Turn­ing lemons into lemon­ade is kind of the theme of the ongo­ing pen­sion fund push into the pri­vate equi­ty space now that so many of the com­mer­cial real estate (CRE) invest­ments of 2022 have start­ed to sour. That’s the whole ratio­nale behind Black­stone’s Real Estate Part­ners IX fund, where pen­sion funds are hop­ing to recoup their CRE loss­es by scoop­ing prop­er­ties as prices col­lapse. But what if the loss­es pen­sion funds are fac­ing in their pri­vate equi­ty invest­ments are actu­al­ly much larg­er than pre­vi­ous­ly dis­closed? How might that affect this ‘mak­ing lemon­ade’ strat­e­gy? Would it cause pen­sion funds to pull back on this dou­ble-down? Or dou­ble-down hard­er? That’s the omi­nous ques­tion raised by the fol­low­ing pair of arti­cles describ­ing a dynam­ic that hints at poten­tial­ly much larg­er loss­es from the pen­sion fund indus­try’s pri­vate equi­ty binge than has been yet dis­closed. A dynam­ic that per­verse­ly incen­tivizes even more pen­sion fund invest­ments in the pri­vate equi­ty space the worse their under­ly­ing fis­cal sit­u­a­tion gets.

So what is this per­verse dynam­ic? Well, as pro­gres­sive colum­nist David Siro­ta warned back in Feb­ru­ary, it’s not just the promis­es of high returns that has caused US pen­sion funds have fall in love with pri­vate equi­ty in recent decades. There’s also the account­ing gim­mick that syn­er­gizes with those promis­es of high returns and allows pen­sions to effec­tive­ly make up their own returns and make their finances appear stronger than they actu­al­ly are. That account­ing gim­mick is root­ed in the fact that it is both extreme dif­fi­cul­ty to a val­ue on a lot of pri­vate equi­ty invest­ments but also required by law. As a result, pri­vate equi­ty firms are allowed to sim­ply make up the alleged mar­ket val­ues for the invest­ments they are hold­ing on behalf of their pen­sion fund clients.

And as stud­ies have shown, those made up val­ues tend to be inflat­ed val­ues that fraud­u­lent­ly puff up the bal­ance sheets of pen­sion funds and at least tem­porar­i­ly make every­thing seem bet­ter than they actu­al­ly are. It’s a con­ve­nient fic­tion for both parties...until the bill comes due. Because at some point these invest­ments have to be sold and real­i­ty inter­venes. That’s the basis for David Siro­ta’s warn­ings that, as bad as things were look­ing for the pri­vate equi­ty-led pen­sion fund invest­ments as CRE write-downs pick up the pace, it’s prob­a­bly actu­al­ly worse.

Inter­est­ing­ly, as we’re going to see in a Bloomberg opin­ion piece from last month by Alli­son Schrager of con­ser­v­a­tive Man­hat­tan Insti­tute, this issue of fraud­u­lent pri­vate equi­ty book­keep­ing just might be one of those issues that can res­onate across the ide­o­log­i­cal spec­trum. Because not only does Schrager acknowl­edge the real abus­es inflict­ed by pri­vate equi­ty man­age­ment on work­ers and com­mu­ni­ties, but she has a solu­tion: giv­en that pen­sion funds now account for rough­ly two-thirds of the capi­tol under pri­vate equi­ty con­trol, one way of reduc­ing the amount of pri­vate equi­ty-induced social harms is to sim­ply starve pri­vate equi­ty of the bil­lions of dol­lars its using to inflict these harms by fix­ing these account­ing loop­holes that make pri­vate equi­ty such an entic­ing tem­porar­i­ly solu­tion to pen­sion funds look­ing to chase high­er returns.

Will such a fix ever actu­al­ly get imple­ment­ed? It’s hard to see that hap­pen­ing in the US, but it’s worth keep­ing in mind that the longer it takes to fix these account­ing gim­micks, the more painful it’s even­tu­al­ly going to be to fix:

The Guardian

US pen­sion funds are on the brink of implo­sion – and Wall Street is ignor­ing it

Pri­vate equi­ty firms man­ag­ing mil­lions of Amer­i­cans’ retire­ment sav­ings may be inflat­ing their invest­ments

David Siro­ta
Thu 2 Feb 2023 06.15 EST

As pub­lic offi­cials across Amer­i­ca pre­pare to fun­nel even more of gov­ern­ment work­ers’ sav­ings to pri­vate equi­ty moguls, an alarm just sound­ed for any­one both­er­ing to lis­ten. It is a warn­ing that Wall Street exec­u­tives, busy skim­ming fees off retire­ment nest eggs, want you to ignore. The longer the warn­ing goes unheed­ed, how­ev­er, the big­ger the finan­cial time bomb may be for work­ers, retirees and the gov­ern­ments that pay them.

Ear­li­er this month, Pitch­Book – the go-to news out­let of the pri­vate equi­ty indus­try – declared that “pri­vate equi­ty returns are a major threat to pen­sion plans’ abil­i­ty to pay retirees in 2023”.

With more than one in 10 pub­lic pen­sion dol­lars invest­ed in pri­vate equi­ty assets – and with states con­tin­u­ing to keep their pri­vate equi­ty con­tracts secret – Pitch­Book cit­ed a new study find­ing that loss­es from the invest­ments may be on the hori­zon for retire­ment sys­tems that sup­port mil­lions of teach­ers, fire­fight­ers, first respon­ders and oth­er gov­ern­ment employ­ees.

“Pri­vate equi­ty returns get report­ed on a lag of up to six months, and with each update in 2022 val­ues were com­ing down – which means 2022 num­bers were includ­ing over­stat­ed pri­vate equi­ty asset val­u­a­tions and 2023 num­bers are going to incor­po­rate those loss­es,” not­ed the study from the Equable Insti­tute.

To com­pre­hend this time­bomb, you have to under­stand pri­vate equity’s busi­ness mod­el.

In gen­er­al, pri­vate equi­ty firms use pen­sion mon­ey to buy up and restruc­ture com­pa­nies to then sell them at a high­er price than they were pur­chased. In between buy­ing and sell­ing, there are no trans­par­ent met­rics for valu­ing the pur­chased asset – pri­vate equi­ty firms can man­u­fac­ture an alleged val­ue to tell pen­sion investors (and there’s evi­dence they inflate val­u­a­tions when seek­ing new invest­ments).

In a sto­ry about an investor receiv­ing two dif­fer­ent val­u­a­tions for the same com­pa­ny, Insti­tu­tion­al Investor under­scored the absur­di­ty: “Every­one Wants to Know What Pri­vate Assets Are Real­ly Worth. The Truth: It’s Com­pli­cat­ed.”

Mean­while, val­u­a­tion and fee terms in con­tracts between pri­vate equi­ty firms and pub­lic pen­sions are kept secret, exempt from open records laws.

With that in mind, the new warn­ings are sim­ple: pri­vate equi­ty firms may have told their pen­sion offi­cials that their assets were worth much more than they actu­al­ly are, all while the firms were skim­ming bil­lions of dol­lars of fees off retirees’ mon­ey.

If write-downs now hap­pen, it could mean that when it’s time to sell the assets to pay promised retiree ben­e­fits, pen­sion funds would have far less mon­ey avail­able than pri­vate equi­ty firms led them to believe. At that point, there are three painful choic­es: cut retire­ment ben­e­fits, slash social pro­grams to fund the ben­e­fits, or raise tax­es to recoup the loss­es.

Signs of a dooms­day sce­nario are already evi­dent: some of the world’s largest pri­vate equi­ty firms have been report­ing big declines in earn­ings, and fed­er­al reg­u­la­tors are report­ed­ly inten­si­fy­ing their scruti­ny of the industry’s write-downs of asset val­u­a­tions. Mean­while, one invest­ment bank report­ed that in its 2021 trans­ac­tions, pri­vate equi­ty assets sold for just 86% of their stat­ed val­ue last year.

But while pen­sion­ers may be imper­iled, Wall Street exec­u­tives are pro­tect­ed thanks to their heads-we-win-tails-you-lose busi­ness mod­el. While report­ing asset loss­es for investors, some of the firms man­ag­ing pen­sion­ers’ mon­ey are rak­ing in even more fees from investors and con­tin­u­ing to raise exec­u­tives’ pay.

Mean­while, even as some sophis­ti­cat­ed pri­vate investors rush to get out of pri­vate equi­ty, the world’s largest pri­vate equi­ty firm, Black­stone, recent­ly reas­sured Wall Street ana­lysts that state pen­sion offi­cials will con­tin­ue using retirees’ sav­ings to boost rev­enues for pri­vate equi­ty firms, hedge funds, real estate funds and oth­er so-called “alter­na­tive invest­ments”.

“The desire for alter­na­tives remains very strong,” the pres­i­dent of Black­stone, Jon Gray, said in an investor call last week. “New York’s state leg­is­la­ture actu­al­ly increased the allo­ca­tion for the big three pen­sion funds here by rough­ly a third.”

Gray was refer­ring to New York Demo­c­ra­t­ic law­mak­ers pass­ing leg­is­la­tion sig­nif­i­cant­ly increas­ing the amount of retiree mon­ey that pen­sion offi­cials can deliv­er to Wall Street. The bill was cham­pi­oned by the New York City comp­trol­ler, Brad Lan­der, just weeks after the Demo­c­rat won office promis­ing he would be “review­ing the funds’ posi­tions with risky and spec­u­la­tive assets includ­ing hedge funds, pri­vate equi­ty, and pri­vate real estate funds”.

The New York gov­er­nor, Kathy Hochul, qui­et­ly signed the leg­is­la­tion on the Sat­ur­day before Christ­mas, just weeks after the Wall Street Jour­nal report­ed that ana­lysts have start­ed warn­ing pen­sion funds of loom­ing pri­vate equi­ty loss­es. New York law­mak­ers simul­ta­ne­ous­ly reject­ed sep­a­rate leg­is­la­tion that would have allowed work­ers and retirees to see the con­tracts signed between state pen­sion offi­cials and Wall Street firms man­ag­ing their mon­ey.

The Empire State is hard­ly alone in con­tin­u­ing to use retirees’ mon­ey to enrich the planet’s wealth­i­est finan­cial spec­u­la­tors – from Cal­i­for­nia to Texas to Iowa, pen­sion funds con­trol­ling hun­dreds of bil­lions of dol­lars of work­ers’ retire­ment sav­ings are plan­ning to dump more mon­ey into pri­vate equi­ty, while keep­ing the terms of the invest­ments secret.

While glo­be­trot­ting to elite con­fer­ences in exot­ic locales, pen­sion offi­cials have defend­ed the high-fee invest­ments by par­rot­ing Wall Street exec­u­tives’ claim that pri­vate equi­ty reli­ably out­per­forms low-fee stock index funds. At the same time, those offi­cials con­tin­ue to con­ceal the terms of the invest­ments, rais­ing the ques­tion: if the invest­ments are so great, why are the details being hid­den?

Per­haps because the invest­ments aren’t as won­der­ful as adver­tised. In a land­mark study enti­tled An Incon­ve­nient Fact: Pri­vate Equi­ty Returns & the Bil­lion­aire Fac­to­ry, Oxford University’s Ludovic Phalip­pou doc­u­ment­ed that pri­vate equi­ty funds “have returned about the same as pub­lic equi­ty indices since at least 2006”, while extract­ing near­ly a quar­ter-tril­lion dol­lars in fees from pub­lic pen­sion sys­tems.

A 2018 Yahoo News analy­sis found that US pen­sion sys­tems had paid more than $600bn in fees for hedge fund, pri­vate equi­ty, real estate and oth­er alter­na­tive invest­ments over a decade.

“The big pic­ture is that they’re get­ting a lot of mon­ey for what they’re doing, and they’re not deliv­er­ing what they have promised or what they pre­tend they’re deliv­er­ing,” Phalip­pou told the New York Times in 2021.

Even some on Wall Street admit the truth: a JP Mor­gan study in 2021 found that pri­vate equi­ty has bare­ly out­per­formed the stock mar­ket, but it remains unclear whether that “very thin” out­per­for­mance is worth the risk of opaque and illiq­uid invest­ments whose actu­al val­ue is often impos­si­ble to deter­mine – invest­ments that could crater when the mon­ey is most need­ed.

While the warn­ings have not halt­ed the flood of pen­sion cash to pri­vate equi­ty, they have bro­ken through in at least some cor­ners of Amer­i­can pol­i­tics.

The Secu­ri­ties and Exchange Com­mis­sion is con­sid­er­ing new rules to require pri­vate equi­ty firms to bet­ter dis­close the fees they charge.

Sim­i­lar­ly, Ohio’s state audi­tor, Kei­th Faber, just issued a report sound­ing an alarm about state pen­sion offi­cials keep­ing pri­vate equi­ty con­tracts secret – a prac­tice repli­cat­ed in states across the coun­try.

And fol­low­ing a pen­sion cor­rup­tion scan­dal in Penn­syl­va­nia – whose state gov­ern­ment over­sees near­ly $100bn in pen­sion mon­ey – there’s a poten­tial finan­cial earth­quake: dur­ing his first week in office, Gov­er­nor Josh Shapiro promised to shift pen­sion­ers’ mon­ey out of the hands of Wall Street firms.

“We need to get rid of these risky invest­ments,” Shapiro told his state’s largest news­pa­per. “We need to move away from rely­ing on Wall Street mon­ey man­agers.”

...

Bet­ter late than nev­er – though the lat­er it gets, the big­ger the risk for mil­lions of work­ers and retirees.

———–

“US pen­sion funds are on the brink of implo­sion – and Wall Street is ignor­ing it” by David Siro­ta; The Guardian; 02/02/2023

“But while pen­sion­ers may be imper­iled, Wall Street exec­u­tives are pro­tect­ed thanks to their heads-we-win-tails-you-lose busi­ness mod­el. While report­ing asset loss­es for investors, some of the firms man­ag­ing pen­sion­ers’ mon­ey are rak­ing in even more fees from investors and con­tin­u­ing to raise exec­u­tives’ pay.”

It’s a cri­sis for pen­sion funds. A cri­sis of under­per­form­ing pri­vate equi­ty invest­ments that sim­ply aren’t liv­ing up to Wall Street’s promis­es. But it’s a cri­sis for the under­per­form­ing fund man­agers. It’s the heads-we-win-tails-you-lose busi­ness mod­el in action. The kind of busi­ness mod­el that rais­es the basic ques­tion of why pen­sion funds agree to these terms in the first place. And that brings us to the brew­ing scan­dal in this sec­tor. The kind of scan­dal that’s only going to grow as pen­sion funds pour more and more mon­ey into pri­vate equi­ty fol­low­ing promis­es of high returns. Because as a grow­ing num­ber of voic­es are point­ing out, these promised returns aren’t meet­ing the hype. Quite the oppo­site, the 2022 returns were actu­al­ly get­ting writ­ten down, with more asset reval­u­a­tions on the way. And that brings us to the dis­turb­ing under­ly­ing fac­tor incen­tiviz­ing the sys­tem­at­ic infla­tion of pen­sion fund’s pri­vate equi­ty returns: pri­vate equi­ty invest­ments are dif­fi­cult to price, with returns often not being real­ized for years. And yet they must be priced for basic account­ing needs. Exist­ing rules han­dle that account­ing para­dox by effec­tive­ly allow­ing pri­vate equi­ty firms to just make up an assumed val­u­a­tion. And the high­er that assumed val­u­a­tion, the less under­fund­ed pen­sion funds will appear. It’s a recipe for cre­at­ing fis­cal time bombs in the bal­ance sheets of pen­sion funds:

...
Ear­li­er this month, Pitch­Book – the go-to news out­let of the pri­vate equi­ty indus­try – declared that “pri­vate equi­ty returns are a major threat to pen­sion plans’ abil­i­ty to pay retirees in 2023”.

With more than one in 10 pub­lic pen­sion dol­lars invest­ed in pri­vate equi­ty assets – and with states con­tin­u­ing to keep their pri­vate equi­ty con­tracts secret – Pitch­Book cit­ed a new study find­ing that loss­es from the invest­ments may be on the hori­zon for retire­ment sys­tems that sup­port mil­lions of teach­ers, fire­fight­ers, first respon­ders and oth­er gov­ern­ment employ­ees.

“Pri­vate equi­ty returns get report­ed on a lag of up to six months, and with each update in 2022 val­ues were com­ing down – which means 2022 num­bers were includ­ing over­stat­ed pri­vate equi­ty asset val­u­a­tions and 2023 num­bers are going to incor­po­rate those loss­es,” not­ed the study from the Equable Insti­tute.

To com­pre­hend this time­bomb, you have to under­stand pri­vate equity’s busi­ness mod­el.

In gen­er­al, pri­vate equi­ty firms use pen­sion mon­ey to buy up and restruc­ture com­pa­nies to then sell them at a high­er price than they were pur­chased. In between buy­ing and sell­ing, there are no trans­par­ent met­rics for valu­ing the pur­chased asset – pri­vate equi­ty firms can man­u­fac­ture an alleged val­ue to tell pen­sion investors (and there’s evi­dence they inflate val­u­a­tions when seek­ing new invest­ments).

...

Mean­while, val­u­a­tion and fee terms in con­tracts between pri­vate equi­ty firms and pub­lic pen­sions are kept secret, exempt from open records laws.

With that in mind, the new warn­ings are sim­ple: pri­vate equi­ty firms may have told their pen­sion offi­cials that their assets were worth much more than they actu­al­ly are, all while the firms were skim­ming bil­lions of dol­lars of fees off retirees’ mon­ey.

If write-downs now hap­pen, it could mean that when it’s time to sell the assets to pay promised retiree ben­e­fits, pen­sion funds would have far less mon­ey avail­able than pri­vate equi­ty firms led them to believe. At that point, there are three painful choic­es: cut retire­ment ben­e­fits, slash social pro­grams to fund the ben­e­fits, or raise tax­es to recoup the loss­es.
...

But it’s not just account­ing trick­ery at work here. There’s also the fact that the terms of these con­tracts between pen­sion funds and pri­vate-equi­ty firms are typ­i­cal­ly hid­den. And as stud­ies have found, a rather grim con­clu­sion is reached when you fac­tor all those hid­den fees: pri­vate equi­ty returns have been more or less in line with pub­lic equi­ty returns:

...
While glo­be­trot­ting to elite con­fer­ences in exot­ic locales, pen­sion offi­cials have defend­ed the high-fee invest­ments by par­rot­ing Wall Street exec­u­tives’ claim that pri­vate equi­ty reli­ably out­per­forms low-fee stock index funds. At the same time, those offi­cials con­tin­ue to con­ceal the terms of the invest­ments, rais­ing the ques­tion: if the invest­ments are so great, why are the details being hid­den?

Per­haps because the invest­ments aren’t as won­der­ful as adver­tised. In a land­mark study enti­tled An Incon­ve­nient Fact: Pri­vate Equi­ty Returns & the Bil­lion­aire Fac­to­ry, Oxford University’s Ludovic Phalip­pou doc­u­ment­ed that pri­vate equi­ty funds “have returned about the same as pub­lic equi­ty indices since at least 2006”, while extract­ing near­ly a quar­ter-tril­lion dol­lars in fees from pub­lic pen­sion sys­tems.

...

Even some on Wall Street admit the truth: a JP Mor­gan study in 2021 found that pri­vate equi­ty has bare­ly out­per­formed the stock mar­ket, but it remains unclear whether that “very thin” out­per­for­mance is worth the risk of opaque and illiq­uid invest­ments whose actu­al val­ue is often impos­si­ble to deter­mine – invest­ments that could crater when the mon­ey is most need­ed.
...

And despite all of these warn­ing signs, all indi­ca­tions are that the flood of pen­sion fund mon­ey into the pri­vate-equi­ty space is only going to grow, with New York law­mak­ers recent­ly rais­ing the cap on the amounts of pen­sion fund mon­ey that can flow into pri­vate-equi­ty invest­ments:

...
Mean­while, even as some sophis­ti­cat­ed pri­vate investors rush to get out of pri­vate equi­ty, the world’s largest pri­vate equi­ty firm, Black­stone, recent­ly reas­sured Wall Street ana­lysts that state pen­sion offi­cials will con­tin­ue using retirees’ sav­ings to boost rev­enues for pri­vate equi­ty firms, hedge funds, real estate funds and oth­er so-called “alter­na­tive invest­ments”.

“The desire for alter­na­tives remains very strong,” the pres­i­dent of Black­stone, Jon Gray, said in an investor call last week. “New York’s state leg­is­la­ture actu­al­ly increased the allo­ca­tion for the big three pen­sion funds here by rough­ly a third.”

Gray was refer­ring to New York Demo­c­ra­t­ic law­mak­ers pass­ing leg­is­la­tion sig­nif­i­cant­ly increas­ing the amount of retiree mon­ey that pen­sion offi­cials can deliv­er to Wall Street. The bill was cham­pi­oned by the New York City comp­trol­ler, Brad Lan­der, just weeks after the Demo­c­rat won office promis­ing he would be “review­ing the funds’ posi­tions with risky and spec­u­la­tive assets includ­ing hedge funds, pri­vate equi­ty, and pri­vate real estate funds”.

The New York gov­er­nor, Kathy Hochul, qui­et­ly signed the leg­is­la­tion on the Sat­ur­day before Christ­mas, just weeks after the Wall Street Jour­nal report­ed that ana­lysts have start­ed warn­ing pen­sion funds of loom­ing pri­vate equi­ty loss­es. New York law­mak­ers simul­ta­ne­ous­ly reject­ed sep­a­rate leg­is­la­tion that would have allowed work­ers and retirees to see the con­tracts signed between state pen­sion offi­cials and Wall Street firms man­ag­ing their mon­ey.

The Empire State is hard­ly alone in con­tin­u­ing to use retirees’ mon­ey to enrich the planet’s wealth­i­est finan­cial spec­u­la­tors – from Cal­i­for­nia to Texas to Iowa, pen­sion funds con­trol­ling hun­dreds of bil­lions of dol­lars of work­ers’ retire­ment sav­ings are plan­ning to dump more mon­ey into pri­vate equi­ty, while keep­ing the terms of the invest­ments secret.
...

That was the assess­ment from pro­gres­sive David Siro­ta from ear­li­er this year. An assess­ment that are part­ly echoed last month in the fol­low­ing Bloomberg piece by Alli­son Schrager of the con­ser­v­a­tive Man­hat­tan Insti­tute. As Schrager acknowl­edges, pri­vate equi­ty earned its ruth­less rep­u­ta­tion for a rea­son. It’s been gen­uine­ly ruth­less in the pur­suit of prof­its and it’s not hard to see why the pub­lic would want that ruth­less­ness reigned in. But Schrager argues against cre­at­ing new rules that would direct­ly restrain pri­vate equi­ty from engag­ing in these kinds of ruth­less man­age­ment tac­tics and instead pro­pos­es an indi­rect approach: fix the account­ing rule chi­canery that has made pri­vate equi­ty such an appe­tiz­ing invest­ment to pen­sion funds. That’s it. Fix that, and there’s going to be A LOT less pen­sion fund mon­ey flow­ing into the pri­vate equi­ty space. Less pri­vate equi­ty mon­ey = less pri­vate equi­ty-caused social dam­age.

That’s the fix Schrager is propos­ing. And while it remains very unclear if any such fix is polit­i­cal­ly fea­si­ble giv­en the immense lob­by­ing pow­er of this indus­try, it’s pret­ty notable that reign­ing in the abus­es of pri­vate equi­ty is a poten­tial point of agree­ment between peo­ple as ide­o­log­i­cal­ly diverse as David Siro­ta and Alli­son Schrager:

Bloomberg
Opin­ion

Pen­sion Funds Share Blame for Pri­vate Equity’s Hor­ror Sto­ries

The promise of high returns — whether true or not — has encour­aged retire­ment funds to pour mon­ey into PE invest­ments, with ter­ri­ble results.

by Alli­son Schrager
May 8, 2023 at 5:00 AM CDT

Pri­vate equi­ty is the lat­est eco­nom­ic boogey­man. And there are good rea­sons for that.

Assets in the pri­vate mar­ket have grown expo­nen­tial­ly in the last 20 years, espe­cial­ly in North Amer­i­ca, and now amount to near­ly $12 tril­lion. The num­ber of com­pa­nies backed by pri­vate equi­ty more than dou­bled between 2006 and 2020, while the num­ber of pub­lic com­pa­nies shrank. Pri­vate equi­ty firms are buy­ing up com­pa­nies that pro­vide ser­vices we use and depend on: hos­pi­tals, nurs­ing homes, real estate, chain restau­rants and even pris­ons.

That’s caused alarm because pri­vate equi­ty firms have a rep­u­ta­tion for focus­ing ruth­less­ly on the bot­tom line to the detri­ment of those depend­ing on the company’s ser­vices. One study even found pri­vate equi­ty con­trol can kill you. Two new books argue the pri­vate equi­ty indus­try is not only killing you, it’s ruin­ing your local busi­ness­es by laden­ing them with debt, har­vest­ing their assets and push­ing them to bank­rupt­cy.

There are some ter­ri­ble abus­es that pri­vate equi­ty firms should be held account­able for, and the mar­ket does need to change. But mit­i­gat­ing the dam­age doesn’t require a bunch of new rules on pri­vate equi­ty itself. A bet­ter and less obvi­ous solu­tion would be fix­ing a dis­tor­tion in the mar­ket that’s pro­vid­ed pri­vate equi­ty funds with so much mon­ey in the first place. It starts with look­ing at the investors in these funds, and in par­tic­u­lar pub­lic sec­tor pen­sions that have pro­vid­ed some of the bags of cash that have empow­ered the reck­less behav­ior.

Some of the crit­i­cisms of pri­vate equi­ty are unfair. There’s noth­ing wrong with run­ning a com­pa­ny for prof­it. Pri­vate equi­ty can serve an impor­tant func­tion in the econ­o­my by mak­ing unpro­duc­tive com­pa­nies bet­ter. When it comes to mak­ing com­pa­nies more prof­itable and pro­duc­tive, pri­vate equi­ty firms have had a fair­ly suc­cess­ful track record. And while pri­vate equi­ty takeovers tend to lead to job cuts in the short term, over the long run more jobs are cre­at­ed.

Not all com­pa­nies are a good fit for pri­vate equi­ty, though, and in the last decade PE buy­outs have become asso­ci­at­ed with more job loss­es and less pro­duc­tiv­i­ty.

The change began when pri­vate equi­ty funds start­ed get­ting more mon­ey from pub­lic pen­sion funds, argued Colum­bia Busi­ness School Ph.D. can­di­date Vrin­da Mit­tal in a recent paper. Pub­lic pen­sions make up 31.3% of all investors to pri­vate equi­ty funds and con­tribute 67% of their cap­i­tal. Many of these pen­sions don’t have enough assets to pay out all their promised ben­e­fits. Mit­tal esti­mates that between 2006 and 2018, the cap­i­tal invest­ed in PE funds from the most under­fund­ed pub­lic pen­sions tripled to 15.6% of all com­mit­ted cap­i­tal.

These under­fund­ed pen­sions had a good rea­son to invest in pri­vate equi­ty. Ultra-low inter­est rates in the past 15 years added urgency to pen­sions’ need to boost returns. Pub­lic pen­sion account­ing stan­dards sug­gest the pen­sion funds mea­sure their lia­bil­i­ties based on the expect­ed rate of return on their invest­ments. The way it works is that pen­sion funds project future ben­e­fits and dis­count them to today’s dol­lars using this return esti­mate. The high­er the return, the low­er their lia­bil­i­ties appear. It’s an account­ing con­ven­tion that, to put it mild­ly, enrages finan­cial econ­o­mists because it doesn’t account for how risky the pension’s invest­ments are. Pub­lic pen­sion funds should account for risk because their ben­e­fits must be paid no mat­ter what hap­pens to finan­cial mar­kets. If the pen­sion can’t pay ben­e­fits, tax­pay­ers are on the hook.

The cur­rent account­ing stan­dards not only ignore risk, they cre­ate an incen­tive to invest in riski­er assets that claim high­er returns with lit­tle trans­paren­cy. Pri­vate equi­ty is per­fect for this because it locks up pen­sion fund mon­ey for years. In the mean­time, they can claim a high and sta­ble return because the pri­vate equi­ty invest­ments don’t have an objec­tive mar­ket val­ue. If you are an under­fund­ed pub­lic pen­sion, it’s the ide­al solu­tion because the high­er (on paper, at least) pri­vate equi­ty return will increase your over­all expect­ed return and, like mag­ic, your pen­sion looks much bet­ter fund­ed.

This is a prob­lem not only because the pen­sion fund will even­tu­al­ly real­ize its loss­es and may run out of mon­ey. It also cre­at­ed a big mar­ket dis­tor­tion that result­ed in a lot of mon­ey flood­ing into sub­par pri­vate equi­ty funds. Mittal’s argu­ment seems right to me: Flush with what he calls “des­per­ate cap­i­tal,” these pri­vate equi­ty funds made many poor invest­ments that result­ed in worse out­comes for the com­pa­nies they tar­get­ed.

...

The good news is that there’s a sim­ple solu­tion: revise the pub­lic pen­sion account­ing stan­dards. Pri­vate-sec­tor pen­sion plans must deter­mine their lia­bil­i­ties using the inter­est rates of bonds trad­ed in the mar­ket. Pub­lic-sec­tor pen­sions should do the same. Ide­al­ly the bonds used to mea­sure lia­bil­i­ties should have the same default risk as the pen­sion ben­e­fits. Since pub­lic pen­sions can’t default on their ben­e­fits (it is writ­ten into their state con­sti­tu­tions) the appro­pri­ate rate should be Trea­suries, or maybe munic­i­pal bonds. This would have been a heavy lift a few years ago because if you dis­count­ed future ben­e­fits with near zero inter­est rates, the under-fund­ed plans’ sit­u­a­tion would look dire. Today, the boost from high­er rates offers an oppor­tu­ni­ty to switch to a bet­ter stan­dard.

...

———–

“Pen­sion Funds Share Blame for Pri­vate Equity’s Hor­ror Sto­ries” by Alli­son Schrager; Bloomberg; 05/08/2023

“There are some ter­ri­ble abus­es that pri­vate equi­ty firms should be held account­able for, and the mar­ket does need to change. But mit­i­gat­ing the dam­age doesn’t require a bunch of new rules on pri­vate equi­ty itself. A bet­ter and less obvi­ous solu­tion would be fix­ing a dis­tor­tion in the mar­ket that’s pro­vid­ed pri­vate equi­ty funds with so much mon­ey in the first place. It starts with look­ing at the investors in these funds, and in par­tic­u­lar pub­lic sec­tor pen­sions that have pro­vid­ed some of the bags of cash that have empow­ered the reck­less behav­ior.”

If you are wor­ried about pri­vate equi­ty’s bru­tal track record of abus­es, there’s a pret­ty pow­er­ful rem­e­dy just sit­ting right there wait­ing to be used: end the per­verse account­ing incen­tives that have encour­age pen­sion funds to flood the pri­vate-equi­ty indus­try with bil­lions of dol­lars based on a lie. The kind of lie of fake high returns that have enticed so many pen­sion funds to engage in a kind of mutu­al­ly con­ve­nient fic­tion with pri­vate equi­ty firms that will keep all par­ties sat­is­fied until the music stops. A fic­tion so con­ve­nient that pen­sion fund mon­ey now accounts for rough­ly two-thirds of the cap­i­tal under pri­vate-equi­ty man­age­ment. In oth­er words, this con­ve­nient account­ing fic­tion has dou­bled as a ampli­fi­er for dam­age inflict­ed upon soci­ety at large by pri­vate-equi­ty’s heads-we-win-tails-you-lose busi­ness mod­el:

...
Some of the crit­i­cisms of pri­vate equi­ty are unfair. There’s noth­ing wrong with run­ning a com­pa­ny for prof­it. Pri­vate equi­ty can serve an impor­tant func­tion in the econ­o­my by mak­ing unpro­duc­tive com­pa­nies bet­ter. When it comes to mak­ing com­pa­nies more prof­itable and pro­duc­tive, pri­vate equi­ty firms have had a fair­ly suc­cess­ful track record. And while pri­vate equi­ty takeovers tend to lead to job cuts in the short term, over the long run more jobs are cre­at­ed.

Not all com­pa­nies are a good fit for pri­vate equi­ty, though, and in the last decade PE buy­outs have become asso­ci­at­ed with more job loss­es and less pro­duc­tiv­i­ty.

The change began when pri­vate equi­ty funds start­ed get­ting more mon­ey from pub­lic pen­sion funds, argued Colum­bia Busi­ness School Ph.D. can­di­date Vrin­da Mit­tal in a recent paper. Pub­lic pen­sions make up 31.3% of all investors to pri­vate equi­ty funds and con­tribute 67% of their cap­i­tal. Many of these pen­sions don’t have enough assets to pay out all their promised ben­e­fits. Mit­tal esti­mates that between 2006 and 2018, the cap­i­tal invest­ed in PE funds from the most under­fund­ed pub­lic pen­sions tripled to 15.6% of all com­mit­ted cap­i­tal.

These under­fund­ed pen­sions had a good rea­son to invest in pri­vate equi­ty. Ultra-low inter­est rates in the past 15 years added urgency to pen­sions’ need to boost returns. Pub­lic pen­sion account­ing stan­dards sug­gest the pen­sion funds mea­sure their lia­bil­i­ties based on the expect­ed rate of return on their invest­ments. The way it works is that pen­sion funds project future ben­e­fits and dis­count them to today’s dol­lars using this return esti­mate. The high­er the return, the low­er their lia­bil­i­ties appear. It’s an account­ing con­ven­tion that, to put it mild­ly, enrages finan­cial econ­o­mists because it doesn’t account for how risky the pension’s invest­ments are. Pub­lic pen­sion funds should account for risk because their ben­e­fits must be paid no mat­ter what hap­pens to finan­cial mar­kets. If the pen­sion can’t pay ben­e­fits, tax­pay­ers are on the hook.
...

And then Schrager points to anoth­er fact that is only going to grow as more and more pen­sion fund mon­ey flows into pri­vate equi­ty’s hands: not all pri­vate equi­ty firms are of the same cal­iber and with pen­sion funds now func­tion­ing and pri­vate-equi­ty’s the pri­ma­ry cus­tomer it’s inevitable that at least some of those bil­lions of dol­lars are being thrown at sub­par pri­vate-equi­ty funds. It’s not just invest­ment oppor­tu­ni­ties get­ting sys­tem­at­i­cal­ly crowd­ed out. It’s invest­ment tal­ent too:

...
The cur­rent account­ing stan­dards not only ignore risk, they cre­ate an incen­tive to invest in riski­er assets that claim high­er returns with lit­tle trans­paren­cy. Pri­vate equi­ty is per­fect for this because it locks up pen­sion fund mon­ey for years. In the mean­time, they can claim a high and sta­ble return because the pri­vate equi­ty invest­ments don’t have an objec­tive mar­ket val­ue. If you are an under­fund­ed pub­lic pen­sion, it’s the ide­al solu­tion because the high­er (on paper, at least) pri­vate equi­ty return will increase your over­all expect­ed return and, like mag­ic, your pen­sion looks much bet­ter fund­ed.

This is a prob­lem not only because the pen­sion fund will even­tu­al­ly real­ize its loss­es and may run out of mon­ey. It also cre­at­ed a big mar­ket dis­tor­tion that result­ed in a lot of mon­ey flood­ing into sub­par pri­vate equi­ty funds. Mittal’s argu­ment seems right to me: Flush with what he calls “des­per­ate cap­i­tal,” these pri­vate equi­ty funds made many poor invest­ments that result­ed in worse out­comes for the com­pa­nies they tar­get­ed.

...

The good news is that there’s a sim­ple solu­tion: revise the pub­lic pen­sion account­ing stan­dards. Pri­vate-sec­tor pen­sion plans must deter­mine their lia­bil­i­ties using the inter­est rates of bonds trad­ed in the mar­ket. Pub­lic-sec­tor pen­sions should do the same. Ide­al­ly the bonds used to mea­sure lia­bil­i­ties should have the same default risk as the pen­sion ben­e­fits. Since pub­lic pen­sions can’t default on their ben­e­fits (it is writ­ten into their state con­sti­tu­tions) the appro­pri­ate rate should be Trea­suries, or maybe munic­i­pal bonds. This would have been a heavy lift a few years ago because if you dis­count­ed future ben­e­fits with near zero inter­est rates, the under-fund­ed plans’ sit­u­a­tion would look dire. Today, the boost from high­er rates offers an oppor­tu­ni­ty to switch to a bet­ter stan­dard.
...

Do the sub­par pri­vate equi­ty fund man­agers charge sub­par fees too? It’s a nice thought but it’s hard to imag­ine that’s actu­al­ly the case for this heads-we-win-tails-you-lose indus­try. Instead, we can expect more of the same, but pre­sum­ably worse. Espe­cial­ly should a wave of pre­vi­ous­ly undis­closed loss­es belat­ed­ly get revealed as David Siro­ta warned. Don’t for­get the under­ly­ing log­ic of the CRE dou­ble down: good deals have to be snagged in order to make up for all the loss­es pil­ing up from last year’s CRE binge. So the worse the sur­prise write­downs get, the more com­pelling the log­ic to dou­ble down even more. Yes, the worse it turns out all these pri­vate equi­ty invest­ments ulti­mate­ly turn out to be, the more pen­sions funds are going to be com­pelled to dive into pri­vate equi­ty because they don’t have no where else to go. Pri­vate equi­ty has become the pen­sion fund indus­try’s last resort, for good or ill. That’s the dement­ed death spi­ral dynam­ic at work here. Well, a death spi­ral at least for the pen­sion­ers’ retire­ments. The fund man­agers of course be get­ting paid either way.

The best invest­ments are often the ones made when every­one is look­ing else­where. When the mar­ket zigs, the best investors zag. Of course, invest­ing in some­thing that almost every­one else is try­ing to get out of is all so a great way to lose your shirt. So what kind of invest­ment did the Uni­ver­si­ty of Cal­i­for­ni­a’s pen­sion fund make ear­li­er this year with its $4.5 bil­lion invest­ment in one of Black­stone’s real estate invest­ment trusts (REITs)? It’s a ques­tion that isn’t just poten­tial­ly weigh­ing on the minds of UC pen­sion­ers. It’s also a ques­tion for a grow­ing num­ber of renters. Espe­cial­ly stu­dent renters. Yes, this large invest­ment was made just months after this same REIT pur­chased 69 per­cent of Amer­i­can Cam­pus Com­mu­ni­ties (ACC), the US’s largest stu­dent hous­ing com­pa­ny, in a $12.8 bil­lion deal in August of 2022. Stu­dent rents from the nation’s largest stu­dent hous­ing com­pa­ny are now help­ing to pay the pen­sion of the largest pub­lic col­lege sys­tem. With Black­stone rak­ing in the hefty pri­vate equi­ty fees the whole time. Was this a good invest­ment?

But there’s anoth­er wrin­kle to this invest­ing deci­sion: that $4.5 bil­lion invest­ment did­n’t hap­pen at time when oth­er investors were scram­bling to cap­i­tal­ize on the avail­able REIT oppor­tu­ni­ties. It hap­pened as the oth­er investors in that same Black­stone REIT were mak­ing redemp­tion requests. So many redemp­tion requests that Black­stone was block­ing them. And it’s not like those redemp­tion requests end­ed after this $4.5 bil­lion UC infu­sion. In fact, In March, the Black­stone REIT received $4.5 bil­lion in redemp­tion requests, while only ful­fill­ing $666 mil­lion of those requests. Does that sound like a sound pri­vate equi­ty fund­ing to be dump­ing bil­lions of dol­lars into? Is the UC pen­sion sys­tem’s Black­stone REIT play ‘crazy like a fox’? Or just crazy?:

Jacobin

The Uni­ver­si­ty of Cal­i­for­nia Is Bail­ing Out Pri­vate Equi­ty Giant Black­stone

By Matthew Cun­ning­ham-Cook
04.24.2023

Amid a hous­ing cri­sis that is leav­ing thou­sands of its stu­dents and employ­ees home­less, the Uni­ver­si­ty of Cal­i­for­nia is bail­ing out pri­vate equi­ty behe­moth Black­stone, siphon­ing bil­lions of dol­lars to pri­va­tized stu­dent hous­ing and cor­po­rate land­lords.

