indus­try — is sit­ting on a record $128 bil­lion at Berk­shire Hath­away. In recent months, the Oma­ha-based firm has passed on mul­ti­ple oppor­tu­ni­ties to acquire com­pa­nies as the firm’s cash hoard grew. In Novem­ber, Buf­fett stepped away from a bid­ding war to buy tech­nol­o­gy dis­trib­u­tor Tech Data, and he declined to pur­chase lux­u­ry jew­el­er Tiffany when it was look­ing for a buy­er last year.

    Com­pet­ing with Black­stone

    Mega-firms such as Black­stone, Apol­lo and KKR have been rais­ing increas­ing­ly larg­er funds for insti­tu­tion­al investors. In some cas­es, they invest in oth­er pri­vate-equi­ty funds. Blackstone’s most recent buy­out fund this year topped $26 bil­lion — mak­ing it the largest of its kind in U.S. his­to­ry. This year, tech-focused Vista Equi­ty Part­ners closed a $16 bil­lion fund, while Thoma Bra­vo raised $12.6 bil­lion for its lat­est fund.

    Despite these mon­ster funds, thou­sands of oth­er firms have been able to raise mon­ey with­out much con­sol­i­da­tion, accord­ing to Bain. They are not “gob­bling up the mar­ket at the expense of oth­er firms,” said Bren­da Rainey, senior direc­tor of Bain & Co.’s glob­al pri­vate equi­ty prac­tice.

    Still, all of these firms are work­ing with a shot clock. Pri­vate-equi­ty invest­ments have a life­cy­cle of five to 10 years, and mon­ey man­agers need to get that cap­i­tal out the door with­in a cer­tain time frame. But Bain said much of Preqin’s esti­mat­ed $1.5 tril­lion total is “fresh” cap­i­tal that still has time to be invest­ed.

    “We don’t have con­cerns that it will go unspent. The ques­tion is, how will it be put to work?” said Rainey. “There’s no short­age of dol­lars to be put to work or indus­tries to spend them on.”

    Many of those oppor­tu­ni­ties are com­ing from pub­lic mar­kets, where com­pa­nies are increas­ing­ly being tak­en pri­vate — a trend that Rainey expects to con­tin­ue. Those who are already pri­vate are increas­ing­ly com­fort­able stay­ing that way, par­tial­ly because there’s plen­ty of cap­i­tal at every stage. She expects more deal activ­i­ty despite val­u­a­tions, which are also ele­vat­ed in pub­lic mar­kets.

    ...

    ————

    “Pri­vate equity’s record $1.5 tril­lion cash pile comes with a new set of chal­lenges” by Kate Rooney; CNBC; 01/03/2020

    Still, all of these firms are work­ing with a shot clock. Pri­vate-equi­ty invest­ments have a life­cy­cle of five to 10 years, and mon­ey man­agers need to get that cap­i­tal out the door with­in a cer­tain time frame. But Bain said much of Preqin’s esti­mat­ed $1.5 tril­lion total is “fresh” cap­i­tal that still has time to be invest­ed.”

    Too much mon­ey chas­ing too few remain­ing oppor­tu­ni­ties and the clock is tick­ing. That was the chal­lenge fac­ing the indus­try right before the pan­dem­ic-induced glob­al eco­nom­ic implo­sion. And then, all of a sud­den, the whole world turned into a fire sale. A fire sale that promis­es to keep inter­est rates even low­er for even longer.

    So instead of fac­ing ques­tions about how the indus­try is going to invest an abun­dance of cash with­out an abun­dance of invest­ment oppor­tu­ni­ties, the new ques­tion is just how much of the econ­o­my isn’t going to be owned by pri­vate equi­ty a decade from now.

    Posted by Pterrafractyl | October 23, 2020, 7:16 pm
  4. Oh look at that: Over the past cou­ple of months the pri­vate equi­ty indus­try has start­ed doing exact­ly the thing peo­ple fear pri­vate equi­ty for doing. Yes, pri­vate equi­ty firms or now forc­ing the com­pa­nies they own to load up on debt for the pur­pose of pay­ing div­i­dends back their pri­vate equi­ty own­ers. This always hap­pens to some degree but as of mid-Sep­tem­ber near­ly 24 per­cent of the mon­ey raised in the US loan mar­ket had been used to fund div­i­dends to pri­vate equi­ty investors, com­pared to 4 per­cent aver­age over the past two years. So there was a sud­den 600% jump in these “div­i­dend recap­i­tal­i­sa­tions” last month and the trend was just get­ting start­ed.

    And as the sec­ond excerpt below demon­strates, part of what’s dri­ving this is a will­ing­ness by bond investors to accept what are known as pay­ment-in-kind (PIK) bonds. PIKs are espe­cial­ly risky bonds that pay rel­a­tive­ly high rate but with terms that allow the bor­row­er to pay inter­est with addi­tion­al bor­row­ing. So lenders get extra high inter­est rates at the cost of ele­vat­ing the risk their bor­row­er will be dri­ven into bank­rupt­cy in order to finance the loan. So pri­vate equi­ty firms are get­ting the com­pa­nies they own to bor­row mon­ey using spe­cial loans that make com­pa­nies extra vul­ner­a­ble to bank­rupt­cy in order to pay out div­i­dends to the pri­vate equi­ty own­ers. Which, again, is why peo­ple hate and fear the pri­vate equi­ty indus­try:

    Finan­cial Times

    Pri­vate equi­ty own­ers pile on lever­age to pay them­selves div­i­dends
    TPG, Apax load com­pa­nies with loans, seiz­ing on strong demand for high-yield­ing debt

    Joe Ren­ni­son in Lon­don
    Sep­tem­ber 16 2020

    Pri­vate equi­ty groups includ­ing TPG and Apax Part­ners are tak­ing advan­tage of block­buster demand for cor­po­rate debt by load­ing com­pa­nies they own with fresh loans and using the cash to award them­selves a bumper pay­day.

    So-called div­i­dend recap­i­tal­i­sa­tions have become a fea­ture of the loan mar­ket in recent weeks, ring­ing alarm bells since they come on top of already high lever­age and weak investor pro­tec­tions and against a back­drop of eco­nom­ic uncer­tain­ty.

    So far in Sep­tem­ber, almost 24 per cent of mon­ey raised in the US loan mar­ket has been used to fund div­i­dends to pri­vate equi­ty own­ers, up from an aver­age of less than 4 per cent over the past two years. That would be the high­est pro­por­tion since the begin­ning of 2015, accord­ing to month­ly data from S&P Glob­al Mar­ket Intel­li­gence.

    The leap in divi recaps part­ly reflects how investors are clam­our­ing for debt that can pro­vide some income as the Fed­er­al Reserve holds inter­est rates low..

    The loan mar­ket — where pri­vate equi­ty firms typ­i­cal­ly fund the com­pa­nies they own — had until recent­ly not seen the same vol­ume of issuance as oth­er parts of the finan­cial mar­kets.

    Investors have been accept­ing divi recaps because “there isn’t a ton going on”, said Jes­si­ca Reiss, head of US lever­aged loan research at Covenant Review.

    “From the lender’s per­spec­tive they are look­ing for deals, so if spon­sors and their com­pa­nies can refi­nance and get a div­i­dend up to their own­ers they will try it.”

    In the lat­est exam­ple, cloud com­put­ing com­pa­ny ECi Soft­ware — owned by Apax Part­ners — is set to raise $740m in new loans, ear­mark­ing $118m to fund a div­i­dend to its own­er, accord­ing to S&P Glob­al Rat­ings and peo­ple famil­iar with the deal.

    It fol­lows on the heels of snack foods mak­er Shearer’s Foods — owned by Chica­go-based pri­vate equi­ty com­pa­ny Wind Point Part­ners and the Ontario Teach­ers’ Pen­sion Plan — which raised over $1bn in the loan mar­ket on Tues­day in part to fund a $388m pay­ment to its own­ers, accord­ing to rat­ing agency Moody’s.

    The bor­row­ings will increase lever­age at Shearer’s from 5.1 times adjust­ed debt to earn­ings to 6.6 times, accord­ing to cal­cu­la­tions from Moody’s. At ECi, it could rise to almost 10 times, accord­ing to S&P.

    Broad­band com­pa­ny Radi­ate Hold­co was also in the mar­ket this week to fund a $500m pay­ment to its own­er TPG.

    ...

    “If pri­vate equi­ty spon­sors can take mon­ey off the table then they are doing it,” said John Gre­go­ry, head of lever­aged finance cap­i­tal mar­kets at Wells Far­go Secu­ri­ties. “There’s going to be more com­ing for sure.”

    Over­all, just over $4bn of the $15bn bor­rowed in the loan mar­ket this month would be paid out in div­i­dends, accord­ing to S&P’s data. Anoth­er $2bn would come before Sep­tem­ber ends, if deals cur­rent­ly being mar­ket­ed to investors get com­plet­ed, accord­ing to peo­ple famil­iar with the plans.

    The peak for recaps came in Octo­ber 2016, as the Fed was gear­ing up to raise rates for the sec­ond time and demand for loans was high. But the $13bn raised that month rep­re­sent­ed a much small­er por­tion of the total $55bn of issuance.

    Investors, bankers and ana­lysts not­ed that the oppor­tu­ni­ty for pri­vate equi­ty com­pa­nies to pull cash out of the groups they con­trol has been lim­it­ed large­ly to high­er-qual­i­ty bor­row­ers.

    Moody’s upgrad­ed Shearer’s this week, fol­low­ing its deal announce­ment, despite say­ing the div­i­dend pay­out and increase in lever­age was “aggres­sive”. The rat­ing agency not­ed the company’s pos­i­tive per­for­mance fol­low­ing the out­break of coro­n­avirus, as well as its improved finan­cial flex­i­bil­i­ty after pay­ing back a bank lend­ing facil­i­ty.

    “You have some very high lever­age deals,” said Mr Gre­go­ry. “But if it’s a good com­pa­ny that peo­ple are famil­iar with and investors have mon­ey that they need to invest then trans­ac­tions tend to go through. It’s a bull mar­ket trade for sure.”

    How­ev­er, investors express con­cern over loose doc­u­men­ta­tion under­pin­ning the loans, offer­ing lit­tle pro­tec­tion to investors should a com­pa­ny end up in trou­ble.

    Some see this year’s mar­ket tur­moil as a missed oppor­tu­ni­ty to improve lend­ing stan­dards after years of see­ing them whit­tled away.

    “It’s a shame,” said John Bell, a port­fo­lio man­ag­er at Loomis Sayles. “I wished this pan­dem­ic could have reset the clock for a while but it doesn’t look like that is hap­pen­ing.”

    ————-

    “Pri­vate equi­ty own­ers pile on lever­age to pay them­selves div­i­dends” by Joe Ren­ni­son; Finan­cial Times; 09/16/2020

    So far in Sep­tem­ber, almost 24 per cent of mon­ey raised in the US loan mar­ket has been used to fund div­i­dends to pri­vate equi­ty own­ers, up from an aver­age of less than 4 per cent over the past two years. That would be the high­est pro­por­tion since the begin­ning of 2015, accord­ing to month­ly data from S&P Glob­al Mar­ket Intel­li­gence.”

    Have we already hit the “bust out” phase of the pri­vate equi­ty cycle, or is that yet to come? It’s sure feel­ing like it at least start­ed. But as the sec­ond arti­cle, from just a cou­ple days ago, make clear, if this is the “bust out” phase — where com­pa­nies are basi­cal­ly stripped of their val­ue and allowed to col­lapse — the pri­vate equi­ty indus­try is going to have a lot of help pulling it off. Help from all the bond investors will­ing to buy the high-risk pay­ment-in-kind (PIK) bonds that are poised to make this explod­ing debt blow up even big­ger down the line:

    Finan­cial Times

    Risky PIK deals pitched by pri­vate equi­ty to yield-hun­gry investors
    Re-emer­gence of pay­ment-in-kind bonds a sign of ‘frothy’ mar­kets

    Joe Ren­ni­son in Lon­don
    Octo­ber 23, 2020 3:26 PM

    Pri­vate equi­ty firms are test­ing investors’ appetite for returns with new sales of pay­ment-in-kind bonds that offer juicy inter­est rates but are among the riski­est deals since the Covid cri­sis began.

    The re-emer­gence of PIKs under­scores how fixed-income investors are increas­ing­ly being asked to accept high­er degrees of risk and more oner­ous terms from cor­po­rate bond issuers as soar­ing prices of high­er-qual­i­ty assets in recent months has deeply depressed yields.

    A duo of high­ly-indebt­ed bor­row­ers are seek­ing to raise a com­bined $1bn through so-called PIK tog­gle deals, in which issuers are allowed to defer inter­est pay­ments. The struc­ture allows com­pa­nies to pay inter­est using more debt, lead­ing the amount that ulti­mate­ly needs to be paid at the bond’s matu­ri­ty to bal­loon.

    Apol­lo and Plat­inum Equi­ty, the pri­vate equi­ty par­ents of the two issuers, will receive bumper pay­outs from the pro­ceeds of the bond sales if they go through as planned.

    The deals fol­low a flur­ry of so-called div­i­dend recap­i­tal­i­sa­tions through the loan mar­ket, where pri­vate equi­ty own­ers have used bor­row­ings to fund pay­outs from their port­fo­lio com­pa­nies.

    Ken Mon­aghan, co-direc­tor of high yield at Amun­di Pio­neer, said the re-emer­gence of PIK deals was an indi­ca­tion of a “frothy” mar­ket. “It tells you investors are will­ing to take on a greater lev­el of risk,” he said.

    Apol­lo-owned Aspen Insur­ance bor­rowed $500m through its Bermu­da-based par­ent com­pa­ny High­land Hold­ings on Fri­day, with rough­ly 50 per cent set aside for a div­i­dend, accord­ing to peo­ple famil­iar with the issuance. The five-year deal priced with an inter­est rate of about 7.63 per cent, which would rise above 8 per cent if the pay­ment is deferred.

    Plat­inum Equi­ty-backed label mak­er Mul­ti-Col­or Cor­po­ra­tion is also look­ing to raise $500m with a five-year note. The pro­ceeds will be used sole­ly to fund a pay­out to the com­pa­nies’ own­ers, after fees, accord­ing to peo­ple famil­iar with the deal. Ear­ly dis­cus­sions hint­ed at a dou­ble-dig­it inter­est rate on the bond.

    How­ev­er, the deal has received some push­back from investors. The bor­row­ing was ini­tial­ly expect­ed to be finalised on Thurs­day but plans have since been delayed to next week, accord­ing to peo­ple famil­iar with the fundrais­ing.

    ...

    Inter­est rates on safer debt either issued by gov­ern­ments or more high­ly rat­ed com­pa­nies have fall­en to his­toric lows since the coro­n­avirus cri­sis began, kick­ing off a hunt by bond investors for deals in which they can gar­ner high­er returns.

    This shift has reduced the bor­row­ing costs lenders can demand even from com­pa­nies with spec­u­la­tive-grade cred­it rat­ings.

    The aver­age yield across high-yield US cor­po­rate debt has fall­en to 5.3 per cent this month, hav­ing trad­ed as high as 11.4 per cent dur­ing the depths of the coro­n­avirus induced mar­ket tumult in March, accord­ing to Ice Data Ser­vices.

    Fed­er­al Reserve offi­cials have repeat­ed­ly warned of the poten­tial for ris­ing lever­age, with some call­ing for tougher rules to pre­vent the cen­tral bank’s pol­i­cy of keep­ing US inter­est rates low from lead­ing to exces­sive risk-tak­ing.

    This is not the first time Plat­inum has turned to PIKs to raise funds through the com­pa­nies it owns. In 2013 the car chas­sis mak­er Chas­six com­plet­ed a $150m PIK to fund a pay­out to Plat­inum. The com­pa­ny slipped into bank­rupt­cy two years lat­er.

    ...

    ————-

    “Risky PIK deals pitched by pri­vate equi­ty to yield-hun­gry investors” by Joe Ren­ni­son in Lon­don; Finan­cial Times; 10/23/2020

    “A duo of high­ly-indebt­ed bor­row­ers are seek­ing to raise a com­bined $1bn through so-called PIK tog­gle deals, in which issuers are allowed to defer inter­est pay­ments. The struc­ture allows com­pa­nies to pay inter­est using more debt, lead­ing the amount that ulti­mate­ly needs to be paid at the bond’s matu­ri­ty to bal­loon.

    The struc­ture allows com­pa­nies to pay inter­est using more debt. What could go wrong?

    And note that these aren’t obscure rel­a­tive­ly tiny pri­vate equi­ty firms doing this. Apol­lo and Plat­inum Equi­ty are giants in the indus­try. In the case of the Apol­lo-own Aspen Insur­ance, half of the $500 mil­lion is set aside for a div­i­dend. And for Plat­inum, all of the $500 mil­lion raised by Mul­ti-col­or Cor­po­ra­tion will go to the pri­vate equi­ty own­ers:

    ...
    Apol­lo and Plat­inum Equi­ty, the pri­vate equi­ty par­ents of the two issuers, will receive bumper pay­outs from the pro­ceeds of the bond sales if they go through as planned.

    ...

    Apol­lo-owned Aspen Insur­ance bor­rowed $500m through its Bermu­da-based par­ent com­pa­ny High­land Hold­ings on Fri­day, with rough­ly 50 per cent set aside for a div­i­dend, accord­ing to peo­ple famil­iar with the issuance. The five-year deal priced with an inter­est rate of about 7.63 per cent, which would rise above 8 per cent if the pay­ment is deferred.

    Plat­inum Equi­ty-backed label mak­er Mul­ti-Col­or Cor­po­ra­tion is also look­ing to raise $500m with a five-year note. The pro­ceeds will be used sole­ly to fund a pay­out to the com­pa­nies’ own­ers, after fees, accord­ing to peo­ple famil­iar with the deal. Ear­ly dis­cus­sions hint­ed at a dou­ble-dig­it inter­est rate on the bond.

    ...

    This is not the first time Plat­inum has turned to PIKs to raise funds through the com­pa­nies it owns. In 2013 the car chas­sis mak­er Chas­six com­plet­ed a $150m PIK to fund a pay­out to Plat­inum. The com­pa­ny slipped into bank­rupt­cy two years lat­er.
    ...

    Whether or not we’ve entered the ‘bust out’ phase for the pri­vate equi­ty indus­try as a whole, Apol­lo and Plat­inum Equi­ty have clear­ly decid­ed to start ‘bust­ing out’ their hold­ings. And find­ing will­ing part­ners in the yield-hun­gry bond investors will­ing to hold the bag. As long as there are enough investors will­ing to buy these ‘bust out’ bonds more of them are going to be issued.

    So when all of this blows up and we see a major cor­po­rate debt cri­sis that threat­ens to crip­ple the glob­al econ­o­my and calls for major bailouts grow, that the pri­vate equi­ty indus­try — which will no doubt be pin­ing for those bailouts — it’s going to be impor­tant to keep in mind that the upcom­ing cor­po­rate debt cri­sis is the pri­vate equi­ty indus­try bailout.

    Posted by Pterrafractyl | October 25, 2020, 7:06 pm
  5. This is rich: Hen­ry Kavis — the co-founder of noto­ri­ous pri­vate equi­ty giant Kohlberg Kravis Roberts (KKR), Pres­i­dent Trump’s first choice for the job of Trea­sury Sec­re­tary to in Novem­ber of 2016, and some­one who is wide­ly seen as an inspi­ra­tion for Gor­don Geck­o’s char­ac­ter in the movie Wall Street who cham­pi­oned the “greed is good” men­tal­i­ty — just gave an inter­view with Bloomberg about his take on the impact of the coro­n­avirus pan­dem­ic. Kravis talks about the extreme and seem­ing­ly irra­tional volatil­i­ty in the mar­kets and the mas­sive swings up or down for no appar­ent rea­son. And then he ends with the type of com­ment that we should expect to hear a lot more of as the pri­vate equi­ty indus­try pounces on this cri­sis to grow big­ger than ever: Kravis claims the pan­dem­ic has made him more empa­thet­ic.

    Now, as we’ll see in the sec­ond excerpts below from back in May, KKR was call­ing the cri­sis an “inflec­tion point” for its busi­ness an even bet­ter oppor­tu­ni­ty for the firm to expand than the 2008 finan­cial cri­sis. Think about that: the busi­ness that has seen explo­sive debt-fueled growth for decades and is now a pri­vate equi­ty giant is hit­ting an inflec­tion point now. It’s pre­dict­ing even more explo­sive growth for years to come.

    And in the third excerpt below, we learn that KKR did indeed make record invest­ments of $5.5 bil­lion in the sec­ond quar­ter of this year and top that record with $6.2 bil­lion in the third quar­ter. KKR real­ly has been expand­ing at an even faster pace than dur­ing the 2008 finan­cial cri­sis as they pre­dict­ed. So let’s hope Hen­ry Kravis and the rest of the pri­vate equi­ty chiefs real­ly are some­how grow­ing a con­science and become gen­uine­ly empa­thet­ic peo­ple, because if cur­rent trends hold the pri­vate equi­ty chiefs are going to be every­one’s boss once this is over:

    Bloomberg Quint

    Hen­ry Kravis Says the Mar­ket Is Wilder Than at Any Time in His Career

    Melis­sa Karsh and Jason Kel­ly
    Pub­lished: Oct 30 2020, 9:35 PM
    Last Updat­ed Oct 31 2020, 3:19 AM

    (Bloomberg) — Hen­ry Kravis said there’s more tur­moil in the mar­kets than any time in his half-cen­tu­ry career as investors react to pan­dem­ic news. “I’ve been invest­ing for over 50 years, I don’t remem­ber a time when I’ve seen such volatil­i­ty as we see today,” Kravis, the co-founder of KKR & Co., said Fri­day on the Bloomberg Invest Talks web­cast. “Just look at our mar­kets in the U.S., we’re up one day 300, 400 points and then the next day, for almost no rea­son, we’re down 400 to 500 points.”

    While he praised glob­al stim­u­lus efforts for keep­ing economies from col­lapse, he said mar­kets remain unnerved by the Covid-19 pan­dem­ic, espe­cial­ly on the prospects for a vac­cine. “Any news com­ing out of the phar­ma­ceu­ti­cal indus­try on progress with a ther­a­peu­tic or with a vac­cine is chang­ing sym­pa­thy in the mar­kets,” he said.

    ...

    Wild swings were also a rou­tine fea­ture of the 2008 finan­cial cri­sis. That year saw 42 days where the S&P 500 moved by more than 3%, com­pared with 28 days this year since the pan­dem­ic start­ed roil­ing mar­kets.

    In the midst of such tur­bu­lence, New York-based KKR has been among the most active deal­mak­ers. It has invest­ed more than $40 bil­lion across var­i­ous strate­gies this year.

    “When we shut down our offices in the U.S. on about March 12, I was won­der­ing, ‘What are we going to do, how are we going to even keep busy?’” Kravis, 76, said. “As it turned out, we’ve prob­a­bly had the busiest year and (most) pro­duc­tive year that we’ve had almost ever.”

    Kravis has been mak­ing deals since he found­ed KKR in 1976 with Bear Stearns & Co. alums Jerome Kohlberg and his cousin George Roberts. Over the years, they’ve built a rep­u­ta­tion as hard-charg­ing cap­i­tal­ists and gained fame with trans­ac­tions includ­ing the takeover of RJR Nabis­co Inc. in the 1980s.

    While buy­ing and sell­ing com­pa­nies still dri­ves Kravis, he said the pan­dem­ic has changed his out­look on life and work.

    “You see so many peo­ple in the U.S., in New York City in par­tic­u­lar ear­li­er on, become ill and so many of them pass away,” he said. “It makes you think about what’s real­ly impor­tant in life and to me, it’s fam­i­ly, my wife with­out a doubt.”

    Beyond that, “I prob­a­bly have become more patient than I was. I’ve always been known to be impa­tient,” he said. “Prob­a­bly my empa­thy lev­els have gone up, and try­ing to show more empa­thy toward every­body that I come into con­tact with, peo­ple at our firm and make sure they are OK.”

    ————-

    “Hen­ry Kravis Says the Mar­ket Is Wilder Than at Any Time in His Career” by Melis­sa Karsh and Jason Kel­ly; Bloomberg Quint; 10/30/2020

    ““When we shut down our offices in the U.S. on about March 12, I was won­der­ing, ‘What are we going to do, how are we going to even keep busy?’” Kravis, 76, said. “As it turned out, we’ve prob­a­bly had the busiest year and (most) pro­duc­tive year that we’ve had almost ever.”

    Oh what a sur­prise. The vul­ture cap­i­tal indus­try ben­e­fit­ed from a glob­al cri­sis. Who could have seen that com­ing. But hey, at least the top vul­tures are report­ed­ly grow­ing a heart:

    ...
    While buy­ing and sell­ing com­pa­nies still dri­ves Kravis, he said the pan­dem­ic has changed his out­look on life and work.

    “You see so many peo­ple in the U.S., in New York City in par­tic­u­lar ear­li­er on, become ill and so many of them pass away,” he said. “It makes you think about what’s real­ly impor­tant in life and to me, it’s fam­i­ly, my wife with­out a doubt.”

    Beyond that, “I prob­a­bly have become more patient than I was. I’ve always been known to be impa­tient,” he said. “Prob­a­bly my empa­thy lev­els have gone up, and try­ing to show more empa­thy toward every­body that I come into con­tact with, peo­ple at our firm and make sure they are OK.”
    ...

    Let’s hope that new found patience and empa­thy applies to all the employ­ees slat­ed to be laid off by the firms gob­bled up by KKR this year. And all the firms that are going to be scoop up at rock-bot­tom prices in years to come. Because as KKR warned us back in may, this cri­sis rep­re­sents an inflec­tion point for the firm and a greater oppor­tu­ni­ty than 2008. The sky’s the lim­it! For KKR. The lim­its are much low­er for the rest of us:

    Bloomberg

    KKR Says Coro­n­avirus Cri­sis Will Spur Deal­mak­ing Oppor­tu­ni­ties

    * Exec­u­tives say firm well posi­tioned for uncer­tain­ty ahead
    * KKR saw declines across most of busi­ness­es in first quar­ter

    By Sab­ri­na Willmer
    May 6, 2020, 6:56 AM EDT
    Updat­ed on May 6, 2020, 12:28 PM EDT

    KKR & Co. is pre­dict­ing the coro­n­avirus cri­sis will ulti­mate­ly be anoth­er inflec­tion point for its busi­ness even as its hold­ings took a hit.

    Scott Nut­tall, co-pres­i­dent of KKR, said dur­ing an earn­ings call that the pos­si­bil­i­ties for the firm to expand are even greater now than dur­ing the last finan­cial cri­sis.

    “We find our­selves in the for­tu­nate posi­tion of being ready as a firm this time to not only play defense but also play­ing more offense and we’ve been doing a lot of both over the last sev­er­al weeks,” Nut­tall said.

    The New York-based firm spent about $8 bil­lion across cred­it and equi­ty since the start of the cri­sis, Nut­tall said. And, in a sign there’s an appetite for deals, KKR has raised $10 bil­lion over the last two months.

    KKR exec­u­tives focused on look­ing ahead after the com­pa­ny post­ed declines in the first quar­ter across most of its busi­ness­es. The firm’s pri­vate equi­ty port­fo­lio fell 12%, accord­ing to a state­ment Wednes­day. Glob­al infra­struc­ture had the only gain, an 18% increase, helped by an asset sale from the sec­ond fund.

    The major pri­vate equi­ty firms suf­fered in the first quar­ter along with most oth­er assets man­agers as the dam­age inflict­ed by the pan­dem­ic spread to all cor­ners of the mar­ket. Apol­lo Glob­al Man­age­ment Inc., Car­lyle Group Inc. and Black­stone Group Inc. saw depre­ci­a­tion last quar­ter across most of their busi­ness seg­ments. Apol­lo also faces the prospect of hav­ing to hand back ear­li­er prof­its from sev­er­al funds.

    The poten­tial for a glob­al reces­sion threat­ens to slow future sales of busi­ness­es as well as fundrais­ing efforts by asset man­agers. Even so, pri­vate equi­ty firms are sit­ting on about $1.5 tril­lion of cap­i­tal and in sev­er­al cas­es look­ing to gath­er more to invest in poten­tial bar­gains cre­at­ed by mar­ket tur­moil.

    KKR is find­ing oppor­tu­ni­ties to pro­vide liq­uid­i­ty to strug­gling com­pa­nies, said Nut­tall. As an exam­ple he cit­ed pub­lic and pri­vate com­pa­nies that are look­ing to sell non-core sub­sidiaries to delever. The firm is also work­ing with sev­er­al of its port­fo­lio com­pa­nies that are look­ing to grow and con­sol­i­date through acqui­si­tions. While there was a pause in the deal pipeline at the start of the cri­sis, oppor­tu­ni­ties have picked up, par­tic­u­lar­ly in Asia.

    Some of KKR’s key hold­ings, includ­ing finan­cial tech­nol­o­gy com­pa­ny Fis­erv Inc. — its largest bal­ance sheet invest­ment — had dou­ble-dig­it declines dur­ing the quar­ter. The S&P 500 Index fell 20%, its biggest quar­ter­ly drop in more than a decade.

    Port­fo­lio com­pa­nies squeezed by the pan­dem­ic include Envi­sion Health­care Corp., one of the largest physi­cian-staffing firms in the U.S. It has been fac­ing steep loss­es after elec­tive surg­eries were stopped because of the virus.

    But like its peers, KKR is try­ing to take advan­tage of the mar­ket stress. Its cred­it busi­ness pur­chased dis­count­ed secured debt in resilient sec­tors such as telecom­mu­ni­ca­tions and nat­ur­al-gas dis­tri­b­u­tion. The firm also reboot­ed an unsuc­cess­ful cred­it fund in hopes that it can raise mon­ey to buy loans and bonds affect­ed by the out­break.

    The firm brought in $7.1 bil­lion dur­ing the quar­ter, lift­ing its dry pow­der to $58 bil­lion, and exec­u­tives said KKR plans to raise mon­ey for three of its largest funds in the com­ing months.

    KKR rose 3% at 12:26 p.m. in New York. The stock was down 16% this year through Tues­day, trail­ing Apol­lo and Black­stone but far­ing bet­ter than Car­lyle.

    ...

    ————

    “KKR Says Coro­n­avirus Cri­sis Will Spur Deal­mak­ing Oppor­tu­ni­ties” by Sab­ri­na Willmer; Bloomberg; 05/06/2020

    “Scott Nut­tall, co-pres­i­dent of KKR, said dur­ing an earn­ings call that the pos­si­bil­i­ties for the firm to expand are even greater now than dur­ing the last finan­cial cri­sis.

    It’s the great­est oppor­tu­ni­ty in his­to­ry. For KKR. Every­one else is basi­cal­ly f*cked but KKR and the rest of the pri­vate equi­ty giants are doing juu­ust fii­ine. Bet­ter than ever, in fact. Note how KKR raised $10 bil­lion alone from March through May! When the pan­dem­ic was just get­ting under­way. Heads we win. Tails you lose:

    ...
    The New York-based firm spent about $8 bil­lion across cred­it and equi­ty since the start of the cri­sis, Nut­tall said. And, in a sign there’s an appetite for deals, KKR has raised $10 bil­lion over the last two months.
    ...

    And note how KKR was “find­ing oppor­tu­ni­ties to pro­vide liq­uid­i­ty to strug­gling com­pa­nies.” It was­n’t with low-inter­est loans. It was from com­pa­nies sell­ing off sub­sidiaries to KKR. That’s how the com­pa­ny is pro­vid­ing liq­uid­i­ty:

    ...
    The poten­tial for a glob­al reces­sion threat­ens to slow future sales of busi­ness­es as well as fundrais­ing efforts by asset man­agers. Even so, pri­vate equi­ty firms are sit­ting on about $1.5 tril­lion of cap­i­tal and in sev­er­al cas­es look­ing to gath­er more to invest in poten­tial bar­gains cre­at­ed by mar­ket tur­moil.

    KKR is find­ing oppor­tu­ni­ties to pro­vide liq­uid­i­ty to strug­gling com­pa­nies, said Nut­tall. As an exam­ple he cit­ed pub­lic and pri­vate com­pa­nies that are look­ing to sell non-core sub­sidiaries to delever. The firm is also work­ing with sev­er­al of its port­fo­lio com­pa­nies that are look­ing to grow and con­sol­i­date through acqui­si­tions. While there was a pause in the deal pipeline at the start of the cri­sis, oppor­tu­ni­ties have picked up, par­tic­u­lar­ly in Asia.
    ...

    .
    Did things turn out the way KKR was pre­dict­ing back in May? The two straight quar­ters of record invest­ments KKR just announced give us our answer:

    Bloomberg

    KKR Invests Record $6.2 Bil­lion With Tur­moil Spurring Deals

    * Firm’s assets under man­age­ment hit $234 bil­lion as of Sept. 30
    * KKR is on track for its most active fundrais­ing year ever

    By Melis­sa Karsh
    Octo­ber 30, 2020, 6:50 AM EDT Updat­ed on Octo­ber 30, 2020, 10:18 AM EDT

    KKR & Co. deployed a record amount of cap­i­tal in the third quar­ter, tak­ing advan­tage of tur­moil spurred by the Covid-19 pan­dem­ic.

    The firm invest­ed about $6.2 bil­lion in mar­kets across pri­vate equi­ty, infra­struc­ture and real estate, New York-based KKR said Fri­day in a state­ment. That fig­ure sur­passed its pre­vi­ous peak of $5.5 bil­lion in the sec­ond quar­ter.

    This year “is on pace to be the most active deploy­ment and fundrais­ing year in our his­to­ry,” co-Chief Exec­u­tive Offi­cers Hen­ry Kravis and George Roberts said in the state­ment.

    KKR has been one of the industry’s busiest deal­mak­ers dur­ing the pan­dem­ic and has said the cri­sis will be an inflec­tion point for its busi­ness. In July, the firm agreed to buy retire­ment and life insur­ance provider Glob­al Atlantic Finan­cial Group in a deal that could be val­ued at more than $4 bil­lion, giv­ing it a major pres­ence in the insur­ance indus­try and adding long-term cap­i­tal.

    ...

    KKR shares slid 0.3% to $34.69 at 10:12 a.m. in New York. They had climbed about 21% this year through Thurs­day.

    ————

    “KKR Invests Record $6.2 Bil­lion With Tur­moil Spurring Deals” by Melis­sa Karsh; Bloomberg; 10/30/2020

    “This year “is on pace to be the most active deploy­ment and fundrais­ing year in our his­to­ry,” co-Chief Exec­u­tive Offi­cers Hen­ry Kravis and George Roberts said in the state­ment.”

    Well, we can’t say they did­n’t warn us. From the begin­ning of the out­break it was clear this was a his­toric oppor­tu­ni­ty for the pri­vate equi­ty industry...just as every eco­nom­ic cri­sis is an oppor­tu­ni­ty for the indus­try. This cri­sis just hap­pens to be his­toric. Heads we his­tor­i­cal­ly win. Tails you his­tor­i­cal­ly lose. But don’t wor­ry, now that we’ve ruth­less­ly cap­tured every­thing we’re final­ly learn­ing to have empa­thy, so we’ll feel extra bad as we squeeze you rubes for every­thing you have.

    Posted by Pterrafractyl | October 30, 2020, 5:49 pm
  6. Pres­i­dent Trump has been tout­ing the third quar­ter GDP growth num­bers that just came out a cou­ple of days ago. And it’s no sur­prise he would be cel­e­brat­ing the num­bers. There was, as expect­ed, a record 33.1% annu­al­ized GDP growth in the quar­ter, the kind of num­ber that could be con­sid­ered beyond spec­tac­u­lar if we were to ignore the con­text of the the num­ber and the fact that it was pre­ced­ed by a record con­trac­tion of 32.9% in the sec­ond quar­ter. And as the fol­low­ing Politi­co excerpt men­tions, when you first con­tract an econ­o­my by 32.9%, a 33.1% rebound does­n’t actu­al­ly get you back to where you were before. You would need 46% growth for that and a 63% gain would have been required in the third quar­ter to get the GDP back to the lev­el where it like­ly would have been if COVID nev­er hap­pened and pre­vi­ous growth rates were main­tained. It’s a sign of how deep an eco­nom­ic hole the US finds itself in the midst of this elec­tion.

    But as the fol­low­ing arti­cle also notes, if there’s one thing that made that record 33.1% annu­al­ized pos­si­ble in the third quar­ter it was the tril­lions in fed­er­al stim­u­lus. That was the cru­cial ingre­di­ent. A cru­cial ingre­di­ent that has been sys­tem­at­i­cal­ly blocked from hap­pen­ing again by the Repub­li­can-con­trolled Sen­ate, which chose to focus on con­firm­ing Amy Coney Bar­rett to the Supreme Court instead of mak­ing a sec­ond stim­u­lus bill hap­pen. Recall how we’re already hear­ing from Repub­li­can insid­ers that pri­or­i­tiz­ing of Bar­ret­t’s Supreme Court nom­i­na­tion over the stim­u­lus bill was sim­ply out of desire to fill that seat. It was also an oppor­tunis­tic ploy that allowed the Sen­ate GOP to ‘keep its pow­der dry’ should Joe Biden win the White House in antic­i­pa­tion of the GOP revert­ing back to its aus­ter­i­ty-focused fix­a­tion on cut­ting fed­er­al spend­ing at all costs, just like it did fol­low­ing the 2008 finan­cial cri­sis.

    It’s one of the many under­ap­pre­ci­at­ed sto­ries of the this elec­tion cycle : the GOP Sen­ate has already shift­ed into eco­nom­ic sab­o­tage mode, which is why econ­o­mists aren’t expect­ing more spec­tac­u­lar (and need­ed) quar­ters com­ings up:

    Politi­co

    GDP rebounds at record pace, but dark clouds reap­pear

    Trump got a great eco­nom­ic report to use on the cam­paign trail. But behind the sur­face, giant risks are loom­ing.

    By BEN WHITE

    10/29/2020 04:30 AM EDT

    Updat­ed: 10/29/2020 11:02 AM EDT

    Pres­i­dent Don­ald Trump got a juicy head­line to brag about with a report Thurs­day show­ing the U.S. econ­o­my rebound­ed in the third quar­ter at a 33.1 per­cent annu­al­ized rate, par­tial­ly recov­er­ing from the col­lapse in eco­nom­ic out­put ear­li­er this year.

    The Com­merce Department’s report Thurs­day marked the fastest pace of annu­al­ized growth on record just after thworst drope worst drop on record. But it still left U.S. eco­nom­ic out­put below pre-pan­dem­ic lev­els as dark clouds reap­pear with anoth­er surge in coro­n­avirus cas­es this month, slam­ming mar­kets just ahead of Elec­tion Day.

    Beneath the eye-pop­ping head­line — and the cam­paign ral­ly applause lines cer­tain to flow from it — the eco­nom­ic pic­ture looks far less sun­ny for busi­ness­es and work­ers alike. Investors are grow­ing increas­ing­ly wor­ried about dark­er days ahead with mar­kets tum­bling on a sharp spike in Covid-19 cas­es in the U.S. and Europe and the lack of fresh res­cue mon­ey com­ing out of Wash­ing­ton.

    Even the 33.1 per­cent annu­al­ized gain — a 7.4 per­cent jump in the third quar­ter from the sec­ond quar­ter — did not get the U.S. econ­o­my back to where it was at the end of the first quar­ter. And it would take a far big­ger jump to get the econ­o­my back to where it would have been had Covid-19 not slammed the coun­try at all.

    “From a num­bers per­spec­tive, you would need 46 per­cent growth in the third quar­ter just to get back to where we were,” said Ian Shep­herd­son, chief econ­o­mist at Pan­theon Macro­eco­nom­ics. Get­ting the econ­o­my back to where it would have been with­out Covid-19 would have tak­en a 63 per­cent gain in the third quar­ter.

    “To look at this more sub­stan­tive­ly, what these num­bers tell you is fis­cal pol­i­cy works,” Shep­herd­son said. “The fed­er­al gov­ern­ment bor­rowed a ton of mon­ey and sent it out to indi­vid­u­als and busi­ness­es and it worked. Now we don’t have those things, and the expec­ta­tion is growth will be much weak­er in the fourth quar­ter and the virus pic­ture is already much worse. We are in dan­ger of falling into a deep hole again.”

    Even includ­ing the rebound, the econ­o­my shrank 2.9 per­cent from the third quar­ter of 2019 to the third quar­ter of this year. The decline is among the largest record­ed in reces­sions over the last half-cen­tu­ry, eclipsed only by the 3.9 per­cent decline hit in the sec­ond quar­ter of 2009 dur­ing the finan­cial cri­sis and sub­se­quent Great Reces­sion.

    Econ­o­mists and Wall Street ana­lysts now expect much slow­er growth in the fourth quar­ter and ear­ly next year than they pre­vi­ous­ly expect­ed, giv­en that the approx­i­mate­ly $4 tril­lion in fed­er­al stim­u­lus spend­ing that propped up con­sumers and busi­ness­es through the end of the sum­mer has large­ly fad­ed. This means it will like­ly take months or years — depend­ing on the direc­tion of the virus — to get back to where the econ­o­my would have been with­out Covid-19..

    Thursday’s num­bers, if tak­en out of con­text, tell us noth­ing about the road ahead. The surge in new virus cas­es is already lead­ing to more restric­tions on activ­i­ty that could fur­ther dent the econ­o­my. Restau­rant and trav­el activ­i­ty is once again slid­ing after bounc­ing back ear­li­er this year. Per­ma­nent­ly changed con­sumer behav­ior could also damp­en fur­ther recov­ery.

    Much of the gain in the third quar­ter came from increas­es in the ser­vices por­tion of per­son­al con­sump­tion with health care and food ser­vices lead­ing the advance as busi­ness­es con­tin­ued to adapt to a social­ly dis­tanced land­scape.

    High-con­tact indus­tries includ­ing air­lines and restau­rants remain less than halfway back to where they were before the virus hit. This sug­gests it will take sig­nif­i­cant improve­ments in the tra­jec­to­ry of Covid-19 and the devel­op­ment of vac­cines and oth­er treat­ments to ful­ly heal the econ­o­my.

    It also shows just how pow­er­ful­ly the injec­tions of fed­er­al cash into people’s pock­ets over the spring and sum­mer con­tributed to the rebound through increased spend­ing. For now at least, that cash is no longer flow­ing. Mean­while, the labor mar­ket remains deeply dam­aged with 751,000 Amer­i­cans seek­ing ini­tial unem­ploy­ment ben­e­fits last week, a relent­less­ly lofty fig­ure that remains above the all-time high of around 700,000 hit back in the 1980s.

    “Con­sumers and busi­ness­es led the way to the fastest peri­od for eco­nom­ic growth on record,” said Ben Ayers, senior econ­o­mist at Nation­wide Insur­ance, in a research note. “While this is an extreme­ly fast start to the next expan­sion, the lev­el of real GDP remains 3.5 per­cent below the peak from the fourth quar­ter of 2019.”

    Trump, who has repeat­ed­ly not­ed on the cam­paign trail that he would get this big GDP num­ber right before the elec­tion, cel­e­brat­ed just that on Thurs­day morn­ing. “GDP num­ber just announced,” he wrote on Twit­ter. “Biggest and Best in the His­to­ry of our Coun­try, and not even close. … So glad this great GDP num­ber came out before Novem­ber 3rd.”

    Trump aides in the White House and cam­paign hit the air­waves and social media to ampli­fy the GDP report. “I think it exceed­ed all expec­ta­tions,” Trump eco­nom­ic advis­er Lar­ry Kud­low said on Fox News Thurs­day morn­ing. “It is a record high since the data going back to 1947. We’ve nev­er had any­thing remote­ly close to this.”

    While that’s true, it’s also true that the surge fol­lowed the equal­ly his­toric 31 per­cent decline in the sec­ond quar­ter. Because the third quar­ter start­ed from such a low base, even an increase slight­ly larg­er than the 31 per­cent decline would not have returned eco­nom­ic activ­i­ty to where it was at the end of the first quar­ter.

    Trump faces anoth­er conun­drum on employ­ment num­bers. He reg­u­lar­ly boasts of record job cre­ation — more than 11 mil­lion in the last sev­er­al months. And they are, in fact, record num­bers. But they fol­lowed a record loss of more than 22 mil­lion jobs dur­ing the ear­ly stages of the Covid-19 cri­sis. The U.S. is only around half way to get­ting all those jobs back. And in brag­ging about the num­bers, Trump risks look­ing out of touch with more than 23 mil­lion Amer­i­cans still on some form of unem­ploy­ment assis­tance.

    This prob­lem is reflect­ed in Trump’s approval num­bers on the econ­o­my, once a clear advan­tage. Demo­c­ra­t­ic nom­i­nee Joe Biden has now erased that advan­tage and even took a very nar­row lead on the econ­o­my as an issue in the lat­est POLITICO/Morning Con­sult poll.

    The num­bers sug­gest that vot­ers are not swayed by juicy-sound­ing head­line num­bers that do not reflect the real­i­ty many Amer­i­cans are liv­ing through, espe­cial­ly those in low­er income brack­ets not able to work from home. Democ­rats are already try­ing to rebut any Trump brag­ging over Thursday’s GDP num­ber.

    ...

    Among the biggest risks now, beyond the sharp rise in Covid-19 cas­es, is the lack of new fed­er­al stim­u­lus keep­ing a floor under the econ­o­my while the nation strug­gles with the health cri­sis.

