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 EDTThe 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.”
...
———-
““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 assistanceJames Fontanella-Khan, Mark Vandevelde and Sujeet Indap in New York and James Politi in Washington
March 31, 2020, 10:13 pmSome 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.
...
—————
“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, 2020Ever 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.
———-
““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. ETBen 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.
...
———–
“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 borrowersEven 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.
...
————-
“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 the 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.
————
“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 CDTPrivate 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, 2019Hi,
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?
Martin Borman, Nazi in Exile
@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
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:
“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:
“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:
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.
@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:
“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.
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:
“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:
“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:
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.
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:
““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:
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:
“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:
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:
.
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:
“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.
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:
““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:
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:
“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:
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.
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:
“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’.
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 $315 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:
“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:
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:
“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 :
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.
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:
“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:
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:
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:
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.
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:
“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:
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.
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:
“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:
“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:
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:
“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:
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:
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:
“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:
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:
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:
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:
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.
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’:
“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?
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:
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:
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.
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:
“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:
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:
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:
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:
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.
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:
“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:
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:
“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:
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:
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:
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?
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.
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 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:
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...
...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...
... 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.
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:
“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:
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:
“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.
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:
“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:
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:
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.
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:
““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:
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:
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.
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:
“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:
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:
“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:
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.
The US has long been a society heavily defined by its absurd juxtapositions. You can’t start off as a slave-owning democracy without a capacity for incredible internal contradictions. Weird internal contradictions that persist to this day, like the US’s deeply held cultural aversion to a heavy-handed government juxtaposed with an almost celebratory embrace of corporatism and private wealth. Private wealth that has largely captured the US government and economy in the post-Reagan era. But perhaps the biggest recent example of that amazing capacity for contradiction has been witnessing the rise of Trumpism — a new kind of branding for the Republican Party based heavily on overtly anti-corporatist/anti-elitist right-wing populism — at the same time the party remains complete in the grip of its corporate mega-donor networks. A rebranding that, somewhat predictably, emerged in the years following the 2008 financial crisis that rattle what remained of the US society’s faith in its political and economic elites.
And yet, at the same time we’ve seen the rise of Trumpism and the faux anti-elite right-wing populism he peddles, the capture of the US economy by those same economic elites has accelerated since 2008. The underlying juxtaposition of ‘the land of the free’ being economically captured by a tiny elite has only grown in the post-crisis years. It’s a key part of the context of US’s seemingly endless era modern political crises: the never-ending political crisis and loss of faith in political institutions coincided with the ongoing capture of the US economy. We can’t actually separate the loss of faith in the US political system from the loss of faith in the basic fairness of the US economy. And yet channeling that sense of grievance and a sense that America is a rigged society is largely at the core of what Trumpism represented. A branding of that profound loss of faith in America’s elites away from the corporate elites and towards ‘cultural elites’ like public school teachers or ‘woke’ academics’. And you can’t argue it hasn’t been a wildly successful redirection operation. When was the last time you heard about some sort of lingering public grumbling over how no bankers were sent to jail for the financial crisis? It’s basically been a non-story for like a decade now. Wall Street and corporate America won. At the expense of the rest of America.
It’s that ongoing and growing internal juxtaposition in American society — where more and more of the economy continues to be captured by a sliver of society — that’s going to remain one of the more fascinating angles to US politics play out in coming election cycles as we wait to see what this Trumpist movement morphs into next. Just how effectively will the Republican Party being able to direct and shape the anti-elitist sentiments that have become a core element of the modern day Republican Party’s grievance-driven messaging without tapping into the very real and justifiable anti-corporate elitist sentiments. After all, if the underlying message for the modern day Republican Party is going to be ‘the system is rigged against conservatives’, it’s going to be hard to ignore the very real economic rigging that has defined the modern American economy. And yet ignoring that corporate elitist economic rigging has to remain a core objective for the party. Corporate America is the GOP’s core constituency, after all.
So with all of that in mind, here’s the latest reminder that not only has the US economy been effectively captured by its corporate economic elites over the last generation, but that it’s done so via the rigging of the stock market. Systematic rigging that has enable corporate executives to effectively engage in unrestricted insider trading for decades in what amounts to a giant scandalous open secret. Due a combination of lax regulations, weaker enforcement, and system of rules seemingly designed to facilitate legal insider trading, corporate executives have been shown to earn annualized returns on their stock trades approach that of the highest-performing hedge funds.
And while insider trading is, legally speaking, a greater problem for publicly traded companies, where the rules are stricter, that doesn’t mean private equity doesn’t suffer from this problem. The unequal treatment of private equity investors is something experts have been warning for years is taking place. It’s especially important to keep in mind given the ongoing interests groups like pension funds have in boosting their returns with private equity investments.
Yes, during the same period when the US embraced stock portfolios for all — turning away from pensions for most workings and making a strong stock market effectively a requirement for average Americans with 401ks to enjoy a retirement — and this same period when stocks have been repeatedly bailed out by the US government, we’re also learning that the corporate executives who have been showering themselves with stock options have also been engaging in rampant insider trading. It’s an open secret. An open secret that average Americans have long suspected but never really had confirmed.
Until now. Because according to new research studying the insider trading in the US, it’s everywhere and no one cares. At least no one involved with preventing it. And while regulators have certainly failed in preventing this insider trading, so to have the corporations themselves, who end up sharing much of the responsibility for overseeing and preventing insider trading under US law. The open secret was confirmed by research. The question now is how long before this open secret becomes a widely recognized open secret by a public that seems to have forgotten how angry it was at corporate America and what will corporate America do to redirect that rage this time. It points towards a truly dangerous political dynamic that we should expect to emerge as public awareness of the gross rigging of America continues to gel. In other words, Trumpism 2.0 is going to have a lot of excess resentment to rechannel regarding the mass systematic rigging and cheating in US stock markets by America’s economic elites:
“In the U.S., an insider is defined as a senior executive, board member, or any shareholder who owns 10% or more of a company. There are about 82,000 of them, and every time they trade they’re required by law to file a disclosure, known as a Form 4, within two days. These filings can be viewed on the U.S. Securities and Exchange Commission’s website, but scores are added each day, and most don’t offer much insight. “You have to know where to look,” says TipRanks Chief Executive Officer Uri Gruenbaum. Directors typically receive a proportion of their compensation in stock options, giving them the right to buy shares at a set price before a certain date, so if an executive is simply exercising an expiring option, it probably doesn’t reveal a great deal about how he views the company’s prospects. Selling may not tell you much either, because there are all sorts of reasons an insider might want to cash out—to buy a boat, for instance. It’s when insiders use their own funds to buy stock on the open market that it’s most worth paying attention.”
Roughly 82,000 “insiders” exist in the US. And while many of these insiders are going to be the insiders of tiny companies of little value, there’s simply no denying that a massive and seemingly ever-growing percentage of the net wealth in the US has been accrued by corporate insiders over the last generation, thanks largely to stock options. Stock options eventually converted into stocks, and then sold. The story of America’s insider trading epidemic is just a subchapter in the larger story of the post-Regan corporate capture of the US economy that’s been underway since 1980. The end of pensions and the rise of the 401k stock retirement plan coinciding with the explosion of executive stock options. The decades-long insider trading pandemic is part of how that larger story of the capture of the US economy actually happened, effectively amplifying that wealth capture.
And a big subchapter in the story of this insider trading pandemic has been how the this pandemic has been practiced more or less out in the open, with virtually no regulatory oversight. Yes, it’s technically illegal to engage in insider trading in the US. But that appears to be a technicality with no legal teeth. Rampant insider trading has long been an open secret on Wall Street:
Part of the reason for this lack of enforcement of insider trading rule is that the US law gives corporations themselves the discretion to impose rules like blackout windows barring executive trading in the runup to earnings reports and taking a rather ‘laid back’ approach them. Those were the findings based on a statistical analysis done by Daniel Taylor, head of the Wharton Forensic Analytics Lab. Time and time again, Taylor found, executives were trading during these “blackout windows” in the lead up to earnings reports. It’s just blatant open insider trading. Consequence free. We’ll, there’s one consequence: higher trading profits for the executives:
And then there’s the fact that the US created the 10b5‑1 plan rule in 2000 that appeared to be effectively designed to executives a means of preemptively legally defending themselves from insider trading charges. As long as executives file a 10b5‑1 plan in advance a trade — even if it’s just days before the trade — this rule protects them from insider trading charges. And there’s no rule they have to stick with the plan. How many cases of been investigated by the SEC for 10b5‑1 abuse in the following two decades? Zero. It’s a ‘get out of jail free’ card for insider traders:
Beyond that, there’s the fact that US law doesn’t really even formally treat insider trading as a standalone offense and didn’t really even consider it illegal until 1961 when the SEC brought a case against Robert Gintel. A case that set the precedent that prosecutors need to prove the defendant knew they had insider information and intended to cheat from it, a much higher bar than simply proving they profited from nonpublic information. And many prosecutors today still don’t even think insider trading is a real crime. The system was set up for insider trading and apparently run by people who think its OK:
Finally, there’s the grim acknowledgment at the end of the article: as long as the people making the top decisions are the primary people benefiting from those decisions you’re going to have the threat of insider trading. An overhaul to our entire approach to corporate governance would be required. It’s a system run by insiders, for insiders, and there’s no expectation of that ever changing:
And that’s all part of why we should probably expect the ongoing and pervasive crisis in confidence in America’s institutions to continue to include a crisis of faith in corporate America’s leadership. And why we should also expect those corporate leaders to rely on the Trumpism 2.0 to redirect that crisis. Because as the research on insider trading makes clear, America’s corporate leaders are more than happy to use whatever means are necessary to accrue as much wealth and power possible as long as they’re confident they can get away with it. And this is 2021. Four years after the history GOP tax cut of 2017 and 13 years following the Great Financial crisis that sent no one to jail. Trumpism has captured the hearts of minds of conservative America and any hope of a unified populist anti-corporate front in American politics is long gone. They divided and conquered and got away with it. Why not do it again. It’s a great business model.
The story of the collapse of the United States from the world’s leading democracy into a present day basket-case society perpetually on verge of a far right coup is a complicated story spanning decades. But on one level, the story is quite simple: the US public kind of intellectually ‘checked out’ for over a generation. Newspaper leadership had been in decline long before the internet came along. TV has been rotting American brains en mass since the 1950s. Everything went to hell in a handbasket because everyone stopped making sure that didn’t happen. It’s a group effort. It’s also part of the reason the explosion of smartphone-delivered social media mass disinformation has been so wildly effective at moving the US public. Pre-smartphone America, when people had to actually go out of their way to get the news, the US really were kind of a blank slate society when it came to what was going on in the world. We were easy pickins.
It’s why one of the more interesting quirks of the US democracy over the past generation has been how little interest there’s been in the story of the collapse of the US news industry over. You’d think this would be a bigger story. Except, when you think about it, the collapse of the news industry is almost, by definition, not really going to be much of a story at all. Following the obligatory lamentations it’s mostly just been a mostly silent death rattle. We’ve already seen how the far right Sinclair Broadcasting has taken over the local TV news and filled it with right-wing disinformation and garbage coverage, in part thanks to the Trump administration’s FEC.
And as the following new piece in The Atlantic describes, the local print media hasn’t fared any better, with the financial sector having bought up almost the entire sector over the last two years. But it’s been in just the last decade when this trend in local newspaper buyouts by cynical investors really accelerated. Specifically, one group of cynical investors: Alden Global Capital.
In just a decade, the private equity firm has suddenly become the second largest owner of local newspapers in the US and experts expect them to be the largest one of these days as their appetite for local news has shown no sign of letting up. And while the ownership of local news across the nation by a single entity is inherently problematic from an anti-monopoly perspective, the problems with Alden Global Capital go much further. Because as we’re going to see in the following four article excerpts. Alden Global Capital isn’t just some random private equity firm. It was started by Randall Smith, a hyper-secretive investor who just happens to be one of the pioneers of debt-driven leveraged buyouts of distressed companies. The kind of investing that gives private equity such a bad name. The kind of investing that claims to be ‘saving’ distressed companies but instead just ends up looting them and liquidating them for anything of value that can be sold off in short order. That’s the guy who is slated to become the biggest owner in the US local newspaper market. A secretive supervillain.
And in case it’s not clear that Smith has a supervillain’s psychology, his own son literally described in an interview what motivates his dad. The answer: a sense that life is all a game and the person with the most money at the end wins. That’s the ethos driving the destruction of local news across the US.
But it gets even worse. Because it’s not just the case that Alden Global Capital is buying up distressed local news outlets and stripping them dry. They’re buying up healthy local news outlets too. And stripping them dry. Yes, it turns out Alden Global Capital operates on the kind of short-term asset-stripping investment model where it makes sense to even destroy profitable enterprises, including selling off the newspaper’s real-estate and have the company lease it back. And when these massive cost-cutting initiatives that gut the newsrooms do end up generating real savings and temporarily increasing revenues, the savings aren’t being reinvested in the papers and instead are flowing back to the investors. The company really is acting like a kind of predatory parasite, with local news nationally as the victim.
And as we should expect, Smith is a Trump supporter. Interestingly, though, he appears to have only arrived at that position in 2019, despite a history of generous GOP support. Smith was effectively a ‘Never Trumper’ in 2016. But in July of 2019, Smith and his wife both mad $50,000 contributions to a “Trump Victory” fund. Why the sudden change? Well, less than two weeks before that $100k contribution, Democratic Senator Elizabeth Warren proposed legislation that would put a major crimp in how the private equity industry operates. In addition to addressing the remarkable secrecy private equity firms are allowed to operate under, Warren’s proposed legislation would make private equity firms liable for the debt they force their companies to take on.
Yes, the core strategy that private equity has long used to prey upon companies — the leveraged buyouts where the firm purchases a company using large amounts of debt and then forces the newly-owned company to issue large amounts of debt to pay back the investors, effectively killing the company in the process — would be ended with this legislation. The strategy Randall Smith pioneered would be ended, presumably along with the private equity industry’s unchecked capture of the US economy. A real kind of economic revolution (really counter-revolution) would transpire if legislation like that ever become reality the US. That’s how wildly destructive the leverage buyout phase of American capitalism has been. It’s effectively been an economic coup.
So the story of the collapse of the local US newspaper market is really just one subchapter in the larger story of the capture of the US economy by the private equity sector using the techniques pioneered by none other than Alden’s Randall Smith. It’s quite a story. One you definitely shouldn’t expect to read about in your local newspaper:
““They call Alden a vulture hedge fund, and I think that’s honestly a misnomer,” Johnson said. “A vulture doesn’t hold a wounded animal’s head underwater. This is predatory.””
You can’t call Alden Global Capital a “Vulture Fund”. Vultures aren’t predators. A genuine vulture fund wouldn’t kill viable companies. Alden Global Capital is acting more like some sort of predatory parasite, bleeding its victims to death. And it’s not a particularly slow bleed. When Alden takes over a news operation, the gutting commences immediately, whether the paper is viable or not. Local news is being actively snuffed out across the US. And the people behind it are able to do this, in plain sight, without ever needing to explain their motivations:
Remarkably, this capture of thew local news has transpired over just a decade, when Alden co-founders Randall Smith and Heath Freeman bought their first paper. This is how contemporary America operates. If you’re secretive private equity firm with grand ambitions to capture and bleed dry local news across the country, that’s a viable business model. A model that literally appears to be predicated on the idea of scamming elderly subscribers into paying more for less unless they finally cancel their subscriptions, at which point the investors already made their money back. And if you execute this business model and destroy the only sources of information in one community after another, you will have to answer to no one, especially those communities. Alden Global Capital is already the second largest owner of local newspapers in the US, after just a decade, and on track to being the largest. You can literally capture the US news market without ever having to give an interview. It’s how economic power operates in the world’s oldest democracy:
Even more gross is the fact that the mastermind behind this is Randall Smith, one of the pioneers of financial sector’s pioneers in “vulture capitalism”. A man who, by his own son’s admission, views life as a giant game where “Whoever dies with the most money.” So the guy who was too greedy for the “greed is good” decade is the man who is actively snuffing out local news for his short-term profit is apparently doing this all for fun. Because it’s all just a big game. Again, welcome to contemporary capitalism. This is how the sausage is made:
It’s also crucial to keep in mind that while this is a story about the capture of local news by a single private equity firm, Alden Global Capital is far from the only financial firm that owns the news. Half of all dailies in the US are controlled by a financial firm. In other words, the story of Alden Global Capital’s capture of a large potion of the local news market is part of the larger story of the financial industry’s near complete capture of this market:
Finally, there’s the fascinating question about the nature of the relationship between Alden Global Capital and Donald Trump. Smith has a history of large contributions to the GOP. And his takeover of the Chicago Tribune was even financed with the help of Cerberus. Recall how Cerberus is owned by Trump ally, GOP mega-donor, and major arms dealer Stephen Feinberg. Smith is also geographically next door to Trump’s Mar-a-Lago estate. And he suddenly made a large donation to Trump’s 2020 campaign. Which raises the question: is Smith’s assault on the what remains of local media in the US part of the GOP’s general coordinated assault on what remains of the US’s democracy?