As the world’s largest pri­vate equi­ty firm faces poten­tial loss­es from a cloudy real estate mar­ket, its exec­u­tives blocked jit­tery investors from with­draw­ing their mon­ey from one of its real estate funds, while insist­ing that rent increas­es and evic­tions will bol­ster returns.

Now, the Black­stone Group’s real estate invest­ment trust has received a multi­bil­lion-dol­lar bailout from a source whose employ­ees and stu­dents are already suf­fer­ing through the hous­ing cri­sis: California’s pub­lic uni­ver­si­ty sys­tem.

Just months after Blackstone’s real estate invest­ment trust pur­chased America’s largest own­er of pri­vate stu­dent hous­ing, the same trust received a $4.5 bil­lion infu­sion from the Uni­ver­si­ty of California’s Board of Regents, two of whom have close ties to the com­pa­ny. The invest­ment rewards the finan­cial firm only a few years after the com­pa­ny and its exec­u­tives spent $5.6 mil­lion to kill Cal­i­for­nia bal­lot ini­tia­tives that would have expand­ed rent con­trol in the state.

Black­stone, a firm that’s val­ued at $111 bil­lion and man­ages $991 bil­lion in assets, also faces broad­er head­winds in its real estate sec­tor. The prof­its that the firm dis­trib­utes to share­hold­ers plunged 36 per­cent last year, dri­ven by real estate loss­es.

Effec­tive­ly, Uni­ver­si­ty of Cal­i­for­nia (UC) is fun­nel­ing cash into pri­va­tized stu­dent hous­ing and cor­po­rate land­lords — dou­bling down on a con­tro­ver­sial invest­ment strat­e­gy that comes with a mas­sive lay­er of fees and Wall Street prof­its — instead of doing its part to address a grow­ing hous­ing cri­sis, one that affects its stu­dents and employ­ees.

In 2021, 5 per­cent of UC stu­dents, or more than four­teen thou­sand, expe­ri­enced home­less­ness, while the university’s unions report that many of their most­ly blue-col­lar mem­bers sim­ply can­not make ends meet due to California’s spi­ral­ing cost of rental hous­ing.

The lat­est episode revolves around the Black­stone Real Estate Income Trust, or BREIT. In August 2022, BREIT pur­chased 69 per­cent of Amer­i­can Cam­pus Com­mu­ni­ties (ACC), the country’s largest stu­dent hous­ing com­pa­ny, in a $12.8 bil­lion deal. ACC’s busi­ness mod­el is built around rent rev­enues; in Jan­u­ary 2022 the company’s CEO boast­ed that it was “expe­ri­enc­ing the most sub­stan­tial fun­da­men­tal tail­winds we’ve seen in many years” thanks in part to soar­ing rents.

ACC has apart­ments at the Uni­ver­si­ty of Cal­i­for­nia, Berke­ley, and the Uni­ver­si­ty of Cal­i­for­nia, Irvine.

Five months after this acqui­si­tion, the UC Regents pumped $4.5 bil­lion into BREIT. Around the same time, Black­stone spent more than $150,000 in the final quar­ter of 2022 on lob­by­ing UC for more invest­ment dol­lars, dou­bling the amount it spent the pre­vi­ous quar­ter.

In Decem­ber, Nadeem Meghji, Blackstone’s head of real estate for the Amer­i­c­as, told CNBC that UC’s unprece­dent­ed bailout of BREIT “changed the nar­ra­tive” around the fund.

That same month, Black­stone began block­ing redemp­tions to investors, after it received an influx of redemp­tion requests. But that didn’t stop Black­stone from dis­trib­ut­ing to itself more than $200 mil­lion in man­age­ment fees in the fourth quar­ter of 2022, a Lever review of Secu­ri­ties and Exchange Com­mis­sion (SEC) fil­ings show. Between man­age­ment and per­for­mance fees, Black­stone extract­ed more than $1.5 bil­lion in fees from the $50 bil­lion fund in 2022.

Black­stone CEO Stephen Schwarz­man earned $1.3 bil­lion in 2022 and has a net worth of $30.7 bil­lion, accord­ing to Bloomberg, and he is a major donor to Repub­li­can can­di­dates.

Now, in a near­ly unprece­dent­ed coor­di­nat­ed inter­ven­tion, the university’s labor unions — rep­re­sent­ing 110,000 work­ers — have called on UC to divest itself not just from the university’s hold­ings in the Black­stone real estate fund, but all of the university’s $6.5 bil­lion invest­ed in Black­stone hold­ings.

“Essen­tial­ly UC is invest­ing in a cor­po­ra­tion that fur­ther dri­ves UC’s own work­ers’ hous­ing inse­cu­ri­ty,” said Kathryn Lybarg­er, the Pres­i­dent of Amer­i­can Fed­er­a­tion of State, Coun­ty & Munic­i­pal Employ­ees (AFSCME) Local 3299, which rep­re­sents blue-col­lar and health care work­ers at the Uni­ver­si­ty of Cal­i­for­nia. “The bot­tom line is that people’s hous­ing should not be a basis for mak­ing a prof­it, espe­cial­ly when it’s a pub­lic insti­tu­tion like UC. We’re demand­ing they divest and it’s on the scale of divest­ing from South Africa in the ’80s. We’re talk­ing about hous­ing as a human right, not as an invest­ing oppor­tu­ni­ty.”

Blackstone’s Hous­ing Play

Real estate invest­ment trusts are pools of investor-backed cash that pur­chase real estate. While pen­sion funds rou­tine­ly invest in both real estate invest­ment trusts (REITs) and pri­vate equi­ty real estate, it is extreme­ly uncom­mon to have a pen­sion effec­tive­ly do a bailout of a fund fac­ing mas­sive redemp­tion requests.

Blackstone’s BREIT dif­fers sub­stan­tial­ly from the $1.3 tril­lion REIT mar­ket. Near­ly all REITs are pub­licly trad­ed, which means that investors can cash out their mon­ey at will. This is not the case with BREIT, which allows Black­stone to sus­pend redemp­tions.

In response to ques­tions from the Lever, Black­stone spokesman Jef­frey Kauth not­ed in an email that “BREIT is not a mutu­al fund and has nev­er gat­ed. It is a semi-liq­uid prod­uct and is work­ing exact­ly as planned.” “Gat­ing” refers to a prac­tice by hedge funds and pri­vate equi­ty where redemp­tions are entire­ly blocked, as opposed to just par­tial­ly blocked, like with BREIT.

Black­stone is the largest pri­vate land­lord in the coun­try, own­ing three hun­dred thou­sand units across the Unit­ed States. In Cal­i­for­nia alone, Black­stone and its affil­i­ates, includ­ing BREIT, own at least nine thou­sand hous­ing units, includ­ing con­cen­tra­tions in San Diego, Los Ange­les, Sacra­men­to, and the Bay Area, accord­ing to research done by the Pri­vate Equi­ty Stake­hold­er Project.

Those units tend to be locat­ed in low­er-income cen­sus tracts, where on aver­age res­i­dents make rough­ly 25 per­cent less than the state’s medi­an house­hold income. Over the past few years, BREIT has also made a play into mobile home parks, acquir­ing near­ly six thou­sand units in the San Diego area, where Black­stone has been rou­tine­ly jack­ing up list­ed rents by 40 per­cent or more.

Esca­lat­ing hous­ing costs are inte­gral to Blackstone’s busi­ness strat­e­gy. “Our major con­cern with Black­stone is that this is a com­pa­ny whose mod­el for mak­ing mon­ey for investors is to buy up rental prop­er­ties and raise the rent,” said Lybarg­er at AFSCME.

Black­stone spent more than $5.6 mil­lion oppos­ing a 2018 bal­lot ini­tia­tive that would have allowed Cal­i­for­nia cities to imple­ment new rent con­trol mea­sures.

In 2019, the UN accused Black­stone of “wreak­ing hav­oc” on the hous­ing mar­ket by its aggres­sive pur­suit of evic­tions and high­er rents. Some ten­ants have suc­cess­ful­ly fought back as it seeks to expand its pres­ence in the hous­ing mar­ket, how­ev­er. In Jan­u­ary, ten­ants at the Stuy­Town com­plex in New York City suc­cess­ful­ly fought an effort to raise rents, and in San Diego, Black­stone ten­ants have formed a union.

“We believe we have the most favor­able res­i­dent poli­cies among any large land­lord in the US, includ­ing not mak­ing a sin­gle non­pay­ment evic­tion for over two years dur­ing COVID,” not­ed Kauth in his email.“We oper­ate in accor­dance with California’s rent sta­bi­liza­tion laws and are invest­ing $100 mil­lion to make these com­mu­ni­ties bet­ter places to live.”

But some BREIT ten­ants say that if any­thing, the trust’s mas­sive for­ay into hous­ing has been any­thing but ben­e­fi­cial.

One ten­ant, Michael McBride, says that since BREIT pur­chased his apart­ment com­plex in Chu­la Vista out­side of San Diego a cou­ple of years ago, basic main­te­nance has fall­en by the way­side. It took “at least” a month for BREIT to fix the heat in his apart­ment after he had com­plained about it in win­ter.

...

BREIT’s approach has late­ly faced tur­bu­lence. Because the fund is sub­stan­tial­ly indebt­ed — it car­ries $90 bil­lion in debt on $140 bil­lion in total assets — even small down­turns like the recent eco­nom­ic decline put the fund in jeop­ardy, since both gains and loss­es are mag­ni­fied because of high lever­age.

What’s more, BREIT has a small but sig­nif­i­cant por­tion of its hold­ings in the office and retail sec­tor, which have been bat­tered in the post-pan­dem­ic econ­o­my. Ear­li­er this month, BREIT sold two office tow­ers in Orange Coun­ty, Cal­i­for­nia, for 36 per­cent less than it paid for them nine years ago.

...

Such upheaval has led many BREIT investors to get cold feet. In March, BREIT received $4.5 bil­lion in redemp­tion requests, but only ful­filled $666 mil­lion of them.

But now, UC has come to the res­cue. In Jan­u­ary, the uni­ver­si­ty announced it was invest­ing $4.5 bil­lion in the strug­gling fund — which in effect allows it to start refund­ing oth­er investors’ mon­ey.

“I Have to Make Some Cap­i­tal­is­tic Deci­sions”

UC’s pen­sion sys­tem is fair­ly unique in that work­ers have no pow­er over how invest­ment deci­sions are made. All deci­sions are made by the regents, which are appoint­ed by the Cal­i­for­nia gov­er­nor for twelve-year terms.

One of the main deci­sion-mak­ers behind the plan to pump bil­lions of UC dol­lars into Black­stone was Richard Sher­man, chair of the UC Invest­ment Com­mit­tee, who has strong con­nec­tions to the invest­ment firm. On Jan­u­ary 3, Sher­man announced in a Black­stone press release, “This type of large, oppor­tunis­tic invest­ment effec­tive­ly lever­ages the UC’s more than $150 bil­lion port­fo­lio to ben­e­fit the 600,000 stu­dents, fac­ul­ty, staff, and pen­sion­ers from our 10 cam­pus­es and six aca­d­e­m­ic health cen­ters.”

Sher­man, who heads up music mogul David Geffen’s invest­ment office, col­lab­o­rat­ed with Black­stone on the 2012 buy­out of music pub­lish­er EMI. What’s more, the late Black­stone cofounder Pete Peter­son pur­chased his New York pent­house from Gef­fen in 2007.

An addi­tion­al mem­ber of the eleven-per­son Invest­ment Com­mit­tee, Mark Robin­son, also has ties to Black­stone. Robin­son is a part­ner at invest­ment bank­ing firm Cen­ter­view Part­ners, which advised Black­stone on a $2.2 bil­lion acqui­si­tion in 2021.

On behalf of the regents, the invest­ment was launched by Jagdeep Singh Bach­her, UC’s chief invest­ment offi­cer — who has been accused of mak­ing invest­ments in response to pres­sure from indi­vid­ual regents with con­flicts of inter­est in the past. In 2018, he invest­ed an unprece­dent­ed $240 mil­lion into a fund meant for high-net-worth indi­vid­u­als head­ed by the for­mer chair of the Regents’ Invest­ment Com­mit­tee, Paul Wachter.

Accord­ing to Kauth, the Black­stone spokesper­son, “The UC Invest­ments team saw [Black­stone pres­i­dent] Jon Gray speak­ing on CNBC in Decem­ber and reached out to Black­stone to see if they could be help­ful by deploy­ing cap­i­tal in a way that would cre­ate a win-win. Fol­low­ing the ini­tial call, UC Invest­ments did exten­sive dili­gence on the port­fo­lio and as a result of that process, decid­ed to invest $4 bil­lion in the fund. To sug­gest that the invest­ment was the result of any­thing oth­er than robust dili­gence is a com­plete mis­char­ac­ter­i­za­tion.”

Kauth added, “Black­stone has nev­er had a cor­po­rate PAC or made cor­po­rate dona­tions to polit­i­cal can­di­dates. The firm has always been bipar­ti­san, and all of our exec­u­tives’ polit­i­cal dona­tions are strict­ly per­son­al.” Schwarz­man pumped $20 mil­lion into the Super­PACs of con­gres­sion­al Repub­li­cans in the 2022 elec­tion and was a major advis­er to Don­ald Trump.

In response to uproar over UC’s invest­ment in Black­stone, Bach­her played it off as a zero-sum game of cap­i­tal­ism.

“The job of this team day in and day out is to pick assets that are going to be accre­tive to future gen­er­a­tions and future retirees,” Bach­her said at a regents meet­ing in March. “And to do that… I have to make some cap­i­tal­is­tic deci­sions. And that deci­sion around Black­stone… was pure­ly an invest­ment deci­sion for the ben­e­fit of the UC… and to help the needs of our pen­sion­ers and our endow­ment.”

But a Lever review of UC’s per­for­mance under Bachher’s lead­er­ship shows that his “cap­i­tal­is­tic“ invest­ment deci­sions have result­ed in the university’s pen­sion and endow­ment funds mas­sive­ly trail­ing a plain vanil­la index fund of stocks and bonds.

Had the pen­sion fund pur­sued a low­er-risk index fund strat­e­gy for the last decade — the kind advo­cat­ed by War­ren Buf­fett — it would now boast $32 bil­lion more in its cof­fers or 40 per­cent more than its cur­rent val­ue. Like­wise, the university’s endow­ment fund would have an addi­tion­al $6.4 bil­lion in its cof­fers or 36 per­cent increase of its cur­rent val­ue.

In response to a request for com­ment from the Lever, the uni­ver­si­ty spokesper­son stat­ed that a sub­stan­tial por­tion of the UC’s invest­ment approach was in index funds. They did not answer ques­tions about poor fund per­for­mance under Bachher’s lead­er­ship, and Bach­her declined an inter­view with the Lever.

...

“A Mean­ing­ful Increase in Eco­nom­ic Occu­pan­cy”

While Black­stone likes to empha­size that it halt­ed all non­pay­ment evic­tions dur­ing the height of the pan­dem­ic, that pol­i­cy is no longer in place. UC’s bailout came just as Black­stone began ramp­ing up evic­tions.

The Finan­cial Times report­ed at the end of Jan­u­ary that Blackstone’s glob­al real estate head had said that the firm was “see­ing a mean­ing­ful increase in eco­nom­ic occu­pan­cy as we move past what were vol­un­tary evic­tion restric­tions that had been in place for the last cou­ple of years,” acknowl­edg­ing that the removal of evic­tion restric­tions has allowed Black­stone to improve its cash flow.

The arti­cle also stat­ed that con­sul­tants work­ing with Black­stone had reached out to local elect­ed offi­cials in Cal­i­for­nia to say that Black­stone planned on restart­ing evic­tion pro­ceed­ings that had been dor­mant dur­ing the COVID-19 pan­dem­ic.

Research from the Pri­vate Equi­ty Stake­hold­er Project in March found that Black­stone launched evic­tion pro­ceed­ings against a ten­ant in Orange Coun­ty, Flori­da, for being one month late on rent.

Addi­tion­al­ly, Black­stone declared in Decem­ber report­ing from Seek­ing Alpha that what they were charg­ing for rents could go 20 per­cent high­er in the mul­ti­fam­i­ly and indus­tri­al sec­tors if they charged what they con­sid­ered to be “mar­ket rates.”

An esti­mat­ed 2.5 mil­lion Cal­i­for­ni­ans are cost bur­dened in pay­ing their rent, mean­ing that they spend more than 30 per­cent of their income on hous­ing, accord­ing to a report pro­duced at the end of Feb­ru­ary by the Cal­i­for­nia Leg­isla­tive Analyst’s Office.

———-

“The Uni­ver­si­ty of Cal­i­for­nia Is Bail­ing Out Pri­vate Equi­ty Giant Black­stone” vy Matthew Cun­ning­ham-Cook; Jacobin; 04/24/2023

“Just months after Blackstone’s real estate invest­ment trust pur­chased America’s largest own­er of pri­vate stu­dent hous­ing, the same trust received a $4.5 bil­lion infu­sion from the Uni­ver­si­ty of California’s Board of Regents, two of whom have close ties to the com­pa­ny. The invest­ment rewards the finan­cial firm only a few years after the com­pa­ny and its exec­u­tives spent $5.6 mil­lion to kill Cal­i­for­nia bal­lot ini­tia­tives that would have expand­ed rent con­trol in the state.”

The Uni­ver­si­ty of Cal­i­for­nia just pumped $4.5 bil­lion into a Black­stone’s REITs that pur­chased 69 per­cent of Amer­i­can Cam­pus Com­mu­ni­ties (ACC), the largest stu­dent hous­ing com­pa­ny in the US, in August of 2022. Now, if the ACC was ded­i­cat­ed to pro­vid­ing stu­dents with afford­able hous­ing, that might be seen as a some­what noble area of invest­ment for the UC pen­sion plan. But this isn’t that kind of an invest­ment. It’s a prof­it-max­i­miz­ing invest­ment. Which means it’s a stu­dent-hous­ing-min­i­miz­ing invest­ment too. Hence the four­teen thou­sands home­less UC stu­dents:

...
Effec­tive­ly, Uni­ver­si­ty of Cal­i­for­nia (UC) is fun­nel­ing cash into pri­va­tized stu­dent hous­ing and cor­po­rate land­lords — dou­bling down on a con­tro­ver­sial invest­ment strat­e­gy that comes with a mas­sive lay­er of fees and Wall Street prof­its — instead of doing its part to address a grow­ing hous­ing cri­sis, one that affects its stu­dents and employ­ees.

In 2021, 5 per­cent of UC stu­dents, or more than four­teen thou­sand, expe­ri­enced home­less­ness, while the university’s unions report that many of their most­ly blue-col­lar mem­bers sim­ply can­not make ends meet due to California’s spi­ral­ing cost of rental hous­ing.

The lat­est episode revolves around the Black­stone Real Estate Income Trust, or BREIT. In August 2022, BREIT pur­chased 69 per­cent of Amer­i­can Cam­pus Com­mu­ni­ties (ACC), the country’s largest stu­dent hous­ing com­pa­ny, in a $12.8 bil­lion deal. ACC’s busi­ness mod­el is built around rent rev­enues; in Jan­u­ary 2022 the company’s CEO boast­ed that it was “expe­ri­enc­ing the most sub­stan­tial fun­da­men­tal tail­winds we’ve seen in many years” thanks in part to soar­ing rents.

ACC has apart­ments at the Uni­ver­si­ty of Cal­i­for­nia, Berke­ley, and the Uni­ver­si­ty of Cal­i­for­nia, Irvine.

...

Now, in a near­ly unprece­dent­ed coor­di­nat­ed inter­ven­tion, the university’s labor unions — rep­re­sent­ing 110,000 work­ers — have called on UC to divest itself not just from the university’s hold­ings in the Black­stone real estate fund, but all of the university’s $6.5 bil­lion invest­ed in Black­stone hold­ings.

“Essen­tial­ly UC is invest­ing in a cor­po­ra­tion that fur­ther dri­ves UC’s own work­ers’ hous­ing inse­cu­ri­ty,” said Kathryn Lybarg­er, the Pres­i­dent of Amer­i­can Fed­er­a­tion of State, Coun­ty & Munic­i­pal Employ­ees (AFSCME) Local 3299, which rep­re­sents blue-col­lar and health care work­ers at the Uni­ver­si­ty of Cal­i­for­nia. “The bot­tom line is that people’s hous­ing should not be a basis for mak­ing a prof­it, espe­cial­ly when it’s a pub­lic insti­tu­tion like UC. We’re demand­ing they divest and it’s on the scale of divest­ing from South Africa in the ’80s. We’re talk­ing about hous­ing as a human right, not as an invest­ing oppor­tu­ni­ty.”
...

But the con­tro­ver­sy over this invest­ment isn’t sim­ply the cap­i­tal­ist moral­i­ty of pay­ing for pen­sion by pau­per­ing stu­dents. It’s the fact that this $4.5 bil­lion invest­ment hap­pened at the same time Black­stone was fac­ing mas­sive redemp­tion requests from the oth­er investors in the fund. So many redemp­tion requests that Black­stone began block­ing redemp­tion requests in Decem­ber, the same month Nadeem Meghji, Blackstone’s head of real estate for the Amer­i­c­as, announced on CNBC that the $4.5 bil­lion UC invest­ment “changed the nar­ra­tive”. And through­out this all, Black­stone dis­trib­uted $200 mil­lion to itself in man­age­ment fees. You almost could­n’t come up with a bet­ter exam­ple of the ‘heads we win, tails you lose’ pri­vate equi­ty busi­ness mod­el:

...
Five months after this acqui­si­tion, the UC Regents pumped $4.5 bil­lion into BREIT. Around the same time, Black­stone spent more than $150,000 in the final quar­ter of 2022 on lob­by­ing UC for more invest­ment dol­lars, dou­bling the amount it spent the pre­vi­ous quar­ter.

In Decem­ber, Nadeem Meghji, Blackstone’s head of real estate for the Amer­i­c­as, told CNBC that UC’s unprece­dent­ed bailout of BREIT “changed the nar­ra­tive” around the fund.

That same month, Black­stone began block­ing redemp­tions to investors, after it received an influx of redemp­tion requests. But that didn’t stop Black­stone from dis­trib­ut­ing to itself more than $200 mil­lion in man­age­ment fees in the fourth quar­ter of 2022, a Lever review of Secu­ri­ties and Exchange Com­mis­sion (SEC) fil­ings show. Between man­age­ment and per­for­mance fees, Black­stone extract­ed more than $1.5 bil­lion in fees from the $50 bil­lion fund in 2022.

...

Real estate invest­ment trusts are pools of investor-backed cash that pur­chase real estate. While pen­sion funds rou­tine­ly invest in both real estate invest­ment trusts (REITs) and pri­vate equi­ty real estate, it is extreme­ly uncom­mon to have a pen­sion effec­tive­ly do a bailout of a fund fac­ing mas­sive redemp­tion requests.

Blackstone’s BREIT dif­fers sub­stan­tial­ly from the $1.3 tril­lion REIT mar­ket. Near­ly all REITs are pub­licly trad­ed, which means that investors can cash out their mon­ey at will. This is not the case with BREIT, which allows Black­stone to sus­pend redemp­tions.

In response to ques­tions from the Lever, Black­stone spokesman Jef­frey Kauth not­ed in an email that “BREIT is not a mutu­al fund and has nev­er gat­ed. It is a semi-liq­uid prod­uct and is work­ing exact­ly as planned.” “Gat­ing” refers to a prac­tice by hedge funds and pri­vate equi­ty where redemp­tions are entire­ly blocked, as opposed to just par­tial­ly blocked, like with BREIT.

...

Such upheaval has led many BREIT investors to get cold feet. In March, BREIT received $4.5 bil­lion in redemp­tion requests, but only ful­filled $666 mil­lion of them.

But now, UC has come to the res­cue. In Jan­u­ary, the uni­ver­si­ty announced it was invest­ing $4.5 bil­lion in the strug­gling fund — which in effect allows it to start refund­ing oth­er investors’ mon­ey.

...

So why did the UC board of Regents decide to make a $4.5 bil­lion invest­ment in a fund that was sus­pend­ing redemp­tions at the time? Well, per­haps the inces­tu­ous rela­tion­ship between Black­stone and the UC Invest­ment Com­mit­tee has some­thing to do with it:

...
UC’s pen­sion sys­tem is fair­ly unique in that work­ers have no pow­er over how invest­ment deci­sions are made. All deci­sions are made by the regents, which are appoint­ed by the Cal­i­for­nia gov­er­nor for twelve-year terms.

One of the main deci­sion-mak­ers behind the plan to pump bil­lions of UC dol­lars into Black­stone was Richard Sher­man, chair of the UC Invest­ment Com­mit­tee, who has strong con­nec­tions to the invest­ment firm. On Jan­u­ary 3, Sher­man announced in a Black­stone press release, “This type of large, oppor­tunis­tic invest­ment effec­tive­ly lever­ages the UC’s more than $150 bil­lion port­fo­lio to ben­e­fit the 600,000 stu­dents, fac­ul­ty, staff, and pen­sion­ers from our 10 cam­pus­es and six aca­d­e­m­ic health cen­ters.”

Sher­man, who heads up music mogul David Geffen’s invest­ment office, col­lab­o­rat­ed with Black­stone on the 2012 buy­out of music pub­lish­er EMI. What’s more, the late Black­stone cofounder Pete Peter­son pur­chased his New York pent­house from Gef­fen in 2007.

An addi­tion­al mem­ber of the eleven-per­son Invest­ment Com­mit­tee, Mark Robin­son, also has ties to Black­stone. Robin­son is a part­ner at invest­ment bank­ing firm Cen­ter­view Part­ners, which advised Black­stone on a $2.2 bil­lion acqui­si­tion in 2021.

On behalf of the regents, the invest­ment was launched by Jagdeep Singh Bach­her, UC’s chief invest­ment offi­cer — who has been accused of mak­ing invest­ments in response to pres­sure from indi­vid­ual regents with con­flicts of inter­est in the past. In 2018, he invest­ed an unprece­dent­ed $240 mil­lion into a fund meant for high-net-worth indi­vid­u­als head­ed by the for­mer chair of the Regents’ Invest­ment Com­mit­tee, Paul Wachter.
...

And then there’s the fact that Black­stone did­n’t just spend $5.6 mil­lion oppos­ing a Cal­i­for­nia rent con­trol bal­lot ini­tia­tive. Its man­age­ment prac­tices as land­lord have been so harm­ful towards renters that the UN accused it of “wreak­ing hav­oc” on hous­ing mar­ket. It’s so bad the UN felt the need to make a state­ment:

...
Black­stone is the largest pri­vate land­lord in the coun­try, own­ing three hun­dred thou­sand units across the Unit­ed States. In Cal­i­for­nia alone, Black­stone and its affil­i­ates, includ­ing BREIT, own at least nine thou­sand hous­ing units, includ­ing con­cen­tra­tions in San Diego, Los Ange­les, Sacra­men­to, and the Bay Area, accord­ing to research done by the Pri­vate Equi­ty Stake­hold­er Project.

Those units tend to be locat­ed in low­er-income cen­sus tracts, where on aver­age res­i­dents make rough­ly 25 per­cent less than the state’s medi­an house­hold income. Over the past few years, BREIT has also made a play into mobile home parks, acquir­ing near­ly six thou­sand units in the San Diego area, where Black­stone has been rou­tine­ly jack­ing up list­ed rents by 40 per­cent or more.

Esca­lat­ing hous­ing costs are inte­gral to Blackstone’s busi­ness strat­e­gy. “Our major con­cern with Black­stone is that this is a com­pa­ny whose mod­el for mak­ing mon­ey for investors is to buy up rental prop­er­ties and raise the rent,” said Lybarg­er at AFSCME.

Black­stone spent more than $5.6 mil­lion oppos­ing a 2018 bal­lot ini­tia­tive that would have allowed Cal­i­for­nia cities to imple­ment new rent con­trol mea­sures.

In 2019, the UN accused Black­stone of “wreak­ing hav­oc” on the hous­ing mar­ket by its aggres­sive pur­suit of evic­tions and high­er rents. Some ten­ants have suc­cess­ful­ly fought back as it seeks to expand its pres­ence in the hous­ing mar­ket, how­ev­er. In Jan­u­ary, ten­ants at the Stuy­Town com­plex in New York City suc­cess­ful­ly fought an effort to raise rents, and in San Diego, Black­stone ten­ants have formed a union.
...

So is Black­stone at least mak­ing the out­sized mar­ket-beat­ing returns that the­o­ret­i­cal­ly jus­ti­fy squeez­ing renters to pay pen­sion­ers? Does this bru­tal ‘zero-sum game of cap­i­tal­ism’ at least help pay for grand­ma’s retire­ment? Nope. Low risk index funds would have per­formed bet­ter over the last decade:

...
In response to uproar over UC’s invest­ment in Black­stone, Bach­her played it off as a zero-sum game of cap­i­tal­ism.

“The job of this team day in and day out is to pick assets that are going to be accre­tive to future gen­er­a­tions and future retirees,” Bach­her said at a regents meet­ing in March. “And to do that… I have to make some cap­i­tal­is­tic deci­sions. And that deci­sion around Black­stone… was pure­ly an invest­ment deci­sion for the ben­e­fit of the UC… and to help the needs of our pen­sion­ers and our endow­ment.”

But a Lever review of UC’s per­for­mance under Bachher’s lead­er­ship shows that his “cap­i­tal­is­tic“ invest­ment deci­sions have result­ed in the university’s pen­sion and endow­ment funds mas­sive­ly trail­ing a plain vanil­la index fund of stocks and bonds.

Had the pen­sion fund pur­sued a low­er-risk index fund strat­e­gy for the last decade — the kind advo­cat­ed by War­ren Buf­fett — it would now boast $32 bil­lion more in its cof­fers or 40 per­cent more than its cur­rent val­ue. Like­wise, the university’s endow­ment fund would have an addi­tion­al $6.4 bil­lion in its cof­fers or 36 per­cent increase of its cur­rent val­ue.

In response to a request for com­ment from the Lever, the uni­ver­si­ty spokesper­son stat­ed that a sub­stan­tial por­tion of the UC’s invest­ment approach was in index funds. They did not answer ques­tions about poor fund per­for­mance under Bachher’s lead­er­ship, and Bach­her declined an inter­view with the Lever.
...

The renters got squeezed for noth­ing. Well, not noth­ing. Black­stone got a big pay­day. Behold the glo­ries of cap­i­tal­ism!

But who knows. Maybe this real­ly will end up being a great invest­ment for the UC pen­sion sys­tem in the long run. Time will tell. Time and the abil­i­ty of Black­stone to ‘squeeze blood from a stone’ in extract­ing every last pen­ny it can from all those renters. Includ­ing all those UC stu­dent renters. Every last pen­ny is going to be need­ed to pay those hefty pri­vate equi­ty fees. Fees that will be paid whether or not the UC pen­sion sys­tem is crazy like a fox or just crazy. Which makes this a reminder that there’s no con­flict between ‘zero-sum cap­i­tal­ism’ and ‘head we win, tails you lose’ busi­ness mod­els. Quite the oppo­site.

Finan­cial mar­kets are no stranger to diverg­ing opin­ions. But they aren’t exact­ly ‘diver­gent opinion’-friendly either. Espe­cial­ly when actu­al­ly buy­ing and sell­ing and hap­pen­ing in the midst of those diver­gent opin­ions. Some­one is get­ting a deal and some­one else is end­ing up with the short end of the stick.

So when we see the fol­low­ing sto­ry about pub­lic and pri­vate real estate funds arriv­ing at sharply diver­gent com­mer­cial real estate (CRE) val­u­a­tions, we have to ask: who is get­ting the short end of the CRE stick? Are the pub­licly trad­ed Real Estate Invest­ment Trusts (REITs) over­ly bear­ish in their CRE val­u­a­tions? Or are the pri­vate real estate funds — the same pri­vate-equi­ty-man­aged funds pub­lic pen­sions have been dou­bling down on — over­ly opti­mistic? That’s one of the big ques­tions raised by a report issued a cou­ple of weeks ago that com­pared the implied “cap rates” between pub­licly trad­ed REITs and their pri­vate real estate fund coun­ter­parts and found sig­nif­i­cant dif­fer­ences in how these dif­fer­ent mar­ket play­ers are esti­mat­ing the future val­ues of var­i­ous CRE invest­ments. Specif­i­cal­ly, it turns out pub­lic REITs are con­sis­tent­ly issu­ing high­er cap rate esti­mates than their pri­vate-equi­ty counter-parts, includ­ing 27 per­cent high­er cap rates for office build­ings.

What are the impli­ca­tions of a pub­lic-pri­vate cap-rate gap? Well, since high­er cap rates are asso­ci­at­ed with high­er-risk (and low­er val­ued) CRE projects, this report is indi­cat­ing that pub­lic REITs are sys­tem­at­i­cal­ly using low­er val­u­a­tion esti­mates for CRE projects than their pri­vate-equi­ty counter-parts. So pri­vate-equi­ty is oper­at­ing off of high­er over­all CRE val­ue esti­mates, and this pub­lic-pri­vate val­u­a­tion gab is hap­pen­ing at the same time pub­lic pen­sion-funds are allow­ing pri­vate equi­ty funds to lead them on a grand CRE dou­ble-down gam­ble. Is this a red flag? Because that seems like maybe it’s a red flag:

Com­mer­cial Observ­er

Report: Pri­vate Mar­ket Lags Pub­lic REITs in CRE Cap Rate Met­rics
Cen­ter­Square Invest­ment Man­age­ment found val­u­a­tion gaps between both mar­kets

By Bri­an Pas­cus
June 27, 2023 12:34 pm

In office real estate — as in life sup­port­ing the New York Mets — real­i­ty often dif­fers from per­cep­tion.

A new report from a real estate-focused invest­ment firm found sharp diver­gences between real estate invest­ment trust (REIT) implied cap rate met­rics and pri­vate mar­ket for­ward-out­look cap rates, under­scor­ing the dis­con­nect between pri­vate mar­ket and pub­lic assump­tions around com­mer­cial real estate val­ues.

The report also showed sig­nif­i­cant val­u­a­tion gaps in how the pub­lic and pri­vate mar­kets view the office, hotel and life sci­ences sec­tors.

Cen­ter­Square Invest­ment Man­age­ment, a Philadel­phia-based real estate invest­ment firm, exam­ined implied cap rate met­rics for rough­ly 200 pub­licly list­ed U.S. REIT com­pa­nies. The firm then used pri­vate real estate data from the NFI-ODCE — an index of the largest pri­vate real estate funds — and esti­mates from ana­lysts and bro­kers. Both data sets use sec­ond-quar­ter 2023 met­rics.

Cen­ter­Square esti­mat­ed that the val­u­a­tion gap between all pub­lic REITs and pri­vate mar­ket val­ues rose from 28 basis points to 50 basis points between the first quar­ter of 2023 and the sec­ond quar­ter, with the pub­lic REITs cap rate ris­ing to 5.96 per­cent and the for­ward-marked pri­vate mar­kets cap rate hit­ting 5.46 per­cent in the sec­ond quar­ter — a val­u­a­tion gap of 8.3 per­cent.

“In the ide­al world, where mar­kets are com­plete­ly ratio­nal, the pub­lic mar­ket val­u­a­tions would reflect what we are see­ing in that for­ward-marked pri­vate mar­ket cap rate,” Uma Mori­ar­i­ty, senior invest­ment strate­gist at Cen­ter­Square, told Com­mer­cial Observ­er. “But there’s a real­ly mean­ing­ful dis­con­nect between where trans­ac­tions are hap­pen­ing and where val­u­a­tions are hap­pen­ing in the pri­vate mar­ket … com­pared to where we think pri­vate mar­ket val­u­a­tions should be.”

Cap rates are among the most crit­i­cal met­rics for mea­sur­ing com­mer­cial real estate. They can gen­er­al­ly be defined as the yields on real estate invest­ments and are found by divid­ing net oper­at­ing income by asset val­ue. Cap rates typ­i­cal­ly rise and fall in con­cert with inter­est rates; low­er cap rates sug­gest low­er inter­est rates, cheap­er lever­age, high­er prices for prop­er­ty and thus greater val­ues, while high­er cap rates sug­gest the inverse: high risk, low prices and low val­ues on those assets.

For most CRE under­writ­ing to make sense, a building’s cap rate should be high­er than the annu­al debt cost, oth­er­wise cash flow will move toward pay­ing off the debt rather than pro­vid­ing the spon­sor with an annu­al prof­it. The rise in inter­est rates over the past 15 months has pro­duced cap rate expan­sion, Mori­ar­i­ty said.

CenterSquare’s research report found that pub­lic REITs cap rates for offices — the industry’s most dis­tressed sec­tor — have reached 8.75 per­cent, com­pared to a for­ward-marked pri­vate mar­kets cap rate of 6.39 per­cent, reflect­ing a pub­lic-pri­vate val­u­a­tion gap of 27 per­cent.

Mori­ar­i­ty said that pub­lic mar­ket sen­ti­ment toward office is “over­ly bear­ish.” Mean­while, pri­vate mar­ket val­u­a­tions have lagged behind where they should be because pri­vate firms are using “trail­ing num­bers” from pri­vate apprais­ers who haven’t account­ed for updat­ed bal­ance sheets.

“The gap between where apprais­ers are mark­ing pri­vate mar­ket val­u­a­tions, there’s an even big­ger gap because those [assets] have not been appro­pri­ate­ly marked to mar­ket for today’s debt costs and don’t reflect the impli­ca­tions of an eco­nom­ic slow­down from a growth per­spec­tive,” she said. “There’s such a big dis­con­nect between where we think real­i­ty should sit ver­sus where the pri­vate mar­ket actu­al­ly is sit­ting, and the REIT mar­kets have sig­nif­i­cant­ly over­cor­rect­ed on the oth­er side.”

Oth­er asset class­es that are show­ing sim­i­lar­ly large pub­lic-pri­vate val­u­a­tion gaps in cap rates are hotels (18.2 per­cent) and life sci­ences (27 per­cent), accord­ing to Cen­ter­Square data.

Cap rates on hotels have like­ly expand­ed due to the asset class’ unique cash-flow mod­el, which relies on leas­es that are more or less dai­ly agree­ments between man­age­ment and con­sumers, many of whom are impact­ed by wider macro­eco­nom­ic pat­terns like pull­backs in con­sumer spend­ing and fluc­tu­at­ing unem­ploy­ment lev­els.

...

Life sci­ences cap rates have like­ly expand­ed due to the over­build­ing, mut­ed leas­ing demand and the asset class being lumped into the office sec­tor, which has expe­ri­enced sim­i­lar head­winds. Some investors have erro­neous­ly equat­ed low cell­phone usage at life sci­ences cen­ters to low office uti­liza­tion num­bers, accord­ing to Mori­ar­i­ty.

...

On the flip side, the sin­gle-fam­i­ly rental and data cen­ter sec­tors saw cap rate com­pres­sion in the last quar­ter (a basis point decrease of 29 and 10 basis points, respec­tive­ly, over three months), accord­ing to Cen­ter Square.

...

———–

“Report: Pri­vate Mar­ket Lags Pub­lic REITs in CRE Cap Rate Met­rics” By Bri­an Pas­cus; Com­mer­cial Observ­er; 06/27/2023

““In the ide­al world, where mar­kets are com­plete­ly ratio­nal, the pub­lic mar­ket val­u­a­tions would reflect what we are see­ing in that for­ward-marked pri­vate mar­ket cap rate,” Uma Mori­ar­i­ty, senior invest­ment strate­gist at Cen­ter­Square, told Com­mer­cial Observ­er. “But there’s a real­ly mean­ing­ful dis­con­nect between where trans­ac­tions are hap­pen­ing and where val­u­a­tions are hap­pen­ing in the pri­vate mar­ket … com­pared to where we think pri­vate mar­ket val­u­a­tions should be.” ”

A mean­ing­ful dis­con­nect between pub­lic and pri­vate mar­ket CRE val­u­a­tions. How mean­ing­ful? Well, for office build­ings, pub­lic REITS have aver­age cap rates of 8.75 per­cent com­pared to the 6.39 per­cent aver­age cap rate they found pri­vate REITS were esti­mat­ing, a pub­lic-pri­vate val­u­a­tion gap of 27 per­cent. That’s a pret­ty mean­ing­ful dis­con­nect con­sid­er­ing that these same pub­lic and pri­vate enti­ties are make deals in the same space. Pre­sum­ably mak­ing deals with each oth­er:

...
The report also showed sig­nif­i­cant val­u­a­tion gaps in how the pub­lic and pri­vate mar­kets view the office, hotel and life sci­ences sec­tors.