    “Broad­ly speak­ing, it was a com­bi­na­tion of aggres­sive mon­e­tary stim­u­lus and fis­cal sup­port that pro­vid­ed a bridge for an econ­o­my try­ing to make it to the oth­er side of a chasm cre­at­ed by a shock that shut down large por­tions of the econ­o­my vir­tu­al­ly overnight ear­li­er this year,” said Jim Baird, chief invest­ment offi­cer at wealth man­age­ment firm Plante Moran, in a note to clients. “Although the recov­ery is on track, both fis­cal and mon­e­tary pol­i­cy sup­port will be need­ed for some time to con­tin­ue to sup­port an econ­o­my that remains vul­ner­a­ble.”

    ————-

    “GDP rebounds at record pace, but dark clouds reap­pear” by BEN WHITE; Politi­co; 10/29/2020

    “From a num­bers per­spec­tive, you would need 46 per­cent growth in the third quar­ter just to get back to where we were,” said Ian Shep­herd­son, chief econ­o­mist at Pan­theon Macro­eco­nom­ics. Get­ting the econ­o­my back to where it would have been with­out Covid-19 would have tak­en a 63 per­cent gain in the third quar­ter.

    It’s basic math: If your GDP drops by a third, you’re going to need to grow by a lot more than a third (50%) to get back to what you were and even high­er to get back to where you should have been if growth had con­tin­ued. There’s A LOT more ground to be made up. Ground that won’t be made up with­out the fur­ther stim­u­lus the GOP is already block­ing. It’s why the major point of cel­e­bra­tion with these new GDP growth num­bers is real­ly a cel­e­bra­tion that fis­cal pol­i­cy works. We already knew but bit it’s a major con­fir­ma­tion. Just hav­ing the fed­er­al gov­ern­ment give every­one mon­ey is actu­al­ly very sound pol­i­cy in a sit­u­a­tion like this. Hooray! That’s a good thing! Too bad the Repub­li­cans in the Sen­ate won’t allow us to keep doing this great pol­i­cy.

    So when we read that econ­o­mists warn that the biggest risk fac­ing the US econ­o­my right now is the risk of inad­e­quate fis­cal stim­u­lus bills, they’re telling us that the biggest risk to the econ­o­my is the Repub­li­can hold­ing onto the Sen­ate:

    ...
    “To look at this more sub­stan­tive­ly, what these num­bers tell you is fis­cal pol­i­cy works,” Shep­herd­son said. “The fed­er­al gov­ern­ment bor­rowed a ton of mon­ey and sent it out to indi­vid­u­als and busi­ness­es and it worked. Now we don’t have those things, and the expec­ta­tion is growth will be much weak­er in the fourth quar­ter and the virus pic­ture is already much worse. We are in dan­ger of falling into a deep hole again.”

    ...

    Econ­o­mists and Wall Street ana­lysts now expect much slow­er growth in the fourth quar­ter and ear­ly next year than they pre­vi­ous­ly expect­ed, giv­en that the approx­i­mate­ly $4 tril­lion in fed­er­al stim­u­lus spend­ing that propped up con­sumers and busi­ness­es through the end of the sum­mer has large­ly fad­ed. This means it will like­ly take months or years — depend­ing on the direc­tion of the virus — to get back to where the econ­o­my would have been with­out Covid-19..

    ...

    It also shows just how pow­er­ful­ly the injec­tions of fed­er­al cash into people’s pock­ets over the spring and sum­mer con­tributed to the rebound through increased spend­ing. For now at least, that cash is no longer flow­ing. Mean­while, the labor mar­ket remains deeply dam­aged with 751,000 Amer­i­cans seek­ing ini­tial unem­ploy­ment ben­e­fits last week, a relent­less­ly lofty fig­ure that remains above the all-time high of around 700,000 hit back in the 1980s.

    ...

    Among the biggest risks now, beyond the sharp rise in Covid-19 cas­es, is the lack of new fed­er­al stim­u­lus keep­ing a floor under the econ­o­my while the nation strug­gles with the health cri­sis.

    “Broad­ly speak­ing, it was a com­bi­na­tion of aggres­sive mon­e­tary stim­u­lus and fis­cal sup­port that pro­vid­ed a bridge for an econ­o­my try­ing to make it to the oth­er side of a chasm cre­at­ed by a shock that shut down large por­tions of the econ­o­my vir­tu­al­ly overnight ear­li­er this year,” said Jim Baird, chief invest­ment offi­cer at wealth man­age­ment firm Plante Moran, in a note to clients. “Although the recov­ery is on track, both fis­cal and mon­e­tary pol­i­cy sup­port will be need­ed for some time to con­tin­ue to sup­port an econ­o­my that remains vul­ner­a­ble.”
    ...

    But as the fol­low­ing Reuters piece also reminds us, it’s not enough to imple­ment poli­cies that sim­ply rebound the GDP. Where that GDP rebound takes place and who ben­e­fits is far more impor­tant. After all, if we have a rebound where the super-rich and pri­vate equi­ty are the pri­ma­ry ben­e­fi­cia­ries while the gen­er­al pub­lic lan­guish­es that would obvi­ous­ly be an mega-dis­as­ter, regard­less of how high those GDP growth num­bers end up being. In fact, one could argue that a full GDP rebound that end­ed up being con­cen­trat­ed in just bank accounts of the rich would be the worst pos­si­ble out­come. A rebound that makes Amer­i­ca’s wealth divide even more of chasm — the ‘K‑shaped’ recov­ery sce­nario where the rich get rich­er and the poor get poor­er and stay poor­er — isn’t real­ly a rebound. It’s eco­nom­ic plun­der­ing. And thus far, the cur­rent rebound that Trump is ask­ing us to cel­e­brate is look­ing a lot like a ‘V’ for the very rich and an ‘E’ recov­ery for every­one else, if ‘E’ stands for an extend­ed eco­nom­ic emer­gency and evic­tions:

    Reuters

    The great diver­gence: U.S. COVID-19 econ­o­my has deliv­ered lux­u­ry hous­es for some, evic­tions for oth­ers

    By Michelle Con­lin
    Octo­ber 31, 2020 6:09 AM Updat­ed

    (Reuters) — When the tem­per­a­ture dipped near freez­ing in Colum­bus, Ohio in mid-Octo­ber, the chil­dren had no heat. The gas had been shut off in their apart­ment for non­pay­ment. DaMir Cole­man, 8, and his broth­er, KyMir, 4, warmed them­selves in front of the elec­tric oven.

    The pow­er, too, was set to be dis­con­nect­ed. Soon there might be no oven, no lights and no inter­net for online school­ing. The boys’ moth­er, Shanell McGee, already had her cell phone switched off and feared she could soon face evic­tion from their $840-a-month apart­ment. The run­down unit con­sumes near­ly half her wages from her job as a med­ical assis­tant at a clin­ic, where she works full-time but gets no health ben­e­fits.

    Just 14 miles north­west of McGee’s neigh­bor­hood, Kiki Kull­man is hav­ing one of the best years of her life.

    The real-estate busi­ness she runs with her fam­i­ly just sold the high­est-priced house in its his­to­ry: a 13,000-square-foot estate, list­ed for $4.5 mil­lion, that came with an ele­va­tor and a clas­sic-car show­room. And in late Octo­ber, Kull­man closed on a home of her own — a $645,000 three-sto­ry Colo­nial, paint­ed a state­ly white with a front door flanked by columns, a pleas­ant place for her two-year-old twin boys to grow up.

    Colum­bus exem­pli­fies the eco­nom­ic split ani­mat­ing America’s coro­n­avirus cri­sis.

    Pro­fes­sion­als like Kull­man are thriv­ing, thanks in part to pan­dem­ic-induced poli­cies by the Fed­er­al Reserve that have buoyed the stock mar­ket and fueled indus­tries such as real estate with record-low inter­est rates.

    For many low­er-wage work­ers, mean­while, the cri­sis has deliv­ered a cru­el shove, top­pling fam­i­lies like the McGees who were already liv­ing on the finan­cial edge. Nation­wide, mil­lions of peo­ple includ­ing hotel work­ers, retail clerks, wait­ers, bar­tenders, air­line employ­ees and oth­er ser­vice work­ers have lost jobs as COVID-19 fears crushed con­sumer demand.

    Econ­o­mists call this phe­nom­e­non a “K‑shaped” recov­ery, in which those on the top con­tin­ue to climb upward while those on the bot­tom see their prospects wors­en.

    Ned Hill, pro­fes­sor of eco­nom­ic devel­op­ment at Ohio State Uni­ver­si­ty, called that down­ward slope of the K “fat and broad and long and ugly look­ing.” He said there’s lit­tle hope for a return to nor­mal as long as coro­n­avirus con­tin­ues to spread unabat­ed in the Unit­ed States. In Ohio, COVID-19 cas­es are soar­ing and hit a record of 3,590 new cas­es on Oct. 29. In Colum­bus alone, at least 643 peo­ple have died.

    “People’s jobs and incomes have dis­ap­peared, and they aren’t com­ing back until people’s threat of dying from the virus dis­si­pates,” Hill said. “That’s it.”

    Locat­ed in the cen­ter of Ohio, about halfway between Pitts­burgh and Indi­anapo­lis, Colum­bus is a city of some 900,000 peo­ple. Home to Ohio State Uni­ver­si­ty and the state’s cap­i­tal, its employ­ment is root­ed in sec­tors like hos­pi­tal­i­ty, edu­ca­tion and health, gov­ern­ment, and pro­fes­sion­al and busi­ness ser­vices.

    That mix has allowed it to fare bet­ter dur­ing the cri­sis than some oth­er Rust Belt cities that are more heav­i­ly depen­dent on man­u­fac­tur­ing. Columbus’s Sep­tem­ber unem­ploy­ment rate of 7.5% was low­er than the nation­al aver­age of 7.9%. But like the rest of the Unit­ed States, its front-line and mod­est­ly skilled work­ers have been slammed the hard­est.

    The diver­gence of for­tune can be seen in the city’s hous­ing mar­ket.

    For those with means, like the clients of real estate agent Kull­man, low inter­est rates have trans­lat­ed into cheap­er mort­gages, allow­ing them to afford big­ger hous­es. Colum­bus is just one of four U.S. cities — along with Cincin­nati, Kansas City and Indi­anapo­lis — where hous­es are sell­ing in less than five days on aver­age, accord­ing to real estate research firm Zil­low.

    “It is crazy to see in Colum­bus the mil­lion-plus price point get­ting mul­ti­ple offers and all-cash bids,” said Kull­man, 36.

    For renters ham­mered by the down­turn, mean­while, hous­ing is a pre­car­i­ous busi­ness.

    Dur­ing the ear­ly days of the pan­dem­ic as Ohio’s res­i­dents shel­tered in place, evic­tions in Colum­bus fell, thanks to local and fed­er­al pro­tec­tions to keep renters in their homes. But since Sep­tem­ber, 1,774 evic­tion cas­es have been filed, far sur­pass­ing sum­mer lev­els, accord­ing to Prince­ton University’s Evic­tion Lab, which tracks evic­tions. The Greater Colum­bus Con­ven­tion Cen­ter now serves as a bustling evic­tion court.

    Those fil­ings came despite a Sept. 4 decree by the U.S. Cen­ters for Dis­ease Con­trol and Pre­ven­tion (CDC) ban­ning all evic­tions nation­wide until Jan. 1 to pre­vent a surge of new­ly home­less peo­ple from con­tract­ing and spread­ing the coro­n­avirus. Under the mora­to­ri­um, land­lords can­not evict ten­ants who can no longer pay rent because their earn­ings have been affect­ed by COVID-19.

    But land­lords are not required to inform ten­ants of these pro­tec­tions and are free to file evic­tion law­suits. Only renters who know about the CDC ban, qual­i­fy for it and take legal action to assert their rights can stop their evic­tions. Among the 24 cities the Evic­tion Lab tracks, Colum­bus is one of the few where evic­tions did not fall after the ban.

    The fall­out can be seen across Colum­bus. The local pot of mon­ey from fed­er­al relief to help cash-strapped ten­ants pay rent was tapped out in Sep­tem­ber. Food banks are run­ning low on sta­ples, and home­less shel­ters are at capac­i­ty, accord­ing to com­mu­ni­ty advo­cates.

    Util­i­ty shut-offs have surged to the point that lawyers for the Legal Aid Soci­ety of Colum­bus have resort­ed to fil­ing per­son­al bank­rupt­cy peti­tions for ten­ants to keep their heat, lights and water on.

    If present con­di­tions per­sist, and with­out a new round of fed­er­al relief, as many as 40 mil­lion peo­ple could be at risk of evic­tion in com­ing months, accord­ing to the Aspen Insti­tute, a think tank. In a typ­i­cal year, 3.6 mil­lion evic­tion cas­es are filed.

    ‘BEING POOR COSTS YOU’

    Even before the pan­dem­ic, McGee, 29, was strug­gling finan­cial­ly. In 2014, she bought a 2008 Chevy Mal­ibu off a cor­ner lot charg­ing 22% inter­est. She said the junker stopped run­ning long ago, so she stopped pay­ing in 2016. McGee said she offered to return the vehi­cle, which has 176,475 miles on it, but the lender wouldn’t take it back.

    In March, McGee’s live-in boyfriend lost his job at a fast-food restau­rant as Ohio went on lock­down, cut­ting their household’s income. In August, he was diag­nosed with COVID-19 and the entire fam­i­ly had to quar­an­tine. That same week, McGee got a call from her employ­er, telling her that her lender had got­ten a court order to gar­nish 25% of her wages to repay more than $10,000, with penal­ties and late fees, that she still owed on the car.

    That left her with take-home pay of $728 every two weeks. She couldn’t afford school sup­plies for her sons and had to bor­row gas mon­ey from her mom to get to work in her boyfriend’s car.

    “It was heart­break­ing, it was every­thing all at once,” said McGee, who wears rec­tan­gu­lar glass­es and has a broad, easy smile.

    She sought help from Paul Bryson, an attor­ney with the Legal Aid Soci­ety who filed a bank­rupt­cy peti­tion in Octo­ber to get McGee’s util­i­ties turned back on and the gar­nish­ment frozen. The court approved the peti­tion, but not before McGee’s lender took $1,023 of her wages.

    “Being poor costs you a lot of mon­ey,” Bryson said. “Even before the pan­dem­ic, somebody’s entire life falls apart when they get a gar­nish­ment. And now? If noth­ing is done, we are just going to have a lot of peo­ple on the street.”

    ...

    LIVING THE DREAM

    For years, Kull­man, the real estate agent, fan­ta­sized about liv­ing on Bed­ford Road, a cov­et­ed address in the Colum­bus sub­urbs.

    In the region’s posh­est neigh­bor­hoods, sump­tu­ous hous­es that make per­fect pan­dem­ic com­pounds, with ameni­ties like his-and-hers home offices and roomy base­ments for online school­ing, can sell in a day, often with mul­ti­ple offers in all-cash deals well above the ask­ing price. Kull­man said some shop­pers are sub­mit­ting bids with­out ever tour­ing a house. The most des­per­ate are agree­ing to “no-rem­e­dy” inspec­tions, mean­ing they won’t ask for con­ces­sions if the inspec­tion turns up a major defect. Oth­ers, she said, have autho­rized “crazy esca­la­tion claus­es with no cap.” In real estate par­lance, that means they will beat any oth­er offer, no mat­ter how high the price.

    “You have to sign away your life to get the house you want,” Kull­man said.

    In August, Kull­man, who runs the Kull­man Group at Street Sotheby’s Inter­na­tion­al with her hus­band, father and sis­ter, found out that a cou­ple who lived on Bed­ford Road were about to move. She made a bid before the house hit the mar­ket and the own­ers accept­ed. The Colo­nial is right next door to her sister’s home; their kids will share back­yards.

    Kull­man is aware of her good for­tune amidst the pan­dem­ic, and the mean hand that coro­n­avirus has dealt to the city’s most vul­ner­a­ble.

    Her hus­band has been doing busi­ness with a land­lord who’s sell­ing a port­fo­lio of homes in Columbus’s low-income neigh­bor­hood of Lin­den. Non-pay­ing ten­ants in those prop­er­ties have been get­ting evic­tion notices.

    “It is night and day, what we see here,” Kull­man said. “Which is not what you would expect in COVID. It’s sad but it’s true.”

    ————-

    “The great diver­gence: U.S. COVID-19 econ­o­my has deliv­ered lux­u­ry hous­es for some, evic­tions for oth­ers” by Michelle Con­lin; Reuters; 10/31/2020

    If present con­di­tions per­sist, and with­out a new round of fed­er­al relief, as many as 40 mil­lion peo­ple could be at risk of evic­tion in com­ing months, accord­ing to the Aspen Insti­tute, a think tank. In a typ­i­cal year, 3.6 mil­lion evic­tion cas­es are filed.”

    If we can’t expect new fed­er­al fis­cal stim­u­lus, what can we expect? 40 mil­lion evic­tions in com­ing months, that’s what. And all those evic­tions will be tak­ing place while the high end hous­ing mar­ket remains so hot peo­ple are buy­ing hous­es sight unseen. A ‘night and day’ recov­ery, where it’s ‘Morn­ing in Amer­i­ca’ for the wealthy, and just ‘Mourn­ing’ for the rest of us:

    ...
    For years, Kull­man, the real estate agent, fan­ta­sized about liv­ing on Bed­ford Road, a cov­et­ed address in the Colum­bus sub­urbs.

    In the region’s posh­est neigh­bor­hoods, sump­tu­ous hous­es that make per­fect pan­dem­ic com­pounds, with ameni­ties like his-and-hers home offices and roomy base­ments for online school­ing, can sell in a day, often with mul­ti­ple offers in all-cash deals well above the ask­ing price. Kull­man said some shop­pers are sub­mit­ting bids with­out ever tour­ing a house. The most des­per­ate are agree­ing to “no-rem­e­dy” inspec­tions, mean­ing they won’t ask for con­ces­sions if the inspec­tion turns up a major defect. Oth­ers, she said, have autho­rized “crazy esca­la­tion claus­es with no cap.” In real estate par­lance, that means they will beat any oth­er offer, no mat­ter how high the price.

    “You have to sign away your life to get the house you want,” Kull­man said.

    In August, Kull­man, who runs the Kull­man Group at Street Sotheby’s Inter­na­tion­al with her hus­band, father and sis­ter, found out that a cou­ple who lived on Bed­ford Road were about to move. She made a bid before the house hit the mar­ket and the own­ers accept­ed. The Colo­nial is right next door to her sister’s home; their kids will share back­yards.

    Kull­man is aware of her good for­tune amidst the pan­dem­ic, and the mean hand that coro­n­avirus has dealt to the city’s most vul­ner­a­ble.

    Her hus­band has been doing busi­ness with a land­lord who’s sell­ing a port­fo­lio of homes in Columbus’s low-income neigh­bor­hood of Lin­den. Non-pay­ing ten­ants in those prop­er­ties have been get­ting evic­tion notices.

    “It is night and day, what we see here,” Kull­man said. “Which is not what you would expect in COVID. It’s sad but it’s true.”
    ...

    And as long as the Repub­li­cans retain con­trol of the Sen­ate this ‘night and day’ recov­ery is exact­ly what we should con­tin­ue to expect. Regard­less of who wins the White House. Sure, Sen­ate Repub­li­cans will prob­a­bly be a lit­tle less Grinch-like with the fis­cal stim­u­lus if Trump wins the White House only because they won’t be quite as incen­tivized to sab­o­tage the econ­o­my for polit­i­cal rea­sons. But when you’re the GOP — par­ty of, by, and for the preda­to­ry super-rich — only don’t need polit­i­cal rea­sons as a moti­va­tion to sab­o­tage the econ­o­my. The ‘K‑shaped’ nature of cur­rent recov­ery, with the rich get­ting rich­er and the poor get­ting poor­er, is rea­son itself to con­tin­ue the sab­o­tag­ing the econ­o­my. A ‘night and day’ recov­ery is just an exten­sion of the GOP’s long-term ‘trick­le-down’ eco­nom­ic agen­da that’s been car­ried out for decades now. Much like Trump’s tax cut scam with ‘night and day’ ben­e­fits. If the GOP sees an oppor­tu­ni­ty to make the rich rich­er and the poor poor­er that’s not an oppor­tu­ni­ty it’s going to pass up. 40 years of empir­i­cal evi­dence proves this beyond a shad­ow of a doubt. Putting the poors in their place (and fool­ing them into accept­ing it) is kind of the meta-point of the con­tem­po­rary GOP.

    So as we enter the post-Elec­tion peri­od — a peri­od where dis­cus­sion of what a ‘post-Trump’ GOP might look like whether or not Trump wins or los­es the elec­tion — it’s going to be impor­tant to keep in mind that we’re cur­rent­ly all liv­ing in the mid­dle of mere­ly the lat­est exam­ple of why the upcom­ing talk about the nature of a ‘post-Trump’ GOP should real­ly be a dis­cus­sion about a ‘post-GOP’ Amer­i­ca. What kind of coun­try could lib­er­als and con­ser­v­a­tives build togeth­er with­out a major par­ty ded­i­cat­ed to mak­ing the rich rich­er and the poor poor­er? There would still be some sort of con­ser­v­a­tive par­ty, just not one that oper­ates at the behest of bil­lion­aires suf­fer­ing from a finan­cial hoard­ing syn­drome. What kind of coun­try could the US become? It’s a fun thought. A fun, hope­ful­ly not too quaint for 2020, thought.

    Posted by Pterrafractyl | November 1, 2020, 8:52 pm
  7. Here’s a quick sto­ry about the large­ly unrec­og­nized role pri­vate equi­ty firms played in the US 2020 elec­tions. Just a rel­a­tive hand­ful of pri­vate equi­ty. Recall how the US elec­tron­ic voting/tabulating machine indus­try is large­ly an oli­gop­oly con­trolled today by three com­pa­nies. Hart Inter­Civic, Domin­ion, and ES&S. As the fol­low­ing Axios arti­cle points out, all three of these vot­ing sys­tem giants are owned by pri­vate equi­ty. Hart Inter­Civic was pur­chased by Enlight­en­ment Cap­i­tal this sum­mer. Enlight­ment Cap­i­tal’s two lead part­ners have a his­to­ry of sig­nif­i­cant dona­tions to Demo­c­ra­t­ic Par­ty can­di­dates. One of Enlight­en­ment Cap­i­tal’s lead part­ners, Devin Tal­bott, is Strobe Tal­bot­t’s son. Devin used to work the Cohen Group, a mer­chant bank found­ed by for­mer defense sec­re­tary William Cohen.

    ES&S been backed for decades by pri­vate equi­ty firm McCarthy Cap­i­tal, whose cur­rent pres­i­dent and man­ag­ing part­ner has a his­to­ry of Repub­li­can dona­tions. Recall how ES&S was run by Chuck Hagel until he left to run for the Nebraskan US Sen­ate seat in the 1996 elec­tion and he won...and kept shares in ES&S as a sen­a­tor. Old school elec­tion scan­dals of yes­ter­year. Quaint.

    The third mem­ber of the oli­gop­oly is Domin­ion, acquired in mid-2018 by Sta­ple Street Cap­i­tal, a mid-mar­ket buy­out firm co-found­ed by two guys from the Car­lyle Groups. Stephen D. Owens became a Man­ag­ing Direc­tor the Car­lyle Group before co-found­ing Sta­ple Street Cap­i­tal. And Hootan Yaghoobzadeh was a Senior Vice Pres­i­dent at Cer­berus Cap­i­tal and worked at the Car­lyle group before that. Recall how Cer­berus’s founder and CEO, Stephen A Fein­berg, is a major Repub­li­can donor and close Trump ally. Domin­ion bought Diebold’s Pre­mier Elec­tion Sys­tems in 2010. So any ‘bugs’ in Diebold’s vot­ing machine were passed along to Domin­ion.

    So pri­vate equi­ty basi­cal­ly owned and oper­at­ed the elec­tron­ic vot­ing infra­struc­ture that ran the US 2020 elec­tion. Fun fact:

    Axios

    Pri­vate equi­ty dom­i­nat­ed the 2020 elec­tion process

    Dan Pri­mack, author of Pro Rata
    Nov 17, 2020 — Pol­i­tics & Pol­i­cy

    Pri­vate equi­ty dom­i­nat­ed Elec­tion Day. Not in terms of the win­ning can­di­dates, but in terms of the elec­tion process itself.

    Between the lines: The most-uti­lized elec­tion sys­tem and soft­ware com­pa­nies are owned by U.S. pri­vate equi­ty firms. Domin­ion Vot­ing Sys­tems is the best-known of these ven­dors, as it’s become the sub­ject of evi­dence-free con­spir­a­cy the­o­ries.

    * The Cana­da-found­ed and Den­ver-based com­pa­ny was acquired in mid-2018 by Sta­ple Street Cap­i­tal, a mid-mar­ket buy­out firm co-found­ed by Car­lyle Group and Cer­berus vets.

    Hart Inter­Civic is a Texas-based com­pa­ny whose sys­tems were used in some of the Michi­gan and Geor­gia coun­ties where some con­spir­a­cy the­o­rists base­less­ly claim that Domin­ion (not Hart) changed votes from Pres­i­dent Trump to Joe Biden.

    * Enlight­en­ment Cap­i­tal, a Wash­ing­ton, D.C., firm whose two lead part­ners have a his­to­ry of sig­nif­i­cant dona­tions to Demo­c­ra­t­ic Par­ty can­di­dates, pur­chased Hart Inter­Civic from H.I.G. Cap­i­tal this past sum­mer.

    ES&S of Oma­ha was found­ed in 1979, and appears to be the coun­try’s largest mak­er of vot­ing machines.

    * It’s been backed for decades by pri­vate equi­ty firm McCarthy Cap­i­tal, whose cur­rent pres­i­dent and man­ag­ing part­ner has donat­ed to Repub­li­can Par­ty can­di­dates.

    Oth­er cer­ti­fied providers include: Clear Bal­lot Group (Boston-based start­up backed by VC firms like Besse­mer Ven­ture Part­ners), MicroVote (owned by Fideli­ty Nation­al Infor­ma­tion Solu­tions) and Unisyn Vot­ing Solu­tions (owned by an Asian lot­tery group).

    Of note: Axios reached out to the pri­vate equi­ty own­ers of Domin­ion, Hart Inter­Civic, and ES&S. None returned any calls or emails.

    * Domin­ion’s own­er is keep­ing a par­tic­u­lar­ly low pro­file, remov­ing the team, port­fo­lio and con­tact pages from its web­site in recent days.

    ...

    ————

    “Pri­vate equi­ty dom­i­nat­ed the 2020 elec­tion process” by Dan Pri­mack; Axios; 11/17/2020

    “The Cana­da-found­ed and Den­ver-based com­pa­ny was acquired in mid-2018 by Sta­ple Street Cap­i­tal, a mid-mar­ket buy­out firm co-found­ed by Car­lyle Group and Cer­berus vets.”

    That’s who owns Domin­ion Vot­ing Sys­tems. Sta­ple Street Cap­i­tal, a pri­vate equi­ty group co-found­ed by Car­lyle Group and Cer­berus vets. Sta­ple Street and its co-investors who can remain mys­ter­ies thanks to the opaque trans­paren­cy rules for the pri­vate equi­ty indus­try. And the rest of the elec­tron­ic vot­ing machine oli­gop­oly is owned by pri­vate equi­ty too.

    So when Pres­i­dent Trump tweets that Domin­ion cheat­ed against him, it’s a good time to bring up the fact that entire elec­tron­ic vot­ing machine indus­try in the US is dom­i­nat­ed by a pri­vate equi­ty owned oli­gop­oly. And since pri­vate equi­ty is noto­ri­ous­ly opaque, with own­er­ship or investor iden­ti­ties often unclear and writ­ten in a note­book some­where, we can con­fi­dent­ly say that we don’t real­ly know who ulti­mate­ly owns any of the major vot­ing machine com­pa­nies. It’s a pri­vate equi­ty ‘fea­ture’.

    Posted by Pterrafractyl | November 19, 2020, 1:17 am
  8. Here’s a poten­tial­ly great (poten­tial­ly hor­ri­bly great) exam­ple of why the grow­ing reliance of pen­sion funds on pri­vate equi­ty invest­ments is a recipe for dis­as­ter. Well, dis­as­ter for the pub­lic. For the pri­vate equi­ty indus­try’s wealthy investors it’s more a recipe for avoid­ing dis­as­ter by pass­ing that dis­as­ter along to the pub­lic:

    It turns out the grow­ing mega-hack­ing hack­ing scan­dal that his the US gov­ern­ment and thou­sands of cor­po­ra­tions involv­ing Solar­Winds has a pri­vate equi­ty angle. A pri­vate-equi­ty-scam­ming-pub­lic-pen­sions angle. Maybe. Either that or it’s a sto­ry about pri­vate equi­ty investors get­ting incred­i­bly lucky at the expense of a pub­lic pen­sion plan.

    On Decem­ber 7, short­ly before the Solar­Winds hack­ing scan­dal was made pub­lic by the US gov­ern­ment, two major pri­vate equi­ty investors in Solar­Winds sold a $315 mil­lion stake in the com­pa­ny to a Cana­di­an pub­lic pen­sion fund, the Cana­da Pub­lic Pen­sion Plan Invest­ment Board (CPPIB). 10 days after this sale the Solar­Winds stock was already down 15 per­cent. As we’ll see in the sec­ond arti­cle excerpt below, the Solar­sWinds stock is down around 26% this week. The two pri­vate equi­ty firms, Sil­ver Lake and Thoma Bra­vo, owned togeth­er rough­ly 75 per­cent of Solar­Winds at the end up Sep­tem­ber and three mem­bers of each firm sit on Solar­Wind­s’s board, which means these were the pri­ma­ry investors in Solar­Winds who dumped that stock on a pub­lic pen­sion plan right before this melt­down. Both Sil­ver Lake and Thoma Bra­vo sold 5.8 per­cent of their shares in Solar­Winds dur­ing this trans­ac­tion, so it was still only a rel­a­tive­ly small por­tion of their total stake in the firm sold to the CPPIB which is an indi­ca­tion of just how much expo­sure these two pri­vate equi­ty enti­ties have to the Solar­Winds scan­dal.

    How was this ill fat­ed trans­ac­tion orches­trat­ed? Well, it also turns out that the CPPIB has has com­mit­ted $1.7bn to four Sil­ver Lake funds since 2004 and $1.1bn to five Thoma Bra­vo funds since 2014. So these were the same pri­vate equi­ty investors that the CPPIB has been team­ing up with for years and trust­ing to invest CPPIB funds in good faith who basi­cal­ly set the CPPIB to take to cush­ion the finan­cial blow of this hack.

    Of course, Sil­ver Lake and Thoma Bra­vo are claim­ing that they knew noth­ing about the hack when they exe­cut­ed the sale of the stake on Decem­ber 7. It was all just real­ly bad luck for CPPIB and real­ly great luck for Sil­ver Lake and Thoma Bra­vo. Which would also make it a ran­dom coin­ci­dence that Solar­Winds got a new CEO on Dec 9, two days after this stock sale. The time­lines we’re being told is as fol­lows:

    Dec 7: the #15 mil­lion in Solar­Winds stock is sold to CPPIB
    Dec 8: Fire­Eye, the cyber­se­cu­ri­ty firm, first announced that it was hacked.
    Dec 9: Solar­Winds gets a new CEO
    Dec 12: Solar­Winds is informed it was hacked by Fire­Eye
    Dec 14: Solar­Winds pub­licly acknowl­edges it was hacked.

    Based on this time­line, the defense of Sil­ver Lake and Thoma Bra­vo is based on the time­line where Fire­Eye informs Solar­Winds about the hack on Decem­ber 12 and not ear­li­er. Fire­Eye itself claims that it did­n’t inform Solar­Winds until Decem­ber 12, so Fire­Eye is back­ing up Solar­Winds on this time­line. But, again, it sure is inter­est­ing that a new CEO was put in place just three days before Solar­Winds alleged­ly first learned about the hack from Fire­Eye. Also a coin­ci­dence? That’s what we are asked to believe. Heads we win, tails you lose. This only looks bad but there’s a good expla­na­tion:

    The Finan­cial Times

    Pri­vate equi­ty firms sold stake in Solar­Winds days before hack warn­ing
    Sil­ver Lake and Thoma Bra­vo offloaded 5% stake to one of Canada’s biggest pen­sion funds

    Mark Van­de­velde in New York and Kaye Wig­gins in Lon­don
    12/16/2020 1:04 pm

    Pri­vate equi­ty investors in Solar­Winds sold a $315m stake in the soft­ware group to one of their own long­stand­ing finan­cial back­ers, short­ly before the US warned that “nation-state” hack­ers had hijacked one of the company’s prod­ucts.

    The trans­ac­tion reduced the expo­sure of Sil­ver Lake and Thoma Bra­vo to the strick­en soft­ware com­pa­ny days before its share price fell as vul­ner­a­bil­i­ties were dis­cov­ered in a prod­uct that is used by mul­ti­ple fed­er­al agen­cies and almost all For­tune 500 com­pa­nies.

    But the trade could prove embar­rass­ing for Men­lo Park-based Sil­ver Lake and its rival Thoma Bra­vo, which rank among the biggest tech­nol­o­gy-focused pri­vate equi­ty firms in the world.

    ***********

    The firms togeth­er held rough­ly 75 per cent of Solar­Winds at the end of Sep­tem­ber, secu­ri­ties fil­ings show, and three exec­u­tives from each of the pri­vate equi­ty firms sit on SolarWind’s board.

    The two firms sold a por­tion of that stake to Cana­da Pub­lic Pen­sion Plan Invest­ment Board at a price of $21.97 a share in a pri­vate place­ment trans­ac­tion that closed on Decem­ber 7, rep­re­sent­ing a 5 per cent stake in the IT com­pa­ny, secu­ri­ties fil­ings show.

    Solar­Wind shares changed hands at $18.52 on Wednes­day, leav­ing the Cana­di­an pen­sion fund nurs­ing a paper loss of about 15 per cent after less than 10 days.

    Insti­tu­tion­al investors often cul­ti­vate long-term rela­tion­ships with pri­vate equi­ty spon­sors in the hope of receiv­ing side-ben­e­fits such as ear­ly access to new funds and the abil­i­ty to co-invest in deals. CPPIB has com­mit­ted $1.7bn to four Sil­ver Lake funds since 2004 and $1.1bn to five Thoma Bra­vo funds since 2014, accord­ing to data from Pitch­Book.

    In a joint state­ment, the firms said they “were not aware of this poten­tial cyber attack at Solar­Winds pri­or to enter­ing into a pri­vate place­ment to a sin­gle insti­tu­tion­al investor on Decem­ber 7”. CPPIB declined to com­ment on the trans­ac­tion.

    Unlike buy or sell orders that are exe­cut­ed by a stock­bro­ker, sec­ondary pri­vate place­ments are typ­i­cal­ly heav­i­ly nego­ti­at­ed over a peri­od of days or weeks, ana­lysts say.

    *********************

    Such “pri­vate place­ments” can pro­vide large investors with an oppor­tu­ni­ty to pur­chase stock at a dis­count, while allow­ing the sell­er to liq­ui­date a large hold­ing at an agreed price.

    ...

    The US gov­ern­ment issued an emer­gency warn­ing on Sun­day about what appeared to be a sophis­ti­cat­ed cyber espi­onage cam­paign that cen­tred on Ori­on, a piece of its soft­ware used by hun­dreds of thou­sands of organ­i­sa­tions around the world.

    The Pen­ta­gon, the US state depart­ment, all five branch­es of the US mil­i­tary, the NSA, the Depart­ment of Jus­tice and the Office of the Pres­i­dent of the Unit­ed States are among Solar­Winds’ clients, accord­ing to its web­site.

    ————

    “Pri­vate equi­ty firms sold stake in Solar­Winds days before hack warn­ing” by Mark Van­de­velde in New York and Kaye Wig­gins; The Finan­cial Times; 12/16/2020

    “Insti­tu­tion­al investors often cul­ti­vate long-term rela­tion­ships with pri­vate equi­ty spon­sors in the hope of receiv­ing side-ben­e­fits such as ear­ly access to new funds and the abil­i­ty to co-invest in deals. CPPIB has com­mit­ted $1.7bn to four Sil­ver Lake funds since 2004 and $1.1bn to five Thoma Bra­vo funds since 2014, accord­ing to data from Pitch­Book.

    The CPPIB clear­ly trusts Sil­ver Lake and Thoma Bra­vo. Years of invest­ing bil­lions with them demon­strates that trust. So was this mis­placed trust? Or did the Sil­ver Lake and Thoma Bra­vo mere­ly get real­ly, real­ly lucky at the expense of the CPPIB? That’s the big ques­tion sur­round­ing these trades. A ques­tion that comes down to whether or not Solar­Winds real­ly did­n’t have any idea about the hack before the Dec 7 trade. Because if Solar­Winds knew about it, Sil­ver Lake and Thoma Bra­vo must have known too since they each have three exec­u­tives sit­ting on the Solar­Winds board:

    ...
    The firms togeth­er held rough­ly 75 per cent of Solar­Winds at the end of Sep­tem­ber, secu­ri­ties fil­ings show, and three exec­u­tives from each of the pri­vate equi­ty firms sit on SolarWind’s board.

    The two firms sold a por­tion of that stake to Cana­da Pub­lic Pen­sion Plan Invest­ment Board at a price of $21.97 a share in a pri­vate place­ment trans­ac­tion that closed on Decem­ber 7, rep­re­sent­ing a 5 per cent stake in the IT com­pa­ny, secu­ri­ties fil­ings show.
    ...

    But all par­ties involved are assur­ing us that Solar­Winds had no idea about the hack until Fire­Eye informed them on Decem­ber 12, five days after the stock sale. And that includes the CPPIB itself, which released state­ment to Axios on Fri­day express­ing its full con­fi­dence in Sil­ver Lake and Thoma Bra­vo and an expec­ta­tion that the pri­vate equi­ty firms will con­tin­ue to give CPPIB excep­tion­al val­ue going for­ward. So it will be inter­est­ing to see if there’s any mean­ing­ful inves­ti­ga­tion of this poten­tial insid­er trading/client abuse scan­dal because the poten­tial­ly abused client is already con­vinced no inves­ti­ga­tion is nec­es­sary. Heads we win, tails you lose. And we assure you every­thing is above board here:

    Axios

    Solar­Winds denies insid­er trad­ing activ­i­ty ahead of hack rev­e­la­tion

    Dan Pri­mack, author of Pro Rata
    Dec 18, 2020 — Tech­nol­o­gy

    Solar­Winds is at the heart of what might be the most sig­nif­i­cant cyber­se­cu­ri­ty breach in U.S. his­to­ry, as hack­ers used an exploit in its sys­tem to pos­si­bly access every­thing from the Nation­al Nuclear Secu­ri­ty Admin­is­tra­tion to most of the U.S. For­tune 500.

    What’s new: The IT ven­dor is (belat­ed­ly) push­ing back against sug­ges­tions that its two largest investors engaged in insid­er trad­ing ahead of the hack rev­e­la­tions.

    The his­to­ry: Texas-based Solar­Winds was tak­en pri­vate in 2016 for $4.5 bil­lion by pri­vate equi­ty firms Sil­ver Lake and Thoma Bra­vo. It then com­plet­ed an IPO in Octo­ber 2018.

    * In August 2020 Solar­Winds announced plans to hire a new CEO.
    * On Dec. 7, Sil­ver Lake and Thoma Bra­vo sold around $315 mil­lion in Solar­Winds stock to Cana­da Pen­sion Plan Invest­ment Board (CPPIB). The two firms retained equi­ty posi­tions and seats on the Solar­Winds board of direc­tors.
    * On Dec. 8, U.S. cyber­se­cu­ri­ty com­pa­ny Fire­Eye dis­closed that it had been hacked, like­ly by a gov­ern­ment.

    * On Dec. 9, Solar­Winds named its new CEO.
    * On Dec. 14 came reports that both the U.S. Trea­sury and Com­merce Depart­ments had been hacked, with Fire­Eye pub­licly iden­ti­fy­ing Solar­Winds for the first time.
    * Solar­Winds on Dec. 14 acknowl­edged it “has been made aware” of the hack, but declined to say when. One day lat­er, the Wash­ing­ton Post pub­lished a sto­ry ques­tion­ing the stock sales.

    All of which leads us to yes­ter­day, when Solar­Winds put more details on its cal­en­dar.

    * Per an 8‑K fil­ing, Solar­Winds says its CEO was first informed of the sit­u­a­tion, by Fire­Eye, on Dec. 12.
    * Solar­Winds does­n’t say when the board, includ­ing Sil­ver Lake and Thoma Bra­vo reps, were informed, but the impli­ca­tion is that it could­n’t have been before the 12th. If so, the trades were clean and CPPIB sim­ply has a case of awful luck, as Solar­Winds stock is down 26% on the week.

    In a state­ment, the pri­vate equi­ty firms said: “Thoma Bra­vo and Sil­ver Lake were not aware of this poten­tial cyber­at­tack at Solar­Winds pri­or to enter­ing into a pri­vate place­ment to a sin­gle insti­tu­tion­al investor on 12/7.”

    * A CPPIB spokesman declined to com­ment on if the sys­tem was aware of Solar­Winds’ CEO hire when clos­ing its pur­chase.

    The bot­tom line: Expect U.S. secu­ri­ties reg­u­la­tors to trust but ver­i­fy.

    ...

    Update: CPPIB pro­vid­ed Axios with the fol­low­ing state­ment on Fri­day after­noon:

    “Ter­rif­ic part­ners with a long track record of col­lab­o­ra­tion. Real­ly good com­pa­ny and we expect they will con­tin­ue to cre­ate excep­tion­al val­ue along our invest­ment hori­zon.

    To the best of our knowl­edge no one was aware of the hack lead­ing to our cap­i­tal com­mit­ment. Nonethe­less we are always focused on the very best inter­ests of the Fund and we will con­tin­ue to assess the cir­cum­stances for opti­mal cer­tain­ty.”

    ————

    “Solar­Winds denies insid­er trad­ing activ­i­ty ahead of hack rev­e­la­tion” by Dan Pri­mack; Axios; 12/18/2020

    “Per an 8‑K fil­ing, Solar­Winds says its CEO was first informed of the sit­u­a­tion, by Fire­Eye, on Dec. 12.”

    Decem­ber 12. That’s the date Solar­Winds is giv­ing for when its CEP was first informed of the sit­u­a­tion by Fire­Eye. It’s worth not­ing that this answer from CEO does­n’t address whether or not Solar­Winds was already made aware of the hack through oth­er means.

    We also aren’t told by the CPPIB whether or not they knew about the new CEO announce­ment that was came two days after their $315 mil­lion invest­ment. But the CPPIB told Axios it had com­plete :

    ...
    * On Dec. 7, Sil­ver Lake and Thoma Bra­vo sold around $315 mil­lion in Solar­Winds stock to Cana­da Pen­sion Plan Invest­ment Board (CPPIB). The two firms retained equi­ty posi­tions and seats on the Solar­Winds board of direc­tors.
    * On Dec. 8, U.S. cyber­se­cu­ri­ty com­pa­ny Fire­Eye dis­closed that it had been hacked, like­ly by a gov­ern­ment.
    * On Dec. 9, Solar­Winds named its new CEO.

    ...

    * Solar­Winds does­n’t say when the board, includ­ing Sil­ver Lake and Thoma Bra­vo reps, were informed, but the impli­ca­tion is that it could­n’t have been before the 12th. If so, the trades were clean and CPPIB sim­ply has a case of awful luck, as Solar­Winds stock is down 26% on the week.

    ...

    * A CPPIB spokesman declined to com­ment on if the sys­tem was aware of Solar­Winds’ CEO hire when clos­ing its pur­chase.

    The bot­tom line: Expect U.S. secu­ri­ties reg­u­la­tors to trust but ver­i­fy.

    ...

    Update: CPPIB pro­vid­ed Axios with the fol­low­ing state­ment on Fri­day after­noon:

    “Ter­rif­ic part­ners with a long track record of col­lab­o­ra­tion. Real­ly good com­pa­ny and we expect they will con­tin­ue to cre­ate excep­tion­al val­ue along our invest­ment hori­zon.

    To the best of our knowl­edge no one was aware of the hack lead­ing to our cap­i­tal com­mit­ment. Nonethe­less we are always focused on the very best inter­ests of the Fund and we will con­tin­ue to assess the cir­cum­stances for opti­mal cer­tain­ty.”

    ...

    Keep in mind that part of what makes this sit­u­a­tion look so bad for Sil­ver Lake and Thoma Bra­vo is that the two firms basi­cal­ly run Solar­Winds. There’s noth­ing Solar­Winds would know or do that Sil­ver Lake and Thoma Bra­vo did­n’t ful­ly know about and agree to. So ques­tions like the ques­tion of whether or not Solar­Winds know about the hack before Fire­Eye told them on Decem­ber 12 dou­ble as ques­tions of whether Sil­ver Lake and Thoma Bra­vo knew about the hack before Decem­ber 12. We’ll see what, if any, inves­ti­ga­tion hap­pens.

    And who knows, maybe it real­ly was just bad luck for the CPPIB and great luck for Sil­ver Lake and Thoma Bra­vo. It’s pos­si­ble. Heads we win, tails you lose, because that’s how damn lucky we are. The only non-cheat­ing form of ‘heads we win, tails you lose’. Hope­ful­ly that’s what hap­pened here. Because oth­er­wise the Cana­di­an pub­lic is like­ly going to get ‘unlike­ly’ like this a lot more in the future.