And that brings us to the following February 2020 piece by Julie Reynolds at her DFWorkers.org site — a site dedicated to chronicling Alden Global Capital’s capture of the media — about the $100,000 Smith and his wife suddenly decided to donate to Donald Trump’s campaign in July of 2019. It was a notable donation in part because, while Smith has a history of large donations to GOP presidential candidates, he was more or less in the ‘Never Trump’. Those 2019 donations were his first big jump into the Trump camp.
So had Smith merely belatedly come around to the reality that, as a loyal GOP mega-donor, he was going to need to get into Trump’s good graces? It’s a reasonable default assumption, but as Reynolds points out, Smith donations just happened to take place less than two weeks after Democratic Senator Elizabeth Warren unveiled proposed legislation aimed at making hedge funds and private equity firms more transparent and accountable. In other words, Senator Warren proposed legislation that would potential destroy the ability of people like Randy Smith to do what he’s done for decades with near complete secrecy. Including, as we’ll see in the third article below, secrecy about the identities of Alden Global Capital’s anonymous investors. Yep, while this might seem like a story about Randy Smith and Heath Freeman, there are actually at least 10 other anonymous Alden Global Capital clients, according to a March 2017 SEC filing. It’s entirely possible the news-destroying agenda that Smith and Freeman appear to be executing for their own personal enrichment is really an agenda shared by a number of other figures who choose to remain even more in the shadows than Smith and Freeman. It’s why this story isn’t just about the capture and destruction of local news. It’s about the capture and destruction of local news by the private equity sector, the area of finance that has effectively captured the rest of US economy too:
“Could it be that Smith, like Puzder, fears that legislators’ efforts to make private equity more transparent are actually a conspiracy to “punish the successful?””
Could it be that Smith and his wife suddenly made that $100,000 donation to Trump’s “Trump Victory” fund less than two weeks after Elizabeth Warren publicly threatened the private equity industry’s coveted secrecy? Keep in mind that context of Warren’s proposal: this was in mid-2019, when any reasonable person could project that the Democrats might retake control of Congress and White House in 2020. Warren wasn’t issuing hollow threats. It points to one of the most important fun-facts in this entire story: Elizabeth Warren’s proposal really was a threat to how private equity operates. A big enough threat to prompt private equity figures like Smith to finally jump on board the Trump train to ward off that threat:
And that brings us to following 2017 piece by Julie Reynolds about Smith and his media spending-spree. As Reynolds points out, Alden Global Capital isn’t solely operating for Smith and Freeman. It has clients. 10 anonymous clients according to that March 2017 report, with a total of $2.1 billion in capital under management. It’s a crucial part aspect of this story about the destruction of local news: this destruction is being executed by an industry that thrives on secrecy, to the benefit of often secret beneficiaries. And few things ensure secrecy better than the systematic public ignorance that comes from the destruction of the media:
“Over the past six years, Digital First Media has become America’s second-largest newspaper chain in terms of circulation. Even as Digital First has downsized or closed its papers, it has held its edge in circulation by continually buying up more publications, such as last year’s acquisition of The Orange County Register. Digital First’s annual profits have averaged a handsome 10 to 12 percent under Alden Global Capital’s management, according to industry analysts, with its smaller publications yielding more than 20 percent. (Because Alden Global Capital is privately held, its financial statements are not publicly available.) Since 2015, the company has intensified its cost-cutting to the point that it imposes budget cuts and layoffs at twice the average rate for US newspapers.”
What kind of returns has Alden Global Capital made on its media investments? We don’t get to know. Being a privately held company, the public isn’t privy to Alden Global Capital’s financial statements. But based on industry analysts, the firm is likely making more than 20 percent on its smaller publications. It’s the kind of returns that reveal the gross lie to the claims that Alden Capital is merely saving a dying industry. Dying industries don’t yield 20 percent annual returns during the restructuring phase. You need to snuff an industry out to get those kinds of returns. Who are the ultimate beneficiaries of all this snuffing? We don’t get to know. It’s a situation that isn’t limited to Alden Global Capital. This is now the norm in the newspaper industry: a few largely anonymous investment funds own almost all of it:
Finally, note the horrible paradox revealed by this whole situation: as the damage from this vulture capitalism model continues to grow, a core lesson that emerges is that the US newspaper industry — and therefore the US democracy — might rely on altruistic investors. Altruism, the exact opposite of the Smith/Freeman business model. The US economy is built to effectively extinguish altruism. Quite literally. Private equity firms have a first obligation to shareholders. It’s the model for how the US operates: the assumption that the collective embrace of greed and selfishness is the best way to secure the collective good. The predatory destruction of local newspapers is just the inevitable consequence of that insane paradigm. And if altruism is what’s required to save local news in the US, that more or less means local news is dead in the US unless someone can come up with a model for for-profit altruism. America doesn’t do altruism. Not for free:
It’s that underlying story about Randy Smith seeming to cozy up to the Trump administration as a defensive act against Senator Warren’s threat to the private equity industry that’s arguably the biggest aspect of this entire story. Because if Smith was prompted to give $100,000 to Trump’s reelection efforts, we have to ask what else he may have done to assist in Trump’s reelection effort. What could the second largest owner of local news outlets in the US do to help a president get reelected? What steps were actively taken? Of course, for a president as scandalous as Trump, simply destroying any meaningful news coverage is itself a form of immense assistance. Just as basically any scandal would be assisted by the lack of a functioning press.
And that brings us to what is perhaps the biggest scandal in this story: the ongoing scandal of the private equity industry’s ability to buy up companies, loot the companies by loading them up with debt, and the letting the companies descend in bankruptcy. Think about all the stories we’ve heard about private equity firms literally forcing the companies they own to issue bonds solely for the purpose of issuing dividends to their private equity owners. That’s been taking place across the US economy for a generation now and nothing is stopping it. It’s a mega scandal. The kind of mega scandal that, in a sane society, would rattle the foundations of the perceived legitimacy of how the US economy operates. And it just happens to be the case that Elizabeth Warren’s 2019 proposal would put an end to that practice. Private equity companies would finally be held liable for the debt they force their companies to take on. It was a direct threat to the business model Randy Smith spent his entire life exploiting. And less than two weeks later, Smith joins the Trump team in a big way. It’s hard to ignore the coincidental timing. A Trump victory was clearly seen by Smith, and probably much of the rest of the private equity industry, as a defensive move against a possible Democratic private equity reform push. So when we’re flailing about looking for solutions to the collapse of the US local newspaper industry, it’s worth keeping in mind that addressing the private equity industry’s ability to legally gut healthy companies would be a good way to start addressing the problem and a lot of other problems as the same time:
“Most critically, however, the plan would hold private equity firms responsible for the large debts that they use to buy companies. These debts, a hallmark of private equity investment, typically wind up as a burden to the targeted company, not the private equity firm, and have precipitated many bankruptcies.”
Take a moment and chew on that: the big regulatory change that private equity fears is a change that would make private equity firms liable for their own debt, instead of passing it on to their victim companies. That’s how warped the US economy is. A major driving force for a generation now has been a business model that allows the wealthiest people to acquire companies with debt that is assumed by the companies they purchase, and it’s all part of a business model that assumes they companies will be driven into bankruptcy. That’s arguably the most successful business model in the US of the last generation and one of the trailblazers behind that model is the guy currently leading the assault on local newspapers. A secret predatory assault conducted, in part, on behalf of still-secret clients. And helping Donald Trump win reelection in 2020 was part of defending that business model:
So should we expect this kind of reform legislation now that the Democrats have the opportunity to pass Warren’s proposals? It’s hard to imagine at this point given the reality that such a move would get 0 Republican support and therefore would require 100 percent support of the Senate Democrats, which isn’t realistic. You would need a sizable Democratic majority in both chambers of Congress for something like that to realistically have a shot. The private equity industry is simply too vast and powerful to be reigned in that easily.
But with the local newspaper industry having been largely captured, and destroyed, as a direct consequence of the private equity industry doing exactly what it does best — short-term asset-stripping — questions about how the ever-growing power of private equity over the US economy will play out politically become increasingly intriguing question. Especially at a time when income inequality and anger at employer abuse and exploitation is becoming an increasingly resonant issue while the “Great Resignation” plays out. American workers have grown super pissed at their bosses over the last generation, without really realizing that private equity is the new boss in many cases. There’s a story here. A really explosive and important story that has yet to be meaningfully told the US public with massive economic and political ramifications. A story that’s been playing out for decades. It would be nice if the US had a functioning industry that specialized in telling these kinds of stories and wasn’t being actively snuffed out.
Following up on the story of Alden Global Capital’s capture and gutting of the local newspaper marketplace across the US over the past decade, here’s a story about a particularly controversial practice by Alden that points towards one of the types of assets at these newspapers that ruthless investors like Alden might be particularly interested in: pension funds. Yes, it turns out Alden Global Capital was caught taking money from the pension funds of the newspapers it bought and investing that money with other Alden investment funds. Over 90 percent of the pension funds in some cases. It’s a massive conflict of interest. The kind of conflict of interest that Gannett — the largest newspaper owner in the US — was publicly pointing out back in 2019 when the company was trying to ward off Alden’s hostile takeover.
And thanks to the extreme secrecy private equity firms are allowed to operate under, there’s a particularly grotesque possibility we can’t rule out: It’s entirely possible Alden was taking that pension fund money and using it to finance the purchase of more newspapers. Now, we don’t know that Alden did this. But we also don’t know they didn’t do this and we know they could have been doing this all along without the public ever finding out. Those are the rules. Rules that force us to effectively trust that companies like Alden Global Capital are acting in an ethical manner while giving every incentive to do the opposite:
“The hedge fund, which is the controlling owner of such newspapers as the Denver Post and Boston Herald under the brand MediaNews Group, in some cases moved 90 percent of retirees’ savings into two funds it controlled, according to public records filed with the Labor Department. Most of the money has now been moved back out of the hedge funds.”
Is it a conflict of interest for Alden Global Capital to take the pension funds from the newspapers it controls and invest 90 percent of those funds in its own investment fund? One would think, yes, this would be a massive conflict of interest. And yet it happened, and the company appears to have largely gotten away with it, despite the federal investigation. The only noticeable consequence of the investigation is that it made it somewhat easier for Gannett — the largest newspaper owner in the US , and also primarily owned by the financial industry — to resist Alden’s hostile takeover attempt. For now:
But note the truly perverse possibility raised by the US’s rules around private equity: Alden’s investment funds are allowed to be so secretive that it’s entirely possible they used the newspaper pension money to buy more newspapers. Talk about a vicious news cycle:
How many newspapers did Alden Global Capital purchase with newspaper pension money? We’ll presumably never find out. But just as we have to ask how many papers have been secretly financed by paper pensions, we also have to ask what happens whey Alden Global Capital runs out of papers. This is basically a pyramid scheme, after all. In order for Paper X’s pension fund to get the return it needs, Paper Y needs to be purchased, asset-stripped, and the cycle gets repeated. What happens when there are no more unstripped local papers left? What keeps the scheme going? Oh, that’s right, the vulture funds can just move on to whatever other industry they can find with assets left to strip. It’ll be just like before, but presumably with few stories written about it.
Did a revolution in political grifting just quietly transpire in the US? That’s the bizarre and rather gross question raised by a number of recent stories about the latest Trump-related media venture. The big plan is for some sort of TRUTH social media app. And this new media venture is going to ultimately be a publicly tradable entity, but only after it completes its newly announced merger with a Special Purpose Acquisition Company (SPAC). Yes, Trump’s new social media company is going the SPAC route. Recall how the SPAC marketplace has been exploding in recent years, in part because it represents a less-regulated and potentially more profitable form of taking companies public than the traditional IPO route. Instead of all the regulator burdens and disclosures that come with an IPO, SPAC investors get to draw money from the broader public while ultimately making private-equity-like investments, creating a publicly-tradable merged company in the end. It’s the kind of model that puts SPACs in a relatively unregulated marketplace that invites retail investors in to play the role private-equity has traditionally made in the IPO marketplace. And a model that potentially benefits the initial pre-merger SPAC investors enormously.
And now, with the emergence of Trump-themed SPACs, this marketplace is poised to draw in political supporters to play the role of those SPAC investors. On the surface, it’s not exactly a story of a revolution in grift. But the more we’re learning about this deal, the more it appears that Donald Trump and the team of investors who set up this SPAC deal may have stumbled upon a powerful new way to raise potentially billions of dollars from public. Yes, the money raised in this manner would ostensibly be investment money in the new media venture. But as we’re going to see, it really does look like a lot of people potentially are just handing money to this new media venture as a means of expressing their support for Trump. Buying shares in a company as a means of expressing your support for a political persona. That’s the revolution in political grifting that’s currently playing out.
Sure, donating funds to politicians you support isn’t new. But merging that process with the pump-and-dump speculative dynamics of investing in a company is a very different scenario. The kind of scenario that could generate huge profits for the political figures who are capable of translating their following into some sort of for-profit corporate enterprise. Huge profits for political figures whether or not the companies they create are actually profitable. It’s a business model focused on raising money and profiting from the IPO, whether or not the newly created company actually has a viable long-term business model of its own is beside the point.
So what indications are there that this new Trump media firm is just a giant fund-raising scam? Well, it’s the fact that the SPAC deal around this new first just busted all the SPAC fund-raising records despite the new company having no actual product ready or even a general business model. Shares of the SPAC, Digital World Acquisition Corp, spiked over %350 percent the day after it was announced the SPAC was going to merge with a newly created Trump Media and Technology Group. Nearly a dozen hedge funds invested in that SPAC in its IPO in September and are set to almost quintuple their investment based on the nearly $50 share price.
Another part of the merger is a $293 million payout to Trump Media should the SPAC shareholders NOT decide to cash in their shares at the planned $10/share price when the eventual merger takes place. With prices currently near $50/share it’s looking like Trump will likely see the entire $293 million.
So what might ruin all of the fun for Trump and his fellow SPAC investors? Too much grifting, of course. Specifically, while almost nothing is known about the actual technology that Trump Media will ultimately deploy, what we do know is that they appear to be building the software using freely available open-source code while violating the terms of use of that code. Terms of use that include making whatever code Trump Media develops publicly available and open for further development by others. In other words, terms that this for-profit Trump Media probably won’t be willing to abide by. The developer of the open source code has already indicated they’re seeking legal counsel.
Now, it’s always going to be an option for Trump Media to just pay for the development of its own proprietary code. But that costs money. And freely available tools are sitting right there. All Trump needs to do is what he always does: break the rules and get away with it. Dominance politics as a business model.
Will Donald Trump break once again break the mold of political grifting? Time will tell, but as the following article makes clear, it’s far from just Trump who is cashing in on this. It’s the kind of political/business grift model that the whole financial sector can potentially cash in on:
“Trump Media and Technology Group and Digital World Acquisition Corp (DWAC.O), , a Special Purpose Acquisition Vehicle (SPAC), announced on Wednesday they would merge to create a social media app called TRUTH Social. Trump’s company said it plans a beta launch — unveiling a trial version — next month and a full roll-out in the first quarter of 2022.”