Cen­ter­Square Invest­ment Man­age­ment, a Philadel­phia-based real estate invest­ment firm, exam­ined implied cap rate met­rics for rough­ly 200 pub­licly list­ed U.S. REIT com­pa­nies. The firm then used pri­vate real estate data from the NFI-ODCE — an index of the largest pri­vate real estate funds — and esti­mates from ana­lysts and bro­kers. Both data sets use sec­ond-quar­ter 2023 met­rics.

Cen­ter­Square esti­mat­ed that the val­u­a­tion gap between all pub­lic REITs and pri­vate mar­ket val­ues rose from 28 basis points to 50 basis points between the first quar­ter of 2023 and the sec­ond quar­ter, with the pub­lic REITs cap rate ris­ing to 5.96 per­cent and the for­ward-marked pri­vate mar­kets cap rate hit­ting 5.46 per­cent in the sec­ond quar­ter — a val­u­a­tion gap of 8.3 per­cent.

...

CenterSquare’s research report found that pub­lic REITs cap rates for offices — the industry’s most dis­tressed sec­tor — have reached 8.75 per­cent, com­pared to a for­ward-marked pri­vate mar­kets cap rate of 6.39 per­cent, reflect­ing a pub­lic-pri­vate val­u­a­tion gap of 27 per­cent.

...

Oth­er asset class­es that are show­ing sim­i­lar­ly large pub­lic-pri­vate val­u­a­tion gaps in cap rates are hotels (18.2 per­cent) and life sci­ences (27 per­cent), accord­ing to Cen­ter­Square data.
...

And as the arti­cle describes, that high­er cap rate for pub­lic REITs trans­lates to low­er val­u­a­tions. In oth­er words, pri­vate real estate funds are sys­tem­at­i­cal­ly putting high­er assumed val­u­a­tions on CRE invest­ments than their pub­lic REIT coun­ter­parts. And as we’ve seen, it’s the pri­vate real estate fund that so many pub­lic pen­sions are increas­ing­ly invest­ed in. That’s why we have to ask: are the pub­lic REITs over­ly bear­ish or are the pri­vate equi­ty funds not bear­ish enough? That’s the big ques­tion posed by this pub­lic-pri­vate val­u­a­tion gap that is as high as 27 per­cent for office build­ings:

...
Cap rates are among the most crit­i­cal met­rics for mea­sur­ing com­mer­cial real estate. They can gen­er­al­ly be defined as the yields on real estate invest­ments and are found by divid­ing net oper­at­ing income by asset val­ue. Cap rates typ­i­cal­ly rise and fall in con­cert with inter­est rates; low­er cap rates sug­gest low­er inter­est rates, cheap­er lever­age, high­er prices for prop­er­ty and thus greater val­ues, while high­er cap rates sug­gest the inverse: high risk, low prices and low val­ues on those assets.

...

Mori­ar­i­ty said that pub­lic mar­ket sen­ti­ment toward office is “over­ly bear­ish.” Mean­while, pri­vate mar­ket val­u­a­tions have lagged behind where they should be because pri­vate firms are using “trail­ing num­bers” from pri­vate apprais­ers who haven’t account­ed for updat­ed bal­ance sheets.

“The gap between where apprais­ers are mark­ing pri­vate mar­ket val­u­a­tions, there’s an even big­ger gap because those [assets] have not been appro­pri­ate­ly marked to mar­ket for today’s debt costs and don’t reflect the impli­ca­tions of an eco­nom­ic slow­down from a growth per­spec­tive,” she said. “There’s such a big dis­con­nect between where we think real­i­ty should sit ver­sus where the pri­vate mar­ket actu­al­ly is sit­ting, and the REIT mar­kets have sig­nif­i­cant­ly over­cor­rect­ed on the oth­er side.”
...

Keep in mind that one effect of over­ly-opti­mistic pri­vate val­u­a­tions is the over­ly opti­mistic val­u­a­tion of the many CRE invest­ments already held by by these pri­vate equi­ty funds. Which, in turn, means the many pen­sion funds invest­ed in these pri­vate equi­ty real estate funds are also going to be sys­tem­at­i­cal­ly over-esti­mat­ing the val­ue of their pri­vate equi­ty invest­ments. So when we see signs of over­ly inflat­ed CRE val­u­a­tions by pri­vate equi­ty funds, it’s worth keep­ing in mind that fix­ing those over­ly inflat­ed esti­mates will simul­ta­ne­ous­ly make their clients finan­cial posi­tions that much worse. And that much more des­per­ate. Per­haps des­per­ate enough for a CRE triple down, which can no doubt be arranged if need­ed.

The US econ­o­my is no stranger to moral injury. One could argue that moral injury is one of the core fuels dri­ving the econ­o­my. And while the US health­care sec­tor is very obvi­ous­ly no stranger to moral injury, it’s worth not­ing the grow­ing pan­dem­ic of moral injury that was high­light­ed in a New York Times Mag­a­zine piece last month about the moral injury increas­ing­ly felt by US doc­tors. Job dis­sat­is­fac­tion is for doc­tors and oth­er med­ical pro­fes­sion­als appar­ent­ly at such lev­els that, as of March of last year, 1 in 5 health care work­ers had quit their job and anoth­er 31 per­cent were con­sid­er­ing it.

And while the stress­es of the COVID are clear­ly a big part of this job dis­sat­is­fac­tion cri­sis across the health care sec­tor, the moral injury we’re talk­ing about did­n’t start with COVID and isn’t abat­ing. On the con­trary, it’s only grow­ing as the pri­vate equi­ty busi­ness mod­el takes over more and more of the health care sec­tor. A prof­its-over-peo­ple busi­ness mod­el that has result­ed in med­ical pro­fes­sion­als increas­ing­ly feel­ing like they expe­ri­enced a moral injury in car­ry­ing out their jobs.

Specif­i­cal­ly, the kind of moral injury anal­o­gous to what mil­i­tary psy­chi­a­trists describe as an emo­tion­al wound sus­tained when, in the course of ful­fill­ing their duties, sol­diers wit­nessed or com­mit­ted acts — raid­ing a home, killing a non­com­bat­ant — that trans­gressed their core val­ues. Doc­tors are increas­ing­ly feel­ing like they are forced to trans­gress their core val­ues. And increas­ing­ly for the prof­its of their employ­ers. In par­tic­u­lar their pri­vate-equi­ty hos­pi­tal own­ing employ­ers. That’s the rel­a­tive­ly new form of moral injury increas­ing­ly being report­ed by work­ers in the US health care sec­tor. And increas­ing­ly report­ed anony­mous­ly as more and more doc­tors are fired for speak­ing out about sub-stan­dard prac­tices man­dates by their prof­it-hun­gry employ­ers.

And, sur­prise, it turns out pri­vate equi­ty firms backed by US pub­lic pen­sion funds are the major play­ers in this space. Black­stone, which pur­chased $6.1 bil­lion TeamHealth in 2016, and KKR, which acquired Envi­sion Health­care for $9.9 bil­lion in 2018, are now two of the biggest play­ers in the US health care space. And there­fore two of the biggest boss­es, deter­min­ing doc­tors’ patient vs prof­its pri­or­i­ties. Moral­ly inju­ri­ous patient vs prof­its pri­or­i­ties that health care work­ers have to work under or get fired. Moral injury done in the name of not just prof­its but the prof­its need­ed to fund the pen­sion fund investors behind those Black­stone and KKR acqui­si­tions. And prof­its need­ed pay for the fund man­agers, of course.

So to get an idea of pri­vate-equi­ty approach to run­ning hos­pi­tals, here’s an arti­cle from Novem­ber of 2019, right before the COVID pan­dem­ic broke out, describ­ing how US pen­sion plans were dodg­ing ques­tions over the grow­ing con­gres­sion­al ire raised by a pan­dem­ic of sur­prise med­ical bills fac­ing patients. Sur­prise med­ical bills that pri­vate-equi­ty-owned hos­pi­tals in par­tic­u­lar were noto­ri­ous for issu­ing, with Envi­sion and TeamHealth lead­ing the way in sur­prise med­ical bills and the focus of the con­gres­sion­al inves­ti­ga­tion:

Finan­cial Times
FTfm

US pen­sion plans dodge queries on health­care hold­ings

Schemes from Cal­i­for­nia to Ore­gon invest in Black­stone and KKR deals that are being probed by US Con­gress

Chris Flood
Novem­ber 2 2019

US pub­lic pen­sion plans have refused to answer ques­tions about their invest­ments in pri­vate equi­ty funds that are under inves­ti­ga­tion by the US Con­gress for their role in dri­ving up health­care costs.

FTfm asked pen­sion plans in Cal­i­for­nia, Ida­ho, Michi­gan, New Jer­sey and Ore­gon if they had con­cerns about dam­age to their rep­u­ta­tion as social­ly respon­si­ble investors from their links to Black­stone and KKR, two of the pri­vate equi­ty man­agers under inves­ti­ga­tion.

These US pen­sions plans, along with Cana­da Pen­sion Plan Invest­ment Board, one of the world’s largest retire­ment funds, declined to answer or failed to respond to ques­tions about their invest­ments in the US health­care indus­try made via funds run by Black­stone and KKR.

Mil­lions of Amer­i­cans with med­ical insur­ance poli­cies have been hit with “sur­prise” bills for thou­sands of dol­lars after receiv­ing hos­pi­tal treat­ment from a health­care com­pa­ny owned by a pri­vate equi­ty man­ag­er.

Mount­ing pub­lic anger prompt­ed US law­mak­ers to launch a bipar­ti­san inves­ti­ga­tion in Sep­tem­ber. The probe is focused on Black­stone and KKR as the respec­tive own­ers of TeamHealth and Envi­sion, two of the largest providers of med­ical ser­vices to hos­pi­tals and oth­er health­care providers.

The Con­gres­sion­al inves­ti­ga­tion is led by Greg Walden from Ore­gon and Frank Pal­lone from New Jer­sey, even though they rep­re­sent two of the states where pub­lic pen­sion plans have invest­ed in health­care via Black­stone and KKR.

Welsh, Car­son, Ander­son & Stowe, a New York-based pri­vate equi­ty man­ag­er that has invest­ed in 85 health­care com­pa­nies over its 40-year his­to­ry, is also under inves­ti­ga­tion by the US Con­gress.

Ludovic Phalip­pou, pro­fes­sor of finance at Oxford Saïd Busi­ness School, said savers were told that retire­ment funds must move into more aggres­sive invest­ment vehi­cles because future returns on pub­licly trad­ed stocks and bonds would be too low to deliv­er on pen­sion promis­es.

“These vehi­cles do every­thing pos­si­ble to gen­er­ate cash, squeez­ing everyone’s pock­ets includ­ing pen­sion­ers. The final nail in the cof­fin is that most of this extra cash cap­tured goes into the hands of the rich­est 1 per cent of the pop­u­la­tion in the form of fees. It is unclear whether pen­sion­ers will get even a crumb,” said Mr Phalip­pou.

Thir­teen US states includ­ing Cal­i­for­nia, New Jer­sey, New York, Ore­gon and Wash­ing­ton have passed bills pro­vid­ing con­sumers with com­pre­hen­sive pro­tec­tion against sur­prise med­ical bills. A fur­ther 15 states offer par­tial pro­tec­tions, accord­ing to the Com­mon­wealth Fund, a New York-based health­care think-tank.

This rais­es the ques­tion of whether the invest­ments by pub­lic pen­sion plans are con­sis­tent with the laws passed in their home states.

...

———-

“US pen­sion plans dodge queries on health­care hold­ings” by Chris Flood; Finan­cial Times; 11/02/2019

“Mil­lions of Amer­i­cans with med­ical insur­ance poli­cies have been hit with “sur­prise” bills for thou­sands of dol­lars after receiv­ing hos­pi­tal treat­ment from a health­care com­pa­ny owned by a pri­vate equi­ty man­ag­er.”

The sur­prise med­ical bill pan­dem­ic of of 2019 was a prod­uct of pri­vate equi­ty-owned hos­pi­tals. In par­tic­u­lar, two of the largest health care providers in the US, TeamHealth and Envi­sion, which hap­pen to be owned by pri­vate equi­ty giants Black­stone and KKR. Sur­prise:

...
Mount­ing pub­lic anger prompt­ed US law­mak­ers to launch a bipar­ti­san inves­ti­ga­tion in Sep­tem­ber. The probe is focused on Black­stone and KKR as the respec­tive own­ers of TeamHealth and Envi­sion, two of the largest providers of med­ical ser­vices to hos­pi­tals and oth­er health­care providers.

...

Welsh, Car­son, Ander­son & Stowe, a New York-based pri­vate equi­ty man­ag­er that has invest­ed in 85 health­care com­pa­nies over its 40-year his­to­ry, is also under inves­ti­ga­tion by the US Con­gress.
...

And as Oxford finance pro­fes­sor Ludovic Phalip­pou grim­ly points out, while pri­vate-equi­ty firms may insist that the cut-throat tac­tics are need­ed to earn the high returns retirees need to fund their pen­sions, it’s not like the prof­it gen­er­at­ed by these sur­prise fees are nec­es­sar­i­ly going to pri­vate equi­ty investors. But we can be very con­fi­dent the pri­vate equi­ty fund man­agers are get­ting a cut. It’s how the ‘heads we win, tails you lose your retire­ment’ busi­ness mod­el oper­ates. Opaque­ly:

...
Ludovic Phalip­pou, pro­fes­sor of finance at Oxford Saïd Busi­ness School, said savers were told that retire­ment funds must move into more aggres­sive invest­ment vehi­cles because future returns on pub­licly trad­ed stocks and bonds would be too low to deliv­er on pen­sion promis­es.

“These vehi­cles do every­thing pos­si­ble to gen­er­ate cash, squeez­ing everyone’s pock­ets includ­ing pen­sion­ers. The final nail in the cof­fin is that most of this extra cash cap­tured goes into the hands of the rich­est 1 per cent of the pop­u­la­tion in the form of fees. It is unclear whether pen­sion­ers will get even a crumb,” said Mr Phalip­pou.
...

And in case it’s not clear that sur­prise med­ical billing is very much part of the pri­vate-equi­ty pre­ferred health care busi­ness mod­el, here’s an arti­cle from Sep­tem­ber of 2019 about the dis­cov­ery of the iden­ti­ties of the enti­ties behind a mas­sive ad cam­paign oppos­ing any gov­ern­ment action to address the sur­prise billing pan­dem­ic. A dark mon­ey cam­paign that had, at that point, anony­mous­ly spent $28 mil­lion on the “Doc­tor Patient Uni­ty” dark mon­ey group: TeamHealth and Envi­sion were behind the ad spend­ing binge ded­i­cat­ed to pro­tect­ing the abil­i­ty to sur­prise bill. In oth­er words, pri­vate-equi­ty was behind the ad cam­paign ded­i­cat­ed to pro­tect­ing the abil­i­ty to sur­prise bill patients. Sur­prise:

The New York Times

Mys­tery Solved: Pri­vate-Equi­ty-Backed Firms Are Behind Ad Blitz on ‘Sur­prise Billing’

Two doc­tor-staffing com­pa­nies are push­ing back against leg­is­la­tion that could hit their bot­tom lines.

By Mar­got Sanger-Katz, Julie Creswell and Reed Abel­son
Pub­lished Sept. 13, 2019
Updat­ed Sept. 30, 2021

Ear­ly this sum­mer, Con­gress appeared on its way to erad­i­cat­ing the large med­ical bills that have shocked many patients after emer­gency care. The leg­is­la­tion to end out-of-net­work charges was pop­u­lar and had sup­port from both sides of the aisle. Pres­i­dent Trump promised his sup­port.

Then, in late July, a mys­te­ri­ous group called Doc­tor Patient Uni­ty showed up. It poured vast sums of mon­ey — now more than $28 mil­lion — into ads oppos­ing the leg­is­la­tion, with­out dis­clos­ing its staff or its fun­ders.

Try­ing to guess who was behind the ads became some­thing of a par­lor game in some Belt­way cir­cles.

Now, the mys­tery is solved. The two largest finan­cial back­ers of Doc­tor Patient Uni­ty are TeamHealth and Envi­sion Health­care, pri­vate-equi­ty-backed com­pa­nies that own physi­cian prac­tices and staff emer­gency rooms around the coun­try, accord­ing to Greg Blair, a spokesman for the group.

“Doc­tor Patient Uni­ty rep­re­sents tens of thou­sands of doc­tors across the coun­try who under­stand the impor­tance of pre­serv­ing access to life­sav­ing med­ical care and sup­port a solu­tion to sur­prise med­ical billing that pro­tects patients,” said Mr. Blair, who issued the state­ment weeks after the group was first con­tact­ed about the cam­paign. “We oppose insur­ance-indus­try-backed pro­pos­als for gov­ern­ment rate set­ting that will lead to doc­tor short­ages, hos­pi­tal clo­sures and loss of access to med­ical care, par­tic­u­lar­ly in rur­al and under­served com­mu­ni­ties.”

TeamHealth was acquired in 2016 by the pri­vate-equi­ty firm Black­stone Group in a deal val­ued at $6.1 bil­lion. And last fall, in one of the largest takeovers of the year, the pri­vate-equi­ty giant KKR spent $9.9 bil­lion to acquire Envi­sion Health­care.

The ads gen­er­al­ly omit ref­er­ences to sur­prise bills. Instead, they warn of “gov­ern­ment rate set­ting” that could harm patient care. In one ad, an ambu­lance crew arrives with a patient, only to find the hos­pi­tal dark and emp­ty.

The pro­posed leg­is­la­tion, which may advance to floor votes this year, is poten­tial­ly bad for busi­ness for TeamHealth and Envi­sion. The two groups have waged many bat­tles against insur­ers over what they see as low physi­cian pay­ments for emer­gency room vis­its. When there is no agree­ment with an insur­er, the physi­cians work “out of net­work,” and bill patients for the amount that insur­ance does not pay.

A recent aca­d­e­m­ic analy­sis of fil­ings from a large com­mer­cial insur­ance com­pa­ny found that the firms, though Envi­sion more than TeamHealth, have rou­tine­ly oper­at­ed out­side the insur­ance net­works of hos­pi­tals where their doc­tors prac­tice. This often leads to sur­prise bills for patients.

Like all so-called dark mon­ey polit­i­cal action groups, Doc­tor Patient Uni­ty is not legal­ly required to reveal the names of its sup­port­ers and, in fact, appears to have worked hard to obscure its iden­ti­ty.

The bread crumbs were scant. Fil­ings by the group to the Fed­er­al Com­mu­ni­ca­tions Com­mis­sion for pur­pos­es of adver­tis­ing list­ed the name of a trea­sur­er who works for a firm that often fills such roles for Repub­li­can polit­i­cal groups. The group’scor­po­rate fil­ing in Vir­ginia lists an agent who is com­mon to more than 150 oth­er polit­i­cal action groups. Nei­ther the trea­sur­er, the named part­ners in her firm, the adver­tis­ing firm or the lawyer asso­ci­at­ed with the cor­po­rate enti­ty respond­ed to calls or emails. An email to the address on the group’s bare-bones web­site went unan­swered for weeks until the group’s state­ment on Fri­day.

Rep­re­sen­ta­tives of both com­pa­nies con­firmed Fri­day that they had fund­ed the group, offer­ing writ­ten state­ments sim­i­lar to the one from Mr. Blair. Nei­ther company’s com­ments explained why they pur­sued a dark-mon­ey advo­ca­cy strat­e­gy.

Sev­er­al Wash­ing­ton news out­lets had looked into the ori­gin of the ads, as had some local reporters in sev­er­al states where the ads have run, includ­ing Col­orado, Texas, Alaba­ma and Min­neso­ta

The $28 mil­lion that Doc­tor Patient Uni­ty has spent on tele­vi­sion and radio adver­tis­ing out­strips the amount spent on adver­tis­ing around Jus­tice Brett Kavanaugh’s Supreme Court con­fir­ma­tion vote, accord­ing to an analy­sis of fil­ings with the F.C.C. by Adver­tis­ing Ana­lyt­ics.

Doc­tor Patient Uni­ty has also spent hun­dreds of thou­sands of dol­lars on Face­book and Google adver­tis­ing, and has been send­ing direct mail to vot­ers in dozens of con­gres­sion­al dis­tricts. In some cas­es, the group describes the leg­is­la­tion as the “first step toward social­ists’ Medicare-for-all dream.”

The group has focused its broad­cast ads in areas where sen­a­tors, most­ly Repub­li­can, are run­ning for re-elec­tion next year. In North Car­oli­na, Doc­tor Patient Uni­ty has spent more than $4 mil­lion on ads to influ­ence Sen­a­tor Thom Tillis’s vote on the bill. Anoth­er tar­get of the ads is Mitch McConnell, the Sen­ate major­i­ty leader, who has expressed sup­port for leg­is­la­tion end­ing sur­prise billing.

One ad, in heavy rota­tion in ear­ly August, fea­tured a woman stand­ing in front of a blank back­ground urg­ing vot­ers to call their sen­a­tors to stop a prac­tice she calls “gov­ern­ment rate set­ting.” She warned the pol­i­cy could affect patients’ access to doc­tors in an emer­gency.

Sen­a­tor Tina Smith, a Demo­c­rat from Min­neso­ta, said she found the ads con­fus­ing and frus­trat­ing. She is a co-spon­sor of a bill that would resolve sur­prise bills using arbi­tra­tion, the stat­ed pref­er­ence of the group. But she was still the tar­get of more than $2 mil­lion in ads. She said she had heard from con­stituents at the Min­neso­ta State Fair dur­ing the August recess, many ask­ing what the ads were about.

“If they were gen­uine­ly inter­est­ed in engag­ing in the polit­i­cal process, they at least would have called me,” she said. “I think the ads are designed to intim­i­date us into back­ing down about doing some­thing about sur­prise med­ical bills, and I refuse to be intim­i­dat­ed.”

The adver­tise­ments are not all neg­a­tive: The group ran one thank­ing Sen­a­tor David Per­due, a Repub­li­can from Geor­gia, and Mag­gie Has­san, a Demo­c­rat from New Hamp­shire. Ms. Has­san, who is the co-spon­sor (with Ms. Smith) of a more doc­tor-friend­ly sur­prise billing approach, was not pleased by the endorse­ment. Aaron Jacobs, her com­mu­ni­ca­tions direc­tor, described the ads as “deeply harm­ful to our efforts to pass bipar­ti­san leg­is­la­tion to end the out­ra­geous prac­tice of sur­prise med­ical billing,” and said the group was act­ing in “bad faith.”

Leg­is­la­tion that has passed out of the Sen­ate Com­mit­tee on Health, Edu­ca­tion, Labor and Pen­sions and a sim­i­lar bill that has passed in the House Ener­gy and Com­merce Com­mit­tee would ban the prac­tice of send­ing bills to patients when they vis­it a hos­pi­tal cov­ered by their insur­ance. In sit­u­a­tions where the doc­tors fail to nego­ti­ate a price with the patient’s insur­er, the bills before Con­gress would mean that the doc­tors would be paid the medi­an price that oth­er such doc­tors in the area get.

Most doc­tor and hos­pi­tal groups would rather have both sides present their pre­ferred price to an inde­pen­dent arbi­tra­tor. Experts say the cur­rent leg­is­la­tion would prob­a­bly low­er the pay for doc­tors in the rel­e­vant med­ical spe­cial­ties, even those who do not engage in sur­prise billing.

...

Togeth­er, Envi­sion and TeamHealth employ tens of thou­sands of physi­cians, most in the kinds of hos­pi­tal-based spe­cial­ties — like emer­gency med­i­cine, radi­ol­o­gy and anes­the­si­ol­o­gy — that can gen­er­ate large sur­prise bills.

After researchers in 2017 point­ed to its high share of out-of-net­work doc­tors, Envi­sion, then a pub­lic com­pa­ny, vowed it would have more of its doc­tors accept insur­ance. A spokes­woman said 90 per­cent of its care is now in-net­work. Dan Col­lard, an exec­u­tive vice pres­i­dent at TeamHealth, said around 85 per­cent of its care is deliv­ered in-net­work.

This sum­mer, Fitch Rat­ings put the debt of both com­pa­nies at the top of its list of “loans of con­cern,” not­ing that the com­pa­nies have been “pres­sured by uncer­tain­ty over the out­come of polit­i­cal efforts to cut med­ical bills.”

“Pri­vate equi­ty com­pa­nies have the most to lose from pro­hibit­ing sur­prise billing, so it’s no sur­prise that they’d be fight­ing the hard­est to blow up the process,” Loren Adler, an asso­ciate direc­tor of the U.S.C.-Brookings Scha­ef­fer Ini­tia­tive for Health Pol­i­cy, said in an email. Mr. Adler, who has stud­ied the issue, endors­es the approach Con­gress is con­sid­er­ing.

Doc­tor Patient Uni­ty is not the only physi­cian group try­ing to influ­ence the sur­prise billing leg­is­la­tion in Con­gress. Physi­cians for Fair Cov­er­age has also begun a dig­i­tal ad cam­paign and has spent an esti­mat­ed $240,000 on con­ven­tion­al lob­by­ing this year, accord­ing to the Cen­ter for Respon­sive Pol­i­tics. That physi­cians group lists its mem­bers on its web­site, and its staff speaks with jour­nal­ists about the group’s per­spec­tive. (Some of its mem­bers also have pri­vate equi­ty ties.)

The Amer­i­can Col­lege of Emer­gency Physi­cians and the Amer­i­can Soci­ety of Anes­the­si­ol­o­gists have also sought changes to the sur­prise billing leg­is­la­tion, but their mes­sage is milder than the TV ads, and they say they want the prob­lem resolved.

Lead­ers in each of those groups denied know­ing who fund­ed Doc­tor Patient Uni­ty or com­mu­ni­cat­ing with the group direct­ly.

“I have no idea who they are — I actu­al­ly tried Google, and when you look at their web­site, there’s noth­ing,” said Michele Kim­ball, the pres­i­dent of Physi­cians for Fair Cov­er­age.

Lau­ra Woost­er, a spokes­woman for the Amer­i­can Col­lege of Emer­gency Physi­cians, said she found the group’s first ad con­fus­ing. After learn­ing about the group’s fun­ders, Ms. Woost­er dis­tin­guished the dark mon­ey group’s strat­e­gy from that of the col­lege.

“ACEP does not want our proac­tive efforts over the past two years to help pro­tect patients from sur­prise bills to be con­flat­ed with more neg­a­tive mes­sages that are per­ceived as obstruc­tion­ist,” she said. The organization’s cur­rent pres­i­dent works for TeamHealth; its pres­i­dent elect works for Envi­sion.

Insur­ance com­pa­nies, which strong­ly favor the pre­vail­ing leg­isla­tive approach, are also heav­i­ly invest­ed in efforts to influ­ence the sur­prise billing leg­is­la­tion, although they have been more trans­par­ent about their involve­ment. An indus­try group, the Coali­tion Against Sur­prise Med­ical Billing, has run dig­i­tal and tele­vi­sion ads worth sev­er­al mil­lion dol­lars. Its lat­est, which ran in Wash­ing­ton dur­ing the Demo­c­ra­t­ic pres­i­den­tial debate on Thurs­day, shows men and one woman nego­ti­at­ing in a dark room as a voice-over describes sur­prise billing as a “pri­vate equi­ty busi­ness mod­el.”

“Can we get a lit­tle pri­va­cy in here?” one per­son asks the cam­era.

The Doc­tor Patient Uni­ty cam­paign is sim­i­lar to oth­er dark-mon­ey efforts in which groups try to influ­ence pub­lic pol­i­cy with­out dis­clos­ing donors. Anna Mas­soglia, a researcher at the Cen­ter for Respon­sive Pol­i­tics, which tracks such cam­paigns, said many of the tac­tics used by Doc­tor Patient Uni­ty were famil­iar. “You do see the same groups and the same oper­a­tives pop­ping up time and time again as these new issues emerge,” she said.

...

———-

“Mys­tery Solved: Pri­vate-Equi­ty-Backed Firms Are Behind Ad Blitz on ‘Sur­prise Billing’” By Mar­got Sanger-Katz, Julie Creswell and Reed Abel­son; The New York Times; 09/13/2023

“Now, the mys­tery is solved. The two largest finan­cial back­ers of Doc­tor Patient Uni­ty are TeamHealth and Envi­sion Health­care, pri­vate-equi­ty-backed com­pa­nies that own physi­cian prac­tices and staff emer­gency rooms around the coun­try, accord­ing to Greg Blair, a spokesman for the group.”

What a shock­ing rev­e­la­tion: the two largest pri­vate equi­ty-owned health care providers that hap­pen to be noto­ri­ous for sur­prise billing are behind dark mon­ey ad cam­paign opposed to end­ing the prac­tice.

And while the iden­ti­ty of the groups behind Doc­tor Patient Uni­ty was tech­ni­cal­ly anony­mous for months after the dark mon­ey group sud­den­ly popped out of nowhere in July of 2019, note how FEC fil­ings indi­cate that the group trea­sur­er worked for a firm that often played sim­i­lar rolls for Repub­li­can affil­i­at­ed groups. Which makes it rather like­ly that the secret iden­ti­ties of the groups behind Doc­tor Patient Uni­ty was real­ly more of a DC open secret:

...
Then, in late July, a mys­te­ri­ous group called Doc­tor Patient Uni­ty showed up. It poured vast sums of mon­ey — now more than $28 mil­lion — into ads oppos­ing the leg­is­la­tion, with­out dis­clos­ing its staff or its fun­ders.

Try­ing to guess who was behind the ads became some­thing of a par­lor game in some Belt­way cir­cles.

...

Like all so-called dark mon­ey polit­i­cal action groups, Doc­tor Patient Uni­ty is not legal­ly required to reveal the names of its sup­port­ers and, in fact, appears to have worked hard to obscure its iden­ti­ty.

The bread crumbs were scant. Fil­ings by the group to the Fed­er­al Com­mu­ni­ca­tions Com­mis­sion for pur­pos­es of adver­tis­ing list­ed the name of a trea­sur­er who works for a firm that often fills such roles for Repub­li­can polit­i­cal groups. The group’scor­po­rate fil­ing in Vir­ginia lists an agent who is com­mon to more than 150 oth­er polit­i­cal action groups. Nei­ther the trea­sur­er, the named part­ners in her firm, the adver­tis­ing firm or the lawyer asso­ci­at­ed with the cor­po­rate enti­ty respond­ed to calls or emails. An email to the address on the group’s bare-bones web­site went unan­swered for weeks until the group’s state­ment on Fri­day.
...

Also note how both TeamHealth and Envi­sion Health­care were tak­en over recent­ly, with Black­stone acquir­ing TeamHealth for $6.1 bil­lion in 2016 and KKR pay­ing $9.9 bil­lion for Envi­sion Health­care in 2018. As such, we also should­n’t be sur­prised to learn that Fitch Rat­ings had the debt loads of both com­pa­nies at the top of its list of “loans of con­cern”. Yes, the talk of the pro­posed anti-sur­prise billing gov­ern­ment action had to be a fact in Fitch’s loan con­cerns, but also keep in mind the under­ly­ing pri­vate-equi­ty busi­ness mod­el: buy a com­pa­ny and load it up with debt to pay out to investors and fund man­agers. It’s a reminder that when pri­vate-equi­ty-own firms engage in sur­prise billing in the pur­suit of prof­it max­i­miza­tion, that extra pro­ceeds aren’t going direct­ly to pay investors and fund man­agers. The extra pro­ceeds are used to pay off the debt that was already issued to pay off the investors and fund man­agers. In keep with the ‘heads we win, tails you lose’ busi­ness mod­el:

...
TeamHealth was acquired in 2016 by the pri­vate-equi­ty firm Black­stone Group in a deal val­ued at $6.1 bil­lion. And last fall, in one of the largest takeovers of the year, the pri­vate-equi­ty giant KKR spent $9.9 bil­lion to acquire Envi­sion Health­care.

...

Togeth­er, Envi­sion and TeamHealth employ tens of thou­sands of physi­cians, most in the kinds of hos­pi­tal-based spe­cial­ties — like emer­gency med­i­cine, radi­ol­o­gy and anes­the­si­ol­o­gy — that can gen­er­ate large sur­prise bills.

...

This sum­mer, Fitch Rat­ings put the debt of both com­pa­nies at the top of its list of “loans of con­cern,” not­ing that the com­pa­nies have been “pres­sured by uncer­tain­ty over the out­come of polit­i­cal efforts to cut med­ical bills.”

“Pri­vate equi­ty com­pa­nies have the most to lose from pro­hibit­ing sur­prise billing, so it’s no sur­prise that they’d be fight­ing the hard­est to blow up the process,” Loren Adler, an asso­ciate direc­tor of the U.S.C.-Brookings Scha­ef­fer Ini­tia­tive for Health Pol­i­cy, said in an email. Mr. Adler, who has stud­ied the issue, endors­es the approach Con­gress is con­sid­er­ing.
...

And in case it’s unclear just how depen­dent the pri­vate-equi­ty-owned firms are on sur­prise billing, not the then-recent study that found that TeamHealth and Envi­sion both rou­tine­ly oper­at­ed “out of net­work”, which more or less guar­an­tees that patients will often face a sur­prise bill:

...
The pro­posed leg­is­la­tion, which may advance to floor votes this year, is poten­tial­ly bad for busi­ness for TeamHealth and Envi­sion. The two groups have waged many bat­tles against insur­ers over what they see as low physi­cian pay­ments for emer­gency room vis­its. When there is no agree­ment with an insur­er, the physi­cians work “out of net­work,” and bill patients for the amount that insur­ance does not pay.

A recent aca­d­e­m­ic analy­sis of fil­ings from a large com­mer­cial insur­ance com­pa­ny found that the firms, though Envi­sion more than TeamHealth, have rou­tine­ly oper­at­ed out­side the insur­ance net­works of hos­pi­tals where their doc­tors prac­tice. This often leads to sur­prise bills for patients.
...

And when we see how most doc­tor and hos­pi­tal groups would rather have both sides (insur­ers and providers) present their pre­ferred price to an inde­pen­dent arbi­tra­tor, it’s impor­tant to keep in mind that these ‘doc­tor and hos­pi­tal groups’ are also going to be heav­i­ly influ­enced by the pri­vate-equi­ty indus­try. So when we see the Amer­i­can Col­lege of Emer­gency Physi­cians (ACEP) dis­tin­guish its own oppo­si­tion to the pro­posed leg­is­la­tion to end sur­prise billing from the dark mon­ey cam­paign of TeamHealth and Envi­sion, and then see that the group’s cur­rent pres­i­dent worked for TeamHealth and its then-pres­i­dent elect worked for Envi­sion, it’s a reminder that pri­vate-equi­ty’s views on these mat­ters are increas­ing­ly going to be the indus­try’s views as pri­vate-equi­ty’s stake in the sec­tor grows:

...
Most doc­tor and hos­pi­tal groups would rather have both sides present their pre­ferred price to an inde­pen­dent arbi­tra­tor. Experts say the cur­rent leg­is­la­tion would prob­a­bly low­er the pay for doc­tors in the rel­e­vant med­ical spe­cial­ties, even those who do not engage in sur­prise billing.

...

The Amer­i­can Col­lege of Emer­gency Physi­cians and the Amer­i­can Soci­ety of Anes­the­si­ol­o­gists have also sought changes to the sur­prise billing leg­is­la­tion, but their mes­sage is milder than the TV ads, and they say they want the prob­lem resolved.

Lead­ers in each of those groups denied know­ing who fund­ed Doc­tor Patient Uni­ty or com­mu­ni­cat­ing with the group direct­ly.

“I have no idea who they are — I actu­al­ly tried Google, and when you look at their web­site, there’s noth­ing,” said Michele Kim­ball, the pres­i­dent of Physi­cians for Fair Cov­er­age.

Lau­ra Woost­er, a spokes­woman for the Amer­i­can Col­lege of Emer­gency Physi­cians, said she found the group’s first ad con­fus­ing. After learn­ing about the group’s fun­ders, Ms. Woost­er dis­tin­guished the dark mon­ey group’s strat­e­gy from that of the col­lege.

“ACEP does not want our proac­tive efforts over the past two years to help pro­tect patients from sur­prise bills to be con­flat­ed with more neg­a­tive mes­sages that are per­ceived as obstruc­tion­ist,” she said. The organization’s cur­rent pres­i­dent works for TeamHealth; its pres­i­dent elect works for Envi­sion.
...

And that role pri­vate-equi­ty is increas­ing­ly play­ing in speak­ing for doc­tors and oth­er peo­ple work­ing in the health care sec­tor brings us to the fol­low­ing NY Times report from last month about anoth­er form of injury being inflict­ed upon this sec­tor in the pur­suit of prof­its. The moral injury a grow­ing num­ber of health care pro­fes­sion­als are expres­sion as they are deal­ing with new hos­pi­tal own­ers who are increas­ing­ly ask­ing them to pri­or­i­tize prof­its over patient health. With pri­vate-equi­ty hos­pi­tal own­ers being the pri­ma­ry per­pe­tra­tors of this moral injury. It’s anoth­er sur­prise:

The New York Times

The Moral Cri­sis of America’s Doc­tors

The cor­po­ra­ti­za­tion of health care has changed the prac­tice of med­i­cine, caus­ing many physi­cians to feel alien­at­ed from their work.

By Eyal Press
Pub­lished June 15, 2023
Updat­ed June 16, 2023

Some years ago, a psy­chi­a­trist named Wendy Dean read an arti­cle about a physi­cian who died by sui­cide. Such deaths were dis­tress­ing­ly com­mon, she dis­cov­ered. The sui­cide rate among doc­tors appeared to be even high­er than the rate among active mil­i­tary mem­bers, a notion that star­tled Dean, who was then work­ing as an admin­is­tra­tor at a U.S. Army med­ical research cen­ter in Mary­land. Dean start­ed ask­ing the physi­cians she knew how they felt about their jobs, and many of them con­fid­ed that they were strug­gling. Some com­plained that they didn’t have enough time to talk to their patients because they were too busy fill­ing out elec­tron­ic med­ical records. Oth­ers bemoaned hav­ing to fight with insur­ers about whether a per­son with a seri­ous ill­ness would be preap­proved for med­ica­tion. The doc­tors Dean sur­veyed were deeply com­mit­ted to the med­ical pro­fes­sion. But many of them were frus­trat­ed and unhap­py, she sensed, not because they were burned out from work­ing too hard but because the health care sys­tem made it so dif­fi­cult to care for their patients.

In July 2018, Dean pub­lished an essay with Simon G. Tal­bot, a plas­tic and recon­struc­tive sur­geon, that argued that many physi­cians were suf­fer­ing from a con­di­tion known as moral injury. Mil­i­tary psy­chi­a­trists use the term to describe an emo­tion­al wound sus­tained when, in the course of ful­fill­ing their duties, sol­diers wit­nessed or com­mit­ted acts — raid­ing a home, killing a non­com­bat­ant — that trans­gressed their core val­ues. Doc­tors on the front lines of America’s prof­it-dri­ven health care sys­tem were also sus­cep­ti­ble to such wounds, Dean and Tal­bot sub­mit­ted, as the demands of admin­is­tra­tors, hos­pi­tal exec­u­tives and insur­ers forced them to stray from the eth­i­cal prin­ci­ples that were sup­posed to gov­ern their pro­fes­sion. The pull of these forces left many doc­tors anguished and dis­traught, caught between the Hip­po­crat­ic oath and “the real­i­ties of mak­ing a prof­it from peo­ple at their sick­est and most vul­ner­a­ble.”