    Posted by Pterrafractyl | December 21, 2020, 12:30 am
  9. Here’s a Finan­cial Times arti­cle about the “K‑shaped” nature of pan­dem­ic eco­nom­ic in the US, where the biggest and strongest com­pa­nies are get­ting big­ger and strong while the small­er and weak­er com­pa­nies get small­er and weak­er or die off com­plete­ly. In many cas­es the pan­dem­ic exac­er­bat­ed and accel­er­at­ed exist­ing trends, like the grow­ing impor­tance of the dig­i­tal sec­tor of the econ­o­my and online retail at the expense of brick-and-mor­tar enter­pris­es. Some com­pa­nies that rely heav­i­ly on brick-and-mor­tar retail have done well this year and seen their mar­ket share grow, but that’s pri­mar­i­ly just the exist­ing giants like Wal­mart, Cost­co, and Home Depot. The giants grew while the lit­tle guy per­ished. That’s one of the mega-trends of 2020.

    The pan­dem­ic also cre­at­ed a sit­u­a­tion where large firms with good cred­it can retain access to his­tor­i­cal­ly low inter­est rates and bor­row mas­sive­ly. Large pub­lic com­pa­nies with invest­ment-grade cred­it rat­ings led a record $2.5 tril­lion of cor­po­rate bor­row­ing this year. At the same time, one study found that the kinds of loans small busi­ness­es rely on from banks become much hard­er to acquire this year as banks tight­ened lend­ing stan­dards. Recall how Repub­li­can Sen­a­tor Pat Toomey demand­ed that a Fed­er­al Reserve pro­gram that could act as a lender of “last resort” for small and mid-sized busi­ness­es be per­ma­nent­ly end­ed as a price of get­ting his sup­port for the COVID relief bill.

    It’s a reflec­tion of the “K‑shaped” nature of the recov­ery when it comes to big vs small busi­ness­es: the strong are giv­en the best cush­ions mon­ey can buy while the small and weak get their cred­it cut off and then the GOP suck­er-punch­es small busi­ness by pulling the “last resort” finan­cial safe­ty-net for no rea­son. Or as Black­stone CEO Steve Schwarz­man put it, “I think it’s going to turn out to be anoth­er one of those accel­er­a­tion moments,” in ref­er­ence to the 2008 finan­cial cri­sis where firms like Black­stone came out larg­er than ever. It’s anoth­er way of look­ing at the impact of the pan­dem­ic, where exist­ing pre-pan­dem­ic trends are get­ting exac­er­bat­ed and accel­er­at­ed. Things are accel­er­at­ing. Accel­er­at­ing to new debt-fueled heights if you’re on top or accel­er­at­ing into the ground for every­one else:

    The Finan­cial Times

    Cor­po­rate Amer­i­ca expe­ri­ences ‘K‑shaped’ recov­ery
    Many of the largest busi­ness­es got larg­er in 2020 as small­er rivals plunged into cri­sis

    Andrew Edge­cliffe-John­son in New York
    Decem­ber 28 2020

    “These are times when the strong can get stronger,” Nike chief exec­u­tive John Don­a­hoe said in Sep­tem­ber, as he cel­e­brat­ed the dig­i­tal invest­ments and robust brand that helped the sports­wear group to increase its earn­ings even as Covid-19 closed its stores.

    Nike was far from the only house­hold name boast­ing of resilient prof­its and a grow­ing share of a mar­ket it already leads. From Ama­zon to Star­bucks, McDonald’s to Mon­delez, many of America’s biggest busi­ness­es got big­ger this year, even as the tur­moils of Covid-19 plunged small­er rivals into cri­sis.

    Just as Black­stone had been “a huge win­ner com­ing out of the glob­al finan­cial cri­sis”, chief exec­u­tive Steve Schwarz­man told ana­lysts who fol­low the pri­vate equi­ty group recent­ly, “I think it’s going to turn out to be anoth­er one of those accel­er­a­tion moments.”

    The unequal, “K‑shaped” recov­ery that econ­o­mists fear is divid­ing the wider US econ­o­my is also play­ing out across cor­po­rate Amer­i­ca, as the pan­dem­ic deep­ens the gulf between the largest, best-financed com­pa­nies and those lack­ing scale, lead­ing brands or robust bal­ance sheets.

    Bank and cen­tral bank poli­cies cou­pled with shifts in con­sumer behav­iour have accen­tu­at­ed trends that were already putting more wealth and growth in the hands of a few large com­pa­nies, accord­ing to aca­d­e­mics, con­sul­tants and cor­po­rate advis­ers.

    That, some of them warn, threat­ens to reduce com­pe­ti­tion, sti­fle inno­va­tion and hold back small­er busi­ness­es that are sup­posed to be sources of job cre­ation and eco­nom­ic dynamism.

    “The last year’s clear­ly been K‑shaped,” said James Manyi­ka, chair­man of the McK­in­sey Glob­al Insti­tute, not­ing that an MGI analy­sis found almost all of the “super­star” com­pa­nies at the top of its rank­ings had become stronger in 2020.

    That part­ly reflect­ed the fact that the group fea­tured many tech­nol­o­gy and phar­ma­ceu­ti­cal com­pa­nies, and that most of its mem­bers had the glob­al reach to ride out local Covid-19 waves.

    But the year’s win­ners had also typ­i­cal­ly invest­ed more in the dig­i­tal tools which became crit­i­cal as employ­ees and cus­tomers scat­tered.

    Even with­in sec­tors, “the vari­a­tions between the most and least digi­tised com­pa­nies were huge”, Mr Manyi­ka said. From retail­ers forced to step up their ecom­merce offer­ings to banks need­ing to move more trans­ac­tions online, “the dig­i­tal­ly enabled ones were ready for this moment”.

    ‘It reminds them of their child­hood’

    The trend towards cor­po­rate con­cen­tra­tion began long before the pan­dem­ic, with large US pub­lic com­pa­nies seiz­ing a grow­ing share of eco­nom­ic activ­i­ty since the mid-1990s, Dart­mouth pro­fes­sor Vijay Govin­dara­jan and col­leagues found in a study last year.

    Small com­pa­nies have found it increas­ing­ly hard to “escape their class”, they wrote, while the biggest busi­ness­es have had the resources to invest in assets includ­ing their brands.

    The com­pa­nies that went into the pan­dem­ic with the strongest brands most­ly extend­ed their lead, as cus­tomers retreat­ed to famil­iar sup­pli­ers.

    ...

    Bureau of Labor Sta­tis­tics data show the human impact of a diver­gence that hap­pened part­ly along sec­toral lines.

    Couri­er and ware­hous­ing com­pa­nies fuelling the ecom­merce boom, tech groups, and big banks and insur­ers were among the few to add jobs in 2020. In the more frag­ment­ed arts and enter­tain­ment world, and at hotel and air­line com­pa­nies which were sin­gu­lar­ly strick­en by the pan­dem­ic, the lay-offs fell heav­i­ly.

    The same data set also reveals the divide between win­ners and losers with­in cer­tain sec­tors. The only retail­ers beyond those sell­ing food and alco­hol to have cre­at­ed jobs in the year to Novem­ber were big box retail­ers such as Wal­mart and Cost­co, and those sell­ing build­ing mate­ri­als and gar­den sup­plies, such as Home Depot.

    In their lat­est earn­ings state­ments, Wal­mart, Cost­co and Home Depot report­ed year-on-year sales increas­es of 5.3 per cent, 16.9 per cent and 23 per cent respec­tive­ly.

    Each has seen its shares rise more than 20 per cent this year, even as Amazon’s grow­ing ecom­merce dom­i­nance lift­ed its stock more than two-thirds.

    Much of the diver­gence stems from big­ger com­pa­nies’ eas­i­er access to cap­i­tal, accord­ing to Olivi­er Dar­mouni, a Colum­bia Busi­ness School eco­nom­ics pro­fes­sor.

    Large pub­lic com­pa­nies with invest­ment-grade cred­it rat­ings led a record $2.5tn of cor­po­rate bor­row­ing this year. That posi­tioned exist­ing indus­try lead­ers such as Ford and Gen­er­al Motors to be ready when demand for their prod­ucts began to recov­er.

    By con­trast, a study led by Mr Dar­mouni showed that the more cost­ly bank loans on which small­er com­pa­nies are more depen­dent became much hard­er to access this year as banks tight­ened their lend­ing stan­dards. The increase in bank cred­it in the first half of 2020 “came almost entire­ly from draw­downs by large firms on pre-com­mit­ted lines of cred­it”, his research con­clud­ed.

    “There’s a very clear pre­mi­um from being large,” he said. “The con­tracts that were signed in good times are... only reli­able if you’re a big firm.”

    ‘It doesn’t trick­le down’

    The past year has shown not only how unequal­ly cred­it flowed, but also how pol­i­cy respons­es to the cri­sis risked ampli­fy­ing the trend, Mr Dar­mouni said.

    “The Fed and the Trea­sury are used to help­ing big com­pa­nies like big automak­ers and big banks. They’re not used to deal­ing with small­er com­pa­nies. The big les­son there is it doesn’t trick­le down,” he said.

    The biggest cor­po­rate casu­al­ties of 2020 were those which went into the pan­dem­ic with frag­ile bal­ance sheets, such as Hertz, the car rental com­pa­ny, and out-of-favour oper­a­tors in mar­kets such as retail, restau­rants and prop­er­ty which suf­fer from over­ca­pac­i­ty.

    “The pan­dem­ic has exac­er­bat­ed the strength of the good and sim­i­lar­ly high­light­ed the weak­ness­es of the worst com­pa­nies,” said Mohsin Meghji, chief exec­u­tive of the restruc­tur­ing advi­so­ry group M‑III Part­ners.

    Poor­ly cap­i­talised com­pa­nies out­side their industry’s top two or three com­peti­tors could “mud­dle along” in a strong econ­o­my, he said, but now “peo­ple will direct their cap­i­tal to the sur­vivors and remove it from the ones that shouldn’t sur­vive”.

    Mr Meghji now expect­ed “sig­nif­i­cant ratio­nal­i­sa­tion” in those over­crowd­ed sec­tors, with some weak com­pa­nies sell­ing to their indus­tries’ win­ners and oth­ers col­laps­ing alto­geth­er.

    If that hap­pened, he argued, “Covid could end up being a sig­nif­i­cant cat­a­lyst for mak­ing the Amer­i­can econ­o­my a lot more clear and com­pet­i­tive because it’s forced what should have tak­en place over five, sev­en or 10 years to hap­pen much faster.”

    Accord­ing to MGI’s Mr Manyi­ka, rough­ly half of the win­ners of one busi­ness cycle fall out of the “super­star” ranks in the next cycle. That, he said, raised ques­tions about how long the K‑shaped dynam­ic would last.

    Those com­pa­nies that ben­e­fit­ed from stim­u­lus-boost­ed con­sumer spend­ing this year could suf­fer if pol­i­cy inter­ven­tions fall short in 2021, while those that depend­ed on a for­giv­ing debt mar­ket “can only rely on [their] bal­ance sheet for so long before share­hold­ers say ‘we can’t keep sup­port­ing this’”, Mr Manyi­ka observed.

    “Even­tu­al­ly, demand has to show back up.”

    ———

    “Cor­po­rate Amer­i­ca expe­ri­ences ‘K‑shaped’ recov­ery” by Andrew Edge­cliffe-John­son; The Finan­cial Times; 12/28/2020

    “Just as Black­stone had been “a huge win­ner com­ing out of the glob­al finan­cial cri­sis”, chief exec­u­tive Steve Schwarz­man told ana­lysts who fol­low the pri­vate equi­ty group recent­ly, “I think it’s going to turn out to be anoth­er one of those accel­er­a­tion moments.”

    Anoth­er “accel­er­a­tion moment” is upon us. That’s how Black­stone’s CEO sees the sit­u­a­tion and he should know. The “accel­er­a­tion moment” the pri­vate equi­ty giant has expe­ri­enced for over a decade now fol­low­ing the 2008 finan­cial cri­sis is accel­er­at­ing some more. But it’s not just Black­stone expe­ri­enc­ing this “accel­er­a­tion moment”, and these “accel­er­a­tion moments” did­n’t start with the 2008 cri­sis. Large cor­po­ra­tions in the US have had a grow­ing share of the over­all econ­o­my for decades now. It’s been a mega-meta-trend in the US ever since it decid­ed to embrace Reaganomics and sup­ply-side eco­nom­ic poli­cies. And now that mega-meta-trend is get­ting tur­bocharged by a pan­dem­ic that is sys­tem­at­i­cal­ly con­sol­i­dat­ing the posi­tion of largest indus­try lead­ers at the same time small and weak­er play­ers are sys­tem­at­i­cal­ly dri­ven out of busi­ness:

    ...
    The unequal, “K‑shaped” recov­ery that econ­o­mists fear is divid­ing the wider US econ­o­my is also play­ing out across cor­po­rate Amer­i­ca, as the pan­dem­ic deep­ens the gulf between the largest, best-financed com­pa­nies and those lack­ing scale, lead­ing brands or robust bal­ance sheets.

    Bank and cen­tral bank poli­cies cou­pled with shifts in con­sumer behav­iour have accen­tu­at­ed trends that were already putting more wealth and growth in the hands of a few large com­pa­nies, accord­ing to aca­d­e­mics, con­sul­tants and cor­po­rate advis­ers.

    That, some of them warn, threat­ens to reduce com­pe­ti­tion, sti­fle inno­va­tion and hold back small­er busi­ness­es that are sup­posed to be sources of job cre­ation and eco­nom­ic dynamism.

    ...

    The trend towards cor­po­rate con­cen­tra­tion began long before the pan­dem­ic, with large US pub­lic com­pa­nies seiz­ing a grow­ing share of eco­nom­ic activ­i­ty since the mid-1990s, Dart­mouth pro­fes­sor Vijay Govin­dara­jan and col­leagues found in a study last year.

    Small com­pa­nies have found it increas­ing­ly hard to “escape their class”, they wrote, while the biggest busi­ness­es have had the resources to invest in assets includ­ing their brands.

    The com­pa­nies that went into the pan­dem­ic with the strongest brands most­ly extend­ed their lead, as cus­tomers retreat­ed to famil­iar sup­pli­ers.

    ...

    The same data set also reveals the divide between win­ners and losers with­in cer­tain sec­tors. The only retail­ers beyond those sell­ing food and alco­hol to have cre­at­ed jobs in the year to Novem­ber were big box retail­ers such as Wal­mart and Cost­co, and those sell­ing build­ing mate­ri­als and gar­den sup­plies, such as Home Depot.

    In their lat­est earn­ings state­ments, Wal­mart, Cost­co and Home Depot report­ed year-on-year sales increas­es of 5.3 per cent, 16.9 per cent and 23 per cent respec­tive­ly.
    ...

    And it’s a trend that showed up crys­tal clear in the 2020 bank lend­ing trends, where cor­po­ra­tions bor­rowed a record $2.5 tril­lion and yet, in the first half of the year, vir­tu­al­ly ALL of the addi­tion­al bank lend­ing was being giv­en to large cor­po­ra­tions with strong cred­it-lines. Big cor­po­ra­tions were giv­en a gold­en cred­it card at the same time their small­er or weak­er com­peti­tors found it hard­er to bor­row:

    ...
    Much of the diver­gence stems from big­ger com­pa­nies’ eas­i­er access to cap­i­tal, accord­ing to Olivi­er Dar­mouni, a Colum­bia Busi­ness School eco­nom­ics pro­fes­sor.

    Large pub­lic com­pa­nies with invest­ment-grade cred­it rat­ings led a record $2.5tn of cor­po­rate bor­row­ing this year. That posi­tioned exist­ing indus­try lead­ers such as Ford and Gen­er­al Motors to be ready when demand for their prod­ucts began to recov­er.

    By con­trast, a study led by Mr Dar­mouni showed that the more cost­ly bank loans on which small­er com­pa­nies are more depen­dent became much hard­er to access this year as banks tight­ened their lend­ing stan­dards. The increase in bank cred­it in the first half of 2020 “came almost entire­ly from draw­downs by large firms on pre-com­mit­ted lines of cred­it”, his research con­clud­ed.

    “There’s a very clear pre­mi­um from being large,” he said. “The con­tracts that were signed in good times are... only reli­able if you’re a big firm.”
    ...

    And note the way the pan­demic’s tur­bocharg­ing of this trend of more and more indus­try con­sol­i­da­tion — where only the top lead­ers in each sec­tor sur­vive as their com­pe­ti­tion per­ish­es or are forced to let them­selves get bought out — is spun by Mohsin Meghji, chief exec­u­tive of the ‘restruc­tur­ing advi­so­ry’ group M‑III Part­ners, which is the kind of busi­ness that makes its mon­ey when oth­er busi­ness­es are going through things like bank­rupt­cy. He described the sce­nario of the pan­dem­ic dri­ving the weak­er com­peti­tors out of busi­ness as a good thing for the Amer­i­can econ­o­my. Why? Because, argues Meghji, many of the weak­er com­pe­ti­tions should have been dri­ven out of busi­ness years ago, and once they are final­ly dri­ven out of busi­ness the remain­ing sur­vivors will the the strongest. And there­fore, by con­sol­i­dat­ing the indus­try into an oli­gop­oly, this will cre­ate com­pe­ti­tion by cre­at­ing clar­i­ty in the sec­tor:

    ...
    “The pan­dem­ic has exac­er­bat­ed the strength of the good and sim­i­lar­ly high­light­ed the weak­ness­es of the worst com­pa­nies,” said Mohsin Meghji, chief exec­u­tive of the restruc­tur­ing advi­so­ry group M‑III Part­ners.

    Poor­ly cap­i­talised com­pa­nies out­side their industry’s top two or three com­peti­tors could “mud­dle along” in a strong econ­o­my, he said, but now “peo­ple will direct their cap­i­tal to the sur­vivors and remove it from the ones that shouldn’t sur­vive”.

    Mr Meghji now expect­ed “sig­nif­i­cant ratio­nal­i­sa­tion” in those over­crowd­ed sec­tors, with some weak com­pa­nies sell­ing to their indus­tries’ win­ners and oth­ers col­laps­ing alto­geth­er.

    If that hap­pened, he argued, “Covid could end up being a sig­nif­i­cant cat­a­lyst for mak­ing the Amer­i­can econ­o­my a lot more clear and com­pet­i­tive because it’s forced what should have tak­en place over five, sev­en or 10 years to hap­pen much faster.”
    ...

    Killing off all the small­er and weak­er com­pe­ti­tion with be good for the Amer­i­can econ­o­my and increase com­pe­ti­tion. These are the kinds of argu­ments we should expect to hear more and more as the eco­nom­ic fall­out con­tin­ues.

    Now, keep in mind that Meghji is echo­ing an argu­ment often heard in the finan­cial sec­tor that the his­tor­i­cal­ly low inter­est rates fol­low­ing the finan­cial cri­sis has cre­at­ed ‘zom­bie’ com­pa­nies that are only viable because of the cheap cost of bor­row­ing and it would have been bet­ter to raise rates and just let them die off (cre­at­ing an even deep Great Reces­sion). And to some extent it’s going to be true that his­tor­i­cal­ly low inter­est rates have allowed for com­pa­nies to sur­vive that would­n’t have oth­er­wise been able to sur­vive with­out years of cheap bor­row­ing costs, albeit to dif­fer­ent degrees in dif­fer­ent sec­tors of the econ­o­my. But it’s obvi­ous­ly not always going to be the the case that the weak­er com­pa­nies — those that can’t sur­vive a pan­dem­ic econ­o­my because they aren’t blessed with the stel­lar cred­it of their larg­er com­peti­tors — are ‘zom­bie’ com­pa­nies that have no viable future and are just burn­ing cash. And for pri­vate equi­ty — where buy­ing dis­tressed com­pa­nies that have a viable future and turn­ing them around is sup­posed to be at the heart of what the indus­try does — they aren’t just inter­est­ed in buy­ing the rem­nants of ‘zom­bie’ com­pa­nies. Healthy firms in the midst of a cred­it squeeze are going to be the juici­est tar­gets. But expect to hear all sorts of excus­es about how the upcom­ing econ­o­my-wide con­sol­i­da­tion is actu­al­ly a good thing because it’s so long-over­due. Oli­gop­o­lies tends to have effec­tive PR.

    Also keep in mind that if ‘good for the econ­o­my’ is defined pure­ly in terms of cor­po­rate prof­its, then, yes, it’s pos­si­ble that a mas­sive pan­dem­ic-dri­ven con­sol­i­da­tion of the US econ­o­my into even few­er hands real­ly will be ‘good’ for the US econ­o­my. Of course, by that def­i­n­i­tion, wealth con­sol­i­da­tion in gen­er­al is as ‘good’ for the econ­o­my and the entire mega-meta-trend of wealth-cap­ture that’s been going on for decades has indeed been ‘great’ for the econ­o­my. One great ‘accel­er­a­tion moment’ that’s been going on for decades and just keeps accel­er­at­ing.

    Posted by Pterrafractyl | January 2, 2021, 10:59 pm
  10. The sto­ry of Robin­hood and GameStop — where small time day traders on a Red­dit mes­sage board used the pow­er of social media and the deep pub­lic antipa­thy towards the super-rich to trig­ger a run­away short-squeeze in GameStop’s stock and bil­lions of dol­lars in loss­es for the hedge funds short­ing the stock — is one of those rare feel good sto­ries where the lit­tle guy seemed to final­ly get the bet­ter of Wall Street for once. But one of the obvi­ous ques­tions raised by the sto­ry was whether or not the ‘lit­tle guy’ investors using social media to orga­nize col­lec­tive runs on stocks were, them­selves, being manip­u­lat­ed by oth­er Wall Street play­ers. And while, at this point, we don’t have evi­dence that the pop­ulist cam­paign to buy GameStop stocks were some­how being dri­ven by large investors, we also should­n’t be too shocked if we do end up learn­ing about pow­er­ful inter­ests who want­ed to see this social media exper­i­ment suc­ceed. Espe­cial­ly since some of the most pow­er­ful pri­vate equi­ty firms on Wall Street were major investors in GameStop and now their hold­ings are worth bil­lions of dol­lars more:

    Vice

    Invest­ment Firms Are the Big Win­ners of the GameStop Stock Rev­o­lu­tion So Far
    Indi­vid­u­als spend­ing hun­dreds or thou­sands of dol­lars on GME stock are up, but the posi­tions of firms like Black­Rock are worth bil­lions.

    by Edward Ong­we­so Jr
    Jan­u­ary 28, 2021, 8:00am

    Over the two past weeks, the stock of ail­ing phys­i­cal video game retail­er GameStop has been sent soar­ing thanks to a per­fect storm of events: greedy hedge funds, an overzeal­ous com­mu­ni­ty of Red­dit day traders, and var­i­ous cycles of hype fueled by social and news media.

    We have a good idea of what got us here. Gamestop investors decid­ed the com­pa­ny was under­val­ued after it announced huge growth in its e‑commerce sales and new board mem­bers focused on con­tin­u­ing that growth. On the oth­er side of the aisle: short sell­ers bet­ting against the company’s stock price. Some, like Cit­ron Research, loud­ly and con­fi­dent­ly declared that buy­ers were “suck­ers” who would eat loss­es once the stock went “back to $20 fast.” Oth­er short sell­ers like Melvin Cap­i­tal, a Wall Street promi­nent hedge fund, sim­ply dou­bled down on short sell­ing with­out any sort of, you know, hedge, on their bets.

    Red­di­tors on the r/WallStreetBets sub­red­dit, social media traders, and buzz gen­er­at­ed from peo­ple like Elon Musk and Chamath Pal­i­hapi­tiya have helped pump GameStop’s stock price, even as short sell­ers have dou­bled down and loaded up on more short posi­tions. To para­phrase Mark Baum in The Big Short: the short sell­ers got greedy, they lost track of the mar­ket, and Wall Street Bets (and even­tu­al­ly every­one else) decid­ed to prof­it from their stu­pid­i­ty. As of this writ­ing, Gamestop is well over $340 and the short sell­ers are in trou­ble. On Fri­day, the vast major­i­ty of these short sell­ing posi­tions expire and they’ll be forced to buy shares they don’t have at stratos­pher­ic prices and eat even greater loss­es than before.

    The dom­i­nant nar­ra­tive of this saga is that it’s essen­tial­ly a mas­sive wealth trans­fer from insti­tu­tion­al investors and hedge funds to “aver­age” peo­ple (who still have enough mon­ey to invest in ran­dom stocks dur­ing a pan­dem­ic). This is true, to a degree. Peo­ple have post­ed sto­ries of now being able to cov­er med­ical bills thanks to GameStop stock, and the orig­i­nal $50,000 invest­ment of the Red­di­tor who start­ed the craze is now worth tens of mil­lions of dol­lars. Bol­ster­ing this nar­ra­tive is the fact that these folks have absolute­ly demol­ished large hedge funds that bet against GameStop, giv­ing it a David vs. Goliath fla­vor.

    But even as the cru­sade con­tin­ues, this isn’t a sim­ple sto­ry of the lit­tle guy win­ning. The enti­ties that own the major­i­ty of GameStop stock are also humon­gous invest­ment firms and pri­vate equi­ty. These enti­ties, such as Fideli­ty and Black­Rock, all own mil­lions of GameStop shares each. Indi­vid­ual day traders spend­ing a few hun­dred or thou­sand dol­lars on GME stock are mak­ing a bit of much-need­ed mon­ey, but these insti­tu­tion­al funds’ posi­tions are now in the bil­lions.

    Take Black­Rock, the mas­sive invest­ment fund which seems to own a chunk of every com­pa­ny, includ­ing 13.2 per­cent of GameStop. Black­Rock owned about 9.2 mil­lion shares worth about $174 mil­lion in Decem­ber 2020 accord­ing to an SEC fil­ing pub­lished on Tues­day. That stake is worth about $3.1 bil­lion right now.

    But wait, there’s more. As short sell­ers scram­ble to cov­er their posi­tion, an investor like Black­rock is in a good posi­tion to help with some­thing called secu­ri­ties lend­ing where “mutu­al funds lend stocks or bonds to gen­er­ate addi­tion­al returns for the funds.” If you are a short sell­er that needs to cov­er your posi­tion, you can always ask Black­Rock to bor­row some of its GameStop shares, pay them a fee, and offer up col­lat­er­al equal in val­ue to the mar­ket val­ue of the loaned GameStop share.

    GameStop’s oth­er big investors are also see­ing their posi­tions rise in val­ue. Board mem­ber Ryan Cohen—who paid rough­ly $76 mil­lion for his 13 per­cent—is also sit­ting on a stake approx­i­mate­ly worth $3 bil­lion. There’s also Don­ald Foss, founder and for­mer chief exec­u­tive of sub­prime auto lender Cred­it Accep­tance Corp. He bought 5 per­cent of Gamestop last Feb­ru­ary for $12 mil­lion, it’s near­ly worth $1.2 bil­lion now.

    ...

    The same is more or less true for oth­er com­pa­nies being pumped by Wall­Street­Bets. They may have net­ted pret­ty returns on AMC by pump­ing up the stock, but its major investors are pri­vate equi­ty firms, hedge funds, and asset man­agers like Sil­ver Lake Group, Black­Rock, Green­vale Cap­i­tal, Van­guard Group, and Mit­tle­man Invest­ment Man­age­ment. Wall­Street­Bets may have wound­ed a few greedy hedge funds, but it’s also (for now) stuff­ing the pock­ets of some while fur­ther enrich­ing oth­er share­hold­ers that will lend secu­ri­ties to hedge funds who were stu­pid enough to dou­ble down on shorts or enter the posi­tion with­out any sort of hedge.

    GameStop’s cur­rent val­u­a­tion will even­tu­al­ly pop, but even if it shoots down to $20 per share, the firms that own GameStop will still be in a bet­ter posi­tion than they were while a bunch of retail investors will prob­a­bly flame out.

    At the end of the day, the stock mar­ket is still a glo­ri­fied casi­no with none of the aes­thet­ic val­ue. That means you can walk out of there with $1 mil­lion, $100 mil­lion, or $10 bil­lion, but as long as the house is still stand­ing, the house is still win­ning. And if you look at the investors for these com­pa­nies, it is very clear the house is still stand­ing.

    —————

    “Invest­ment Firms Are the Big Win­ners of the GameStop Stock Rev­o­lu­tion So Far” by Edward Ong­we­so Jr; Vice; 01/28/2021

    “But even as the cru­sade con­tin­ues, this isn’t a sim­ple sto­ry of the lit­tle guy win­ning. The enti­ties that own the major­i­ty of GameStop stock are also humon­gous invest­ment firms and pri­vate equi­ty. These enti­ties, such as Fideli­ty and Black­Rock, all own mil­lions of GameStop shares each. Indi­vid­ual day traders spend­ing a few hun­dred or thou­sand dol­lars on GME stock are mak­ing a bit of much-need­ed mon­ey, but these insti­tu­tion­al funds’ posi­tions are now in the bil­lions.”

    The lit­tle guy won at the expense of Wall Street. It’s the feel-good part of this sto­ry. The only prob­lem is the lit­tle guy won to the ben­e­fit of some of the biggest play­ers out there too, like pri­vate equi­ty giant Black­Rock. And, impor­tant­ly, this is also going to be true for the rest of the stocks out there that end up being tar­get­ed by future pop­ulist short-squeezes. The biggest win­ners are inevitably going to be the biggest share­hold­ers and the biggest share­hold­ers of com­pa­nies in today’s econ­o­my are inevitably big investors. That’s just the nature of the obscene con­cen­tra­tion of wealth in mod­ern Amer­i­ca. The inevitable win­ners of any short-squeezes are going to be major share­hold­ers who will ulti­mate­ly be the super-rich:

    ...
    Take Black­Rock, the mas­sive invest­ment fund which seems to own a chunk of every com­pa­ny, includ­ing 13.2 per­cent of GameStop. Black­Rock owned about 9.2 mil­lion shares worth about $174 mil­lion in Decem­ber 2020 accord­ing to an SEC fil­ing pub­lished on Tues­day. That stake is worth about $3.1 bil­lion right now.

    ...

    The same is more or less true for oth­er com­pa­nies being pumped by Wall­Street­Bets. They may have net­ted pret­ty returns on AMC by pump­ing up the stock, but its major investors are pri­vate equi­ty firms, hedge funds, and asset man­agers like Sil­ver Lake Group, Black­Rock, Green­vale Cap­i­tal, Van­guard Group, and Mit­tle­man Invest­ment Man­age­ment. Wall­Street­Bets may have wound­ed a few greedy hedge funds, but it’s also (for now) stuff­ing the pock­ets of some while fur­ther enrich­ing oth­er share­hold­ers that will lend secu­ri­ties to hedge funds who were stu­pid enough to dou­ble down on shorts or enter the posi­tion with­out any sort of hedge.
    ...

    Again, we don’t have any evi­dence that these finan­cial giants active­ly used anony­mous social media accounts to orches­trate this pop­ulist short-squeeze. But we can be pret­ty sure they’re think­ing about it now. Why would­n’t they? All they would poten­tial­ly need is a few influ­en­tial per­son­al­i­ties on these stock trad­ing social media boards to get the nar­ra­tive going again. For all we know, we just saw the dawn­ing of a new era of social-media-dri­ven mar­ket manip­u­la­tion that’s only just get­ting start­ed.

    At the same time, the idea of using gen­uine grass­roots col­lec­tive actions by small-time investors to bank­rupt a hedge fund and dilute the dan­ger­ous con­cen­tra­tions of wealth is indeed quite appeal­ing. If social media can real­ly be used to make things at least a lit­tle less rigged in favor of the super-rich that should prob­a­bly be seen as a pos­i­tive devel­op­ment. So it’s going to be inter­est­ing to see what the future holds for online social-media dri­ven pop­ulist invest­ment cam­paigns.

    Still, keep in mind that if a soci­ety relies on the col­lec­tive actions of the lit­tle guy to out-rig the big guy in high­ly-manip­u­lat­ed finan­cial mar­kets as a means of address­ing the broad­er issue of obscene socioe­co­nom­ic inequal­i­ty, that’s still clos­er to a peas­ant revolt than a real democ­ra­cy. Actu­al­ly tax­ing the super-rich in ways they can’t dodge, break­ing up the grotesque con­cen­tra­tions of wealth, and final­ly reg­u­lat­ing the rou­tine mar­ket manip­u­la­tion car­ried out by the hedge fund indus­try is prob­a­bly going to be a lot more effec­tive, and won’t end up acci­den­tal­ly mak­ing bil­lions more for Black­Rock.

    Posted by Pterrafractyl | January 30, 2021, 3:07 pm
  11. Here’s a set of arti­cles about an emerg­ing trend in the pri­vate equi­ty indus­try: spe­cial pur­pose acqui­si­tion com­pa­nies (SPACs). It turns out SPACs are the new hot thing, with record fil­ings in 2020, and the “king of SPACs” just hap­pens to be Chamath Pal­i­hapi­tiya, the Sil­i­con Val­ley investor who announced that he’s inter­est­ed in run­ning against Gavin New­som in Cal­i­for­ni­a’s guber­na­to­r­i­al recall race. Run­ning as a pop­ulist. Sort of. The kind of pop­ulist who talks like a left­ist with social jus­tice con­cerns but is also call­ing for elim­i­nat­ing the state income tax. The kind of left­ist who recent­ly said the surge in the val­ue of Bit­coin was a sign of the fragili­ty of the finan­cial sys­tem and the com­ing replace­ment of the dol­lar as the glob­al reserve cur­ren­cy with a cryp­tocur­ren­cy ‘sta­ble­coin’. The recall effort Pal­i­hapi­tiya has jumped into appears to be a far right project with heavy back­ing from the QAnon com­mu­ni­ty, so we have a Sil­i­con Val­ley investor who has been build­ing his ‘pub­lic mav­er­ick’ cred in recent years play­ing a major role in facil­i­tat­ing a far right recall effort so he can run a ‘pop­ulist’ cam­paign against the Demo­c­ra­t­ic gov­er­nor. The red flags are boun­ti­ful.

    Pal­i­hapi­tiya’s career in Sil­i­con Val­ley was most­ly work in the ven­ture cap­i­tal side of things with some years work­ing on the tech­nol­o­gy side at AOL and Face­book. Fol­low­ing a stint at AOL in 2004, Pal­i­hapi­tiya got his start in Sil­i­con Val­ley’s invest­ment com­mu­ni­ty at the May­field ven­ture cap­i­tal fund in 2005 before jump­ing over to Face­book in 2007 to be senior exec­u­tive to work on their mes­sag­ing ser­vice. He left Face­book to start his ven­ture cap­i­tal fund Social Cap­i­tal in 2011. As we’ve seen, he’s been strik­ing an increas­ing­ly pop­ulist tone in recent year. Recall how, in 2017, he told audi­ences that he felt Face­book and social media are tear­ing soci­ety apart and exploit­ing human psy­chol­o­gy. Grow­ing up as a poor immi­grant in Cana­da, he’s also spo­ken pos­i­tive­ly of things like social safe­ty-nets and the role they played in his life. He even said in 2016 that he would have thrown Peter Thiel off the boards of com­pa­nies he owns over Thiel’s back­ing of Don­ald Trump.

    So Pal­i­hapi­tiya has brand­ed him­self as anoth­er ‘can­did’ Sil­i­con Val­ley per­son­al­i­ty who is high­ly crit­i­cal of the sys­tem that has made him a bil­lion­aire. But as we’ll see, he’s simul­ta­ne­ous­ly got a his­to­ry of rail­ing against gov­ern­ment and push­ing ‘small gov­ern­ment’ mar­ket-based pol­i­cy solu­tions that sound a lot like lib­er­tar­i­an­ism. And he just hap­pens to owe his suc­cess great­ly to Peter Thiel, who intro­duced him to the ‘Pay­Pal Mafia’ net­work of investors when he was set­ting up his ven­ture cap­i­tal fund Social Cap­i­tal in 2011. It appears that Pal­i­hapi­tiya is either loved or hat­ed in the Sil­i­con Val­ley investor com­mu­ni­ty which makes his asso­ci­a­tion with Thiel’s Pay­Pal Mafia net­work all the more sig­nif­i­cant because he needs them for mon­ey. The broad­er pos­si­ble invest­ment com­mu­ni­ty that comes with SPACs are report­ed­ly part of the appeal they have to Pal­i­hapi­tiya and his polar­iz­ing views in Sil­i­con Val­ley would play into that desire. That’s why it’s impor­tant that Thiel’s net­work of co-investors loves him and, more impor­tant­ly, invests in him. That’s his based of sup­port.

    We can be assured that Cal­i­for­ni­a’s right-wing busi­ness com­mu­ni­ty is going to have an inter­est in cul­ti­vat­ing busi­ness-friend­ly ‘left-wing’ polit­i­cal forces which is part of why this is an impor­tant sto­ry. Recall Pay­Pal Mafia alum and LinkedIn founder Reid Hoff­man, who also has a his­to­ry of pub­licly sup­port­ing Democ­rats while rail­ing against gov­ern­ment bureau­cra­cy and advo­cat­ing for a hyper-cap­i­tal­ist per­va­sive gig econ­o­my. A glob­al gig econ­o­my pow­ered by a kind of super LinkedIn. And now we find what appears to be anoth­er lib­er­tar­i­an wolf in sheep­’s cloth­ing fuel­ing a far right recall cam­paign while putting for­ward a pop­ulist per­sona. And this lib­er­tar­i­an wolf is the king of SPACs, one of the hottest trends in finance.

    So what exact­ly are SPACs? Well, they’re sort like a hybrid of pri­vate equi­ty and pub­licly trad­ed com­pa­nies: investors buy shares in a new­ly formed com­pa­ny, but that com­pa­ny has no pur­pose oth­er than to merge with anoth­er com­pa­ny with the even­tu­al goal of bring­ing the merged com­pa­ny to the pub­lic with an IPO. Com­pared to tra­di­tion­al pri­vate equi­ty, SPAC deals draw from a much larg­er pool of poten­tial investors, have few­er reg­u­la­tions than a tra­di­tion­al IPO, and the found­ing investors tend to get a larg­er share of the result­ing pub­licly trad­ed com­pa­ny with few­er invest­ments. So SPACs are basi­cal­ly an alter­na­tive mod­el to the pri­vate equi­ty indus­try and one that is arguably a bet­ter alter­na­tive, hence the record year for SPACs:

    Reuters

    Wall Street’s SPAC craze scales new heights with record fil­ings

    By Reuters Staff
    Feb­ru­ary 12, 2021 15:53 PM Updat­ed

    (Reuters) — Richard Bran­son and Bar­ry Stern­licht were among more than two dozen investor groups that filed with U.S. reg­u­la­tors on Fri­day to raise new blank-check acqui­si­tion com­pa­nies, set­ting a new record.

    The 28 fil­ings for new spe­cial pur­pose acqui­si­tion com­pa­nies (SPACs) under­score their grow­ing appeal on Wall Street. SPACs raised a record $82 bil­lion last year, and the trend has gath­ered fur­ther steam in the ear­ly weeks of 2021.

    Over­all, 144 SPACs have raised $45.7 bil­lion so far this year, accord­ing to data from SPAC Research, with back­ers includ­ing high-pro­file investors, politi­cians and sports per­son­al­i­ties.

    ...

    Friday’s fil­ings count more than dou­bled a pre­vi­ous record of 13 deals on Feb. 5, SPAC Research said.

    A SPAC is a shell com­pa­ny that rais­es mon­ey in an IPO to merge with a pri­vate­ly held com­pa­ny that then becomes pub­licly trad­ed as a result.

    SPACs have emerged as a pop­u­lar IPO alter­na­tive for com­pa­nies, pro­vid­ing a path to going pub­lic with less reg­u­la­to­ry scruti­ny and more cer­tain­ty over the val­u­a­tion that will be attained and funds that will be raised.

    ————–

    “Wall Street’s SPAC craze scales new heights with record fil­ings” by Reuters Staff; Reuters; 02/12/2021

    “The 28 fil­ings for new spe­cial pur­pose acqui­si­tion com­pa­nies (SPACs) under­score their grow­ing appeal on Wall Street. SPACs raised a record $82 bil­lion last year, and the trend has gath­ered fur­ther steam in the ear­ly weeks of 2021.

    2020 was a record year for SPACS and 2021 is on track for anoth­er record. Wall Street loves these blank check shell com­pa­nies. Because it’s a bet­ter invest­ment to buy a pri­vate com­pa­ny than buy pub­lic stock. In the con­text of the his­toric stock mar­ket mega-bull run of the last decade that even COVID could­n’t stop, the fact that finan­cial cir­cles have record inter­est in blind­ly buy­ing pri­vate com­pa­nies to sell on the stock mar­ket in IPOs is a mar­ket sig­nal in terms of where we are in terms of stock val­u­a­tions rel­a­tive to fun­da­men­tals. It’s also a sign of how much more advan­ta­geous the rules for SPACs are com­pared to the alter­na­tive invest­ment options that the pri­vate equi­ty indus­try rou­tine­ly deals with. And that’s why, as the fol­low­ing Pitch­Book arti­cle makes clear, if SPACs are expe­ri­enc­ing record inflows it’s prob­a­bly the pri­vate equi­ty indus­try we can thank:

    Pitch­Book

    Pri­vate equi­ty plays a star­ring role in 2020’s SPAC boom

    By Adam Lewis
    Sep­tem­ber 17, 2020

    For most of their exis­tence, spe­cial-pur­pose acqui­si­tion com­pa­nies were most­ly unknown. But this year, they’ve become some of the hottest invest­ment vehi­cles on Wall Street, offer­ing com­pa­nies an alter­na­tive to a tra­di­tion­al IPO and open­ing up fer­tile new ground for deal­mak­ers.

    Entre­pre­neurs, busi­ness exec­u­tives, hedge fund founders, politi­cians and sports exec­u­tives have all got­ten in on the act, launch­ing new blank-check com­pa­nies that are now hunt­ing for acqui­si­tion tar­gets. But few seg­ments of the finan­cial world have been as close­ly inter­twined with the SPAC boom as pri­vate equi­ty. Even an indus­try pow­er­house with $414 bil­lion in assets under man­age­ment has joined the fren­zy: On Wednes­day, Apol­lo Glob­al Man­age­ment reg­is­tered its own blank-check com­pa­ny with the SEC, with plans to raise $750 mil­lion.

    For some firms that were ear­ly adopters, this year is the con­tin­u­a­tion of a long­time strat­e­gy. Oth­er firms are dip­ping a toe into the SPAC pool for the first time. For vet­er­ans and new­com­ers alike, these deals have become a pop­u­lar path to cap­i­tal­iz­ing on the mar­ket volatil­i­ty dri­ven by this year’s pan­dem­ic. Alec Gores, the founder and CEO of The Gores Group, told CNBC in August that, because they offer sell­ers flex­i­bil­i­ty, effi­cien­cy and bet­ter val­u­a­tion cer­tain­ty, SPACs have become a great way to get to Wall Street.

    SPACs essen­tial­ly func­tion as shell com­pa­nies, with no oper­a­tions of their own. They first raise cap­i­tal from out­side investors in an IPO, and then lat­er use the pro­ceeds of that offer­ing to acquire a pri­vate com­pa­ny in a reverse merg­er. The tar­get com­pa­ny is still sub­ject to cer­tain reg­u­la­to­ry reviews, but the process offers a sim­pler path onto the pub­lic mar­ket than the usu­al IPO roadshow—particularly now, when trav­el and in-per­son meet­ings are much more dif­fi­cult. SPACs have exist­ed since the 1990s but only began to come into vogue in recent years.

    Few, if any, pri­vate equi­ty exec­u­tives are bet­ter posi­tioned than Gores to speak to the grow­ing appeal of SPACs. His firm launched its first blank-check com­pa­ny in 2015, rais­ing $375 mil­lion that it deployed the next year in a merg­er with Host­ess Brands. Gores has backed five more SPACs in the years since, includ­ing two that were active in August. That month, the firm raised $525 mil­lion from the IPO of a new vehi­cle, and one of its old­er SPACs lined up a $3.4 bil­lion merg­er with Lumi­nar Tech­nolo­gies, a devel­op­er of sen­sors for autonomous cars.

    Busy sum­mer for PE firms and SPACs

    Oth­er pri­vate equi­ty firms have also been busy this past sum­mer. Red­Bird Cap­i­tal Part­ners teamed up with famed base­ball exec­u­tive Bil­ly Beane—the man who inspired “Moneyball”—to launch a SPAC that will aim to acquire a pro­fes­sion­al sports team, rais­ing $575 mil­lion in an August IPO. Days lat­er, Solamere Cap­i­tal, led by Tagg Rom­ney, Mitt Rom­ney’s son, announced plans to raise up to $300 mil­lion for a new SPAC formed in con­junc­tion with for­mer House Speak­er Paul Ryan. And it was report­ed in late August that TPG Cap­i­tal is plan­ning a pair of SPACs, one focus­ing on tech and the oth­er on social impact deals, that will total some $700 mil­lion.

    These new blank-check com­pa­nies are con­tribut­ing to a sig­nif­i­cant spike in SPAC deal count and cap­i­tal raised. As of this writ­ing, 85 dif­fer­ent SPACs have gone pub­lic this year in the US, com­bin­ing to raise more than $39 bil­lion, accord­ing to Pitch­Book data. Those fig­ures are already more than dou­ble the full-year totals for 2019, a year that had estab­lished new annu­al highs.

    Why are SPACs pop­u­lar with PE firms?

    What’s mak­ing SPACs so pop­u­lar, espe­cial­ly among pri­vate equi­ty firms?

    The struc­ture of most reverse merg­ers means the deals require a more mod­est out­lay than tra­di­tion­al buy­outs. A pri­vate equi­ty firm spon­sor­ing a SPAC typ­i­cal­ly buys between 2% and 3% of the shares offered in its pub­lic list­ing.

    “For the pri­vate equi­ty firm, they get a large eco­nom­ic stake in the busi­ness for less upfront invest­ment,” said Cameron Stan­fill, a ven­ture cap­i­tal ana­lyst at Pitch­Book who spe­cial­izes in SPAC research.