Yes, the newly Trump media venture announced this week doesn’t actually have a beta version of its product ready and while be unveiling it until next month. Nor did the announcement include any of the trappings of a detailed business plan normally expected with a deal like this. Despite this lack a product, or any sign of meaningful planning, the announcement of the merger triggered a %350 increasing in the value of Digital World’s share prices, closing at $45.50 at the end of the day:
And note how Trump himself directly benefits from the soaring Digital World share price: as part of the deal, as long as no shareholder chooses to cash in their shares for $10/share, Trump Media gets $293 million. And as long as the share price of Digital World stays about $10/share, those investors will have an incentive to NOT cash in their shares. It’s like a system designed to maximize the potential profits from Trump’s ability to create short-term hype:
But it’s the following observation that makes this potentially a revolution in political grifting: while some observers interpret this exploding stock price as a bet based on hopes and dreams, others see this as a market reflection of political support for Trump himself. A publicly traded vehicle for expressing one’s support of Trump. That’s new:
And it’s not like this has to be the ONLY Trump-related SPAC deal of this nature. There’s nothing stopping Trump from forming new companies and repeating this process. Of course, if these investors end up getting ultimately burned there may not be as much interest in future Trump SPACs. But that’s where the ambiguous nature about the intention of these investors comes into question. Because if people are buying these shares as an expression of their support for Trump and analogous to a political donation where there isn’t really anything directly expected in return then we shouldn’t necessarily expect a poor Trump SPAC track record to squash the prospects for future Trump SPACs. We just have to wait and see how this emerging ‘politicized SPACs’ marketplace is going to settle but following the spectacular success of Trump’s SPAC so far for investors it’s hard to imagine there isn’t plenty of interest in repeating this phenomena. Because as the following article points out, the surging share prices of Digital World following Wednesday’s announcement of the planned merger with Trump Media isn’t just a great day for those investors and Trump. It was a record-setting day for the SPAC world, recording the highest SPAC gain ever on the first day following the announcement of a merger:
“It is the biggest gain investors in so-called special purpose acquisition companies (SPACs) have ever recorded on the first day after a deal was announced, according to SPAC Research.”
The precedent has been established. A new bar has been set for what is possible following this record-setting surge in Digital World’s shares a day after the announced merger.
But, of course, the possibility that this whole venture is going to collapse under the weight of its own lack of a business model looms large too and a boom-bust SPAC precedent might ultimately get established. And based on the following TPM piece, it looks like that implosion could come about sooner than investors expect. Because while there’s no working product yet available for this new media venture, there is a prototype of sorts. A software prototype with a significant legal problem: the prototype appears to violate the terms of the software tools used to build it.
Yep, it turns out Trump Media built its TRUTH app using the Mastodon open source software. And while Trump Media has every right to build its app based on that freely available software, the open source license does comes with a few requirements. Namely, any software built using Mastodon must, itself, also be publicly available, in keeping with the open source philosophy. And Trump Media has shown no indication of making its modified Mastodon code available, in direct violation of the license. So it appears that Trump Media decided to build its for-profit app with freely available software while refusing to abide by the rules. Yes, Trump’s new social media venture has somehow managed to find a way to steal free code. It’s like distillation of the Trump ethos.
So are there going to be consequences for this effective theft? Possibly. Mastodon founder Eugen Rochko told TPM he’s planning on seeking legal counsel. Now, keep in mind that there’s no reason this TRUTH app needs to be build with Mastodon. There are alternatives. But this was a free option. ‘Free’, with a few conditions. So it looks like the Trump Media social media venture is starting off with a controversy that revolves around whether or not Trump needs to follow the same rules that apply to rest of us. Which is remarkably on-brand if you think about:
““I do intend to seek legal counsel on the situation though,” Rochko told TPM, while declining to discuss any specific legal action he may be contemplating.”
It’s going to be Mastodon founder Eugen Rochko vs Trump Media in a legal battle that could determine whether or not Trump’s record-setting SPAC debut crumbles right out of the gate. Then again, Trump Media could just develop its own social media app code. It’s not like the venture is lacking in financial resources. But that would required Trump backing down from an opportunity for another scam. And based on everything we know about his psychology it’s almost as if he’s compelled to find ways to cheat and grift whenever possible. It really does appear to be pathological. That’s part of what makes what should be a minor story about this legal issue potentially so significant. Openly stealing Mastodon’s code is the kind of Trumpian dominance play that really does seem to appeal to him. Perhaps more importantly, backing down in the face of legal threats at this point is the kind of public sign of weakness Trump abhors. It’s like he’s psychologically backed himself into a corner. And yet this is a corner where he might ultimately bully his way to another victory and wild profit.
But whether or not this Trump Media venture ultimately implodes under the weight of its own grift and mismanagement, the template is established. Political icons now have a means of creating IPO-like opportunities for their political supporters to show their support. And can grift like they’ve never grifted before.
Is the ‘Great Resignation’ more accurately a ‘Great Resignation’ from mostly crappy jobs offered by private-equity-owned firms? That’s the question posed by the following pair of articles. David Dayen just published a big new piece in The American Prospect that involved a number of interviews of US workers walking away from their jobs an found a pervasive trend: crappy pay, no benefits, bad hours. It’s a low-wage ‘Great Resignation’, decades in the making. And while companies are grudgingly raising pay in response, Dayen’s investigation found that it wasn’t just higher pay they’re seeking out. It’s meaningful careers with employers who respect them. And as Dayen points out, respect and paying workers more and not treating them like expendable commodities is something corporate American simply cannot sustain. It goes against the entire ‘investors first’ ethos that has dominated the employer/employee relationship in the US since the 1980. That’s part of what’s driving the great resignation: the kind of pay and dignity workers want doesn’t work with the dominant modern corporate business model reliant on cheap exploitable labor. A business model exemplified by the private equity industry:
“As of 2020, nearly one-quarter of U.S. jobs were low-wage, the highest percentage in the developed world. “We think it has to be this way,” said Autor. “But look at peer countries, it doesn’t fit. All have rising educational attainment and drops in worker power. But many have higher wages and lower economic insecurity at the low end of the spectrum.””
Nearly a quarter of US jobs were low-wage in 2020, the highest percentage in the developed world. The US economy is built on a foundation of cheap labor. Cheap exploited labor constantly churned from one low wage job to another with minimal negotiating power. But this isn’t just a major foundation of the US economy. It’s also the core of the private equity low-wage business model. A low wage business model built to maximized executive pay and investor payouts. That giant pool of exploitable low wage labor was a key resource from which to generate the historically high private equity returns. The US shifted towards an ‘everyone for themselves’ private equity social contract between labor and ownership in the 1980s and spent the next forty years looking out exclusively for investors by taking over one company after another and gutting the pay and benefits. A ruthless extraction of profits where pay and quality of life of the employees are seen as the raw materials from which to extract those extra profits. It was all going so well. For four decades. Creating a sea of workers who have nothing to lose.
And then the pandemic hits. Suddenly, for the first time in decades, the low-wage American workers have some real bargaining power. It’s why so many of the workers quitting or, even bigger, organizing mass walk-offs and strikes, and walking away from jobs at private equity-owned companies. Shady exploitation is a private equity specialty:
To get another sense of the scale of private equity’s reliance on low-wage jobs, here’s a recent report about the domination of the private-equity industry in areas like restaurants, hotels, and other industries with exploitable workforces. As the article notes, a 2019 study by the National Bureau of Economic Research analyzed almost 10,000 debt-fueled buyouts between 1980 and 2013 and found that employment fell by 13 percent when a private-equity firm took over a public company and by 16 percent when private equity acquired a unit or division of a company.
Crucially, as one of the study co-authors, Eileen Appelbaum, observed, the growing clout of the private equity industry isn’t just a threat to US workers. That same focus on short-term profits and extraction — where the investor profits are prioritized above all else — is a threat to US productivity. Companies that underpay and abuse workers might to maximize profits are doing all sorts of other things that will hurt long-term productivity in order to maximize short-term profits. It’s a business model focused on maximizing private investor returns through the systematic dismantlement and divestments in a functioning economy and society. In other words, the private-equity model isn’t about a health county or economy. It’s about maximum profits. Those aren’t the same thing.
The following article also includes some more information on fast-food giant Roark Capital, which owns Inspire Brands. It turns out the name Roark is a reference to the libertarian protaganist in Ayn Rand’s The Fountainhead. It also turns out three-dozen Roark-owned companies received $183 million in federal assistance under the CARES Act in response to the pandemic. Imagine that. It also turns out that Inspire Brands has been opposing efforts to raise the federal minimum wage to $15/hour every time it’s come up since first introduced to Congress in 2017. It’s a sustained anti-minimum-wage lobbying campaign that started before the pandemic and continues through it.
And as the article also notes, despite all these concerns about private equity, it continues to grow, even as the historic returns have shrunk to some extent. There are now more companies owned by private equity firms than listed on US stock exchanges. And its shared of the US economy is only poised to grow. There’s more extracting to be done. So while low-wage workers in the US may have some short-term leverage in the labor market, it’s going to be important to keep in mind that private equity isn’t going anywhere and is only going to have a bigger slice of the labor market going forward, long past this pandemic and into the next one:
“Eileen Appelbaum is an economist and co-director at the Center for Economic and Policy Research, a progressive think tank, and co-author of “Private Equity at Work: When Wall Street Manages Main Street.” Her study of private equity has led her to conclude that the industry’s growing clout is not only a concern for workers, but also has the potential to harm the nation’s broader economy.”
Private equity has the potential to harm the US’s broader economy if it keeps growing. That’s the conclusion Eileen Appelbaum arrived at. The private equity extractive exploitative business model is so damaging it’s a threat to US productivity. Keep in mind she arrived at this conclusion in her 2019 study, before the pandemic arrived to show the world just how correct their warnings were. Private-equity owned companies that rely heavily on exploitable labor have suddenly found they can’t really function. People hate the jobs created by these companies so much there’s a quasi-national strike of that exploited workforce. And that’s just the labor component. All sorts of aspects of the business can be mismanaged in this manner. As Appelbaum put it, “You have a lot more ownership of productive resources by investors who don’t know an industry, don’t understand the value of skilled workers and who are just in it to make their profit and get out. That erodes productivity.” And there are now more private equity owned companies than publicly traded firms. This is a growth sector. Pirate capitalism is the growth sector. It’s not great for a nation’s productivity:
And look at Roark Capital, owner of Inspire Brand which employs more than 700,000 people at a range of fast-food chains. Starting in 2017, Inspire Brand lobbied against the push to raise the federal minimum waged to $15, pre and post-pandemic:
As Roark Capital’s ongoing battle against a $15 federal minimum wage reminds us, all of these higher wages that employees in fast-food and other low-wage sectors are finally making aren’t necessarily permanent. Predatory industries aren’t going to permanently change their ways. They’re going to bide their time. Minimum wage laws can be repealed. Inspire Brands isn’t going to give up. And neither are the rest of it fellow private equity peers who own business predicated on a wage-slave model.
So yeah, all of that might have something to do with the ‘Great Resignation’. And why the exploitation that led up to the ‘Great Resignation’ will likely return at the first available opportunity. It’s just business.
Here’s an update on the Trump SPAC media venture. Or rather, three updates on three separate scandals related to this story:
First, recall how it appeared that Donald Trump had developed a major innovation in political grifting with the formation of the Trump Media and Technology Group (TMTG), a newly formed entity that announced its merger with Digital World Acquisition Corp (DWAC), a special purpose acquisition company (SPAC), back in October. The merged entity promised to produce ‘non-woke’ media content, but as we saw, the real promise was handful profits for the initial SPAC investors who saw their share prices in Digital World spike on the news.
It’s those handsome SPAC investor profits that are part of what’s under investigation. According to US law, SPACs can’t secretly have a merger in mind before the company is formed and shares are sold to investors. Otherwise, SPACs could end up become an end-run around the disclosure rules for IPOs. So, of course, that’s exactly what likely happened with Trump Media.
It turns out Trump-insiders met with the Digital World figures in April, weeks before Digital World filed with the SEC for its September 3 IPO at $10 per share. And in that May SEC disclosure, Digital World told the SEC it had no particular plans for a merger, a clear lie. It’s like a kind of pre-SPAC insider trading. Surprise! The Securities and Exchange Commission (SEC) announced on Monday that it was investigating this. That’s scandal number one.
On Friday we got word of another SPAC-insider trading-like scandal when the Financial Industry Regulatory Authority (FINRA) announced an investigation. But this time it’s in relation to the October announcement of the Trump Media/Digital World merger. It turns out there was an anomalous spike in the trading of warrants in DWAC stock in the weeks leading up to that October 20 announcement by Trump about the Trump Media merger with Digital World. October 20 is the day the price of DWAC stock went nuts and the value of those warrants went up even more, relatively speaking. The spike was first observed on Oct 4, and wasn’t matched in the trading volume of the shares. Just a spike in the volume of warrant trading. Was there insider warrant-trading going on?
Adding to the suspicious nature of this spike in warrants trading is that Digital World announced on September 27 that shares and warrants can trade separately. The first two days of warrant trading saw volumes in keeping with expectations, but suddenly on October 4 the first of a surge in volume for just warrant trading took place. About a week into the start of these secret Trump Media org talks. Are these things connected? That’s what FINRA investigators are looking into.
But there’s much more that makes this warrant trading spike, first observed, much more suspicious: It also turns out Trump Media and Digital World entered formal talks in the late September, about a week before the October 4 surge in warrant trading volume. These formal talks were not made public, a violation of securities law already. Don’t forget, DWAC had its on September 3. Digital World was a publicly traded company when it held those secret formal talks with Trump Media in the last few days of September.
The final major wrinkle in this story is that the secret Trump meeting in late September appears to roughly coincide with a September 27 announcement by Digital World that it was now allowing the separate trading of shares and warrants. Normally, when SPACs first have an IPO, shares and warrants are traded as “units”, typically consisting of a share and a fraction of a warrant (like 1 share and 1/3 of a warrant). There were two days of separate warrant trading before October 4 that appeared to be in line with the share trading volume and what analysts expected. But then on October 4 there’s a surge in warrants trading volume, the beginning of a pattern that leads up to October 20, when Trump announces to the world that Digital World and Trump Media are creating a joint venture. How much insider trading was trading place with those warrants during the weeks leading up to that October 20 announcement? It’s a significant legal question. Don’t forget, this really would be insiders cheating ‘the little guy’. Digital World was already a publicly traded company when this apparently insider trading was happening.
Finally, there’s the third scandal, which isn’t really being investigated because there isn’t anything to investigate. Instead, it’s just a scandalous state of affairs. Specifically, it’s the scandalous fact that a ‘Trump SPAC’ is the perfect vehicle for allowing foreign governments, mobsters, and pretty much anyone we can think of to buy influence with Trump. Just invest a ton in his SPAC and he’ll kind of owe you one. A debt he’ll have little trouble repaying should he take office in 2025.
So the figure who is the likely GOP nominee for the US presidency in 2024 has been striking it rich with a group of mystery investors who appear to have been engaged in rampant insider trading. And that’s part of why the two newly opened investigations into the mysterious Trump media venture is potentially far more than just the latest Trump business corruption scandal. It’s political corruption scandal too with implication that could go well into the Trump’s putative second term:
“The New York Times reported in October that Trump Media’s discussion of a deal with an executive of Digital World may have skirted securities laws because the SPAC did not disclose those talks in its filings. The April videoconference is a further indication that may have happened.”
We already had hints of a SPAC scandal. Because of course this was going to be as scandalous as possible. This is a Trump SPAC. How could it not be scandalous? The reports of the April videoconference attended by Trump media figures is just further confirmation of what we should have already known. SPACs aren’t supposed to have mergers worked out in advance and yet it has long looked like that is exactly what happened here. Hence the need for an investigation:
An investigation that could include turning over the identifies of the investors, which is reminder that these Trump-related SPAC scandals have, at their core, mystery investors:
Digital World primary backer, ARC, is itself an interesting firm. A scandal-ridden Shanghai-based company that helps Chinese companies list their shares on US stock exchanges. So when the SEC looks into the identities of these SPAC investors, the earliest of those investors will have the closest ties to this mysterious ARC Group:
And note the story we are being given to explain away this potentially illegal insider trading: The April meeting between Patrick Orlando, Digital World’s CEO, and the Trump Media representatives is being characterized as not a meeting between Digital World and Trump Media. No, instead, it was a meeting between Trump Media and a different SPAC that Orlando just happened to also represent at that time, Benessere Capital Acquisition. How convenient:
We are told that ARC had been trying to arrange a SPAC with Trump and this Benessare SPAC as early as March. But that alibi raises the same question: even if the meetings really were between Benessere and Trump Media, wouldn’t those meetings also be illegal in exactly the same way? Or is this some sort SPAC loophole they discovered: using a dummy SPAC to hold meetings with your prospective merger partners and then switch to the real SPAC. Unless that’s a valid loophole, it seems like this was still a very illegal arrangement:
Finally, we get a hint at the end of the article about the other Trump SPAC insider-trading investigation announced the week: The FINRA investigation in into apparent insider trading activity that took place in the weeks leading up to the actual announced Trump Media/Digital World October 20 merger announcement:
Ok, now here’s Friday’s report on the newly announced FINRA investigation. An investigation in suspicious warrant trading activity that took place in the weeks leading up to the October 20 merger announcement. On October 27, Digital World made the unusual announcement that holders of “units” (a blends of shares and a fraction of a warrant held by early investors) can trade those shares and warrants separately. Around this same time, Trump Media and Digital World entered into secret meetings. Digital World began allowing the pre-IPO trading of shares and warrants at the beginning of October. For the first two days the trading was as one might expect, but on October 4 the trading in warrants surged 8‑fold without a concurrent surge in the share trading volume. In the end, it turns out the warrants, which were priced at 50 cents pre-IPO, ended up being a far more profitable asset than the actual shares themselves.