The arti­cle was pub­lished on Stat, a med­ical-news web­site with a mod­est read­er­ship. To Dean’s sur­prise, it quick­ly went viral. Doc­tors and nurs­es start­ed reach­ing out to Dean to tell her how much the arti­cle spoke to them. “It went every­where,” Dean told me when I vis­it­ed her last March in Carlisle, Pa., where she now lives. By the time we met, the dis­tress among med­ical pro­fes­sion­als had reached alarm­ing lev­els: One sur­vey found that near­ly one in five health care work­ers had quit their job since the start of the pan­dem­ic and that an addi­tion­al 31 per­cent had con­sid­ered leav­ing. Pro­fes­sion­al orga­ni­za­tions like Nation­al Nurs­es Unit­ed, the largest group of reg­is­tered nurs­es in the coun­try, had begun refer­ring to “moral injury” and “moral dis­tress” in pam­phlets and news releas­es. Mona Masood, a psy­chi­a­trist who estab­lished a sup­port line for doc­tors short­ly after the pan­dem­ic began, recalls being struck by how clin­i­cians react­ed when she men­tioned the term. “I remem­ber all these physi­cians were like, Wow, that is what I was look­ing for,” she says. “This is it.”

Dean’s essay caught my eye, too, because I spent much of the pre­vi­ous few years report­ing on moral injury, inter­view­ing work­ers in menial occu­pa­tions whose jobs were eth­i­cal­ly com­pro­mis­ing. I spoke to prison guards who patrolled the wards of vio­lent pen­i­ten­tiaries, undoc­u­ment­ed immi­grants who toiled on the “kill floors” of indus­tri­al slaugh­ter­hous­es and roustabouts who worked on off­shore rigs in the fos­sil-fuel indus­try. Many of these work­ers were hes­i­tant to talk or be iden­ti­fied, know­ing how eas­i­ly they could be replaced by some­one else. Com­pared with them, physi­cians were priv­i­leged, earn­ing six-fig­ure salaries and doing pres­ti­gious jobs that spared them from the drudgery endured by so many oth­er mem­bers of the labor force, includ­ing nurs­es and cus­to­di­al work­ers in the health care indus­try. But in recent years, despite the esteem asso­ci­at­ed with their pro­fes­sion, many physi­cians have found them­selves sub­ject­ed to prac­tices more com­mon­ly asso­ci­at­ed with man­u­al labor­ers in auto plants and Ama­zon ware­hous­es, like hav­ing their pro­duc­tiv­i­ty tracked on an hourly basis and being pres­sured by man­age­ment to work faster.

Because doc­tors are high­ly skilled pro­fes­sion­als who are not so easy to replace, I assumed that they would not be as reluc­tant to dis­cuss the dis­tress­ing con­di­tions at their jobs as the low-wage work­ers I’d inter­viewed. But the physi­cians I con­tact­ed were afraid to talk open­ly. “I have since recon­sid­ered this and do not feel this is some­thing I can do right now,” one doc­tor wrote to me. Anoth­er texted, “Will need to be anon.” Some sources I tried to reach had signed nondis­clo­sure agree­ments that pro­hib­it­ed them from speak­ing to the media with­out per­mis­sion. Oth­ers wor­ried they could be dis­ci­plined or fired if they angered their employ­ers, a con­cern that seems par­tic­u­lar­ly well found­ed in the grow­ing swath of the health care sys­tem that has been tak­en over by pri­vate-equi­ty firms. In March 2020, an emer­gency-room doc­tor named Ming Lin was removed from the rota­tion at his hos­pi­tal after air­ing con­cerns about its Covid-19 safe­ty pro­to­cols. Lin worked at St. Joseph Med­ical Cen­ter, in Belling­ham, Wash. — but his actu­al employ­er was TeamHealth, a com­pa­ny owned by the Black­stone Group.

E.R. doc­tors have found them­selves at the fore­front of these trends as more and more hos­pi­tals have out­sourced the staffing in emer­gency depart­ments in order to cut costs. A 2013 study by Robert McNa­ma­ra, the chair­man of the emer­gency-med­i­cine depart­ment at Tem­ple Uni­ver­si­ty in Philadel­phia, found that 62 per­cent of emer­gency physi­cians in the Unit­ed States could be fired with­out due process. Near­ly 20 per­cent of the 389 E.R. doc­tors sur­veyed said they had been threat­ened for rais­ing qual­i­ty-of-care con­cerns, and pres­sured to make deci­sions based on finan­cial con­sid­er­a­tions that could be detri­men­tal to the peo­ple in their care, like being pushed to dis­charge Medicare and Med­ic­aid patients or being encour­aged to order more test­ing than nec­es­sary. In anoth­er study, more than 70 per­cent of emer­gency physi­cians agreed that the cor­po­ra­ti­za­tion of their field has had a neg­a­tive or strong­ly neg­a­tive impact on the qual­i­ty of care and on their own job sat­is­fac­tion.

There are, of course, plen­ty of doc­tors who like what they do and feel no need to speak out. Clin­i­cians in high-pay­ing spe­cial­ties like ortho­pe­dics and plas­tic surgery “are doing just fine, thank you,” one physi­cian I know joked. But more and more doc­tors are com­ing to believe that the pan­dem­ic mere­ly wors­ened the strain on a health care sys­tem that was already fail­ing because it pri­or­i­tizes prof­its over patient care. They are notic­ing how the empha­sis on the bot­tom line rou­tine­ly puts them in moral binds, and young doc­tors in par­tic­u­lar are con­tem­plat­ing how to resist. Some are mulling whether the sac­ri­fices — and com­pro­mis­es — are even worth it. “I think a lot of doc­tors are feel­ing like some­thing is trou­bling them, some­thing deep in their core that they com­mit­ted them­selves to,” Dean says. She notes that the term moral injury was orig­i­nal­ly coined by the psy­chi­a­trist Jonathan Shay to describe the wound that forms when a person’s sense of what is right is betrayed by lead­ers in high-stakes sit­u­a­tions. “Not only are clin­i­cians feel­ing betrayed by their lead­er­ship,” she says, “but when they allow these bar­ri­ers to get in the way, they are part of the betray­al. They’re the instru­ments of betray­al.”

Not long ago, I spoke to an emer­gency physi­cian, whom I’ll call A., about her expe­ri­ence. (She did not want her name used, explain­ing that she knew sev­er­al doc­tors who had been fired for voic­ing con­cerns about unsat­is­fac­to­ry work­ing con­di­tions or patient-safe­ty issues.) A soft-spo­ken woman with a gen­tle man­ner, A. referred to the emer­gency room as a “sacred space,” a place she loved work­ing because of the pro­found impact she could have on patients’ lives, even those who weren’t going to pull through. Dur­ing her train­ing, a patient with a ter­mi­nal con­di­tion somber­ly informed her that his daugh­ter couldn’t make it to the hos­pi­tal to be with him in his final hours. A. promised the patient that he wouldn’t die alone and then held his hand until he passed away. Inter­ac­tions like that one would not be pos­si­ble today, she told me, because of the new empha­sis on speed, effi­cien­cy and rel­a­tive val­ue units (R.V.U.), a met­ric used to mea­sure physi­cian reim­burse­ment that some feel rewards doc­tors for doing tests and pro­ce­dures and dis­cour­ages them from spend­ing too much time on less remu­ner­a­tive func­tions, like lis­ten­ing and talk­ing to patients. “It’s all about R.V.U.s and going faster,” she said of the ethos that per­me­at­ed the prac­tice where she’d been work­ing. “Your door-to-doc­tor time, your room-to-doc­tor time, your time from ini­tial eval­u­a­tion to dis­charge.”

Appeas­ing her peers and supe­ri­ors with­out breach­ing her val­ues became increas­ing­ly dif­fi­cult for A. On one occa­sion, a frail, elder­ly woman came into the E.R. because she was unable to walk on her own. A nurse case man­ag­er deter­mined that the woman should be dis­charged because she didn’t have a spe­cif­ic diag­no­sis to explain her con­di­tion and Medicare wouldn’t cov­er her stay, even though she lived alone and couldn’t get out of a chair to eat or go to the bath­room. A. cried with the woman and tried to com­fort her. Then she plead­ed with the hos­pi­tal­ist on duty to admit her. A.’s appeal was suc­cess­ful, but after­ward, she won­dered, What are we being asked to do? When we spoke, A. had tak­en a leave from work and was unsure if she would ever go back, because of how deplet­ed she felt. “It’s all about the almighty dol­lar and all about pro­duc­tiv­i­ty,” she said, “which is obvi­ous­ly not why most of us sign up to do the job.”

That’s not always clear to patients, many of whom nat­u­ral­ly assume that their doc­tors are the ones who decide how much time to spend with them and what to charge them for care. “Doc­tors are increas­ing­ly the scape­goats of sys­temic prob­lems with­in the health care sys­tem,” Masood says, “because the patient is not see­ing the insur­ance com­pa­ny that denied them the pro­ce­dure, they’re not see­ing the elec­tron­ic med­ical records that are tak­ing up all of our time. They’re just see­ing the doc­tor who can only spend 10 min­utes with them in the room, or the doc­tor who says, ‘I can’t get you this med­ica­tion, because it costs $500 a month.’ And what ends up hap­pen­ing is we inter­nal­ize that feel­ing.”

I spoke to a rheuma­tol­o­gist named Diana Gir­ni­ta, who found this cycle deeply dis­tress­ing. Orig­i­nal­ly from Roma­nia, Gir­ni­ta came to the Unit­ed States to do a post­doc at Har­vard and was daz­zled by the qual­i­ty of the train­ing she received. Then she began prac­tic­ing and hear­ing patients com­plain about the exor­bi­tant bills they were sent for rou­tine labs and med­ica­tions. One patient came to her in tears after being billed $7,000 for an IV infu­sion, for which the patient held her respon­si­ble. “They have to blame some­one, and we are the inter­face of the sys­tem,” she said. “They think we are the greedy ones.” Fed up, Gir­ni­ta even­tu­al­ly left the prac­tice.

Some doc­tors acknowl­edged that the pres­sures of the sys­tem had occa­sion­al­ly led them to betray the oaths they took to their patients. Among the physi­cians I spoke to about this, a 45-year-old crit­i­cal-care spe­cial­ist named Kei­th Corl stood out. Raised in a work­ing-class town in upstate New York, Corl was an ide­al­ist who quit a lucra­tive job in finance in his ear­ly 20s because he want­ed to do some­thing that would ben­e­fit peo­ple. Dur­ing med­ical school, he felt inspired watch­ing doc­tors in the E.R. and I.C.U. stretch them­selves to the break­ing point to treat who­ev­er hap­pened to pass through the doors on a giv­en night. “I want to do that,” he decid­ed instant­ly. And he did, spend­ing near­ly two decades work­ing long shifts as an emer­gency physi­cian in an array of hos­pi­tals, in cities from Prov­i­dence to Las Vegas to Sacra­men­to, where he now lives. Like many E.R. physi­cians, Corl viewed his job as a call­ing. But over time, his ide­al­ism gave way to dis­il­lu­sion­ment, as he strug­gled to pro­vide patients with the type of care he’d been trained to deliv­er. “Every day, you deal with some­body who couldn’t get some test or some treat­ment they need­ed because they didn’t have insur­ance,” he said. “Every day, you’re remind­ed how sav­age the sys­tem is.”

Corl was par­tic­u­lar­ly haunt­ed by some­thing that hap­pened in his late 30s, when he was work­ing in the emer­gency room of a hos­pi­tal in Paw­tuck­et, R.I. It was a frigid win­ter night, so cold you could see your breath. The hos­pi­tal was busy. When Corl arrived for his shift, all of the facility’s E.R. beds were filled. Corl was espe­cial­ly con­cerned about an elder­ly woman with pneu­mo­nia who he feared might be slip­ping into sep­sis, an extreme, poten­tial­ly fatal immune response to infec­tion. As Corl was mon­i­tor­ing her, a call came in from an ambu­lance, inform­ing the E.R. staff that anoth­er patient would soon be arriv­ing, a woman with severe men­tal health prob­lems. The patient was famil­iar to Corl — she was a fre­quent pres­ence in the emer­gency room. He knew that she had bipo­lar dis­or­der. He also knew that she could be a hand­ful. On a pre­vi­ous vis­it to the hos­pi­tal, she detached the bed rails on her stretch­er and fell to the floor, injur­ing a nurse.

In a hos­pi­tal that was ade­quate­ly staffed, man­ag­ing such a sit­u­a­tion while keep­ing tabs on all the oth­er patients might not have been a prob­lem. But Corl was the sole doc­tor in the emer­gency room that night; he under­stood this to be in part a result of cost-cut­ting mea­sures (the hos­pi­tal has since closed). After the ambu­lance arrived, he and a nurse began talk­ing with the incom­ing patient to gauge whether she was sui­ci­dal. They deter­mined she was not. But she was com­bat­ive, argu­ing with the nurse in an increas­ing­ly aggres­sive tone. As the argu­ment grew more heat­ed, Corl began to fear that if he and the nurse focused too much of their atten­tion on her, oth­er patients would suf­fer need­less­ly and that the woman at risk of sep­tic shock might die.

Corl decid­ed he could not let that hap­pen. Exchang­ing glances, he and the nurse unplugged the patient from the mon­i­tor, wheeled her stretch­er down the hall, and pushed it out of the hos­pi­tal. The blast of cold air when the door swung open caused Corl to shud­der. A nurse called the police to come pick the patient up. (It turned out that she had an out­stand­ing war­rant and was arrest­ed.) Lat­er, after he returned to the E.R., Corl could not stop think­ing about what he’d done, imag­in­ing how the med­ical-school ver­sion of him­self would have judged his con­duct. “He would have been hor­ri­fied.”

Con­cerns about the cor­po­rate takeover of America’s med­ical sys­tem are hard­ly new. More than half a cen­tu­ry ago, the writ­ers Bar­bara and John Ehren­re­ich assailed the pow­er of phar­ma­ceu­ti­cal com­pa­nies and oth­er large cor­po­ra­tions in what they termed the “med­ical-indus­tri­al com­plex,” which, as the phrase sug­gests, was any­thing but a char­i­ta­ble enter­prise. In the decades that fol­lowed, the offi­cial bod­ies of the med­ical pro­fes­sion seemed untrou­bled by this. To the con­trary, the Amer­i­can Med­ical Asso­ci­a­tion con­sis­tent­ly opposed efforts to broad­en access to health care after World War II, under­tak­ing aggres­sive lob­by­ing cam­paigns against pro­pos­als for a sin­gle-pay­er pub­lic sys­tem, which it saw as a threat to physi­cians’ auton­o­my.

But as the soci­ol­o­gist Paul Starr not­ed in “The Social Trans­for­ma­tion of Amer­i­can Med­i­cine,” physi­cians earned the public’s trust and derived much of their author­i­ty because they were per­ceived to be “above the mar­ket and pure com­mer­cial­ism.” And in fields like emer­gency med­i­cine, an ethos of ser­vice and self-sac­ri­fice pre­vailed. At aca­d­e­m­ic train­ing pro­grams, Robert McNa­ma­ra told me, stu­dents were taught that the needs of patients should always come first, and that doc­tors should nev­er allow finan­cial inter­ests to inter­fere with how they did their jobs. Many of these pro­grams were based in inner-city hos­pi­tals whose emer­gency rooms were often filled with indi­gent patients. Car­ing for peo­ple regard­less of their finan­cial means was both a legal oblig­a­tion — cod­i­fied in the Emer­gency Med­ical Treat­ment and Labor Act, a fed­er­al law passed in 1986 — and, in pro­grams like the one McNa­ma­ra ran at Tem­ple, a point of pride. But he acknowl­edged that over time, these val­ues increas­ing­ly clashed with the real­i­ty that res­i­dents encoun­tered once they entered the work force. “We’re train­ing peo­ple to put the patient first,” he says, “and they’re run­ning into a buzz saw.”

Through­out the med­ical sys­tem, the insis­tence on rev­enue and prof­its has accel­er­at­ed. This can be seen in the shut­ter­ing of pedi­atric units at many hos­pi­tals and region­al med­ical cen­ters, in part because treat­ing chil­dren is less lucra­tive than treat­ing adults, who order more elec­tive surg­eries and are less like­ly to be on Med­ic­aid. It can be seen in emer­gency rooms that were under­staffed because of bud­getary con­straints long before the pan­dem­ic began. And it can be seen in the push by multi­bil­lion-dol­lar com­pa­nies like CVS and Wal­mart to buy or invest in pri­ma­ry-care prac­tices, a rapid­ly con­sol­i­dat­ing field attrac­tive to investors because many of the patients who seek such care are enrolled in the Medicare Advan­tage pro­gram, which pays out $400 bil­lion to insur­ers annu­al­ly. Over the past decade, mean­while, pri­vate-equi­ty invest­ment in the health care indus­try has surged, a wave of acqui­si­tions that has swept up physi­cian prac­tices, hos­pi­tals, out­pa­tient clin­ics, home health agen­cies. McNa­ma­ra esti­mates that the staffing in 30 per­cent of all emer­gency rooms is now over­seen by pri­vate-equi­ty-owned firms. Once in charge, these com­pa­nies “start squeez­ing the doc­tors to see more patients per hour, cut­ting staff,” he says.

As the focus on rev­enue and the adop­tion of busi­ness met­rics has grown more per­va­sive, young peo­ple embark­ing on careers in med­i­cine are begin­ning to won­der if they are the ben­e­fi­cia­ries of cap­i­tal­ism or just anoth­er exploit­ed class. In 2021, the aver­age med­ical stu­dent grad­u­at­ed with more than $200,000 in debt. In the past, one priv­i­lege con­ferred on physi­cians who made these sac­ri­fices was the free­dom to con­trol their work­ing con­di­tions in inde­pen­dent prac­tices. But today, 70 per­cent of doc­tors work as salaried employ­ees of large hos­pi­tal sys­tems or cor­po­rate enti­ties, tak­ing orders from admin­is­tra­tors and exec­u­tives who do not always share their val­ues or pri­or­i­ties.

Philip Sossen­heimer, a 30-year-old med­ical res­i­dent at Stan­ford, told me that these changes had begun to pre­cip­i­tate a shift in self-per­cep­tion among doc­tors. In the past, physi­cians “didn’t real­ly see them­selves as labor­ers,” he notes. “They viewed them­selves as busi­ness own­ers or sci­en­tists, as a class above work­ing peo­ple.” Sossen­heimer feels that it is dif­fer­ent for his gen­er­a­tion, because younger doc­tors real­ize that they will have far less con­trol over their work­ing con­di­tions than their elders did — that the pres­tige of their pro­fes­sion won’t spare them from the degra­da­tion expe­ri­enced by work­ers in oth­er sec­tors of the econ­o­my. “For our gen­er­a­tion, mil­len­ni­als and below, our feel­ing is that there is a big pow­er imbal­ance between employ­ers and work­ers,” he says.

Last May, the med­ical res­i­dents at Stan­ford vot­ed to form a union by a tal­ly of 835 to 214, a cam­paign Sossen­heimer enthu­si­as­ti­cal­ly sup­port­ed. “We’ve seen a boom in union­iza­tion in many oth­er indus­tries,” he told me, “and we real­ize it can lev­el the pow­er dynam­ics, not just for oth­er work­ers but with­in med­i­cine.” One thing that drove this home to him was see­ing the nurs­es at Stan­ford, who belong to a union, go on strike to advo­cate for safer staffing and bet­ter work­ing con­di­tions. Their out­spo­ken­ness stood in strik­ing con­trast to the silence of res­i­dents, who risked being sin­gled out and dis­ci­plined if they dared to say any­thing that might attract the notice of the admin­is­tra­tion or their supe­ri­ors. “That’s a big rea­son that union­iza­tion is so impor­tant,” he says.

The Stan­ford exam­ple has inspired med­ical res­i­dents else­where. Not long ago, I spoke with a group of res­i­dents in New York City who were think­ing about union­iz­ing, on the con­di­tion that I not dis­close their iden­ti­ties or insti­tu­tion­al affil­i­a­tions. Although the med­ical pro­fes­sion has been slow to diver­si­fy, the res­i­dents came from strik­ing­ly var­ied back­grounds. Few grew up in wealthy fam­i­lies, judg­ing by the num­ber of hands that went up when I asked if they’d tak­en on debt to fin­ish med­ical school. “Any­one here not take on debt?” said a woman sit­ting on the car­pet in the liv­ing room where we gath­ered, prompt­ing sev­er­al peo­ple to laugh.

Hav­ing a union, one res­i­dent explained, would enable the group to demand bet­ter work­ing con­di­tions with­out hav­ing to wor­ry about get­ting in trou­ble with their supe­ri­ors or los­ing fel­low­ship oppor­tu­ni­ties. They would be able to advo­cate for patients rather than apol­o­giz­ing to them for prac­tices they con­sid­ered shame­ful, anoth­er added. When I asked what they meant by shame­ful, I learned that a num­ber of the res­i­dents had trained at a hos­pi­tal that served an extreme­ly poor com­mu­ni­ty with a lim­it­ed num­ber of I.C.U. beds — beds that dur­ing the pan­dem­ic were some­times giv­en to wealthy “V.I.P.” patients from oth­er states while sick­er patients from the sur­round­ing neigh­bor­hood lan­guished on the gen­er­al floor.

Form­ing unions is just one way that patient advo­cates are find­ing to push back against such inequities. Crit­ics of pri­vate equity’s grow­ing role in the health care sys­tem are also close­ly watch­ing a Cal­i­for­nia law­suit that could have a major impact. In Decem­ber 2021, the Amer­i­can Acad­e­my of Emer­gency Med­i­cine Physi­cian Group (A.A.E.M.P.G.), part of an asso­ci­a­tion of doc­tors, res­i­dents and med­ical stu­dents, filed a law­suit accus­ing Envi­sion Health­care, a pri­vate-equi­ty-backed provider, of vio­lat­ing a Cal­i­for­nia statute that pro­hibits non­med­ical cor­po­ra­tions from con­trol­ling the deliv­ery of health ser­vices. Pri­vate-equi­ty firms often cir­cum­vent these restric­tions by trans­fer­ring own­er­ship, on paper, to doc­tors, even as the com­pa­nies retain con­trol over every­thing, includ­ing the terms of the physi­cians’ employ­ment and the rates that patients are charged for care, accord­ing to the law­suit. A.A.E.M.P.G.’s aim in bring­ing the suit is not to pun­ish one com­pa­ny but rather to pro­hib­it such arrange­ments alto­geth­er. “We’re not ask­ing them to pay mon­ey, and we will not accept being paid to drop the case,” David Mill­stein, a lawyer for the A.A.E.M.P.G. has said of the suit. “We are sim­ply ask­ing the court to ban this prac­tice mod­el.” In May 2022, a judge reject­ed Envision’s motion to dis­miss the case, rais­ing hopes that such a ban may take effect.

...

———–

“The Moral Cri­sis of America’s Doc­tors” By Eyal Press; The New York Times; 06/15/2023

“Because doc­tors are high­ly skilled pro­fes­sion­als who are not so easy to replace, I assumed that they would not be as reluc­tant to dis­cuss the dis­tress­ing con­di­tions at their jobs as the low-wage work­ers I’d inter­viewed. But the physi­cians I con­tact­ed were afraid to talk open­ly. “I have since recon­sid­ered this and do not feel this is some­thing I can do right now,” one doc­tor wrote to me. Anoth­er texted, “Will need to be anon.” Some sources I tried to reach had signed nondis­clo­sure agree­ments that pro­hib­it­ed them from speak­ing to the media with­out per­mis­sion. Oth­ers wor­ried they could be dis­ci­plined or fired if they angered their employ­ers, a con­cern that seems par­tic­u­lar­ly well found­ed in the grow­ing swath of the health care sys­tem that has been tak­en over by pri­vate-equi­ty firms. In March 2020, an emer­gency-room doc­tor named Ming Lin was removed from the rota­tion at his hos­pi­tal after air­ing con­cerns about its Covid-19 safe­ty pro­to­cols. Lin worked at St. Joseph Med­ical Cen­ter, in Belling­ham, Wash. — but his actu­al employ­er was TeamHealth, a com­pa­ny owned by the Black­stone Group.”

It’s a pret­ty damn­ing state­ment on the pow­er rela­tion­ship between the ‘investor class’ in the US and every­one else: even doc­tors are so pow­er­less in mod­ern Amer­i­ca that they have suc­cess­ful­ly been ter­ri­fied into silence under the threat of get­ting fired. Silence over sys­temic patient abus­es all done in the name of ‘pro­duc­tiv­i­ty’ and high­er investor returns. And it’s the doc­tors work­ing under pri­vate-equi­ty firm — which over­see the staffing in rough­ly 30 per­cent of Emer­gency Rooms already — who are the most ter­ri­fied to share their sense of moral injury with the rest of soci­ety. It’s hard to come up with a more apt metaophor for pri­vate equi­ty’s cap­ture of Amer­i­can soci­ety than this tru­ly sick state of affairs:

...
E.R. doc­tors have found them­selves at the fore­front of these trends as more and more hos­pi­tals have out­sourced the staffing in emer­gency depart­ments in order to cut costs. A 2013 study by Robert McNa­ma­ra, the chair­man of the emer­gency-med­i­cine depart­ment at Tem­ple Uni­ver­si­ty in Philadel­phia, found that 62 per­cent of emer­gency physi­cians in the Unit­ed States could be fired with­out due process. Near­ly 20 per­cent of the 389 E.R. doc­tors sur­veyed said they had been threat­ened for rais­ing qual­i­ty-of-care con­cerns, and pres­sured to make deci­sions based on finan­cial con­sid­er­a­tions that could be detri­men­tal to the peo­ple in their care, like being pushed to dis­charge Medicare and Med­ic­aid patients or being encour­aged to order more test­ing than nec­es­sary. In anoth­er study, more than 70 per­cent of emer­gency physi­cians agreed that the cor­po­ra­ti­za­tion of their field has had a neg­a­tive or strong­ly neg­a­tive impact on the qual­i­ty of care and on their own job sat­is­fac­tion.

There are, of course, plen­ty of doc­tors who like what they do and feel no need to speak out. Clin­i­cians in high-pay­ing spe­cial­ties like ortho­pe­dics and plas­tic surgery “are doing just fine, thank you,” one physi­cian I know joked. But more and more doc­tors are com­ing to believe that the pan­dem­ic mere­ly wors­ened the strain on a health care sys­tem that was already fail­ing because it pri­or­i­tizes prof­its over patient care. They are notic­ing how the empha­sis on the bot­tom line rou­tine­ly puts them in moral binds, and young doc­tors in par­tic­u­lar are con­tem­plat­ing how to resist. Some are mulling whether the sac­ri­fices — and com­pro­mis­es — are even worth it. “I think a lot of doc­tors are feel­ing like some­thing is trou­bling them, some­thing deep in their core that they com­mit­ted them­selves to,” Dean says. She notes that the term moral injury was orig­i­nal­ly coined by the psy­chi­a­trist Jonathan Shay to describe the wound that forms when a person’s sense of what is right is betrayed by lead­ers in high-stakes sit­u­a­tions. “Not only are clin­i­cians feel­ing betrayed by their lead­er­ship,” she says, “but when they allow these bar­ri­ers to get in the way, they are part of the betray­al. They’re the instru­ments of betray­al.”

Not long ago, I spoke to an emer­gency physi­cian, whom I’ll call A., about her expe­ri­ence. (She did not want her name used, explain­ing that she knew sev­er­al doc­tors who had been fired for voic­ing con­cerns about unsat­is­fac­to­ry work­ing con­di­tions or patient-safe­ty issues.) A soft-spo­ken woman with a gen­tle man­ner, A. referred to the emer­gency room as a “sacred space,” a place she loved work­ing because of the pro­found impact she could have on patients’ lives, even those who weren’t going to pull through. Dur­ing her train­ing, a patient with a ter­mi­nal con­di­tion somber­ly informed her that his daugh­ter couldn’t make it to the hos­pi­tal to be with him in his final hours. A. promised the patient that he wouldn’t die alone and then held his hand until he passed away. Inter­ac­tions like that one would not be pos­si­ble today, she told me, because of the new empha­sis on speed, effi­cien­cy and rel­a­tive val­ue units (R.V.U.), a met­ric used to mea­sure physi­cian reim­burse­ment that some feel rewards doc­tors for doing tests and pro­ce­dures and dis­cour­ages them from spend­ing too much time on less remu­ner­a­tive func­tions, like lis­ten­ing and talk­ing to patients. “It’s all about R.V.U.s and going faster,” she said of the ethos that per­me­at­ed the prac­tice where she’d been work­ing. “Your door-to-doc­tor time, your room-to-doc­tor time, your time from ini­tial eval­u­a­tion to dis­charge.”

...

Con­cerns about the cor­po­rate takeover of America’s med­ical sys­tem are hard­ly new. More than half a cen­tu­ry ago, the writ­ers Bar­bara and John Ehren­re­ich assailed the pow­er of phar­ma­ceu­ti­cal com­pa­nies and oth­er large cor­po­ra­tions in what they termed the “med­ical-indus­tri­al com­plex,” which, as the phrase sug­gests, was any­thing but a char­i­ta­ble enter­prise. In the decades that fol­lowed, the offi­cial bod­ies of the med­ical pro­fes­sion seemed untrou­bled by this. To the con­trary, the Amer­i­can Med­ical Asso­ci­a­tion con­sis­tent­ly opposed efforts to broad­en access to health care after World War II, under­tak­ing aggres­sive lob­by­ing cam­paigns against pro­pos­als for a sin­gle-pay­er pub­lic sys­tem, which it saw as a threat to physi­cians’ auton­o­my.

But as the soci­ol­o­gist Paul Starr not­ed in “The Social Trans­for­ma­tion of Amer­i­can Med­i­cine,” physi­cians earned the public’s trust and derived much of their author­i­ty because they were per­ceived to be “above the mar­ket and pure com­mer­cial­ism.” And in fields like emer­gency med­i­cine, an ethos of ser­vice and self-sac­ri­fice pre­vailed. At aca­d­e­m­ic train­ing pro­grams, Robert McNa­ma­ra told me, stu­dents were taught that the needs of patients should always come first, and that doc­tors should nev­er allow finan­cial inter­ests to inter­fere with how they did their jobs. Many of these pro­grams were based in inner-city hos­pi­tals whose emer­gency rooms were often filled with indi­gent patients. Car­ing for peo­ple regard­less of their finan­cial means was both a legal oblig­a­tion — cod­i­fied in the Emer­gency Med­ical Treat­ment and Labor Act, a fed­er­al law passed in 1986 — and, in pro­grams like the one McNa­ma­ra ran at Tem­ple, a point of pride. But he acknowl­edged that over time, these val­ues increas­ing­ly clashed with the real­i­ty that res­i­dents encoun­tered once they entered the work force. “We’re train­ing peo­ple to put the patient first,” he says, “and they’re run­ning into a buzz saw.”

Through­out the med­ical sys­tem, the insis­tence on rev­enue and prof­its has accel­er­at­ed. This can be seen in the shut­ter­ing of pedi­atric units at many hos­pi­tals and region­al med­ical cen­ters, in part because treat­ing chil­dren is less lucra­tive than treat­ing adults, who order more elec­tive surg­eries and are less like­ly to be on Med­ic­aid. It can be seen in emer­gency rooms that were under­staffed because of bud­getary con­straints long before the pan­dem­ic began. And it can be seen in the push by multi­bil­lion-dol­lar com­pa­nies like CVS and Wal­mart to buy or invest in pri­ma­ry-care prac­tices, a rapid­ly con­sol­i­dat­ing field attrac­tive to investors because many of the patients who seek such care are enrolled in the Medicare Advan­tage pro­gram, which pays out $400 bil­lion to insur­ers annu­al­ly. Over the past decade, mean­while, pri­vate-equi­ty invest­ment in the health care indus­try has surged, a wave of acqui­si­tions that has swept up physi­cian prac­tices, hos­pi­tals, out­pa­tient clin­ics, home health agen­cies. McNa­ma­ra esti­mates that the staffing in 30 per­cent of all emer­gency rooms is now over­seen by pri­vate-equi­ty-owned firms. Once in charge, these com­pa­nies “start squeez­ing the doc­tors to see more patients per hour, cut­ting staff,” he says.

As the focus on rev­enue and the adop­tion of busi­ness met­rics has grown more per­va­sive, young peo­ple embark­ing on careers in med­i­cine are begin­ning to won­der if they are the ben­e­fi­cia­ries of cap­i­tal­ism or just anoth­er exploit­ed class. In 2021, the aver­age med­ical stu­dent grad­u­at­ed with more than $200,000 in debt. In the past, one priv­i­lege con­ferred on physi­cians who made these sac­ri­fices was the free­dom to con­trol their work­ing con­di­tions in inde­pen­dent prac­tices. But today, 70 per­cent of doc­tors work as salaried employ­ees of large hos­pi­tal sys­tems or cor­po­rate enti­ties, tak­ing orders from admin­is­tra­tors and exec­u­tives who do not always share their val­ues or pri­or­i­ties.
...

What does the future hold for this field? Well, less trained doc­tors, if the stun­ning lev­els of per­son­al dis­tress reflect­ed in the sur­vey results of med­ical pro­fes­sion­als are any indi­ca­tion of what to expect: one recent sur­vey found that 1 in 5 health care work­ers had already quit their job since the start of the pan­dem­ic, with anoth­er 31 per­cent con­sid­er­ing that option. So a major­i­ty of med­ical pro­fes­sion­als have either quit or are con­sid­er­ing quit­ting in just the last few years. And while the unique stress­es of the pan­dem­ic obvi­ous­ly played a role in those sur­vey results, the ‘moral injury’ report­ed by these pro­fes­sion­als was­n’t cre­at­ed by the pan­dem­ic. It was cre­at­ed by the stress­es of pro­vid­ed care to peo­ple while adher­ing to the prof­it-max­i­miz­ing man­dates of their employ­ers. The pan­dem­ic has reced­ed. Pri­vate equi­ty’s ruth­less­ness in the pur­suit of those prof­its will nev­er end:

...
In July 2018, Dean pub­lished an essay with Simon G. Tal­bot, a plas­tic and recon­struc­tive sur­geon, that argued that many physi­cians were suf­fer­ing from a con­di­tion known as moral injury. Mil­i­tary psy­chi­a­trists use the term to describe an emo­tion­al wound sus­tained when, in the course of ful­fill­ing their duties, sol­diers wit­nessed or com­mit­ted acts — raid­ing a home, killing a non­com­bat­ant — that trans­gressed their core val­ues. Doc­tors on the front lines of America’s prof­it-dri­ven health care sys­tem were also sus­cep­ti­ble to such wounds, Dean and Tal­bot sub­mit­ted, as the demands of admin­is­tra­tors, hos­pi­tal exec­u­tives and insur­ers forced them to stray from the eth­i­cal prin­ci­ples that were sup­posed to gov­ern their pro­fes­sion. The pull of these forces left many doc­tors anguished and dis­traught, caught between the Hip­po­crat­ic oath and “the real­i­ties of mak­ing a prof­it from peo­ple at their sick­est and most vul­ner­a­ble.”

The arti­cle was pub­lished on Stat, a med­ical-news web­site with a mod­est read­er­ship. To Dean’s sur­prise, it quick­ly went viral. Doc­tors and nurs­es start­ed reach­ing out to Dean to tell her how much the arti­cle spoke to them. “It went every­where,” Dean told me when I vis­it­ed her last March in Carlisle, Pa., where she now lives. By the time we met, the dis­tress among med­ical pro­fes­sion­als had reached alarm­ing lev­els: One sur­vey found that near­ly one in five health care work­ers had quit their job since the start of the pan­dem­ic and that an addi­tion­al 31 per­cent had con­sid­ered leav­ing. Pro­fes­sion­al orga­ni­za­tions like Nation­al Nurs­es Unit­ed, the largest group of reg­is­tered nurs­es in the coun­try, had begun refer­ring to “moral injury” and “moral dis­tress” in pam­phlets and news releas­es. Mona Masood, a psy­chi­a­trist who estab­lished a sup­port line for doc­tors short­ly after the pan­dem­ic began, recalls being struck by how clin­i­cians react­ed when she men­tioned the term. “I remem­ber all these physi­cians were like, Wow, that is what I was look­ing for,” she says. “This is it.”

Dean’s essay caught my eye, too, because I spent much of the pre­vi­ous few years report­ing on moral injury, inter­view­ing work­ers in menial occu­pa­tions whose jobs were eth­i­cal­ly com­pro­mis­ing. I spoke to prison guards who patrolled the wards of vio­lent pen­i­ten­tiaries, undoc­u­ment­ed immi­grants who toiled on the “kill floors” of indus­tri­al slaugh­ter­hous­es and roustabouts who worked on off­shore rigs in the fos­sil-fuel indus­try. Many of these work­ers were hes­i­tant to talk or be iden­ti­fied, know­ing how eas­i­ly they could be replaced by some­one else. Com­pared with them, physi­cians were priv­i­leged, earn­ing six-fig­ure salaries and doing pres­ti­gious jobs that spared them from the drudgery endured by so many oth­er mem­bers of the labor force, includ­ing nurs­es and cus­to­di­al work­ers in the health care indus­try. But in recent years, despite the esteem asso­ci­at­ed with their pro­fes­sion, many physi­cians have found them­selves sub­ject­ed to prac­tices more com­mon­ly asso­ci­at­ed with man­u­al labor­ers in auto plants and Ama­zon ware­hous­es, like hav­ing their pro­duc­tiv­i­ty tracked on an hourly basis and being pres­sured by man­age­ment to work faster.
...

So are there any viable cures avail­able for the grow­ing num­bers of doc­tors who feel like they are vio­lat­ing their own con­sciences in the pur­suit of investor prof­its? Well, there are solu­tions. Unfor­tu­nate­ly, they’re the kinds of solu­tions that are increas­ing­ly unthink­able for the cap­tured Amer­i­can econ­o­my: union­iza­tion. This is a good time to recall how threat­en­ing employ­ees if they vote to union­ize remains ram­pant among large US employ­ers:

...
Philip Sossen­heimer, a 30-year-old med­ical res­i­dent at Stan­ford, told me that these changes had begun to pre­cip­i­tate a shift in self-per­cep­tion among doc­tors. In the past, physi­cians “didn’t real­ly see them­selves as labor­ers,” he notes. “They viewed them­selves as busi­ness own­ers or sci­en­tists, as a class above work­ing peo­ple.” Sossen­heimer feels that it is dif­fer­ent for his gen­er­a­tion, because younger doc­tors real­ize that they will have far less con­trol over their work­ing con­di­tions than their elders did — that the pres­tige of their pro­fes­sion won’t spare them from the degra­da­tion expe­ri­enced by work­ers in oth­er sec­tors of the econ­o­my. “For our gen­er­a­tion, mil­len­ni­als and below, our feel­ing is that there is a big pow­er imbal­ance between employ­ers and work­ers,” he says.

Last May, the med­ical res­i­dents at Stan­ford vot­ed to form a union by a tal­ly of 835 to 214, a cam­paign Sossen­heimer enthu­si­as­ti­cal­ly sup­port­ed. “We’ve seen a boom in union­iza­tion in many oth­er indus­tries,” he told me, “and we real­ize it can lev­el the pow­er dynam­ics, not just for oth­er work­ers but with­in med­i­cine.” One thing that drove this home to him was see­ing the nurs­es at Stan­ford, who belong to a union, go on strike to advo­cate for safer staffing and bet­ter work­ing con­di­tions. Their out­spo­ken­ness stood in strik­ing con­trast to the silence of res­i­dents, who risked being sin­gled out and dis­ci­plined if they dared to say any­thing that might attract the notice of the admin­is­tra­tion or their supe­ri­ors. “That’s a big rea­son that union­iza­tion is so impor­tant,” he says.