    Pri­vate equi­ty investors, of course, are very famil­iar with rais­ing cap­i­tal on the pri­vate mar­ket to finance future takeovers. In a SPAC, they instead draw from pub­lic back­ers, allow­ing them to broad­en their invest­ment base and elim­i­nat­ing the time com­mit­ment and oth­er dif­fi­cul­ties of rais­ing funds from LPs.

    The spon­sors of a SPAC often line up an anchor com­mit­ment through a PIPE deal with an out­side investor, offer­ing pos­si­bil­i­ties for addi­tion­al liq­uid­i­ty after the SPAC goes pub­lic. A recent exam­ple came when hedge fund Mil­len­ni­um Man­age­ment pur­chased a 7.8% stake in Red­Bird’s sports-focused SPAC short­ly after its IPO.

    ...

    ————-

    “Pri­vate equi­ty plays a star­ring role in 2020’s SPAC boom” by Adam Lewis; Pitch­Book; 09/17/2020

    SPACs essen­tial­ly func­tion as shell com­pa­nies, with no oper­a­tions of their own. They first raise cap­i­tal from out­side investors in an IPO, and then lat­er use the pro­ceeds of that offer­ing to acquire a pri­vate com­pa­ny in a reverse merg­er. The tar­get com­pa­ny is still sub­ject to cer­tain reg­u­la­to­ry reviews, but the process offers a sim­pler path onto the pub­lic mar­ket than the usu­al IPO roadshow—particularly now, when trav­el and in-per­son meet­ings are much more dif­fi­cult. SPACs have exist­ed since the 1990s but only began to come into vogue in recent years.”

    Shell com­pa­nies that exist exclu­sive­ly merge with oth­er com­pa­nies and then go pub­lic, but allow for investors from a much broad­er group than tra­di­tion­al pri­vate equi­ty. You can see why pri­vate equi­ty would be inter­est­ed:

    ...
    The struc­ture of most reverse merg­ers means the deals require a more mod­est out­lay than tra­di­tion­al buy­outs. A pri­vate equi­ty firm spon­sor­ing a SPAC typ­i­cal­ly buys between 2% and 3% of the shares offered in its pub­lic list­ing.

    “For the pri­vate equi­ty firm, they get a large eco­nom­ic stake in the busi­ness for less upfront invest­ment,” said Cameron Stan­fill, a ven­ture cap­i­tal ana­lyst at Pitch­Book who spe­cial­izes in SPAC research.

    Pri­vate equi­ty investors, of course, are very famil­iar with rais­ing cap­i­tal on the pri­vate mar­ket to finance future takeovers. In a SPAC, they instead draw from pub­lic back­ers, allow­ing them to broad­en their invest­ment base and elim­i­nat­ing the time com­mit­ment and oth­er dif­fi­cul­ties of rais­ing funds from LPs.
    ...

    SPACs are where it’s at. At least right now when stocks are near record highs and it’s a great time to engage in an IPO.

    And as the fol­low­ing Jacobin arti­cle describes, the ‘king of SPACs’ is cur­rent­ly attempt­ing to unseat the gov­er­nor of Cal­i­for­nia under a ban­ner of pop­ulism. Pop­ulism that, upon clos­er scruti­ny, appears to be a lot of tra­di­tion­al lib­er­tar­i­an­ism and ‘mar­ket-based’ pol­i­cy solu­tion, but sol­id with a gen­uine­ly much more empa­thet­ic mes­sen­ger in Pal­i­hapi­tiya.
    He talks a great game about how the sys­tem is rigged by the pow­er­ful against the mass­es and how this needs to change. And then he pro­pos­es solu­tions that make the pow­er­ful more pow­er­ful. It’s either some seri­ous polit­i­cal con­fu­sion or fun­da­men­tal­ly right-wing pop­ulist cam­paign that has tak­en on a left­ish veneer. And giv­en that Pal­i­hapi­tiya career as a ven­ture cap­i­tal­ist was pro­pelled by his rela­tion­ship with Peter Thiel and his plans for Cal­i­for­nia involve elim­i­nat­ing the state income tax, we should prob­a­bly be sus­pect­ing the worst:

    Jacobin Mag­a­zine

    Sil­i­con Val­ley Star Chamath Pal­i­hapi­tiya Is No Robin Hood

    In the recent GameStop saga, Chamath Pal­i­hapi­tiya por­trayed him­self as a defend­er of the lit­tle guy and float­ed run­ning for office. But beyond the shrewd PR, he’s just anoth­er cor­po­rate-friend­ly Third Way cen­trist with an intense devo­tion to free-mar­ket tri­umphal­ism.

    By Walk­er Brag­man
    02.11.2021

    In all the recrim­i­na­tions over the GameStop trad­ing boom­let last month, bil­lion­aire ven­ture cap­i­tal­ist Chamath Pal­i­hapi­tiya emerged as a con­quer­ing hero. On Twit­ter and in elite media, he was depict­ed as the rare swash­buck­ling, tech age investor with the integri­ty to side with those demand­ing jus­tice for rapa­cious short sell­ers and hedge fund vul­tures. The myth­mak­ing and the euphor­ic enthu­si­asm crescen­doed with him float­ing the idea of a run for gov­er­nor of America’s largest state.

    Pal­i­hapi­tiya was mak­ing an oppor­tu­ni­ty out of Amer­i­can pol­i­tics’ age-old dream of an enlight­ened cap­i­tal­ist-turned-pop­ulist para­chut­ing in to bridge the par­ti­san divide and res­cue the coun­try. But Pal­i­hapi­tiya is not a typ­i­cal man of the peo­ple: beneath the pub­lic image is a par­a­dig­mat­ic tech indus­try oli­garch pro­mot­ing anti-gov­ern­ment ide­ol­o­gy, repack­aged and updat­ed for the social media age.

    Whether or not he ends up run­ning for pub­lic office — he’s said he’s “not ready” to run for gov­er­nor — Pal­i­hapi­tiya rep­re­sents a counter to the resur­gent pro­gres­sive wing of the Demo­c­ra­t­ic Par­ty: a cor­po­rate-friend­ly Third Way cen­trist, with a sprin­kle of social jus­tice rhetoric but also an intense devo­tion to lib­er­tar­i­an free-mar­ket tri­umphal­ism.

    From Col­orado Gov. Jared Polis to Elon Musk and Peter Thiel, the arche­type is increas­ing­ly famil­iar in pol­i­tics and in the online game of think­flu­ence — but Pal­i­hapi­tiya has struck the most pop­ulist pose of all.

    “I Am Biased”

    Pal­i­hapi­tiya, who did not respond to mul­ti­ple requests for com­ment, burst into the nation­al con­scious­ness back in April when he sug­gest­ed in a CNBC inter­view that the fed­er­al gov­ern­ment should not bail out the air­lines and oth­er “zom­bie com­pa­nies.”

    “On Main Street today, peo­ple are get­ting wiped out,” he said. “Right now, rich CEOs are not, boards that have hor­ri­ble gov­er­nance are not. Peo­ple are.”

    Pal­i­hapi­tiya did not make his wealth on Main Street. He was an ear­ly Face­book exec­u­tive, and on the side he invest­ed in com­pa­nies such as Dis­ney and Thiel’s Palan­tir — the lat­ter of which came under fire in 2019 for pro­vid­ing Immi­gra­tion and Cus­toms Enforce­ment (ICE) with the dig­i­tal pro­fil­ing tools it need­ed to car­ry out for­mer pres­i­dent Don­ald Trump‘s depor­ta­tion agen­da. Thiel, a cofounder of Pay­Pal who was on Facebook’s board, became a busi­ness con­tact and ear­ly investor in Palihapitiya’s com­pa­ny, Social Cap­i­tal, and intro­duced Pal­i­hapi­tiya to oth­er Pay­Pal exec­u­tives.

    Pal­i­hapi­tiya has now become a viral sen­sa­tion after he weighed in on the shake­up on Wall Street over GameStop and oth­er “meme stocks,” which retail traders coor­di­nat­ing on Red­dit pumped up in val­ue to stick it to hedge fund short sell­ers. In anoth­er CNBC inter­view, he defend­ed the Red­di­tors.

    “I think what you’re see­ing is a push­back against the estab­lish­ment in a real­ly impor­tant way,” said the ven­ture cap­i­tal­ist.

    It was a per­fect TV moment, coin­cid­ing with spec­u­la­tion over a guber­na­to­r­i­al run. Pal­i­hapi­tiya went on to con­demn Wall Street spec­u­la­tors for their role in caus­ing the 2008 sub­prime mort­gage cri­sis, not­ing that mil­lions of Amer­i­cans nev­er tru­ly recov­ered.

    The next day, after Robin­hood halt­ed pur­chas­es of the so-called meme stocks, Pal­i­hapi­tiya exco­ri­at­ed the bro­ker­age. He rec­om­mend­ed alter­na­tives to Robinhood’s app, includ­ing one in which his firm has a stake.

    “Here are three apps you can use to replace Robin­hood: 1) @SoFi * 2) @CashApp 3) @public,” Pal­i­hapi­tiya wrote in a tweet that was shared thou­sands of times. “*Dis­claimer: I am tak­ing this com­pa­ny pub­lic via $IPOE so I am biased, but I think it kicks ass.”

    I remem­ber when I met the @RobinhoodApp founders when they were rais­ing their Seed, Series A and Series B. I passed.Why? Opti­mize for integri­ty when­ev­er pos­si­ble because integri­ty com­pounds and ass­holes will fuck you.#DeleteR­obin­hood— Chamath Pal­i­hapi­tiya (@chamath) Jan­u­ary 29, 2021

    A day lat­er, Pal­i­hapi­tiya com­pared Robin­hood to Face­book, sug­gest­ing the bro­ker­age had turned users of its app into a prod­uct by sell­ing their data — pre­sum­ably a dig at Robinhood’s rela­tion­ship with Citadel LLC, a hedge fund with which it has an order-flow agree­ment.

    Face­book and @RobinhoodApp are the same:They both trick you into think­ing you are the cus­tomer. But, in fact, you are the prod­uct and your data is the asset. These assets are then sold to their true cus­tomers who pay them mon­ey and always at your expense.STOP BEING TRICKED!— Chamath Pal­i­hapi­tiya (@chamath) Jan­u­ary 29, 2021

    SoFi Active Invest­ing is being brought pub­lic by Social Cap­i­tal. And despite Palihapitiya’s repeat­ed crit­i­cism of Robin­hood, SoFi engages in sim­i­lar prac­tices to the app, in that it has an order-flow agree­ment with clear­ing­house Apex — a firm that is par­tial­ly owned by SoFi, accord­ing to its S‑4.

    The King of SPACs

    Pal­i­hapi­tiya emerged a “hero,” as Vox’s Recode put it, for appar­ent­ly weigh­ing in on the side of Red­dit retail investors. While Red­di­tors were call­ing on their fel­low investors to hold, Pal­i­hapi­tiya bought in and sold off the meme stocks, mak­ing $500,000. And while he announced that the mon­ey would go to the Barstool Fund for small busi­ness, many Red­di­tors end­ed up hold­ing the bag on the stocks he tac­it­ly pro­mot­ed, suf­fer­ing stag­ger­ing loss­es.

    Indeed, the big win­ners appeared to be Palihapitiya’s pub­lic image and SoFi. Shares of Social Capital’s spe­cial pur­pose acqui­si­tion com­pa­ny (SPAC) linked to SoFi shot up rough­ly 30 per­cent the day Pal­i­hapi­tiya com­pared Robin­hood to Face­book.

    Pal­i­hapi­tiya is known as the king of SPACs, which are shell com­pa­nies used as vehi­cles to take oth­er com­pa­nies pub­lic. SPACs are a cheap­er and faster alter­na­tive to the ini­tial pub­lic offer­ing (IPO) route but come with more risks for investors who effec­tive­ly go in blind since the com­pa­nies are formed with­out spe­cif­ic tar­gets in mind. In the 1980s, they were known as “blank check com­pa­nies” and were hotbeds for fraud, though the rules sur­round­ing them have been tight­ened since.

    A recent, exten­sive report from short sell­ing firm Hin­den­burg Research alleged that a com­pa­ny brought pub­lic by a Pal­i­hapi­tiya SPAC, Clover Health, was fac­ing an undis­closed Depart­ment of Jus­tice inves­ti­ga­tion, among oth­er issues.

    Respond­ing to the report, Pal­i­hapi­tiya tweet­ed that the Hin­den­burg report was “rife with per­son­al attacks, thin facts and blus­ter that has been rebuked by the com­pa­ny.” He called on investors to “trust the process.”

    For those fol­low­ing $CLOV, trust the process and the facts. pic.twitter.com/AfSHhNVLSe— Chamath Pal­i­hapi­tiya (@chamath) Feb­ru­ary 5, 2021

    Hin­den­burg fired back:

    The fact is we do “trust the process”; our own research process – and we didn’t need your help to find the same “truth” you should have already dis­closed to $CLOV investors.

    “If the Gov­ern­ment Shuts Down, Noth­ing Hap­pens”

    Palihapitiya’s pop­ulism is laced with lib­er­tar­i­an, anti-gov­ern­ment views.

    In a 2017 inter­view on CNBC, he echoed Ron Paul in encour­ag­ing peo­ple to invest in Bit­coin, which he said would even­tu­al­ly reach $1 mil­lion a coin, explain­ing that the cryp­tocur­ren­cy was “a fan­tas­tic, fun­da­men­tal hedge and store val­ue against auto­crat­ic regimes and bank­ing infra­struc­ture that we know is cor­ro­sive to how the world needs to work prop­er­ly.”

    “You can­not have cen­tral banks infi­nite­ly print­ing cur­ren­cy,” he said. “You can­not have folks with mis­guid­ed and mis­di­rect­ed fis­cal pol­i­cy.”

    Pal­i­hapi­tiya has tout­ed social safe­ty nets, telling Insti­tu­tion­al Investor that as a Sri Lankan refugee who grew up in Cana­da, he was “a by-prod­uct of an enor­mous num­ber of pro­gres­sive ideals—universal health care, almost-free basic edu­ca­tion, a social wel­fare pol­i­cy to take care of the low­est rungs of soci­ety but give them a path of upward mobil­i­ty.”

    How­ev­er, there’s an inher­ent ten­sion between those views and his anti-tax zealotry. For exam­ple, Pal­i­hapi­tiya has sug­gest­ed zero­ing out the cap gains tax rate over time.

    “There should be a step down in cap­i­tal gains tax for indi­vid­u­als as they hold stocks. 20% per year decrease in cap gains tax. 0% after a five year hold peri­od,” he tweet­ed. “Reward long term behav­ior.”

    It’s not just fed­er­al tax­es Pal­i­hapi­tiya wants to cut. He has also called for slash­ing California’s tax rate to zero and tout­ed pop­u­la­tion growth in low tax states.

    If you recall @GavinNewsom here is my plat­form for Governor:1) Cut CA income tax from 16% to 0%2) free edu­ca­tion vouch­ers for all kids3) $2k for every new child born and raised in CA4) make CA the glob­al cen­ter of all tech and cli­mate job­sWho wants some?— Chamath Pal­i­hapi­tiya (@chamath) Jan­u­ary 16, 2021

    An amaz­ing graph:1) All US cities with pop­u­la­tion growth are in states where income tax­es are 5% or less2) 5 of 9 US cities (55%) with pop­u­la­tion growth are in states with zero income taxes3) Back­drop is only 7 states (14%) in the US have zero income tax­es pic.twitter.com/F6aOtELLqc— Chamath Pal­i­hapi­tiya (@chamath) June 12, 2020

    ...

    Palihapitiya’s polit­i­cal phi­los­o­phy tout­ing the suprema­cy of cor­po­ra­tions and den­i­grat­ing the pub­lic sec­tor was summed up most suc­cinct­ly in a state­ment he made in 2013 about the loom­ing gov­ern­ment shut­down.

    “If com­pa­nies shut down, the stock mar­ket would col­lapse,” he said at the time. “If the gov­ern­ment shuts down, noth­ing hap­pens and we all move on, because it just doesn’t mat­ter. Sta­sis in the gov­ern­ment is actu­al­ly good for all of us.

    —————

    “Sil­i­con Val­ley Star Chamath Pal­i­hapi­tiya Is No Robin Hood” by Walk­er Brag­man; Jacobin Mag­a­zine; 02/11/2021

    Pal­i­hapi­tiya is known as the king of SPACs, which are shell com­pa­nies used as vehi­cles to take oth­er com­pa­nies pub­lic. SPACs are a cheap­er and faster alter­na­tive to the ini­tial pub­lic offer­ing (IPO) route but come with more risks for investors who effec­tive­ly go in blind since the com­pa­nies are formed with­out spe­cif­ic tar­gets in mind. In the 1980s, they were known as “blank check com­pa­nies” and were hotbeds for fraud, though the rules sur­round­ing them have been tight­ened since.”

    The king of SPACs wants to become gov­er­nor of Cal­i­for­nia. He’s talk­ing a pop­ulist game. But he also talks like a cor­po­ratist lib­er­tar­i­an who at best presents a ‘Third Way’-style cen­ter-Right col­lec­tion of pol­i­cy pre­scrip­tions while pump­ing Bit­coin, rail­ing against ‘big gov­ern­ment’ and advo­cat­ing a gov­ern­ment shut down. Even his pro­pos­als for Cal­i­for­nia include elim­i­nat­ing Cal­i­for­ni­a’s income tax:

    ...
    Pal­i­hapi­tiya was mak­ing an oppor­tu­ni­ty out of Amer­i­can pol­i­tics’ age-old dream of an enlight­ened cap­i­tal­ist-turned-pop­ulist para­chut­ing in to bridge the par­ti­san divide and res­cue the coun­try. But Pal­i­hapi­tiya is not a typ­i­cal man of the peo­ple: beneath the pub­lic image is a par­a­dig­mat­ic tech indus­try oli­garch pro­mot­ing anti-gov­ern­ment ide­ol­o­gy, repack­aged and updat­ed for the social media age.

    Whether or not he ends up run­ning for pub­lic office — he’s said he’s “not ready” to run for gov­er­nor — Pal­i­hapi­tiya rep­re­sents a counter to the resur­gent pro­gres­sive wing of the Demo­c­ra­t­ic Par­ty: a cor­po­rate-friend­ly Third Way cen­trist, with a sprin­kle of social jus­tice rhetoric but also an intense devo­tion to lib­er­tar­i­an free-mar­ket tri­umphal­ism.

    ...

    Palihapitiya’s pop­ulism is laced with lib­er­tar­i­an, anti-gov­ern­ment views.

    In a 2017 inter­view on CNBC, he echoed Ron Paul in encour­ag­ing peo­ple to invest in Bit­coin, which he said would even­tu­al­ly reach $1 mil­lion a coin, explain­ing that the cryp­tocur­ren­cy was “a fan­tas­tic, fun­da­men­tal hedge and store val­ue against auto­crat­ic regimes and bank­ing infra­struc­ture that we know is cor­ro­sive to how the world needs to work prop­er­ly.”

    “You can­not have cen­tral banks infi­nite­ly print­ing cur­ren­cy,” he said. “You can­not have folks with mis­guid­ed and mis­di­rect­ed fis­cal pol­i­cy.”

    Pal­i­hapi­tiya has tout­ed social safe­ty nets, telling Insti­tu­tion­al Investor that as a Sri Lankan refugee who grew up in Cana­da, he was “a by-prod­uct of an enor­mous num­ber of pro­gres­sive ideals—universal health care, almost-free basic edu­ca­tion, a social wel­fare pol­i­cy to take care of the low­est rungs of soci­ety but give them a path of upward mobil­i­ty.”

    How­ev­er, there’s an inher­ent ten­sion between those views and his anti-tax zealotry. For exam­ple, Pal­i­hapi­tiya has sug­gest­ed zero­ing out the cap gains tax rate over time.

    “There should be a step down in cap­i­tal gains tax for indi­vid­u­als as they hold stocks. 20% per year decrease in cap gains tax. 0% after a five year hold peri­od,” he tweet­ed. “Reward long term behav­ior.”

    It’s not just fed­er­al tax­es Pal­i­hapi­tiya wants to cut. He has also called for slash­ing California’s tax rate to zero and tout­ed pop­u­la­tion growth in low tax states.

    ...

    Palihapitiya’s polit­i­cal phi­los­o­phy tout­ing the suprema­cy of cor­po­ra­tions and den­i­grat­ing the pub­lic sec­tor was summed up most suc­cinct­ly in a state­ment he made in 2013 about the loom­ing gov­ern­ment shut­down.

    “If com­pa­nies shut down, the stock mar­ket would col­lapse,” he said at the time. “If the gov­ern­ment shuts down, noth­ing hap­pens and we all move on, because it just doesn’t mat­ter. Sta­sis in the gov­ern­ment is actu­al­ly good for all of us.
    ...

    And to top it all, we find that Pal­i­hapi­tiya was an ear­ly investor in Peter Thiel’s Palan­tir, with Thiel also invest­ing in Pal­i­hapi­tiya’s ven­ture cap­i­tal firm, Social Cap­i­tal, and intro­duc­ing Pal­i­hapi­tiya to “oth­er Pay­Pal exec­u­tives” which is pre­sum­ably a term for the Pay­Pal Mafia Sil­i­con Val­ley net­work:

    ...
    Pal­i­hapi­tiya did not make his wealth on Main Street. He was an ear­ly Face­book exec­u­tive, and on the side he invest­ed in com­pa­nies such as Dis­ney and Thiel’s Palan­tir — the lat­ter of which came under fire in 2019 for pro­vid­ing Immi­gra­tion and Cus­toms Enforce­ment (ICE) with the dig­i­tal pro­fil­ing tools it need­ed to car­ry out for­mer pres­i­dent Don­ald Trump‘s depor­ta­tion agen­da. Thiel, a cofounder of Pay­Pal who was on Facebook’s board, became a busi­ness con­tact and ear­ly investor in Palihapitiya’s com­pa­ny, Social Cap­i­tal, and intro­duced Pal­i­hapi­tiya to oth­er Pay­Pal exec­u­tives.
    ...

    So when we learn that Thiel has been invest­ing in Pal­i­hapi­tiya’s ven­ture cap­i­tal firms, keep in mind that there’s a good chance this broad­er Pay­Pal Mafia net­work of obscene­ly wealthy peo­ple have played a major role in financ­ing Pal­i­hapi­tiya invest­ments, in addi­tion to Thiel. That’s part of why Thiel’s intro­duc­tion of Pal­i­hapi­tiya to the ‘oth­er Pay­Pal exec­u­tives’ is poten­tial­ly a very sig­nif­i­cant detail in Pal­i­hapi­tiya’s career path from senior Face­book exec­u­tive to “king of SPACs” and a big part of why the vot­ers of Cal­i­for­nia should be extreme­ly wary of this ‘pop­ulist’ lib­er­tar­i­an financier claim­ing to be look­ing out for the lit­tle guy. That’s the net­work that’s pro­vid­ing him a base of finan­cial secu­ri­ty while he rails against Sil­i­con Val­ley.

    And as the fol­low­ing May 2020 pro­file of Pal­i­hapi­tiya in Insti­t­u­a­tion­al Investor describes, his grow­ing rep­u­ta­tion as a vocal insid­er crit­ic of the finan­cial sys­tem that dri­ves Sil­i­con Val­ley has and harsh social media crit­ic has made his rela­tion­ships with the Pay­Pal mafia net­work of investors all the more valu­able. Because a lot of the rest of the Sil­i­con Val­ley invest­ment com­mu­ni­ty hates him for his com­ments. So Pal­i­hapi­tiya is seem­ing to wage a pop­ulist insid­er Sil­i­con Val­ley cru­sade with the back­ing of Thiel and the Pay­Pal Mafia. It’s the kind of arrange­ment that should, at a min­i­mum, give one pause. But as the fol­low­ing arti­cle also makes clear, Pal­i­hapi­tiya is very seri­ous about talk­ing his pop­ulist game. Pal­i­hapi­tiya explains that it’s only been in the last few yers that he’s felt free to express his con­trar­i­an views crit­i­cal of the invest­ment com­mu­ni­ty and how things like expect­ed short-term invest­ment returns skew busi­ness deci­sion-mak­ing in a neg­a­tive way. But now he’s free to share how he real­ly feels, which is appar­ent­ly a feel­ing that the sys­tem needs pro­found change. Now, as we now know, that kind of pro­found change includes poli­cies like elim­i­nat­ing Cal­i­for­ni­a’s income tax, which gives us a sense of the kind of pol­i­cy solu­tions. But as this pro­file of Pal­i­hapi­tiya from May fo 2020 makes clear, he’s very much inter­est­ed in cul­ti­vat­ing a pub­lic per­sona of being high­ly crit­i­cal of the sys­temic inequities exem­pli­fied by Sil­i­con Val­ley and very much inter­est­ed in social reform. He wants to be the kind of change agent that advo­cates for fun­da­men­tal change, which is why the foun­da­tions of his true ide­o­log­i­cal ori­en­ta­tion are impor­tant ques­tions yet to be answered:

    Insti­tu­tion­al Investor

    The Unusu­al Ambi­tions of Chamath Pal­i­hapi­tiya

    A bil­lion­aire turns on his own.

    By Michelle Celar­i­er
    May 31, 2020

    Among the gild­ed denizens of Sil­i­con Val­ley, it’s known as the “Who cares? rant.”

    It began when Chamath Pal­i­hapi­tiya argued, in a a CNBC inter­view on April 9, that “zom­bie com­pa­nies” like air­lines did not deserve a bailout from the U.S. gov­ern­ment, despite a glob­al pan­dem­ic that had shut down busi­ness — and trav­el — the world over.

    Then he took aim square­ly at the men (and they are almost entire­ly men) run­ning the hedge funds he blames for the cor­po­rate world’s inabil­i­ty to weath­er a cri­sis in the first place.

    “The peo­ple that get wiped out are the spec­u­la­tors that own the unse­cured tranch­es of debt or the folks that own the equi­ty,” he stressed, unmut­ed insis­tence ris­ing in his voice. “And by the way, those are the rules of the game. That’s right. Because these are the peo­ple who pur­port to be the most sophis­ti­cat­ed investors in the world. They deserve to get wiped out.”

    Pal­i­hapi­tiya con­tin­ued. “Who are we talk­ing about? We’re talk­ing about a hedge fund that serves a bunch of bil­lion­aire fam­i­ly offices. Who cares? Let them get wiped out. Who cares?” And then, with a prac­ticed insou­ciance: “They don’t get to sum­mer in the Hamp­tons? Who cares?”

    By the time of the inter­view, of course, hedge fund man­agers had already fled Man­hat­tan for the Hamp­tons. It was also when tens of mil­lions of Amer­i­cans had signed up for unem­ploy­ment and the coro­n­avirus pan­dem­ic was at its peak in New York City, where hun­dreds of cit­i­zens — most of them work­ing-class peo­ple of col­or — were dying in hos­pi­tals every day.

    “On Main Street today, peo­ple are get­ting wiped out,” an utter­ly calm Pal­i­hapi­tiya remind­ed CNBC’s well-heeled view­ers. “Hedge funds are not.”

    He offers a sly grin when remind­ed of the inter­view — which CNBC esti­mates has been viewed more than 10 mil­lion times — dur­ing the first of two Zoom con­ver­sa­tions with Insti­tu­tion­al Investor in May. How­ev­er, Palihapitiya’s not hav­ing any of that rant busi­ness. “Rants, rants. I pre­fer to call them thought­ful com­men­tary,” he says.

    “I just con­tin­ue to want to say the things that are on my mind,” he explains, his large brown eyes lean­ing for­ward into the com­put­er from a spa­cious sun­room in his Palo Alto home, the light illu­mi­nat­ing the over­size house­plants and cream-col­ored easy chairs behind him. “I don’t think these things are con­tro­ver­sial. These are the things that I believe. And I think what hap­pens is that peo­ple are a lit­tle shocked by the rad­i­cal can­dor in pub­lic because they’re not used to it.”

    These “peo­ple” should start get­ting used to it, for Pal­i­hapi­tiya, it is clear, is not tak­ing on just hedge funds. Whether it’s val­ue-invest­ing “morons,” the Sil­i­con Val­ley ven­ture cap­i­tal­ist elite, or uni­ver­si­ty endow­ments, to name a few of his tar­gets, Pal­i­hapi­tiya — him­self a bil­lion­aire — is doing one thing that many of sim­i­lar means find abhor­rent:

    Turn­ing on his own.

    ********

    It was not his first rant, what­ev­er he’d like to call it. In 2015, for exam­ple, Pal­i­hapi­tiya went after the free-spend­ing hip­ster ways of San Fran­cis­co start-ups in what oth­er VCs refer to as his “Kind bar rant.”

    “It’s fine to fail,” he told atten­dees at a San Fran­cis­co Strict­lyVC event that year. “But if you fail because you didn’t have the courage to move to Oak­land, and instead you burned 30 per­cent of your cash on Kind bars and exposed brick walls in the office, you’re a fuck­ing moron.”

    Then in 2018, Pal­i­hapi­tiya took on the ser­i­al fundrais­ing of that world in his “Ponzi scheme rant.” In a 45-minute inter­view at a Launch Scale con­fer­ence, he attacked the growth-at-all-costs imper­a­tive for start-ups forced to meet the con­stant fundrais­ing, fee-mak­ing needs of their ven­ture cap­i­tal back­ers. “It’s got­ten out of con­trol,” he said, telling atten­dees they were “in the mid­dle of an enor­mous, mul­ti­var­ied kind of Ponzi scheme.”

    Pal­i­hapi­tiya has, of course, prof­it­ed hand­some­ly from the VC busi­ness mod­el he so open­ly dis­dains. The 43-year-old founder of invest­ment firm Social Cap­i­tal — which for sev­er­al years ran both a hedge fund and five ven­ture cap­i­tal funds — cur­rent­ly has a $6 bil­lion bal­ance sheet invest­ed in every­thing from start-ups tack­ling thorny social, eco­nom­ic, and envi­ron­men­tal issues to tech-enabled giants Ama­zon and Tes­la.

    Those two stocks — along with work mes­sag­ing plat­form Slack Tech­nolo­gies (Pal­i­hapi­tiya owns 10 per­cent of the com­pa­ny, which went pub­lic last year) and space tourism pio­neer Vir­gin Galac­tic (which he teamed up with founder Richard Bran­son to buy with his first blank-check com­pa­ny, or SPAC, and of which he is now chair­man) — made up the bulk of Social Capital’s $1.7 bil­lion prof­it last year.

    Such finan­cial suc­cess has, of course, led some to view Palihapitiya’s attacks as hyp­o­crit­i­cal.

    “He’s per­sona non gra­ta with a lot of Sil­i­con Val­ley,” one indi­vid­ual says, men­tion­ing sev­er­al of those Pal­i­hapi­tiya has crit­i­cized by name. They include Marc Andreessen, Sequoia Cap­i­tal, and even Mark Zuckerberg’s Face­book — Palihapitiya’s for­mer employ­er.

    Yet the blunt-speak­ing investor has just as many back­ers with­in that ecosys­tem.

    ...

    Chamath Pal­i­hapi­tiya, a Sri Lankan native whose fam­i­ly received refugee sta­tus in Cana­da when he was a child, start­ed as an out­sider in the tech world. At May­field Fund, where he land­ed his first job in the VC world some 15 years ago, “Chamath wore the same jack­et every day — a light-tan velour jack­et — and jeans,” one for­mer col­league recalls. When the col­league asked Pal­i­hapi­tiya about his sar­to­r­i­al choic­es at the time, the young ana­lyst talked about “low ROI,” mean­ing he didn’t want to spend his time and mon­ey wor­ry­ing about clothes.

    The out­fit was also a not-so-sub­tle way for Pal­i­hapi­tiya to thumb his nose at the Sil­i­con Val­ley dress code of the era: kha­ki pants and blue blaz­er. “His atti­tude was ‘I’m not like all you guys. Fuck you. I’m smarter than you, and I’m going to show you,’” says the for­mer col­league.

    Kapoor, then a May­field prin­ci­pal who had hired Pal­i­hapi­tiya away from AOL, where the young man had a rep­u­ta­tion as some­thing of a wun­derkind after head­ing its instant-mes­sag­ing divi­sion, recalls him as par­tic­u­lar­ly artic­u­late. But Pal­i­hapi­tiya also had mas­tered what has become almost a cliché require­ment for suc­cess in VC land: “He didn’t just think about where things were — but where they were going to go,” Kapoor notes.

    In 2007, Pal­i­hapi­tiya left May­field for Face­book, where he is cred­it­ed with help­ing orches­trate its mas­sive growth. His time at Face­book, and a per­son­al invest­ment in gam­ing com­pa­ny Play­dom, which was sold to Dis­ney, put him on the fast track. Pal­i­hapi­tiya had the cap­i­tal and access to investors to start his own firm, which he named Social+Capital Part­ner­ship, in 2011.

    Kapoor says Palihapitiya’s “mag­net­ic per­son­al­i­ty” drew in the big names. They have includ­ed such well-known VC giants as John Doerr of Klein­er Perkins and Reid Hoff­man, co-founder of LinkedIn, along with hedge fund tech investor Chase Cole­man, the Tiger Glob­al founder. Pal­i­hapi­tiya also gained entrée into the so-called Pay­Pal mafia of tech­nol­o­gy heavy­weights when one of its founders, Peter Thiel — then on the board of Face­book — became an ear­ly investor and intro­duced him to oth­er Pay­Pal execs.

    “Peo­ple want­ed to lis­ten to him,” Kapoor says of Pal­i­hapi­tiya. “Lots of peo­ple can artic­u­late ideas that every­one agrees with, but can you artic­u­late with vision and log­ic ideas that are not main­stream? That’s his gift.”

    Pal­i­hapi­tiya had opened his firm, along with his then-wife Brigette Lau, with a plan to invest in com­pa­nies in fields being ignored by the VC world, like health, finan­cial ser­vices, and edu­ca­tion. But the VC game seems to have worn him down.

    And then he filed for divorce.

    “Every­thing was so suc­cess­ful. I’m work­ing and work­ing and work­ing, but I wasn’t hap­py,” he recalls. “And then as I sought hap­pi­ness in my per­son­al life, I found hap­pi­ness in my pro­fes­sion­al life. I didn’t need to man­age hun­dreds of peo­ple or thou­sands of peo­ple any­more. I want­ed to be a real allo­ca­tor of cap­i­tal, because I want­ed to change the parts of soci­ety I dis­agreed with.”

    Social Cap­i­tal was on the verge of rais­ing a cred­it fund when Pal­i­hapi­tiya found he could not pull the trig­ger. “I could not sign the doc­u­ments,” he says. “And that was the point where I was like ‘You know what? I’m bet­ter off doing what I want to do.’”

    About this time, sev­er­al of the firm’s top exec­u­tives left. Mamoon Hamid, an ear­ly part­ner, went to Klein­er Perkins; a num­ber of oth­ers, includ­ing for­mer part­ner Ted Maid­en­berg, start­ed a new VC firm called Tribe Cap­i­tal.

    By the end of 2018, Pal­i­hapi­tiya had closed the hedge fund he had launched to invest in pub­licly trad­ed com­pa­nies and shut his out­stand­ing VC funds to new mon­ey. He says those steps were part of his plan to shrink the firm and change the way it was run.

    “I don’t think invest­ing is a team sport,” he says, refer­ring to argu­ments at the firm over what he calls “pow­er-shar­ing agree­ments” that led to the depar­tures — some vol­un­tary, oth­ers not. (By all accounts, it was messy and Pal­i­hapi­tiya didn’t han­dle it well.)

    “The fun­da­men­tal under­writ­ing deci­sions of great investors over long peri­ods of time are very lone­ly indi­vid­ual deci­sions,” he explains. “It’s about a kind of pat­tern recog­ni­tion that very few peo­ple have. I don’t know if I have it. But in order to find out, I need to iso­late myself and do it myself.”

    At the time, the scut­tle­butt was that Social Cap­i­tal would not sur­vive. But Pal­i­hapi­tiya says the funds have com­pound­ed at 33 per­cent annu­al­ly, with a 3‑and-30 fee struc­ture that result­ed in net returns in the mid- to upper 20 per­cent range. To top those off, he recent­ly raised more than $1 bil­lion in two addi­tion­al blank-check IPOs, includ­ing one launched in the midst of the pan­dem­ic.

    Pal­i­hapi­tiya says he prefers the mon­ey-rais­ing process of a SPAC to that of a VC fund. “SPACs are short bursts of effort from a fundrais­ing per­spec­tive, while VC fundrais­ing requires more hand-hold­ing and thus time and focus,” he notes. “As a head of a VC fund, you are no longer an investor; you become the head of investor rela­tions. This is not a job I either liked or want­ed to do.”

    Pal­i­hapi­tiya adds, “I still have a cou­ple of bil­lion that I’m man­ag­ing on behalf of oth­ers. But there’s a $4 bil­lion bal­ance sheet that’s mine. I don’t have to answer to any­body.” He then jokes that the $4 bil­lion is “all fake, and I wouldn’t take that num­ber very seri­ous­ly. I am always 100 per­cent invest­ed, and at any moment some­thing cat­a­clysmic could make it zero in an instant.”

    It was after he quit rais­ing mon­ey for his VC funds that Pal­i­hapi­tiya became vocal in his crit­i­cisms about the VC mod­el.

    As he explains it, “In the ven­ture mar­ket, build­ing has become hard­er. Com­pa­nies take longer and longer to get any kind of mate­r­i­al break­out, and they’re less and less like­ly to do so, which then means that these com­pa­nies are pri­vate for 12, 13 years. But if a ven­ture fund is to be in busi­ness, they need to raise mon­ey every two or three years. So they’re in the busi­ness of basi­cal­ly pump­ing up their com­pa­nies. You show mark-to-mar­ket gains, you show fake IRR, and you raise more funds. And LPs are the fuel to all of this. They are the ones that are torch­ing their mon­ey on fire, feed­ing this dynam­ic.”

    Expos­ing what he sees as venture’s ugly truths has made him unpop­u­lar in some quar­ters. But, as one long­time lim­it­ed part­ner points out, Social Cap­i­tal is one VC firm that has actu­al­ly returned mon­ey, not just unre­al­ized gains, to investors in its funds.

    Hedge funds, of course, are also engaged in the hunt for fees. More cap­i­tal is being raised by the funds, even as the uni­verse of pub­lic com­pa­nies they can invest in has shrunk. “Very quick­ly,” says Pal­i­hapi­tiya, “you real­ize that you want to opti­mize for short-term fees, because it’s hard­er and hard­er to have an edge.”

    He argues that that dynam­ic dri­ves a lot of short-term behav­ior, which is then imposed on the com­pa­nies hedge funds invest in via buy­backs or div­i­dends. “Less than a third of S&P com­pa­nies actu­al­ly have R&D bud­gets. Do you think that’s by choice, or do you think that’s by investor pres­sure? I think a lot of it is the lat­ter.”

    Pal­i­hapi­tiya has called for a ban on stock buy­backs, which he con­sid­ers “idi­ot­ic.”

    Provoca­tive, yes. But his way with words, not to men­tion his wealth, gives Pal­i­hapi­tiya a plat­form — espe­cial­ly at a time when the rules appear to have sud­den­ly changed.

    Con­sid­er his mas­sive gains on just two stocks that have soared — Ama­zon and Tes­la. In 2017, as he likes to tell the sto­ry, Pal­i­hapi­tiya was almost laughed off the stage at the Sohn Invest­ment Con­fer­ence for rec­om­mend­ing investors buy Tes­la con­vert­ible bonds. At that time, seem­ing­ly every­one who was any­one in the world of finance was short Tes­la. A year ear­li­er his Ama­zon call at Sohn was also dis­missed by atten­dees, includ­ing Green­light Cap­i­tal founder David Ein­horn.

    As the bull mar­ket of the past decade reached what seemed to be bub­ble pro­por­tions, val­ue investors like Ein­horn expect­ed the bust to come from high-fly­ing, unprof­itable tech com­pa­nies, and val­ue investors who had suf­fered in the loose-mon­ey after­math of 2008 would shine again. It hasn’t hap­pened.

    “Those guys are morons,” says Pal­i­hapi­tiya of many val­ue investors. The his­toric way of deter­min­ing val­ue by look­ing at bal­ance sheets and dis­count­ed cash flow no longer works, he asserts.

    “Today, when mon­ey has no val­ue, because we’ve essen­tial­ly print­ed all the mon­ey in the world and we’ll con­tin­ue to print it over and over, you have to find val­ue in oth­er parts of the bal­ance sheet, so you have to go to things like brand or intan­gi­bles,” he says. “And this is where their math­e­mat­i­cal mod­els break, and then their brains explode.”

    Pal­i­hapi­tiya, who moved to Cana­da when he was six years old, grew up with a father who was often unem­ployed and a moth­er who worked as a house­keep­er, then a nurse’s aide. The fam­i­ly, which also includes his two sis­ters, lived in a small apart­ment above a laun­dro­mat and got by on wel­fare.

    Pover­ty fueled the young man’s ambi­tion, but it also made him acute­ly aware of the impor­tance of the country’s social safe­ty net. “I went to one of the best schools in Cana­da, but it cost me $8,000 a year,” he says. (Pal­i­hapi­tiya earned a degree in elec­tri­cal engi­neer­ing from the Uni­ver­si­ty of Water­loo in 1999.) “I am a by-prod­uct of an enor­mous num­ber of pro­gres­sive ideals — uni­ver­sal health care, almost-free basic edu­ca­tion, a social wel­fare pol­i­cy to take care of the low­est rungs of soci­ety but give them a path of upward mobil­i­ty.”

    His goal, at an ear­ly age, was to make it onto the Forbes bil­lion­aire list. “I guess I’m like the 300th- or 400th- or 500th-rich­est per­son in the world now,” he says.

    Pal­i­hapi­tiya acts like it doesn’t mat­ter. “I can still only wear one pair of pants. I can only live in one house. I can only eat one thing at a time.” But he has hard­ly tak­en a vow of pover­ty. He owns three Tes­las, as well as a stake in the NBA’s Gold­en State War­riors.

    Still, he insists he has lofti­er goals. “I care more that there’s change. I like to think that if all of these start­ing lines are evened up, there’s peo­ple way bet­ter than me who will do even more than me. I’d like to see some of that in my life­time,” he says.

    Davi­da Her­zl, the founder and CEO of Acli­ma, a Social Cap­i­tal port­fo­lio com­pa­ny, refers to Palihapitiya’s path as the “long dis­tance trav­eled.”

    She notes, “That jour­ney cre­ates a lot of grit. It gives you a dif­fer­ent per­spec­tive on what’s pos­si­ble.”

    Take Acli­ma, a mak­er of dig­i­tal sen­sors that can take a block-by-block mea­sure­ment of air pol­lu­tion and green­house gas­es.

    “Why is that impor­tant?” asks Pal­i­hapi­tiya. “It turns out that when kids go to school near places that have high emis­sions, they have high absen­teeism. They actu­al­ly are more func­tion­al­ly and edu­ca­tion­al­ly, not pejo­ra­tive­ly, retard­ed — like you’re held back rel­a­tive to peers that go to oth­er high schools or pri­ma­ry schools or mid­dle schools in areas where there isn’t as much pol­lu­tion. Turns out that socioe­co­nom­i­cal­ly, we do a real­ly good job of putting immi­grants and poor peo­ple near areas of high pol­lu­tion.”

    Aclima’s tech­nol­o­gy can pin­point where those areas are, yet the com­pa­ny was starved of cap­i­tal when Pal­i­hapi­tiya showed up to become its Series A lead investor, says Her­zl. (Pal­i­hapi­tiya notes that Acli­ma was reject­ed by his part­ners, so “I just did it by myself.”)

    As Her­zl explains, “The kind of inno­va­tion in Sil­i­con Val­ley applied to retail and con­sumer apps has not been applied to the biggest chal­lenges fac­ing soci­ety. That’s what Chamath is try­ing to do — take all of these amaz­ing tech­nolo­gies and capa­bil­i­ties devel­oped in Sil­i­con Val­ley and apply them to the biggest chal­lenges in soci­ety.”

    Oth­ers in Palihapitiya’s port­fo­lio include com­pa­nies like Sail­drone, which maps the ocean floor to under­stand cli­mate change, and Cov­er, which elim­i­nates the mid­dle­man for con­sumers and busi­ness­es buy­ing insur­ance.

    But Pal­i­hapi­tiya also believes that the prob­lems are much big­ger than what tech­nol­o­gy can solve on its own. They need gov­ern­ment. “That’s its job. One of the most impor­tant jobs, right after health and safe­ty and secu­ri­ty of cit­i­zens, is incen­tives. Gov­ern­ment shapes behav­ior with incen­tives.”

    Speak­ing up about the role of gov­ern­ment, and extolling his views on things like uni­ver­sal health care — which he con­sid­ers a “no-brain­er” — is some­thing rel­a­tive­ly new for Pal­i­hapi­tiya.

    “Up until about two or three years ago, I was fun­da­men­tal­ly afraid of rejec­tion. I think that was prob­a­bly my great­est fear. And so I oper­at­ed out of fear for a long time,” he says.

    Pal­i­hapi­tiya traces that fear to grow­ing up the child of an alco­holic.

    “When you go back to being a kid in a sit­u­a­tion that is that com­pli­cat­ed, you learn to basi­cal­ly do what­ev­er it takes to get by,” he explains. “Because if the par­ent is drink­ing, then con­fronta­tion or dia­logue or rad­i­cal can­dor can go in a very bad direc­tion. And so it becomes a cop­ing mech­a­nism.”