Keep in mind that, as we just saw, Digital World and the Trump Team had been in contact working on some sort of deal since at least March or April. So it’s not like the secret meeting at the end of September was the first meeting between the two key entities in this enterprise. But the timing sure is suspicious, and the fact that it was a secret meeting may make it illegal whether or not they were indeed discussing the kinds of things that would impact the likely value of those Digital World shares. That’s why FINRA is now investigating. Whether or not it ends up being found corrupt, it’s just a grossly corrupt looking situation that screams insider-trading:
“Warrants cost only a fraction of what a share does because they can’t be exercised right away, but are a valuable commodity if share prices rise sharply. In the case of Digital World, a warrant is redeemable 30 days after the merger closes and can be used to buy a share at $11.50. Warrants were trading at roughly 50 cents each before the merger was announced, and closed at $21.50 on Wednesday. The price of a single share of Digital World was $65.42.”
These Digital World warrants were trading at around 50 cents right before the merger with Trump Media was announced on October 20. As of last week, those warrants were trading at around $21.50, meaning whoever held those warrants made a very handsome return.
But the wild profits aren’t what caught regulator’s eyes here. It was the fact that trading in these warrants surged in the weeks leading up to that October 20 IPO. A surge in warrant trading that didn’t have a parallel surge in actual share trading.
It was several weeks before that October 20 IPO that Digital World first began allowing the trading of warrants separately. In the first couple of days, the warrants were trading at levels roughly in line with the volume of traded shares. But on October 4 — a week after Digital World and Trump Media & Technology Group entered into formal talks that were not disclosed at the time — the volume of warrant trading suddenly spiked round 8‑fold without a parallel surge in share trading. Then, on October 20, the announcement is made and everyone makes a ton of money as the value of shares spike and the value of the warrants spike even more. That’s what caught the eyes of observers, prompting this FINRA investigation:
And again, note how we had an announced decoupling of the warrant and share trading announced on September 27, to commence on September 30, right around the same time of the secret formal talks with Trump Media. In the end, those warrants turned out to be far better investment than the shares. It raises an interesting additional question of who sold and who bought the warrants. Was it small investors selling to insiders during this initial period? The fact that Digital World was already public suggested convincing the public to sell its warrants for cheap back to insiders would have been a tempting target:
So at roughly the same time Digital World makes an unusual rule change that allows for the maximal profit in warrant sales, there’s a secret meeting with Trump Media. A few days later, the trading of warrants and shares is allowed. A few days after that, on Oct 4, there’s an anomalous surge in warrant trading observed. Then on Oct 20, Trump Media announces to the world that it’s committed to this SPAC and the next chapter in political grift was upon us.
But as the following article reminds us, the concern here shouldn’t simply be that Trump has found a new way to fleece the public and cheat the system for his personal benefit. As someone running in 2024 and very possibly the next President, this SPAC has created a remarkable mechanism for a kind of backdoor IOU. The kind of IOU where it’s Trump who ends up indebted to these ‘investors’, who will be ‘paid back’ after Trump is back in office. Investors that could include Saudi Princes, mobsters, and all the other cast of shady characters the first Trump administration introduced us to...any one of them could be ‘investors’ in Trump’s new highly lucrative media venture. A highly lucrative media venture that doesn’t actually do anything yet other than make money:
“Trump’s indebtedness, his reliance on income from overseas and his refusal to authentically distance himself from his hodgepodge of businesses made him a national security threat as president. That threat will reemerge if he seeks reelection in 2024.”
It’s not like we can play innocent this time. We know who Trump is and what he does. A second Trump term is going to be an orgy of corruption. This SPAC is just one of what will be many avenues for facilitating. But given how this is template that can be replicated, this could end up being a particularly important avenue. It’s hard to imagine this is the last ‘Trump’ branded SPAC. Barring, of course, a nasty investigative outcome:
What shady foreign relationships are being set up as part of this already corrupt Trump Media fiasco? Let’s hope the SEC or FINRA can get to the bottom of it. Because otherwise we’ll have to wait for Trump to run and win in 2024 and we can learn about these shady relations in the upcoming Trump Admin II scandal-palooza. It will be a lot like the Trump I scandal-palooza, but with IPOs so you can own a piece of it.
Will increasing the potential profits of for-profit healthcare providers save Medicare? It seems like a rather absurd proposition. And yet that appears to be the grand strategy behind an experimental program the Biden administration just extended through 2026. The program is centered around so called direct contracting entities (DCEs), which are tasked with providing care to Medicare patients under a model that pays them a fixed amount per patient from the government but allows the DCI to keep left over payments as profits if the DCE can provide adequate care for less cost.
The pitch behind the scheme is that by incentivizing these care providers with more profits through lower spending, newer more efficient models for care can be developed. In that sense the DCE sounds a lot like the existing privately managed Medicare Advantage plans. And as we already know, Medicare Advantage costs both patients and the government more. It’s a giant for-profit scam.
But the DCE scheme differs from Medicare Advantage in one key way: patients have to be convinced to sign up for a Medicare Advantage plan. But under this new DCE model, Medicare patients could be transferred to a DCE without their consent. Yep, if you want to stick with a classic Medicare plan you might have to find a new doctor.
So this new ‘experiment’ in controlling Medicare costs appears to be a stealth move to actually expand the scammy privatized Medicare Advantage model by forcing patients onto it. And that’s what the Biden administration extended to 2026 back in February in the face of intense industry lobbying to keep the program going.
But it’s important to point out that when the Biden administration extended the program — rebranding it as the the Accountable Care Organization Realizing Equity, Access, and Community Health program, or “ACO REACH” — the administration did actually significantly pare back the Trump administration’s original design. The original scheme involved mass enrolling entire geographic regions all at once. That ‘geo streaming’ provision is no longer in place. So the involuntary shifting of Medicare patients into these for-profit schemes will continue for another four years, but not quite as extensively as the Trump administration planned.
It’s also worth noting the timing of the original announcements for this plan by the Trump administration: December of 2020, which would have been right in the middle of the Trump team’s efforts to overturn the election. It’s a reminder that these massively controversial changes to the safety net don’t have to be deliberated in public or even passed by Congress before they happen. The White House as the power to effectively privatize Medicare on its own. And since the Biden administration extended the program through 2026, it also means that a reimposition of those ‘geo streaming’ rules is a virtual certainty should the GOP win back the White House in 2024.
Oh, and guess which sector of the economy is already a major playing in this DCE marketplace: private equity. Yes, it turns out that private equity firms are major investors or owners of a quarter of the companies licensed to provide these DCE services. So the industry notorious for gutting companies and slashing customer service and quality in the search of profits is already a major part of this grand experiment in using the profit motive to discover new efficiencies in providing healthcare. Because of course:
“While the DCE program was launched under President Trump, Biden expanded the effort in February under a new name: the Accountable Care Organization Realizing Equity, Access, and Community Health program, or “ACO REACH.” Now, hospital-backed for-profit health benefit programs are also allowed to automatically enroll Medicare patients into their health care plans.”
This experimental “direct contracting entities” (DCE) program was announced in the final months of Donald Trump’s term, but it was up to the Biden administration as to whether or it would be continued. That decision was made in February with the announcement of the new name for the program: the Accountable Care Organization Realizing Equity, Access, and Community Health program, or “ACO REACH.” In other words, this Medicare experiment — an experiment in involuntarily shunting Medicare patients into these privately-managed for-profit systems — is going to continue. Which means private equity’s grip on providing Medicare services is only going to continue too. Experts aren’t sure what impact this will have on the quality of care, but they’re sure about one thing: it’s going to reduce the quality of patient care in the pursuit of higher profits. That’s literally how the incentives are structured:
But the program isn’t just being extended. This is a dynamic process, with plenty of opportunities for additional revisions to the program. That’s part of why critics are quick to point out that the government official overseeing the program, the Centers for Medicare & Medicaid Services’ (CMS) Innovation Center, is headed by none other than Liz Fowler. Not only has Fowler worked as the vice president for public policy for Anthem, one of the health care giants participating in the DCE program, but she was literally the Democratic staffer who stripped out the public option from the original Obamacare health care overhaul back in 2009. So the person with the most direct influence over how this program evolves has an extensive track record of doing the industry’s bidding both in and out of government:
But as the following BuzzFeed article from back in January points out, the biggest red flag about the potential that this DCE experiment has to privatize Medicare en mass isn’t the fact that industry shills like Liz Fowler are heading the program. It’s the fact that the original Trump administration plan for the program involved the mass privatization for entire geographic regions of the US under the ‘geo streaming’ program announced by the Trump administration in December of 2020. That part of the program was halted by the Biden administration back in March of 2021. But that was the GOP’s plan: mass Medicare privatizations for entire geographic regions. So when the Biden administration decided to extent the DCE program through 2026, it implicitly left in the place the option to reimplement that ‘geo streaming’ mass privatization provision should the GOP win back the White House in 2024:
“Whether the program ends up as a short-lived experiment or the Trojan horse that leads to the wholesale privatization of Medicare may depend on what the Biden administration does between now and 2024. With one side calling for the program to be shut down and the other calling for it to be expanded, the current plan remains to keep it going as is and see how it goes.”
Yes, The Biden administration’s decision to extend the DCE program in February was actually the compromise position. On one side you had the progressive Democratic caucus that wants to end the program entirely. But on the other side was the original Trump administration plans for the program, which was a dramatic expansion that would push entire geographic regions of the US into this DCE privatized Medicare model. Yep, Trump actually single-handedly put in place a scheme that would have effectively privatized Medicare entirely for regions of the US by now had he won second term in office. So while the Biden administration is extending the DCE program, it’s actually pared back its scope significantly from what the Trump administration had planned for 2022. The mass privatization was supposed to be already underway. Instead, we’re left with an ongoing looming threat of a mass privatization as this experiment is continued through 2026. In other words, a republican win the white House in 2024 means the mass privatization of Medicare is basically assured:
And we don’t have to ask whether or not the private equity-owned entities participating in this program are expecting to see their per-patient profits increase as time goes on. They’re openly telling investors that’s what they’re expecting. Higher profits, but also higher payments from the government compared to other Medicare patients. So if these DCEs are projecting that they’re going to ultimately receive higher per-patient payments from the government, it raises the question of what exactly the purpose of this privatization program is in the first place. Wasn’t reducing government costs the whole point?
Finally, while only 25 percent of the current DCE providers have private equity ownership, keep in mind that there’s absolutely stopping further private equity buyouts in the DCE sector. But beyond that, there’s the reality that the DCE providers that do the best job on behalf of their patients — prioritizing patient outcomes over profits — are the companies that are going to present the most tempting takeover targets for private equity. Because those are going to be the companies with the most profit ‘potential’. Potential in the form of cutting back on patient services:
So as we can see, the privatization of Medicare is indeed happening. More slowly than it would have under a second Trump term, but happening nonetheless. We’ll see if this ongoing stealth privatization scheme ends up becoming an issue in the 2024 presidential elections. Either way, try not to be super shocked if the Medicare system suddenly develops all sorts of innovative new private equity-inspired efficiencies over the next four years. Not necessarily efficiencies in providing better care. But the new efficiencies in maximizing profits should be extraordinary.
Modern capitalism has long had a Ponzi-like feel to it. The seemingly endless need for growth and ever higher asset valuation does indeed have a Ponzi dynamic, after all. So on one level it probably shouldn’t be too surprising to learn that Europe’s largest asset manager, Amundi Asset Management, is publicly warning that the parts of the market are coming to resemble a Ponzi scheme. Specifically, parts of the private equity markets, where private equity’s lack of transparency potentially allows fund management to obscure from investors changes in the valuations of the underlying assets. In other words, if a private equity firm over-pays for one of the company’s it bought, that fact can be effectively hidden from investors. And when you hide bad news from investors in the private equity industry you’re basically encouraging them to invest more. That’s part of the Ponzi-like dynamic Amundi is warning about.
But there’s another very disturbing aspect to this warning that makes potentially sound like prelude to a dot-com-style market meltdown: it appears that part of what is driving this Ponzi-like dynamic is the assumption within the private equity industry that there’s always going to be another private equity firm to buy up their overvalued assets. It’s like a variation of the ‘greater fool’ assumption that has long driven asset bubbles: it’s the ‘great private equity fool’ assumption. And it sounds like this assumption has been driven by the fact that there really has been another private equity ‘greater fool’ willing to pay an even higher price, driving prices ever higher. In other words, these warnings of Ponzi-like behavior in the private equity markets double as a warning about asset bubbles.
Beyond that, private equity firms are increasingly selling assets to themselves. In 2021, $42bn worth of deals involved these kinds of sales.
And as we’ll see in the second except below from last year, these warnings of Ponzi-like behavior in the private equity sector aren’t limited to Ponzi-like asset bubbles. One of the most respected private equity firms in the world, Abraaj, was caught literally operating a Ponzi scheme rooted in fraud. Financial statements were manipulated, loans were taken out to cover the losses, and new investments came in to temporarily fill in the gap.
As we’ll also see, it sounds like the investors in Abraaj had plenty of warnings, including a whistleblower. But those warnings were ignored. And according to the financial journalists who uncovered this story, the industry as a whole was continuing to largely ignore the lessons.
Another factor to keep in mind in this story is the growing role of pension funds as private equity investors. Any quality Ponzi scheme requires dupes who end up holding the bag and we can be pretty confident who those dupes are going to be if pension funds are involved.
And then there’s the possibility that private equity firms will actually use the pension funds of the companies they buy to fuel more purchases. Recall how Alden Capital was doing this exact thing to finance its rapacious buyout of the US local landscape. The opportunities for Ponzi-like behavior abound.
So the next time you read a headline about a giant Ponzi scheme threatening the financial sector, don’t assume that headline is necessarily referring to crypto. And also don’t assume that anything is really being done about it. After all, we’ve been warned. Repeatedly:
““Some parts of private equity look like a pyramid scheme in a way,” Amundi Asset Management’s chief investment officer Vincent Mortier said in a presentation on Wednesday. “You know you can sell [assets] to another private equity firm for 20 or 30 times earnings. That’s why you can talk about a Ponzi. It’s a circular thing.””
There’s always a bigger sucker. That assumption has apparently been driving how the private equity industry has been operating in recent years. And on one level it’s not surprising to learn that the markets are operating under a ‘greater fool’ paradigm. What is surprising is that this ‘greater fool’ dynamic is playing out inside the private equity industry itself. It’s the kind of trend that’s troubling for a number of reasons. But it’s the facts that the industry has been flush with cash, doesn’t have the same transparency requirements as its public counterparts, and can hide losses from investors that makes this warning from Amundi Asset Management especially ominous. Private Equity firms are basically making high risk bets on the assumption that the moment that has propelled the industry thus far will continue indefinitely and another private equity firm will inevitably come along and assume those risks. Which has indeed been happening. But what happens when that stops?
Even worse, it appears that private equity firms aren’t just playing hot potato with each other with these overvalued assets. In 2021, $42 billion worth of deals in were made where they sold portfolio companies to themselves. Nice work if you can get it:
It’s an ominous warning for a global economy that’s already looking rather strained. Especially ominous when you factor in the growing role pension funds have played in this industry. They perfect patsies.
But as the following Axios piece from last fall reminds us, it’s not like we should just be concerned about Ponzi-like activity in this sector. The same lack of transparency and poorly aligned incentives that encourage the industry to mutually inflate asset prices in a in a Ponzi-like manner also act as incentives for actual Ponzi schemes. That’s what the private equity world was reminded up when Abraaj, one of the world’s most respected private equity firms, ended up imploding in an actual Ponzi scheme carried out with falsified statements and convenient loans intended to make the firm look ‘whole’ when reports where sent out to the “limited partner” (LP) investors.
And it gets worse. Because it also turns out that Abraaj’s implosion didn’t come out of nowhere. There were all sorts of red flags, including a whistleblower. But the LPs ignored those red flags, with the kind of disastrous consequences one expects from a Ponzi scheme.