The Stan­ford exam­ple has inspired med­ical res­i­dents else­where. Not long ago, I spoke with a group of res­i­dents in New York City who were think­ing about union­iz­ing, on the con­di­tion that I not dis­close their iden­ti­ties or insti­tu­tion­al affil­i­a­tions. Although the med­ical pro­fes­sion has been slow to diver­si­fy, the res­i­dents came from strik­ing­ly var­ied back­grounds. Few grew up in wealthy fam­i­lies, judg­ing by the num­ber of hands that went up when I asked if they’d tak­en on debt to fin­ish med­ical school. “Any­one here not take on debt?” said a woman sit­ting on the car­pet in the liv­ing room where we gath­ered, prompt­ing sev­er­al peo­ple to laugh.

Hav­ing a union, one res­i­dent explained, would enable the group to demand bet­ter work­ing con­di­tions with­out hav­ing to wor­ry about get­ting in trou­ble with their supe­ri­ors or los­ing fel­low­ship oppor­tu­ni­ties. They would be able to advo­cate for patients rather than apol­o­giz­ing to them for prac­tices they con­sid­ered shame­ful, anoth­er added. When I asked what they meant by shame­ful, I learned that a num­ber of the res­i­dents had trained at a hos­pi­tal that served an extreme­ly poor com­mu­ni­ty with a lim­it­ed num­ber of I.C.U. beds — beds that dur­ing the pan­dem­ic were some­times giv­en to wealthy “V.I.P.” patients from oth­er states while sick­er patients from the sur­round­ing neigh­bor­hood lan­guished on the gen­er­al floor.
...

Final­ly, we get to this inter­est­ing legal approach to weak­en­ing pri­vate equi­ty’s grow­ing grip on med­i­cine in the US: state laws that pro­hibits non­med­ical cor­po­ra­tions from con­trol­ling the deliv­ery of health ser­vices. Cal­i­for­nia has such a law. And as we can see, it’s a law the pri­vate equi­ty indus­try has already wormed its way around. But that does­n’t mean the law can’t be changed and fixed. And then actu­al­ly enforced. Legal­ly reign­ing in these kinds of busi­ness mod­els real­ly is an option, even if it does­n’t feel like one in a soci­ety cap­tured by spe­cial inter­ests. But it is an option:

...
Form­ing unions is just one way that patient advo­cates are find­ing to push back against such inequities. Crit­ics of pri­vate equity’s grow­ing role in the health care sys­tem are also close­ly watch­ing a Cal­i­for­nia law­suit that could have a major impact. In Decem­ber 2021, the Amer­i­can Acad­e­my of Emer­gency Med­i­cine Physi­cian Group (A.A.E.M.P.G.), part of an asso­ci­a­tion of doc­tors, res­i­dents and med­ical stu­dents, filed a law­suit accus­ing Envi­sion Health­care, a pri­vate-equi­ty-backed provider, of vio­lat­ing a Cal­i­for­nia statute that pro­hibits non­med­ical cor­po­ra­tions from con­trol­ling the deliv­ery of health ser­vices. Pri­vate-equi­ty firms often cir­cum­vent these restric­tions by trans­fer­ring own­er­ship, on paper, to doc­tors, even as the com­pa­nies retain con­trol over every­thing, includ­ing the terms of the physi­cians’ employ­ment and the rates that patients are charged for care, accord­ing to the law­suit. A.A.E.M.P.G.’s aim in bring­ing the suit is not to pun­ish one com­pa­ny but rather to pro­hib­it such arrange­ments alto­geth­er. “We’re not ask­ing them to pay mon­ey, and we will not accept being paid to drop the case,” David Mill­stein, a lawyer for the A.A.E.M.P.G. has said of the suit. “We are sim­ply ask­ing the court to ban this prac­tice mod­el.” In May 2022, a judge reject­ed Envision’s motion to dis­miss the case, rais­ing hopes that such a ban may take effect.
...

Can the pri­vate-equi­ty indus­try actu­al­ly get reigned in? Well, in Decem­ber of 2020 Con­gress did pass the “No Sur­pris­es Act” that was signed into law and has been in force in Jan­u­ary of 2022, remov­ing patients from pay­ment dis­putes between hos­pi­tals and insur­ance com­pa­nies. Yes, to some extent, the pri­vate-equi­ty indus­try real­ly has been reigned in on this par­tic­u­lar front.

Of course, pri­vate-equi­ty will still be allowed to own a seem­ing­ly ever-grow­ing stake in the health care sec­tor and inflict gen­er­al moral injury on its staff. And as the Biden admin­is­tra­tion’s recent updates to the No Sur­pris­es Act imple­men­ta­tion — updates designed to thwart var­i­ous cheats and workarounds the indus­try has already come up with to get around the new reg­u­la­tions — we can’t real­ly expect the sur­prise billing to tru­ly end. Nor can we expect the dark mon­ey lob­by­ing cam­paigns to end. Or the grow­ing num­bers of doc­tors quit­ting or think­ing of quit­ting. We can’t real­ly real­is­ti­cal­ly that to end. But at least the pri­vate-equi­ty indus­try’s sur­prise billing spree has sort of put of hold for now. Seem­ing­ly to the detri­ment of the pen­sion­ers indi­rect­ly rely­ing on those sur­prise bills to pay for their retire­ments. Yes, Amer­i­ca’s bro­ken retire­ment sys­tem and bro­ken health sys­tem are increas­ing­ly the same bro­ken sys­tem. Owned and oper­at­ed by pri­vate-equi­ty, for whom the sys­tem is very much not bro­ken and work­ing just fine.

Is anoth­er Fed rate hike on the way? Or might we be look­ing at the begin­ning of the end of the cur­rent cycle? We’ll pre­sum­ably have bet­ter answers to those ques­tions fol­low­ing this week’s sched­uled Fed­er­al Reserve meet­ing, when the Fed is expect­ed to hike rates once again, but pos­si­ble for the last time for a while.

And while many fac­tors — in par­tic­u­lar ris­ing wages — play a role in the Fed’s rate hike deci­sion-mak­ing, you have to won­der how big a fac­tor the fol­low­ing pri­vate-equi­ty finan­cial time-bomb is in the Fed’s deci­sion-mak­ing process. Because as the fol­low­ing arti­cles describe, the pri­vate-equi­ty indus­try’s rate-sen­si­tiv­i­ty goes well beyond just the impact ris­ing rates have on the sec­tor’s bloat­ed com­mer­cial real estate (CRE) hold­ings.

For exam­ple, there’s all the cor­po­rate debt that’s become increas­ing­ly pop­u­lar with pri­vate-equi­ty investors in recent year. Cor­po­rate debt that obvi­ous­ly has­n’t per­formed well in response to all the rate hikes.

But then there’s the rate-sen­si­tiv­i­ty asso­ci­at­ed with the pri­vate-equi­ty assets that have been fuel­ing the cor­po­rate bond buy­ing binge: insur­ance com­pa­ny asset pools. Yes, insur­ance com­pa­nies are one of the oth­er sec­tors pri­vate-equi­ty has been increas­ing­ly invest­ing in over the last decade. Why insur­ance com­pa­nies? Well, thanks to reg­u­la­tions, they tend to have large pools of assets that well exceed their long-term lia­bil­i­ties. Assets that can be tak­en and invest­ed by a pri­vate-equi­ty par­ent com­pa­ny. Insur­ance com­pa­nies also have a lot of ‘float’, which is the mon­ey com­ing into the firm before it has to lat­er be paid out. Gam­bling with the ‘float’ is the appar­ent­ly one of the new hot things in pri­vate-equi­ty.

And here’s where it gets extra dement­ed. There’s one par­tic­u­lar type of insur­ance prod­uct pri­vate-equi­ty firms are espe­cial­ly inter­est­ed in: Annu­ities, which are effec­tive­ly like per­son­al pen­sion insur­ance prod­ucts. It turns out annu­ities have a fea­ture that pri­vate equi­ty finds par­tic­u­lar­ly attrac­tive in the form of ‘sur­ren­der charges’, which impose a poten­tial­ly stiff fee for the ear­ly with­draw­al of funds. So what we are ulti­mate­ly see­ing is pri­vate-equi­ty firms using pen­sion fund mon­ey to pur­chase insur­ance com­pa­nies so they can gam­ble with the assets back­ing the annu­ity poli­cies. And the gam­ble of choice has been cor­po­rate bonds, a par­tic­u­lar­ly dis­tressed asset class in a ris­ing rate envi­ron­ment. It’s not great.

Ok, first, here’s an Insti­tu­tion­al Investor arti­cle from Feb­ru­ary 2022 describ­ing pri­vate-equi­ty’s big dive into insur­ance. A big dive that comes with enor­mous oppor­tu­ni­ties. In par­tic­u­lar, a big oppor­tu­ni­ty to take those giant insur­ance asset pools and invest them in high­er-risk/high­er-yield­ing oppor­tu­ni­ties. But also risks. Like the obvi­ous risk that the under­ly­ing assets placed in high­er-risk invest­ments will be mis­man­aged and lose mon­ey:

Insti­tu­tion­al Investor

Pri­vate Equi­ty Is Tak­ing a Long, Hard Look at Insur­ance. So Far, It Likes What It Sees.

Life and annu­ity com­pa­nies are now pro­vid­ing pri­vate equi­ty firms with “a once-in-a-gen­er­a­tion oppor­tu­ni­ty,” accord­ing to McK­in­sey.

Han­nah Zhang
Feb­ru­ary 2, 2022

Pri­vate equi­ty and oth­er alter­na­tives firms have long sali­vat­ed over insur­ance com­pa­ny assets as a source of per­ma­nent cap­i­tal. Now that trend has been kicked into high gear.

Just look at deal mak­ing. In Decem­ber, Allianz Life entered a rein­sur­ance agree­ment with Sixth Street’s port­fo­lio com­pa­ny Tal­cott and part­ner Res­o­lu­tion Life. Late last month, Sixth Street announced a $25 bil­lion rein­sur­ance trans­ac­tion between an affil­i­ate of Tal­cott Res­o­lu­tion and Prin­ci­pal Finan­cial Group. Ear­li­er in 2021, pri­vate equi­ty giants like Black­stone, KKR, and Apol­lo all announced merg­ers or acqui­si­tion plans to fur­ther build up their insur­ance port­fo­lios. In total, pri­vate investors in the U.S. acquired or rein­sured more than $200 bil­lion in 2021, accord­ing to a McK­in­sey report.

“Assum­ing the pend­ing deals close suc­cess­ful­ly, pri­vate investors will own 12 per­cent of the life and annu­ity assets in the U.S., total­ing $620 bil­lion, and rep­re­sent more than a third of U.S. net writ­ten pre­mi­ums of indexed annu­ities,” the report said.

Accord­ing to McK­in­sey, one major fac­tor that has attract­ed pri­vate equi­ty firms to the insur­ance space is the spread between the cost of lia­bil­i­ties and the poten­tial invest­ment returns. Insur­ance com­pa­nies are “well stocked with assets,” which usu­al­ly exceed the future pay­outs by a large amount. Until the com­pa­nies approve insur­ance claims, they need to find return-gen­er­at­ing invest­ment vehi­cles in which to park the assets, and that falls into pri­vate equity’s area of exper­tise. Of course, insur­ance firms are high­ly reg­u­lat­ed and only a small por­tion of these firms’ assets, which back poli­cies, can be moved into high­er risk invest­ments.

The report not­ed that there are three advan­tages to PE firms con­trol­ling life and annu­ity firms through equi­ty invest­ments. First, asset man­agers can gen­er­ate inter­nal rates of return as high as 10 to 14 per­cent by rotat­ing through dif­fer­ent asset class­es. Insur­ers are thus exposed to assets with high­er risks, such as asset-backed secu­ri­ties, and high­er poten­tial returns. Sec­ond, insur­ance invest­ments are a nat­ur­al way for GPs to expand their foot­print in cred­it invest­ments, which “is a strate­gic growth area for many firms at a time when PE mar­kets are becom­ing more com­pet­i­tive.” Last­ly, the mas­sive insur­ance mar­ket could help PE firms scale up quick­ly, accord­ing to the report.

...

The report also list­ed three main chal­lenges for PE firms that are look­ing to expand their foot­print in insur­ance. The first one is illiq­uid­i­ty and cred­it risk. “Rotat­ing the port­fo­lio into high­er-risk cred­it assets has advan­tages, but [it] also cre­ates risk that is impor­tant to man­age, par­tic­u­lar­ly as the port­fo­lio has typ­i­cal­ly been invest­ed in more liq­uid, sta­ble assets,” the report said. The sec­ond is that life insur­ance is a high­ly reg­u­lat­ed indus­try, and PE firms need to find their own meth­ods of engag­ing with state insur­ance com­mis­sions.

———

“/private Equi­ty Is Tak­ing a Long, Hard Look at Insur­ance. So Far, It Likes What It Sees.” by Han­nah Zhang; Insti­tu­tion­al Investor; 02/02/2022

“Accord­ing to McK­in­sey, one major fac­tor that has attract­ed pri­vate equi­ty firms to the insur­ance space is the spread between the cost of lia­bil­i­ties and the poten­tial invest­ment returns. Insur­ance com­pa­nies are “well stocked with assets,” which usu­al­ly exceed the future pay­outs by a large amount. Until the com­pa­nies approve insur­ance claims, they need to find return-gen­er­at­ing invest­ment vehi­cles in which to park the assets, and that falls into pri­vate equity’s area of exper­tise. Of course, insur­ance firms are high­ly reg­u­lat­ed and only a small por­tion of these firms’ assets, which back poli­cies, can be moved into high­er risk invest­ments.”

Yes, there was one major fac­tor dri­ving the recent pri­vate equi­ty insur­ance com­pa­ny binge: insur­ance com­pa­nies tend to have far more assets on hand than their future lia­bil­i­ties, as required by reg­u­la­tions. Assets that’s that need to be invest­ed in the mean time. It’s those giant pools of reg­u­lat­ed assets fuel­ing pri­vate equi­ty’s grow­ing insur­ance appetite.

Of course, giant pools of assets don’t gen­er­ate out­sized returns with­out tak­ing on addi­tion­al risks. And that’s why the push towards pri­vate equi­ty-owned insur­ance com­pa­nies should real­ly be seen as an ele­va­tion in the over­all risk of the insur­ance indus­try. That’s how pri­vate-equi­ty oper­ates, after all.

But the arti­cle also hints at anoth­er risk: many of the insur­ance indus­try’s reg­u­la­tions hap­pen at the state lev­el. As such, it’s state reg­u­la­tors that pri­vate-equi­ty firms nav­i­gat­ing the insur­ance indus­try’s reg­u­la­tions have to work with. In oth­er words, every state rep­re­sents oppor­tu­ni­ties to find an extreme­ly com­pli­ant reg­u­la­tor:

...
The report not­ed that there are three advan­tages to PE firms con­trol­ling life and annu­ity firms through equi­ty invest­ments. First, asset man­agers can gen­er­ate inter­nal rates of return as high as 10 to 14 per­cent by rotat­ing through dif­fer­ent asset class­es. Insur­ers are thus exposed to assets with high­er risks, such as asset-backed secu­ri­ties, and high­er poten­tial returns. Sec­ond, insur­ance invest­ments are a nat­ur­al way for GPs to expand their foot­print in cred­it invest­ments, which “is a strate­gic growth area for many firms at a time when PE mar­kets are becom­ing more com­pet­i­tive.” Last­ly, the mas­sive insur­ance mar­ket could help PE firms scale up quick­ly, accord­ing to the report.

...

The report also list­ed three main chal­lenges for PE firms that are look­ing to expand their foot­print in insur­ance. The first one is illiq­uid­i­ty and cred­it risk. “Rotat­ing the port­fo­lio into high­er-risk cred­it assets has advan­tages, but [it] also cre­ates risk that is impor­tant to man­age, par­tic­u­lar­ly as the port­fo­lio has typ­i­cal­ly been invest­ed in more liq­uid, sta­ble assets,” the report said. The sec­ond is that life insur­ance is a high­ly reg­u­lat­ed indus­try, and PE firms need to find their own meth­ods of engag­ing with state insur­ance com­mis­sions.
...

That was the sit­u­a­tion in Feb­ru­ary 2022. Flash for­ward a year and we find the fol­low­ing Amer­i­can Prospect piece by David Dayen describ­ing how the pen­sion fund clients ulti­mate­ly financ­ing these pri­vate-equi­ty insur­ance acqui­si­tions aren’t the only retire­ment funds put at risk by this strat­e­gy. Pri­vate equi­ty has a par­tic­u­lar appetite for insur­ance com­pa­nies that issue large vol­umes of annu­ities. The kinds of annu­ities that oper­ate as per­son­al retire­ment sup­ple­ments.

Why annu­ities? Well, the funds put into annu­ities have a num­ber of obsta­cles to the ear­ly with­draw­al of funds, mak­ing the pools of annu­ity pre­mi­ums par­tic­u­lar­ly use­ful in cre­at­ing what is known as ‘float’, or rev­enue streams com­ing into insur­ers before it goes out to pay claims and ben­e­fits. But while large pools of ‘float­ing’ cash rep­re­sent an obvi­ous­ly use­ful source for gen­er­at­ing income, that’s not nec­es­sar­i­ly risk free income. There’s no guar­an­tee the ‘float­ed’ funds aren’t going to be lost. Loss­es that could ulti­mate­ly trans­late to retirees not receiv­ing their promised annu­ity pay­ments. Annu­ities aren’t pro­tect­ed against an insur­ance com­pa­ny’s default, after all. And as the arti­cle also notes, while the insur­ance indus­try is indeed reg­u­lat­ed at the state lev­el, the track record for state reg­u­la­tors over the last decade has been rather under­whelm­ing. Which is why we prob­a­bly should­n’t assume reg­u­la­tors will pre­vent the next melt­down:

Prospect

Pri­vate Equity’s Newest Play

Insur­ance com­pa­nies are the lat­est morsel for these finan­cial preda­tors to devour.

by David Dayen
Feb­ru­ary 7, 2023

Black­stone is the world’s largest pri­vate equi­ty firm.

To some observers, the flip side of the Fed­er­al Reserve’s inter­est rate hikes, and their poten­tial­ly dam­ag­ing impact on labor mar­kets, is that the end of cheap cred­it is pun­ish­ing some of the most preda­to­ry mon­ey­mak­ing schemes in the econ­o­my. Obvi­ous­ly sketchy enter­pris­es in the form of cryp­to com­pa­nies or SPACs have fal­tered or out­right col­lapsed. Even the alleged­ly more rep­utable cor­ners of the mar­ket (at least to men in suits) also appear to be strug­gling.

At the head of that is the pri­vate equi­ty indus­try. As David Siro­ta report­ed last week, returns for pri­vate equi­ty firms aver­aged around ‑6.1 per­cent in the 2022 fis­cal year, with “dra­mat­ic” declines expect­ed to be report­ed in 2023. An advis­er to pub­lic employ­ee retire­ment sys­tems recent­ly sent out a warn­ing that these loss­es could impact pen­sion fund­ing sta­tus, or the amount of mon­ey on hand avail­able to pay promised retiree ben­e­fits.

On top of over­promis­ing returns, some PE funds have got­ten tied up in the prop­er­ty mar­ket, where droves of investors are scram­bling to escape. Black­stone, the world’s largest PE firm, whose Real Estate Invest­ment Trust (BREIT) lim­it­ed with­drawals in Decem­ber, saw with­draw­al requests jump to $5 bil­lion in a sec­ond fund in Jan­u­ary. Hilar­i­ous­ly, Black­stone pres­i­dent Jonathan Gray told the Finan­cial Times that “the tone of the con­ver­sa­tions … is much improved,” which I guess means that investors are say­ing “please” when they ask for all their mon­ey back right now. Black­stone has increased its ten­ant evic­tions in a scram­ble to raise cash.

Between the less favor­able invest­ing envi­ron­ment and reg­u­la­to­ry pres­sure from the likes of the Secu­ri­ties and Exchange Com­mis­sion, investors may final­ly rec­og­nize that pri­vate equi­ty returns—which were nev­er all that good even dur­ing the bull market—could be a mon­ey pit today. Some nation­al lead­ers, like Penn­syl­va­nia Gov. Josh Shapiro, have dared to say out loud the unmen­tion­able: that pub­lic pen­sion funds should get out of the pri­vate equi­ty busi­ness, and stop sup­ply­ing work­er funds to an indus­try that relent­less­ly harms work­ers. As I wrote last sum­mer, weak­en­ing the pri­vate equi­ty mon­ey stream is the key to get­ting these enti­ties’ bad prac­tices out of the econ­o­my.

The prob­lem is that PE always man­ages to find a new vic­tim. Even as it reports loss­es to pen­sion funds and oth­er investors, man­agers are feel­ing lit­tle pain thanks to astro­nom­i­cal fees. And anoth­er juicy meal for the indus­try has recent­ly emerged: insur­ance com­pa­nies.

For the past decade, pri­vate equi­ty firms have either bought out or forged part­ner­ships with the insur­ance indus­try, which always has a mas­sive amount of assets avail­able for invest­ment. This is known as the “float,” rep­re­sent­ing the rev­enue com­ing into insur­ers before it goes out to pay claims and ben­e­fits. This does not just rep­re­sent home and auto insur­ance pre­mi­ums. There’s retire­ment mon­ey in there in the form of life insur­ance plans and annu­ities, the often high-cost plans that give seniors a ded­i­cat­ed fund­ing stream in their lat­er years.

Float is what built War­ren Buffett’s empire, and PE sees a way to adapt this mod­el for a new age of finance. In oth­er words, pri­vate equi­ty is insu­lat­ed from the loss of cheap mon­ey by lit­er­al­ly buy­ing mon­ey out. But hand­ing the insur­ance float pile over to pri­vate equi­ty puts more work­ers at risk of not see­ing the ben­e­fits they were promised.

“It’s about hav­ing a steady flow of invest­ment funds with­out hav­ing to recruit,” said Eileen Appel­baum, co-direc­tor of the Cen­ter for Eco­nom­ic and Pol­i­cy Research. “It’s also about increas­ing assets under man­age­ment so big boys look even big­ger. And it’s about lack of reg­u­la­tion or over­sight.”

That last part is key: While the SEC and oth­er fed­er­al finan­cial reg­u­la­tors can mon­i­tor pieces of the pri­vate equi­ty mar­ket, insur­ance is typ­i­cal­ly reg­u­lat­ed at the state lev­el. And though the pri­vate equi­ty move to insur­ance began over a decade ago, state insur­ance com­mis­sion­ers appear to have done lit­tle to mit­i­gate the risks.

Accord­ing to the Nation­al Asso­ci­a­tion of Insur­ance Com­mis­sion­ers, at the end of 2021 (the last year stud­ied) pri­vate equi­ty out­right owned insur­ers with total cash and invest­ed assets of $472 bil­lion. This was actu­al­ly a lit­tle down from 2020, but a 37 per­cent increase over 2019. This is only about 6 per­cent of the insur­ance industry’s mon­u­men­tal $8 tril­lion in avail­able cash and assets, so there’s lots more room to run.

The mod­el for pur­chas­ing insur­ers and gain­ing the abil­i­ty to man­age their invest­ments was pio­neered by Apol­lo, which cre­at­ed Athene, an annu­ity com­pa­ny, in 2012. The Wall Street Jour­nal notes that half of the $523 bil­lion that Apol­lo has under man­age­ment comes from Athene.

Some PE firms have fol­lowed that path by buy­ing into annu­ity or life insur­ance com­pa­nies. But Black­stone, Car­lyle, and oth­ers have more recent­ly made deals to man­age insur­ance com­pa­ny assets. Oth­ers pro­vide rein­sur­ance (the insur­ance that insur­ance com­pa­nies buy for them­selves) and invest the pre­mi­ums from that. They are also sell­ing pri­vate-debt instru­ments to insur­ers that promise greater returns than gov­ern­ment bonds. This is just an exten­sion of the acqui­si­tions pri­vate equi­ty always makes, except their goal is real­ly to get their hands on more mon­ey so they can buy more firms.

Appel­baum has pro­posed three key guardrails for pri­vate equi­ty annu­ity and insur­ance invest­ments: a cap on man­age­ment fees for mon­ey that comes from retire­ment sav­ings vehi­cles, an increase in reserve require­ments to absorb poten­tial loss­es from riski­er invest­ments, and a ban on firms “self-deal­ing” by invest­ing insur­ance assets in their own funds. That last one seems to be the entire ratio­nale for this maneu­ver. “They’re claim­ing they want to only move 5 to 10 per­cent of assets into risky things,” Appel­baum told me last year. “That’s a lot of mon­ey. And if they have a fund that’s fail­ing, they can give [the mon­ey] to their own fund.”

But the Nation­al Asso­ci­a­tion of Insur­ance Com­mis­sion­ers, which would be a first line of defense from this trend, blew off an ini­tial inquiry about it from Sen­ate Bank­ing Com­mit­tee chair Sen. Sher­rod Brown (D‑OH), who asked about the impact of pri­vate equi­ty on insur­ance. The NAIC response boiled down to assur­ing Brown that there was noth­ing to wor­ry about, and that PE firms were “in it for the long term.” Appel­baum said that there has been no move­ment on reg­u­la­tion since then.

Insur­ance com­mis­sion­ers are either elect­ed or select­ed by state gov­er­nors, and have a vary­ing ide­o­log­i­cal com­mit­ment to strong reg­u­la­tion, along with lit­tle expe­ri­ence deal­ing with pri­vate equi­ty. An indus­try that thrives on reg­u­la­to­ry cap­ture like­ly faces lit­tle threat from this cohort.

...

Unfor­tu­nate­ly, this gives pri­vate equi­ty anoth­er steady stream of cash to plow into buy­ing cloth­ing stores or ski resorts or tod­dler gyms or what­ev­er else they want. The idea of a “reck­on­ing” for pri­vate equi­ty is seduc­tive but wrong. Changes in the inter­est rate envi­ron­ment may take some of their cheap mon­ey away. But there’s always some­one else will­ing to step up and pro­vide those dol­lars. As a wise man once said, there’s one born every minute.

———–

“Pri­vate Equity’s Newest Play” by David Dayen; Prospect; 02/07/2023

“The prob­lem is that PE always man­ages to find a new vic­tim. Even as it reports loss­es to pen­sion funds and oth­er investors, man­agers are feel­ing lit­tle pain thanks to astro­nom­i­cal fees. And anoth­er juicy meal for the indus­try has recent­ly emerged: insur­ance com­pa­nies.”

As David Dayen warned just five months ago, pri­vate-equi­ty has been on an insur­ance binge of late, and the con­se­quences of putting those mas­sive insur­ance reserves under pri­vate equi­ty man­age­ment are still unfold­ing. Down­stream con­se­quences like the even­tu­al fall­out from all of the gam­bling done using the insur­ance ‘float’. In par­tic­u­lar, the ‘float’ com­ing in from annu­ity poli­cies, which are them­selves basi­cal­ly per­son­al pen­sion insur­ance prod­ucts. So pri­vate-equi­ty is pur­chas­ing insur­ance com­pa­nies and tak­ing the ‘float­ed’ mon­ey allo­cat­ed for annu­ities to make big bets and earn the high returns their most­ly-pen­sion fund clients desire. Yes, pen­sion funds are being financed by mak­ing bets with annu­ity mon­ey. Sure, all that ‘float­ed’ mon­ey will have to be paid out to the insur­ance clients some­day. But not today. And if the mon­ey isn’t actu­al­ly there when its even­tu­al­ly need­ed, it’s the annu­ity hold­ers and pen­sion­ers who will feel the pain. The pri­vate equi­ty fund man­agers will be just fine:

...
For the past decade, pri­vate equi­ty firms have either bought out or forged part­ner­ships with the insur­ance indus­try, which always has a mas­sive amount of assets avail­able for invest­ment. This is known as the “float,” rep­re­sent­ing the rev­enue com­ing into insur­ers before it goes out to pay claims and ben­e­fits. This does not just rep­re­sent home and auto insur­ance pre­mi­ums. There’s retire­ment mon­ey in there in the form of life insur­ance plans and annu­ities, the often high-cost plans that give seniors a ded­i­cat­ed fund­ing stream in their lat­er years.

Float is what built War­ren Buffett’s empire, and PE sees a way to adapt this mod­el for a new age of finance. In oth­er words, pri­vate equi­ty is insu­lat­ed from the loss of cheap mon­ey by lit­er­al­ly buy­ing mon­ey out. But hand­ing the insur­ance float pile over to pri­vate equi­ty puts more work­ers at risk of not see­ing the ben­e­fits they were promised.

“It’s about hav­ing a steady flow of invest­ment funds with­out hav­ing to recruit,” said Eileen Appel­baum, co-direc­tor of the Cen­ter for Eco­nom­ic and Pol­i­cy Research. “It’s also about increas­ing assets under man­age­ment so big boys look even big­ger. And it’s about lack of reg­u­la­tion or over­sight.”

That last part is key: While the SEC and oth­er fed­er­al finan­cial reg­u­la­tors can mon­i­tor pieces of the pri­vate equi­ty mar­ket, insur­ance is typ­i­cal­ly reg­u­lat­ed at the state lev­el. And though the pri­vate equi­ty move to insur­ance began over a decade ago, state insur­ance com­mis­sion­ers appear to have done lit­tle to mit­i­gate the risks.

...

Appel­baum has pro­posed three key guardrails for pri­vate equi­ty annu­ity and insur­ance invest­ments: a cap on man­age­ment fees for mon­ey that comes from retire­ment sav­ings vehi­cles, an increase in reserve require­ments to absorb poten­tial loss­es from riski­er invest­ments, and a ban on firms “self-deal­ing” by invest­ing insur­ance assets in their own funds. That last one seems to be the entire ratio­nale for this maneu­ver. “They’re claim­ing they want to only move 5 to 10 per­cent of assets into risky things,” Appel­baum told me last year. “That’s a lot of mon­ey. And if they have a fund that’s fail­ing, they can give [the mon­ey] to their own fund.”

But the Nation­al Asso­ci­a­tion of Insur­ance Com­mis­sion­ers, which would be a first line of defense from this trend, blew off an ini­tial inquiry about it from Sen­ate Bank­ing Com­mit­tee chair Sen. Sher­rod Brown (D‑OH), who asked about the impact of pri­vate equi­ty on insur­ance. The NAIC response boiled down to assur­ing Brown that there was noth­ing to wor­ry about, and that PE firms were “in it for the long term.” Appel­baum said that there has been no move­ment on reg­u­la­tion since then.
...

And note the com­pa­ny that appears to have pio­neered the approach of using the large vol­umes of ‘float­ed’ annu­ity pre­mi­ums to earn high­er returns: Apol­lo, which cre­at­ed Athene in 2012 to focus on annu­ities. Annu­ities that now account for half of Apol­lo’s total assets under man­age­ment:

...
Accord­ing to the Nation­al Asso­ci­a­tion of Insur­ance Com­mis­sion­ers, at the end of 2021 (the last year stud­ied) pri­vate equi­ty out­right owned insur­ers with total cash and invest­ed assets of $472 bil­lion. This was actu­al­ly a lit­tle down from 2020, but a 37 per­cent increase over 2019. This is only about 6 per­cent of the insur­ance industry’s mon­u­men­tal $8 tril­lion in avail­able cash and assets, so there’s lots more room to run.

The mod­el for pur­chas­ing insur­ers and gain­ing the abil­i­ty to man­age their invest­ments was pio­neered by Apol­lo, which cre­at­ed Athene, an annu­ity com­pa­ny, in 2012. The Wall Street Jour­nal notes that half of the $523 bil­lion that Apol­lo has under man­age­ment comes from Athene.
...

So if pri­vate-equi­ty’s new mod­el is to buy insur­ance com­pa­nies to con­trol those giant pools of as sets, what kinds of invest­ments are pri­vate-equi­ty firms mak­ing with all that mon­ey? Well, as the fol­low­ing Finan­cial Times arti­cle from last month describes, the pri­vate-equi­ty indus­try has found a new ‘tar­get’ for its large pools of cash to invest in: cor­po­rate debt.

Keep in mind that, the insur­ance indus­try in gen­er­al has been on a cor­po­rate debt binge over the past decade, so it’s prob­a­bly not entire­ly a coin­ci­dence that the pri­vate-equi­ty cor­po­rate debt spree fol­lowed its insur­ance indus­try spree. And the fact that Apol­lo in par­tic­u­lar is seen as lead­ing the way in this trend only under­scores that it’s like­ly Athene annu­ity pre­mi­ums ulti­mate­ly financ­ing a lot of those debt pur­chas­es.

But as the fol­low­ing arti­cle also describes, it’s not as sim­ple as just buy­ing more cor­po­rate debt. Pri­vate-equi­ty is increas­ing­ly using ‘finan­cial wiz­ard­ly’ to issue that debt in a man­ner that par­tial­ly obscures the debt from cor­po­rate bal­ance sheets. Tech­niques like trans­fer­ring a man­u­fac­tur­ing facil­i­ty or real estate port­fo­lio into a sub­sidiary or “spe­cial pur­pose vehi­cle” and then bor­row­ing against that, allow­ing the par­ent com­pa­ny to avoid report­ing that debt on its bal­ance sheet.

Don’t for­get the caveat we got in the above piece: self-deal­ing is an inher­ent dan­ger when we’re talk­ing about pri­vate-equi­ty. Self-deal­ing like using pri­vate-equi­ty funds to pur­chase the debt of oth­er com­pa­nies owned by the same fund. And here we are find­ing that pri­vate-equi­ty is increas­ing­ly involved in set­ting ‘spe­cial pur­pose vehi­cles’ that can obscure cor­po­rate debt lev­els. It’s not hard to see how this ends poor­ly:

The Finan­cial Times

Pri­vate cred­it finds its next big tar­get: invest­ment-grade debt

Blue-chip com­pa­nies bypass banks and bond mar­kets to bor­row from indus­try with $1.4tn war chest

Eric Platt in New York
June 26 2023

Alter­na­tive asset man­agers such as Apol­lo, KKR and Black­stone are increas­ing­ly financ­ing blue-chip com­pa­nies, as busi­ness­es look for new sources of cap­i­tal to help coun­ter­act the effects of high­er inter­est rates and a slow­ing econ­o­my.

The deals — includ­ing two announced this month with AT&T and Pay­Pal — under­score the grow­ing reach of the pri­vate cred­it indus­try as it helps com­pa­nies bypass tra­di­tion­al banks and bond mar­kets to raise mon­ey.

Pri­vate cred­it has boomed in the decade since the glob­al finan­cial cri­sis into a sec­tor with $1.4tn in assets. Loans from pri­vate cred­it typ­i­cal­ly went to com­pa­nies that were small­er or riski­er.

Now, alter­na­tive asset man­ag­er lenders are tar­get­ing larg­er, more sta­ble com­pa­nies. “Pri­vate cred­it is going invest­ment grade,” said Akhil Bansal, head of cred­it strate­gic solu­tions at Car­lyle, the pri­vate equi­ty group.

Exec­u­tives said the shift was a nat­ur­al out­growth of pri­vate credit’s fundrais­ing spree, giv­ing man­agers cash to lend. As well, most major pri­vate equi­ty groups have bought or invest­ed in an insur­ance com­pa­ny in the past five years, draw­ing in hun­dreds of bil­lions of pre­mi­ums to invest.

Super­charg­ing the push has been Apol­lo, whose insur­er Athene has amassed near­ly $260bn in cap­i­tal — rough­ly half of Apollo’s assets.

“We made a bet on pri­vate invest­ment grade,” Marc Rowan, Apollo’s chief exec­u­tive, told a con­fer­ence this month. “We are also a ben­e­fi­cia­ry of this de-bank­ing of the world because the assets that we need . . . were the kinds of things that used to go on to the bal­ance sheets of banks, invest­ment-grade pri­vate cred­it.”

Apol­lo is not alone. KKR in 2021 bought a major­i­ty stake in insur­er Glob­al Atlantic, adding $90bn to the group’s assets at the time. Car­lyle pur­chased just under a fifth of rein­sur­er For­ti­tude Re from AIG in 2018 before strik­ing a new deal last year that reduced its stake but boost­ed Carlyle’s assets by about $50bn. Black­stone, mean­while, invests on behalf of insur­ers such as Core­bridge through its insur­ance solu­tions divi­sion.

The insur­ance units are required by state reg­u­la­tors to invest the vast major­i­ty of their hold­ings in invest­ment-grade rat­ed debt, to safe­guard pol­i­cy­hold­ers.

But unlike tra­di­tion­al insur­ers, alter­na­tive invest­ment man­agers have been more com­fort­able using finan­cial wiz­ardry to design pri­vate trans­ac­tions that can pro­vide a few extra per­cent­age points of return com­pared with tra­di­tion­al invest­ment-grade cor­po­rate bonds, which yield about 5.5 per cent.

That can prove attrac­tive to com­pa­nies need­ing to raise cash with­out tap­ping the invest­ment-grade bond mar­ket, par­tic­u­lar­ly when issu­ing more debt at the cor­po­rate lev­el would influ­ence a business’s cred­it rat­ing.

The deals have tak­en sev­er­al dif­fer­ent forms, but often a com­pa­ny will move some assets — per­haps a man­u­fac­tur­ing facil­i­ty or real estate port­fo­lio — to a sub­sidiary or new spe­cial pur­pose vehi­cle. Then com­pa­nies raise pre­ferred equi­ty or debt against the unit, which brings in cash the par­ent can use to run its day-to-day busi­ness.

Rat­ing agen­cies typ­i­cal­ly treat pre­ferred stock deals more favourably than run-of-the-mill loans. And often, because the equi­ty is raised in a spe­cial pur­pose vehi­cle, the par­ent com­pa­ny does not have to report it on its bal­ance sheet.

Apol­lo bought $2bn of AT&T pre­ferred stock in a deal that allowed the wire­less car­ri­er to par­tial­ly repay some of its out­stand­ing pre­ferred equi­ty. That fol­lowed a $1bn invest­ment in Ger­man real estate group Vonovia in a sim­i­lar struc­ture.

...

Oth­er deals, such as KKR’s agree­ment last week to pur­chase up to €40bn of con­sumer loans orig­i­nat­ed by Pay­Pal, have more close­ly resem­bled tra­di­tion­al asset-backed secu­ri­ties. In those trans­ac­tions, a pool of assets — such as mort­gages, cred­it card receiv­ables or auto loans — are pack­aged togeth­er, with the inter­est pay­ments fund­ing new slices of debt that are sold on to investors.

The use of insur­ance cap­i­tal and pri­vate cred­it is just the lat­est exam­ple of blue-chip com­pa­nies pair­ing up with alter­na­tive asset man­agers.

Intel last year struck a $30bn deal with Brook­field and its infra­struc­ture funds, with the asset man­ag­er invest­ing $15bn in a new chip foundry.

Intel, like most com­pa­nies enter­ing into these agree­ments, did not say how much it would pay Brook­field for the invest­ment. How­ev­er, its chief finan­cial offi­cer David Zin­sner told ana­lysts last year that Brook­field would receive part of the cash flows the plant gen­er­ates once it is oper­a­tional, giv­ing the invest­ment firm a return some­where between 4.4 per cent and 8.5 per cent.

...

———-

“Pri­vate cred­it finds its next big tar­get: invest­ment-grade debt” ny Eric Platt; The Finan­cial Times; 06/26/2023

“Exec­u­tives said the shift was a nat­ur­al out­growth of pri­vate credit’s fundrais­ing spree, giv­ing man­agers cash to lend. As well, most major pri­vate equi­ty groups have bought or invest­ed in an insur­ance com­pa­ny in the past five years, draw­ing in hun­dreds of bil­lions of pre­mi­ums to invest.”

A giant pool of insur­ance com­pa­ny assets. That’s appar­ent­ly what’s fuel­ing the cur­rent pri­vate-equi­ty binge on cor­po­rate debt. It start­ed with a binge on insur­ance com­pa­nies over the past decade, leav­ing pri­vate equi­ty firms with large pools of assets avail­able for invest­ment. And in the case of Apol­lo, rough­ly half its assets under man­age­ment are thanks to a sin­gle insur­er, Athene:

...
Super­charg­ing the push has been Apol­lo, whose insur­er Athene has amassed near­ly $260bn in cap­i­tal — rough­ly half of Apollo’s assets.