    Oth­ers sus­pect his wealth made Pal­i­hapi­tiya less con­cerned about what oth­er peo­ple — pre­sum­ably those in the finan­cial world — think of him. He has an answer for that:

    “I actu­al­ly think I care even more now what oth­er peo­ple think, but I care more about the peo­ple that don’t have a voice as much” instead of some “ran­dom cap­i­tal allo­ca­tor who at some very basic lev­el I don’t fun­da­men­tal­ly respect because of the pol­i­tics, or because of the game that the cap­i­tal allo­ca­tion process trans­forms it into.”

    The coro­n­avirus pan­dem­ic has had a way of alter­ing real­i­ty by forc­ing even the rich­est peo­ple back to basics. Pal­i­hapi­tiya, for one, says he cleans the toi­lets twice a week and does all the vac­u­um­ing in the home he shares with his part­ner, Ital­ian phar­ma­ceu­ti­cals heiress Nathalie Dompe, the CEO of Dompe Hold­ings, and his four chil­dren. (His ex-wife, with whom he shares cus­tody of three of those chil­dren, lives four min­utes away.)

    It won’t last for­ev­er, of course. But Pal­i­hapi­tiya couldn’t have envi­sioned that that’s what 2020 would look like when he wrote Social Capital’s 2019 annu­al let­ter, which came out just before Covid-19 took hold of the glob­al dis­course. In it, he talks about the com­ing end of the gild­ed age, with its mas­sive eco­nom­ic inequal­i­ties, and pre­dicts that an era of reform will replace it, with tighter reg­u­la­tion and high­er tax­es.

    There are a grow­ing num­ber in his class who agree. “I think he’s absolute­ly right,” says Kapoor. “You can be a great investor and a great cap­i­tal­ist and at the same time rewrite the rules of how it’s all dis­trib­uted.”

    Pal­i­hapi­tiya still believes that reform is com­ing — but prob­a­bly not until 2024. “Right now we are going to go through two or three years of pain. And then I think going into 2024 and out of it, we’ll have a polit­i­cal change, we’ll have an ide­o­log­i­cal change.”

    For the time being, he believes there will be defla­tion in the real econ­o­my and asset infla­tion at the same time, giv­en the Fed’s recent moves to sup­port finan­cial mar­kets. That might “unfor­tu­nate­ly end in mas­sive civ­il con­flict,” Pal­i­hapi­tiya says. “The ques­tion is, how tumul­tuous is it from here to there? And can we get the next gen­er­a­tion of lead­er­ship that keeps the lid on so that it doesn’t blow off?”

    Every day, it seems, his more than 340,000 Twit­ter fol­low­ers look to Pal­i­hapi­tiya for such lead­er­ship, often beg­ging him to run for pres­i­dent.

    He can’t.

    “I’m Cana­di­an, so I can rule that out,” he says. “Thank you, no.” But there is an alter­na­tive, he teas­es.

    “Maybe prime min­is­ter.”

    ———–

    “The Unusu­al Ambi­tions of Chamath Pal­i­hapi­tiya” by Michelle Celar­i­er; Insti­tu­tion­al Investor; 05/31/2020

    “Pal­i­hapi­tiya still believes that reform is com­ing — but prob­a­bly not until 2024. “Right now we are going to go through two or three years of pain. And then I think going into 2024 and out of it, we’ll have a polit­i­cal change, we’ll have an ide­o­log­i­cal change.””

    An ide­o­log­i­cal change is com­ing to Amer­i­ca in 2024. That’s the pre­dic­tion of Chamath Pal­i­hapi­tiya in this May 2020. An ide­o­log­i­cal change that he clear­ly has an inter­est in cat­alyz­ing. The guy has ambi­tion. And until 2024, he pre­dicts simul­ta­ne­ous defla­tion with asset infla­tion (very plau­si­ble and an exten­sion of the trend we’ve seen for a while in the US) with the pos­si­bil­i­ty of mas­sive civ­il con­flict. But instead of blam­ing that mas­sive civ­il con­flict on Don­ald Trump and the mil­i­tant far right, he appears to blame the Fed­er­al Reserve’s mon­e­tary poli­cies and pines for a next gen­er­a­tion of lead­er­ship that avoid this mas­sive civ­il con­flict:

    ...
    For the time being, he believes there will be defla­tion in the real econ­o­my and asset infla­tion at the same time, iven the Fed’s recent moves to sup­port finan­cial mar­kets. That might “unfor­tu­nate­ly end in mas­sive civ­il con­flict,” Pal­i­hapi­tiya says. “The ques­tion is, how tumul­tuous is it from here to there? And can we get the next gen­er­a­tion of lead­er­ship that keeps the lid on so that it doesn’t blow off?”
    ...

    And more gen­er­al, Pal­i­hapi­tiya has spent the last few year rebrand­ing him­self as a crit­ic of his own class. The Sil­i­con Val­ley ven­ture cap­i­tal­ist class. It’s part of what’s led to his image as a polar­iz­ing fig­ure who has half of Sil­i­con Val­ley not want­i­ng to talk to him and the oth­er half, with Pay­Pal Mafia half, financ­ing his rise as a ven­ture cap­i­tal­ist:

    ...
    He offers a sly grin when remind­ed of the inter­view — which CNBC esti­mates has been viewed more than 10 mil­lion times — dur­ing the first of two Zoom con­ver­sa­tions with Insti­tu­tion­al Investor in May. How­ev­er, Palihapitiya’s not hav­ing any of that rant busi­ness. “Rants, rants. I pre­fer to call them thought­ful com­men­tary,” he says.

    “I just con­tin­ue to want to say the things that are on my mind,” he explains, his large brown eyes lean­ing for­ward into the com­put­er from a spa­cious sun­room in his Palo Alto home, the light illu­mi­nat­ing the over­size house­plants and cream-col­ored easy chairs behind him. “I don’t think these things are con­tro­ver­sial. These are the things that I believe. And I think what hap­pens is that peo­ple are a lit­tle shocked by the rad­i­cal can­dor in pub­lic because they’re not used to it.”

    These “peo­ple” should start get­ting used to it, for Pal­i­hapi­tiya, it is clear, is not tak­ing on just hedge funds. Whether it’s val­ue-invest­ing “morons,” the Sil­i­con Val­ley ven­ture cap­i­tal­ist elite, or uni­ver­si­ty endow­ments, to name a few of his tar­gets, Pal­i­hapi­tiya — him­self a bil­lion­aire — is doing one thing that many of sim­i­lar means find abhor­rent:

    Turn­ing on his own.

    ...

    “He’s per­sona non gra­ta with a lot of Sil­i­con Val­ley,” one indi­vid­ual says, men­tion­ing sev­er­al of those Pal­i­hapi­tiya has crit­i­cized by name. They include Marc Andreessen, Sequoia Cap­i­tal, and even Mark Zuckerberg’s Face­book — Palihapitiya’s for­mer employ­er.

    Yet the blunt-speak­ing investor has just as many back­ers with­in that ecosys­tem.

    ...

    In 2007, Pal­i­hapi­tiya left May­field for Face­book, where he is cred­it­ed with help­ing orches­trate its mas­sive growth. His time at Face­book, and a per­son­al invest­ment in gam­ing com­pa­ny Play­dom, which was sold to Dis­ney, put him on the fast track. Pal­i­hapi­tiya had the cap­i­tal and access to investors to start his own firm, which he named Social+Capital Part­ner­ship, in 2011.

    Kapoor says Palihapitiya’s “mag­net­ic per­son­al­i­ty” drew in the big names. They have includ­ed such well-known VC giants as John Doerr of Klein­er Perkins and Reid Hoff­man, co-founder of LinkedIn, along with hedge fund tech investor Chase Cole­man, the Tiger Glob­al founder. Pal­i­hapi­tiya also gained entrée into the so-called Pay­Pal mafia of tech­nol­o­gy heavy­weights when one of its founders, Peter Thiel — then on the board of Face­book — became an ear­ly investor and intro­duced him to oth­er Pay­Pal execs.

    “Peo­ple want­ed to lis­ten to him,” Kapoor says of Pal­i­hapi­tiya. “Lots of peo­ple can artic­u­late ideas that every­one agrees with, but can you artic­u­late with vision and log­ic ideas that are not main­stream? That’s his gift.”
    ...

    And then, around 2018, a num­ber of exec­u­tives left his Social Cap­i­tal fund at the same time Pal­i­hapi­tiya cut off addi­tion­al out­side fund­ing and began talk­ing about chang­ing how the fund was ran and mak­ing the invest­ment deci­sions in iso­la­tion. This break from the ven­ture cap­i­tal fundrais­ing was appar­ent­ly was freed Pal­i­hapi­tiya to start becom­ing more vocal about his con­cerns with the sys­temic prob­lems of ven­ture cap­i­tal:

    ...
    Pal­i­hapi­tiya had opened his firm, along with his then-wife Brigette Lau, with a plan to invest in com­pa­nies in fields being ignored by the VC world, like health, finan­cial ser­vices, and edu­ca­tion. But the VC game seems to have worn him down.

    And then he filed for divorce.

    “Every­thing was so suc­cess­ful. I’m work­ing and work­ing and work­ing, but I wasn’t hap­py,” he recalls. “And then as I sought hap­pi­ness in my per­son­al life, I found hap­pi­ness in my pro­fes­sion­al life. I didn’t need to man­age hun­dreds of peo­ple or thou­sands of peo­ple any­more. I want­ed to be a real allo­ca­tor of cap­i­tal, because I want­ed to change the parts of soci­ety I dis­agreed with.”

    Social Cap­i­tal was on the verge of rais­ing a cred­it fund when Pal­i­hapi­tiya found he could not pull the trig­ger. “I could not sign the doc­u­ments,” he says. “And that was the point where I was like ‘You know what? I’m bet­ter off doing what I want to do.’”

    About this time, sev­er­al of the firm’s top exec­u­tives left. Mamoon Hamid, an ear­ly part­ner, went to Klein­er Perkins; a num­ber of oth­ers, includ­ing for­mer part­ner Ted Maid­en­berg, start­ed a new VC firm called Tribe Cap­i­tal.

    By the end of 2018, Pal­i­hapi­tiya had closed the hedge fund he had launched to invest in pub­licly trad­ed com­pa­nies and shut his out­stand­ing VC funds to new mon­ey. He says those steps were part of his plan to shrink the firm and change the way it was run.

    “I don’t think invest­ing is a team sport,” he says, refer­ring to argu­ments at the firm over what he calls “pow­er-shar­ing agree­ments” that led to the depar­tures — some vol­un­tary, oth­ers not. (By all accounts, it was messy and Pal­i­hapi­tiya didn’t han­dle it well.)

    “The fun­da­men­tal under­writ­ing deci­sions of great investors over long peri­ods of time are very lone­ly indi­vid­ual deci­sions,” he explains. “It’s about a kind of pat­tern recog­ni­tion that very few peo­ple have. I don’t know if I have it. But in order to find out, I need to iso­late myself and do it myself.”

    ...

    But Pal­i­hapi­tiya also believes that the prob­lems are much big­ger than what tech­nol­o­gy can solve on its own. They need gov­ern­ment. “That’s its job. One of the most impor­tant jobs, right after health and safe­ty and secu­ri­ty of cit­i­zens, is incen­tives. Gov­ern­ment shapes behav­ior with incen­tives.”

    peak­ing up about the role of gov­ern­ment, and extolling his views on things like uni­ver­sal health care — which he con­sid­ers a “no-brain­er” — is some­thing rel­a­tive­ly new for Pal­i­hapi­tiya.

    “Up until about two or three years ago, I was fun­da­men­tal­ly afraid of rejec­tion. I think that was prob­a­bly my great­est fear. And so I oper­at­ed out of fear for a long time,” he says.
    ...

    And yet, while Pal­i­hapi­tiya stopped tak­ing ven­ture cap­i­tal mon­ey in 2018, he appar­ent­ly start­ed tak­ing in bil­lions of dol­lars in “blank-check IPO” SPAC mon­ey right at this time. So he did­n’t break off out­side fund­ing. He just shift­ed from ven­ture cap­i­tal fund­ing to SPAC fund­ing. Which, in the­o­ry, does allow a broad­er field of poten­tial investors. But it’s still most­ly just real­ly, real­ly rich peo­ple and prob­a­bly large­ly the same peo­ple who would have invest­ed through the ven­ture cap­i­tal any­way. In oth­er words, large­ly cos­met­ic:

    ...
    At the time, the scut­tle­butt was that Social Cap­i­tal would not sur­vive. But Pal­i­hapi­tiya says the funds have com­pound­ed at 33 per­cent annu­al­ly, with a 3‑and-30 fee struc­ture that result­ed in net returns in the mid- to upper 20 per­cent range. To top those off, he recent­ly raised more than $1 bil­lion in two addi­tion­al blank-check IPOs, includ­ing one launched in the midst of the pan­dem­ic.

    Pal­i­hapi­tiya says he prefers the mon­ey-rais­ing process of a SPAC to that of a VC fund. “SPACs are short bursts of effort from a fundrais­ing per­spec­tive, while VC fundrais­ing requires more hand-hold­ing and thus time and focus,” he notes. “As a head of a VC fund, you are no longer an investor; you become the head of investor rela­tions. This is not a job I either liked or want­ed to do.”

    Pal­i­hapi­tiya adds, “I still have a cou­ple of bil­lion that I’m man­ag­ing on behalf of oth­ers. But there’s a $4 bil­lion bal­ance sheet that’s mine. I don’t have to answer to any­body.” He then jokes that the $4 bil­lion is “all fake, and I wouldn’t take that num­ber very seri­ous­ly. I am always 100 per­cent invest­ed, and at any moment some­thing cat­a­clysmic could make it zero in an instant.”

    It was after he quit rais­ing mon­ey for his VC funds that Pal­i­hapi­tiya became vocal in his crit­i­cisms about the VC mod­el.

    As he explains it, “In the ven­ture mar­ket, build­ing has become hard­er. Com­pa­nies take longer and longer to get any kind of mate­r­i­al break­out, and they’re less and less like­ly to do so, which then means that these com­pa­nies are pri­vate for 12, 13 years. But if a ven­ture fund is to be in busi­ness, they need to raise mon­ey every two or three years. So they’re in the busi­ness of basi­cal­ly pump­ing up their com­pa­nies. You show mark-to-mar­ket gains, you show fake IRR, and you raise more funds. And LPs are the fuel to all of this. They are the ones that are torch­ing their mon­ey on fire, feed­ing this dynam­ic.”

    Expos­ing what he sees as venture’s ugly truths has made him unpop­u­lar in some quar­ters. But, as one long­time lim­it­ed part­ner points out, Social Cap­i­tal is one VC firm that has actu­al­ly returned mon­ey, not just unre­al­ized gains, to investors in its funds.
    ...

    And that’s the dis­turbing­ly fas­ci­nat­ing devel­op­ing sto­ry of Chamath Pal­i­hapi­tiya and his quest to recall Gavin New­som and run Cal­i­for­nia. He’s gone from one of Sil­i­con Val­ley’s ven­ture cap­i­tal shin­ing stars to the ‘king of SPACs’ and one of Sil­i­con Val­ley’s ven­ture cap­i­tal biggest crit­ics. So he is in the­o­ry free of Sil­i­con Val­ley’s oli­garchic influ­ences now that he’s jumped from VC to SPACS, and yet he’s cho­sen to sup­port a far right recall effort on a plat­form of elim­i­nat­ed the state income tax. This does­n’t look good for the prospects of Pal­i­hapi­tiya actu­al­ly doing good if he’s giv­en pow­er. The recent his­to­ry of busi­ness­ment promis­ing to ‘shake up’ pol­i­tics isn’t exact­ly great.

    So now that SPACs are a hot new invest­ment vehi­cle, and one that democ­ra­tizes finances as Pal­i­hapi­tiya puts it, we have a time­ly reminder in Pal­i­hapi­tiya that even if SPACs free up peo­ple like Pal­i­hapi­tiya from hav­ing to care what the rest of Sil­i­con Val­ley invest­ment com­mu­ni­ty thinks (in the­o­ry), it does­n’t free them of their ide­olo­gies. That requires a dif­fer­ent kind of invest­ment.

    Posted by Pterrafractyl | February 15, 2021, 2:33 am
  12. With all of the grow­ing inter­est­ing in spe­cial pur­pose acqui­si­tion com­pa­nies (SPACs) in the ven­ture cap­i­tal indus­try — where com­pa­nies are incor­po­rat­ed for the sole pur­pose of buy­ing up exist­ing com­pa­nies — here’s an arti­cle about anoth­er alter­na­tive form of invest­ment that investors are flock­ing towards: sec­ondary pri­vate mar­ket sales, where the shares of a pri­vate­ly held com­pa­nies are sold to oth­er investors in pri­vate­ly arranged trans­ac­tions.

    Sec­ondary pri­vate mar­ket trans­ac­tions have the obvi­ous­ly advan­tage over buy­ing pub­licly trad­ed shares in that you can buy shares in pri­vate­ly held com­pa­nies, espe­cial­ly before they go pub­lic. But there’s a dis­tinct dis­ad­van­tage to buy­ing pub­licly trad­ed shared: the dis­clo­sure rules are far more lenient for the sale of pri­vate­ly held shares. Lenient in the sense that much less needs to be revealed to the buy­er about the com­pa­ny’s inter­nal finances. In oth­er words, when shares are trad­ed in a pri­vate­ly held com­pa­ny it’s a lot eas­i­er for a sell­er to unload the shares with­out reveal­ing prob­lems with the com­pa­ny’s finances. So the sec­ondary pri­vate mar­ket is tempt­ing to buy­ers look­ing to pur­chase shares of com­pa­nies ear­ly before they have their IPOs, but also tempt­ing to sell­ers who can unload shares with few­er dis­clo­sures. All in all, we can see why there’s grow­ing inter­est in the sec­tor. It poten­tial­ly gives buy­ers and sell­ers an edge. Specif­i­cal­ly, buy­ers and sell­ers who pos­sess an infor­ma­tion edge have a big poten­tial advan­tage in this unreg­u­lat­ed sec­tor.

    But there’s anoth­er sig­nif­i­cant new devel­op­ment in this sec­tor: mul­ti­ple groups are plan­ning on cre­at­ing what amounts to sec­ondary pri­vate mar­ket exchanges, in the hopes of cre­at­ing the pri­vate mar­ket equiv­a­lent of the Nas­daq or New York Stock Exchange. Bro­ker­ages where any­one can go by buy pri­vate­ly-owned shares. The mar­ket already exists, but it’s cur­rent­ly split up between dozens of dif­fer­ent bro­kers. What we’re see­ing now is the push to con­sol­i­date that mar­ket place, and there­fore cap­ture all of those fees.

    To get a sense of the scale of this mar­ket, accord­ing to a Finan­cial Times analy­sis, there are an esti­mat­ed 546 “uni­corn” pri­vate com­pa­nies with a col­lec­tive val­ue of $1.8 tril­lion. So just the “uni­corns” alone have tril­lions in pri­vate­ly held shares that can poten­tial­ly be pri­vate­ly trad­ed. Now con­sid­er the much larg­er uni­verse of pri­vate non-uni­corn com­pa­nies and fac­tor in that this is a mar­ket where com­pa­nies don’t have to dis­close their finances in the same way pub­licly trad­ed com­pa­nies do. But some of those non-uni­corns are obvi­ous­ly yet-to-be-dis­cov­ered uni­corns that are prob­a­bly a great bar­gain if you can get your hands on those pri­vate­ly-held shares. So we have the mak­ings of a mar­ket­place com­prised of juicy “uni­corns” and yet-to-be-dis­cov­ered uni­corns hid­den in a sea of lemons. And min­i­mal trans­paren­cy rules. As the arti­cle describes, the demand for pri­vate­ly held shares is huge and grow­ing. It’s the sup­ply that’s the prob­lem. And these mar­kets could facil­i­tate grow­ing the sup­ply of avail­able pri­vate­ly held shares by pro­vid­ing those share­hold­ers ready access to mar­ket with a huge sup­ply-demand imbal­ance. The oppor­tu­ni­ty for IPO prices with­out the actu­al IPO. What could pos­si­bly go wrong?

    One such com­pa­ny work­ing to cre­ate a pri­vate share Nas­daq, Car­ta, has the back­ing of Sil­i­con Val­ley investor Marc Andreessen. Anoth­er, Zan­ba­to, is backed by JP Mor­gan. Zan­ba­to’s plans are some­what less pop­ulist than Car­ta’s, and lim­it­ed to act­ing as a cen­tral match­mak­er for more than 100 banks and bro­kers exe­cut­ing orders on behalf of clients. Even Nas­daq itself is report­ed­ly work­ing on some sort of pri­vate share mar­ket­place. Car­ta’s founder, Hen­ry Ward, says he envi­sions his pri­vate share exchange as allow­ing com­pa­nies to raise cap­i­tal while remain­ing pri­vate for­ev­er. So the growth of the pri­vate sec­ondary mar­ket is, in some sense, the emer­gence of a new reg­u­la­to­ry loop­hole to allow com­pa­nies to avoid the reg­u­la­tions of pub­licly trad­ed com­pa­nies.

    The over­all trend in the ultra-hot IPO mar­ket is clear. Bar­ring reg­u­la­tion, the direct sales of pri­vate-held shares is com­ing one way or anoth­er. Which means, in real­i­ty, we’re look­ing at an emer­gence of a new bare­ly reg­u­lat­ed stock mar­ket dri­ven by the mar­ket dynam­ics of obfus­ca­tion and decep­tion and every­one plays ‘find-the-hid­den-uni­corn’:

    The Finan­cial Times

    Stay­ing pri­vate: the boom­ing mar­ket for shares in the hottest start-ups
    New exchanges aim to boost trade in promis­ing busi­ness­es, but more reg­u­la­tion of an opaque sec­tor may be need­ed

    Miles Krup­pa in San Fran­cis­co
    Feb­ru­ary 27 2021

    In 2014, an Aus­tri­an entre­pre­neur offered investors a rare chance to pur­chase shares in Jumio, his fast-grow­ing and prof­itable pay­ments com­pa­ny. The deal was not a typ­i­cal ven­ture cap­i­tal trans­ac­tion. Instead of pur­chas­ing new shares, investors could buy out ear­li­er share­hold­ers, in what are known as pri­vate sec­ondary trans­ac­tions.

    Daniel Mattes, who calls him­self a “vision­ary” on his Insta­gram page and has been a judge on the Aus­tri­an ver­sion of Shark Tank, the Amer­i­can real­i­ty TV series for entre­pre­neurs, told at least one prospec­tive buy­er he had no plans to reduce his own stake in the busi­ness, accord­ing to a US Secu­ri­ties and Exchange Com­mis­sion com­plaint filed in 2019. Mattes also signed off on doc­u­ments that, accord­ing to the com­plaint, claimed Jumio made a small prof­it and rev­enues of more than $100m in 2013 — a sig­nif­i­cant sum for a three-year-old com­pa­ny.

    Two years lat­er, Jumio filed for bank­rupt­cy, and the company’s shares became worth­less. In real­i­ty, accord­ing to the SEC, Jumio had only made one-tenth of the rev­enues it claimed, and Mattes had bypassed his board of direc­tors to sell about $14m of his own shares.

    Jumio’s case high­light­ed the risks of an opaque but fast-grow­ing cor­ner of finance: the glob­al mar­ket for shares in pri­vate start-ups such as Tik­Tok own­er ByteDance, Elon Musk’s SpaceX and pay­ments com­pa­ny Stripe. In 2019, the mar­ket was esti­mat­ed to host almost $40bn in light­ly reg­u­lat­ed trades, accord­ing to one par­tic­i­pant, more than dou­bling its vol­ume from 2014.

    Recent­ly, the mar­ket has been hot­ter than ever. Though pri­vate com­pa­nies have large­ly tried to restrict trad­ing, bro­kers say hedge funds, mutu­al funds and oth­er insti­tu­tion­al investors have begun pour­ing in, buy­ing large blocks of exist­ing shares in start-ups that are near­ing ini­tial pub­lic offer­ings or big acqui­si­tions. Often, the investors receive scant rights to infor­ma­tion on finan­cial per­for­mance.

    Tech­nol­o­gy upstarts and finan­cial insti­tu­tions includ­ing big banks have rushed to cap­i­talise on the inter­est by bro­ker­ing deals and form­ing trad­ing venues, set­ting up a bat­tle that could fun­da­men­tal­ly alter the market’s struc­ture and poten­tial­ly allow com­pa­nies to stay pri­vate indef­i­nite­ly.

    The boom reflects how cash-flush investors are clam­our­ing for stakes in fast-grow­ing busi­ness­es, with low inter­est rates push­ing non-tra­di­tion­al funds deep­er into pri­vate mar­kets. To meet the demand, bro­kers now face two key chal­lenges: increas­ing the sup­ply of shares in desir­able com­pa­nies while pre­vent­ing fraud and manip­u­la­tion in a com­pet­i­tive mar­ket.

    Until recent­ly, pri­vate sec­ondary mar­kets resem­bled “that guy with a trench­coat that’s sell­ing you watch­es in Times Square”, says Inder­pal Singh, who leads a pri­vate sec­ondary mar­ket project at the start-up mar­ket­place Angel­List. “In the last year, there’s been a big shift.”

    In addi­tion to Angel­List, JPMor­gan and the soft­ware start-up Car­ta have begun facil­i­tat­ing trades in pri­vate com­pa­nies. They com­pete with estab­lished play­ers like Nas­daq and Forge Glob­al, which pur­chased the rival mar­ket­place Share­s­Post in a $160m deal last year, as well as scores of small­er inde­pen­dent bro­kers.

    Car­ta and some oth­er inter­me­di­aries have advo­cat­ed that the SEC relax restric­tions on who can pur­chase shares in pri­vate com­pa­nies, poten­tial­ly open­ing up the mar­ket to a broad­er swath of investors.

    But some observers remain scep­ti­cal that the grow­ing mar­ket can pro­tect investors against bad actors. Mattes, who paid $17m to set­tle the charges, did not admit or deny the SEC’s alle­ga­tions, though he resigned from Jumio in 2015 fol­low­ing an inter­nal inves­ti­ga­tion. The entre­pre­neur did not respond to ques­tions sent to his per­son­al web­site.

    The rush to expand trad­ing could lead to fraud and manip­u­la­tion, says Stephen Dia­mond, a pro­fes­sor of law at San­ta Clara Uni­ver­si­ty who has stud­ied pri­vate sec­ondary trans­ac­tions.

    “All too often in Sil­i­con Val­ley, peo­ple want to basi­cal­ly ignore the con­se­quences of unhealthy mar­ket struc­tures,” Dia­mond says.

    The Face­book episode

    The debates reflect a decade-long shift in cap­i­tal mar­kets as com­pa­nies grow larg­er than ever in pri­vate — secur­ing bil­lion-dol­lar val­u­a­tions and “uni­corn” sta­tus while push­ing back their pub­lic debuts. As a con­se­quence, start-ups, investors and employ­ees have accu­mu­lat­ed tril­lions of dol­lars’ worth of shares that can­not eas­i­ly be bought and sold, bar­ring a pub­lic list­ing or acqui­si­tion.

    Pri­vate sec­ondary mar­kets grew in impor­tance in the lead-up to Facebook’s ini­tial pub­lic offer­ing in 2012. Investors rushed to buy the social media company’s shares, cre­at­ing a fren­zied mar­ket where inde­pen­dent bro­kers facil­i­tat­ed thou­sands of trades with lit­tle over­sight from the com­pa­ny.

    The trades cre­at­ed headaches. One Face­book exec­u­tive left the com­pa­ny after he report­ed­ly pur­chased stock ahead of a big fund­ing announce­ment. Face­book some­times lost track of who owned its shares, com­pli­cat­ing prepa­ra­tions for its IPO.

    Facebook’s strug­gles caused many start-ups to adopt strict claus­es in their legal doc­u­ments that pre­vent­ed employ­ees from trad­ing shares with­out com­pa­ny approval. Some com­pa­nies have gone even fur­ther, requir­ing sell­ers to receive approval from boards of direc­tors months in advance of any trans­ac­tion.

    Though the restric­tions have made trad­ing dif­fi­cult, bro­kers say the mar­ket has been busier than ever in the past 12 months, with big investors such as Tiger Glob­al Man­age­ment hunt­ing for shares in start-ups that look like sure bets for block­buster pub­lic list­ings.

    Tiger Glob­al has used sec­ondary sales to gain stakes in com­pa­nies such as China’s ByteDance and the soft­ware group Snowflake, accord­ing to fund doc­u­ments and peo­ple famil­iar with the trades. Oth­er hedge funds and mutu­al funds rou­tine­ly pur­chase new stakes in com­pa­nies worth tens of mil­lions of dol­lars, bro­kers say.

    On the oth­er side of the trades, exist­ing share­hold­ers such as ven­ture cap­i­tal­ists have sought to unload stakes in high­ly-val­ued com­pa­nies as they delay pub­lic list­ings. The mar­ket can also be an impor­tant source of cash for start-up employ­ees, who receive a large por­tion of their pay in stock options.

    Sev­er­al new entrants, such as Carta’s pri­vate stock exchange Car­taX, now hope to for­malise the mar­ket and cap­ture trad­ing fees that have been spread between dozens of inde­pen­dent bro­kers.

    “There is now, in the past few years, not a push to go all the way back to the days of strict pro­hi­bi­tions on sec­ondary trad­ing, but a push to have more avenues for organ­ised liq­uid­i­ty,” says Cameron Con­ti­zano, a part­ner at law firm Good­win Proc­ter who works on sec­ondary trans­ac­tions.

    Mean­while, investor demand has pushed up prices for com­pa­nies such as ByteDance, SpaceX and Stripe. Bar­rett Cohn, chief exec­u­tive of the pri­vate secu­ri­ties bro­ker Scenic Advise­ment, says he advised com­pa­nies on twice as many sec­ondary trans­ac­tions in 2020 com­pared with the pre­vi­ous year. Of the last dozen deals Scenic worked on in the past few quar­ters, only one result­ed in shares being sold at a dis­count to a company’s most recent stock price, he says.

    Com­pet­ing for busi­ness

    The rise in trad­ing vol­umes and the rush to cap­ture the mar­ket will shape the way pri­vate shares change hands. San Fran­cis­co-based Car­ta, a com­pa­ny best known for sell­ing share­hold­er man­age­ment soft­ware to start-ups, has become a light­ning rod in debates about the market’s direc­tion. Its 45-year-old chief exec­u­tive, Hen­ry Ward, has set out an ambi­tious goal to build the “pri­vate stock exchange” for tech start-ups.

    Ward wants the Car­taX mar­ket­place to com­pete with the Nas­daq exchange, pro­vid­ing a list­ing venue where com­pa­nies could poten­tial­ly stay pri­vate indef­i­nite­ly. The exchange uses an auc­tion mod­el that Ward says will result in high­er prices for sell­ers.

    But the project has already drawn strong respons­es from rivals and mar­ket par­tic­i­pants. Some bro­kers and start-ups say Car­taX amount­ed to an attempt to monop­o­lise the mar­ket, and the com­pa­ny is naive to think it could unseat pub­lic exchanges. Scenic’s Cohn says Car­ta has made it increas­ing­ly dif­fi­cult for its clients to export their share­hold­er data for use in oth­er kinds of sec­ondary trans­ac­tions, such as ten­der offers.

    ...

    Oth­ers say the most desir­able start-ups would not want to use Car­taX because few pri­vate com­pa­nies want to sub­ject their shares to month­ly or quar­ter­ly auc­tions mar­ket­ed by the exchange.

    Eric Folke­mer, head of Nas­daq Pri­vate Mar­kets, says it has already set up a sim­i­lar mar­ket­place with price dis­cov­ery tools for com­pa­nies such as the work­place col­lab­o­ra­tion com­pa­ny Asana that want to facil­i­tate trad­ing in their shares before going pub­lic.

    ...

    JPMor­gan has put its mon­ey behind Zan­ba­to, a pri­vate share trad­ing sys­tem that is tak­ing a dif­fer­ent approach from Car­ta, act­ing as a cen­tral match­mak­er for more than 100 banks and bro­kers exe­cut­ing orders on behalf of clients.

    Nico Sand, chief exec­u­tive of Zan­ba­to, says the exchange has made a con­scious choice to focus on trades between large, qual­i­fied buy­ers with more than $100m in assets, who reg­u­la­tors assume have high amounts of finan­cial exper­tise and require less over­sight.

    Zan­ba­to has applied for a patent for a trad­ing sys­tem with “firm orders”, a legal con­tract that forces buy­ers and sell­ers to trans­act shares in a pri­vate com­pa­ny after they have sub­mit­ted orders with desired prices and quan­ti­ties, says Sand.

    He says the con­cept, which is stan­dard in pub­lic mar­kets, is nec­es­sary for cre­at­ing effi­cient trad­ing in pri­vate shares. “At the end of the day, it comes down to for­mal­is­ing the mar­ket struc­ture in a way it’s not cur­rent­ly for­malised.”

    ‘The third con­fig­u­ra­tion’

    So far, Car­ta is the only com­pa­ny that is list­ed for trad­ing on Car­taX. This month, investors pur­chased almost $100m in shares fol­low­ing the company’s first auc­tions on the exchange, in trades that val­ued the com­pa­ny at $6.9bn — more than dou­ble the val­u­a­tion it received from ven­ture cap­i­tal­ists less than one year ago.

    Marc Andreessen, the Netscape co-founder and Car­ta board mem­ber, said in a blog post that he would encour­age start-ups backed by his ven­ture cap­i­tal firm Andreessen Horowitz to con­sid­er list­ing on the exchange. He also said the firm would buy shares in com­pa­nies on the exchange.

    “The third con­fig­u­ra­tion — beyond the false bina­ry of sim­ply pri­vate or pub­lic — is here,” Andreessen wrote.

    But Ward has set tar­gets for the exchange that some peo­ple famil­iar with its work­ings described as over­ly ambi­tious.

    Ward told investors he expect­ed Car­taX to gen­er­ate about $1.1bn in annu­al rev­enues by 2024, accord­ing to a pre­sen­ta­tion viewed by the Finan­cial Times. Under the most opti­mistic sce­nario, the mar­ket­place would bring in $3.9bn in rev­enues that year, the pre­sen­ta­tion said. Car­ta declined to com­ment for this arti­cle.

    Car­taX charges 1 per cent fees to both buy­ers and sell­ers, imply­ing it would need to facil­i­tate about $55bn in trades a year to reach Ward’s expec­ta­tions.

    Those vol­umes would require about 3 per cent of the shares in all bil­lion-dol­lar start-ups to change hands every year, accord­ing to Finan­cial Times analy­sis of data from CB Insights, which esti­mates that 546 “uni­corns” hold a col­lec­tive val­ue of $1.8tn.

    Plat­forms like Car­taX may strug­gle to meet their tar­gets if pri­vate com­pa­nies remain selec­tive about who owns their shares. SpaceX, one of the most active com­pa­nies in sec­ondary trad­ing, already hosts an inter­nal mar­ket­place where employ­ees and ven­ture cap­i­tal­ists can sell stock to invit­ed investors.

    “They have a lot of demand from buy­ers,” says Hans Swildens, chief exec­u­tive of Indus­try Ven­tures, which has invest­ed in Car­ta. “The ques­tion, like all the oth­er mar­ket­places, is sup­ply.”

    Ven­ture cap­i­tal­ists say the new exchange could also face com­pe­ti­tion from an unlike­ly source — spe­cial pur­pose acqui­si­tion com­pa­nies (Spacs), which have recent­ly lured rel­a­tive­ly young start-ups to pub­lic mar­kets.

    Car­taX would force com­pa­nies to share two years of finan­cial state­ments pre­pared using gen­er­al­ly accept­ed account­ing prin­ci­ples, in order to com­ply with a secu­ri­ties exemp­tion the exchange is using to allow par­tic­i­pa­tion from an unlim­it­ed num­ber of accred­it­ed investors.

    Lawyers and gov­er­nance experts say the require­ment could help solve incon­sis­ten­cies in infor­ma­tion dis­clo­sure in pri­vate mar­kets. But oth­ers say it would be a bur­den for young com­pa­nies, which often remain pri­vate to avoid shar­ing their finan­cial infor­ma­tion to a broad audi­ence of investors, reflect­ing a cen­tral ten­sion in the mar­ket as bro­kers and traders attempt to cap­i­talise on the surge of inter­est in sec­ondary trans­ac­tions.

    “The ‘move fast and break things’ cul­ture of start-ups mil­i­tates pre­cise­ly against this,” says Dia­mond at San­ta Clara Uni­ver­si­ty. “That, to me, is the fun­da­men­tal para­dox here.”

    ————-

    “Stay­ing pri­vate: the boom­ing mar­ket for shares in the hottest start-ups” by Miles Krup­pa; The Finan­cial Times; 02/27/2021

    Until recent­ly, pri­vate sec­ondary mar­kets resem­bled “that guy with a trench­coat that’s sell­ing you watch­es in Times Square”, says Inder­pal Singh, who leads a pri­vate sec­ondary mar­ket project at the start-up mar­ket­place Angel­List. “In the last year, there’s been a big shift.””

    Yes, until last year, the pri­vate sec­ondary mar­kets resem­bled “that guy with a trench­coat that’s sell­ing you watch­es in Times Square”. This is the sec­tor of finance that’s explod­ing now, with a grow­ing num­ber of com­pa­nies promis­ing to bring those ‘guy with a trench­coat that’s sell­ing you watch­es in Times Square’ ser­vices to the broad­er pub­lic. They’re even lob­by­ing the SEC to relax restric­tions on who can pur­chase shares in pri­vate com­pa­nies. Again, what could go wrong?

    ...
    Car­ta and some oth­er inter­me­di­aries have advo­cat­ed that the SEC relax restric­tions on who can pur­chase shares in pri­vate com­pa­nies, poten­tial­ly open­ing up the mar­ket to a broad­er swath of investors.

    But some observers remain scep­ti­cal that the grow­ing mar­ket can pro­tect investors against bad actors. Mattes, who paid $17m to set­tle the charges, did not admit or deny the SEC’s alle­ga­tions, though he resigned from Jumio in 2015 fol­low­ing an inter­nal inves­ti­ga­tion. The entre­pre­neur did not respond to ques­tions sent to his per­son­al web­site.

    The rush to expand trad­ing could lead to fraud and manip­u­la­tion, says Stephen Dia­mond, a pro­fes­sor of law at San­ta Clara Uni­ver­si­ty who has stud­ied pri­vate sec­ondary trans­ac­tions.

    “All too often in Sil­i­con Val­ley, peo­ple want to basi­cal­ly ignore the con­se­quences of unhealthy mar­ket struc­tures,” Dia­mond says.

    ...

    Sev­er­al new entrants, such as Carta’s pri­vate stock exchange Car­taX, now hope to for­malise the mar­ket and cap­ture trad­ing fees that have been spread between dozens of inde­pen­dent bro­kers.
    ...

    And notice how Car­ta’s CEO, Hen­ry Ward, talks about his dream of cre­at­ing a sys­tem where com­pa­nies can access cap­i­tal mar­kets while remain­ing pri­vate indef­i­nite­ly. And Car­ta investor Marc Andreessen speaks of how com­pa­nies don’t have to be pub­lic or pri­vate and that’s there’s a ‘third way’. This is the third way: pri­vate com­pa­nies fund­ed in the pri­vate sec­ondary mar­kets mar­kets made avail­able to the pub­lic:

    ...
    The rise in trad­ing vol­umes and the rush to cap­ture the mar­ket will shape the way pri­vate shares change hands. San Fran­cis­co-based Car­ta, a com­pa­ny best known for sell­ing share­hold­er man­age­ment soft­ware to start-ups, has become a light­ning rod in debates about the market’s direc­tion. Its 45-year-old chief exec­u­tive, Hen­ry Ward, has set out an ambi­tious goal to build the “pri­vate stock exchange” for tech start-ups.

    Ward wants the Car­taX mar­ket­place to com­pete with the Nas­daq exchange, pro­vid­ing a list­ing venue where com­pa­nies could poten­tial­ly stay pri­vate indef­i­nite­ly. The exchange uses an auc­tion mod­el that Ward says will result in high­er prices for sell­ers.

    But the project has already drawn strong respons­es from rivals and mar­ket par­tic­i­pants. Some bro­kers and start-ups say Car­taX amount­ed to an attempt to monop­o­lise the mar­ket, and the com­pa­ny is naive to think it could unseat pub­lic exchanges. Scenic’s Cohn says Car­ta has made it increas­ing­ly dif­fi­cult for its clients to export their share­hold­er data for use in oth­er kinds of sec­ondary trans­ac­tions, such as ten­der offers.

    ...

    ‘The third con­fig­u­ra­tion’

    So far, Car­ta is the only com­pa­ny that is list­ed for trad­ing on Car­taX. This month, investors pur­chased almost $100m in shares fol­low­ing the company’s first auc­tions on the exchange, in trades that val­ued the com­pa­ny at $6.9bn — more than dou­ble the val­u­a­tion it received from ven­ture cap­i­tal­ists less than one year ago.

    Marc Andreessen, the Netscape co-founder and Car­ta board mem­ber, said in a blog post that he would encour­age start-ups backed by his ven­ture cap­i­tal firm Andreessen Horowitz to con­sid­er list­ing on the exchange. He also said the firm would buy shares in com­pa­nies on the exchange.

    “The third con­fig­u­ra­tion — beyond the false bina­ry of sim­ply pri­vate or pub­lic — is here,” Andreessen wrote.
    ...

    But these pri­vate sec­ondary mar­ket exchanges like Car­taX are still going to have dis­clo­sure require­ments of their own. In the case of the Car­taX exchange, it forces com­pa­nies to share two years of finan­cial state­ments pre­pared using gen­er­al­ly accept­ed account prin­ci­ples, which grants them a reg­u­la­to­ry exemp­tion that allows for an unlim­it­ed num­ber of a accred­it­ed investors to use their plat­form:

    ...
    Oth­ers say the most desir­able start-ups would not want to use Car­taX because few pri­vate com­pa­nies want to sub­ject their shares to month­ly or quar­ter­ly auc­tions mar­ket­ed by the exchange.

    ...

    Car­taX would force com­pa­nies to share two years of finan­cial state­ments pre­pared using gen­er­al­ly accept­ed account­ing prin­ci­ples, in order to com­ply with a secu­ri­ties exemp­tion the exchange is using to allow par­tic­i­pa­tion from an unlim­it­ed num­ber of accred­it­ed investors.

    Lawyers and gov­er­nance experts say the require­ment could help solve incon­sis­ten­cies in infor­ma­tion dis­clo­sure in pri­vate mar­kets. But oth­ers say it would be a bur­den for young com­pa­nies, which often remain pri­vate to avoid shar­ing their finan­cial infor­ma­tion to a broad audi­ence of investors, reflect­ing a cen­tral ten­sion in the mar­ket as bro­kers and traders attempt to cap­i­talise on the surge of inter­est in sec­ondary trans­ac­tions.

    “The ‘move fast and break things’ cul­ture of start-ups mil­i­tates pre­cise­ly against this,” says Dia­mond at San­ta Clara Uni­ver­si­ty. “That, to me, is the fun­da­men­tal para­dox here.”
    ...

    So Car­ta is requir­ing some degree of pub­lic dis­clo­sure by these com­pa­nies, but only because that’s the price they had to pay to get a reg­u­la­to­ry exemp­tion on the num­ber of peo­ple, which is an exemp­tion they would obvi­ous­ly need to make the exchange open to the broad­er pub­lic. It’s an impor­tant detail because it rais­es the ques­tion of what hap­pens if that secu­ri­ty reg­u­la­tion is relaxed. Like, what if the two year dis­clo­sure is dropped entire­ly or exot­ic account­ing rules are allowed by the SEC in order to qual­i­ty for the exemp­tion that grants unlim­it­ed investors to access the exchange? Will Car­ta sim­i­lar­ly relax its dis­clo­sure rules? Drop them entire­ly? We don’t know. But the fact that Car­ta’s two year dis­clo­sure require­ment was put in place to gain that secu­ri­ties exemp­tion, and not out of a ded­i­ca­tion to greater-than-required-trans­paren­cy, does­n’t bode well.

    And that points to what is prob­a­bly the most omi­nous aspect of this sto­ry: it’s a finan­cial indus­try sto­ry so we know it’s going to get worse. As bad is this idea sounds now, it’s going to get a lot worse. Reg­u­la­tors will be lob­bied, leg­is­la­tors bribed, and what­ev­er else that is required to make this ‘third con­fig­u­ra­tion’ pub­licly-financed pri­vate com­pa­ny a real­i­ty will tran­spire. Some­thing will be done to turn the pri­vate sec­ondary mar­ket­place of shares into a tick­ing finan­cial time bomb that makes a select few for­tunes before blow­ing up while the pub­lic holds the bag.

    We know that’s what will hap­pen because that’s the only thing that hap­pens when con­cen­trat­ed wealth cap­tures the econ­o­my and pol­i­tics to the extent that it has done so in the US. New exot­ic ways to break the rules and blow up bub­bles are devised. A bunch of ‘inno­va­tors’ make obscene bub­ble for­tunes. What­ev­er safe­guards to the pub­lic that hap­pen to be put in place will be even­tu­al­ly removed and then it will all blow up in a man­ner than was obvi­ous­ly inevitable with no one held account­able and the pub­lic hold­ing the bag. It’s the lat­est iter­a­tion of that same old sto­ry. That same old sto­ry that some­how nev­er gets old.