And it gets even worse. Because it’s not just the case that LPs were ignoring a whistleblower trying to warn them about how the firm was stealing their money. The entire tale of Abraaj’s malfeasance was told in a book published by British journalists Simon Clark and Will Louch last year, and the industry has largely ignored the implications of that book, according to Clark and Louch. So when we’re trying to assess the potential impact of Ponzi-like behavior in the private equity industry, the fact that the industry appears to be actively ignoring these red flags is something to keep in mind:
“Naqvi also appears to have been a crook, allegedly stealing money from Abraaj and its investors. He’d fill the holes he created by raising new capital, with fundraising bolstered by falsified valuations. If that failed, he’d surreptitiously borrow money so that Abraaj’s bank accounts looked “full” in quarterly statements sent to LPs.”
A literal Ponzi scheme. That was the scandal that rocked the private equity world last fall when Arif Naqvi was found to have been falsifying valuations and borrowing money to hide holes while he raised more capital. But this wasn’t just a private equity firm getting caught in a Ponzi scheme. This was a highly respected private equity investor who regularly appeared and Davos and peddled his fund as an ethical alternative to the brutalities of capitalism. But beyond that, the scandal highlight the shaky nature of the assumption that investors will be on the lookout for this kind of fraud. The limited partners (LPs) just kept ignoring the red flags. even when a whistleblower was waving them:
Yes, it’s all a big reminder of how much private equity is based on trust. Trust on the part of investors that the managers are handling investor money responsibly. And on the part of the managers that there’s always enough fools out there to cover for their fraud and mistakes. The kind of fraud/trust scheme that could keep itself going indefinitely. Until it can’t and implodes.
All in all, there’s no shortage of questions looming over these warnings. Massive questions like just Ponzi schemes are there current operating in the private equity sector? But perhaps the biggest question is just how intertwined are these Ponzi schemes? Don’t forget the big lesson from 2008: when whole sectors of finance get corrupted simultaneously, the entire system can become a House of Cards.
And then there was the other major lesson from 2008: when the whole system becomes a House of Cards, the expected response is massive bailouts. So try not to be surprised if we learn that the private equity sector really has turned itself into a Ponzi scheme large enough to threaten the entire global economy and on verge of collapse. And also try not to be super shocked when the industry gets bailed out as punishment and we’re all assured that lessons have been learned and we can trust the industry again. Because there’s always another fool. Sometimes a whole planet full of them.
It’s been quite a week for Democrats. There was the historic FBI seizure of classified documents from Donald Trump’s Mar-a-Lago compound, potentially signalling the opening salvo in a long-overdue criminal prosecution for at least one of the crimes committed by the former Rogue in Chief. But that historic event was preceded by a Vote-o-Rama that culminated in the passage of the Inflation Reduction Act in Congress, which promises to take unprecedented steps to address major challenges like climate change. The unprecedented criminal investigation of a criminal ex-president and an unprecedented plan to take major long-term challenges facing the US. It the kind of week that isn’t supposed to happen in the politically broken contemporary US. It was like we got the privilege of living with ‘Bizarro DC’ for a week.
But, of course, there were still plenty of signs of Old DC. For example, as the following pair of articles describe, the push to modify a loophole that’s become symbolic of the overarching power of financial interests ultimately had to be shelved when Arizona Democrat Kyrsten Sinema — one of the two long-standing Democratic holdouts on this legislation along with Senator Joe Manchin — refused to support the bill unless the modification was removed. That “carried interest” loophole basically exists to allow the investment managers at private equity firms and hedge funds to have their compensation taxed at the 20 percent capital gains tax rate instead of the 37 percent top personal income tax rate. A sleazy loophole to allow some of the most overpaid people on the planet pay less in taxes
And that was just one of the private equity industry’s last-minute wins. Under pressure from private equity lobbyists, Senator Sinema also managed to block a change in how the new 15 percent minimum corporate tax was applied: Under the original version of the bill, companies with a “book income” of more than $1 billion have to pay the new 15 percent minimum tax. But what about companies that own other companies? Because that’s basically how the private equity industry work. Well, originally, the small and medium-sized business owned by private equity companies would still have to pay the 15 percent tax as long as they were own by a company that has a combined book income of $1 billion across all the companies they own. In other words, small business owned by giant business couldn’t pretend to actually be small businesses under the original version of the bill. But that had to be tossed from the bill in the end. Small and medium-sized business owned by private equity giants could still avoid paying taxes.
The more things change, the more they stay the same. That’s the big story here. The private equity industry won out on multiple fronts even in the face of what was a genuine historic legislative victory that almost never happens in DC. It’s a reminder that the US won’t every truly be allowed to govern itself until big money can no longer buy legislators:
“On Friday, the private equity and hedge fund industries applauded the development, describing it as a win for small business.”
Yes, the private equity industry touted its victory as a win for small businesses. It’s more than a little rich.
So what exactly what this grand victory for small businesses? Well, the investment managers at the private equity giants that own these small businesses will continue to only have to hold their investments for three years instead of five years in order to continue qualifying for the “carried interest” loophole that allows them to have their incomes taxes at the lower 20 percent capital gains tax rate instead of the 37 percent top personal tax bracket. That’s the big victory for ‘small business’ that Senator Sinema delivered for her financial backers:
And note how even Republicans, including Donald Trump, have campaigned against the “carried interest” loophole. It’s basically the highest-compensate people in the world shouting “Pay us MORE! We are worth it!” It’s the worst impulses from the greediest parasites on the planet manifesting as an iron grip on the democratic processes. Which is reminder that this isn’t just a story about the long-standing gross excesses of the private equity industry and the growing power of that sector over society. It’s also about the long-standing gross excessive power moneyed-interests wield in the US’s broken campaign finance system dominated by corporate cash. Both parties agree the loophole should be closed and yet the industry wins out every time:
Even Bill Ackman — the guy who became the living emblem of financial excess when he pulled off what was arguably the most profitable trade in history in March of 2020 at the height of the pandemic-panic — calls the carried interest loophole a “stain on the tax code”. Because it is a stain. An utterly indefensible loophole that the industry itself only defends by mischaracterizing it as a benefit to ‘small business’:
And as the senior fellow from the Center for American Progress reminds us, it’s not like the loophole was going to be closed under the proposed legislation. They were merely going to increase the mandatory holding period for the private equity fund managers to hold their investments before selling. The carried interest loophole was never really at risk:
And that carried interest loophole preservation was just one of the private equity industry’s wins during this final round of negotiations delivered by Senator Sinema. As the following article describes, the industry got to also tout its big victory for ‘small business’. Specifically, small and medium-sized businesses that happen to be owned by private equity giants:
“The issue stems from how private equity firms work: They typically invest in a portfolio of companies. Under the provision that was the point of contention, if the combined “book income” of companies controlled by the same private equity fund exceeded $1 billion, all of those companies, even if they were small or medium-size, would be liable to pay the new 15 percent tax on the income they reported to their shareholders.”
Yep, the private-equity giants with portfolios exceeding $1 billion denounced proposed 15 percent minimum corporate income tax as an attack on small and medium-sized businesses. That was part of the spin, although in the end it was really the private equity industry’s grip on Senator Sinema that really made gave the industry leverage in these negotiations. In the end, private equity won out and all of those private-equity-owned firms get to continue paying little to no taxes. Because of course. Might still makes right in contemporary America and will continue to do so as long as politicians can be legally bought off with unlimited campaign cash:
But as frustrating as it is to read about the private equity industry once again demonstrating its iron grip on US policy-making, note the caveats from tax experts: a corporate minimum tax is basically already an acknowledgement of policy failure. Corporations will still find ways around these minimum taxes. If you really want to make corporations pay, reverse all the tax breaks that resulted in zero-taxes in the first place. It’s one of the big lessons the US public should probably take from this whole story. There really is no viable substitute for reversing the disastrous 2017 GOP tax cuts:
It’s a reflection of how profoundly broken the US political and economic structures have become over the last generation of increasingly ‘pro-business’ policies. A broken political structure effectively captured by a broken economic structure and passing laws making that economic structure all the more corrupt and bloated. For all the historic fretting about ‘Big Government’, there’s a shocking lack of concern in the American zeitgeist about ‘Bigger Business’ capturing that government. And yet, as we can see, the political battles being fought and lost wouldn’t really make a major difference even if they were ultimately won and the battles that would actually address these fundamental problems are seen as effectively unwinnable and never fought. The more things change, the more they stay the same. At least when it comes to the primacy of wealth and power over democracy in America.
Are we looking at the biggest pyramid scheme ever? That’s the truly disturbing, yet predictable, question raised by the following pair of articles about the major alarms flashing in the financial sector. Specifically, alarms flashing in the private equity sector flush with ever-increasing volumes of cash from pension funds looking for higher returns:
First, we just got a warning in the Wall Street Journal about the brutal losses experienced by public pensions’ private equity investment already recorded for this year. Losses poised to grow in coming months since the current losses also reflect the enormous market gains from 2021. We’re expected to have a better sense of those losses by December and they’re only expected to grow. As the article notes, private equity investments for public pension in the US have grown from $300 billion to $480 billion from 2018–2021 alone. It’s a reflection of how pensions really have been the relative late-comers to the private equity boom that’s been going on for years. A boom that some experts see coming to an end given the flood of new market into the marketplace in recent years. In other, too much money has been chasing the relatively high returns private equity has traditionally yielded and now those returns aren’t so high any more.
That brings us to the second alarm flashing in this market: recall how, back in June, the chief investment officer (CIO) of French asset management giant Amundi Asset Management told a conference that some parts of the private equity industry “look like a pyramid scheme in a way”. Those comments were echoed last week by the CIO of Danish public pension giant ATP, who observed that over 80 percent of the sales of companies held by the private equity funds that ATP has invested in were either to another private equity fund or were “continuation fund” deals, where a private equity group passes it between two different funds that it controls. In other words, he was observing the industry behaving like a pyramid scheme, and was quite explicit about it, commenting that “This is not good business, right? This is the start of, potentially, I’m saying ‘potentially’, a pyramid scheme. Everybody’s selling to each other . . . Banks are lending against it. These are the concerns I’ve been sharing.”
Those are the twin alarms blaring across this industry. The kind of warning that could signal municipal financial crises across the West. Losses for public pensions necessitate tax hikes or something to cover the gaps, after all. And we still don’t know yet just how big these losses are ultimately going to be. But what is becoming increasingly clear is that the private equity industry’s multi-decade-long boom is increasingly unsustainable and pension funds are slated to play the ‘duped bag holder’ role as this unsustainable story plays itself out:
“Public pensions reported returning a median minus 7.9% for the fiscal year ended June 30, their worst losses since 2009, according to data from Wilshire Trust Universe Comparison Service published in The Wall Street Journal last month.”
A ‑7.9% annualized median return for the fiscal year. The worst since 2009 for public pension funds. And 2009 obviously was an exceptionally awful year for investments. And these losses are apparently likely understated and poised to grow in coming quarters:
And this is all happening following a period where public pension funds have increasingly been piling into the private equity sector. State and local pensions in the US saw their investments in private equity jump from $300 billion to $480 billion between 2018 and 2021. This is an important factor to keep in mind in this story because of the illiquid nature of private equity investments, where investors are typically making investments that aren’t expected to pay out for at least a decade. In other words, these losses are being experienced this year are likely on relatively recent investments that are still years away from being liquid:
So what can we expect pension funds to do in response to this situation? Well, if the following Financial Times article from last week is any indication of what to expect, we’ll probably experience even more staggering losses in coming years...to the benefit of the rest of the private-equity investor class. Yes, that’s the truly dire warning we’ve been getting from multiple Chief Investment Officers at major European asset management firms. First, back in June, Amundi Asset Management’s CIO Vincent Mortier commented that some parts of the private equity industry “look like a pyramid scheme in a way”. last week, the CIO of the largest Danish public pension manager echoed those comments when he observed that more than 80 per cent of the sales of portfolio companies by the private equity funds that ATP has invested in were either to another buyout group or were “continuation” deals, where a private equity group passes the asset between two different funds it controls. More than 80 percent of the sales from funds ATP invested in have been these kind of deals, where one private equity investor gets to secure their investment returns at the expense of another investor who is now taking on those asset risks. That really is pyramid scheme behavior.
And based on the people making these observations it sounds like it’s pyramid scheme behavior where the public pensions are the ones typically purchasing these assets for other private equity funds and ultimately left holding the bag. That’s part of the context of the warnings about public pensions’ flailing private equity funds: part of the reasons those public pensions private equity assets are flailing is due to the general market turmoil. But the other part of the story is how the public pension are being used to shield the rest of the private equity investors from that turmoil. Just like a pyramid scheme but apparently legal:
“Mikkel Svenstrup, chief investment officer at ATP, said he was concerned because last year more than 80 per cent of the sales of portfolio companies by the private equity funds that ATP has invested in were either to another buyout group or were “continuation fund” deals, where a private equity group passes it between two different funds that it controls.”
It’s quite a warning to be issued by the chief investment officer of a giant Danish public pension fund ATP: more than 80% of the sales of the companies held by the funds ATP has invested in are sales between funds. That’s shady. The kind of shady activity that one would associate with with a pyramid scheme. The kind of pyramid scheme that has the public pension funds playing the role of the final marks left holding the bag. And the CIO of ATP isn’t the only person making these observation. He was echoing comment made by the CIO of French asset management giant Amundi Asset Management: This market is behaving like a pyramid scheme:
Those are the twin warning signs we’re seeing flashing red in this marketplace: pension funds are experiencing major losses that have yet to be recorded and poised to grow. And the broader private equity industry is treating the pension funds like the bag-holders in a pyramid scheme.
Well, and then there’s the third warning sign implicit in this story that that we are living in a civilian run by and for powerful interests who view the public as resources to be manipulated, exploited, and ultimately consumed and tossed away as refuse. It’s the kind of warning that manifests in all sorts of awful ways involving unchecked systemic abuses of power. And here it is again.
Setting up pension funds to be the ‘bag holders’ for the private equity industry might seem like a win-win situation for the industry, at least the parts of the industry who actually count in this world. But treating pension funds like financial fall guys isn’t consequence free as we were reminded of last week by the UK. Consequences that include potentially triggering a ‘Lehman moment’. That’s almost what happened last week. A Lehman moment for the UK bond markets. And a market illiquidity moment that almost spilled over into the rest of the markets were it not for the emergency gilt buying by the Bank of England (BOE), a reversal of the BOE’s policy of selling gilts to reduce inflation. Something catastrophic almost happened. And still might. The underlying stresses that triggered the near meltdown are still very much in place. Specifically, the stresses on the bond markets caused by the budget-busting tax cuts for the rich just passed by the Truss government. Rapidly rising interest rates in response to all the new UK debt set off a collateral call in the ‘Liability Driven Investment’ {LDI} funds used by a lot of pension funds as the rising interest rates erode the value of the gilts acting as collateral. Pension funds short on cash were forced to raise cash fast and their gilts were one of the most liquid assets around. The ‘doom loop’ was formed: gilts were being sold to cover the falling value of the gilts.
The was another fact that helped put the doom loop in motion: As we’re going to see in the second article excerpt below, when the pension funds went to their sponsoring parent companies asking for emergency cash they were turned down. The markets were ready to the let the bond markets crash.
And as we’re going to see, there’s a grimly fascinating private equity angle to the melt down: time was of the essence when the collateral call on the pension fund’s LDI investments hit as a result of the rising interest rates. And that meant the private equity assets held by the pension funds were of little use. They’re too illiquid. You can’t sell shares of private equity investments on the open markets like you can with stocks and bonds. That’s part of what fueled the selloff in gilts: so much of pension funds’ assets are tied up in illiquid private equity assets that gilts were one of the few liquid assets left when the collateral calls hit. So while this wasn’t a crisis directly in the private equity markets, it was indeed tied into the broader story of the pension fund industry’s growing reliance on private equity over the past decade. Interestingly, it sounds like these LDI investments have also been an area large growth for pension funds over the last decade. So the two areas that pension funds have been heavily doubling and tripling down on over the last decade — private equity and LDI investments — just helped produce a ‘doom loop’ in the UK’s bond markets last week.