“We made a bet on pri­vate invest­ment grade,” Marc Rowan, Apollo’s chief exec­u­tive, told a con­fer­ence this month. “We are also a ben­e­fi­cia­ry of this de-bank­ing of the world because the assets that we need . . . were the kinds of things that used to go on to the bal­ance sheets of banks, invest­ment-grade pri­vate cred­it.”

Apol­lo is not alone. KKR in 2021 bought a major­i­ty stake in insur­er Glob­al Atlantic, adding $90bn to the group’s assets at the time. Car­lyle pur­chased just under a fifth of rein­sur­er For­ti­tude Re from AIG in 2018 before strik­ing a new deal last year that reduced its stake but boost­ed Carlyle’s assets by about $50bn. Black­stone, mean­while, invests on behalf of insur­ers such as Core­bridge through its insur­ance solu­tions divi­sion.
...

But unlike tra­di­tion­al insur­ance com­pa­nies, pri­vate equi­ty-owned insur­ance com­pa­nies don’t face the same kinds of reg­u­la­tions that require they invest their hold­ings in rel­a­tive­ly safe invest­ments. This allows the pri­vate equi­ty firms to engage in ‘finan­cial wiz­ardry’ poten­tial­ly involv­ing the cre­ation of “spe­cial pur­pose vehi­cles” that have the ben­e­fit of hid­ing the new­ly issued cor­po­rate debt. So it sounds like we have pri­vate equi­ty firms buy­ing up insur­ance com­pa­nies and then using those mas­sive new asset war chests to make the kinds of risky invest­ments the insur­ance com­pa­nies them­selves would­n’t be legal­ly allowed to engage in. Risky invest­ments that, in turn, allow com­pa­nies to obscure their debt loads. What could pos­si­bly go wrong?

...
Pri­vate cred­it has boomed in the decade since the glob­al finan­cial cri­sis into a sec­tor with $1.4tn in assets. Loans from pri­vate cred­it typ­i­cal­ly went to com­pa­nies that were small­er or riski­er.

Now, alter­na­tive asset man­ag­er lenders are tar­get­ing larg­er, more sta­ble com­pa­nies. “Pri­vate cred­it is going invest­ment grade,” said Akhil Bansal, head of cred­it strate­gic solu­tions at Car­lyle, the pri­vate equi­ty group.

...

The insur­ance units are required by state reg­u­la­tors to invest the vast major­i­ty of their hold­ings in invest­ment-grade rat­ed debt, to safe­guard pol­i­cy­hold­ers.

But unlike tra­di­tion­al insur­ers, alter­na­tive invest­ment man­agers have been more com­fort­able using finan­cial wiz­ardry to design pri­vate trans­ac­tions that can pro­vide a few extra per­cent­age points of return com­pared with tra­di­tion­al invest­ment-grade cor­po­rate bonds, which yield about 5.5 per cent.

That can prove attrac­tive to com­pa­nies need­ing to raise cash with­out tap­ping the invest­ment-grade bond mar­ket, par­tic­u­lar­ly when issu­ing more debt at the cor­po­rate lev­el would influ­ence a business’s cred­it rat­ing.

The deals have tak­en sev­er­al dif­fer­ent forms, but often a com­pa­ny will move some assets — per­haps a man­u­fac­tur­ing facil­i­ty or real estate port­fo­lio — to a sub­sidiary or new spe­cial pur­pose vehi­cle. Then com­pa­nies raise pre­ferred equi­ty or debt against the unit, which brings in cash the par­ent can use to run its day-to-day busi­ness.

Rat­ing agen­cies typ­i­cal­ly treat pre­ferred stock deals more favourably than run-of-the-mill loans. And often, because the equi­ty is raised in a spe­cial pur­pose vehi­cle, the par­ent com­pa­ny does not have to report it on its bal­ance sheet.
...

And if this already does­n’t sound like a dicey enough sit­u­a­tion, deals resem­bling tra­di­tion­al asset-backed secu­ri­ties are also increas­ing­ly pop­u­lar in the pri­vate equi­ty space. This is a good time to recall how the sys­tem­at­ic mis­pric­ing of mort­gage-backed secu­ri­ties played a key role in the lead up to the 2008 finan­cial cri­sis. Let’s hope the pri­vate equi­ty indus­try is doing a bet­ter job this time around!

...
Oth­er deals, such as KKR’s agree­ment last week to pur­chase up to €40bn of con­sumer loans orig­i­nat­ed by Pay­Pal, have more close­ly resem­bled tra­di­tion­al asset-backed secu­ri­ties. In those trans­ac­tions, a pool of assets — such as mort­gages, cred­it card receiv­ables or auto loans — are pack­aged togeth­er, with the inter­est pay­ments fund­ing new slices of debt that are sold on to investors.
...

Will pri­vate-equi­ty’s big insur­ance play pan out for all of its pen­sion fund clients? Time will tell. And as the fol­low­ing Reuters piece from the end of March, this insur­ance-fueled invest­ment strat­e­gy has a rather large poten­tial vul­ner­a­bil­i­ty: ris­ing inter­est rates. Yes, ris­ing rates pose an acute threat to this annu­ity-cen­tric insur­ance-fueled phase of pri­vate-equi­ty expan­sion. A threat in the form of annu­ity hold­ers ask­ing for an ear­ly with­draw­al as high­er rates cre­ate more and more temp­ing alter­na­tive oppor­tu­ni­ties. Hence, Apol­lo hav­ing to assure the mar­kets that it was­n’t going to face its own ver­sion of a ‘bank run’ due on Athene’s large annu­ity hold­ings. As Apol­lo point­ed out, the bulk of its annu­ities have ‘sur­ren­der charges’ that impose a fine for ear­ly with­drawals. It’s a finan­cial “fortress” as the com­pa­ny put it. But as the arti­cle also notes, that only cov­ers 82% of Apol­lo’s annu­ity hold­ings, mean­ing 18%, or $33 bil­lion, in annu­ities are indeed eli­gi­ble for an ear­ly with­draw­al. Apol­lo’s fortress has a pret­ty wide open back door.

Apol­lo also tout­ed its then-$73 bil­lion in avail­able liq­uid­i­ty (as of March 10) includ­ing $56.9 bil­lion in invest­ment-grade cor­po­rate bonds. Also keep in mind that bond port­fo­lio pre­sum­ably dropped in val­ue with each Fed rate hike since then. It’s all a reminder that the pri­vate-equi­ty indus­try’s strat­e­gy in recent years of of plow­ing annu­ity pre­mi­ums into cor­po­rate bond pur­chas­es could be par­tic­u­lar­ly vul­ner­a­ble to a ris­ing rate envi­ron­ment:

Reuters

Focus: Apol­lo assures investors deposit flight won’t spill over to Athene

By Chibuike Oguh
March 30, 2023 5:33 AM CDT
Updat­ed

March 30 (Reuters) — Apol­lo Glob­al Man­age­ment Inc (APO.N) has been telling investors and ana­lysts in the last few days that its rein­sur­ance busi­ness Athene does not face the risk of a run on its annu­ities akin to how deposits fled some U.S. region­al banks.

Apol­lo shares have lost 15% of their val­ue since the bank­ing cri­sis start­ed on March 8, a greater drop than expe­ri­enced by major peers Black­stone Inc (BX.N), KKR & Co Inc (KKR.N) and Car­lyle Group Inc (CG.O).

In a quar­ter­ly update to share­hold­ers pub­lished on March 13, Apol­lo out­lined how Athene’s fund­ing mod­el is dif­fer­ent than a bank’s. Most of the annu­ities that Athene pro­vides can­not be sur­ren­dered by their hold­ers, it said, and Apol­lo called its bal­ance sheet a “fortress” that can with­stand with­drawals from those who have the right to pull their mon­ey.

Annu­ities are finan­cial prod­ucts pur­chased for a lump sum or through install­ments in exchange for a fixed stream of pay­ments over time.

They are typ­i­cal­ly offered by insur­ance firms. Apol­lo, one of the world’s biggest pri­vate equi­ty firms, helped launch Athene in 2009 and has used the cap­i­tal raised from the annu­ities offered to earn lucra­tive fees and grow its assets beyond its tra­di­tion­al funds.

...

“Now that we are see­ing runs on select U.S. region­al banks, we’re also start­ing to see some investors voice those same con­cerns about insur­ance firms. What’s going on in region­al banks is like a wake­up call,” said BMO Cap­i­tal Mar­kets ana­lyst Rufus Hone. Fol­low­ing a meet­ing with Apol­lo exec­u­tives, Hone wrote in a note last week that he does not antic­i­pate a spike in with­drawals from Athene’s annu­ity hold­ers and that Athene’s fund­ing base was sta­ble.

An Apol­lo spokesper­son said Athene had ample cash and liq­uid­i­ty and that its issuance of new annu­ity poli­cies “mean­ing­ful­ly” exceed­ed the poli­cies that matured and oth­er with­drawals.

Apol­lo said in its March 13 pre­sen­ta­tion to investors that it had seen inflows of $8.8 bil­lion to Athene from the start of the year to March 10. Out­flows have been con­sis­tent with the quar­ter­ly aver­age of around $5 bil­lion, a per­son famil­iar with the mat­ter said.

Athene’s esti­mat­ed lia­bil­i­ties stood at $184 bil­lion as of March 10. About 82% of those annu­ities are not at risk of with­draw­al by clients, either because their terms make them non-sur­rend­able or finan­cial­ly oner­ous to sur­ren­der, or because the hold­ers are insur­ance firms rather than indi­vid­u­als, accord­ing to the Apol­lo pre­sen­ta­tion.

But annu­ities worth about $33 bil­lion, equiv­a­lent to 18% of Athene’s lia­bil­i­ties, are not pro­tect­ed by sur­ren­der charges, mak­ing them eas­i­er to be with­drawn by hold­ers. Ques­tions from investors and ana­lysts to Apol­lo have focused on this sub­set of annu­ity poli­cies that have a poten­tial­ly high­er flight risk.

STICKY ASSETS

Apol­lo in the pre­sen­ta­tion gave sev­er­al rea­sons why annu­ity hold­ers are less like­ly to with­draw their mon­ey than bank account hold­ers, includ­ing that annu­ities are long-term invest­ment prod­ucts that are typ­i­cal­ly used for retire­ment and offer high­er returns than tra­di­tion­al bank prod­ucts.

Apol­lo also said it had $73 bil­lion in avail­able liq­uid­i­ty as of March 10 to meet any poten­tial spikes in demand for annu­ity with­drawals, includ­ing a $56.9 bil­lion fixed-income port­fo­lio com­prised most­ly of pub­licly trad­ed invest­ment-grade cor­po­rate bonds.

Apol­lo would like­ly have to real­ize loss­es if it sold some of that port­fo­lio giv­en that the rise in inter­est rates in the last few months has led to a gen­er­al drop in the val­ue of bonds, said Argus Research ana­lyst Stephen Big­gar.

Oth­er insur­ers that are major providers of annu­ities, includ­ing Amer­i­can Equi­ty Invest­ment Life Hold­ing Co (AEL.N), have also seen a drop in their mar­ket cap­i­tal­iza­tion in the wake of the bank­ing cri­sis.

Wells Far­go ana­lyst Fin­ian O’Shea said he did not believe Athene’s busi­ness was cur­rent­ly at risk because with­drawals from annu­ities remained lim­it­ed. But he said the fall­out from the Fed­er­al Reserve’s push to raise inter­est rates as well as the recent col­lapse of some U.S. region­al banks prompt­ed some Apol­lo investors to raise con­cerns about Athene’s bal­ance sheet.

“It’s not a right-now thing. Peo­ple are think­ing about it for more down the road — if inter­est rates keep going up that Athene’s sur­ren­der lev­els on annu­ities could go up,” O’Shea said.

———

“Focus: Apol­lo assures investors deposit flight won’t spill over to Athene” By Chibuike Oguh; Reuters; 03/30/2023

““Now that we are see­ing runs on select U.S. region­al banks, we’re also start­ing to see some investors voice those same con­cerns about insur­ance firms. What’s going on in region­al banks is like a wake­up call,” said BMO Cap­i­tal Mar­kets ana­lyst Rufus Hone. Fol­low­ing a meet­ing with Apol­lo exec­u­tives, Hone wrote in a note last week that he does not antic­i­pate a spike in with­drawals from Athene’s annu­ity hold­ers and that Athene’s fund­ing base was sta­ble.”

So with banks start­ing to teeter, what’s the sta­tus of all those annu­ity invest­ments? That was one of the big ques­tions fac­ing Apol­lo back in March as the region­al bank run was play­ing out.

But Apol­lo had an answer ready: Don’t wor­ry about us! Our annu­ities are fine because of all the sur­ren­der charges that penal­ize annu­ity hold­ers for ear­ly with­drawals! That was the mes­sage to the mar­kets Apol­lo had to issue back in March as the bank run was play­ing out. A mes­sage of assur­ance: there sim­ply could­n’t be a ‘run on annu­ities’ the same way there was a run on the banks. Except, of course, it’s not that sim­ple. Yes, sur­ren­der charges do impose an obsta­cle to annu­ity with­drawals, but not a com­plete obsta­cle. If inter­est rates rise enough, it’s going to be worth pay­ing those sur­ren­der charge fees and with­draw­ing any­way:

...
Oth­er insur­ers that are major providers of annu­ities, includ­ing Amer­i­can Equi­ty Invest­ment Life Hold­ing Co (AEL.N), have also seen a drop in their mar­ket cap­i­tal­iza­tion in the wake of the bank­ing cri­sis.

Wells Far­go ana­lyst Fin­ian O’Shea said he did not believe Athene’s busi­ness was cur­rent­ly at risk because with­drawals from annu­ities remained lim­it­ed. But he said the fall­out from the Fed­er­al Reserve’s push to raise inter­est rates as well as the recent col­lapse of some U.S. region­al banks prompt­ed some Apol­lo investors to raise con­cerns about Athene’s bal­ance sheet.

“It’s not a right-now thing. Peo­ple are think­ing about it for more down the road — if inter­est rates keep going up that Athene’s sur­ren­der lev­els on annu­ities could go up,” O’Shea said.
...

And then there’s the fact that 18% of Athene’s annu­ity lia­bil­i­ties don’t have sur­ren­der charges. Yes, it turns out the whole ‘no prob­lem, we have sur­ren­der charges to save us from ear­ly with­drawals’ nar­ra­tive ignores about $33 bil­lion in lia­bil­i­ties:

...
In a quar­ter­ly update to share­hold­ers pub­lished on March 13, Apol­lo out­lined how Athene’s fund­ing mod­el is dif­fer­ent than a bank’s. Most of the annu­ities that Athene pro­vides can­not be sur­ren­dered by their hold­ers, it said, and Apol­lo called its bal­ance sheet a “fortress” that can with­stand with­drawals from those who have the right to pull their mon­ey.

Annu­ities are finan­cial prod­ucts pur­chased for a lump sum or through install­ments in exchange for a fixed stream of pay­ments over time.

They are typ­i­cal­ly offered by insur­ance firms. Apol­lo, one of the world’s biggest pri­vate equi­ty firms, helped launch Athene in 2009 and has used the cap­i­tal raised from the annu­ities offered to earn lucra­tive fees and grow its assets beyond its tra­di­tion­al funds.

...

An Apol­lo spokesper­son said Athene had ample cash and liq­uid­i­ty and that its issuance of new annu­ity poli­cies “mean­ing­ful­ly” exceed­ed the poli­cies that matured and oth­er with­drawals.

...

But annu­ities worth about $33 bil­lion, equiv­a­lent to 18% of Athene’s lia­bil­i­ties, are not pro­tect­ed by sur­ren­der charges, mak­ing them eas­i­er to be with­drawn by hold­ers. Ques­tions from investors and ana­lysts to Apol­lo have focused on this sub­set of annu­ity poli­cies that have a poten­tial­ly high­er flight risk.
...

Final­ly, note the type of assets Apol­lo was tout­ing as part of its assur­ances that it has enough assets on hand to weath­er any upcom­ing storms: $56.9 bil­lion in cor­po­rate bonds. It’s a finan­cial war chest for sure. A war chest that shrinks with each rate hike:

...
Apol­lo in the pre­sen­ta­tion gave sev­er­al rea­sons why annu­ity hold­ers are less like­ly to with­draw their mon­ey than bank account hold­ers, includ­ing that annu­ities are long-term invest­ment prod­ucts that are typ­i­cal­ly used for retire­ment and offer high­er returns than tra­di­tion­al bank prod­ucts.

Apol­lo also said it had $73 bil­lion in avail­able liq­uid­i­ty as of March 10 to meet any poten­tial spikes in demand for annu­ity with­drawals, includ­ing a $56.9 bil­lion fixed-income port­fo­lio com­prised most­ly of pub­licly trad­ed invest­ment-grade cor­po­rate bonds.

Apol­lo would like­ly have to real­ize loss­es if it sold some of that port­fo­lio giv­en that the rise in inter­est rates in the last few months has led to a gen­er­al drop in the val­ue of bonds, said Argus Research ana­lyst Stephen Big­gar.
...

Of course, rates and fall and this ever-grow­ing bond port­fo­lio could end up being a great invest­ment. Again, time will tell. But it’s hard to avoid notic­ing how a lot of the under­ly­ing moti­va­tion for these invest­ment strate­gies seem to have less to do with the under­ly­ing qual­i­ty of the invest­ments and more to do with the fact that these pri­vate-equi­ty firms have more and more mon­ey under man­age­ment with few­er and few­er remain­ing invest­ment oppor­tu­ni­ties to work with. More and more mon­ey under man­age­ment thanks to the insa­tiable appetite of pen­sion funds that, them­selves, hav­ing been plow­ing more and more mon­ey into pri­vate-equi­ty for the same lack of alter­na­tives.

We’ll see if this ulti­mate­ly blows up. But it’s also worth keep­ing in mind that when you have a sit­u­a­tion where pri­vate-equi­ty firms can self-deal — like you sing the assets of insur­ance com­pa­nies they own to pur­chase the cor­po­rate debt from oth­er com­pa­nies in their own port­fo­lios that might be run­ning into dif­fi­cul­ties — and obscure, for a time, the real finan­cial sta­tus of that port­fo­lio of com­pa­nies, it might take a while for things to all apart. But when it does, let’s just say Amer­i­ca’s grow­ing retire­ment cri­sis might final­ly be too big to real­is­ti­cal­ly ignore. Not that we won’t still find an unre­al­is­tic way to ignore it.

Up we go. Ever high­er. They did it. The Fed pulled the trig­ger and raised inter­est rates to the high­est lev­el in 22 years on Thurs­day and hint­ed at more rate hikes to come lat­er this year.

On one lev­el, it points to a robust econ­o­my seem­ing­ly intent on a ‘soft land­ing’ in the face of his­toric rate hikes. But as we’re going to see in the fol­low­ing pair of arti­cles, the high­er these rates go the more we’re see­ing busi­ness­es forced scram­ble to adjust to a cred­it mar­ket envi­ron­ment that also has­n’t been seen in years. A cred­it mar­ket envi­ron­ment that is par­tic­u­lar­ly poor­ly suit­ed for the pri­vate equi­ty mod­el of lever­aged buy­outs in antic­i­pa­tion of an IPO.

And that brings us to a new trend in pri­vate-equi­ty invest­ing. Two trends, in fact: first, pri­vate-equi­ty firms are increas­ing­ly pur­chas­ing the debt issued by their own ‘port­fo­lio com­pa­nies’ (i.e. the com­pa­nies held by a pri­vate-equi­ty fir­m’s invest­ment port­fo­lio man­aged on behalf of its clients). Sec­ond, it turns out that pri­vate-equi­ty firms are increas­ing­ly sell­ing shares of com­pa­nies in their port­fo­lios despite mar­ket con­di­tions being dis­tinct­ly unap­pe­tiz­ing for such sales. Oh, and it also turns out that the investors on the oth­er side of these share sales are the port­fo­lio com­pa­nies them­selves buy­ing back their own shares. So we have pri­vate-equi­ty firms pur­chas­ing the debt of their own com­pa­nies at the same time they are sell­ing shares in their com­pa­nies back to the com­pa­nies them­selves. Is this a prob­lem? Because that seems like a poten­tial prob­lem.

Now, we should prob­a­bly had some addi­tion­al details. For starters, the reports on the new trend in pri­vate-equi­ty buy­ing the debt of their own com­pa­nies came back in April, right in the mid­dle of the region­al bank­ing cri­sis. A cri­sis that cre­at­ed some rather appe­tiz­ing oppor­tu­ni­ties for investors with cash to spend as banks scram­bling for cap­i­tal were will­ing to sell off their cor­po­rate bond hold­ings at fire sale prices. In that sense, the sto­ry was an exam­ple of the enor­mous eco­nom­ic advan­tage pri­vate-equi­ty for oppor­tunis­tic mar­ket plays like tak­ing advan­tage of crises that have oth­er mar­ket play­ers scram­bling for the exits.

But as with all of these sto­ries, there’s anoth­er side to the sto­ry. Like the fact that banks were will­ing to sell those bonds at reduced prices in part because of the expec­ta­tion of fur­ther Fed rate hikes to come. Rate hikes that threat­en to depress the prof­its, and there­fore the share prices, of the same com­pa­nies held in these port­fo­lios. Which, of course, is direct­ly relat­ed to the sec­ond trend, which Bloomberg report­ed on ear­li­er this month, about the grow­ing vol­ume of “fol­low-on share sales” (share sales by insid­ers fol­low­ing an IPO) that are also increas­ing­ly be sold back to the port­fo­lio com­pa­nies them­selves. Share sales tak­ing place in a notably week mar­ket envi­ron­ment that has extend­ed the 12–18 month peri­od tra­di­tion­al­ly need­ed to com­plete all the fol­low-on share sales into a much longer time­frame. And as the report notes, part of the motive for these ques­tion­able share sales is the fact that ris­ing inter­est rates are not only putting a crimp on cor­po­rate prof­its but also poten­tial­ly mak­ing the upcom­ing refi­nanc­ing of cor­po­rate debt all the more expen­sive. In oth­er words, the shares are being rushed to mar­ket over fears of an even worse mar­ket to come. And that’s all why we have to ask: it’s this a loom­ing pri­vate-equi­ty prob­lem of self-deal­ing, con­flicts of inter­est, and ‘kick­ing the can down the road’ strate­gies? Or pri­vate-equi­ty earn­ing its out­sized ser­vice fees by being extra savvy? As always, time will tell.

Ok, first, here’s that Bloomberg arti­cle from back in April, right in the mid­dle of the region­al bank­ing cri­sis, describ­ing pri­vate-equi­ty’s big play: buy­ing port­fo­lio com­pa­ny debt. And as the arti­cle notes, while there were indeed bar­gains to be had, it was still a gam­ble. The kind of gam­ble that may not pan out well should inter­est rates keep ris­ing:

Bloomberg

Pri­vate Equity’s Lat­est Mon­ey-Mak­ing Trade: Buy­ing Its Own Debt

* Advent, CD&R, Elliott boost bets in port­fo­lio com­pa­nies
* Banks offer­ing steep dis­counts to shed debt stuck on books

By Claire Ruckin, and Paula Selig­son
April 12, 2023 at 6:00 AM EDT
Updat­ed on April 12, 2023 at 11:33 AM EDT

Some of the world’s top pri­vate equi­ty firms are scoop­ing up the debt of their own port­fo­lio com­pa­nies from banks at steep dis­counts as they seek juicy returns amid a lull in deal mak­ing.

Advent Inter­na­tion­al Corp. recent­ly bought a por­tion of a loan that helped fund its buy­out of a Roy­al DSM unit, while Clay­ton Dubili­er & Rice has pur­chased debt sup­port­ing at least two of its deals over the past year. Just last week Elliott Invest­ment Man­age­ment snapped up a $550 mil­lion chunk of bonds back­ing its acqui­si­tion of Cit­rix Sys­tems Inc. at 79 cents on the dol­lar, fol­low­ing a sim­i­lar move in Sep­tem­ber.

The trades come as banks have stepped up efforts to offload bil­lions of dol­lars of debt stuck on their bal­ance sheets — the prod­uct of a sharp repric­ing of risk assets last year that upend­ed under­writ­ing pledges. With Wall Street will­ing to real­ize sig­nif­i­cant loss­es in some cas­es to shed the risk, buy­out firms com­ing off the weak­est quar­ter for M&A since 2020 are find­ing the often dou­ble-dig­it yields on debt of com­pa­nies they’re already well acquaint­ed with too good to pass up.

“A lot of these pri­vate equi­ty firms are smart buy­ers of debt when the time is right,” said Steven Messi­na, head of the bank­ing group at Skad­den, Arps, Slate, Meagher & Flom LLP in its New York office. “Right now, we’re in a sit­u­a­tion where pri­vate equi­ty firms gen­er­al­ly are flush with cash and have the abil­i­ty to take advan­tage of sit­u­a­tions where the debt is trad­ing at a dis­count.”

When firms buy the debt at the spon­sor lev­el, it’s gen­er­al­ly held as an invest­ment. This allows them to prof­it from the inter­est pay­ments, as well as any poten­tial refi­nanc­ing, sale of the com­pa­ny or ini­tial pub­lic offer­ing, where­in the debt gets repaid at around par. Some­times it’s bought via an invest­ment firm’s cred­it arm, which are often man­aged sep­a­rate­ly from the pri­vate equi­ty unit.

Alter­na­tive­ly, the debt can be pur­chased by the port­fo­lio com­pa­ny itself, in which case it’s usu­al­ly can­celed, cut­ting future inter­est costs while reduc­ing lever­age.

Either way, the wager is far from a sure thing. The Fed­er­al Reserve con­tin­ues to raise inter­est rates to tame run­away infla­tion, while a poten­tial reces­sion in the com­ing months could weigh on cor­po­rate earn­ings, dent­ing already depressed prices for risky debt.

“Pri­vate equi­ty is expand­ing into oth­er venues and look­ing at dif­fer­ent ways to carve up the car­cass,” said John McClain, port­fo­lio man­ag­er at Brandy­wine Glob­al Invest­ment Man­age­ment. “There’s a con­cen­tra­tion of sin­gle-name risk.”

‘Pos­i­tive Sig­nal’

Still, the appeal is plain to see.

Elliott last week bought $550 mil­lion of sec­ond-lien bonds that are part of a $15 bil­lion debt pack­age banks under­wrote to finance its buy­out of Cit­rix with Vista Equi­ty Part­ners. The bonds have a 9% coupon and were sold at a price of 79 cents, bring­ing the all-in yield to rough­ly 14%.

The firm made a sim­i­lar trade last year, buy­ing about $1 bil­lion of Citrix’s first-lien junk bonds from banks at around 83.6 cents on the dol­lar.

Vista’s cred­it arm also bought a $200 mil­lion slice of the sec­ond-lien bonds, Bloomberg report­ed. A rep­re­sen­ta­tive for the firm declined to com­ment.

“Buy­ing the debt of a port­fo­lio com­pa­ny at a dis­count is an inter­est­ing way of poten­tial­ly cre­at­ing more equi­ty val­ue at a cheap­er lev­el,” said Brad Rogoff, head of fixed-income research at Bar­clays Plc. “If you liked it at one price, you prob­a­bly like it more at a cheap­er price.”

There are often also oth­er incen­tives for pur­chas­ing port­fo­lio com­pa­ny debt, accord­ing to CreditSights’s glob­al head of strat­e­gy Win­nie Cis­ar.

Pri­vate equi­ty firms may val­ue the stronger nego­ti­at­ing posi­tion being a cred­i­tor affords should the com­pa­ny need to amend or extend its debt, espe­cial­ly if the eco­nom­ic out­look wors­ens, she said. Buy­ing their port­fo­lio com­pa­ny debt also sends a strong mes­sage to exist­ing and poten­tial lenders that the spon­sor has con­vic­tion in the invest­ment.

“That’s a very pos­i­tive sig­nal to oth­er investors,” said Cis­ar. “That lends some reas­sur­ance.”

For some firms, part of the ratio­nal is undoubt­ed­ly about main­tain­ing strong rela­tion­ships with Wall Street lever­aged finance desks, indus­try insid­ers say.

CD&R bought a $475 mil­lion slice of debt back­ing its pur­chase of a major­i­ty stake in Rop­er Tech­nolo­gies Inc.’s indus­tri­al oper­a­tions busi­ness in Novem­ber, reliev­ing some of the bur­den on its bank lenders. The sec­ond-lien loan was offered at around 90 cents, accord­ing to peo­ple famil­iar with the mat­ter who asked not to be iden­ti­fied dis­cussing a pri­vate trans­ac­tion.

It also bought rough­ly $464 mil­lion of risky pay­ment-in-kind notes back­ing its acqui­si­tion of Cor­ner­stone Build­ing Brands Inc. at a dis­count of about 60 cents mid-last year, the peo­ple said.

Buy­ing junior debt of port­fo­lio com­pa­nies can also make it eas­i­er for under­writ­ers to place senior debt down the road.

More Bar­gains

In Europe, Advent Inter­na­tion­al recent­ly pur­chased the equiv­a­lent of €450 mil­lion of debt back­ing its buy­out of Roy­al DSM’s engi­neer­ing mate­ri­als busi­ness, which lenders under­wrote a year ago. Banks sold the remain­der of debt at a dis­count­ed price of 90 cents just before it was con­sid­ered hung, and Advent was like­ly able to secure slight­ly bet­ter terms as an ear­ly anchor order, mar­ket watch­ers say.

Going for­ward, there are like­ly to be few­er oppor­tu­ni­ties to scoop up port­fo­lio com­pa­ny debt at dis­count­ed prices as banks con­tin­ue to chip away at the pile of hung debt on their bal­ance sheet, accord­ing to Barclays’s Rogoff. Oth­ers say a steady stream of new deals pric­ing with attrac­tive dis­counts will con­tin­ue to lure buy­out firms.

Pri­vate equi­ty could also increas­ing­ly turn to the sec­ondary mar­ket in search of bar­gains, espe­cial­ly if high-yield bond and lever­aged loan prices remain depressed, Rogoff added.

Some firms are already doing just that. KKR & Co.-owned Upfield bought its own Pol­ish zlo­ty and ster­ling debt worth about €250 mil­lion in recent months, accord­ing to a per­son famil­iar with the mat­ter, can­cel­ing the debt and reduc­ing its inter­est bur­den.

...

“There will con­tin­ue to be sec­ondary-mar­ket oppor­tu­ni­ties that com­pa­nies can take advan­tage of,” CreditSights’s Cis­ar said.

———–

“Pri­vate Equity’s Lat­est Mon­ey-Mak­ing Trade: Buy­ing Its Own Debt” By Claire Ruckin, and Paula Selig­son; Bloomberg; 04/12/2023

“The trades come as banks have stepped up efforts to offload bil­lions of dol­lars of debt stuck on their bal­ance sheets — the prod­uct of a sharp repric­ing of risk assets last year that upend­ed under­writ­ing pledges. With Wall Street will­ing to real­ize sig­nif­i­cant loss­es in some cas­es to shed the risk, buy­out firms com­ing off the weak­est quar­ter for M&A since 2020 are find­ing the often dou­ble-dig­it yields on debt of com­pa­nies they’re already well acquaint­ed with too good to pass up.”

It was a pri­vate-equi­ty bond buy­ing bonan­za back in April, thanks in large part to bank­ing cri­sis that left region­al banks scram­bling for cash and will­ing to take a loss. In that sense, step­ping in to buy those cheap bonds might be a shrewd busi­ness deci­sion. The bank­ing cri­sis cre­at­ed a fire sale too good to pass up.

And yet, as the arti­cle notes, it’s impor­tant to keep in mind that the same fac­tor that trig­gered the bank­ing cri­sis — rapid­ly ris­ing inter­est rates — is the same fac­tor that was depress­ing those bond prices and cre­at­ing the oppor­tu­ni­ty too good to pass up. And as we were just remind­ed of on Wednes­day’s Fed rate hike, there was nev­er a guar­an­tee rates would­n’t keep ris­ing and keep depress­ing those bond prices:

...
“A lot of these pri­vate equi­ty firms are smart buy­ers of debt when the time is right,” said Steven Messi­na, head of the bank­ing group at Skad­den, Arps, Slate, Meagher & Flom LLP in its New York office. “Right now, we’re in a sit­u­a­tion where pri­vate equi­ty firms gen­er­al­ly are flush with cash and have the abil­i­ty to take advan­tage of sit­u­a­tions where the debt is trad­ing at a dis­count.”

When firms buy the debt at the spon­sor lev­el, it’s gen­er­al­ly held as an invest­ment. This allows them to prof­it from the inter­est pay­ments, as well as any poten­tial refi­nanc­ing, sale of the com­pa­ny or ini­tial pub­lic offer­ing, where­in the debt gets repaid at around par. Some­times it’s bought via an invest­ment firm’s cred­it arm, which are often man­aged sep­a­rate­ly from the pri­vate equi­ty unit.

Alter­na­tive­ly, the debt can be pur­chased by the port­fo­lio com­pa­ny itself, in which case it’s usu­al­ly can­celed, cut­ting future inter­est costs while reduc­ing lever­age.

Either way, the wager is far from a sure thing. The Fed­er­al Reserve con­tin­ues to raise inter­est rates to tame run­away infla­tion, while a poten­tial reces­sion in the com­ing months could weigh on cor­po­rate earn­ings, dent­ing already depressed prices for risky debt.
...

Also note how pur­chas­ing port­fo­lio com­pa­ny debt — the debt of com­pa­nies held in a pri­vate-equi­ty fir­m’s port­fo­lio — can be spun as a sign a strength and con­fi­dence in the com­pa­ny. And while that could indeed be the moti­va­tion, there’s obvi­ous­ly a range of oth­er motives when we’re talk­ing about com­pa­nies that are intend­ed to be sold off for a big prof­it some­day, espe­cial­ly if we’re in an envi­ron­ment where there sim­ply aren’t a lot pri­vate­ly-held com­pa­nies going to mar­ket of late. In oth­er words, are pri­vate-equi­ty firms pur­chas­ing their own port­fo­lio debt because they have a lot of con­fi­dence in those com­pa­nies? Or because they don’t have a lot of oth­er invest­ment options and want to low­er debt loads to sell those com­pa­nies as soon as they can?

...
There are often also oth­er incen­tives for pur­chas­ing port­fo­lio com­pa­ny debt, accord­ing to CreditSights’s glob­al head of strat­e­gy Win­nie Cis­ar.

Pri­vate equi­ty firms may val­ue the stronger nego­ti­at­ing posi­tion being a cred­i­tor affords should the com­pa­ny need to amend or extend its debt, espe­cial­ly if the eco­nom­ic out­look wors­ens, she said. Buy­ing their port­fo­lio com­pa­ny debt also sends a strong mes­sage to exist­ing and poten­tial lenders that the spon­sor has con­vic­tion in the invest­ment.

“That’s a very pos­i­tive sig­nal to oth­er investors,” said Cis­ar. “That lends some reas­sur­ance.”
...

That was the news back in April, as the bank­ing cri­sis that prompt­ed that bond sale was still shak­ing out. Jump to ear­li­er this month, and we find a very inter­est­ing new trend in self-deal­ing: pri­vate-equi­ty firms are increas­ing­ly engaged in “fol­low-on share sales” (share sales by insid­ers fol­low­ing an IPO), despite the unfa­vor­able mar­ket con­di­tions. And guess who is increas­ing­ly buy­ing those shares: the port­fo­lio com­pa­nies them­selves.

What’s dri­ving this trend? Well, it sounds like the IPO mar­ket in gen­er­al has been awful, with the nor­mal 12 to 18 month expect­ed time­frame for a com­pa­ny ful­ly unload­ing its shares after an IPO dis­rupt­ed and tak­ing longer. As a result, pri­vate-equi­ty firms have yet to real­ize and lock in the gains much of the for their clients. Large­ly pen­sion fund clients that are increas­ing­ly over­ex­posed to pri­vate-equi­ty and eager to see results.

But there’s anoth­er omi­nous rea­son for the rushed sales that only grew more omi­nous fol­low­ing the lat­est rate hike: ris­ing inter­est rates are depress­ing the prof­its of these port­fo­lio com­pa­nies. In oth­er words, they don’t expect these shares to actu­al­ly do well going for­ward. Bet­ter to sell them now.

So we have pri­vate-equi­ty rush­ing the remain­ing shares in port­fo­lio com­pa­nies into a lousy mar­ket in a race against high­er inter­est rates and, in turn, increas­ing­ly sell­ing them back to the port­fo­lio com­pa­nies them­selves. Is this a pen­ny-wise but pound-fool­ish invest­ment strat­e­gy? Or some­thing savvi­er? *fin­gers crossed*:

Bloomberg

Pri­vate Equi­ty Firms Are Forc­ing Stock Sales Into Frag­ile Mar­ket

Funds need to show investors prof­its regard­less of con­di­tions
Pres­sure due to slug­gish fundrais­ing, high­er oper­at­ing costs

By Amy Or
July 10, 2023 at 10:07 AM EDT

With pres­sure mount­ing on pri­vate equi­ty funds to show prof­its, many are push­ing through share sales of the com­pa­nies they own even as mar­ket con­di­tions remain far from opti­mal.

PE-backed com­pa­nies rep­re­sent­ed 17% of the fol­low-on share sales in the sec­ond quar­ter, up from only 6% a year ear­li­er, accord­ing to data provider Dealog­ic. There were 27 deals worth $5.3 bil­lion last quar­ter, up from eight deals total­ing $1.2 bil­lion in the year-ear­li­er peri­od.

“Funds need to recy­cle cap­i­tal,” to show they can make prof­its and attract new invest­ments, said Daniel Klaus­ner, head of equi­ty cap­i­tal mar­kets advi­so­ry at Houli­han Lokey. “They have been hav­ing a chal­leng­ing time fundrais­ing, as we are no longer in a zero-inter­est rate envi­ron­ment.”

While fol­low-up share sales have picked up, they are prob­a­bly not going at the pace pri­vate equi­ty funds need to show mean­ing­ful gains to investors. It used to take 12 to 18 months for a fund to ful­ly unload its shares in a com­pa­ny after going pub­lic. But high volatil­i­ty vir­tu­al­ly shut down the IPO mar­ket for much of the past 18 months and dis­rupt­ed the rhythm of fol­low-ons.

...

With a lack of real­ized gains on their invest­ments as proof of their capa­bil­i­ties, PE firms have a tough time con­vinc­ing insti­tu­tion­al investors like pen­sion funds and endow­ments to fork over fresh cap­i­tal for their lat­est funds. That’s exac­er­bat­ed by the fact that insti­tu­tion­al investors have an over­ex­po­sure to pri­vate equi­ty after last years’ infla­tion-fueled mar­ket swoon.

Mar­gin Headaches

The delay in pub­lic mar­ket exits and the result­ing longer hold peri­ods cre­ate anoth­er headache: The prof­it mar­gins of many of the com­pa­nies they own are being squeezed by high­er inter­est rates.

“We’re in a high­er rate envi­ron­ment and some of these pri­vate com­pa­nies are lev­ered five and six times,” said UBS AG’s Brad Miller, head of US equi­ty cap­i­tal mar­kets syn­di­cate. “If that debt matu­ri­ty comes due, com­pa­nies would have to refi­nance at 200, 300 basis points high­er than where the his­tor­i­cal debt was, which is going to have an impact on your net income.”

As a result, PE firms are get­ting cre­ative. For exam­ple, when Clay­ton Dubili­er & Rice win­nowed its posi­tion in Agilon Health Inc. in May, the PE firm agreed not to sell its remain­ing 24.7% stake for 900 days so it didn’t inun­date the mar­ket with stock and depress prices. The wait for fol­low-ons is typ­i­cal­ly 30-to-60 days.

Pri­vate equi­ty funds also are increas­ing­ly sell­ing their stock back to the com­pa­nies them­selves, said Eric Juer­gens, a part­ner at Debevoise & Plimp­ton.

“It allows the com­pa­ny to get a big chunk of shares back, and allows the PE spon­sor to sell shares with­out sell­ing into the mar­ket,” Juer­gens said.