    Posted by Pterrafractyl | February 28, 2021, 10:02 pm
  13. Here’s an inter­est­ing sto­ry about pri­vate equi­ty in the coal indus­try that has sud­den­ly become much more top­i­cal in light of the Texas win­ter black­out dis­as­ter:

    It turns out pri­vate equi­ty has been busy buy­ing up coal plants of late. It’s a rather unex­pect­ed shake­up for an indus­try that’s long been seen as a dying lega­cy that human­i­ty needs to phase out and replace with renew­ables. So why is are pri­vate equi­ty com­pa­nies so inter­est­ed in a dying indus­try? Because coal tends to play a spe­cial role in the US elec­tri­cal grid: back­up pow­er.

    Yes, it turns out that states with harsh win­ters like Penn­syl­va­nia and Michi­gan have coal pow­ered elec­tri­cal plants that are paid to essen­tial­ly not oper­ate but be ready to oper­ate at a momen­t’s notice. These pay­ments are called capac­i­ty pay­ments, and grid oper­a­tors tend to favor coal pow­ered plants that keep a large stock­pile of coal on hand for these pay­ments.

    Now, it’s worth not­ing that in the case of Texas and the black­outs, there was no issue with the back­up pow­er seg­ment of the pow­er mar­ket because there is no back­up sege­ment of the Texas pow­er mar­ket. Instead of pay­ing ener­gy oper­a­tors capac­i­ty pay­ments to ensure there’s enough pow­er avail­able under high-stress peri­ods, Texas lift­ed the max­i­mum price that pro­duc­ers could charge to $9,000/megawatt-hour and assumed that allow­ing such exor­bi­tant prices would ensure there’s enough capac­i­ty. So this issue with pri­vate equi­ty buy­ing up the back­up pow­er capac­i­ty of the elec­tri­cal grid excludes Texas because Texas has an even more insane mar­ket design.

    And as we’ll see, there’s anoth­er rea­son pri­vate equi­ty has shown a new inter­est in coal. Sad­ly for coal work­ers, it’s the same rea­son pri­vate equi­ty shows an inter­est in all sorts of dying indus­try: it’s a new oppor­tu­ni­ty to load the com­pa­nies up with debt to pay out div­i­dends to the pri­vate equi­ty share­hold­ers. So pri­vate equi­ty is basi­cal­ly try­ing to cap­ture the mar­ket for these poten­tial­ly lucra­tive capac­i­ty pay­ments by buy­ing up com­pa­nies in a doomed indus­try and then accel­er­at­ing the doom by load­ing the com­pa­nies up with debt:

    Reuters

    How pri­vate equi­ty squeezes cash from the dying U.S. coal indus­try

    By Tim McLaugh­lin
    March 2, 2021 9:59 AM
    Updat­ed

    BOSTON (Reuters) — Pri­vate equi­ty firms are prov­ing there’s still plen­ty of prof­it in the U.S. coal indus­try despite a decade of falling demand for the fos­sil fuel. They are spend­ing bil­lions of dol­lars buy­ing coal-fired plants on the cheap — and get­ting paid even when they are not pro­vid­ing pow­er.

    Since the end of 2014, at least five U.S. pri­vate equi­ty firms have bought coal plants in mar­kets where reg­u­la­tors pay them to be on stand­by to pro­vide emer­gency pow­er when demand surges with extreme hot or cold weath­er, accord­ing to a Reuters review of U.S. reg­u­la­to­ry dis­clo­sures and cred­it-rat­ing agency reports.

    The lucra­tive invest­ments illus­trate how fos­sil fuels will remain an impor­tant part of the ener­gy mix — and con­tin­ue spin­ning off cash for investors — even years after demand for them peaks as the world tran­si­tions toward clean­er ener­gy sources.

    The need for reserve pow­er was on dis­play dur­ing the util­i­ty cri­sis this month in Texas — the only U.S. grid sys­tem that oper­ates with­out such an emer­gency sys­tem. A cold snap knocked out sev­er­al of the state’s gen­er­at­ing plants and trig­gered wide­spread black­outs, leav­ing a wake of human suf­fer­ing includ­ing sev­er­al dozen deaths.

    The so-called capac­i­ty pay­ments are giv­en out in most U.S. pow­er mar­kets, and reg­u­la­tors tend to favor coal-fired gen­er­a­tors that store heaps of coal on site when oth­er pow­er sources might be dis­rupt­ed. In the Penn­syl­va­nia, Jer­sey, Mary­land Pow­er Pool (PJM), which has the largest stand­by mar­ket, capac­i­ty rev­enue pay­ments aver­age more than $100 per megawatt per day — an insur­ance pol­i­cy that costs about $9 bil­lion a year and aims to make sure the grid’s 65 mil­lion cus­tomers avoid black­outs dur­ing heat waves and Arc­tic blasts.

    “The capac­i­ty pow­er mar­ket is a cer­tain source of rev­enue for coal plants that might oth­er­wise be uneco­nom­i­cal,” said Sylvia Bialek, an econ­o­mist at New York University’s Insti­tute for Pol­i­cy Integri­ty.

    The admin­is­tra­tion of for­mer Pres­i­dent Don­ald Trump, a Repub­li­can, encour­aged capac­i­ty mar­ket incen­tives for coal-fired gen­er­a­tors. But Pres­i­dent Joe Biden, a Demo­c­rat, is like­ly to change those poli­cies in the com­ing years as part of an effort to slash near­ly all of the U.S. pow­er sector’s reliance on fos­sil fuels by 2035.

    In the mean­time, pri­vate equi­ty firms are in a good posi­tion to com­pete for capac­i­ty pay­ments because tra­di­tion­al util­i­ties are under pres­sure from activist share­hold­ers to reduce green­house gas emis­sions and to lim­it debt.

    The pri­vate equi­ty own­ers of Ohio’s Gavin Pow­er Plant in the PJM grid, for exam­ple, have squeezed hun­dreds of mil­lions of dol­lars out of the facil­i­ty since buy­ing it four years ago, even though it only runs about 60% of the time.

    Light­stone Gen­er­a­tion LLC — a joint ven­ture between Boston’s ArcLight Cap­i­tal Part­ners LLC and New York-based Black­stone Group Inc — took on $2.1 bil­lion in debt from Wall Street banks to buy the plant and three much small­er gas-fired units from Amer­i­can Elec­tric Pow­er Com­pa­ny Inc in 2017, accord­ing to term sheets viewed by Reuters.

    From 2018 to 2020, Lightstone’s pow­er plant oper­a­tions pro­duced about $1.1 bil­lion in oper­at­ing prof­it, accord­ing to esti­mates from Moody’s Investors Ser­vice. Up to 50% of Gavin’s cash flow comes from being on stand­by for emer­gency pow­er, accord­ing to sev­er­al econ­o­mists and cred­it ana­lysts.

    About 18 months after the Gavin acqui­si­tion, ArcLight and Black­stone went back to Wall Street to finance most of a $375 mil­lion spe­cial div­i­dend they paid to them­selves, accord­ing to cred­it rat­ing agen­cies. Such div­i­dends are a way for pri­vate equi­ty firms to lock in prof­its and shift risk to their debt-hold­ers, which are often mutu­al funds. If the busi­ness does well, the debt gets paid off at a pre­mi­um. But if the busi­ness fails, the debt-hold­ers end up with equi­ty stakes in plants of declin­ing val­ue.

    ...

    The pri­vate equi­ty firms’ back­ers have also been mak­ing mon­ey on the invest­ments, accord­ing to fil­ings. The state of Connecticut’s retire­ment plan, for exam­ple, invest­ed $85 mil­lion in ArcLight’s Ener­gy Part­ners Fund VI, which holds stakes in the Gavin plant along with oth­er ener­gy invest­ments, and has seen returns of about 8%.

    Mean­while, mutu­al funds that invest­ed in Lightstone’s debt are receiv­ing pay­ments pegged to a float­ing inter­est rate that has ranged from 4% to 6% — far high­er than about 1.4% on the U.S. bench­mark 10-year yield.

    ‘ABSOLUTELY VITAL’

    Oth­er pri­vate equi­ty firms have also been bet­ting on coal pow­er capac­i­ty pay­ments.

    Atlas Hold­ings, for exam­ple, led a joint ven­ture to buy New Hampshire’s Mer­ri­mack Sta­tion coal plant in 2018, the cen­ter­piece of a $175 mil­lion acqui­si­tion of gen­er­a­tors from New Eng­land-based util­i­ty Ever­source Ener­gy.

    Atlas declined to com­ment.

    The coal plant hard­ly runs but has been eli­gi­ble to receive up to $188 mil­lion in capac­i­ty pay­ments from the New Eng­land ISO between 2018 and 2023, accord­ing to dis­clo­sures by reg­u­la­tors. Work­ers at Mer­ri­mack Sta­tion see their mis­sion as a mat­ter of life and death. They keep boil­ers warm and the plant in a con­stant state of readi­ness, said Tony Sapien­za, busi­ness man­ag­er for Local 1837 of the Inter­na­tion­al Broth­er­hood of Elec­tri­cal work­ers.

    “The capac­i­ty mar­ket is absolute­ly vital,” Sapien­za said. “And with­out Mer­ri­mack Sta­tion, peo­ple might die in the win­ter or dur­ing real­ly hot weath­er. It’s real­ly that sim­ple.”

    The reserve coal plants cre­ate good jobs. Pri­vate-equi­ty owned coal plants can pay their staff about $100,000 a year for keep­ing the facil­i­ties on stand­by and fir­ing them up when need­ed, accord­ing to Shawn Stef­fee, busi­ness agent for the Boil­er­mak­ers Local 154 union in Penn­syl­va­nia. He said coal plants in the state “ran like a freight train” dur­ing the recent cold snap.

    In anoth­er prof­itable invest­ment, pri­vate equi­ty firm River­stone Hold­ings LLC paid $1.8 bil­lion in late 2016 to buy the remain­ing stake in elec­tric­i­ty pro­duc­er Tal­en Ener­gy Corp. The take-pri­vate deal includ­ed stakes in sev­er­al coal plants, includ­ing ones receiv­ing PJM capac­i­ty pay­ments, an “impor­tant com­po­nent” of gross prof­its, accord­ing to an SEC dis­clo­sure. About a year lat­er, Tal­en paid its own­ers, includ­ing River­stone, a spe­cial $500 mil­lion div­i­dend. River­stone did not return mes­sages seek­ing com­ment.

    WITH REWARD COMES RISK

    Pri­vate equi­ty ven­tures into coal-fired pow­er don’t always turn out well, with some deals get­ting caught up in the broad­er decline of the coal indus­try. A cred­it fund run by pri­vate equi­ty firm KKR & Co Inc in 2015, for exam­ple, took a big stake in Longview Pow­er LLC — whose major asset is a West Vir­ginia coal plant plugged into the PJM elec­tric grid — as part of a bank­rupt­cy restruc­tur­ing.

    But in April 2020, Longview filed for bank­rupt­cy pro­tec­tion again, wip­ing out some $350 mil­lion in debt, as coro­n­avirus lock­downs cut elec­tric­i­ty demand. KKR declined to com­ment.

    Ana­lysts and econ­o­mists expect Biden’s admin­is­tra­tion to crack down on rules that pro­long the lifes­pan of dirty coal plants as part of sweep­ing mea­sures to fight cli­mate change. Biden has named Richard Glick, a Demo­c­rat, as the new chair­man of the Fed­er­al Ener­gy Reg­u­la­to­ry Com­mis­sion. Under a Repub­li­can major­i­ty on the com­mis­sion, Glick had been crit­i­cal of FERC rules he con­tends unfair­ly favor coal over renew­able ener­gy sources in capac­i­ty pow­er mar­kets, say­ing they “would have made the Krem­lin econ­o­mists in the old Sovi­et Union blush.”

    ...

    “I’m con­fi­dent, in the next cou­ple of years, FERC will order changes,” said Ari Peskoe, direc­tor of the Elec­tric­i­ty Law Ini­tia­tive at Har­vard Law School.

    Pol­i­cy changes could make it hard­er for high­ly-lever­aged pri­vate equi­ty own­ers of coal plants, like Light­stone, to refi­nance their debts, accord­ing to Richard Don­ner, a cred­it ana­lyst at Moody’s Investors Ser­vice. About $1.7 bil­lion in the company’s debt comes due in 2024.

    Even so, Lightstone’s cred­i­tors are the ones with the great­est risk, accord­ing to Peskoe.

    “Some­how the pri­vate equi­ty guys always make out OK,” Peskoe said. “It’s every­one else who doesn’t.”

    ————

    “How pri­vate equi­ty squeezes cash from the dying U.S. coal indus­try” by Tim McLaugh­lin; Reuters; 03/02/2021

    “The so-called capac­i­ty pay­ments are giv­en out in most U.S. pow­er mar­kets, and reg­u­la­tors tend to favor coal-fired gen­er­a­tors that store heaps of coal on site when oth­er pow­er sources might be dis­rupt­ed. In the Penn­syl­va­nia, Jer­sey, Mary­land Pow­er Pool (PJM), which has the largest stand­by mar­ket, capac­i­ty rev­enue pay­ments aver­age more than $100 per megawatt per day — an insur­ance pol­i­cy that costs about $9 bil­lion a year and aims to make sure the grid’s 65 mil­lion cus­tomers avoid black­outs dur­ing heat waves and Arc­tic blasts.

    A pow­er insur­ance mar­ket that pays out $9 bil­lion a year in capac­i­ty pay­ments for the states of Penn­syl­va­nia, Jer­sey, Mary­land alone. That’s the scale of this sec­tor of elec­tric­i­ty mar­ket the pri­vate equi­ty indus­try is try­ing to cor­ner.

    And the fact that coal plants are the kind of thing a lot of activist share­hold­ers reject over eth­i­cal con­cerns only makes it that much eas­i­er for pri­vate equi­ty to suc­ceed. They’re lack of eth­i­cal con­straint allows them to go where oth­er investors won’t:

    ...
    In the mean­time, pri­vate equi­ty firms are in a good posi­tion to com­pete for capac­i­ty pay­ments because tra­di­tion­al util­i­ties are under pres­sure from activist share­hold­ers to reduce green­house gas emis­sions and to lim­it debt.
    ...

    But the capac­i­ty pay­ments are just one of fac­tors entic­ing pri­vate equi­ty to enter thes sec­tor. The fact that they can load up these com­pa­nies with debt to pay them­selves div­i­dends. It’s an oldie but a good­ie:

    ...
    The pri­vate equi­ty own­ers of Ohio’s Gavin Pow­er Plant in the PJM grid, for exam­ple, have squeezed hun­dreds of mil­lions of dol­lars out of the facil­i­ty since buy­ing it four years ago, even though it only runs about 60% of the time.

    Light­stone Gen­er­a­tion LLC — a joint ven­ture between Boston’s ArcLight Cap­i­tal Part­ners LLC and New York-based Black­stone Group Inc — took on $2.1 bil­lion in debt from Wall Street banks to buy the plant and three much small­er gas-fired units from Amer­i­can Elec­tric Pow­er Com­pa­ny Inc in 2017, accord­ing to term sheets viewed by Reuters.

    From 2018 to 2020, Lightstone’s pow­er plant oper­a­tions pro­duced about $1.1 bil­lion in oper­at­ing prof­it, accord­ing to esti­mates from Moody’s Investors Ser­vice. Up to 50% of Gavin’s cash flow comes from being on stand­by for emer­gency pow­er, accord­ing to sev­er­al econ­o­mists and cred­it ana­lysts.

    About 18 months after the Gavin acqui­si­tion, ArcLight and Black­stone went back to Wall Street to finance most of a $375 mil­lion spe­cial div­i­dend they paid to them­selves, accord­ing to cred­it rat­ing agen­cies. Such div­i­dends are a way for pri­vate equi­ty firms to lock in prof­its and shift risk to their debt-hold­ers, which are often mutu­al funds. If the busi­ness does well, the debt gets paid off at a pre­mi­um. But if the busi­ness fails, the debt-hold­ers end up with equi­ty stakes in plants of declin­ing val­ue.
    ...

    But there are still risks with these kinds of invest­ments. Risks like reg­u­la­to­ry changes intend­ed to phase out coal entire­ly. But as we saw, the indus­try has its ways of trans­fer­ring those risks to oth­ers while lock­ing in the gains. It’s the cred­i­tors who finance these debt-fuel div­i­dends who are assum­ing that reg­u­la­to­ry risk:

    ...
    Pol­i­cy changes could make it hard­er for high­ly-lever­aged pri­vate equi­ty own­ers of coal plants, like Light­stone, to refi­nance their debts, accord­ing to Richard Don­ner, a cred­it ana­lyst at Moody’s Investors Ser­vice. About $1.7 bil­lion in the company’s debt comes due in 2024.

    Even so, Lightstone’s cred­i­tors are the ones with the great­est risk, accord­ing to Peskoe.

    “Some­how the pri­vate equi­ty guys always make out OK,” Peskoe said. “It’s every­one else who doesn’t.”
    ...

    Final­ly, note how the pre­vail­ing ultra-low inter­est rates are help­ing to fuel this trend: As long as the bonds issued by these pri­vate-equi­ty-owned coal com­pa­nies (to pay out div­i­dends) are pay­ing rates high­er than the cur­rent his­tor­i­cal­ly-low trea­sury rates, there’s going to be demand for those bonds:

    ...
    Mean­while, mutu­al funds that invest­ed in Lightstone’s debt are receiv­ing pay­ments pegged to a float­ing inter­est rate that has ranged from 4% to 6% — far high­er than about 1.4% on the U.S. bench­mark 10-year yield.
    ...

    And keep in mind that, should rates on US trea­suries rise, the rates offered on these coal com­pa­ny bonds are going to have to rise too, fur­ther indebt­ing these com­pa­nies. In oth­er words, while the trend of buy­ing up coal com­pa­nies and load­ing them up on debt is cer­tain­ly con­cern­ing, it’s going to become a lot more con­cern­ing in the future as rates rise. At least con­cern­ing to those bond hold­ers who financed the div­i­dends.

    And that points towards a larg­er con­cern that we should keep in mind about what pri­vate equi­ty has been up to in recent years as the rates on US Trea­suries are at a 1‑year high and threat­en to go high­er in the future: the pri­vate pri­vate equi­ty sec­tor has had an unprece­dent­ed oppor­tu­ni­ty to load up the com­pa­nies they own with debt at his­tor­i­cal­ly low inter­est rates. And when an indus­try that exists for the pur­pose of buy­ing up com­pa­nies — typ­i­cal­ly using lots of debt fol­low­ing by load­ing those com­pa­nies up with even more debt to pay out div­i­dends — has access to record low bor­row­ing costs, we should expect record high bor­row­ing from the these pri­vate-equi­ty owned com­pa­nies. Record high bor­row­ing that’s only going to get more expen­sive as rates rise. It’s the kind of dynam­ic to could wreak hav­oc across all sec­tors of the econ­o­my with heavy pri­vate equi­ty own­er­ship, not just the coal indus­try.

    Final­ly, keep in mind that an indus­try that’s noto­ri­ous for gut­ting the com­pa­nies it owns and dri­ving them into the ground prob­a­bly isn’t the best indus­try to rely on for back­up pow­er capac­i­ty.

    Posted by Pterrafractyl | March 5, 2021, 8:41 pm
  14. Here’s a pair of arti­cles about a grow­ing pan­dem­ic-fueled trend in the insur­ance indus­try. A trend that, if crit­ics are cor­rect, is only going to result in the pri­vate equi­ty indus­try find­ing a new source of prof­its to exploit, with the indi­vid­ual life insur­ance and annu­ity pol­i­cy hold­ers pay­ing the price:

    First, here’s a report about a new insur­ance indus­try sur­vey show­ing a sig­nif­i­cant uptick in life insur­ance pol­i­cy sales over the past year, pre­sum­ably as a result of the pan­dem­ic. At the same time, the sur­vey notes that life insur­ance cov­er­age for US cit­i­zens is at the low­est point since the sur­vey was start­ed in 1960, with just 52% of Amer­i­cans own­ing a life insur­ance pol­i­cy out of their work­place cov­er­age (work­place cov­er­age that is inad­e­quate for many fam­i­lies). About 40% of the US adult pop­u­la­tion falls into the cat­e­gories of being unin­sured or under­in­sured accord­ing to this sur­vey, with the cost of life insur­ance cit­ed as one of the chief rea­sons peo­ple are going with­out it. So it sounds like the a pan­dem­ic man­aged to increase the demand for life insur­ance, but that jump in new poli­cies does­n’t ful­ly reflect the rise demand for life insur­ance because a large por­tion of the pop­u­lace can’t afford it even if they want it:

    Pitts­burgh Post-Gazette

    Life insur­ance sales have increased dur­ing the pan­dem­ic

    TIM GRANT
    APR 13, 2021 3:47 AM

    The num­ber of Amer­i­cans who own life insur­ance poli­cies remains at a low, but sales are pick­ing up, and an insur­ance indus­try sur­vey released Mon­day indi­cates fam­i­lies are more inter­est­ed in buy­ing life insur­ance.

    Life insur­ance pol­i­cy sales jumped 14% in Jan­u­ary com­pared with Jan­u­ary 2020. Sales increased 12% in Feb­ru­ary com­pared with Feb­ru­ary 2020, accord­ing to Lim­ra, a Wind­sor, Conn.-based trade group for the finan­cial ser­vices indus­try.

    Sales num­bers for life insur­ance poli­cies also grew in the sec­ond, third and fourth quar­ters of 2020 as more fam­i­lies choose to pur­chase life insur­ance cov­er­age dur­ing the COVID-19 pan­dem­ic.

    Lim­ra researchers found there’s a his­tor­i­cal basis for pan­dem­ic fears caus­ing fam­i­lies to make life insur­ance a pri­or­i­ty. Based on data from the country’s top three mutu­al life insur­ance com­pa­nies, the num­ber of poli­cies sold, on aver­age, increased 58% in 1919 — the year after the flu pan­dem­ic of 1918.

    “If you look at life insur­ance sales, they tend to go up after some type of life event — the birth of a child, get­ting mar­ried or the pass­ing of a loved one,” said David Lev­en­son, pres­i­dent and CEO of Lim­ra. “Sure­ly at a macro lev­el, the pan­dem­ic has been a sig­nif­i­cant life event for many indi­vid­u­als.”

    Limra’s Insur­ance Barom­e­ter Study released Mon­day found 36% of Amer­i­cans plan to buy life insur­ance in the next 12 months, which is the high­est pur­chase intent the sur­vey has found in 11 years.

    “This is a macro life event that affects every­one,” Mr. Lev­en­son said. “Now every­one is eval­u­at­ing what would hap­pen to their fam­i­ly if some­thing hap­pened to them. That is a nat­ur­al way of think­ing in the midst of a pan­dem­ic, and that’s why we see such demand for life insur­ance.”

    Cur­rent­ly, just 52% of Amer­i­cans own a life insur­ance pol­i­cy out­side of their work­place cov­er­age, which Lim­ra says is the low­est lev­el since it start­ed track­ing life insur­ance own­er­ship in 1960.

    Even with the increased demand, that still leaves 102 mil­lion unin­sured and under­in­sured Amer­i­cans, rep­re­sent­ing 40% of the adult pop­u­la­tion.

    The most com­mon rea­sons peo­ple sur­veyed in the study give for not pur­chas­ing life insur­ance are cost and hav­ing oth­er finan­cial pri­or­i­ties.

    Just over half (53%) aren’t sure what type of life insur­ance they need or how much cov­er­age to pur­chase; almost half (47%) stat­ed they have sim­ply put off buy­ing life insur­ance; and more than a third (36%) don’t believe they would qual­i­fy for life insur­ance cov­er­age.

    Forty-four per­cent of mil­len­ni­als esti­mat­ed the annu­al cost of a 20-year term life insur­ance pol­i­cy for a 30-year-old was more than $1,000, when it’s actu­al­ly clos­er to $165 per year.

    The study found many are at risk of putting too much reliance on employ­er-spon­sored life insur­ance cov­er­age. Men (35%) are more like­ly to believe the cov­er­age they get from their job is suf­fi­cient than women do (22%).

    Accord­ing to the U.S. Bureau of Labor Sta­tis­tics, the medi­an life insur­ance cov­er­age offered at the work­place is either a flat sum of $20,000 or one year’s salary.

    The lat­est Barom­e­ter study found more than half of U.S. house­holds rely on dual incomes (54%) and for many, los­ing one income could be finan­cial­ly dev­as­tat­ing to the fam­i­ly. It found that 42% of fam­i­lies would face finan­cial hard­ship in six months and a quar­ter of fam­i­lies would be in dire straits with­in a month.

    “Hav­ing ade­quate life insur­ance cov­er­age is the foun­da­tion of a secure finan­cial future,” Mr. Lev­en­son said. “A good rule of thumb is con­sumers should have 10 times their annu­al salary to ensure their loved ones’ futures are pro­tect­ed.

    ...

    ————-

    “Life insur­ance sales have increased dur­ing the pan­dem­ic” by TIM GRANT; Pitts­burgh Post-Gazette; 04/13/2021

    Lim­ra researchers found there’s a his­tor­i­cal basis for pan­dem­ic fears caus­ing fam­i­lies to make life insur­ance a pri­or­i­ty. Based on data from the country’s top three mutu­al life insur­ance com­pa­nies, the num­ber of poli­cies sold, on aver­age, increased 58% in 1919 — the year after the flu pan­dem­ic of 1918.”

    There’s noth­ing quite like a dead­ly pan­dem­ic to remind peo­ple of their own mor­tal­i­ty. And almost half the US pop­u­lace is unin­sured or under­in­sured, with the lack of afford­abil­i­ty being one of the top rea­sons:

    ...
    Cur­rent­ly, just 52% of Amer­i­cans own a life insur­ance pol­i­cy out­side of their work­place cov­er­age, which Lim­ra says is the low­est lev­el since it start­ed track­ing life insur­ance own­er­ship in 1960.

    Even with the increased demand, that still leaves 102 mil­lion unin­sured and under­in­sured Amer­i­cans, rep­re­sent­ing 40% of the adult pop­u­la­tion.

    The most com­mon rea­sons peo­ple sur­veyed in the study give for not pur­chas­ing life insur­ance are cost and hav­ing oth­er finan­cial pri­or­i­ties.
    ...

    So is there some hope around the cor­ner for that large group of US adults who sim­ply can’t afford decent life insur­ance? Not real­ly. But it sounds like there’s plen­ty of hope for the pri­vate equi­ty indus­try to increase its prof­its by buy­ing up life insur­ance com­pa­nies and squeez­ing them for what­ev­er prof­its they can get:

    CNBC

    Pri­vate equi­ty is buy­ing up annu­ity and life insur­ance poli­cies. That may be bad for con­sumers

    Greg Iacur­ci
    Pub­lished Sat, Apr 24 2021 11:19 AM EDT

    * Pri­vate equi­ty firms are buy­ing up busi­ness­es with bil­lions of dol­lars of annu­ity and life insur­ance assets.
    * Finan­cial advi­sors warn pol­i­cy­hold­ers could see high­er insur­ance costs and oth­er fees as a result.
    * How­ev­er, some deals are struc­tured so there may be a dis­in­cen­tive for firms to raise costs. Pol­i­cy­hold­ers could also ben­e­fit from high­er returns.

    Pri­vate equi­ty firms are buy­ing up insur­ers — and the poli­cies they hold — at a fever­ish pace.

    Some groups, name­ly finan­cial advi­sors, fear the trend may be bad for con­sumers who own annu­ity and life insur­ance con­tracts.

    Crit­ics are con­cerned the buy­ers will wring prof­its from cus­tomers — via high­er costs — to boost returns for their investors. Con­sumers may have owned such insur­ance for years and depend on a cer­tain price for their finan­cial plans.

    They may have bought a pol­i­cy based on an insurer’s finan­cial strength or cred­it rat­ing. New buy­ers may not have the same rat­ing, which sig­ni­fies its abil­i­ty to pay future ben­e­fits, advi­sors cau­tioned.

    “There’s noth­ing good in this for the pol­i­cy­hold­er,” Lar­ry Ryb­ka, chair­man and CEO of Akron, Ohio-based Val­mark Finan­cial Group, said of the pri­vate equi­ty trend.

    But oth­ers don’t see a five-alarm-fire sce­nario.

    Many of the big­ger buy­ers are well-cap­i­tal­ized firms and not all deals are inher­ent­ly bad, accord­ing to some ana­lysts. Pol­i­cy­hold­ers may ben­e­fit from poten­tial­ly high­er invest­ment returns in an envi­ron­ment of low inter­est rates.

    “I don’t know if I’d say [they’re] unfound­ed,” Dafi­na Dun­more, lead ana­lyst for alter­na­tive invest­ment man­agers at Fitch Rat­ings, said of the fears. “I’d say they’re over­played.”

    ‘Watch close­ly’

    The pace of acqui­si­tions has accel­er­at­ed since 2014, accord­ing to Refini­tiv, which tracks finan­cial data.

    There were 191 pri­vate-equi­ty-backed insur­ance deals last year in the U.S., beat­ing the pri­or record of 154 set in 2019.

    Buy­ers paid $12.1 bil­lion so far in 2021 for the deals — eclips­ing the $9.7 bil­lion record set in full-year 2018, accord­ing to Refini­tiv.

    “By def­i­n­i­tion, [pri­vate equity’s] man­date is not the pol­i­cy­hold­ers,” said Gre­go­ry Olsen, a cer­ti­fied finan­cial plan­ner and part­ner at Lenox Advi­sors. “It’s to make as much mon­ey for their investors [as pos­si­ble].”

    Annu­ity and life insur­ance poli­cies car­ry var­i­ous annu­al fees for con­sumers. Those fees can be raised up to a cer­tain cap guar­an­teed by the con­tract.

    Advi­sors are con­cerned pri­vate equi­ty buy­ers will raise those var­i­ous fees to their max­i­mum val­ues. The result may be erod­ed invest­ment earn­ings in a vari­able annu­ity or high­er annu­al pre­mi­ums required to keep a life insur­ance pol­i­cy, for exam­ple.

    “I’d watch close­ly on the expens­es,” Olsen said.

    Wor­ried or adverse­ly affect­ed con­sumers may be able to exchange their annu­ity or life insur­ance for anoth­er.

    How­ev­er, such trans­fers are com­pli­cat­ed, advi­sors said. Con­sumers may inad­ver­tent­ly trig­ger penal­ties and fees, or may be bet­ter suit­ed stay­ing in their cur­rent con­tract even with high­er annu­al fees, they said.

    Types of deals

    Acqui­si­tions are often com­pli­cat­ed and can take dif­fer­ent struc­tures, which have dif­fer­ent impli­ca­tions for con­sumers.

    For exam­ple, a buy­er may pur­chase a major­i­ty stake in an insur­er or buy it out­right.

    In Feb­ru­ary, KKR bought a 60% stake in insur­er Glob­al Atlantic for more than $4 bil­lion. More than 2 mil­lion peo­ple have fixed annu­ities, life insur­ance oth­er poli­cies with Glob­al Atlantic.

    In Jan­u­ary, Black­stone agreed to buy All­state Life Insur­ance Com­pa­ny for $2.8 bil­lion.

    The life insur­er rep­re­sents 80% — or $23 bil­lion — of All­state Corporation’s life insur­ance and annu­ity assets. (All­state is try­ing to sell the oth­er $5 bil­lion cur­rent­ly held by All­state Life Insur­ance Com­pa­ny of New York, it said in the deal announce­ment.)

    In these types of deals, pri­vate-equi­ty firms may have an incen­tive to avoid rais­ing costs and risk­ing rep­u­ta­tion­al dam­age that may cost them future busi­ness.

    Glob­al Atlantic, for exam­ple, hasn’t changed pol­i­cy­hold­er fees on any exist­ing poli­cies since the own­er­ship change, accord­ing to a KKR spokesper­son.

    “As own­er, KKR has a vest­ed inter­est in the long-term suc­cess of Glob­al Atlantic which can only be achieved through strong, trust­ed rela­tion­ships with pol­i­cy­hold­ers and their finan­cial advi­sors and by con­tin­u­ing to offer com­pet­i­tive prod­ucts,” accord­ing to an e‑mailed state­ment.

    Oth­er recent deals have involved lega­cy busi­ness lines closed to new cus­tomers. These types of trans­ac­tions may be a bit shaki­er, since that same incen­tive doesn’t exist, advi­sors said.

    Sixth Street Part­ners announced a deal to buy Tal­cott Res­o­lu­tion Life Insur­ance Com­pa­ny, which owns a large block of lega­cy insur­ance busi­ness, in Jan­u­ary. Tal­cott man­ages over $90 bil­lion for rough­ly 900,000 cus­tomers, includ­ing near­ly 600,000 annu­ity con­tract hold­ers.

    ...

    Low inter­est rates

    Insur­ers have large­ly sold off insur­ance busi­ness due to per­sis­tent­ly low inter­est rates since the Great Reces­sion, ana­lysts said.

    Low inter­est rates equate to low­er returns on bonds that under­pin their insur­ance port­fo­lios. That, in turn, makes it hard­er to keep the required cash on hand to pay promised insur­ance ben­e­fits.

    Sell­ing a block of busi­ness lets insur­ers free up cap­i­tal to invest else­where, accord­ing to Dou­glas Mey­er, lead life insur­ance ana­lyst at Fitch.

    Char­lie Lowrey, chair­man and CEO of Pru­den­tial Finan­cial, said in Feb­ru­ary dur­ing an investor call that the insur­er is look­ing at a poten­tial sale of “low-growth busi­ness­es” like annu­ities and life insur­ance to free up $5 bil­lion to $10 bil­lion of cap­i­tal, for exam­ple.

    Pri­vate equi­ty firms can lever­age the insur­ance pools, and con­sumers’ insur­ance pre­mi­ums and oth­er con­tract fees, as a steady stream of reli­able assets. Hav­ing that “per­ma­nent cap­i­tal” at their dis­pos­al means they won’t have to raise mon­ey in the mar­ket as read­i­ly, ana­lysts said.

    “The P/E angle is real­ly to gath­er assets that are ‘sticky,’” David Havens, a glob­al insur­ance ana­lyst at Impe­r­i­al Cap­i­tal, said in an e‑mail.

    KKR, for exam­ple, added $90 bil­lion of assets under man­age­ment with its pur­chase of Glob­al Atlantic.

    And pri­vate-equi­ty man­agers may be invest­ed across a broad­er range of assets, and in turn earn high­er returns for pol­i­cy­hold­ers beyond tra­di­tion­al bonds, said Dun­more of Fitch.

    “We believe the high­er returns net of all fees we’ve pro­duced — while main­tain­ing strong cred­it qual­i­ty — are espe­cial­ly vital to pol­i­cy­hold­ers in this low-inter­est-rate envi­ron­ment,” accord­ing to Matt Ander­son, a Black­stone spokesman.

    ———-

    “Pri­vate equi­ty is buy­ing up annu­ity and life insur­ance poli­cies. That may be bad for con­sumers” by Greg Iacur­ci; CNBC; 08/24/2021

    Crit­ics are con­cerned the buy­ers will wring prof­its from cus­tomers — via high­er costs — to boost returns for their investors. Con­sumers may have owned such insur­ance for years and depend on a cer­tain price for their finan­cial plans.”

    With the new pri­vate-equi­ty own­ers of these life insur­ance poli­cies attempt to raise fees to max­i­mize prof­its or low­er fees to be nice to the pol­i­cy hold­ers? Hmmm...which of those options will the pri­vate equi­ty indus­try choose? It’s such a mys­tery:

    ...
    “There’s noth­ing good in this for the pol­i­cy­hold­er,” Lar­ry Ryb­ka, chair­man and CEO of Akron, Ohio-based Val­mark Finan­cial Group, said of the pri­vate equi­ty trend.

    ...

    “By def­i­n­i­tion, [pri­vate equity’s] man­date is not the pol­i­cy­hold­ers,” said Gre­go­ry Olsen, a cer­ti­fied finan­cial plan­ner and part­ner at Lenox Advi­sors. “It’s to make as much mon­ey for their investors [as pos­si­ble].”

    Annu­ity and life insur­ance poli­cies car­ry var­i­ous annu­al fees for con­sumers. Those fees can be raised up to a cer­tain cap guar­an­teed by the con­tract.

    Advi­sors are con­cerned pri­vate equi­ty buy­ers will raise those var­i­ous fees to their max­i­mum val­ues. The result may be erod­ed invest­ment earn­ings in a vari­able annu­ity or high­er annu­al pre­mi­ums required to keep a life insur­ance pol­i­cy, for exam­ple.
    ...

    And note the tepid con­so­la­tion from Fitch ana­lyst: it’s not like ALL the pri­vate equi­ty buy­outs in the life insur­ance sec­tor are inher­ent­ly bad? It’s not exact­ly reas­sur­ing. Also, recall how the cred­it rat­ing indus­try played a major role in fuel­ing the 2008 finan­cial cri­sis by sys­tem­at­i­cal­ly under­stat­ing the risks asso­ci­at­ed with mortage-backed secu­ri­ties and these under­ly­ing con­flicts of inter­est in the indus­try con­tin­ue to this day. So when we hear a Fitch ana­lyst assure us that there real­ly should­n’t be THAT big of a con­cern about the finan­cial sta­bil­i­ty of these new pri­vate equi­ty own­ers, it’s the kind of reas­sur­ance we should take with a big grain a salt. As the 2008 finan­cial cri­sis made clear, the busi­ness mod­el of the cred­it rat­ings agen­cies are to pro­vide cred­it rat­ings in exchange for a fee. Not nec­es­sar­i­ly accu­rate cred­it rat­ings:

    ...
    But oth­ers don’t see a five-alarm-fire sce­nario.

    Many of the big­ger buy­ers are well-cap­i­tal­ized firms and not all deals are inher­ent­ly bad, accord­ing to some ana­lysts. Pol­i­cy­hold­ers may ben­e­fit from poten­tial­ly high­er invest­ment returns in an envi­ron­ment of low inter­est rates.

    “I don’t know if I’d say [they’re] unfound­ed,” Dafi­na Dun­more, lead ana­lyst for alter­na­tive invest­ment man­agers at Fitch Rat­ings, said of the fears. “I’d say they’re over­played.”
    ...

    Also note how, while we are being told that the new pri­vate equi­ty own­ers won’t have an incen­tive to abuse their new clients because that would dam­age their rep­u­ta­tion and hin­der their abil­i­ty to get new busi­ness, that log­ic does­n’t apply when it’s sole­ly lega­cy poli­cies that are pur­chased. There aren’t going to be any new clients to wor­ry about in that case:

    ...
    Oth­er recent deals have involved lega­cy busi­ness lines closed to new cus­tomers. These types of trans­ac­tions may be a bit shaki­er, since that same incen­tive doesn’t exist, advi­sors said.

    Sixth Street Part­ners announced a deal to buy Tal­cott Res­o­lu­tion Life Insur­ance Com­pa­ny, which owns a large block of lega­cy insur­ance busi­ness, in Jan­u­ary. Tal­cott man­ages over $90 bil­lion for rough­ly 900,000 cus­tomers, includ­ing near­ly 600,000 annu­ity con­tract hold­ers.
    ...

    Final­ly, note how part of the expla­na­tion for why we should­n’t be too con­cern about the finan­cial sta­bil­i­ty of these new pri­vate-equi­ty-owned insur­ance com­pa­nies is that the pri­vate equi­ty firms can lever­age the insur­ance pools. And while it is true that ‘risk pool­ing’ is an estab­lished way for indi­vid­ual insur­ance com­pa­nies to low­er their costs by pool­ing their risks togeth­er, these risk pools could also be turned into finan­cial time-bombs if the com­pa­nies in the pool are col­lec­tive­ly try­ing to juice their prof­its with risky investe­ments. And yet we’re also told that pri­vate equi­ty firms might be able to achieve high­er yields than tra­di­tion­al insur­ance com­pa­nies because pri­vate equi­ty firms can be invest­ed across a broad­er range of assets that earn high­er returns than tra­di­tion­al bonds. It’s anoth­er way of say­ing pri­vate equi­ty can earn high­er returns than tra­di­tion­al insur­ance com­pa­nies because pri­vate equi­ty can invest in riski­er assets. What could pos­si­bly go wrong?

    ...
    Pri­vate equi­ty firms can lever­age the insur­ance pools, and con­sumers’ insur­ance pre­mi­ums and oth­er con­tract fees, as a steady stream of reli­able assets. Hav­ing that “per­ma­nent cap­i­tal” at their dis­pos­al means they won’t have to raise mon­ey in the mar­ket as read­i­ly, ana­lysts said.

    “The P/E angle is real­ly to gath­er assets that are ‘sticky,’” David Havens, a glob­al insur­ance ana­lyst at Impe­r­i­al Cap­i­tal, said in an e‑mail.

    KKR, for exam­ple, added $90 bil­lion of assets under man­age­ment with its pur­chase of Glob­al Atlantic.

    And pri­vate-equi­ty man­agers may be invest­ed across a broad­er range of assets, and in turn earn high­er returns for pol­i­cy­hold­ers beyond tra­di­tion­al bonds, said Dun­more of Fitch.

    “We believe the high­er returns net of all fees we’ve pro­duced — while main­tain­ing strong cred­it qual­i­ty — are espe­cial­ly vital to pol­i­cy­hold­ers in this low-inter­est-rate envi­ron­ment,” accord­ing to Matt Ander­son, a Black­stone spokesman.
    ...

    So it looks like we’re see­ing the devel­op­ment of a life insur­ance mar­ket­place where pri­vate-equi­ty-owned insur­ance com­pa­nies can increase prof­its by mak­ing high­er-risk invest­ments than tra­di­tion­al insur­ance com­pa­nies while osten­si­bly mit­i­gat­ing the ele­vat­ed risk by pool­ing their high­er-risk invest­ments togeth­er.

    Now, in fair­ness, pool­ing assets does reduce net risk. But that’s only true as long as there aren’t sys­temic risks affect­ing all of the assets like we saw with the 2008 finan­cial cri­sis and the sys­tem­at­ic under­pric­ing of risk in the mort­gage-backed secu­ri­ties mar­ket. And that points to one of the biggest risks cre­at­ed by this new life insur­ance indus­try trend: life insur­ance poli­cies are slat­ed to become much more exposed to the sys­temic risks of the US finan­cial sys­tem.

    In oth­er words, if you hap­pen to have a large life insur­ance pol­i­cy that you are hop­ing will be there for your descen­dents, the odds of your life insur­ance pol­i­cy actu­al­ly being paid out to your fam­i­ly will be a lot high­er if you can man­aged to get all that dying tak­en care of before the next finan­cial cri­sis. No rush. Well, ok, there’s actu­al­ly a bit of a rush. But don’t rush it too much.

    Posted by Pterrafractyl | April 25, 2021, 7:22 pm
  15. The New York Times has an arti­cle about a busi­ness trend that, in once sense, is like an annu­al arti­cle that gets writ­ten every year. But in anoth­er sense, it’s a very unusu­al arti­cle about a very unusu­al occurence. And it’s the fact that this is an arti­cle about a very unusu­al occurence that’s also busi­ness as unusu­al that is per­haps the most sig­nif­i­cant:

    It turns out CEO pay at pub­licly trad­ed US com­pa­nies remained essen­tial­ly undent­ed by the pan­dem­ic-induced eco­nom­ic shock of 2020. Work­ers were frozen or fired. But it was the sta­tus quo for CEO com­pen­sa­tion. Same as last year. And the year before that. And a cou­ple of decades before that too. Sky high. Same as always in the mod­ern post-Rea­gan age for Amer­i­ca: Heads we win, tails you lose. Espe­cial­ly dur­ing a pan­dem­ic.

    So what’s the expla­na­tion giv­en for keep­ing CEO com­pen­sa­tion pack­ages at their already absurd lev­els even dur­ing a glob­al pan­dem­ic? Part of it has to do with the nature of mod­ern exec­u­tive com­pen­sa­tion pack­ages: much of the exec­u­tive pay comes in the form of stock options which have sim­i­lar­ly defied the pan­dem­ic and near records highs. So in that sense this is anoth­er aspect of how we’ve sys­tem­at­i­cal­ly rigged the US econ­o­my for eco­nom­ic cap­ture by the exec­u­tive class by cre­at­ing a soci­ety that requires a boom­ing stock mar­ket for every­one — to keep 401ks financed, etc — while sys­tem­at­i­cal­ly hand­ing out large chunks of the own­er­ship of that stock mar­ket direct­ly to exec­u­tives. It’s like we’ve struc­tured soci­ety into a giant gold­en para­chute.

    But we’re also told in the sto­ry about how cor­po­rate boards viewed the pan­dem­ic as an ‘Act of God’ and jus­ti­fied main­tain­ing high pay even in the mid­dle of mass lay­offs by argu­ing that it real­ly was­n’t any­one’s fault.

    So we can now answer the ques­tion of whether or not a glob­al pan­dem­ic that shut­ters much of the glob­al econ­o­my for a year can make a real dent in exec­u­tive pay. And that answer is no. It’s the kind of ques­tion we nev­er should have had to ask, were it not for the col­lec­tive actions of exec­u­tive com­pen­sa­tion boards for large cor­po­ra­tions seem­ing­ly every­where:

    The New York Times

    C.E.O. Pay Remains Stratos­pher­ic, Even at Com­pa­nies Bat­tered by Pan­dem­ic
    While mil­lions of peo­ple strug­gled to make ends meet, many of the com­pa­nies hit hard­est in 2020 show­ered their exec­u­tives with rich­es.

    By David Gelles
    April 24, 2021

    Boe­ing had a his­tor­i­cal­ly bad 2020. Its 737 Max was ground­ed for most of the year after two dead­ly crash­es, the pan­dem­ic dec­i­mat­ed its busi­ness, and the com­pa­ny announced plans to lay off 30,000 work­ers and report­ed a $12 bil­lion loss. Nonethe­less, its chief exec­u­tive, David Cal­houn, was reward­ed with some $21.1 mil­lion in com­pen­sa­tion.