But we can’t forget that it was the irresponsible Tory tax cuts that actually set it all in motion. Tax cuts the Truss government has indicated it has no plans on clawing back. No, instead the plan to deal with the turmoil in the UK bond markets resulting from the glut of new tax-cut-caused debt is to call for all government agencies to slash their budgets through 2025. Also, government-backed pension funds won’t get the inflation ‘uprating’ that was planned for next year. So the tax cuts for the rich will stay in place while pensioners will effectively get cuts. Because of course. It’s an ominous start for the Truss government. Or as Simon Hoare, Tory MP for North Dorset, tweeted out “These are not circumstances beyond the control of Govt/Treasury. They were authored there. This inept madness cannot go on.”:
“The central bank warned of a “material risk to UK financial stability” from turmoil in the gilts market sparked by chancellor Kwasi Kwarteng’s tax cuts and borrowing plan last week.”
Oops. It appears the new UK Conservative government’s extreme tax cuts for the rich almost broke the UK’s financial markets. Or rather, the tax cuts did actually break the markets very briefly before the BOE stepped in right when it was looking like the country was facing a ‘Lehman Moment’ in the gilts market. A moment precipitated by pension funds running out of collateral and being forced to sell off their gilts following the historic drop in the pound. A historic drop in the pound that was, of course, triggered by the fiscal crisis created by the tax cuts:
To get a sense of the scope of the potential crisis that was developing in the pension markets, note how around 90% of the UK’s pension funds could have been forced into selling gilts had the BOE neglected to intervened:
And note the response from treasury: don’t worry, we’re going to be imposing such massive budget cuts over the next two years that the fiscal crisis created by the tax cuts will go away. Big savings from things like not ‘uprating’ pension plans next year in line with inflation. Yes, the plan to deal with the fiscal crisis that is deeply intertwined with inflation fears triggered by the extreme tax cuts for the rich is to freeze pensions in the face of the inflation. That’s the plan and they’re sticking with it. At least until the next crisis triggered by the tax cuts:
So did the UK at least resolve the immediate crisis? The Truss government seems to think so but her fellow conservatives don’t appear to share her confidence. Confidence in her response or confidence in her government in general it seems. As one Tory MP put it, “These are not circumstances beyond the control of Govt/Treasury. They were authored there. This inept madness cannot go on”:
And if it seems like this was just a scare in the UK bond markets, don’t assume a ‘Lehman event’ in the bond market is going to stay there. Fears of contagion remain and understandably so after we learn that a bunch of these pension funds’ parent entities already turned down pleas for more funds which is part of what triggered the massive selloff in the first place:
“Some funds crashed out of derivative positions because they could not raise the money in time, but are trying to put those hedges back on so they are not exposed to further volatile moves, the people said. The cash demands from liability-driven investment (LDI) funds that manage the derivatives prompted a crisis that threatened many of Britain’s biggest pension funds. Some fear it could spread wider contagion.”
Wider contagion. Not the words you want hear following a near Lehman-like event. But that’s the reality of what happened and almost happened. It was a genuine financial disaster and a narrowly averted mega-disaster. Less than a week ago. Had the BOE not stepped in the mega-disaster was going to happen. As this report describes, there was no one else. When pension funds went to their parent companies and explained the situation and why the pension funds needed emergency cash, they were getting turned down. The “doom loop” markets dynamics needed to let in all crash were in place:
And notice this interesting detail in relation to the pension funds’ growing reliance on private equity: one of the asset classes the pension funds couldn’t sell off when the cash crunch hit was their private equity holdings. The relatively illiquid private investments were of no use during a market emergency. You can’t just sell a company in a few hours. You can sell gilts and other types of bonds, hence the precipitous drop in the price of gilts and corresponding rise in interest rates the triggered the margin calls and set in motion:
What’s going to happen to those private equity investments during the next crisis. Nothing, again, presumably. It’s too illiquid. That’s not changing. Just as the tax cuts for the rich that created the bond market instability in the first place isn’t changing either. The underlying dynamic that set this doom loop in motion are all still there. It’s the BOE holding this together. For now. We’ll see how willing the BOE is to intervene during the next ‘Lehman moment’. But we can be pretty confident the next moment is coming. This inept madness can go on for a lot longer than we might like to think.
Did the Bank of England (BoE) manage to pull the UK financial markets back from financial brink following the “inept madness” of the Trust administration’s tax cut fiasco? We’re about to find out with the lifting of the BoE’s emergency intervention in the UK bond markets. The last emergency bond purchase was Friday. Monday is a big day for the UK.
And as we’re going to see, of the £65bn the BoE allocated for the emergency spending, only £19bn was actually spent. So this has been a rather tepid emergency intervention that just ended. And as the following article except describes, the lifting of the emergency intervention is coming at the same time there appears to be a growing consensus that the Truss government’s reversals of it radical supply-side policies hasn’t gone far enough. And that’s all why the UK bond market appears to be getting ready for a new round of emergencies:
“A senior executive with a large pension fund, who did not wish to be named, said the BoE’s gamble, by not extending its support programme, “has not paid off”.”
The LDI time-bomb is still exploding. Just more slowly thanks to the BoE’s emergency intervention in the gilts markets. Intervention that ended on Friday, followed by major swings in 30-year yields, a clear that that the market has yet to settle. And when we see that only £19bn of the £65bn allocated for this emergency intervention, it’s becoming even more clear that the BoE is highly inclined to give as little emergency support as possible, even if doing so runs the risk of extending and exacerbating the crisis. The current UK government seems to be biased towards crisis:
So with the BoE signaling that it’s going to be doing as little as possible to stabilize the markets, risking further destabilization, it’s worth noting the investment management community’s to the crisis: we’re sticking with LDI, it’s still the best option available:
“But Wolfson and his team ultimately rejected the plan. “If you only took historical data, it looked pretty robust,” said Wolfson. “But the great lesson from the financial crisis is that you can’t look to the past as a foolproof way of predicting the future. In the end, we didn’t care what the spreadsheets said: we didn’t like the smell of it, so we decided not to do it.””
As Next chief executive Lord Simon Wolfson warned the BoE back in 2017, while the LDI investment scheme promoted by by investment consultants was being sold as a safe stress-free approach to investing, that’s only true as long as rates stayed at the historic lows. It’s the kind of condition turned LDI’s into a time bomb. Rising rates was just a matter of time:
And note how long LDI investments had been embraced by UK pensions when Wolfson made this observation in 2017: it started with an accounting rule change back in 2000 that forced pension funds to better finance their long-term liabilities. These new rules — which pushed pensions to give greater weight to fixed interest investments like bonds — also ended up increasing the risks associated with rising inflation or falling interest. LDI was created to address these new risks. Specifically, it was created by Dawid Konotey-Ahulu, then a managing director at Merrill Lynch in London. And as we can see, Konotey-Ahulu remains highly confident that LDI’s are still a great strategy for pension funds. As far as Konotey-Ahulu sees it, the problems are really just with the pooled LDI’s that are used by smaller pension funds where liquidity can become more complicated during a crisis. In other words, this LDI-driven crisis isn’t a big enough crisis to warrant a new strategy. LDI forever! Or as Edi Truell, a former chair of the London Pension Fund Authority, put it, “Investment consultants love LDI...It’s superbly complex so no one understands it and therefore they can look smart and earn a fee. To about 99 per cent of trustees it’s totally unclear”:
Also note the kind of financial alchemy these LDI investments were performing for pension fund: LDIs use derivative let pension funds have exposure to the gilts market while providing protection against rising interest rates moves...unless those rates rise too fast, at which point the “doom loop” we all witnessed will transpire. In other words: the LDI markets will smooth out the markets against relatively small disruptions but actually amplify and exacerbate those disruptions if those disruptions are too large. That’s the time bomb. The entirely foreseeable time bomb that was just a matter of time:
And yet, despite the foreseeable crisis that is playing out, asset managers don’t seem to be scared off from LDI schemes. Instead, the plan appears to be to muddle through the current crisis by raising emergency funds to deal with collateral calls and just stick with the LDI strategy. It’s seen as the least worst option:
And that apparent resolve to stick with the LDI strategy has other asking whether or not the current crisis has scared the markets enough to actually questions the same erroneous assumptions that that created this crisis in the first. Along with questions about whether or not we can expect similar crises elsewhere. It’s not like the UK is the only country facing rising rates and underfunded pensions:
Yes, it does appear that there is a shortage of soul-searching in the industry. Although with the crisis still not over and at risk of flaring up again there still may be plenty of additional time and reason for soul-searching. But as the following article excerpt about the origins of the LDI strategy makes clear, this is going to be a hard habit to kick. LDI was first devised after a regulatory change in the year 2000 forced UK pensions to better prepare for long-term liabilities. And given the historically low interest rates of the past two decades this is been a strategy that has been seen as both necessary (to account for the low rates) and successfully (due to the persistent low rates).
And LDI was a strategy that survived the 2008 financial crisis, although, as the article notes, there were moments were it wasn’t clear if banking giants like Goldman Sachs that were on the other side of the derivatives at the core of the LDI strategy were actually solvent. It’s a reminder that, while the LDI investment strategy has an obvious systemic vulnerability to the kind of interest rate shock that just transpired in the UK bond markets, that’s far from the LDI strategy’s only systemic vulnerability:
“But the strategy worked. In August this year, the WHSmith pension fund was sold to Standard Life in a £1bn bulk purchase annuity deal. The retirement income of the members is now assured.”
It’s an apparent LDI success story. The WHSmith pension fund has been using since 2005, until August of this year, when the fund was sold to Standard Life. And as we can see, WHSmith is now being touted as an LDI success story.
Of course, this success story was sold to an insurance giant a month before the current market tumult and didn’t actually have to face the same stress test the rest of the LDI market just failed. And while the LDI funds didn’t blow up during the 2008 financial crisis, the crisis nonetheless demonstrated some of their vulnerabilities, like the risk of the counterparties for all these derivatives going under. LDI, being a derivatives-heavy investment strategy, is deeply vulnerable to the kind of systemic chain-reactions that characterized the 2008 crisis. A crisis that started as a liquidity crisis in the derivatives market tied to mortgage-backed securities and spread from there. It’s a key point to keep in mind with this story: just because we’re now seeing the systemic vulnerabilities in the LDI market in the face of spiking interest rates doesn’t mean that’s the only systemic vulnerability at risk with LDI schemes. Anything that risks the health of those derivatives counterparties like Goldman Sachs risks blowing up the LDI market too.
But it’s not hard to see why the investment management industry and the companies with pensions under management are hesitant to drop LDI strategies: LDI allowed underfunded pension funds to fulfill their new regulatory burdens of adequately accounting for their long-term liabilities. LDI was seemingly financial magic. A gamble that operated like magic as long as the gamble didn’t go wrong. And no one wants to give up magic:
Finally, also note the other bit of common wisdom we’re seeing emerge from this crisis: the idea that the problem was really just with pooled LDI funds created by smaller pension funds. It’s the kind of lesson that suggests the pension funds that end up dropping the LDI strategy as a result of this experience are going to be the smaller pension funds:
So what are the smaller pension funds going to do instead? We’ll see, but as we’ve seen, the investment management industry appears to be broadly convinced that the LDI strategy is still the best strategy despite the now-obvious risks. There don’t appear to be better options. At least not better options of financial alchemical nature. But who knows what the investment management industry will come up with next.
But there is one obvious solution for the pension funds large and small that doesn’t rely on financial magic and luck: better funding these pension in the first place. Or cutting them. So yeah, there’s two obvious options, the latter of which will presumably be much more obvious for the investors and company boards responsible for making these decisions.
It just keeps getting worse. It like the meta-theme for a broken modern America. Chronic problems that require collective action seem to never get solved and only grow worse. So it should come as little surprise that the ongoing childcare crisis in the US is on track to get worse. A lot worse in two years after the emergency pandemic childcare federal support expired. As as of now, nothing substantive looks likely to fix the problem.
Not that something substantive wasn’t proposed. The Build Back Better bill that couldn’t quite muster 50 votes in the Democratically-controlled Senate did actually include a large federal solution to the US’s childcare crises. A crises of accessibility and affordability that got a lot worse during the pandemic and never really recovered. And as we’re going to see, one of the groups lobbying to strip out those child care provisions from Build Back Better was none other than a lobbying group for the growing private-equity-owned sector of childcare. Childcare may be in crisis in general in the US, but not the private-equity-owned national chains which have seen growing profits, and fees, in recent. And they don’t want to see those profits hampered by the government.
At the same time, it’s clear that private-equity isn’t part of the solution, with private-equity-owned chains often not accepting lower-income students even when they are subsidized. At the same time, private-equity opposes the proposals to fix one of the other major components of the childcare industry’s crisis: a growing shortage of employees, driven heavily by stubbornly low wages that don’t seem to rise even when other industries are seem healthy wage growth. As a result, childcare providers are increasingly losing employees to fast-food chains are other employers who can pay more and provide benefits like health insurance. So private-equity won’t be part of a private-sector solution but instead exacerbates the problem, at the same time works to block public-sector solutions because those solutions might limit private-equity’s ability make growing profits by providing more and more expensive childcare to the ‘haves’ in the US’s increasingly ‘haves and have nots’ childcare economy. Because of course:
“Recent employment data suggests the lack of accessible child care is holding back the economic recovery. Senate Majority Leader Chuck Schumer went so far in August as to say he believes “the number 1 or number 2 reason in the whole country we are short of labor is we don’t have adequate child care.””
Like so many of the festering crises in American, the childcare industry’s crisis isn’t just a crisis for all the families finding themselves unable to find affordable childcare. It’s a macroeconomic crisis too. A crisis that existed well before the COVID pandemic but only got worse and never recovered:
And like so many of the festering crises in American, it’s a crisis that hits the poor and minorities the hardest, as the the recent drop in labor force participation by Black women reminds us. While it may not be clear what exactly is driving that trend, it’s pretty obvious the childcare crisis is playing a role. How could it not be?
And despite this massive and growing supply/demand imbalance for childcare industry workers, the median wage in the industry was a paltry $13.22 an hour. Inflation-adjusted wages actually dropped between 2012 and 2019. That’s despite the steadily rising prices for parents and despite the generally rising wages in other industries in recent years. It’s a reflection of how broken this industry is despite the obvious solutions. Suppressed wages are driving a worker shortage but the industry refuses to budge:
So why isn’t the industry raising wages? Well, in part because that would likely come with price hikes, pushing more and more families out of the market. Wages need to rise without prices rises. Because childcare isn’t a luxury for millions of households. It’s a necessity for the parents (or single parent) to be able to go to work and earn an income. It’s an example of house the childcare crisis in the US parallel’s the country’s healthcare crisis: if the market childcare market, like healthcare market, breaks, it breaks the rest of the economy. You can’t allow childcare to become as luxury for the wealthy. And yet, left to market dynamics, that’s exactly what we can expect to happen. Families below some income threshold simply won’t be offered childcare they can afford, breaking the labor market. Government subsidies and regulations are the only realistic options because regular market dynamics can’t work:
It’s also going to be increasingly important to keep in mind that crisis is poised to explode in about two years when the federal government’s pandemic child care relief expires. And the proposals for guaranteed affordable child care in Biden’s Build Back Better bill never came to be thanks to Joe Manchin’s to the overall bill. As a result, a childcare crisis is scheduled to explode three months before the 2024 election:
And that lack of a political solution is made all the more remarkable by the fact that this is one of those issues where Democrats and Republicans agree. At least Democrat and Republican voters. But the only political options for which there appears to be bipartisan support in Congress are limited to relatively tepid options like expanding the Child Care Development Block Grant (CCDBG), which is targeted only at low income families and does nothing about the poverty wages being paid by the industry:
And as the following NY Times article describes, the CCDBG has a particularly influential fan in this debate: private-equity. In particular, the lobbying consortium set up by the growing number of private-equity-owned childcare chains. Extremely profitable childcare chains that appear to have achieved these growing profits by focusing on upper-middle-class families and charging much higher fees than the smaller independent providers who tend to provide childcare for lower-income families. But this consortium lobby wasn’t just in favor of expanding the CCDBG. It was also extremely opposed to the much larger childcare provisions in the original Build Back Better package that ultimately never passed. Especially the provisions like providing a livable wage or other provisions that might put a damper on the industry’s profits. Profits that are often coming at the expense of the smaller independent operators that are often the only ones willing to take on larger or lower-income families. Many private-equity-owned childcare firms charge so much that they don’t even accept children on state and federal subsidies because those are enough. That’s all part of the ongoing and growing crisis in US childcare: private-equity is finding it an extremely profitable crisis. And the longer this goes, the profitable it’s going to get:
“Millions of American families are coping with a child care shortage brought on by the coronavirus pandemic. But one end of the business is thriving: national chains, some charging silver-spoon prices.”