Look­ing ahead, there’s still a lot of pent-up demand for pri­vate equi­ty funds to sell down their hold­ings. Near­ly 200 pri­vate equi­ty-backed com­pa­nies list­ed in the US in 2021, and 51 more fol­lowed suit last year, Pre­qin said. Almost all of them will be prime can­di­dates for fol­low-on deals.

———-

“Pri­vate Equi­ty Firms Are Forc­ing Stock Sales Into Frag­ile Mar­ket” By Amy Or; Bloomberg; 07/10/2023

“With a lack of real­ized gains on their invest­ments as proof of their capa­bil­i­ties, PE firms have a tough time con­vinc­ing insti­tu­tion­al investors like pen­sion funds and endow­ments to fork over fresh cap­i­tal for their lat­est funds. That’s exac­er­bat­ed by the fact that insti­tu­tion­al investors have an over­ex­po­sure to pri­vate equi­ty after last years’ infla­tion-fueled mar­ket swoon.”

Yikes. It appears that pri­vate-equi­ty firms are feel­ing pres­sured to bring shares to mar­ket under very non-ide­al mar­ket con­di­tions. What are the sources of these pres­sures? Well, a lack of real­ized gains for their clients — which are large­ly pen­sion funds at this point — is iron­i­cal­ly one of the pri­ma­ry rea­son these shares are being sold as pre­sum­ably sub-opti­mal prices. But there’s also the fact that pen­sion funds are sim­ply over-exposed to pri­vate equi­ty at this point mak­ing them all the more sen­si­tive to a lack of real­ized results:

...
While fol­low-up share sales have picked up, they are prob­a­bly not going at the pace pri­vate equi­ty funds need to show mean­ing­ful gains to investors. It used to take 12 to 18 months for a fund to ful­ly unload its shares in a com­pa­ny after going pub­lic. But high volatil­i­ty vir­tu­al­ly shut down the IPO mar­ket for much of the past 18 months and dis­rupt­ed the rhythm of fol­low-ons.
...

But then we get to the real­ly scary poten­tial sce­nario down the road pen­sion funds who are ulti­mate­ly depen­dent on the sale of these shares to see the nec­es­sary yield on their invest­ments: with inter­est rates poised to go high­er, the future sale of the remain­ing shares might have to take place in a high­er inter­est rate envi­ron­ment that has not just erod­ed the prof­its of these port­fo­lio com­pa­nies but made their debt-ser­vice more expen­sive. And because these are pri­vate-equi­ty-owned com­pa­nies, they are loaded with debt. So this is like a ‘hot pota­to’ kind of sce­nario: they need to sell those shares before ris­ing inter­est rates tank their val­ue. Fear of what’s to come is part of what’s behind this rush to mar­ket:

...
The delay in pub­lic mar­ket exits and the result­ing longer hold peri­ods cre­ate anoth­er headache: The prof­it mar­gins of many of the com­pa­nies they own are being squeezed by high­er inter­est rates.

“We’re in a high­er rate envi­ron­ment and some of these pri­vate com­pa­nies are lev­ered five and six times,” said UBS AG’s Brad Miller, head of US equi­ty cap­i­tal mar­kets syn­di­cate. “If that debt matu­ri­ty comes due, com­pa­nies would have to refi­nance at 200, 300 basis points high­er than where the his­tor­i­cal debt was, which is going to have an impact on your net income.”

As a result, PE firms are get­ting cre­ative. For exam­ple, when Clay­ton Dubili­er & Rice win­nowed its posi­tion in Agilon Health Inc. in May, the PE firm agreed not to sell its remain­ing 24.7% stake for 900 days so it didn’t inun­date the mar­ket with stock and depress prices. The wait for fol­low-ons is typ­i­cal­ly 30-to-60 days.
...

Notably, it’s the port­fo­lio com­pa­nies them­selves who are pur­chas­ing a grow­ing num­ber of these new­ly shares. And while such moves have the ben­e­fit of allow­ing the com­pa­nies to retire those shares, the shares aren’t free. Are the com­pa­nies pay­ing the low­est price they can get away with when repur­chas­ing these shares or are they padding the port­fo­lio’s imme­di­ate returns by pay­ing an inflat­ed price? We don’t know, but con­flicts of inter­est abound:

...
Pri­vate equi­ty funds also are increas­ing­ly sell­ing their stock back to the com­pa­nies them­selves, said Eric Juer­gens, a part­ner at Debevoise & Plimp­ton.

“It allows the com­pa­ny to get a big chunk of shares back, and allows the PE spon­sor to sell shares with­out sell­ing into the mar­ket,” Juer­gens said.
...

And with the pri­vate-equi­ty firms pur­chas­ing the bonds of their own port­fo­lio com­pa­nies, we have to ask the ques­tion: so is it the port­fo­lio com­pa­nies that had their debt pur­chased and can­celed back in April who are now pur­chas­ing these new shares? And are they issu­ing new debt to pur­chase these shares? If so, who is ulti­mate­ly pur­chas­ing that debt? The pri­vate-equi­ty firms ben­e­fit­ing from those share pur­chas­es, per­haps? Again, time will tell.

But let’s not for­get that the com­ple­tion of the fol­low-on share sales might allow pri­vate-equi­ty firms to exit their expo­sure to the com­pa­nies in their port­fo­lios, damn the down­stream con­se­quences. But the peo­ple work­ing for those com­pa­nies are pre­sum­ably going to care about those down­stream con­se­quences. And we’re talk­ing about the pri­vate-equi­ty indus­try here, an indus­try noto­ri­ous for lard­ing up the com­pa­nies they buy with debt and then screw­ing over the employ­ees and strip­ping the assets. So when we read about port­fo­lio com­pa­nies buy­ing the fol­low-on shares them­selves, we should prob­a­bly be ask­ing whether or not we’re look­ing at anoth­er round of that same pat­tern. Those shares aren’t free and aren’t nec­es­sar­i­ly being pur­chased at the best price.

And while some sort of upcom­ing pri­vate-equi­ty self-deal­ing dis­as­ter sounds pos­si­ble should inter­est rates just keep tick­ing high­er and high­er, let’s not for­get the down­sides to this pan­ning out and actu­al­ly being a great invest­ment strat­e­gy. Sure, it would be great for the pri­vate-equi­ty fund man­agers and their pen­sion fund clients if all of these trends ends up being savvy moves. But when the biggest play­ers sit­ting on large piles of cash are able to cap­i­tal­ize on finan­cial crises through self-deal­ing in their large port­fo­lios of com­pa­nies, what kind of sys­temic risks does this pose to the broad­er econ­o­my? Don’t for­get that one of the clas­sic crit­i­cisms of the rise of pri­vate-equi­ty indus­try has been how it oper­ates with an unfair mar­ket advan­tage that oth­er play­ers lack, mean­ing a lot of that savvi­ness is real­ly just exploit­ing those unfair advan­tages. Advan­tages that, again, are per­verse­ly ampli­fied with large­ly pen­sion fund mon­ey these days. Pen­sion­ers increas­ing­ly rely on a busi­ness mod­el that dam­ages soci­ety and prob­a­bly should­n’t exist.

And that’s all why we already kind of know how this ‘Heads we win, tails you lose your pen­sion fund, and soci­ety is dam­aged either way’ gam­ble is going to pan out. The details have yet to be worked out, but it’s sure to work out great for a few insid­ers, espe­cial­ly the fund man­agers, and not to great for pret­ty much every­one else, espe­cial­ly pen­sion­ers and the employ­ees of these com­pa­nies. Which is sort of the meta-busi­ness mod­el for the world in 2023, and anoth­er rea­son the pri­vate-equi­ty busi­ness mod­el, and many, many oth­er busi­ness mod­els, prob­a­bly should­n’t exist.

Pen­sion funds increas­ing­ly invest­ing in the annu­ity indus­try is one of those fea­tures of the US’s retire­ment indus­try that should raise all sorts of ques­tions about what the future holds for Amer­i­ca’s grow­ing retire­ment cri­sis. Lim­it­ing annu­ity pay­outs to retirees to help pay pen­sion plans is a rather ques­tion­able busi­ness mod­el, after all.

But how about pen­sion fund invest­ments in oth­er areas of insur­ance? Like auto insur­ance? What kinds of busi­ness mod­el conun­drums can we expect from these types of invest­ments? Well, we got a hint of those conun­drums thanks to a recent $90 mil­lion set­tle­ment arrived at in a law­suit that pit­ted the investors of All­state auto insur­ance indus­try against All­state’s exec­u­tives. Investors who were large­ly pen­sion funds and annu­ity funds who faced a sud­den 10% drop in the val­ue of their invest­ments back in 2015 after All­state’s exec­u­tives decid­ed to update investors on the rea­sons for the then-38% drop in quar­ter­ly prof­its.

It was­n’t the weath­er, as the exec­u­tives had pre­vi­ous­ly sug­gest­ed. No, it turns out that the pre­cip­i­tous decline in quar­ter­ly prof­its was due to a loos­en­ing of under­writ­ing stan­dards the com­pa­ny engaged in start­ing in 2013, the year Geico over­took All­state in the auto insur­ance mar­ket. Loos­ened under­writ­ing stan­dards that, for a peri­od of time, did indeed increase All­state’s cus­tomer base. But by the last quar­ter of 2014, that busi­ness strat­e­gy came with a pre­dictable cost in the form of high­er pay­outs. It was that loos­en­ing of stan­dards, and the ini­tial­ly decep­tion about the impact of those loos­ened stan­dards, that formed the basis for the now-suc­cess­ful law­suit.

And while it’s not clear that the pen­sion fund invest­ments in All­state were done through a pri­vate-equi­ty fund — All­state accepts a range of insti­tu­tion­al investors includ­ing pen­sion funds and hedge funds — this remains a sto­ry with poten­tial­ly sig­nif­i­cant future impli­ca­tions for the pen­sion fund indus­try’s ongo­ing and deep­en­ing love affair with pri­vate-equi­ty. Because it’s hard not to notice the par­al­lels between the short-term enrich­ment strat­e­gy pur­sued by the All­state exec­u­tives and the over­all pri­vate-equi­ty ‘heads we win, tails you lose’ busi­ness mod­el.

And that brings us to one of the very inter­est­ing details of this law­suit: when it was first file in 2017, the pen­sion fund plain­tiffs were seek­ing to have at least part of the set­tle­ment paid via dis­gorge­ments from the top exec­u­tives’ salaries from 2014 and 2015. Which makes sense if you think about the fact that many of these plain­tiff were pos­si­ble still All­state investors. Hav­ing the com­pa­ny itself pay a fine over the malfea­sance of top exec­u­tives out to share­hold­ers might direct­ly com­pen­sate the share­hold­ers, but poten­tial­ly also impact the exist­ing share prices, a prob­lem that pre­sum­ably would­n’t come if the fine is paid via the dis­gorge­ments from the top exec­u­tives past salaries.

Sad­ly, it does­n’t appear that such dis­gorge­ments were part of the ulti­mate $90 mil­lion set­tle­ment. At least the report­ing does­n’t men­tion it. But still, it’s nice to see pen­sion funds at least pur­su­ing the option. You nev­er know when dis­gorge­ments might come in handy for deal­ing with the pen­sion funds’ part­ners in this ‘heads we win, tails you lose your retire­ment’ indus­try.

Ok, first, here’s a report on the $90 mil­lion set­tle­ment. A set­tle­ment pur­sued by two class­es of investor: pen­sion funds and annu­ity funds:

Reuters

All­state to pay $90 mln in share­hold­er set­tle­ment

By Jonathan Stem­pel
August 16, 2023 2:56 PM CDT
Updat­ed

Aug 16 (Reuters) — All­state (ALL.N) agreed to pay $90 mil­lion to set­tle a class action law­suit by share­hold­ers who accused the insur­er of defraud­ing them by con­ceal­ing that it low­ered under­writ­ing stan­dards to boost growth.

A pre­lim­i­nary set­tle­ment was filed on Mon­day in fed­er­al court in Chica­go, and requires a judge’s approval.

The law­suit came after All­state on Aug. 3, 2015, report­ed unex­pect­ed­ly high claims pay­outs from auto acci­dents, caus­ing a larg­er-than-expect­ed 38% decline in quar­ter­ly oper­at­ing prof­it.

All­state’s share price fell 10.1% the next day, wip­ing out $2.8 bil­lion of mar­ket val­ue.

Share­hold­ers said All­state had false­ly assured ear­li­er in the year that claims had been increas­ing because of fac­tors beyond its con­trol, such as the econ­o­my and weath­er.

They said the stock fell after it became clear that loos­ened under­writ­ing stan­dards were the cause.

The North­brook, Illi­nois-based insur­er denied wrong­do­ing, but set­tled to avoid the bur­den, cost and uncer­tain­ty of lit­i­ga­tion, accord­ing to the set­tle­ment.

...

The law­suit is led by pen­sion and annu­ity funds asso­ci­at­ed with the Car­pen­ter Funds of Oak­land, Cal­i­for­nia.

Their law firms plan to seek up to $22.5 mil­lion from the set­tle­ment for legal fees and up to $4.6 mil­lion for expens­es.

Share­hold­ers may recov­er an aver­age 46 cents per share if a judge approves the fee and expense request.

The case is In re All­state Corp Secu­ri­ties Lit­i­ga­tion, U.S. Dis­trict Court, North­ern Dis­trict of Illi­nois, No. 16–10510.

———–

“All­state to pay $90 mln in share­hold­er set­tle­ment” By Jonathan Stem­pel; Reuters; 08/16/2023

“The law­suit came after All­state on Aug. 3, 2015, report­ed unex­pect­ed­ly high claims pay­outs from auto acci­dents, caus­ing a larg­er-than-expect­ed 38% decline in quar­ter­ly oper­at­ing prof­it.”

All­state’s pen­sion fund and annu­ity fund investors did­n’t like being lied to by the exec­u­tives. Espe­cial­ly when the exec­u­tives were lying about the cause of the 38% drop in quar­ter­ly oper­at­ing prof­its. Hence the set­tle­ment. $90 mil­lion paid out to the share­hold­ers at that time who actu­al­ly took a hit from the 10% drop in All­state’s stock fol­low­ing the belat­ed mea cul­pa be All­state’s top exec­u­tives that, yes, it was a loos­en­ing of the under­writ­ing stan­dards two years ear­li­er that was the cause. Not the weath­er as pre­vi­ous­ly claimed

Again, keep in mind the grow­ing trend of pen­sion funds invest­ing in annu­ity com­pa­nies via pri­vate-equi­ty. So when we see both pen­sion fund and annu­ity funds suing over this, don’t for­get that the pen­sion funds may be behind those annu­ity fund too:

...
All­state’s share price fell 10.1% the next day, wip­ing out $2.8 bil­lion of mar­ket val­ue.

Share­hold­ers said All­state had false­ly assured ear­li­er in the year that claims had been increas­ing because of fac­tors beyond its con­trol, such as the econ­o­my and weath­er.

They said the stock fell after it became clear that loos­ened under­writ­ing stan­dards were the cause.

...

The law­suit is led by pen­sion and annu­ity funds asso­ci­at­ed with the Car­pen­ter Funds of Oak­land, Cal­i­for­nia.
...

So giv­en that the law­suit suc­ceed­ed in arriv­ing at a set­tle­ment, it’s worth not­ing what the plain­tiffs orig­i­nal­ly asked for when the suit was filed back in 2017: a dis­gorge­ment of the top exec­u­tives’ salaries from 2014–2015, on top of dam­ages. And while it does­n’t appear that such dis­gorge­ments were part of the set­tle­ment, it’s a rather remark­able request from screwed over investors. Espe­cial­ly should such insur­ance-relat­ed law­suits end up hit­ting the pri­vate-equi­ty indus­try. An indus­try with a ‘heads we win, tails you lose’ busi­ness mod­el where the pri­vate-equi­ty fund man­agers make a for­tune regard­less of how the invest­ments per­form. That’s part of the sig­nif­i­cance of this law­suit: It was almost tai­lor-mode for address­ing the inher­ent gross injus­tices with the indus­try’s ‘heads we win, tails you lose’ busi­ness mod­el:

Cour­t­house News Ser­vice

All­state Share­hold­ers Sue Over Under­writ­ing Changes

All­state relaxed under­writ­ing stan­dards in 2013 to boost auto insur­ance sales but did not tell investors about the change – caus­ing shares to fall more than 10 per­cent when the truth came out, a deriv­a­tive law­suit filed Thurs­day claims.

Lor­raine Bai­ley / August 3, 2017

CHICAGO (CN) – All­state relaxed under­writ­ing stan­dards in 2013 to boost auto insur­ance sales but did not tell investors about the change – caus­ing shares to fall more than 10 per­cent when the truth came out, a deriv­a­tive law­suit filed Thurs­day claims.

Share­hold­ers, led by Don­na Biefeldt, sued Allstate’s CEO Thomas J. Wil­son, CFO Steven E. Shed­bik and mem­bers of the insurer’s board of direc­tors in Cook Coun­ty Court.

In 2013, Geico passed All­state to become the sec­ond largest auto insur­er in the Unit­ed States after State Farm.

In response, the share­hold­ers say All­state man­age­ment decid­ed to aggres­sive­ly chase growth in auto insur­ance sales, which account for 90 per­cent of its busi­ness.

“The eas­i­est way to achieve this growth was for All­state to increase renewals and new poli­cies by loos­en­ing under­writ­ing stan­dards. Low­er­ing under­writ­ing stan­dards comes with risks, how­ev­er. In par­tic­u­lar, low­er­ing under­writ­ing stan­dards can increase PIF [poli­cies in force] but it can also increase the fre­quen­cy and cost of claims,” the com­plaint says.

Unsur­pris­ing­ly, relax­ing under­writ­ing stan­dards improved Allstate’s sales. But by the fourth quar­ter of 2014, All­state expe­ri­enced a cor­re­spond­ing increase in claims, cut­ting direct­ly into the company’s prof­its.

Its exec­u­tives blamed the prob­lem on exter­nal fac­tors, accord­ing to the com­plaint, with­out acknowl­edg­ing the change in under­writ­ing prac­tices.

When All­state final­ly told investors in August 2015 that the new poli­cies were the cause of declin­ing prof­its for the past few quar­ters, Allstate’s share price fell more than 10 per­cent – from $69.38 per share to $62.34 per share.

...

Share­hold­ers seek dis­gorge­ment of top exec­u­tives’ salaries for 2014 and 2015, plus dam­ages for breach of fidu­cia­ry duty and unjust enrich­ment. The com­plaint also demands share­hold­ers be allowed to vote on pro­pos­als to strength­en con­trols over finan­cial report­ing and to strength­en the board’s over­sight of under­writ­ing stan­dards.

They are rep­re­sent­ed by Charles F. Mor­ris­sey with Mor­ris­sey & Don­ahue in Chica­go, and Bri­an J. Rob­bins with Rob­bins Arroyo in San Diego.

All­state did not imme­di­ate­ly respond to a request for com­ment.

———-

“All­state Share­hold­ers Sue Over Under­writ­ing Changes” by Lor­raine Bai­ley; Cour­t­house News Ser­vice; 08/03/2017

“Share­hold­ers seek dis­gorge­ment of top exec­u­tives’ salaries for 2014 and 2015, plus dam­ages for breach of fidu­cia­ry duty and unjust enrich­ment. The com­plaint also demands share­hold­ers be allowed to vote on pro­pos­als to strength­en con­trols over finan­cial report­ing and to strength­en the board’s over­sight of under­writ­ing stan­dards.”

It sure would have been nice to see some top exec­u­tives have their past salaries dis­gorged. If only as a tiny first step in the right direc­tion. That did­n’t hap­pen, but it was nice to see some investors actu­al­ly call­ing for those kinds of solu­tions.

And note how, for a while, the strat­e­gy of loos­en­ing those under­writ­ing stan­dards did indeed improve All­state’s sales. It’s a reminder of why this strat­e­gy was so tempt­ing: it was guar­an­teed to get results in the short-term. It obvi­ous­ly came with the implic­it gam­ble that those poli­cies were going to have to be paid out one day, but it worked for a while:

...
Unsur­pris­ing­ly, relax­ing under­writ­ing stan­dards improved Allstate’s sales. But by the fourth quar­ter of 2014, All­state expe­ri­enced a cor­re­spond­ing increase in claims, cut­ting direct­ly into the company’s prof­its.

Its exec­u­tives blamed the prob­lem on exter­nal fac­tors, accord­ing to the com­plaint, with­out acknowl­edg­ing the change in under­writ­ing prac­tices.

When All­state final­ly told investors in August 2015 that the new poli­cies were the cause of declin­ing prof­its for the past few quar­ters, Allstate’s share price fell more than 10 per­cent – from $69.38 per share to $62.34 per share.
...

Also note part of the motive behind the loos­en­ing under­writ­ing stan­dards: All­state was los­ing mar­ket share in 2013. Loos­en­ing under­writ­ing stan­dards was a clear way of revers­ing that trend. It came at a price. But, again, it’s not like the loos­en­ing of the under­writ­ing stan­dards did­n’t accom­plish the desired results in the short-run:

...
In 2013, Geico passed All­state to become the sec­ond largest auto insur­er in the Unit­ed States after State Farm.

In response, the share­hold­ers say All­state man­age­ment decid­ed to aggres­sive­ly chase growth in auto insur­ance sales, which account for 90 per­cent of its busi­ness.

“The eas­i­est way to achieve this growth was for All­state to increase renewals and new poli­cies by loos­en­ing under­writ­ing stan­dards. Low­er­ing under­writ­ing stan­dards comes with risks, how­ev­er. In par­tic­u­lar, low­er­ing under­writ­ing stan­dards can increase PIF [poli­cies in force] but it can also increase the fre­quen­cy and cost of claims,” the com­plaint says.
...

Also keep in mind that what we are see­ing play out in this auto insur­ance sec­tor will poten­tial­ly apply to all sort of areas of insur­ance. Health insur­ance, home insur­ance, life insur­ance. All of these sec­tors could ‘ben­e­fit’ in the short-run from loos­en­ing of under­writ­ing stan­dards. That’s, again, why the dis­gorge­ment law­suit strat­e­gy to end up being much more pop­u­lar in future years.

Also keep in mind that, with cli­mate change wors­en­ing, it’s entire­ly pos­si­ble that ‘the weath­er’ real­ly will be the cul­prit. In oth­er words, for weath­er-vul­ner­a­ble forms of insur­ance like home and auto insur­ance, a refusal to tight­en under­writ­ing stan­dards could effec­tive­ly oper­at­ing as a ‘loos­en­ing’ over time. The insur­ance indus­try, like the pen­sion indus­try, is based on a mak­ing sane long-term bets. Which is also a reminder that the whole econ­o­my-wide par­a­digm of pay­ing top exec­u­tives gobs of mon­ey to ensure short-term share price appre­ci­a­tion isn’t actu­al­ly com­pat­i­ble with pen­sions. Or insur­ance. Or a viable future. The kind of future we won’t be able to dis­gorge our way out of.

How dan­ger­ous would an AI-dri­ven pri­vate equi­ty firm be to the world? It’s one of those fun thoughts that’s no longer idle spec­u­la­tion. At least it won’t be some­day. It’s real­ly just a mat­ter of time before the CEOs of large invest­ment firms — some of the most expen­sive employ­ees on the plan­et — get replaced by AIs, so we might as well start think­ing about the poten­tial con­se­quences. And per­haps a good way to ask that ques­tion is to try and answer a close­ly relat­ed ques­tion: how much more, or less, dan­ger­ous would an AI pri­vate equi­ty CEO be to human­i­ty than, for exam­ple, Tim Gurn­er, the lat­est financier to ‘say the qui­et part out loud’ before quick­ly apol­o­giz­ing? Those would be the com­ments, now heard loud­ly around the world, that Gurn­er — founder of the Gurn­er Group real estate devel­op­ment firm — made at a recent Aus­tralian Finan­cial Review pan­el. Com­ments that decried how uppi­ty employ­ees were get­ting with respect to employ­ers, with all sorts of employ­ees get­ting the notion that their employ­ers are actu­al­ly for­tu­nate to have some­one capa­ble of pro­vid­ing their labor and con­tri­bu­tions. Gurn­er went on to cheer the pol­i­cy cur­rent­ly being pur­sued by cen­tral banks — notably the Fed — of rais­ing inter­est rates for the expressed pur­pose of rais­ing unem­ploy­ment and tamp­ing down wage gain demands. Gurn­er pines for “pain in the econ­o­my”, in par­tic­u­lar a rise in unem­ploy­ment by 50%, so peo­ple would relearn that they work for their employ­ers who aren’t actu­al­ly for­tu­nate to get their labor. Yep, he said that. In pub­lic.

And then, pre­dictably, Gurn­er apol­o­gized a few days lat­er and retract­ed the insen­si­tive com­ments. Pre­sum­ably after all his pri­vate-equi­ty friends called him up and hound­ed him out for say­ing the qui­et part out loud. The ultra-rich aren’t sup­posed to pub­licly share their con­tempt for the rab­ble. It’s not just class­less. It’s like an invi­ta­tion for a class war. Or rather, an invi­ta­tion for the rab­ble to rec­og­nize that the major rea­son aver­age peo­ple have been strug­gling so much in recent decades is pre­cise­ly because the ultra-rich have been qui­et­ly wag­ing a class war the whole time. Wag­ing and win­ning that class war, one tax cut, dereg­u­la­tion, and gut­ted social pro­gram at a time. It’s like Fight Club in that you don’t talk about. Although it’s the oppo­site of Fight Club in that it’s just a few rich guys beat­ing the snot out of the mass­es ruth­less­ly for decades on end. Either way, you’re not sup­posed to talk like that.

Tim Gurn­er obvi­ous­ly isn’t the first ultra-rich guy to express such sen­ti­ments. But he might be the first one to do so in such a big way in the era of tru­ly impres­sive AI. The kind of AI that por­tends future AIs that could plau­si­bly replace a CEO like Gurn­er for much of the deci­sion-mak­ing of the firm. So giv­en this oppor­tu­ni­ty Gurn­er gave us to once again exam­ine the ongo­ing stealth class war that’s been wage and won with bru­tal effi­cien­cy by Gurn­er and his fel­low glob­al ultra-rich, it’s worth ask­ing the ques­tion: how much more dan­ger­ous would an AI CEO be to human­i­ty than Tim Gurn­er? Which one would exhib­it more human­i­ty and pos­sess a high­er degree of empa­thy?

And for­get hypo­thet­i­cal future intel­li­gence AIs. How about Chat­G­PT? Which one would you rather see at the helm of the Gurn­er Group, from the per­spec­tive of a non-investor who is just try­ing to sur­vive in this world? Tim Gurn­er? Or Chat­G­PT? These are the sad ques­tions we get to ask in our sad world run by fig­ures like Tim Gurn­er. Of course, for the Gurn­er Group’s investors, the answer is clear, for now, that Gurn­er as CEO would be prefer­able to Chat­G­PT. But you real­ly do have to won­der how long it will be before an AI real­ly could per­form Gurn­er’s role with just as much pro­fi­cien­cy. Because odds are the AI will be able to do the job at a frac­tion of Gurn­er’s cost too. And with­out his pub­lic image.

But there’s anoth­er rea­son that just took place last month that made Gurn­er’s com­ments par­tic­u­lar­ly untime­ly for the finan­cial indus­try: pri­vate-equi­ty just dodged a bul­let. Again. As always.

Or as Axios put it in the arti­cle below, Gary Gensler, head of the Secu­ri­ties and Exchange Com­mis­sion (SEC), ‘blinked’ in the face of indus­try demands to defang the new reg­u­la­tion con­gres­sion­al Democ­rats were demand­ing. Not that there aren’t new rules and reg­u­la­tions for the sec­tor. But it was by all accounts dra­mat­i­cal­ly watered down from what was being talked about just weeks ear­li­er.

Gensler ‘blinked’, and almost no one noticed (who knows why). And then, a few weeks after Gensler ‘blinked’ with­out any­one notic­ing, Gurn­er ‘blabbed’. The tim­ing almost could­n’t have been worse.

And while the Gurn­er Group might be pri­mar­i­ly focused on real estate devel­op­ment, it also takes insti­tu­tion­al client mon­ey like sov­er­eign wealth fund mon­ey. In oth­er words, the Gurn­er Group is effec­tive­ly a real estate focused pri­vate-equi­ty fund. As we’re going to see, the Gurn­er Group been expand­ing heav­i­ly in Aus­trali­a’s res­i­den­tial rental mar­kets, set­ting up funds that recent got $400 mil­lion in invest­ment from Sin­ga­pore’s nation­al ‘rainy day’ sov­er­eign wealth fund of for­eign reserve invest­ments and even raised $2 bil­lion back in Feb­ru­ary from an investor its choos­ing not to name to build build-to-rent (BTR) lux­u­ry apart­ments in Aus­tralia. Because it turns out the Aus­tralian-based Gurn­er Group, much like the rest of the pri­vate-equi­ty indus­try in US, isn’t required to pub­licly dis­close their investors. And that still appears to be the case in the US fol­low­ing the new SEC rul­ing.

Of course, none of this will actu­al­ly result in the pri­vate-equi­ty indus­try’s bul­let-dodg­ing last month gar­ner­ing a large amount of pub­lic atten­tion or out­rage. As is the case with most out­ra­geous abus­es of pow­er. The pub­lic does­n’t real­ly care, in large part because the pri­vate equi­ty take-over of the eco­nom­ic has been qui­et­ly steadi­ly build­ing for decades. It’s slow motion. Not head­line grab­bing. Plus, the indus­try known for gob­bling up entire sec­tors of the econ­o­my is on its way to own­ing the media land­scape too. Because of course that’s what hap­pen­ing. What else did we expect? Odds are all the pri­vate-equi­ty-owned media isn’t going to be super keen on report­ing about how pri­vate-equi­ty just won its show­down with the SEC two weeks before Gurn­er made these remarks. Which is why, odds are, the indus­try is going to dodge anoth­er bul­let. A very bad PR bul­let, loud­ly fired by Tim Gurn­er’s big care­less mouth that got acci­den­tal­ly hon­est and gave use a glimpse at how the world looks from on high when you’re at the top of rigged pyra­mid:

New States­man

This is what plu­toc­ra­cy looks like

We should applaud Tim Gurn­er for his ghoul­ish hon­esty.

By Sohrab Ahmari
Sep­tem­ber 13, 2023

Tim Gurn­er is an Aus­tralian prop­er­ty devel­op­er with a net worth north of £500 mil­lion and an obses­sion with the pseu­do­science of “anti-age­ing”. Mem­bers of Saint Haven, his pri­vate club in Mel­bourne, skin­ny-dip in ice water, take IV drips, retreat to “med­i­ta­tion caves” and par­take in some­thing called “cryother­a­py”, among oth­er steps aimed at halt­ing the rav­ages of decrepi­tude. When he isn’t fight­ing human nature, Gurn­er wages class war­fare.

At a recent prop­er­ty sum­mit con­vened by Australia’s Finan­cial Review, Gurn­er ven­tured to explain what ails the world: name­ly, work­ing-class people’s rel­a­tive gains in terms of wages and pow­er amid tighter labour mar­kets brought about by the pan­dem­ic and its after­math.

“We need to see unem­ploy­ment rise,” Gurn­er declared. “Unem­ploy­ment has to jump 40, 50 per cent in the econ­o­my. We need to see pain in the econ­o­my. We need to remind peo­ple that they work for the employ­er, not the oth­er way around. There’s been a sys­tem­at­ic change where employ­ees feel the employ­er is extreme­ly lucky to have them, as opposed to the oth­er way around. It’s a dynam­ic that has to change, we’ve got to kill that atti­tude, and that has to come through hurt­ing the econ­o­my, which is what the whole glob­al – the world – is try­ing to do… to increase unem­ploy­ment to get back to some sort of nor­mal­i­ty.”

...

Neolib­er­al­ism is a fuzzy sig­ni­fi­er imbued with a mul­ti­tude of mean­ings by those who deploy it. Crit­ics asso­ciate it with dereg­u­la­tion, deu­nion­i­sa­tion, pri­vati­sa­tion, finan­cial­i­sa­tion and cor­po­rate-led glob­al­i­sa­tion, as well as an impov­er­ished “pol­i­tics” in which mate­r­i­al con­di­tions and the com­mon good are occlud­ed by ques­tions of iden­ti­ty and self-expres­sion. These asso­ci­a­tions aren’t incor­rect, but they don’t get at the basic pur­pose of the neolib­er­al order: what the eco­nom­ic geo­g­ra­ph­er David Har­vey calls a “restora­tion of class pow­er” that rescind­ed the class com­pro­mis­es struck, on both sides of the Atlantic, after the Depres­sion and two world wars.

The oth­er ele­ments of neolib­er­al­ism all serve this deep­er pur­pose. Pri­vatis­ing pub­lic goods – includ­ing fire­fight­ing and emer­gency ser­vices in the US – not only opens up fresh avenues for prof­i­teer­ing, but shrinks the pub­lic realm where ordi­nary peo­ple can con­test the dis­tri­b­u­tion of social resources. The takeover of the real econ­o­my by finance trans­forms the cor­po­rate form into a pure ser­vant of short-term pri­vate gains, heed­less of any larg­er pub­lic ben­e­fit. Neolib­er­al glob­al­i­sa­tion allows cap­i­tal to play states against each oth­er in a race to the bot­tom to “attract invest­ment” – and removes deci­sion-mak­ing from pop­u­lar sov­er­eigns and into the hands of transna­tion­al bod­ies and “experts”.

Nowhere is this neolib­er­al will to pow­er more appar­ent, how­ev­er, than in the direct assault on labour’s pow­er – the stuff of Gurner’s tirade, in oth­er words. As Gurn­er made clear, in order to ensure the dom­i­na­tion of the asset-less many by the asset-rich few, it is essen­tial to restore what he con­sid­ers “some sort of nor­mal­i­ty” in labour mar­kets. And “nor­mal­i­ty”, by Gurner’s reck­on­ing and that of his neolib­er­al con­frères, means slack labour mar­kets, in which high­er unem­ploy­ment trans­lates into low­er wages and thus a small­er wage share of the social income. Intro­duc­ing slack into labour mar­kets via high inter­est rates – “what the whole world is try­ing to do,” as Gurn­er put it – also instils a greater sense of fear and pre­car­i­ty that makes work­ers less like­ly to exert polit­i­cal or on-the-job pres­sure for bet­ter con­di­tions.

Boost­ing inter­est rates is the clas­sic strat­e­gy for achiev­ing this, deployed noto­ri­ous­ly by the Fed­er­al Reserve chair­man Paul Vol­ck­er in the 1980s to tack­le the “stagfla­tion” that char­ac­terised the pre­vi­ous decade – caus­ing exact­ly the kind of reces­sion­ary “pain” Gurn­er fan­ta­sis­es about today. And while the Biden admin­is­tra­tion is in many ways opposed to the neolib­er­al con­sen­sus, Volcker’s cur­rent suc­ces­sor, Jerome Pow­ell, has made it clear that he views the wage-price com­po­nent of infla­tion – as clear an index of work­er pow­er as any – as the main prob­lem (not, you know, share­hold­er greed for prof­its).

Mad­den­ing­ly, neolib­er­als and lib­er­tar­i­ans insist that employ­ers and employ­ees enjoy the free­dom to enter into and exit employ­ment agree­ments, and thus their rela­tions are ordi­nar­i­ly opti­mal and shouldn’t be inter­fered with by unions or gov­ern­ment. At the same time, they mil­i­tate against full employ­ment, pre­cise­ly to cre­ate lop­sided pow­er asym­me­tries between work­ers and boss­es.

In the US, the results of Gurner’s “nor­mal­i­ty” have been stag­nant real wages for the bot­tom half of work­ers going back two gen­er­a­tions, and an econ­o­my in which half of fast-food work­ers and a quar­ter of adjunct col­lege teach­ers have to rely on wel­fare to make ends meet; and in which four in ten Amer­i­cans would strug­gle to come up with $400 in cash to pay for an emer­gency pro­ce­dure, accord­ing to the Fed. Under the Thatch­er-Blair-Gurn­er dis­pen­sa­tion, Britain has sim­i­lar­ly moved towards a low-wage, low-work­er-pow­er econ­o­my.

...

———

“This is what plu­toc­ra­cy looks like” by Sohrab Ahmari; New States­man; 09/13/2023

““We need to see unem­ploy­ment rise,” Gurn­er declared. “Unem­ploy­ment has to jump 40, 50 per cent in the econ­o­my. We need to see pain in the econ­o­my. We need to remind peo­ple that they work for the employ­er, not the oth­er way around. There’s been a sys­tem­at­ic change where employ­ees feel the employ­er is extreme­ly lucky to have them, as opposed to the oth­er way around. It’s a dynam­ic that has to change, we’ve got to kill that atti­tude, and that has to come through hurt­ing the econ­o­my, which is what the whole glob­al – the world – is try­ing to do… to increase unem­ploy­ment to get back to some sort of nor­mal­i­ty.””

Surg­ing unem­ploy­ment is a social good, accord­ing to Gurn­er Group founder Tim Gurn­er, because it will put work­ers back in their place. The pro­les are get­ting too uppi­ty, it seems. Sure, Gurn­er has now recant­ed those words fol­low­ing the glob­al out­cry. But the arti­cle points out, there’s no real way to deny what he said. Gurn­er was just regur­gi­tat­ing the unspo­ken rules of neolib­er­al­ism. Along with the unspo­ken goal. A goal of revers­ing the class gains of the last cen­tu­ry and return­ing to a more feu­dal era. A time when the serfs know their place. Which hap­pens be be beneath the boot of the ultra-wealthy. Wealth is for the wealthy. Work is for the poor:

...
Neolib­er­al­ism is a fuzzy sig­ni­fi­er imbued with a mul­ti­tude of mean­ings by those who deploy it. Crit­ics asso­ciate it with dereg­u­la­tion, deu­nion­i­sa­tion, pri­vati­sa­tion, finan­cial­i­sa­tion and cor­po­rate-led glob­al­i­sa­tion, as well as an impov­er­ished “pol­i­tics” in which mate­r­i­al con­di­tions and the com­mon good are occlud­ed by ques­tions of iden­ti­ty and self-expres­sion. These asso­ci­a­tions aren’t incor­rect, but they don’t get at the basic pur­pose of the neolib­er­al order: what the eco­nom­ic geo­g­ra­ph­er David Har­vey calls a “restora­tion of class pow­er” that rescind­ed the class com­pro­mis­es struck, on both sides of the Atlantic, after the Depres­sion and two world wars.

The oth­er ele­ments of neolib­er­al­ism all serve this deep­er pur­pose. Pri­vatis­ing pub­lic goods – includ­ing fire­fight­ing and emer­gency ser­vices in the US – not only opens up fresh avenues for prof­i­teer­ing, but shrinks the pub­lic realm where ordi­nary peo­ple can con­test the dis­tri­b­u­tion of social resources. The takeover of the real econ­o­my by finance trans­forms the cor­po­rate form into a pure ser­vant of short-term pri­vate gains, heed­less of any larg­er pub­lic ben­e­fit. Neolib­er­al glob­al­i­sa­tion allows cap­i­tal to play states against each oth­er in a race to the bot­tom to “attract invest­ment” – and removes deci­sion-mak­ing from pop­u­lar sov­er­eigns and into the hands of transna­tion­al bod­ies and “experts”.

Nowhere is this neolib­er­al will to pow­er more appar­ent, how­ev­er, than in the direct assault on labour’s pow­er – the stuff of Gurner’s tirade, in oth­er words. As Gurn­er made clear, in order to ensure the dom­i­na­tion of the asset-less many by the asset-rich few, it is essen­tial to restore what he con­sid­ers “some sort of nor­mal­i­ty” in labour mar­kets. And “nor­mal­i­ty”, by Gurner’s reck­on­ing and that of his neolib­er­al con­frères, means slack labour mar­kets, in which high­er unem­ploy­ment trans­lates into low­er wages and thus a small­er wage share of the social income. Intro­duc­ing slack into labour mar­kets via high inter­est rates – “what the whole world is try­ing to do,” as Gurn­er put it – also instils a greater sense of fear and pre­car­i­ty that makes work­ers less like­ly to exert polit­i­cal or on-the-job pres­sure for bet­ter con­di­tions.
...