    Nor­we­gian Cruise Line bare­ly sur­vived the year. With the cruise indus­try at a stand­still, the com­pa­ny lost $4 bil­lion and fur­loughed 20 per­cent of its staff. That didn’t stop Nor­we­gian from more than dou­bling the pay of Frank Del Rio, its chief exec­u­tive, to $36.4 mil­lion.

    And at Hilton, where near­ly a quar­ter of the cor­po­rate staff were laid off as hotels around the world sat emp­ty and the com­pa­ny lost $720 mil­lion, it was a good year for the man in charge. Hilton report­ed in a secu­ri­ties fil­ing that Chris Nas­set­ta, its chief exec­u­tive, received com­pen­sa­tion worth $55.9 mil­lion in 2020.

    The coro­n­avirus plunged the world into an eco­nom­ic cri­sis, sent the U.S. unem­ploy­ment rate sky­rock­et­ing and left mil­lions of Amer­i­cans strug­gling to make ends meet. Yet at many of the com­pa­nies hit hard­est by the pan­dem­ic, the exec­u­tives in charge were show­ered with rich­es.

    The diver­gent for­tunes of C.E.O.s and every­day work­ers illus­trate the sharp divides in a nation on the precipice of an eco­nom­ic boom but still racked by steep income inequal­i­ty. The stock mar­kets are up and the wealthy are spend­ing freely, but mil­lions are still fac­ing sig­nif­i­cant hard­ship. Exec­u­tives are mint­ing for­tunes while laid-off work­ers line up at food banks.

    “Many of these C.E.O.s have improved prof­itabil­i­ty by lay­ing off work­ers,” said Sen­a­tor Eliz­a­beth War­ren, Demo­c­rat of Mass­a­chu­setts, who has pro­posed new tax­es on the ultra­wealthy. “A tiny hand­ful of peo­ple who have shim­mied all the way to the top of the greasy pole get all of the rewards, while every­one else gets left behind.”

    For exec­u­tives who own large stakes in giant com­pa­nies, the gains have been even more pro­nounced. Eight of the 10 wealth­i­est peo­ple in the world are men who found­ed or ran tech com­pa­nies in the Unit­ed States, and each has grown bil­lions of dol­lars rich­er this year, accord­ing to Bloomberg. Jeff Bezos, the founder of Ama­zon, which saw prof­its sky­rock­et with peo­ple stuck at home, is now worth $193 bil­lion. Lar­ry Page, a Google co-founder, is worth $103 bil­lion, up $21 bil­lion in the last four months alone, as his company’s for­tunes have only improved dur­ing the pan­dem­ic.

    And, accord­ing to secu­ri­ty fil­ings, a select few are rapid­ly accu­mu­lat­ing new for­tunes. Chad Richi­son, founder and chief exec­u­tive of an Okla­homa soft­ware com­pa­ny, Pay­com, is worth more than $3 bil­lion and was award­ed $211 mil­lion last year, when his com­pa­ny made $144 mil­lion in prof­it. John Leg­ere, the for­mer chief exec­u­tive of T‑Mobile, was award­ed $137.2 mil­lion last year, a reward for tak­ing over the rival Sprint.

    “We’ve cre­at­ed this class of cen­timil­lion­aires and bil­lion­aires who have not been good for this coun­try,” said Nell Minow, vice chair of Val­ueEdge Advi­sors, an invest­ment con­sult­ing firm. “They may build a wing on a muse­um. But it’s not infra­struc­ture — it’s not the mid­dle class.”

    The gap between exec­u­tive com­pen­sa­tion and aver­age work­er pay has been grow­ing for decades. Chief exec­u­tives of big com­pa­nies now make, on aver­age, 320 times as much as their typ­i­cal work­er, accord­ing to the Eco­nom­ic Pol­i­cy Insti­tute. In 1989, that ratio was 61 to 1. From 1978 to 2019, com­pen­sa­tion grew 14 per­cent for typ­i­cal work­ers. It rose 1,167 per­cent for C.E.O.s.

    The pan­dem­ic only com­pound­ed these dis­par­i­ties, as hun­dreds of com­pa­nies award­ed their lead­ers pay pack­ages worth sig­nif­i­cant­ly more than most Amer­i­cans will make in their entire lives.

    “To my mind, they’re the log­i­cal con­se­quence of our total embrace of share­hold­er cap­i­tal­ism, start­ing with the cor­po­rate raiders of the 1980s, to the exclu­sion and sac­ri­fice of all else, includ­ing Amer­i­can work­ers,” said Robert Reich, a labor sec­re­tary under Pres­i­dent Bill Clin­ton. “The pay pack­ages reflect soar­ing share prices, which in turn reflect, at least in part, the will­ing­ness if not eager­ness of cor­po­ra­tions to cut pay­rolls at the slight­est provo­ca­tion.”

    AT&T, the media con­glom­er­ate, lost $5.4 bil­lion and cut thou­sands of jobs through­out the year. John Stankey, the chief exec­u­tive, received $21 mil­lion for his work in 2020, down from $22.5 mil­lion in 2019.

    T‑Mobile said it would cre­ate new jobs through its merg­er with Sprint, but has already begun lay­offs. It made $3.1 bil­lion in 2020. In addi­tion to Mr. Legere’s wind­fall, the com­pa­ny award­ed its cur­rent chief exec­u­tive, Mike Siev­ert, $54.9 mil­lion.

    Tenet Health­care, a hos­pi­tal chain, fur­loughed about 11,000 work­ers dur­ing the pan­dem­ic, but made near­ly $399 mil­lion in prof­it. “The last 12 months clear­ly have been an extra­or­di­nary chal­lenge and learn­ing expe­ri­ence,” the company’s chief exec­u­tive, Ronald Rit­ten­mey­er, wrote in a fil­ing with the Secu­ri­ties and Exchange Com­mis­sion. In the same doc­u­ment, Tenet revealed that Mr. Rit­ten­mey­er earned $16.7 mil­lion last year.

    And L Brands, the own­er of Victoria’s Secret, cut 15 per­cent of its office staff and tem­porar­i­ly closed most of its stores dur­ing the pan­dem­ic. Andrew Mes­low, who took over from Leslie H. Wexn­er as chief exec­u­tive in Feb­ru­ary last year, still earned $18.5 mil­lion.

    “They always talk about how their employ­ees are the most impor­tant assets,” Ms. Minow said. “But they sure don’t treat them that way.”

    Dozens of pub­lic com­pa­nies have already report­ed pay­ing their C.E.O.s $25 mil­lion or more last year, accord­ing to Equi­lar, an exec­u­tive com­pen­sa­tion con­sult­ing firm. Sev­er­al com­pa­nies that announced major lay­offs last year, includ­ing Com­cast and Nike, have not yet released exec­u­tive com­pen­sa­tion data for last year.

    Many com­pa­nies defend­ed their exec­u­tive com­pen­sa­tion plans. In some cas­es, C.E.O.s took less than they were enti­tled to. Most top exec­u­tives receive the bulk of their pay in shares, which may decrease in val­ue and often vest over sev­er­al years. And at many com­pa­nies, the stock price was up despite the tur­bu­lence in the econ­o­my and regard­less of whether the com­pa­ny was prof­itable.

    “At the end of the day, C.E.O.s end up get­ting reward­ed for how they respond to these exter­nal occur­rences,” said Jan­nice Koors, a com­pen­sa­tion con­sul­tant at Pearl Mey­er who works with com­pa­nies to deter­mine exec­u­tive pay. “If you think about stores clos­ing, fur­loughs, etc., C.E.O.s are get­ting reward­ed for mak­ing those deci­sions.”

    In many ways, the role of cor­po­rate chief­tains has nev­er been more pro­nounced. Beyond run­ning their busi­ness­es, C.E.O.s have emerged as promi­nent voic­es in the nation­al con­ver­sa­tions around race, cli­mate change and vot­ing rights.

    At the same time, they face crit­ics on all sides. Sen­a­tor Mitch McConnell recent­ly told com­pa­nies protest­ing Repub­li­can efforts to over­haul vot­ing laws to “stay out of pol­i­tics.” Mean­while, labor advo­cates are call­ing on com­pa­nies to take bet­ter care of their work­ers.

    “It’s time for the cor­po­ra­tions in this nation to play their part in a recov­ery that can be shared by every­body,” said Mary Kay Hen­ry, inter­na­tion­al pres­i­dent of the Ser­vice Employ­ees Inter­na­tion­al Union. “We can­not rein­force the eco­nom­ic inequal­i­ty that exist­ed before the pan­dem­ic.”

    Exec­u­tives at pub­licly trad­ed com­pa­nies receive most of their com­pen­sa­tion in stock, an arrange­ment intend­ed to align pay with the per­for­mance of a company’s share price. When the stock price goes up, the the­o­ry goes, investors and exec­u­tives alike share in the gains.

    Defy­ing log­ic, the stock mar­ket has been soar­ing for months now, more than mak­ing up the loss­es it suf­fered ear­ly in the pan­dem­ic. As a result, many chief exec­u­tives end­ed the first year of the pan­dem­ic hav­ing over­seen, improb­a­bly, a rise in their company’s share price. The resilience of the mar­kets, and the sense that Covid-19 was an act of God, not the fault of any one per­son, helped com­pa­nies jus­ti­fy big pay pack­ages.

    “Boards were think­ing: ‘This isn’t our man­age­ment team’s fault. This isn’t the result of bad plan­ing or lax gov­er­nance. This kind of hap­pened to every­body,’” Ms. Koors said. “There was a sense in board rooms that if, despite all this, they man­aged to deliv­er on the num­bers, who are we to cut those pay­ments in a year when every­one worked their butts off?”

    Some investors and cor­po­rate gov­er­nance groups are push­ing back on exec­u­tive com­pen­sa­tion plans.

    Star­bucks share­hold­ers vot­ed last month against the com­pen­sa­tion plans for the company’s two top exec­u­tives. The res­o­lu­tion was non­bind­ing, how­ev­er, and the chief exec­u­tive, Kevin John­son, received $14.7 mil­lion in cash and stock last year.

    The biggest clash over pay this year is at Gen­er­al Elec­tric, a com­pa­ny still reel­ing from years of mis­man­age­ment. Lar­ry Culp, the chief exec­u­tive, received $73.2 mil­lion last year and could col­lect well over $100 mil­lion more, thanks to a recent­ly updat­ed pay plan. Sev­er­al promi­nent cor­po­rate gov­er­nance groups have come out in oppo­si­tion to Mr. Culp’s pay, and investors will vote on the issue at G.E.’s annu­al meet­ing next month.

    Even when exec­u­tive pay was slashed, it often remained high. Robert A. Iger, the chair­man of the Walt Dis­ney Com­pa­ny, last year earned less than half what he did in 2019, but his com­pen­sa­tion was still $21 mil­lion. The pay cut was a reflec­tion of the dif­fi­cult year at Dis­ney, which laid off more than 28,000 peo­ple as its theme parks shut down.

    At Boe­ing, Mr. Cal­houn vol­un­tar­i­ly gave up most of his cash salary this year, tak­ing just $269,231 of the $1.4 mil­lion he was enti­tled to. Still, thanks to stock awards, his com­pen­sa­tion was more than $21 mil­lion.

    “Dave obvi­ous­ly gave up a lot,” a Boe­ing spokesman said in an email.

    ...

    ———-

    “C.E.O. Pay Remains Stratos­pher­ic, Even at Com­pa­nies Bat­tered by Pan­dem­ic” By David Gelles; The New York Times; 04/24/2021

    “The coro­n­avirus plunged the world into an eco­nom­ic cri­sis, sent the U.S. unem­ploy­ment rate sky­rock­et­ing and left mil­lions of Amer­i­cans strug­gling to make ends meet. Yet at many of the com­pa­nies hit hard­est by the pan­dem­ic, the exec­u­tives in charge were show­ered with rich­es.

    Heads we win, tails we win, pan­demics we win. It’s all about win­ning. Win­ning by greater and greater mar­gins over the past four decades:

    ...
    “We’ve cre­at­ed this class of cen­timil­lion­aires and bil­lion­aires who have not been good for this coun­try,” said Nell Minow, vice chair of Val­ueEdge Advi­sors, an invest­ment con­sult­ing firm. “They may build a wing on a muse­um. But it’s not infra­struc­ture — it’s not the mid­dle class.”

    The gap between exec­u­tive com­pen­sa­tion and aver­age work­er pay has been grow­ing for decades. Chief exec­u­tives of big com­pa­nies now make, on aver­age, 320 times as much as their typ­i­cal work­er, accord­ing to the Eco­nom­ic Pol­i­cy Insti­tute. In 1989, that ratio was 61 to 1. From 1978 to 2019, com­pen­sa­tion grew 14 per­cent for typ­i­cal work­ers. It rose 1,167 per­cent for C.E.O.s.

    The pan­dem­ic only com­pound­ed these dis­par­i­ties, as hun­dreds of com­pa­nies award­ed their lead­ers pay pack­ages worth sig­nif­i­cant­ly more than most Amer­i­cans will make in their entire lives.

    “To my mind, they’re the log­i­cal con­se­quence of our total embrace of share­hold­er cap­i­tal­ism, start­ing with the cor­po­rate raiders of the 1980s, to the exclu­sion and sac­ri­fice of all else, includ­ing Amer­i­can work­ers,” said Robert Reich, a labor sec­re­tary under Pres­i­dent Bill Clin­ton. “The pay pack­ages reflect soar­ing share prices, which in turn reflect, at least in part, the will­ing­ness if not eager­ness of cor­po­ra­tions to cut pay­rolls at the slight­est provo­ca­tion.”
    ...

    How much win­ning is too much win­ning? It’s the ques­tion cor­po­rate Amer­i­ca prob­a­bly does­n’t want the rest of the coun­try to ask. It’s the kind ques­tion that could raise a whole host of oth­er unpleas­ant ques­tions. Unpleas­ant ques­tions like what it is that the CEOs actu­al­ly do with their time that pro­vides gen­uine val­ue to these cor­po­ra­tions on par with their com­pen­sa­tion? Like, what are some exam­ples a gen­uine­ly inno­v­a­tive or impres­sive deci­sions being made by these fig­ures that played cru­cial roles in the suc­cess of the com­pa­nies and/or ben­e­fit­ed soci­ety at large? Like, are there any exam­ples that could be list­ed for all the top exec­u­tives where they made a deci­sion demon­strat­ing real wis­dom or insight that could­n’t eas­i­ly have been made by a range of oth­er peo­ple at the com­pa­ny? Do such wise deci­sion ever hap­pen for peo­ple in these posi­tion being paid mas­sive small and large for­tunes each year? If so, how often are these wise deci­sions made? Like once a week? Once a year at least, right?

    It all points towards one of the inter­est­ing ironies in mod­ern Amer­i­ca: the class of super-rich who most trans­par­ent­ly deserve their wealth are movies stars and pro­fes­sion­al ath­letes. Not because being a movie star or pro­fes­sion­al ath­lete should nec­es­sar­i­ly make one super-rich, but at least in those pro­fes­sions you have a sense of the ser­vice they pro­vide in exchange for that wealth. Very wealthy doc­tors at least hope­ful­ly pro­vid­ed a lot of good medicine/incredible plas­tic surgery in return. What gen­uine ser­vice to these com­pa­nies did these high­est paid exec­u­tives actu­al­ly pro­vide last year that could war­rants pay on this scale? We have absolute­ly no idea. Think about it: we just read an arti­cle about how exec­u­tive pay con­tin­ued its mul­ti-decade surge despite an eco­nom­i­cal­ly-crip­pling pan­dem­ic and the pri­ma­ry rea­son giv­en in the arti­cle for why this pay was so high were the excus­es giv­en for why exec­u­tive com­pen­sa­tion boards felt like it was unfair to pun­ish the exec­u­tives for a pan­dem­ic that was seen as an act of God...

    ...
    Defy­ing log­ic, the stock mar­ket has been soar­ing for months now, more than mak­ing up the loss­es it suf­fered ear­ly in the pan­dem­ic. As a result, many chief exec­u­tives end­ed the first year of the pan­dem­ic hav­ing over­seen, improb­a­bly, a rise in their company’s share price. The resilience of the mar­kets, and the sense that Covid-19 was an act of God, not the fault of any one per­son, helped com­pa­nies jus­ti­fy big pay pack­ages.

    “Boards were think­ing: ‘This isn’t our man­age­ment team’s fault. This isn’t the result of bad plan­ing or lax gov­er­nance. This kind of hap­pened to every­body,’” Ms. Koors said. “There was a sense in board rooms that if, despite all this, they man­aged to deliv­er on the num­bers, who are we to cut those pay­ments in a year when every­one worked their butts off?”
    ...

    ...and yet there’s almost nev­er an expla­na­tion giv­en from cor­po­ra­tions for why the cor­po­rate exec­u­tive pay was that high on the first place. Com­pa­nies can just point to ‘the mar­ket’ for CEO pay and observe that ‘every­body’ is pay­ing real­ly high com­pen­sa­tion pack­ages and jus­ti­fy almost any absurd com­pen­sa­tion pack­age based on that.

    Sure, com­pen­sa­tion in the form of stock options and his­tor­i­cal­ly high stock prices have played a role in this trend, but this is clear­ly not some­thing dri­ven just by stocks. And when a coun­try struc­tures its soci­ety around an ever-ris­ing stock mar­ket — which is exact­ly what the US has done by shift­ing to a 401k-cen­tric retire­ment mod­el — we can’t treat stock options as just an incen­tive too. It’s part of the rig­ging. Plus, it’s not like stock options are free for the rest of the investors. It points towards a fun­da­men­tal­ly bro­ken mar­ket­place for CEOs that’s oper­at­ing more like an unchecked union for the exec­u­tive class. As long as all the exec­u­tive com­pen­sa­tion boards gross­ly over-pay their exec­u­tives, it’s no one’s fault. Just blame ‘the mar­ket’ for exec­u­tives.

    At least with some of the top exec­u­tives, like Jeff Bezos, they can claim to have start­ed the com­pa­ny. Not that there still aren’t major issues with own US-style mod­ern cap­i­tal­ism sys­tem­i­cal­ly shunts almost all of the val­ue gen­er­at­ed by every­one into the hands of the ‘own­er­ship class, but at least some of them can make a lega­cy claim about start­ed the com­pa­ny. What about exec­u­tives who just kind of rose through the ranks or got recruit­ed to be a CEO? What nov­el val­ue are they actu­al­ly pro­vid­ing? It’s in increas­ing­ly impor­tant ques­tion. Increas­ing­ly impor­tant because the more the CEO-to-aver­age-pay ratio grows the more impor­tant the ques­tion becomes.

    Even worse, as the exec­u­tive class and investor class­es cap­ture greater and greater shares of the over­all stock mar­ket, the nat­ur­al mar­ket counter-force for this trend — the cor­po­rate own­ers putting a stop to exec­u­tive over-com­pen­sa­tion — can get blunt­ed. It’s cor­po­rate com­pen­sa­tion incest, which means we can’t just hope that ‘activist share­hold­ers’ are going to reverse this.

    It points towards an inter­est­ing tool that could be used by soci­ety at large solu­tions for address­ing this issue: cre­ate the social expec­ta­tion that com­pa­nies actu­al­ly pro­vide to the rest of soci­ety a gen­er­al descrip­tion of the actu­al ser­vices pro­vid­ed by the high­est paid offi­cers in the com­pa­ny for the past year. Like, what did these peo­ple actu­al­ly do that was in any way sig­nif­i­cant? Could cre­at­ing such an expec­ta­tion that com­pa­nies actu­al­ly attempt to jus­ti­fy their exec­u­tive com­pen­sa­tion pack­ages to the gen­er­al pub­lic actu­al­ly shame com­pa­nies into reign­ing in these absurd pay pack­ages? Indus­tries can be incred­i­bly com­plex that require spe­cial­ized knowl­edge and expe­ri­ence that only a few peo­ple have. It’s not like there isn’t a case to be made for why a CEO could jus­ti­fy a high pay. But when the growth in CEO pay surges past the pay of every­one else decade after decade, some pub­lic jus­ti­fi­ca­tion for why that’s hap­pen­ing should be seen as a basic required for the integri­ty and log­ic of cap­i­tal­ism to keep work­ing. If the gen­er­al pub­lic stops believ­ing the peo­ple who own the econ­o­my basi­cal­ly earned that own­er­ship, that’s kind of an exis­ten­tial threat to some­thing like cap­i­tal­ism. Or at least sup­posed to be in a free soci­ety.

    Along those lines, if we were to apply this expec­ta­tion to And L Brands to explain why Andrew Mes­low was paid $18.5 mil­lion dur­ing a year when he cut office staff and tem­porar­i­ly closed most of the com­pa­ny’s stores...

    ...
    And L Brands, the own­er of Victoria’s Secret, cut 15 per­cent of its office staff and tem­porar­i­ly closed most of its stores dur­ing the pan­dem­ic. Andrew Mes­low, who took over from Leslie H. Wexn­er as chief exec­u­tive in Feb­ru­ary last year, still earned $18.5 mil­lion.

    “They always talk about how their employ­ees are the most impor­tant assets,” Ms. Minow said. “But they sure don’t treat them that way.”
    ...

    ... note that there is one major ser­vice Andrew Mes­low pro­vides that his pre­de­ces­sor, Leslie H. Wexn­er, could­n’t pro­vide the com­pa­ny: Mes­low can hon­est­ly claim to NOT be one of the clos­est fig­ures to Jef­frey Epstein and arguably the secret sources of Epstein’s wealth. Which is some­thing Wexn­er can’t quite claim. So in that sense, Mes­low real­ly has pro­vid­ed his com­pa­ny an enor­mous ser­vice. Although it seems like there should be a lot of peo­ple who could pro­vide that ser­vice. Maybe Mes­low knows a ton about fir­ing peo­ple extra-prof­itably and that’s the great ser­vice he pro­vid­ed. Who knows, but it would be nice to hear even an attempt at an expla­na­tion one of these years.

    Posted by Pterrafractyl | April 26, 2021, 10:38 pm
  16. Jonathan Gray, pres­i­dent and chief oper­a­tion offi­cer of pri­vate equi­ty giant Black­stone, recent­ly held a results call that includ­ed some pret­ty remark­able state­ments about a grow­ing trend in the indus­try that Gray is pre­dict­ing will be grow­ing much more going for­ward that rep­re­sents a fun­da­men­tal shift in the pri­vate equi­ty indus­try’s busi­ness mod­el. A shift away from a focus on debt-dri­ven short­er-term acqui­si­tions with an eye on mak­ing a quick prof­it towards more a ‘Berk­shire Hath­away’ busi­ness mod­el of long-term own­er­ship of com­pa­nies.

    To put it in indus­try jar­gon terms, ‘alter­na­tive asset man­agers’ (pri­vate equi­ty firms) are increas­ing­ly cre­at­ing non-pri­vate equi­ty invest­ment funds called “per­pet­u­al cap­i­tal” funds, which are basi­cal­ly funds where investors are not inter­est­ed in cash­ing out any time soon in favor of long-term invest­ments that can gen­er­ate an income. Which is basi­cal­ly anti­thet­i­cal to the short-term ‘bor­row, buy on lever­age, and sell for a quick prof­it’ mod­el that has been gen­er­at­ing the indus­try tur­bo-charged returns in recent decades. It’s also obvi­ous­ly poten­tial­ly very tempt­ing to pen­sion funds that might val­ue con­sis­ten­cy over net-returns, although we’re also told that these long-term invest­ments should­n’t expect the same kind of rates of return as the pre­vail­ing high­er-risk/high­er-reward pri­vate equi­ty mod­el. It’s like an invest­ment prod­uct that offers some of the rates of return of high qual­i­ty cor­po­rate bonds for the per­pet­u­al cap­i­tal fund investors, but instead of buy­ing the bond they’re buy­ing the cor­po­ra­tion and milk­ing it for a steady rev­enue stream.

    It sounds like Black­stone has been lead­ing the indus­try in per­pet­u­al cap­i­tal, open­ing a num­ber of funds over the last 7 years with a focus on real estate invest­ments. But oth­er firms have been using per­pet­u­al cap­i­tal for pur­chas­es of life insur­ance and annu­ity com­pa­nies. So while the pri­vate equi­ty indus­try has been increas­ing­ly shap­ing the glob­al econ­o­my for decades, that pres­ence might be more strong­ly felt as giants like Black­stone become Berk­shire Hawath­way-like long-term own­ers of a grow­ing port­fo­lio of com­pa­nies.

    And per­haps more impor­tant­ly, that means pri­vate equi­ty firms like Black­stone will have the abil­i­ty to impose its tra­di­tion­al cut-throat­ed man­age­ment atti­tude — and least when it comes to employ­ees vs investors — on a grow­ing num­ber of large employ­ers for decades to come. It’s an ‘alter­na­tive asset man­age­ment’ indus­try cap­ture of cor­po­rate deci­sion-mak­ing.

    What is dri­ving this change in the long-stand­ing pri­vate equi­ty busi­ness mod­el? Well, on the one hand, the indus­try is telling us that investors appre­ci­ate the steady income streams that can come with long-term invest­ments. At the same time, as the arti­cle notes, it’s pos­si­ble this shift is a reflec­tion of asset man­ager’s chang­ing expec­ta­tions about the long-term via­bil­i­ty of main­tain­ing the pri­vate equi­ty indus­try’s rel­a­tive­ly high annu­al returns. Recall how much of the expla­na­tion we’ve heard for why pen­sion funds are increas­ing­ly invest­ed in pri­vate equi­ty is due to the his­tor­i­cal­ly low rates of returns avail­able else­where. So if it is the case that the pri­vate equi­ty indus­try is fac­ing a future if low­er expect­ed returns, that effec­tive­ly dou­bles as a warn­ing to pen­sion funds unless these per­pet­u­al cap­i­tal funds can fill the gap. Let’s hope that’s pos­si­ble but it sure sucks that we have to hope the pri­vate equi­ty indus­try — which is like the legal man­i­fes­ta­tion of a scammy/predatory eco­nom­ic mod­el — does well on its new per­pet­u­al cap­i­tal busi­ness mod­el to save the pen­sion funds. It was always one of the trag­ic parts of tying the fate of peo­ples’ retire­ments to an indus­try that pri­mar­i­ly exists to make the rich rich­er.

    We’re also told that the COVID pan­dem­ic played a role in this his­toric indus­try shift from short-term to long-term invest­ment in the sense that the pan­dem­ic lim­it­ed the abil­i­ty of pri­vate equi­ty firms to exit out of their invest­ments. But at the same time, the expe­ri­ence gave pri­vate equi­ty giants like Black­stone a new appre­ci­a­tion on the val­ue of patient long-term investors who are will­ing to sit on an invest­ment until bet­ter oppor­tu­ni­ties to sell emerge. And let’s not for­get that the pri­vate equi­ty indus­try has explod­ed dur­ing the pan­dem­ic in part because it is an indus­try incred­i­bly well-posi­tioned to ben­e­fit from the eco­nom­ic tur­moil of the pan­dem­ic. So part of the shift to per­pet­u­al cap­i­tal may be due to the pan­dem­ic caus­ing the indus­try to rec­og­nize the perks of long-term invest­ment funds over the tra­di­tion­al ‘turn­around’ mod­el. But it’s also the case that the indus­try is sit­ting on records amount of cash, in part because investors gave it record amounts of cash because they know it’s the indus­try that always wins in our ‘heads we win, tails you lose’ econ­o­my and the pan­dem­ic cre­at­ed a whole bunch of new eco­nom­ic losers.

    So it sounds like the pri­vate equi­ty indus­try — an indus­try with a tra­di­tion­al busi­ness mod­el of lever­aged debt and fast turn-arounds — is hit­ting some sort of sat­u­ra­tion point. Too much cash. Not enough invest­ment options. And lots of investors who now need to be con­vinced that these forced changes to the indus­try busi­ness mod­el are in their best inter­ests too:

    Bloomberg

    Black­stone Wants to Be More Like Berk­shire Hath­away

    With per­pet­u­al cap­i­tal vehi­cles, pri­vate equi­ty firms are buy­ing and hold­ing, much like War­ren Buf­fett. It’s a dra­mat­ic shift from the rapid turn­around typ­i­cal of the indus­try.

    By Anjani Trive­di
    May 13, 2021, 6:30 PM EDT

    Are pri­vate-equi­ty firms tak­ing to the Berk­shire Hath­away Inc.’s buy-and-hold mod­el? It sure looks like it.

    Alter­na­tive asset man­agers are increas­ing­ly diver­si­fy­ing into what is called per­pet­u­al cap­i­tal. Such vehi­cles are “fuel­ing a pow­er­ful trans­for­ma­tion in the assets we man­age and the earn­ings we gen­er­ate,” Jonathan Gray, pres­i­dent and chief oper­a­tion offi­cer of Black­stone said on a recent results call. The War­ren Buf­fett-style for­ev­er time hori­zon is a stark shift from the tra­di­tion­al pri­vate-equi­ty mod­el, where exit­ing invest­ments is cen­tral to max­i­mum prof­its and min­i­mum time.

    t Black­stone Group Inc., per­pet­u­al cap­i­tal rose 47% to $149.1 bil­lion in the first quar­ter of the year, at a faster pace than over­all assets under man­age­ment. At KKR & Co. Inc., it made up over 30% of the total.

    Tra­di­tion­al pri­vate equi­ty in its most basic sense is about buy­ing assets to sell them at an oppor­tune time. It’s all about turn­arounds: buy a com­pa­ny and pad it with debt. Then, fix it up, cut costs, man­age gov­er­nance and rejig­ger oper­a­tions for growth, greater effi­cien­cies and returns. Typ­i­cal funds run any­where from sev­en to 10 years. Investors pro­vide cap­i­tal and pay man­age­ment fees, then the mon­ey is put to work and in the final years of the fund, it’s har­vest­ed.

    Buffet’s approach is almost entire­ly dia­met­ri­cal­ly opposed to that. The Berk­shire way “induces cost min­i­miza­tion” with­out need­ing to impose dis­ci­pline on the com­pa­nies it buys, George Wash­ing­ton Uni­ver­si­ty Law School’s Lawrence A. Cun­ning­ham not­ed in his 2015 paper on Berk­shire ver­sus KKR. He also not­ed, “The idea of sell­ing a busi­ness is anti­thet­i­cal to the sense of per­ma­nence intend­ed to hold Berk­shire togeth­er in per­pe­tu­ity.”

    ...

    The evo­lu­tion Gray spoke of is like­ly to change the way firms like his invest and divest — and how they price assets over the long run. Alter­na­tive asset man­agers could hold assets through one, two or more cycles. Because the assets aren’t being primped and gussied up for a rel­a­tive­ly fast prof­it, returns from these vehi­cles will be low­er. That hasn’t deterred alter­na­tive asset man­agers from offer­ing this prod­uct as invest­ments to their clients.

    What’s the advan­tage? Covid-19 ham­strung pri­vate-equi­ty firms from exit­ing invest­ments. The likes of Black­stone, how­ev­er, have real­ized that pools of long-term, patient cap­i­tal give them the lux­u­ry of time. There’s no require­ment to return mon­ey to investors, except in cer­tain cir­cum­stances like ter­mi­nat­ing invest­ment man­age­ment agree­ments. There isn’t an oblig­a­tion to sell assets at prices they don’t like, either. Com­mit­ments are longer, remov­ing the oner­ous fundrais­ing and cap­i­tal allo­ca­tion process­es.

    Just look at Blackstone’s stock price. Share­hold­ers are reward­ing it for this shift: Pub­lic equi­ty mar­kets love the safe­ty of a con­stant stream of man­age­ment fees that this kind of cap­i­tal brings since it ensures sus­tain­able rev­enues. Oth­er types of fees that asset man­agers’ gen­er­ate like per­for­mance-dri­ven ones or those asso­ci­at­ed with trans­ac­tions, aren’t reward­ed as hand­some­ly.

    With the shift to longer-term cap­i­tal, alter­na­tive funds are tak­ing a big­ger share of the broad­er mul­ti-tril­lion dol­lar asset man­age­ment industry’s pie. Can the thrifty ethos of Buf­fet con­verge with that of pri­vate-equi­ty firms habit­u­at­ed to impos­ing dis­ci­pline on port­fo­lio com­pa­nies?

    Like Berkshire’s ever-grow­ing pile of cash, pri­vate-equi­ty giants are sit­ting on a record amount of unused cap­i­tal or dry pow­der. That’s worked well through nor­mal busi­ness cycles. But the aver­age age of such cap­i­tal is ris­ing along­side the wait. Deploy­ing cap­i­tal and find­ing assets isn’t get­ting any eas­i­er.

    As the process of invest­ing gets longer and hard­er, alter­na­tive-asset man­agers may be admit­ting that they can no longer guar­an­tee the high-octane returns they used to pro­duce. At the same time, they are dis­cov­er­ing that it may pay to be patient.

    ————

    “Black­stone Wants to Be More Like Berk­shire Hath­away” by Anjani Trive­di; Bloomberg; 05/13/2021

    “As the process of invest­ing gets longer and hard­er, alter­na­tive-asset man­agers may be admit­ting that they can no longer guar­an­tee the high-octane returns they used to pro­duce. At the same time, they are dis­cov­er­ing that it may pay to be patient.”

    Yeah, you can’t just keep shov­el­ing record amounts of investor mon­ey into the pri­vate equi­ty ‘alter­na­tive asset man­age­ment’ space year after year and expect to find end­less oppor­tu­ni­ties for the tra­di­tion­al ‘turn­around’ mod­el. New types of asset man­age­ment will need to be invent­ed to come up with things to do with all that mon­ey and “per­pet­u­al cap­i­tal” is how they going to do it. Now we know how the obscene amounts of mon­ey flow­ing into the pri­vate equi­ty space will be used. It will spill over into the long-term cap­ture of more and more of the econ­o­my:

    ...
    Tra­di­tion­al pri­vate equi­ty in its most basic sense is about buy­ing assets to sell them at an oppor­tune time. It’s all about turn­arounds: buy a com­pa­ny and pad it with debt. Then, fix it up, cut costs, man­age gov­er­nance and rejig­ger oper­a­tions for growth, greater effi­cien­cies and returns. Typ­i­cal funds run any­where from sev­en to 10 years. Investors pro­vide cap­i­tal and pay man­age­ment fees, then the mon­ey is put to work and in the final years of the fund, it’s har­vest­ed.

    ...

    The evo­lu­tion Gray spoke of is like­ly to change the way firms like his invest and divest — and how they price assets over the long run. Alter­na­tive asset man­agers could hold assets through one, two or more cycles. Because the assets aren’t being primped and gussied up for a rel­a­tive­ly fast prof­it, returns from these vehi­cles will be low­er. That hasn’t deterred alter­na­tive asset man­agers from offer­ing this prod­uct as invest­ments to their clients.

    ...

    With the shift to longer-term cap­i­tal, alter­na­tive funds are tak­ing a big­ger share of the broad­er mul­ti-tril­lion dol­lar asset man­age­ment industry’s pie. Can the thrifty ethos of Buf­fet con­verge with that of pri­vate-equi­ty firms habit­u­at­ed to impos­ing dis­ci­pline on port­fo­lio com­pa­nies?

    Like Berkshire’s ever-grow­ing pile of cash, pri­vate-equi­ty giants are sit­ting on a record amount of unused cap­i­tal or dry pow­der. That’s worked well through nor­mal busi­ness cycles. But the aver­age age of such cap­i­tal is ris­ing along­side the wait. Deploy­ing cap­i­tal and find­ing assets isn’t get­ting any eas­i­er.
    ...

    But as the fol­low­ing Forbes piece notes, Black­stone did­n’t just jump into the ‘per­pet­u­al cap­i­tal’ busi­ness yes­ter­day. Their core real estate per­pet­u­al cap­i­tal fund was start­ed sev­en years ago and now has $77 bil­lion in assets under man­age­ment. And Black­stone is just the biggest exam­ple in a trend that’s already well under­way across the indus­try, with per­pet­u­al cap­i­tal funds gob­bling up com­pa­nies in indus­tries like life insur­ance and annu­ities:

    Forbes

    Behind Blackstone’s Ban­ner Quar­ter And PE’s Pur­suit Of A Per­pet­u­al Earn­ings Machine

    Kevin Dowd
    Forbes Staff
    Apr 25, 2021, 07:00am EDT

    I’d like to start today with a big thank you to every­one who joined me for the first week of Deal Flow. There was plen­ty to cov­er, that’s for sure: Five newslet­ters and more than 12,000 words on every­thing from rail­road rival­ries to edi­ble insects.

    Here’s a recap of 11 things you need to know from that busy week, begin­ning with a ban­ner quar­ter at Black­stone that is the lat­est exam­ple of the firm’s seem­ing­ly insa­tiable invest­ing ambi­tions:

    1. Blackstone’s bonan­za

    When Black­stone report­ed its lat­est quar­ter­ly earn­ings this week, the green thumb of firm pres­i­dent Jonathan Gray was on full dis­play.

    It was a record-break­ing stretch in sev­er­al respects. Black­stone logged $1.75 bil­lion in net income for the quar­ter, a year-over-year increase of more than $2.8 bil­lion. Fee-relat­ed earn­ings leaped to $741 mil­lion. Assets under man­age­ment were up 21% year-over-year, hit­ting a new peak of $649 bil­lion, more than any oth­er pri­vate equi­ty firm in the world. Amid all that good news, Blackstone’s stock price rose near­ly 10% this week, tak­ing its mar­ket cap above $100 bil­lion for the first time.

    A plu­ral­i­ty of Blackstone’s cap­i­tal is still housed in its pri­vate equi­ty arm. But increas­ing­ly, the firm’s prof­its are com­ing from oth­er types of invest­ments. Which brings us back to Gray’s ideas about gar­den­ing.

    In a con­fer­ence call, Gray com­pared the tra­di­tion­al pri­vate equi­ty busi­ness to grow­ing crops. You plant a seed (or acquire a com­pa­ny), nur­ture it for a while, reap a har­vest (in the form of an exit), and then plant new seeds. It’s a great mod­el, Gray said. But it’s no longer the only strat­e­gy on Blackstone’s mind.

    This quarter’s earn­ings were aid­ed by an ongo­ing push into per­pet­u­al capital—essentially, fee-gen­er­at­ing assets that can be held for an unlim­it­ed time hori­zon, with no rush to return cash to LPs. It’s a type of invest­ment that’s boom­ing in pop­u­lar­i­ty across the pri­vate equi­ty sec­tor. To explain the appeal, Gray con­tin­ued his botan­i­cal metaphor.

    “With per­pet­u­al cap­i­tal, we’re now also plant­i­ng peren­ni­als,” he said. “Per­pet­u­al cap­i­tal remains in the ground and com­pounds in val­ue, gen­er­at­ing man­age­ment fees and, in most cas­es, recur­ring per­for­mance rev­enues with­out asset sales. These strate­gies are fuel­ing an accel­er­a­tion in the growth and qual­i­ty of the firm’s earn­ings.”

    Black­stone has 15 dif­fer­ent vehi­cles man­ag­ing per­pet­u­al cap­i­tal assets. As a top per­former, Gray sin­gled out the firm’s core real estate strat­e­gy, which tar­gets sta­ble, long-term invest­ments in var­i­ous indus­tri­al, res­i­den­tial, office and retail assets. Found­ed just sev­en years ago, it now boasts some $77 bil­lion in assets under man­age­ment.

    “This per­pet­u­al cap­i­tal is fuel­ing a pow­er­ful trans­for­ma­tion in the assets we man­age and the earn­ings we gen­er­ate,” Gray said. “It’s hard to over­state their pos­i­tive impact.”

    Not every pri­vate equi­ty pow­er­house is tak­ing the same approach to per­pet­u­al cap­i­tal. With­in the past year, both Apol­lo Glob­al Man­age­ment and KKR have opt­ed to expand in the space by acquir­ing life insur­ance annu­ity providers, with Apol­lo buy­ing Athene in an $11 bil­lion deal and KKR snap­ping up Glob­al Atlantic for $4.7 bil­lion.

    ...

    ————-

    “Behind Blackstone’s Ban­ner Quar­ter And PE’s Pur­suit Of A Per­pet­u­al Earn­ings Machine” by Kevin Dowd; Forbes; 04/25/2021

    This quarter’s earn­ings were aid­ed by an ongo­ing push into per­pet­u­al capital—essentially, fee-gen­er­at­ing assets that can be held for an unlim­it­ed time hori­zon, with no rush to return cash to LPs. It’s a type of invest­ment that’s boom­ing in pop­u­lar­i­ty across the pri­vate equi­ty sec­tor. To explain the appeal, Gray con­tin­ued his botan­i­cal metaphor.”

    Fee-gen­er­at­ing assets that can be held for an unlim­it­ed time hori­zon. It’s cer­tain­ly dif­fer­ent from the ‘turn­around’ mod­el. And while there’s no short­age of sig­nif­i­cant prob­lems with the impact the ‘turn­around’ mod­el has the econ­o­my and soci­ety — with its focus on aggres­sive cost-cut­ting and short-term think­ing — it remains to be seen if hav­ing the indus­try get into long-term invest­ing will make the sit­u­a­tion bet­ter. It might just trans­late into mak­ing the short-term think­ing the indus­try is known for into the long-term think­ing of one employ­er after anoth­er across the econ­o­my. In per­pe­tu­ity. Or at least until the assets are no longer gen­er­at­ing enough income, at which point they can be ‘turned around’ (stripped and gut­ted) and sold back to the pub­lic under the tra­di­tion­al mod­el.

    Posted by Pterrafractyl | May 17, 2021, 12:45 am
  17. There was a recent Bloomberg arti­cle about the his­to­ry of the Colo­nial Pipeline and the var­i­ous changes in own­er­ship it under­went over the decades lead­ing up to the great ran­somware hack of 2021. The arti­cle con­tained some fun facts about the own­er­ship his­to­ry of the pipeline that could be impor­tant to keep in mind now that the pri­vate equi­ty indus­try is set­ting its sights on the ‘per­pet­u­al cap­i­tal’ mod­el of invest­ing, where invest­ments that pay steady income streams are held over long peri­ods of time instead of the tra­di­tion ‘turn­around’ mod­el. Because not only are the Koch broth­ers the largest investors in the pipeline, but more recent investors include pri­vate equi­ty funds man­ag­ing on behalf of pen­sion funds, includ­ing a state-run Kore­an pen­sion fund. And it sounds like the pipeline has been treat­ed like a finan­cial asset over the past decade — pay­ing out almost all prof­its as div­i­dends — at the expense of main­te­nance and rein­vest­ments. Like cyber­se­cu­ri­ty invest­ments, pre­sum­ably.

    Yes, the pipeline that sup­plied about 45% of the gas to US East Coast was run like a cash cow. It’s part of the prob­lem with hav­ing retire­ment sys­tems depen­dent on mak­ing the kind of high returns pre­vi­ous­ly only avail­able to wealthy pri­vate equi­ty investors. The real needs of the pen­sion­ers act as cov­er for the greed of the rest of the investors and can pro­vide moral cov­er for cash cow treat­ments of infra­struc­ture. After all, if you’re going to treat a piece of crit­i­cal infra­struc­ture like a cash cow, it helps if at least some of that cash is going to a sym­pa­thet­ic group like pen­sion­ers. And based on the cyber­se­cu­ri­ty experts, less than 25% of the US oil and gas indus­try has ade­quate cyber­se­cu­ri­ty in place. And if the Colo­nial mod­el of own­er­ship of infra­struc­ture by pen­sion funds via pri­vate equi­ty catch­es on the way it looks like it will in com­ing years (the ‘per­pet­u­al cap­i­tal’ mod­el), we could end up with a lot more pen­sion funds invest­ed in pipelines and oth­er large pri­vate infra­struc­ture projects because that’s where the steady income streams can be found. The lit­tle guy is going to be increas­ing­ly co-invest­ed with whales like Charles Koch in Amer­i­ca’s pri­va­tized infra­struc­ture land­scape. But also increas­ing­ly sign­ing up for old lia­bil­i­ties that haven’t been addressed because the infra­struc­ture was being treat­ed like a cash cow:

    Bloomberg
    News

    Colo­nial Pipeline Has Been a Lucra­tive Cash Cow for Many Years

    By Ger­son Fre­itas Jr, Javier Blas, and David Wethe
    May 14, 2021, 6:00 AM EDT

    * It pays out near­ly all its prof­its in div­i­dends to own­ers
    * It has had a series of acci­dents that have raised con­cerns

    The U.S. com­pa­ny that just paid a $5 mil­lion ran­som to East Euro­pean hack­ers has been qui­et­ly mak­ing hun­dreds of mil­lions of dol­lars a year pro­vid­ing a vital ser­vice with lit­tle com­pe­ti­tion and a safe­ty record that has raised con­cerns.

    Colo­nial Pipeline, based in the Atlanta sub­urb of Alpharet­ta, Geor­gia, oper­ates the largest fuel pipeline in the coun­try, trans­port­ing more than 100 mil­lion gal­lons a day from Hous­ton to New York City, half the region’s needs.

    While it began six decades ago as a proud joint project of big oil com­pa­nies — the U.S. com­merce sec­re­tary was present for the 1962 ground­break­ing — today it’s most­ly owned by an arm of Koch Indus­tries and sev­er­al Wall Street investors, and is run as much like a finan­cial asset as a major piece of infra­struc­ture.

    Over the past decade, Colo­nial has dis­trib­uted near­ly all its prof­its, some­times more, in the form of div­i­dends. In 2018, for exam­ple, it paid near­ly $670 mil­lion to its own­ers, even more than the $467 mil­lion net income. Last year, it returned to investors over 90% of its $421.6 mil­lion in prof­its.