It’s an industry in crisis. But not the entire industry. Private-equity owned child care businesses are growing and thriving. Thriving, for a profit perspective. Not so much thriving in terms of fulfilling the US’s childcare needs, but rather thriving at the expense of the rest of the industry. And with private-equity focusing on expensive child care targeting higher-income neighborhoods, we have a recipe for a “haves and have-nots” childcare sector. Where only the wealthy get to have childcare:
And notice how even the private-equity employees often don’t really get significantly higher wage. But thanks to their scale, they can offer some basic benefits like health insurance. It’s a reminder that the $13 an wage paid to the rest of the smaller independent operators in the industry often doesn’t come with health insurance either, which is presumably part of the reason the independent operators are losing so many workers to places like fast-food chains too:
Adding to the “haves and have nots” dynamic is the fact that many private-equity-own childcare chains charge so much that they won’t even accept students on federal and state subsidies because the subsidies aren’t enough:
So with the private-equity-owned childcare industry pointing its finger at a lack of federal and state subsidies, it would seem like the large federal subsidies in the proposed Build Back Better package. But the private-equity lobby ‘reacted skeptically’ to the idea of subsidies that potentially helped middle-class families too. But it was parts of package that potentially limited profits and the ability to raise to tuition that was obviously the source of private-equity’s opposition. The government intervention required to really meaningfully fix this industry and make affordable childcare something accessible to all parents required both government subsidies and scaling back some of the profits, which made it a solution the industry won’t accept. Keeping childcare a cash cow profit center for private-equity’s investors is the top priority:
So what about the Child Care and Development Block Grant (CCDBG) proposal that’s pitched as some sort of bipartisan compromise? Well, it’s about 1 percent the size of the proposals in Build Back Better. And that’s an example of what the private-equity consortium lobby put forward as a solution it could get behind. It’s a non-solution-solution that speaks volumes about how much interest there actually is in fixing the problem:
We’ll see if that bipartisan solution of expanding the CCDBG grants even happens at all. It’s kind of hard to imagine anything bipartisan passing in this political climate.
But as we saw, ‘the market’ isn’t going to provide the solution here. The warping of the marketplace by private-equity is that market solution. A solution to more profits. Same solution as always. If we want a different solution government is going to have to do it. And as we also saw, this is indeed overwhelming a bipartisan issue, at least from the voters’ perspective who want to see government do something. As a national crisis impacting millions of households across the political spectrum there really should be the kind of political will to find a real comprehensive solution.
And yet we have to admit that ‘special interest’ finds a way in DC. And few special interests are more special than a private-equity lobbying consortium. So should we expect so solutions ever? Not necessarily. Some solutions will be allowed. The problem is they are going to be solutions the ensure private-equity continues to make hefty and growing profits for the foreseeable future. Because prioritizing special interests is more or less the US’s meta-solution and has been for quite some time. It’s one of private-equity’s biggest edges. Prioritizing special interesting is largely how the US guides itself into the future at this point. Literally ‘protecting the future’ in the case of the childcare industry. Of all the chronic problems facing the US, the grip of special interests on DC is probably the longest and most ‘meta’. Which has a lot to do with why all the other chronic problems facing the US seem to just keeps getting worse. Except for the chronic problem of excessive profits by powerful special interests. Those generally seem to be getting better, at least from private-equity’s very special perspective.
We know who did and why. Those are no longer mysteries in the assassination of UnitedHealthcare CEO Brian Thompson. We also have a pretty good answer as to whether or not the public at large would sympathize with the young assassin and his motives. The shooter, Luigi Mangione, is basically an American folk hero at this point. The big mystery at this point is whether or not the US is in store for a wave of copycat killings. Copycat healthcare killings, in particular. Because as the following set of articles remind us, it’s not just that the state of the US healthcare sector is so bad that it potentially drove Mangione to kill a CEO as part of some sort of social justice crusade. The state of US healthcare is poised to get much worse. And fast.
That’s the warning we’re getting from experts regarding the likely fate of the millions of Medicare enrollees. Enrollees who might be part of a government run healthcare program today but could easily find themselves switched to a privately run for-profit Medicare alternative plan tomorrow. Or maybe the switch already happened and nobody told them. It’s already that bad.
The crux of the issue has to do with a key difference in how Medicare operates compared to the privately managed “Medicare Advantage” alternatives. While Medicare basically covers what needs to be covered for a patient, the Medicare Advantage plans operate on a model where they receive a fixed payment per patient and make their profits based on providing less services than the costs of those payments. In other words, the Medicare Advantage providers maximize profits by minimizing care. It’s that simple. And as we should expect, those keen on cutting government spending are seeing the transfer of as many Medicare patients onto Medicare Advantage as possible. Including Dr Mehmet Oz, the person tapped by Donald Trump to be the next head of the Centers for Medicare and Medicaid Services. As we’re going to see, not only did Oz proposed expanding Medicare Advantage back in 2022 when he was running for the US Senate, but he actually proposed transferring all Medicare enrollees onto Medicare Advantage plans back in 2020. That’s the guy likely to be managing Medicare under a second Trump term.
But the concerns about Oz’s qualifications aren’t limited to concerns over the impact his Medicare Advantage plans might have for American seniors. There’s also conflict of interest concerns over the fact that Oz owns around $550,000 in UnitedHealth stock and UnitedHealth happens to be one of the largest players in the Medicare Advantage market. Yes, that’s another angle to the UnitedHealth assassination story: UnitedHealth isn’t just the largest health insurer in the US. UnitedHealth is also poised to see its market share grow significantly as this Medicare privatization trend plays out.
And, as we probably should expect, this isn’t a purely partisan issue. We we’ve seen, it turns out the Biden administration has been turbo charging a kind of stealth Medicare privatization scheme initially launched under the first Trump administration: Under a system launched in 2019, companies are tapped to serve as “direct contracting entities” (DCEs) that are allowed to offer benefits — like gym memberships — beyond tradition Medicare coverage. The catch is they just receive a fixed payment from the government per patient, meaning this is basically the same Medicare Advantage, where the same for-profit incentives exist to minimize the amount of care provided. It’s just a different name. Then, in April of 2021, the Biden administration double down on this program, selecting 53 companies to serve as DCEs, and granted them an incredible new ability: the ability to switch patients out of Medicare onto these new DCEs without their consent.
And as we also saw, while the Biden administration did strip out one of the more troubling parts of the original Trump plan, there’s going to be nothing preventing a second Trump administration from putting it back in place: the policy of mass enrolling Medicare patients into these DCEs based on region. Yes, every in selected regions were to be enrolled in these DCE plans without their consent under the original plan. It really was a the complete privatization of Medicare. A mass stealth privatization, set to take place one region of the US at a time. What are the odds Dr Oz doesn’t put those location-based mass enrollment policies back in place?
That’s the horrific stealth trend already playing out in the Medicare sector. A trend that is almost guaranteed to explode under the ‘Dr Oz’ era of Medicare. But as we’re also going to see, there’s an additional dark twist to this story: while a large number of these DCEs are healthcare behemoths like UnitedHealth, the private-equity industry has also been aggressively moving into this space. And as we’ve seen, if there’s one thing we can be confident of when the private-equity industry moves into a sector it’s that the quality of services will decline, likely precipitously. It’s a business model based on leverage debt and cutting costs as much as possible, after all. So if you though UnitedHealth was a merciless entity with its life-and-death for-profit powers, get ready for private-equity.
That’s all part of the grim context of the UnitedHealth assassination story: we can be confident the shooter isn’t going to be shooting anyone else anytime soon. But when it comes to the question of whether or not we should expect copycat killings now that ‘the cat is out of the bag’ when it comes to the targeting of healthcare CEOs, it seems like the big question is less whether or not we’re going to see more shootings of this nature and more a question of whether or not the next shooter is a retiree forced off their Medicare:
“Privatization is deadly without adequate consumer protections.”
Privatization kills. At least when it’s the privatization of services with life and death consequences attached. It’s a lesson Americans have learned in one sector of the economy after another in recent decades but no sector makes this clearer than health care. And while it’s unclear if Luigi Mangione was at all animated over anger over the privatization of Medicare, it’s Medicare that is currently facing the greatest risk of a new round of mass privatization. If COVID didn’t kill off grandma and grandpa, the profit-motive should do the trick this time. We don’t yet know how this process is going to play out under the Trump administration. But we know it’s going to happen. And people are going to die as a result. With for-profit health care investors making more and more money as a result. That’s the social powderkeg still sitting there after UnitedHealth shooting. A growing powderkeg waiting for the right spark:
And that growing socioeconomic powderkeg brings us to Donald Trump’s pro-Medicare-privatization pick to lead the Centers for Medicare and Medicaid Services (CMS): Dr Oz. Not only did Oz call for expanding the privatized Medicare Advantage plans during his Senate run back in 2022, but he called for moving ALL seniors from Medicare to Medicare Advantage back in 2020. And now he’s set to manage Medicare.
It also appears Dr Oz’s stock ownership has created some concerns about a conflict of interest as this Medicare privatization process plays out. Because it turns out that, as of his 2022 senate run, Oz owned more thant $550,000 in UnitedHealth stock. And UnitedHealth happens to be the largest private insurer in Medicare Advantage:
“The Democrats referred to a 2020 opinion piece that Oz co-wrote calling for putting all Americans into Medicare Advantage, effectively replacing the traditional Medicare program in which the government directly insures Americans 65 and older in tandem with private insurance plans.”
Is Dr Oz still an proponent of moving all seniors onto Medicare Advantage? Either way, it seems highly likely he’s going to take steps to expand Medicare Advantage like he proposed in 2022. Much to the benefit of UnitedHealth and the other major players in this space. And yes, UnitedHealth is currently facing investigations for antitrust violations as well as aggressively upcoding Medicare Advantage enrollees to secure higher payments. But that’s not the kind of thing that’s going to prevent the company from making hundreds of billions of dollars more in profit as the Medicare Advantage expansions play out. Which, again, is part of the context of the Luigi Mangione plot: companies like UnitedHealth really can operate with de facto impunity. Sure, maybe there’s a fine here and there. But that’s just the cost of doing business. A wildly profitable business, where the less healthcare delivered the higher the profits:
And as the following Jacobin piece from 2022 reminds us, the coming privatization of Medicare isn’t a process that’s going to suddenly start under a second Trump term. It’s already started under the Biden administration, with patients sometimes getting switched to Medicare Advantage plans without their consent. So while the forced move of everyone off of Medicare onto Medicare Advantage plans may not happen all at once, don’t be surprise to find out it eventually happens slowly, without consent, and without everyone realizing what happened. And with UnitedHealth as one of the biggest players in this DCE market, also try not to be surprised to discover that UnitedHealth was one of the biggest beneficiaries of this ongoing stealth privatization scheme:
“In April last year, the Biden administration contracted with fifty-three third-party companies to mandate privatized health care plans through Medicare. The resulting health care options are effectively Medicare Advantage plans, or private coverage offered through the national health insurance program for seniors and people with disabilities — but with one wrinkle: Patients are being assigned to these new plans without their consent.”
That’s quite a wrinkle: patients are getting switched to these private plans without their consent. That’s apparently legal now after the Biden administration contracted with 53 third-party companies to manage these plans. Which are effectively Medicare Advantage plans even if they aren’t technically called that. It’s all part of a process that was started under Trump’s first term but got a boost under Biden. The trend is clear: Medicare is another Wall Street profit-center. Profits that can only realistically be achieved through the withholding of as much care as possible:
And as we should expect, it’s private-equity, the sector notorious for utterly ruthless profit-at-all-costs business models, playing a major role in this new “direct contracting entities” privatized Medicare market. It’s not a mystery regarding what to expect. Everyone knows what’s going to happen. Everyone, except maybe the patients who were unwittingly shifted to these new plans:
And finally, of course, we find the health insurance giants like UnitedHealth are also major players in this new DCE market, which has raised further conflict of interest concerns given the fact that this DCE market is being led by the Centers for Medicare & Medicaid Services’ (CMS) Innovation Center, headed under Biden by Liz Fowler, someone apparently widely seen as a health insurance industry crony. Yes, Fowler is presumably going to be replaced by Trump. And presumably with someone even more corrupt:
It’s hard to imagine the healthcare sector isn’t going to be getting everything it possible could want from a Trump administration, and then some. It’s an awful situation that’s only getting worse. An awful, worsening, life and death situation that’s going to make a few people A LOT of money. Not a great status quo when it comes to copycat revenge assassinations.
It’s starts with the mass firings. But it’s not ending there. The evisceration of the US federal government isn’t just about Donald Trump inflicting his vengeance on the federal bureaucracy. Privatization is the end goal. Privatization and massive profits.
It’s already happening. At least the privatization chatter has already begun. In some cases, like the Federal Aviation Administration (FAA), the privatization chatter has come in the form of Elon Musk lending some of his SpaceX employees to the agency. The SpaceX employees are now serving as senior FAA advisors. At the same time, Musk’s Department of Government Efficiency (DOGE) has engaged in the same kind of firing spree that’s impacted the rest of the federal government. Firings that have reportedly raised a number of safety issues. Like layoffs from the legal teams tasked with keeping pilots of with criminal records or substance abuse histories out of the cockpit. And while we haven’t hard the Trump administration explicitly announce plans to FAA yet, keep in mind that Trump did announce those FAA privatization plans back in June of 2017 during his first term. It’s not hard to see what this is heading. Especially with the Heritage Foundation — one of the key entities behind Project 2025 — already openly behind the idea.
And that brings us to the overt calls for mass privatization that we’re already hearing. The privatization of the US Postal Service. Like the FAA, plans to privatize the Postal Service is nothing new. That was the big concern after Trump selected Louis DeJoy to lead the agency during his first term, after all. Recall how, DeJoy was initially tapped by Trump to lead the postal service, his ‘modernization’ plan ended up eroding overall service and seemingly set the postal service up for privatization. And DeJoy — a long-time Republican mega-donor AND someone with major investments in the mail processing private contractor XPO Logistics — was precisely the kind of person who stood to profit handsomely from a privatization of the postal service. Mail-in voting, and things like the number and location of postal drop boxes, was also directly impacted by DeJoy’s modernization plan. DeJoy even made the still inexplicable decision to remove hundreds of mail-sorting machines — critical for the timely process of all those mail-in votes — in the months leading up to the 20220 election in key swing states.
DeJoy was a loyal Trump crony. And yet, as we’re going to see, he’s now be derided by the Trump White House and Republicans as some sort of holdover from the Biden administration who is standing in the way of Trump’s efficiency purge. At least that’s narrative we’re hearing that appears to be serving as the pretext for the latest Trump administration power grab: the dissolution of the US Postal System’s board of governors and the absorption of the entire independent agency into the Commerce Department. Keep in mind that the postal system’s board of governors is bipartisan and comprised of nominees selected by the president and confirmed by the senate. In other words, a few more checks and balances are being tossed out the window, in keeping with the Unitary Executive theory that has been guiding the Trump administration’s actions to date. But the plans for the postal service aren’t limited to a White House takeover. Trump is already openly talking about privatizing the whole thing.
And, of course, the privatization push isn’t going to end with the FAA and Postal Service. Privatization is, in many respects, the ultimate fulfillment of Project 2025. After all, undoing the damage done by Project 2025 is going to be exceedingly difficult for agencies that are entirely dissolved and handed over to for-profit entities. And this second Trump administration is very intent on doing as much irreversible damage as possible. Privatization is the logical goal for both the short and long-term agenda driving these policies.
But that long-term agenda isn’t just ideological. Making ungodly amounts of profit off the public’s back is a key goal too. And that brings us to the third article below about an extremely unpleasant recent reminder of what the public can realistically expect when critical services are being handled by the for-profit sector. Because as the article reminds us, the private sector in the US today isn’t some sort of capitalist utopian ideal. It’s a corporate landscape dominated by monopolies and oligopolies that have mastered the art of exploiting their market positions to deliver as few services as possible for the maximum profit. Even when it comes to the service of manufacturing and maintaining firetrucks. Yes, it turns out the US’s municipal firetruck manufacturing sector has been captured by a handful of private-equity firms operating in profit-maximization mode. The kind of profit-maximizing mode only an oligopoly can manage, where reduced availability of firetrucks and big delays in delivers come hand in hand with extra-high prices. With brutal consequences for the communities that find themselves without the firetrucks they need. Communities like Los Angeles. Yes, it turns out the historic LA fires were fueled, in part, by large numbers of out-of-service firetrucks thanks to the private-equity capture of this sector of the economy.