    It’s an approach that’s made plen­ty of mon­ey for its own­ers. Last year’s $421 mil­lion in net income was a gain of near­ly 32 cents for every dol­lar of rev­enue. Investors are get­ting an annu­al return of about 10%.

    Mean­while, its aging pipelines have suf­fered a series of acci­dents. Last August, a seg­ment of a con­duit was inter­rupt­ed for almost a week after more than 28,000 bar­rels of gaso­line spilled for days in a North Car­oli­na nature pre­serve, dis­cov­ered by two teenagers rid­ing all-ter­rain vehi­cles.

    That was caused by a fail­ure in a sleeve repair installed 16 years ear­li­er. In March, a fed­er­al reg­u­la­tor said sim­i­lar threats exist through­out the sys­tem and the con­tin­ued oper­a­tion with­out cor­rec­tive mea­sures “would pose a pipeline integri­ty risk to pub­lic safe­ty, prop­er­ty, or the envi­ron­ment.”

    Three oth­er spills due to cracks have been report­ed since 2015. In Sep­tem­ber 2016, a line was shut for 12 days, cut­ting sup­plies to mil­lions of cus­tomers. Two months lat­er, a fatal blast near­by led to anoth­er inter­rup­tion.

    “Colonial’s inabil­i­ty to effec­tive­ly detect and respond to such releas­es has poten­tial­ly exac­er­bat­ed the impacts of numer­ous releas­es over the oper­a­tional his­to­ry of Colonial’s entire pipeline sys­tem,” Pipeline and Haz­ardous Mate­ri­als Safe­ty Admin­is­tra­tion said in a notice of pro­posed safe­ty order sent to Colo­nial Chief Exec­u­tive Offi­cer Joseph Blount.

    Colo­nial Pipeline dis­agrees with those state­ments, is work­ing with the reg­u­la­tor to more ful­ly address any con­cerns and began to imple­ment lessons from the inci­dent almost imme­di­ate­ly after it occurred, a com­pa­ny spokesper­son said in an emailed response to ques­tions. “While one gal­lon released to our right of way is one too many, our safe­ty cul­ture is focused on zero oper­a­tional events,” the com­pa­ny said.

    Some have also accused Colo­nial, like much of the rest of the indus­try, of insuf­fi­cient atten­tion to cyber­se­cu­ri­ty. Matias Katz, founder of the cyber­se­cu­ri­ty firm Byos, esti­mates that less than 25% of the U.S. oil and gas indus­try has ade­quate cyber­se­cu­ri­ty in place.

    In a response to ques­tions, Colo­nial said it has increased over­all spend­ing on infor­ma­tion tech­nol­o­gy by 50% since 2017, when a new chief infor­ma­tion offi­cer was appoint­ed. Colo­nial uses more than 20 dif­fer­ent and over­lap­ping cyber­se­cu­ri­ty tools to mon­i­tor and defend the company’s net­works, and its third-par­ty inves­ti­ga­tor “has acknowl­edged many of the best prac­tices we had in place pri­or to the inci­dent,” it said in a state­ment.

    Colo­nial Pipeline’s capac­i­ty has increased mar­gin­al­ly since the ear­ly 2000s yet reliance on it has grown marked­ly as refiner­ies along the East Coast have shut down due to com­pe­ti­tion from shale sources in Texas and North Dako­ta.

    Fuel mak­ers in New Jer­sey and Penn­syl­va­nia depend on prici­er oil from Europe and West Africa, or domes­tic crude shipped on trains or on U.S. flagged-tankers, both expen­sive propo­si­tions. In 2019, Philadel­phia Ener­gy Solu­tions Inc., the largest refin­ing com­plex on the East Coast, shut after a gaso­line-mak­ing unit was almost destroyed by an explo­sion and fire.

    “The pipeline is 60 years old, but its impor­tance has only increased as Mid-Atlantic refin­ing capac­i­ty has decreased, and his­tor­i­cal­ly oper­at­ing refiner­ies in Vir­ginia, Penn­syl­va­nia and New Jer­sey have shut down,” said James Luci­er at Cap­i­tal Alpha Part­ners LLC, a Wash­ing­ton-based con­sul­tant.

    Tougher reg­u­la­tion and fierce oppo­si­tion from envi­ron­men­tal activists have made it increas­ing­ly cost­ly and more com­plex for com­pa­nies to pur­sue major pipeline projects, accord­ing to Alan Gelder, vice pres­i­dent of refin­ing and oil mar­kets at Wood Macken­zie, a con­sult­ing firm. In Jan­u­ary, Pres­i­dent Joe Biden blocked the $9 bil­lion Key­stone XL project. Even dur­ing the Trump admin­is­tra­tion, ener­gy com­pa­nies such as Williams Cos. and Domin­ion Ener­gy Inc. were forced to scrap major pipeline projects.

    “Build­ing pipelines is com­pli­cat­ed,” says Gelder. “Share­hold­ers would be very care­ful about cap­i­tal invest­ments.”

    If in the 1960s, pipelines made clear eco­nom­ic sense in a coun­try rapid­ly expand­ing its indus­tri­al econ­o­my, in 2021, with demand flat­ten­ing and gaso­line-burn­ing cars being grad­u­al­ly replaced by elec­tric ones, it’s become much hard­er to make the case for mas­sive invest­ment in fos­sil fuel infra­struc­ture.

    “Colo­nial con­tin­ues to active­ly explore growth oppor­tu­ni­ties, which are sub­ject to con­fi­den­tial pro­tec­tions,” the com­pa­ny said. “Refined prod­uct con­sump­tion in the Unit­ed States has remained rel­a­tive­ly flat, but our com­mer­cial affairs team is con­stant­ly eval­u­at­ing expan­sion oppor­tu­ni­ties to meet ship­per and mar­ket demand.”

    The reliance on Colo­nial Pipeline is also a result of reg­u­la­tion like the 1920’s Jones Act, a fed­er­al law that requires goods shipped between U.S. ports to be trans­port­ed on ves­sels that are built, owned, and oper­at­ed by U.S. cit­i­zens or per­ma­nent res­i­dents. The lim­it­ed num­ber of ves­sels that meet the cri­te­ria makes it extreme­ly expen­sive for refin­ers to get oil sup­plies from the Gulf of Mex­i­co by sea.

    “Is this the way it’s sup­posed to be? I would say ‘no’,” Gelder said. “I don’t think U.S. ener­gy infra­struc­ture has ever had a par­tic­u­lar plan.”

    It didn’t start out this way.

    In 1961, nine ener­gy behe­moths includ­ing Tex­a­co, Phillips Petro­le­um, Con­ti­nen­tal Oil and Mobil joined to build what was then the country’s largest-ever pri­vate­ly-fund­ed con­struc­tion project. The pipeline cost­ing $370 mil­lion (about $3.3 bil­lion today) would allow them to haul gaso­line and oth­er fuels from Hous­ton to New York Har­bor and points in-between. Colo­nial was oper­at­ing ful­ly by 1964.

    After mak­ing mas­sive invest­ments that more than dou­bled the system’s capac­i­ty over the 1970s and 1980s, the oil majors that held and ran the pipeline even­tu­al­ly sold their stakes as depressed oil prices through the end of the cen­tu­ry forced them to shed assets and com­bine oper­a­tions.

    The pipeline’s own­er­ship pro­file then began to change com­plete­ly. Today, a unit of Roy­al Dutch Shell PLC is the only oil major among the five firms which split the con­trol of the pipeline.

    .0A unit of the indus­tri­al con­glom­er­ate owned by bil­lion­aires Charles and David Koch emerged as Colonial’s largest share­hold­er after acquir­ing BP Plc’s and Marathon Oil Corp.’s inter­ests from 2002 onward. A joint ven­ture between pri­vate equi­ty firm Kohlberg, Kravis Roberts & Co. and South Korea’s state-run Nation­al Pen­sion Ser­vice bought Chevron Corp.’s stake in 2010. A year lat­er, Caisse de dépôt et place­ment du Québec, a Cana­di­an fund man­ag­er, bought out Cono­coPhillips. IFM Investors, an invest­ment firm owned by Aus­tralian pen­sion funds, holds a stake since 2007.

    Pri­vate equi­ty firms and pen­sion funds are attract­ed to pipelines because they are nat­ur­al monop­o­lies and typ­i­cal­ly pro­vide steady income streams even dur­ing eco­nom­ic down­turns. Investors led by EIG Glob­al Ener­gy Part­ners LLC last month paid $12.4 bil­lion for a stake in Sau­di Aramco’s pipeline pro­ceeds.

    ...

    ————–

    “Colo­nial Pipeline Has Been a Lucra­tive Cash Cow for Many Years” by Ger­son Fre­itas Jr, Javier Blas, and David Wethe; Bloomberg; 05/14/2021

    “Some have also accused Colo­nial, like much of the rest of the indus­try, of insuf­fi­cient atten­tion to cyber­se­cu­ri­ty. Matias Katz, founder of the cyber­se­cu­ri­ty firm Byos, esti­mates that less than 25% of the U.S. oil and gas indus­try has ade­quate cyber­se­cu­ri­ty in place.

    The wealth­i­est indus­try on the plan­et can’t be both­ered to invest in cyber­se­cu­ri­ty. Or basic safe­ty. But hey, at least the investors got their 10% annu­al returns in div­i­dends. Pri­or­i­ties:

    ...
    While it began six decades ago as a proud joint project of big oil com­pa­nies — the U.S. com­merce sec­re­tary was present for the 1962 ground­break­ing — today it’s most­ly owned by an arm of Koch Indus­tries and sev­er­al Wall Street investors, and is run as much like a finan­cial asset as a major piece of infra­struc­ture.

    Over the past decade, Colo­nial has dis­trib­uted near­ly all its prof­its, some­times more, in the form of div­i­dends. In 2018, for exam­ple, it paid near­ly $670 mil­lion to its own­ers, even more than the $467 mil­lion net income. Last year, it returned to investors over 90% of its $421.6 mil­lion in prof­its.

    It’s an approach that’s made plen­ty of mon­ey for its own­ers. Last year’s $421 mil­lion in net income was a gain of near­ly 32 cents for every dol­lar of rev­enue. Investors are get­ting an annu­al return of about 10%.

    Mean­while, its aging pipelines have suf­fered a series of acci­dents. Last August, a seg­ment of a con­duit was inter­rupt­ed for almost a week after more than 28,000 bar­rels of gaso­line spilled for days in a North Car­oli­na nature pre­serve, dis­cov­ered by two teenagers rid­ing all-ter­rain vehi­cles.

    That was caused by a fail­ure in a sleeve repair installed 16 years ear­li­er. In March, a fed­er­al reg­u­la­tor said sim­i­lar threats exist through­out the sys­tem and the con­tin­ued oper­a­tion with­out cor­rec­tive mea­sures “would pose a pipeline integri­ty risk to pub­lic safe­ty, prop­er­ty, or the envi­ron­ment.”

    Three oth­er spills due to cracks have been report­ed since 2015. In Sep­tem­ber 2016, a line was shut for 12 days, cut­ting sup­plies to mil­lions of cus­tomers. Two months lat­er, a fatal blast near­by led to anoth­er inter­rup­tion.

    “Colonial’s inabil­i­ty to effec­tive­ly detect and respond to such releas­es has poten­tial­ly exac­er­bat­ed the impacts of numer­ous releas­es over the oper­a­tional his­to­ry of Colonial’s entire pipeline sys­tem,” Pipeline and Haz­ardous Mate­ri­als Safe­ty Admin­is­tra­tion said in a notice of pro­posed safe­ty order sent to Colo­nial Chief Exec­u­tive Offi­cer Joseph Blount.
    ...

    The Koch broth­ers (now just Charles Koch) are the largest of the investors get­ting these hefty annu­al div­i­dends. But pen­sion funds hun­gry for reg­u­lar annu­al returns have been drawn to the sec­tor too. It’s a trend that’s poised to just keep grow­ing:

    ...
    A unit of the indus­tri­al con­glom­er­ate owned by bil­lion­aires Charles and David Koch emerged as Colonial’s largest share­hold­er after acquir­ing BP Plc’s and Marathon Oil Corp.’s inter­ests from 2002 onward. A joint ven­ture between pri­vate equi­ty firm Kohlberg, Kravis Roberts & Co. and South Korea’s state-run Nation­al Pen­sion Ser­vice bought Chevron Corp.’s stake in 2010. A year lat­er, Caisse de dépôt et place­ment du Québec, a Cana­di­an fund man­ag­er, bought out Cono­coPhillips. IFM Investors, an invest­ment firm owned by Aus­tralian pen­sion funds, holds a stake since 2007.

    Pri­vate equi­ty firms and pen­sion funds are attract­ed to pipelines because they are nat­ur­al monop­o­lies and typ­i­cal­ly pro­vide steady income streams even dur­ing eco­nom­ic down­turns. Investors led by EIG Glob­al Ener­gy Part­ners LLC last month paid $12.4 bil­lion for a stake in Sau­di Aramco’s pipeline pro­ceeds.
    ...

    It rep­re­sents anoth­er aspect of the sys­temic risks asso­ci­at­ed with the explo­sive growth of the pri­vate equi­ty sec­tor. The asset-strip­ping ‘turn­around’ mind­set the indus­try is known for is going to be increas­ing­ly applied to crit­i­cal infra­struc­ture.

    Posted by Pterrafractyl | May 23, 2021, 5:25 pm
  18. Remem­ber those reports from back in Decem­ber about the surge in “div­i­dend recap­i­tal­iza­tions” in the pri­vate equi­ty indus­try, where pri­vate equi­ty-owned com­pa­nies bor­row mon­ey in the US cor­po­rate bond mar­kets almost exclu­sive­ly for the pur­pose of pay­ing their pri­vate equi­ty own­ers div­i­dend. Well, it sounds like that trend has moved on to Europe. A com­bi­na­tion of ultra-low bor­row­ing rates and investors hun­gry for yield has fueled a growth of cor­po­rate bond for the pur­pose of div­i­dend recap­i­tal­iza­tions. Cor­po­rate junk bonds in many cas­es. As the arti­cle makes clear, there does­n’t appear to be a lot of strong eco­nom­ic log­ic behind this kind of bond issuance beyond pure oppor­tunism: rates are low, investors are hun­gry for high­est-yield­ing bonds, and they don’t real­ly care if they’re buy­ing bonds in com­pa­nies that are under­min­ing their own futures pure­ly to pay out div­i­dends to pri­vate equi­ty investors. That’s what’s dri­ving the peo­ple buy­ing these bonds and the peo­ple sell­ing them. The stars have aligned for oppor­tunis­tic debt-fueled loot­ing so that’s what’s hap­pen­ing. It’s the mag­ic of cap­i­tal­ism in action:

    Bloomberg

    ‘Buy Any­thing’ Debt Mar­ket Sees Pri­vate Equi­ty Pay­day

    By Lau­ra Ben­itez and Irene Gar­cia Perez
    May 20, 2021, 12:00 AM EDT Cor­rect­ed May 24, 2021, 12:49 PM EDT

    * PE firms take bond-fund­ed pay­outs at fastest pace since 2017
    * Afflelou deal to pay Lion Cap­i­tal flies; Picard is reject­ed

    It’s the lat­est sign of lever­aged mania hit­ting bond­hold­ers: Com­pa­nies across Europe are pil­ing on debt at the fastest pace in at least four years to enrich their pri­vate-equi­ty own­ers.

    The con­tro­ver­sial prac­tice known as div­i­dend recaps is grow­ing as investors gorge on every cred­it risk, hand­ing a wind­fall to buy­out pros at Lion Cap­i­tal LLP, Part­ners Group and Hell­man & Fried­man LLC, to name a few.

    Pri­vate equi­ty firms have always bor­rowed to buy com­pa­nies. But they’re lay­er­ing on extra debt to write them­selves div­i­dend checks at a time when cen­tral banks have dri­ven bor­row­ing costs to all-time lows to help fos­ter a glob­al eco­nom­ic rebound.

    “If peo­ple want to put cap­i­tal to work they’re just buy­ing any­thing with a bit of yield, regard­less of what pro­ceeds are for,” said Mark Ben­bow, a high-yield fund man­ag­er at Aegon Asset Man­age­ment. “Per­haps the mar­ket is just too com­pla­cent or per­haps believes the cen­tral bankers will always be there as a back­stop. What­ev­er the rea­son, these deals are get­ting done very eas­i­ly.”

    More than 10 com­pa­nies in the region have raised junk bonds this year in part to fund div­i­dends, the high­est year-to-date num­ber since 2017, accord­ing to data provider 9Fin. Some 13 firms also sold loans to finance pay­outs in the first quar­ter of this year, a post-finan­cial cri­sis high, accord­ing to data com­piled by Bloomberg.

    Some of this year’s trans­ac­tions were rat­ed CCC — the low­est rank­ing of junk debt — and paid rel­a­tive­ly high­er rates. But viewed along­side decades of his­to­ry, the deals are still dirt cheap.

    The div­i­dend pay­outs are one way for buy­out firms to take prof­its as they wait for the growth rebound to spur high­er prices in the IPO mar­ket. By issu­ing div­i­dend recaps they can take a cut now and keep their end investors hap­py while they bide their time to cash out com­plete­ly.

    “You have a lot of pri­vate equi­ty involve­ment in the high-yield mar­ket, and spon­sors don’t want to nec­es­sar­i­ly exit busi­ness­es now because we haven’t seen the full open­ing-up trade devel­op,” said Mar­tin Horne, head of glob­al pub­lic fixed income at Bar­ings LLC. “Maybe they wouldn’t get the right mul­ti­ple if they tried to get a full exit by nor­mal mechan­ics.”

    Alain Afflelou SA is the lat­est exam­ple. The French eye-glass retail­er skimmed off a por­tion of bonds sold this month and used some of its own cash to make a 135 mil­lion-euro pay­ment to own­er Lion Cap­i­tal, accord­ing to Andre Ver­neyre, Afflelou’s head of finan­cial oper­a­tions.

    The senior notes received orders for an excess of three times the amount on sale, indi­cat­ing that “investors know us very well and are hap­py to con­tin­ue with us,” he said. Despite the new debt, gross lever­age has remained steady as the com­pa­ny retired old­er bor­row­ings, Ver­neyre said.

    Frozen Out

    The deal fol­lowed div­i­dend recaps for French real-estate devel­op­er Fon­cia Hold­ing SAS and Swedish secu­ri­ty sys­tems mak­er Verisure Hold­ing AB this year. In the U.S., Ver­i­zon Com­mu­ni­ca­tions Vic­tra tapped investors for a div­i­dend twice in the space of just three months this year. The sec­ond $75 mil­lion trans­ac­tion which priced last week was used to fund a $65 mil­lion div­i­dend to its pri­vate-equi­ty spon­sor Lone Star.

    Yet even in the lat­est wave of mar­ket froth, there’s been push­back from bond investors.

    Lion Cap­i­tal failed to pull off a deal to extract div­i­dends from anoth­er one of its port­fo­lio hold­ings, French frozen-food retail­er Picard Groupe SAS. Investors demand­ed high­er pric­ing on the 1.7 bil­lion-euro deal in April and Lion walked away.

    “We com­plet­ed Afflelou but pulled Picard because we were being oppor­tunis­tic and didn’t like the pric­ing,” said Lyn­don Lea, co-founder of Picard’s major­i­ty own­er Lion Cap­i­tal. “There was no urgency because the pro­ceeds were for a div­i­dend, which is not time-sen­si­tive.”

    While the econ­o­my pow­ers ahead and com­pa­nies are grow­ing, ser­vic­ing the extra debt may not seem like much of a strain. The prob­lem aris­es when the eco­nom­ic boom comes to an end, and frag­ile bal­ance sheets are left strug­gling under the weight of large debt piles and falling rev­enue. In the U.S., the finan­cial tra­vails of the Pay­less shoe com­pa­ny were blamed in part on such pay­outs, and have been the tar­get of crit­i­cism from Sen­a­tor Eliz­a­beth War­ren.

    ...

    “It’s eas­i­er to keep adding debt when busi­ness mul­ti­ples are so high as the mar­ket still thinks there is plen­ty of equi­ty below the bonds,” said Ben­bow at Aegon. “Obvi­ous­ly when the cycle turns and the mar­ket cheap­ens up you real­ize that there is lit­tle to no equi­ty left.”

    ————

    “‘Buy Any­thing’ Debt Mar­ket Sees Pri­vate Equi­ty Pay­day” by Lau­ra Ben­itez and Irene Gar­cia Perez; Bloomberg; 05/20/2021

    ““It’s eas­i­er to keep adding debt when busi­ness mul­ti­ples are so high as the mar­ket still thinks there is plen­ty of equi­ty below the bonds,” said Ben­bow at Aegon. “Obvi­ous­ly when the cycle turns and the mar­ket cheap­ens up you real­ize that there is lit­tle to no equi­ty left.”

    Yes, all this cor­po­rate debt is obvi­ous­ly going to be a prob­lem when the econ­o­my even­tu­al­ly weak­ens. But for now, there’s an oppor­tu­ni­ty. As long as bond investors are hap­py to buy bonds that will do noth­ing oth­er than imper­il the finances of these com­pa­nies, pri­vate equi­ty investors will be hap­py to issue them. We’ll wor­ry about the future in the future:

    ...
    Pri­vate equi­ty firms have always bor­rowed to buy com­pa­nies. But they’re lay­er­ing on extra debt to write them­selves div­i­dend checks at a time when cen­tral banks have dri­ven bor­row­ing costs to all-time lows to help fos­ter a glob­al eco­nom­ic rebound.

    “If peo­ple want to put cap­i­tal to work they’re just buy­ing any­thing with a bit of yield, regard­less of what pro­ceeds are for,” said Mark Ben­bow, a high-yield fund man­ag­er at Aegon Asset Man­age­ment. “Per­haps the mar­ket is just too com­pla­cent or per­haps believes the cen­tral bankers will always be there as a back­stop. What­ev­er the rea­son, these deals are get­ting done very eas­i­ly.”

    ...

    While the econ­o­my pow­ers ahead and com­pa­nies are grow­ing, ser­vic­ing the extra debt may not seem like much of a strain. The prob­lem aris­es when the eco­nom­ic boom comes to an end, and frag­ile bal­ance sheets are left strug­gling under the weight of large debt piles and falling rev­enue. In the U.S., the finan­cial tra­vails of the Pay­less shoe com­pa­ny were blamed in part on such pay­outs, and have been the tar­get of crit­i­cism from Sen­a­tor Eliz­a­beth War­ren.
    ...

    Now, in fair­ness, much of this sit­u­a­tion has aris­es as a result of the still his­tor­i­cal­ly low cen­tral bank inter­est rates that has cre­at­ed this incred­i­ble demand for any­thing that pays high­er rates. It’s a cen­tral bank pol­i­cy designed to assets like junk bonds more tempt­ing to investors. And that’s great as long as those junk bonds are being used to help invest in busi­ness­es, or sim­ply keep them afloat dur­ing a rough peri­od. But issu­ing bonds to pay out div­i­dends is just loot­ing. Note how even Lion Cap­i­tal is acknowl­edg­ing that “we were being oppor­tunis­tic” when they had Alain Afflelou SA issue a bunch of bonds to pay Lion a 135 mil­lion euro div­i­dend. It points to one of the fun­da­men­tal prob­lems with the pri­vate equi­ty ‘turn­around’ busi­ness mod­el: The long-term future health of these com­pa­nies is kind of beside the point:

    ...
    Alain Afflelou SA is the lat­est exam­ple. The French eye-glass retail­er skimmed off a por­tion of bonds sold this month and used some of its own cash to make a 135 mil­lion-euro pay­ment to own­er Lion Cap­i­tal, accord­ing to Andre Ver­neyre, Afflelou’s head of finan­cial oper­a­tions.

    The senior notes received orders for an excess of three times the amount on sale, indi­cat­ing that “investors know us very well and are hap­py to con­tin­ue with us,” he said. Despite the new debt, gross lever­age has remained steady as the com­pa­ny retired old­er bor­row­ings, Ver­neyre said.

    ...

    Yet even in the lat­est wave of mar­ket froth, there’s been push­back from bond investors.

    Lion Cap­i­tal failed to pull off a deal to extract div­i­dends from anoth­er one of its port­fo­lio hold­ings, French frozen-food retail­er Picard Groupe SAS. Investors demand­ed high­er pric­ing on the 1.7 bil­lion-euro deal in April and Lion walked away.

    “We com­plet­ed Afflelou but pulled Picard because we were being oppor­tunis­tic and didn’t like the pric­ing,” said Lyn­don Lea, co-founder of Picard’s major­i­ty own­er Lion Cap­i­tal. “There was no urgency because the pro­ceeds were for a div­i­dend, which is not time-sen­si­tive.”
    ...

    We don’t know when the next eco­nom­ic down­turn is com­ing. But based on this trend, we know that future down­turn is going to be worse than it need­ed to be. Well, not worse for the pri­vate equi­ty investors who got all those div­i­dends.

    Posted by Pterrafractyl | May 29, 2021, 7:06 pm
  19. Check out the new kid on the pri­vate equi­ty block: Chi­na. Or rather, Chi­nese cities. Yes, it turns out that Chi­na has been on a kind of munic­i­pal pri­vate-equi­ty binge in recent years. Near­ly every major Chi­nese city has set up local invest­ment funds with the encour­age­ment of Chi­nese author­i­ties, with more than 1,000 gov­ern­ment-guid­ed invest­ment funds hav­ing popped up since 2015.

    But unlike the tra­di­tion­al pri­vate-equi­ty busi­ness mod­el, which are typ­i­cal­ly focused on max­i­miz­ing share­hold­er returns at any cost, these city-run funds are more inter­est­ed in attract­ing new busi­ness­es to the local area to increase the tax base. At the same time, many of these city-backed funds are still forced to team up with tra­di­tion­al pri­vate-sec­tor funds to car­ry out these invest­ments due to a lack of in-house invest­ment tal­ent. So there’s a grow­ing sit­u­a­tion in Chi­na’s pri­vate equi­ty mar­kets where the pub­lic investors — the cities — have a fun­da­men­tal­ly dif­fer­ent set of pri­or­i­ties than their pri­vate-sec­tor part­ners. This is lead­ing to some grous­ing by these pri­vate-sec­tor part­ners, and yet it sounds like it’s the cities that have the most clout because they have most of the mon­ey to invest­ment. It also sounds like this approach to invest­ing has worked out rea­son­ably well for these cities. At least no major deba­cles so far. So Chi­na appears to be exper­i­ment­ing with a pub­lic pri­vate-equi­ty mod­el that pri­or­i­ties local pros­per­i­ty over investor prof­its and it’s at least kind of work­ing so far:

    The Econ­o­mist

    The Chi­nese state is pump­ing funds into pri­vate equi­ty
    It sounds too good to be true to pri­vate investors—and it might be

    Jun 5th 2021

    HONG KONG

    STATE CASH is burn­ing a hole in the pock­et of Shenzhen’s Com­mu­nist Par­ty sec­re­tary. Wang Weizhong told angel investors late last year that if they set up a fund in the south Chi­na tech hub, the gov­ern­ment would bear 40% of their loss­es. For the mon­strous 400bn-yuan ($62bn) state fund back­ing such activ­i­ty, an invest­ment of 3m yuan—the size of a typ­i­cal angel investment—is a round­ing error. For pri­vate investors the invi­ta­tion sounds too good to be true. It might be.

    After sev­er­al years of loose mon­e­tary con­di­tions and bumper deal­mak­ing, liq­uid­i­ty in pri­vate equi­ty (PE) in Chi­na began to dry up in 2018. New reg­u­la­tions made it hard­er for banks and insur­ers to invest. So-called “gov­ern­ment-guid­ed” funds set up by local gov­ern­ments or nation­al min­istries, by con­trast, thrived. Local author­i­ties were encour­aged to launch such invest­ment vehi­cles to lure star­tups to their cities, along with tal­ent, tech­nol­o­gy and, even­tu­al­ly, tax rev­enues. Owing to a lack of in-house invest­ment tal­ent, most of them have act­ed as lim­it­ed part­ners (LPs) in pri­vate-sec­tor funds.

    More than 1,000 gov­ern­ment-guid­ed funds have cropped up across Chi­na since 2015. By late 2020 they man­aged some 9.4trn yuan, accord­ing to Chi­na Ven­ture, a research firm. A nation­al fund focused on upgrad­ing man­u­fac­tur­ing tech­nol­o­gy held 147bn yuan at the last count. One spe­cial­is­ing in microchips exceed­ed 200bn yuan in 2019. Almost every city of note across Chi­na oper­ates its own fund. A munic­i­pal fund in Shen­zhen says it has more than 400bn yuan in assets under man­age­ment, mak­ing it the largest city-lev­el man­ag­er of its kind. In the north­ern city of Tian­jin, the Hai­he Riv­er Indus­try Fund is putting to work 100bn yuan along with anoth­er 400bn yuan from oth­er investors.

    As a result, PE in Chi­na is now flush with state financ­ing. In 2015 pri­vate-sec­tor mon­ey made up at least 70% of lim­it­ed-part­ner funds pour­ing into the indus­try. By the end of 2019, state-backed funds account­ed for at least that much. Their dom­i­nance has only increased since then; by some counts they hold more than 90% of the mon­ey in Chi­nese funds of funds (ie, those that invest in oth­er funds). Accord­ing to Chi­nese media, learn­ing to deal with gov­ern­ment funds is now a “required course” for PE man­agers.

    A degree of state influ­ence is now unavoid­able. But whether that is ben­e­fi­cial or not is hot­ly con­test­ed. Some investors and advis­ers say tak­ing gov­ern­ment cash can help align pri­vate and pub­lic inter­ests. “Gov­ern­ment LPs can open doors for you,” says Kiki Yang of Bain, a con­sult­ing firm. State fund man­agers often under­stand local pol­i­cy objec­tives and can steer investors in the right direc­tion, says a ven­ture-cap­i­tal investor. The influ­ence can go too far, how­ev­er: Shen­zhen Cap­i­tal, a huge state fund, post­ed pic­tures on its web­site of a meet­ing it held in Decem­ber where it helped each of the 42 com­pa­nies it had invest­ed in to launch a Com­mu­nist Par­ty com­mit­tee. These are seen as a way to imbue pri­vate com­pa­nies with par­ty ide­ol­o­gy.

    There are oth­er draw­backs, too. Gov­ern­ment funds are “squeez­ing out oth­er LPs”, says one of China’s top ven­ture-cap­i­tal investors. Clear mis­match­es in inter­ests have also sur­faced. Mem­bers of China’s PE elite cut their teeth at glob­al invest­ment groups such as KKR and TPG, two Amer­i­can firms. Their main aim is to pro­duce hefty returns for LPs. Not so for gov­ern­ment-guid­ed funds. “Rarely do you have a guid­ed fund that is chas­ing returns,” says an advis­er to sev­er­al of them. Instead, state investors are main­ly try­ing to engi­neer a wind­fall in local tax rev­enues by attract­ing new com­pa­nies, espe­cial­ly tech groups. Bal­anc­ing these inter­ests can lead to ten­sions, says one Chi­na-based investor, and often results in invest­ments that hinge on whether or not a com­pa­ny is will­ing to move to a spe­cif­ic city. Some even fear such prob­lems could grad­u­al­ly low­er over­all returns for pri­vate-sec­tor investors.

    So far, though, the arrange­ment has worked well for many pri­vate funds. With small­er funds dying off over the past few years—either owing to lack of cap­i­tal or huge losses—competition for tar­get assets has eased a lit­tle. The mar­ket is health­i­er, investors say, as pri­vate and state cap­i­tal is chan­nelled to bet­ter fund man­agers.

    ...

    ———–

    “The Chi­nese state is pump­ing funds into pri­vate equi­ty”; The Econ­o­mist; 06/05/2021

    More than 1,000 gov­ern­ment-guid­ed funds have cropped up across Chi­na since 2015. By late 2020 they man­aged some 9.4trn yuan, accord­ing to Chi­na Ven­ture, a research firm. A nation­al fund focused on upgrad­ing man­u­fac­tur­ing tech­nol­o­gy held 147bn yuan at the last count. One spe­cial­is­ing in microchips exceed­ed 200bn yuan in 2019. Almost every city of note across Chi­na oper­ates its own fund. A munic­i­pal fund in Shen­zhen says it has more than 400bn yuan in assets under man­age­ment, mak­ing it the largest city-lev­el man­ag­er of its kind. In the north­ern city of Tian­jin, the Hai­he Riv­er Indus­try Fund is putting to work 100bn yuan along with anoth­er 400bn yuan from oth­er investors.

    Every major city gets its own invest­ment fund. That’s the state of con­tem­po­rary ‘com­mu­nism’ in Chi­na, which is real­ly oper­at­ing on a state-run cap­i­tal­ism mod­el. And it’s that mod­el of state-run cap­i­tal­ism that is get­ting put to the test in a big way with the emer­gence of this city-fund trend. Will pri­vate-sec­tor investors be sat­is­fied part­ner­ing with city-funds that have a dif­fer­ent set of pri­or­i­ties? So far so good, although the fact that the city-funds are the ones bring­ing all the cash to the table pre­sum­ably has a lot to do with it:

    ...
    As a result, PE in Chi­na is now flush with state financ­ing. In 2015 pri­vate-sec­tor mon­ey made up at least 70% of lim­it­ed-part­ner funds pour­ing into the indus­try. By the end of 2019, state-backed funds account­ed for at least that much. Their dom­i­nance has only increased since then; by some counts they hold more than 90% of the mon­ey in Chi­nese funds of funds (ie, those that invest in oth­er funds). Accord­ing to Chi­nese media, learn­ing to deal with gov­ern­ment funds is now a “required course” for PE man­agers.

    A degree of state influ­ence is now unavoid­able. But whether that is ben­e­fi­cial or not is hot­ly con­test­ed. Some investors and advis­ers say tak­ing gov­ern­ment cash can help align pri­vate and pub­lic inter­ests. “Gov­ern­ment LPs can open doors for you,” says Kiki Yang of Bain, a con­sult­ing firm. State fund man­agers often under­stand local pol­i­cy objec­tives and can steer investors in the right direc­tion, says a ven­ture-cap­i­tal investor. The influ­ence can go too far, how­ev­er: Shen­zhen Cap­i­tal, a huge state fund, post­ed pic­tures on its web­site of a meet­ing it held in Decem­ber where it helped each of the 42 com­pa­nies it had invest­ed in to launch a Com­mu­nist Par­ty com­mit­tee. These are seen as a way to imbue pri­vate com­pa­nies with par­ty ide­ol­o­gy.

    There are oth­er draw­backs, too. Gov­ern­ment funds are “squeez­ing out oth­er LPs”, says one of China’s top ven­ture-cap­i­tal investors. Clear mis­match­es in inter­ests have also sur­faced. Mem­bers of China’s PE elite cut their teeth at glob­al invest­ment groups such as KKR and TPG, two Amer­i­can firms. Their main aim is to pro­duce hefty returns for LPs. Not so for gov­ern­ment-guid­ed funds. “Rarely do you have a guid­ed fund that is chas­ing returns,” says an advis­er to sev­er­al of them. Instead, state investors are main­ly try­ing to engi­neer a wind­fall in local tax rev­enues by attract­ing new com­pa­nies, espe­cial­ly tech groups. Bal­anc­ing these inter­ests can lead to ten­sions, says one Chi­na-based investor, and often results in invest­ments that hinge on whether or not a com­pa­ny is will­ing to move to a spe­cif­ic city. Some even fear such prob­lems could grad­u­al­ly low­er over­all returns for pri­vate-sec­tor investors.

    So far, though, the arrange­ment has worked well for many pri­vate funds. With small­er funds dying off over the past few years—either owing to lack of cap­i­tal or huge losses—competition for tar­get assets has eased a lit­tle. The mar­ket is health­i­er, investors say, as pri­vate and state cap­i­tal is chan­nelled to bet­ter fund man­agers.
    ...

    It’s going to be inter­est­ing to see how this plays out. Giv­en the sim­plis­tic por­tray­als of Chi­na as a ‘com­mu­nist’ nation, it’s easy to for­get that one of the biggest threats Chi­na pos­es to ‘the West’ is pro­vid­ing the world an exam­ple of a dif­fer­ent kind of eco­nom­ic mod­el. Yes, the Chi­nese gov­ern­men­t’s polit­i­cal mod­el is obvi­ous­ly com­plete­ly author­i­tar­i­an in nature. It’s not exact­ly appeal­ing. But as Chi­na moves more and more towards a state-run cap­i­tal­ist sys­tem, its polit­i­cal mod­el is becom­ing more and more decou­pled from its eco­nom­ic mod­el and eas­i­er for oth­er nations to emu­late. But for the bil­lions of peo­ple in the devel­op­ing world liv­ing under some form of cap­i­tal­ism or anoth­er, the Chi­nese mod­el of state-run cap­i­tal­ism real­ly does present itself as a viable alter­na­tive mod­el to West­’s full-throat­ed embrace of a cut-throat pri­vate sec­tor as the cure all for near­ly all needs. It’s not as if cap­i­tal­ism has­n’t been a dis­as­ter for the glob­al poor. Coun­tries around the world have sov­er­eign wealth funds, after all. Chi­na is effec­tive­ly cre­at­ing city-lev­el sov­er­eign wealth funds and run­ning them with a ‘com­mu­ni­ty prof­its’ mind-set. That seems like some­thing that could be done else­where.

    With that in mind, it’s also worth not­ing the find­ings just released on a new report on the invest­ing philoso­phies guid­ing the worlds sov­er­eign wealth funds: in addi­tion to find­ing an explo­sion of sov­er­eign wealth fund invest­ments in pri­vate equi­ty projects, the report found less than 1 in 5 sov­er­eign wealth funds actu­al­ly have for­mal envi­ron­men­tal, social and gov­er­nance (ESG) poli­cies in place:

    IPE

    Few­er than 20% of SWFs have for­mal ESG pol­i­cy, Pre­qin reports

    By Rachel Fixsen
    2 June 2021

    Only one in five, or 19%, of the world’s sov­er­eign wealth funds (SWFs) have for­mal envi­ron­men­tal, social and gov­er­nance (ESG) poli­cies in place, accord­ing to a new report by alter­na­tives data provider Pre­qin. and law firm Bak­er McKen­zie.

    In their new “Sov­er­eign Wealth Funds in Motion” report, the firms also said the role of SWFs is chang­ing due to the pan­dem­ic, with the funds becom­ing tools of recon­struc­tion, with many invest­ing domes­ti­cal­ly, for exam­ple in big infra­struc­ture projects.

    While only 19% of SWFs had for­mal ESG poli­cies, Pre­qin said the funds that did were gen­er­al­ly the larg­er ones. In terms of assets under man­age­ment (AUM), $4.24trn (54%) of the total $7.84trn of SWF AUM at the end of 2020 was man­aged by funds that did have stat­ed poli­cies, it said.

    Over­all, the report found there had been a grow­ing momen­tum among SWFs “to a more sus­tain­able invest­ment future”, Pre­qin said.

    This has been dri­ven by inter­nal ini­tia­tives as well as stake­hold­er pres­sure from with­in the funds, and a vari­ety of recent nation­al and inter­na­tion­al reg­u­la­to­ry devel­op­ments, it said.

    David Low­ery, head of research insights at Pre­qin, said: “With most economies work­ing their way through the post-COVID-19 recov­ery phase, ESG is the means to focus on returns while deliv­er­ing pos­i­tive out­comes.”

    ...

    Pre­qin said SWFs were becom­ing more promi­nent in the glob­al finan­cial sys­tem, with col­lec­tive AUM hav­ing grown at a rate of 8% per annum since the end of 2011.

    At the end of 2020, SWFs made up rough­ly 7% of glob­al assets under man­age­ment (AUM) of $111.2trn, accord­ing to the report.

    Alter­na­tives allo­ca­tions up

    Pre­qin said alter­na­tive invest­ment funds were one way SWFs could play a part in the recon­struc­tion and recov­ery efforts, and that SWF invest­ments in pri­vate equi­ty, real estate, infra­struc­ture, pri­vate debt and hedge funds had grown a lot over the past decade.

    Cumu­la­tive SWF allo­ca­tions to such assets was over $700bn at the end of 2020, accord­ing to the report.

    Pri­vate equi­ty was the most pop­u­lar asset class out of these alter­na­tives for SWFs, Pre­qin said, with the sov­er­eign funds hav­ing a medi­an allo­ca­tion of 9.3% here, fol­lowed by real estate at 6.7%.

    Com­bined medi­an SWF tar­get allo­ca­tions to pri­vate equi­ty, real estate, and infra­struc­ture had grown to 30% in 2020, from just 18% back in 2011, it said.

    ———-

    “Few­er than 20% of SWFs have for­mal ESG pol­i­cy, Pre­qin reports” by Rachel Fixsen; IPE; 06/02/2021

    Only one in five, or 19%, of the world’s sov­er­eign wealth funds (SWFs) have for­mal envi­ron­men­tal, social and gov­er­nance (ESG) poli­cies in place, accord­ing to a new report by alter­na­tives data provider Pre­qin. and law firm Bak­er McKen­zie.”

    Only 19% of the funds set up to invest on behalf of entire nations for­mal­ly care about any­thing oth­er than mak­ing as much mon­ey as pos­si­ble. For the oth­er 81%, it’s pre­sum­ably just about invest­ing in what­ev­er brings the best finan­cial returns. It’s one of those fun fact that peo­ple in the future are going to look back on after we’ve allowed cap­i­tal­ism to col­lapse the bios­phere and tear soci­eties apart.

    And with a medi­an allo­ca­tion of near­ly 10% of sov­er­eign wealth fund assets in pri­vate equi­ty invest­ments and that num­ber only grow­ing, we can be con­fi­dent that what­ev­er type of influ­ence these sov­er­eign wealth funds decide to exert on their invest­ments will like­ly be sig­nif­i­cant­ly felt. These funds have the clout that comes with size. So should that 81% of sov­er­eign wealth funds that cur­rent­ly like an ESG pol­i­cy even­tu­al­ly put on in place, a whole lot of pos­i­tive impacts could poten­tial­ly be chan­neled through that own­er­ship. There’s no rea­son the recent sto­ry about an activist invest­ment fund forc­ing major pro-envi­ron­men­tal changes at Exxon could­n’t be repli­cat­ed else­where with all these sov­er­eign wealth invest­ments:

    ...
    Pre­qin said alter­na­tive invest­ment funds were one way SWFs could play a part in the recon­struc­tion and recov­ery efforts, and that SWF invest­ments in pri­vate equi­ty, real estate, infra­struc­ture, pri­vate debt and hedge funds had grown a lot over the past decade.

    Cumu­la­tive SWF allo­ca­tions to such assets was over $700bn at the end of 2020, accord­ing to the report.

    Pri­vate equi­ty was the most pop­u­lar asset class out of these alter­na­tives for SWFs, Pre­qin said, with the sov­er­eign funds hav­ing a medi­an allo­ca­tion of 9.3% here, fol­lowed by real estate at 6.7%.
    ...

    So that’s the lay­out of a fas­ci­nat­ing clash of mod­els in the pri­vate equi­ty space that’s cur­rent­ly unfold­ing glob­al­ly. We have an explo­sion of gov­ern­ment-guid­ed funds in Chi­na oper­at­ing under a ‘max­i­mal indi­rect prof­it for the city’ mod­el focused on bring­ing busi­ness to the city. At the same time, sov­er­eign wealth funds around the globe are con­tin­u­ing to pile into pri­vate equi­ty, but large­ly still oper­at­ing under a social­ly irre­spon­si­ble ‘prof­it for prof­it’s sake’ kind of tra­di­tion­al invest­ment mod­el. The two mod­els aren’t exact­ly in direct com­pe­ti­tion with each oth­er as long as there remains a democ­ra­cy vs autoc­ra­cy divide between Chi­na and West. But as the West con­tin­ues its decades-long lurch away from mean­ing­ful democ­ra­cy and close and clos­er towards an embrace of anti-demo­c­ra­t­ic far right fas­cism world views, that com­pe­ti­tion between the eco­nom­ic mod­els of Chi­na and the West real­ly does become much more of a direct com­par­i­son.

    That’s part of what makes this such a grim­ly fas­ci­nat­ing trend: as Chi­na con­tin­ues to evolve its econ­o­my more and more towards a form of state-run cap­i­tal­ism, the West con­tin­ues to move away from democ­ra­cy and clos­er towards a civ­i­liza­tion almost entire­ly cap­tured by a mod­el of short-term rapa­cious prof­it-max­i­mal­iz­ing cap­i­tal­ism. If trends con­tin­ue, the eco­nom­ic con­trasts of these two mod­els are only going to grow in impor­tance because the democ­ra­cy gap will have with­ered away. It’s the kind of dynam­ic that’s going to be increas­ing­ly impor­tant to keep in mind as the glob­al far right fix­a­tion on Chi­na con­tin­ues to fes­ter all. In oth­er words, an author­i­tar­i­an Chi­na that embraces cap­i­tal­ism isn’t a threat to West­ern fas­cism because of some sort of pro­found dis­agree­ment with Chi­nese author­i­tar­i­an­ism. The Chi­nese mod­el is a exis­ten­tial threat because the Chi­nese mod­el of author­i­tar­i­an cap­i­tal­ism has been demon­stra­bly bet­ter as deliv­er­ing very real eco­nom­ic gains to the mass­es than the crony cap­i­tal­ism of the West over the past cou­ple of gen­er­a­tions and that’s going to be a painful con­trast to deal with after the far right push­es the West into the post-democ­ra­cy future it has planned for us. The world is inevitably watch­ing.

    Posted by Pterrafractyl | June 6, 2021, 5:13 pm

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