It wasn’t always like this. There used to be a large number of small manufacturers who provided US communities with the firetrucks they need as a reasonable price. And the antitrust law are already on the books to address the capture of key market by a handful of players. But just because laws are on the books doesn’t mean they are enforced. That’s also part of this story: unused anti-trust laws have ensure that one sector of the US economy after another is now dominated by a handful of players capable to wield immense market power for profit-maximizing ends. It’s that oligopolistic modern US corporate sector that is poised to now engorge itself on the buffet of federal services soon to be privatized under this administration:
“While the current and former FAA staffers do not blame Trump and Musk’s purge or their crackdown on diversity programs for any of these accidents, they all say that the administration’s mass firings and needlessly shambolic management could make it more difficult for an already stretched-thin workforce to do its job and keep Americans safe.”
The Musk-led Project 2025 purge of the FAA didn’t cause all these plane accidents that alarmingly took place over the last month. They just made accidents more likely to happen going forward. No harm done. Yet. But it’s coming. That’s the message from these current and former FAA staffers anonymously talking to the press. And as they warn, the obviously dangerous cuts include cuts to the legal teams in charge of looking out for pilots with criminal records or other concerns. Quality control legal teams. Probably not the place you want to be cutting. But that’s what’s getting cut. Along with all the other cuts that presumably aren’t helping making flying safer
And note how Musk and Trump have claimed that it’s just probationary workers who have been on the job for less than a year who have been impacted by these mass indiscriminate initial cuts. But as we can see, probationary employees also include people who have been recently promoted. Who are obviously valued employees. So they are indiscriminately firing new employees and valued recently promoted employees. For ‘efficiency’:
And then we get to heart of the matter: privatization. In particular, privatization to SpaceX. It’s starts with ‘lending some SpaceX engineers to fix government’, and ends with ‘why not just have SpaceX do it for cheaper?’ and Musk’s takeover of air travel safety. The stars are aligning for corruption on that kind kind of scale:
And that’s just the FAA. One of a number of federal agencies ripe for some sort of corrupt privatization scheme. Which brings us to the peril now looming over the US Postal Service. Peril that isn’t new. The head of the US Postal Service is Louis DeJoy, a Trump appointee from his first term, after all. As we’ve seen, DeJoy’s tenure has involved a ‘modernization’ scheme that was effectively setting the stage for privatization. And here we are, with the Trump administration and Republicans now attacking DeJoy as somehow being some sort of Democratic stalwart who needs to go. But they aren’t planning on simply jettisoning DeJoy and replacing him with a more up-to-date crony. The Trump administration is instead planning on dissolving the bipartisan, senate-confirm postal board of governors and seizing control of the entire agency itself...while openly talking about privatization plans:
“Trump is expected to issue an executive order as soon as this week to fire the members of the Postal Service’s governing board and place the agency under the control of the Commerce Department and Secretary Howard Lutnick, according to six people familiar with the plans, who spoke on the condition of anonymity out of fear of reprisals.”
The executive order is expected as soon as this week. A order to dissolve the US Postal Services governing board — a bipartisan board consisting of members nominated by the president and confirmed by the Senate. Trump is getting rid of that board and taking unilateral control of the whole thing. No more bipartisan boards or Senate confirmations:
And as experts warn, the return of a partisans postal service under someone like Trump is effectively a recipe for political gamesmanship and retribution to play out. Geographic regions (like Blue cities) could see their services selectively slowed or meddled with. In other words, Blue state mail in voting in about to get a lot more inconvenient:
Also note how the Trump administration’s demonization of the job the postal service is doing — demonization that is fundamental to the Project 2025 narrative — is happening at the same time the postal service is earning a profit. And let’s not forget that its leader, Louis DeJoy, was Trump’s pick. He’s not some Biden crony. He was already a Trump crony. This narrative about DeJoy developing ‘close ties to the Biden administration’ is just part of the bad faith narrative. A say-and-do-whatever-is-necessary strategy to attacking and destroying the postal service as an institution:
And, of course, all of this in the service of one goal: the privatization of the US postal service. The same goal in mind for the FAA. And as much of the rest of the government as they can get away with. Which raises the question of how Musk will profit from a private postal system too:
The writing isn’t just on the wall. It’s coming out of Trump’s mouth. The US Postal Service is going to be privatized through one means or another. Although breaking the service somehow, possibly during an election and screwing up mail-in voting, will likely come first. And, again, there’s more federal agencies ripe for privatization than just the FAA and Postal Service. This is just the low-hanging fruit.
So with mass privatization slated to be the future of federal services for the United States, here’s a reminder that, for all the hoopla about the ‘efficiency’ and ‘productivity’ of the US private sector, the sad reality is that privatization in the contemporary US is basically a request for a new monopoly. Or maybe an oligopoly at best. After all, for many services it’s not logistically possible to really have many competitors. And even those services for which is it possible for healthy competition to keep prices down and services robust, we can’t assume competition is actually going to be enforced in today’s economy. Because while the US does have antitrust laws and regulations, those haven’t really been enforced for many years. And as a result, privatization is basically replacing government bureaucrats with For-profit oligopolies that prioritize profits over all else. Maybe that results in overprices poor service when it comes to something like postal delivery. Or maybe, when it comes to the private-equity-dominated firetruck manufacturing sector, it results in chronic shortages for extra-expensive trucks that won’t be available when the city burns down:
“Why couldn’t the LAFD keep its equipment in working order? A lot of people blame budget cuts, but there’s another root issue — increasing prices and metastasizing production delays for these vehicles. The cost of fire trucks has skyrocketed in recent years––going from around $300 ‑500,000 for a pumper truck and $750–900,000 for a ladder truck in the mid-2010s, to around $1 million for a pumper truck and $2 million for a ladder truck in the last couple years. Meanwhile, the time it takes to get a fire truck delivered has grown dramatically, from less than a year before the pandemic to anywhere between 2 and 4.5 years today. (It’s not just trucks, all fire equipment is increasing quickly in price, from air supply packs to maintenance contracts.)”
Higher prices with more delays. That’s been the real-world consequence of the private-equity capture of firetruck manufacturing sector in the US. A sector that, for decades, had been comprised of many competing small firms that managed to serve US municipalities for decades. A few private-equity firms — led by American Industrial Partners (AIP) — come to dominate the sector and all of a sudden working firetrucks are in short supply and very expensive to procure even if you’re willing to pay the private-equity premium prices. Sure, AIP initial pledged that it would allow its many subsidiaries to compete with each other to ensure its growth didn’t lead to unfair anticompetitive practices. But that turned out to not be true. Imagine that:
And as we can see, it appears that AIP used its dominant position to effectively exploit manufacturing bottlenecks as profit-maximizing opportunities. In other words, the worse the service, the higher the profits, thanks to the ‘floating’ price structure and the extended delays. And the higher the probability that disasters like the LA catastrophe will happen again:
And as the article reminds us, when it comes to the question of what can be done to address the negative consequences of the private-equity capture of the US firetruck industry, it can start with the enforcement of existing antitrust laws and regulations:
“State and federal antitrust laws already prohibit the kind of monopolistic roll-up that AIP perpetrated — they just need to be enforced.”
Take that in. State and federal laws already prohibit the slow-motion capture of the US firetruck sector that’s been playing out over the last decade. That’s the broken state of affair for the US economy. Illegal monopolies are just allowed to form without any legal consequence. Even after one of the largest cities in the country burns down as a result. It’s been a profit bonanza for the private-equity firetruck sector. What kind of profit bonanza is there awaiting the postal and air traffic control service sectors? We’ll find out. Or at least the investors of the firms allowed to capture these sectors will find out. The public will mostly just get to find out about all the horrible consequences.
The State of the Union is kind of joke at the moment. But that doesn’t mean it can’t become an even bigger joke. After all, as we’ve seen, undoing the federal civil service and returning to the spoils system that preceded it was a core goal of the entire Schedule F/Project 2025 plot. With with Project 2025 in full swing, it’s pretty clear that the spoils system is back. Back and already turning out to be laughably corrupt.
And it’s just getting started. There’s still plenty of looting yet to be done. Which brings us to the ongoing historic looting of the federal government currently underway under the guise of Elon Musk’s ‘Department of Government Efficiency’ (DOGE) scheme. A scheme that, in one sense, appears to be following the private-equity model of gutting companies in the name of ‘cost cutting’ and ‘efficiency’ but really in the name of short-term profits and transferring risks and liabilities onto employees and the public. Except, of course, as we keep seeing with so many of these disastrous DOGE cuts, there isn’t actually any short-term profit. Instead, DOGE is effectively Project 2025 under a new name. A scheme to not just gut the federal government but replace it with private contractors wherever possible. Including at the Federal Aviation Administration (FAA), where Musk has already ‘volunteered’ SpaceX’s services to “help make air travel safer” with some SpaceX employees already ‘joining’ the FAA. As we’re going to see, it looks like the plans for SpaceX’s ‘fixing’ of the FAA has already moved on to the next step, with SpaceX’s Starlink service poised to be tapped to play a major role in the FAA’s operations.
Now, as we’ve seen, Starlink has already received incredibly favorable treatment by the US government, with what amounts to a free pass granted to Starlink to turn the Earth’s lower orbits into a giant ‘Kessler syndrome’ disaster waiting to happen. And it appears more incredibly favorable treatment for Starlink is set to happen at the FAA. Because the new role Starlink is set to play at the FAA doesn’t just entail the obvious conflicts of interest inherent in Starlink getting new FAA contracts as a consequence of the FAA’s DOGE ‘audit’. It appears that an existing $2.4 billion contract with Verizon that performed similar services will also be canceled, at the recommendation of DOGE and Musk. In fact, according to Musk’s social media posts, the Verizon communication system at the FAA is “breaking down very rapidly” and that the “FAA assessment is single digit months to catastrophic failure, putting air traveler safety at serious risk.” Musk has also offered to send Starlink terminals to the FAA on an emergency basis for no cost in order to fix the situation. And, of course, no evidence for the apparently looming aviation catastrophe that Musk warned about has been presented.
Now, while it remains unclear if the Verizon contract cancellation will indeed happen, we’re also getting reports that the FAA has quietly ordered staff to somehow find tens of millions of dollars to be made available for funding contracts with Starlink. Very quietly ordered. In fact, anonymous sources are telling reporters that the orders to find the tens of millions of dollars were issued verbally, which is described as highly unusual. As the source puts it, its as though “someone does not want a paper trail.”
Oh, but get this: it turns out we don’t have to worry about these glaring conflicts of interest because Elon Musk has already promised to remove himself from any situations that pose so as conflict. The Trump White House has already cited those assurances by Elon as a reason to not be concerned. Yep.
At the same time, we’re also learning that some of the SpaceX employees who have arrived at the FAA as part of this DOGE scheme were issued temporary conflict-of-interest waivers so they could go about their jobs without violating federal conflict of interest laws. So we have to ask: did Elon get a similar waiver? Or is he just self-policing himself through this entire scam? Who knows. Either way, one of the most conflicted ‘audits’ imaginable is still underway, and only getting more corrupt with each passing week.
And that’s just the FAA. NASA employees are already sounding the alarm about the many obvious conflicts of interest inherent in having SpaceX employees review NASA contracts and make recommendations. NASA has invested $15 billion in SpaceX already. How big will the investments get after DOGE is done ‘making recommendation’.
Beyond that, we’re also learning about NASA researchers who were planning on publishing a report on the challenges AI presents to aviation safety but decided to withhold the publication. Why? Because they were worried about drawing negative attention from DOGE and Musk. Yep. And as we’ve seen, replacing as many federal workers with AI is another core DOGE goal. What kinds of AI plans do Musk and DOGE have in mind for the FAA? Time will tell, but it appears we’re all going to have to be content with just hoping Elon polices himself and doesn’t abuse the situation. At the same time we read about one abuse after another after another:
” The Federal Aviation Administration is on the cusp of canceling a $2.4 billion contract to overhaul the communication system for the nation’s air traffic control system and handing it to the SpaceX subsidiary instead, The Washington Post reports, citing two unnamed sources briefed on the plans. The news was also confirmed by Bloomberg and The Associated Press.”
As we can see, Project 2025 isn’t just about gutting the federal government. There’s a whole new spoils system ready to be exploited. With spoils that include canceling existing contracts and handing them over to Musk’s companies. With SpaceX employees apparently making the decision. Who knew the new spoils system was going to be so in-your-face about it all:
And as we can see, not only has Musk been ‘greasing the skids’ for this contract capture with unsourced claims on social media about how the Verizon system is “not working and so is putting air travelers at serious risk.” He’s also been claiming that Starlink terminals would be provided at “NO COST to the taxpayer on an emergency basis to restore air traffic control connectivity.” So according to Musk’s unsourced claims, connecting the FAA to Starlink is preventing some sort of looming catastrophe that was going to happen under the Verizon contract. It’s entirely unclear how exactly Starlink internet connections will somehow prevent these looming catastrophes, that’s the public claim Musk was making. It’s not a conflict of interest. It’s Musk saving the day. That’s the spin:
And while it remains unclear if Starlink will ultimately get Verizon’s contract, it appears Musk has already ordered the FAA to find tens of millions of dollars to pay for Starlink’s services. Verbally ordered. Yes, it turns out the orders to find these Starlink funds aren’t being written down and only issued verbally. As one source puts it, it appears as though “someone does not want a paper trail”:
” Elon Musk’s satellite business Starlink may not have officially taken over Verizon’s $2.4 billion contract with the Federal Aviation Administration yet to upgrade the systems it uses to manage America’s airspace. However, on Friday, FAA officials ordered staff to begin finding tens of millions of dollars for a Starlink deal, according to a source with knowledge of the FAA and two people briefed on the situation.”
Well isn’t that fascinating. A $2.4 billion contract with Verizon is on the verge of being cancelled and replaced with Starlink’s services. And now FAA employees are being ordered to scrounge up tens of millions of dollars for the Starlink contract. Wouldn’t the cancellation of a $2.4 billion contract free up those resources? Or are we seeing some sort of attempt to establish a Starlink foothold at the FAA before the Verizon contract is canceled? It’s very unclear what we’re looking at here. Apparently by design, with anonymous sources telling reporters that they’ve only been receiving verbal orders to find these funds, as though “someone does not want a paper trail”:
And that scandalous state of affairs at the FAA brings us to what is possibly the most ethically grotesque twist in this whole mess: Musk has already publicly pledge to remove himself from any situations that might pose a conflict of interest. A pledge the Trump White House has publicly cited as a reason for no concern. So it’s particularly interesting to also learn that some of the SpaceX employee who arrived at the FAA as part of the DOGE review have already received temporary conflict-of-interest waivers so they can carry out their duties. Which raises the question: how many of these conflict-of-interest waivers are there getting issued as part of DOGE? And has Elon received any of them? At this point it’s unclear which answer would be the most scandalous:
“Since formally joining the Trump administration as a “special government employee,” Musk has said he would recuse himself from tasks that might pose a conflict of interest; the White House has said Musk would police those conflicts himself. But that hasn’t eased concerns in agencies that do business with Musk’s companies or his competitors.”
Isn’t that special. Elon pledged to remove himself from tasks that might pose a conflict of interest. A pledge that was apparently enough to convince the Trump White House that all was good. Despite federal law. So when we see how some of the SpaceX employees now embedded at the FAA have gotten temporary conflict-of-interest waivers, we have to ask: did Elon get a conflict-of-interest waiver too?
And as the article reminds us, the FAA is just one of a number of federal agencies where Musk’s business empire has direct conflicts of interest. Including NASA, an agency that literally invested over $15 billion into SpaceX and has extensive contracts with the company. Given the power grab we’re already seeing at the FAA, just imagine the power grabs Musk has in mind for NASA:
Finally, note this incredibly disturbing detail: the authors of a forthcoming NASA report on the challenges AI presents to aviation safety decided not to publish the piece in order to avoid the wrath of Musk and DOGE:
That’s how much implicit authoritarian power Musk and his DOGE team are already wielding. How many more intergovernmental reports warning about the disastrous consequences of this historic power grab are there getting preemptively censured over fears of angering ‘Dear Leader’? It’s hard to imagine this was the only one. Either way, it’s pretty clear Musk is going to turn the FAA into another one of his playthings. So let’s hope those NASA researchers were somehow mistaken. Because when it comes to the risks associated with haphazardly applying artificial intelligence to government roles, we’re going to be finding out the hard way whether or not it’s a disaster. Risks to the general public, of course. Elon Musk will be just fine, disasters or not. Fine and much, much wealthier and more influential, regardless of the outcome. That’s how authoritarian power grabs work. An ability to intimidate everyone into compliance is the only real competence required.