And as Gurn­er remind­ed us with his com­ments about how, “we’ve got to kill that atti­tude, and that has to come through hurt­ing the econ­o­my, which is what the whole glob­al – the world – is try­ing to do… to increase unem­ploy­ment to get back to some sort of nor­mal­i­ty,” that class war­fare sen­ti­ment and a desire to keep the poors in their place real­ly is being pur­sued around the globe, espe­cial­ly be cen­tral banks that have long view wage infla­tion as the most per­ni­cious form of infla­tion pos­si­ble and an excuse to hike rates in the pur­suit of high­er unem­ploy­ment and low­er wages. It’s pre­sum­ably part of why Gurn­er felt the need to issue a pub­lic apol­o­gy: he was­n’t just say­ing his own ‘qui­et part out loud’. He was shar­ing the finan­cial world’s gen­er­al sen­ti­ment. Fed Chair Jerome Pow­ell has­n’t been shy about express­ing exact­ly that opin­ion. The real­ly is a glob­al elite desire to reign in the rab­ble with the threat of unem­ploy­ment. Or as Gurn­er might put it, a “return to nor­mal­cy”. The kind of nor­mal­cy an aris­to­crat might find famil­iar:

...
Boost­ing inter­est rates is the clas­sic strat­e­gy for achiev­ing this, deployed noto­ri­ous­ly by the Fed­er­al Reserve chair­man Paul Vol­ck­er in the 1980s to tack­le the “stagfla­tion” that char­ac­terised the pre­vi­ous decade – caus­ing exact­ly the kind of reces­sion­ary “pain” Gurn­er fan­ta­sis­es about today. And while the Biden admin­is­tra­tion is in many ways opposed to the neolib­er­al con­sen­sus, Volcker’s cur­rent suc­ces­sor, Jerome Pow­ell, has made it clear that he views the wage-price com­po­nent of infla­tion – as clear an index of work­er pow­er as any – as the main prob­lem (not, you know, share­hold­er greed for prof­its).

Mad­den­ing­ly, neolib­er­als and lib­er­tar­i­ans insist that employ­ers and employ­ees enjoy the free­dom to enter into and exit employ­ment agree­ments, and thus their rela­tions are ordi­nar­i­ly opti­mal and shouldn’t be inter­fered with by unions or gov­ern­ment. At the same time, they mil­i­tate against full employ­ment, pre­cise­ly to cre­ate lop­sided pow­er asym­me­tries between work­ers and boss­es.

In the US, the results of Gurner’s “nor­mal­i­ty” have been stag­nant real wages for the bot­tom half of work­ers going back two gen­er­a­tions, and an econ­o­my in which half of fast-food work­ers and a quar­ter of adjunct col­lege teach­ers have to rely on wel­fare to make ends meet; and in which four in ten Amer­i­cans would strug­gle to come up with $400 in cash to pay for an emer­gency pro­ce­dure, accord­ing to the Fed. Under the Thatch­er-Blair-Gurn­er dis­pen­sa­tion, Britain has sim­i­lar­ly moved towards a low-wage, low-work­er-pow­er econ­o­my.
...

So with Tim Gurn­er acci­den­tal­ly expos­ing him­self, and his indus­try peers, to the world, it’s worth ask­ing: so who are the Gurn­er Group’s investor clients? Pen­sion funds pos­si­bly? Oth­er ‘lit­tle peo­ple’ who need to be put in their place? It sure would be inter­est­ing to know how those types of investors feel about part­ner­ing with the Gurn­er Group.

And that brings us to the fol­low­ing arti­cle in the Aus­tralian Finan­cial Review from Feb­ru­ary of this year about the $2 bil­lion raised by the Gurn­er Group for its ‘build-to-rent’ (BTR) invest­ment fund. A fund set up to build rental prop­er­ties in Aus­tralia. Specif­i­cal­ly, lux­u­ry rental prop­er­ties. This isn’t about address­ing Aus­trali­a’s afford­able hous­ing cri­sis. It’s about mak­ing mon­ey for Gurn­er and his investors.

So who gave the Gurn­er Group $2 bil­lion months ago to build lux­u­ry rental prop­er­ties in Aus­tralia? We have no idea because the Gurn­er Group isn’t say­ing and they don’t have to say. Which is a reminder that Gurn­er’s ‘starve the poors’ atti­tude is oper­at­ing in an indus­try that enjoy with extra­or­di­nary priv­i­leges glob­al­ly:

Finan­cial Review

Rich Lis­ter Tim Gurn­er rais­es $2b for Syd­ney build-to-rent push

Lar­ry Schlesinger
Feb 21, 2023 – 7.00pm

Rich list devel­op­er Tim Gurn­er and real estate financier Qual­i­tas have secured a $2 bil­lion cap­i­tal injec­tion from an off­shore insti­tu­tion­al investor to dri­ve the growth of their build-to-rent plat­form, as they look to expand its pres­ence in Syd­ney.

The block­buster rais­ing for the sec­ond fund under the GQ Mul­ti­fam­i­ly Build-to-Rent plat­form fol­lows the joint ven­ture part­ners secur­ing $1.2 bil­lion of equi­ty invest­ments for the first fund, includ­ing a cor­ner­stone back­ing from a sov­er­eign wealth fund.

Most of this ini­tial cap­i­tal has already been com­mit­ted to four BTR projects – three in Mel­bourne and one in Syd­ney – that are either under con­struc­tion or close to start­ing and that will yield over 1400 apart­ments once com­plete.

Mr Gurn­er, who last year secured $400 mil­lion from Sin­ga­pore­an sov­er­eign wealth fund GIC, to grow his east coast build-to-sell apart­ment busi­ness, would not dis­close the iden­ti­ty of the new $2 bil­lion BTR investor, but con­firmed there was no Aus­tralian mon­ey involved.

Off­shore insti­tu­tion­al investors, who already have stakes in Aus­tralian BTR projects include US pri­vate equi­ty giant Black­stone, which this month flagged fur­ther invest­ment in Aus­tralia, and GIC, which is back­ing Gro­con scion Daniel Grollo’s $2 bil­lion Home BTR plat­form.

...

While not specif­i­cal­ly focused on one Syd­ney, Mr Gurn­er said he was keen to do a lot more in Syd­ney, pro­vid­ed devel­op­ment site val­ues start­ed to fall.

“We believe that all cap­i­tal cities, but Syd­ney espe­cial­ly will expe­ri­ence a 15–20 per cent cor­rec­tion in land price in the com­ing 12 months, so we will be ready to jump on any oppor­tu­ni­ties that arise,” he said.

With $3.2 bil­lion raised across the two BTR funds cre­at­ing a future pipeline of 3500 rental apart­ments, the GQ plat­form is on track to achiev­ing its goal of hav­ing 5000 apart­ments worth $5 bil­lion under man­age­ment by 2026.

ASX-list­ed Qual­i­tas, which will report its half-year results on Wednes­day, has launched a fund pro­vid­ing both equi­ty and debt to the fast-expand­ing BTR sec­tor. In August, Qual­i­tas secured a $700 mil­lion invest­ment man­date from the Abu Dhabi Invest­ment Author­i­ty to grow its devel­op­er lend­ing busi­ness.

Glob­al head of real estate and co-founder Mark Fis­ch­er said the fund man­ag­er saw “huge oppor­tu­ni­ty for the build-to-rent mar­ket in Aus­tralia” giv­en insti­tu­tion­al own­er­ship of rental units is as high as 11 per cent in the US, but only just tak­ing off local­ly.

“Our ambi­tion is to be a dom­i­nant play­er in the Aus­tralian build-to-rent mar­ket and with this lat­est invest­ment, we are on our way to achiev­ing this,” Mr Fis­ch­er said.

Amid an ongo­ing rental cri­sis dri­ven by record low vacan­cy rates in the cap­i­tal city mar­kets, apart­ments devel­oped by Gurn­er-Qual­i­tas won’t be at the afford­able end of the mar­ket, but will instead be tar­get­ed at young pro­fes­sion­als want­i­ng to rent lux­u­ry, inner-city accom­mo­da­tion with a pletho­ra of ameni­ties.

...

————-

“Rich Lis­ter Tim Gurn­er rais­es $2b for Syd­ney build-to-rent push” by Lar­ry Schlesinger; Finan­cial Review; 02/21/2023

“Mr Gurn­er, who last year secured $400 mil­lion from Sin­ga­pore­an sov­er­eign wealth fund GIC, to grow his east coast build-to-sell apart­ment busi­ness, would not dis­close the iden­ti­ty of the new $2 bil­lion BTR investor, but con­firmed there was no Aus­tralian mon­ey involved.”

Who is that mys­te­ri­ous $2 bil­lion investor? It sure is an inter­est­ing ques­tion now that Gurn­er has turned him­self into an ene­my of the com­mon man. What kind of investors are these? Investors osten­si­bly work­ing for the com­mon man, per­haps? Pen­sion funds? Sov­er­eign Wealth funds? Gurn­er isn’t say­ing, oth­er than that it’s off­shore mon­ey. But thanks to the extreme secre­cy enjoyed by his indus­try we have no idea who it is, which also pre­sum­ably means this inter­na­tion­al investor hails from a coun­try with its own secre­cy rules in place that allow this investor to keep their own invest­ments secret too.

Intrigu­ing­ly, this $2 bil­lion mys­tery invest­ment came weeks after reports that Black­stone was also plan­ning fur­ther BTR invest­ments of its own in Aus­trali­a’s mar­ket. Which rais­es the ques­tion: could the mys­tery investor be Black­stone’s own Aus­tralian BTR fund? We have no idea, but it’s hard to avoid sus­pi­cions giv­en the secre­cy:

...
Off­shore insti­tu­tion­al investors, who already have stakes in Aus­tralian BTR projects include US pri­vate equi­ty giant Black­stone, which this month flagged fur­ther invest­ment in Aus­tralia, and GIC, which is back­ing Gro­con scion Daniel Grollo’s $2 bil­lion Home BTR plat­form.
...

And just note the kind of impact the Gurn­er Group’s real estate invest­ments are going to have on Aus­trali­a’s hous­ing mar­ket: it’s exclu­sive­ly lux­u­ry hous­ing. In oth­er words, these are the kinds of invest­ments that are only going to exac­er­bate exist­ing hous­ing afford­abil­i­ty crises:

...
Glob­al head of real estate and co-founder Mark Fis­ch­er said the fund man­ag­er saw “huge oppor­tu­ni­ty for the build-to-rent mar­ket in Aus­tralia” giv­en insti­tu­tion­al own­er­ship of rental units is as high as 11 per cent in the US, but only just tak­ing off local­ly.

“Our ambi­tion is to be a dom­i­nant play­er in the Aus­tralian build-to-rent mar­ket and with this lat­est invest­ment, we are on our way to achiev­ing this,” Mr Fis­ch­er said.

Amid an ongo­ing rental cri­sis dri­ven by record low vacan­cy rates in the cap­i­tal city mar­kets, apart­ments devel­oped by Gurn­er-Qual­i­tas won’t be at the afford­able end of the mar­ket, but will instead be tar­get­ed at young pro­fes­sion­als want­i­ng to rent lux­u­ry, inner-city accom­mo­da­tion with a pletho­ra of ameni­ties.
...

And in case it’s not clear that the kind of secre­cy enjoyed by the Gurn­er Group in Aus­tralia is also rou­tine for the pri­vate-equi­ty indus­try in the US, here’s a look at a poten­tial­ly mas­sive change in how pri­vate-equi­ty was forced to oper­ate in the US. At least that’s how it looked last month when the fol­low­ing For­tune Mag­a­zine arti­cle was writ­ten and the SEC had yet to rule on the new slate of reg­u­la­tions backed by con­gres­sion­al Democ­rats like Eliz­a­beth War­ren. New rules like a require­ment to issue quar­ter­ly per­for­mance reports or con­duct annu­al audits. Along with new rules on the pub­lic dis­close of investors. Yep, pri­vate-equi­ty can legal­ly keep its investors secret under the cur­rent reg­u­la­tions. And this is still the case despite pri­vate-equi­ty eclips­ing com­mer­cial bank­ing in 2020. It’s a giant, and rapid­ly grow­ing, large­ly unreg­u­lat­ed shad­ow bank­ing sec­tor of the glob­al econ­o­my.

Now, as we’ll see, this slate of new rules that promised to gut the indus­try’s abil­i­ty to oper­ate in the shad­ows were, them­selves, gut­ted at the last minute when the SEC made its rul­ing a few weeks ago. The indus­try dodge the bul­let again. But it’s worth not­ing that it was just last month when it looked like pri­vate equi­ty might final­ly be fac­ing a kind of moment of truth...before dodg­ing the bul­let as usu­al:

For­tune

The $25 tril­lion sec­tor that includes VC, PE, and hedge funds is bat­tling new rules that would shine a light on what they’re actu­al­ly up to. The clock is tick­ing

BY Rachel Shin
August 8, 2023 at 6:00 AM CDT

In recent years, the val­ue of assets man­aged by the pri­vate funds indus­try has bal­looned to a stag­ger­ing $25 tril­lion, over­tak­ing com­mer­cial bank­ing in size. You know this sec­tor already: it includes hedge funds, ven­ture cap­i­tal and pri­vate equi­ty. But the clock is tick­ing down for a tough new set of reg­u­la­tions to take effect that do the one thing that “pri­vate” cap­i­tal is designed to avoid: forc­ing firms to dis­close more about their invest­ments. It could also crimp those lucra­tive prof­its, too.

Last year, the Secu­ri­ties and Exchange Com­mis­sion pro­posed new rules for the indus­try that it may adopt as soon as this month, the Wall Street Jour­nal report­ed, cit­ing peo­ple famil­iar with the mat­ter. It would be a major change for pri­vate funds, which have, until now, enjoyed loose reg­u­la­tion. The pri­vate mar­ket has bur­geoned and drawn investors because of its lack of reg­u­la­tion com­pared to the pub­lic mar­ket, which has become increas­ing­ly reg­u­lat­ed over time, Steven Kaplan, a pri­vate equi­ty researcher at the Uni­ver­si­ty of Chica­go, said.

“The pro­posed rule will fun­da­men­tal­ly alter the fruit­ful, long­stand­ing rela­tion­ships between pri­vate funds and their sophis­ti­cat­ed investors, who will find it hard­er to deliv­er for ben­e­fi­cia­ries,” Bryan Cor­bett, CEO of the Man­aged Funds Asso­ci­a­tion wrote in a state­ment to For­tune. “Many investors will expe­ri­ence high­er fees and decreased trans­paren­cy. Oth­ers will have reduced access to invest­ment oppor­tu­ni­ties.”

Kaplan large­ly con­curred, say­ing, “you might decrease the returns or increase fees.” He also offered a hedged pre­dic­tion: “And you’ll have more con­cen­tra­tion among the larg­er play­ers.”

...

Here’s just how much is at stake—and why the pri­vate funds sec­tor is fight­ing this change so hard they’ve even set up a non­prof­it enti­ty entire­ly devot­ed to fore­stalling the change.

An embat­tled sec­tor

The rules, called The Pri­vate Funds Pro­pos­al, would require pri­vate equi­ty firms and hedge funds to con­duct annu­al audits of their finan­cial state­ments and report quar­ter­ly invest­ment per­for­mance to clients. They would pro­vide guide­lines about pro­vid­ing dis­clo­sures to clients, and would also increase firms’ lia­bil­i­ty for neg­li­gence and mis­man­age­ment, and ban the now com­mon prac­tice of giv­ing “side let­ters,” or pref­er­en­tial terms, to high-pro­file investors.

Pri­vate funds in this sec­tor man­age the mon­ey of wealthy indi­vid­u­als, pen­sion funds, and uni­ver­si­ties. They are now the most pop­u­lar place to park big mon­ey, as they have brought big­ger returns on invest­ments than the pub­lic mar­ket, includ­ing stocks and mutu­al funds, in recent years.

In 2020 the pri­vate funds indus­try leapfrogged over the com­mer­cial bank sec­tor, with near­ly $3 tril­lion more in gross invest­ment assets. But the SEC and pol­i­cy­mak­ers think it may be time to rein pri­vate funds in, fear­ing that a lack of trans­paren­cy could allow firms to over­charge investors and lie about the val­u­a­tions of their port­fo­lios.

The pri­vate fund sec­tor is opaque, as cur­rent­ly there are no guide­lines for funds to val­ue their hold­ings, report invest­ment per­for­mance to their clients, and dis­close the fees that they charge clients. They’re also under no require­ment to dis­close infor­ma­tion about their clients, includ­ing their iden­ti­ties, or infor­ma­tion about how the firms raise mon­ey.

“The pri­vate equi­ty firms in the past, some of them have not been so clear [on dis­clo­sures] and that was a mis­take on their part,” Kaplan, one of the fore­most schol­ars on pri­vate funds, said. “If the rules say they have to dis­close but give some guid­ance as to what is okay, that would actu­al­ly be a ben­e­fit with­out a lot of costs.”

But Kaplan thinks the audit require­ments are “in some sense irrel­e­vant” and an unnec­es­sary cost. Because the firms only get paid upon sell­ing some­thing, inter­im reports between sales are a waste of mon­ey, he said.

The new rules are main­ly being pushed by Democ­rats, who out­lined their argu­ments in a May let­ter. Signed by eight Demo­c­ra­t­ic sen­a­tors, the let­ter said that more guardrails are need­ed to pre­vent bad prac­tices. Because pri­vate funds direct­ly com­pete with banks, they deserve to be over­seen and reg­u­lat­ed in sim­i­lar ways, they said.

“Trou­bling­ly, there is lim­it­ed data on fund size and fund activ­i­ties, and almost no data on the fees assessed by those funds,” the let­ter, co-signed by Sen. Eliz­a­beth War­ren and her col­leagues, reads. “Investors need increased trans­paren­cy, more infor­ma­tive and use­ful data, and pro­hi­bi­tions on abu­sive and con­flict­ed prac­tices.”

Tighter reg­u­la­tions could be a blow to the indus­try just as it starts to feel the effects of last year’s finan­cial down­turn. For the first time since the finan­cial cri­sis in 2009, pri­vate equi­ty funds have report­ed neg­a­tive annu­al returns for the year end­ing March 31. The sector’s deal vol­ume also decreased 26% and its deal count fell 15%, to $2.4 tril­lion and 60,000 respec­tive­ly, accord­ing to con­sult­ing firm McK­in­sey.

Pri­vate funds are push­ing back aggres­sive­ly on the pro­posed rules. In the 18 months since the reg­u­la­tions were first sug­gest­ed, the indus­try has band­ed togeth­er on a lob­by­ing effort against the reg­u­la­tions. As part of the lob­by­ing push, sev­er­al funds, includ­ing Mil­len­ni­um Man­age­ment and HBK Cap­i­tal Man­age­ment, cre­at­ed a non­prof­it to head off the pro­posed rules, the Wall Street Jour­nal report­ed.

...

In an April 2022 let­ter from the non­prof­it, the indus­try argued to the SEC that it has a prece­dent of loose reg­u­la­tion, and that the SEC has no author­i­ty to adopt the new rules because pri­vate funds have long been exempt­ed from such restric­tions by Con­gress. The rules would also dis­crim­i­nate against pri­vate funds com­pared to oth­er mon­ey man­agers like those that rep­re­sent retail investors, the let­ter claims.

“Because the Pro­posed Rules result in unsup­port­ed dis­crim­i­na­to­ry treat­ment of pri­vate funds and their advis­ers, they are arbi­trary and capri­cious,” the let­ter reads. “This is whol­ly con­trary to the pre­vi­ous­ly expressed posi­tions of the Com­mis­sion that pri­vate funds were appro­pri­ate only for cer­tain sophis­ti­cat­ed clients and, giv­en that such funds were not avail­able to retail investors, pri­vate funds did not need to be sub­ject to the same restric­tions as pub­lic funds.”

But the sen­a­tors argue that if trans­paren­cy rules had been in place ear­li­er, the dam­age done by pre­vi­ous crises like FTX’s col­lapse could’ve been reduced. FTX was a lead­ing cryp­tocur­ren­cy exchange once val­ued at $32 bil­lion before it implod­ed in Novem­ber after alleged crim­i­nal mis­man­age­ment and a large vol­ume of with­drawals caused it to file for bank­rupt­cy. While the pro­posed new rules wouldn’t have pre­vent­ed the fraud and mon­ey laun­der­ing at the exchange, investors at firms that invest­ed in FTX could have accessed “crit­i­cal detail” that could have served as a “start­ing place to ques­tion those val­ues” that under­laid the fraud, the sen­a­tors said.

For large firms, the pro­pos­al will be an annoy­ance but not an exis­ten­tial cri­sis, accord­ing to Kaplan. “The Black­stones of the world” can afford to hire new teams of lawyers and accoun­tants to tack­le the reg­u­la­tions, but small pri­vate funds might not, and it will become hard­er for new firms to enter the mar­ket because of increased fixed costs, he said. So could the pro­pos­al kill the pri­vate funds indus­try? No—but it may dec­i­mate it, shrink­ing the sec­tor and pop­u­lat­ing it with a few larg­er firms.

———-

“The $25 tril­lion sec­tor that includes VC, PE, and hedge funds is bat­tling new rules that would shine a light on what they’re actu­al­ly up to. The clock is tick­ing” by Rachel Shin; For­tune; 08/08/2023

“Last year, the Secu­ri­ties and Exchange Com­mis­sion pro­posed new rules for the indus­try that it may adopt as soon as this month, the Wall Street Jour­nal report­ed, cit­ing peo­ple famil­iar with the mat­ter. It would be a major change for pri­vate funds, which have, until now, enjoyed loose reg­u­la­tion. The pri­vate mar­ket has bur­geoned and drawn investors because of its lack of reg­u­la­tion com­pared to the pub­lic mar­ket, which has become increas­ing­ly reg­u­lat­ed over time, Steven Kaplan, a pri­vate equi­ty researcher at the Uni­ver­si­ty of Chica­go, said.”

New rules for pri­vate-equi­ty are on the way! At least that’s how it looked last year when the Pri­vate Funds Pro­pos­al was I’ll get­ting for­mu­lat­ed. Not only would pri­vate-equi­ty firms and hedge funds be forced to issue quar­ter­ly per­for­mance reports to clients and con­duct annu­al audits, and actu­al­ly dis­close to clients the fees they are charg­ing, but they could be forced to dis­close infor­ma­tion about clients too. Infor­ma­tion like client iden­ti­ties:

...
The rules, called The Pri­vate Funds Pro­pos­al, would require pri­vate equi­ty firms and hedge funds to con­duct annu­al audits of their finan­cial state­ments and report quar­ter­ly invest­ment per­for­mance to clients. They would pro­vide guide­lines about pro­vid­ing dis­clo­sures to clients, and would also increase firms’ lia­bil­i­ty for neg­li­gence and mis­man­age­ment, and ban the now com­mon prac­tice of giv­ing “side let­ters,” or pref­er­en­tial terms, to high-pro­file investors.

...

The pri­vate fund sec­tor is opaque, as cur­rent­ly there are no guide­lines for funds to val­ue their hold­ings, report invest­ment per­for­mance to their clients, and dis­close the fees that they charge clients. They’re also under no require­ment to dis­close infor­ma­tion about their clients, includ­ing their iden­ti­ties, or infor­ma­tion about how the firms raise mon­ey.

...

“Trou­bling­ly, there is lim­it­ed data on fund size and fund activ­i­ties, and almost no data on the fees assessed by those funds,” the let­ter, co-signed by Sen. Eliz­a­beth War­ren and her col­leagues, reads. “Investors need increased trans­paren­cy, more infor­ma­tive and use­ful data, and pro­hi­bi­tions on abu­sive and con­flict­ed prac­tices.”
...

And note the indus­try’s rather laugh­able defense against these rules: the SEC had no stand­ing to reg­u­late the indus­try because con­gress has exempt­ed the indus­try from these rules for such a long time. There’s a prece­dent for loose reg­u­la­tions that should be adhered to. It’s a remark­able way to express that pro­found sense of enti­tle­ment. Espe­cial­ly since it was con­gres­sion­al Democ­rats push­ing for these new rules:

...
The new rules are main­ly being pushed by Democ­rats, who out­lined their argu­ments in a May let­ter. Signed by eight Demo­c­ra­t­ic sen­a­tors, the let­ter said that more guardrails are need­ed to pre­vent bad prac­tices. Because pri­vate funds direct­ly com­pete with banks, they deserve to be over­seen and reg­u­lat­ed in sim­i­lar ways, they said.

...

In an April 2022 let­ter from the non­prof­it, the indus­try argued to the SEC that it has a prece­dent of loose reg­u­la­tion, and that the SEC has no author­i­ty to adopt the new rules because pri­vate funds have long been exempt­ed from such restric­tions by Con­gress. The rules would also dis­crim­i­nate against pri­vate funds com­pared to oth­er mon­ey man­agers like those that rep­re­sent retail investors, the let­ter claims.
...

Also note the tim­ing of these poten­tial new rules: they were com­ing right when pri­vate-equi­ty funds are report­ing their first neg­a­tive-return year since 2009. Which rais­es the ques­tion: just how much more neg­a­tive might those returns be under these pro­posed dis­clo­sure rules? And how many oth­er FTX-like finan­cial time bombs are there wait­ing to go off the moment they are exposed to sun­light? Because it does­n’t sound like clients were nec­es­sar­i­ly oblig­at­ed to receive accu­rate infor­ma­tion under the exist­ing rules. Every­thing is allowed to remain opaque until the assets are sold. In oth­er words, the opaque­ness at risk of being lost under these rules are prob­a­bly excep­tion­al­ly con­ve­nient for the indus­try dur­ing a down year when loss­es have to be hid­den:

...
Tighter reg­u­la­tions could be a blow to the indus­try just as it starts to feel the effects of last year’s finan­cial down­turn. For the first time since the finan­cial cri­sis in 2009, pri­vate equi­ty funds have report­ed neg­a­tive annu­al returns for the year end­ing March 31. The sector’s deal vol­ume also decreased 26% and its deal count fell 15%, to $2.4 tril­lion and 60,000 respec­tive­ly, accord­ing to con­sult­ing firm McK­in­sey.

...

But the sen­a­tors argue that if trans­paren­cy rules had been in place ear­li­er, the dam­age done by pre­vi­ous crises like FTX’s col­lapse could’ve been reduced. FTX was a lead­ing cryp­tocur­ren­cy exchange once val­ued at $32 bil­lion before it implod­ed in Novem­ber after alleged crim­i­nal mis­man­age­ment and a large vol­ume of with­drawals caused it to file for bank­rupt­cy. While the pro­posed new rules wouldn’t have pre­vent­ed the fraud and mon­ey laun­der­ing at the exchange, investors at firms that invest­ed in FTX could have accessed “crit­i­cal detail” that could have served as a “start­ing place to ques­tion those val­ues” that under­laid the fraud, the sen­a­tors said.
...

Final­ly, note that this sec­tor now eclipses the com­mer­cial bank­ing sec­tor. With almost none of the com­mer­cial bank­ing sec­tor’s reg­u­la­tions. Because we appar­ent­ly can’t learn lessons:

...
Pri­vate funds in this sec­tor man­age the mon­ey of wealthy indi­vid­u­als, pen­sion funds, and uni­ver­si­ties. They are now the most pop­u­lar place to park big mon­ey, as they have brought big­ger returns on invest­ments than the pub­lic mar­ket, includ­ing stocks and mutu­al funds, in recent years.

In 2020 the pri­vate funds indus­try leapfrogged over the com­mer­cial bank sec­tor, with near­ly $3 tril­lion more in gross invest­ment assets. But the SEC and pol­i­cy­mak­ers think it may be time to rein pri­vate funds in, fear­ing that a lack of trans­paren­cy could allow firms to over­charge investors and lie about the val­u­a­tions of their port­fo­lios.
...

Yes, it was a moment of hope, not too long ago. The pri­vate equi­ty indus­try’s amaz­ing mul­ti-decade run in the US as a reg­u­la­to­ri­ly-pre­ferred sec­tor of finance was fac­ing a very real threat. But that was then, and this is now:

Axios

The SEC waters down new pri­vate equi­ty rules

Dan Pri­mack, author of Axios Pro Rata
Aug 23, 2023 — Econ­o­my & Busi­ness

U.S. secu­ri­ties reg­u­la­tors today will vote to approve a Pri­vate Fund Advis­ers rule that’s a far cry from what was first pro­posed 18 months ago, in a major win for pri­vate equi­ty indus­try lob­by­ists.

...

* In Feb­ru­ary 2022 we wrote: “The SEC is in charge of investor pro­tec­tion, no mat­ter the type of investor, and believes that pen­sion funds and oth­er lim­it­ed part­ners in pri­vate equi­ty funds aren’t always giv­en ade­quate vis­i­bil­i­ty. Pri­vate equi­ty, of course, would argue that its LP agree­ments are heav­i­ly-nego­ti­at­ed con­tracts between sophis­ti­cat­ed investors. Or, put anoth­er way, leave us alone.”

* The U.S. Secu­ri­ties and Exchange Com­mis­sion, led by Gary Gensler, appears to accept­ed the indus­try’s argu­ment.

What’s new: The rule would require reg­is­tered pri­vate funds to dis­trib­ute a quar­ter­ly finan­cial state­ment to their investors, includ­ing infor­ma­tion on fees, and also require annu­al finan­cial state­ment audits. That’s as orig­i­nal­ly draft­ed.

* When it comes to GP-led sec­on­daries, it would require that the GP obtain a fair­ness opin­ion or val­u­a­tion opin­ion, where­as the orig­i­nal lan­guage only per­mit­ted the for­mer.

After that, the draft begins to dis­in­te­grate.

* A “pro­hib­it­ed activ­i­ties rule” has become a “restrict­ed activ­i­ties rule,” with many of the under­ly­ing actions now allowed so long as there is investor dis­clo­sure.

* For exam­ple, the ban on “fees for unper­formed ser­vices” like accel­er­at­ed mon­i­tor­ing fees is gone, although an SEC offi­cial insists that’s because staff deter­mined they were already pro­hib­it­ed under oth­er statute.

* Funds still will be allowed to charge LPs for fees tied to reg­u­la­to­ry or com­pli­ance issues, so long as it’s dis­closed. They even can charge fees on a non pro rata basis, so long as it describes to LPs why it believes such a move is fair and equi­table. The only excep­tion is for fees tied to an SEC inves­ti­ga­tion.

* Dis­clo­sure also is the buzz­word for a clause that would have stopped GPs from reduc­ing claw­backs by the amount of actu­al or expect­ed tax­es. So long as LPs are informed, it’s allowed.

Key ommi­sion: There was no change made to pri­vate fund lia­bil­i­ty rules, which would made it much eas­i­er for LPs to sue GPs.

* Fund man­agers will now be required to share any pref­er­en­tial LP terms with all prospec­tive investors, but only by the time an investor clos­es on its com­mit­ment. If they par­tic­i­pate in an inter­im close and then there are pref­er­en­tial terms on a sub­se­quent close, they can­not rescind their com­mit­ment.

* An SEC offi­cial said that this clause would still pro­tect investors because they’d have more infor­ma­tion when being pitched by the man­ag­er on a sub­se­quent fund, although that may be a tough argu­ment for LPs to swal­low.

The bot­tom line: Gensler blinked.

———-

“The SEC waters down new pri­vate equi­ty rules” by Dan Pri­mack; Axios; 08/23/2023

“The bot­tom line: Gensler blinked.”

Yep, the new rules basi­cal­ly got tossed. Not all of the new rules. But most of them it seems. Gary Gensler, the SEC Chair, ‘blinked’ in the face of all the indus­try lob­by­ing. Because of course he did. That’s what hap­pens. Vir­tu­al­ly always. Pow­er wins.

So that almost con­cludes our look at how Tim Gurn­er’s sur­pris­ing­ly hon­est com­ments about the need to teach the lit­tle peo­ple to stay in their place was almost eclipsed by an end­ing of an era of the pri­vate-equi­ty indus­try. Almost. But then the same thing that always hap­pened hap­pened again. Tim Gurn­er’s era con­tin­ues.

But, again, Tim Gurn­er was­n’t just express­ing his own per­son­al views. He real­ly was reveal­ing a wide­ly held class sen­ti­ment. A sen­ti­ment that in many ways echoed now-noto­ri­ous com­ments made by Black­stone’s CEO Stephen Schwarz­man back in 2011. As Schwarz­man lament­ed at the time, not enough poor peo­ple pay income tax­es and he wish­es all of them had to pay at least a little....so they would have ‘skin in the game’ as he put it.

And then Schwarz­man went on to elab­o­rate by sug­gest­ing that the 45% of Amer­i­cans who are too poor to pay income tax­es aren’t real­ly “part of the sys­tem” and can’t have an “we’re all in this togeth­er, solv­ing prob­lems togeth­er” atti­tude. He real­ly said that. This was just months into the Occu­py Wall Street move­ment. That’s how firm­ly Schwarz­man held those views. He expressed them as peo­ple were camp­ing out in the streets to protest peo­ple like him. The guy who is still lead­ing the world’s largest pri­vate-equi­ty firm, a firm with almost $10 bil­lion in pub­lic pen­sion mon­ey under man­age­ment as of March 2020 as the pan­dem­ic was unfold­ing, views aver­age peo­ple as a bunch of leech­es who aren’t real­ly ‘part of the sys­tem’ or will­ing to ‘solve prob­lems togeth­er’. And in the years that fol­lowed, pub­lic pen­sion funds show­ered his firm with bil­lions.

Keep in mind that Schwarz­man topped the list of US CEO pay in 2008, the year Black­stone went pub­lic. Which was also, of course, right before the finan­cial cri­sis cre­at­ed by Wall Street’s grotesque greed blew up the stock mar­ket, dev­as­tat­ing Black­stone’s share price. But at least the insid­ers got to get out before things went south.

And that’s all why we have to assume Tim Gurn­er’s ultra-wealthy peers prob­a­bly weren’t very pleased with his com­ments. Because, again, Tim Gurn­er was­n’t just express­ing his per­son­al opin­ion. He was echo­ing a sen­ti­ment we’ve been hear­ing from his ultra-wealthy brethren for years as they got wealth­i­er and wealth­i­er, whether Stephen Schwarz­man prefers we remem­ber or not:

Busi­ness Insid­er

Bil­lion­aire Steve Schwarz­man Wish­es More Poor Peo­ple Would Pay Income Tax­es

Julia La Roche
Nov 30, 2011, 12:02 PM CST

Bil­lion­aire pri­vate equi­ty tycoon Stephen Schwarz­man, the chief exec­u­tive of Black­stone Group, told Bloomberg Tele­vi­sion this morn­ing that he wants more peo­ple to pay income tax­es.

“We have a sys­tem today in the Unit­ed States were 45% of Amer­i­cans don’t pay any income tax...You have to have skin in the game,” he said.

That essen­tial­ly means he wants more poor peo­ple in the U.S. to pony up and pay income tax­es.

How­ev­er, he did­n’t spec­i­fy the amount he wants them to pay.

“The issue isn’t the amount, it’s the con­cept that we are all in this togeth­er, solv­ing prob­lems togeth­er. I can’t micro­man­age what any­body pays or does­n’t pay. But the con­cept that half of the pub­lic isn’t involved with the income-tax sys­tem is some­what odd and I’m not say­ing how much peo­ple should do, but we should all be part of the sys­tem,” he added.

...

————

“Bil­lion­aire Steve Schwarz­man Wish­es More Poor Peo­ple Would Pay Income Tax­es” by Julia La Roche; Busi­ness Insid­er; 11/30/2011

“The issue isn’t the amount, it’s the con­cept that we are all in this togeth­er, solv­ing prob­lems togeth­er.”

Why can’t the poors just work with us to solve prob­lems togeth­er. So said the bil­lion­aire two months into Occu­py Wall Street. It was so stu­pid on so many lev­els it rais­es the ques­tion: who got yelled at more by their ultra-wealthy peers after their laps­es in acci­den­tal hon­est? Schwarz­man in 2011 or Gurn­er in 2023? Either, it’s the same old sto­ry, just with a lot more wealth and pow­er for the indus­try in 2023 com­pared to 2011. Don’t for­get what Schwarz­man said in Decem­ber 2020: the pan­dem­ic pre­sent­ed the kind of ‘accel­er­a­tion moment’ for the indus­try that the 2008 finan­cial cri­sis pre­sent­ed for the indus­try, where it came out of it big­ger than ever. In 2011, Black­stone was already rid­ing that ‘accel­er­a­tion moment’, and it sure looks like the last few years of been anoth­er one of those ‘moments’. A moment heav­i­ly fueled by pen­sions, sov­er­eign wealth funds, and oth­er large pools of insti­tu­tion­al mon­ey lured in by the promis­es of high­er returns. Steve Schwarz­man, Tim Gurn­er, and a whole lot of oth­er extreme­ly wealthy peo­ple are a lot wealth­i­er than they were in 2011 thanks in large part to access to the pools of funds of the sav­ings of aver­age work­ing peo­ple. Aver­age peo­ple who aren’t earn­ing their keep appar­ent­ly, in the eyes of these titans of indus­try.

Which, again, begs the ques­tion: who would be worse for aver­age work­ing peo­ple to be man­ag­ing these invest­ment firms? Fig­ure like Tim Gurn­er and Steve Schwarz­man? Or some sort of next-gen AI that will maybe be avail­able in a decade or so? The AI obvi­ous­ly pos­es risks. But are they worse risks? We’ll find out. But if it turns out that human­i­ty ulti­mate­ly seals its doom after hand­ing too much con­trol over to AIs put in charge of invest­ment funds and oth­er insti­tu­tions that keep soci­ety hum­ming along, let it be known that the guys in charge before made it very dif­fi­cult to not give Skynet a try.

Are pri­vate-equi­ty giants behav­ing like finan­cial preda­tors in today’s mar­kets? Or are they oper­at­ing more like pen­sion-fund-bloat­ed use­ful-idiot prey for for sophis­ti­cat­ed investors? It’s long been a ques­tion loom­ing over this sec­tor of finance and as we’re going to see, there’s a new twist to this ques­tion: the grow­ing trend of com­mer­cial real estate (CRE) investors turn­ing to ‘dequity’ in the search for financ­ing to fill in exist­ing finan­cial gaps. ‘Dequity’ being a term to describe the range of lend­ing tools that com­bine a mix of debt and equi­ty. High­er risk lend­ing like mez­za­nine loans that tends to charge high­er inter­est rates and come with con­di­tions that allow the lender to trade in the debt for equi­ty in the prop­er­ty. In oth­er words, the kinds of loans that bor­row­ers to typ­i­cal­ly engage in unless they have no bet­ter options. That’s the new big trend in the CRE sec­tor.

And while pri­vate-equi­ty giants are obvi­ous­ly in a posi­tion to exploit this kind of mar­ket dis­tress and seek out oppor­tu­ni­ties for dis­tressed bor­row­ers who they can shake down with a stingy ‘dequity’ offer, we’re also implic­it­ly talk­ing about a num­ber of dis­tressed pri­vate-equi­ty-backed CRE projects if when we’re learn­ing about new lev­els of dis­tress in the CRE mar­kets. And that’s why we have to ask: is this sto­ry about the grow­ing CRE reliance on ‘dequity’ a net good-new or net bad-news sto­ry for pri­vate-equi­ty? And in par­tic­u­lar, pri­vate-equi­ty’s exten­sive list of pen­sion fund clients already deeply invest­ed in the CRE sec­tor. How is this trend going for that group CRE play­ers?

The answer isn’t obvi­ous, at least not based on exam­ples we’re going to read about. In one case, Mas­ter­works Devel­op­ment bought a dis­count­ed note on a $61M mez­za­nine loan belong­ing to a port­fo­lio of dis­tressed Black­stone-owned hotels just last month. The $61 mez­za­nine loan was first issued in 2017, short­ly after Black­stone’s 2016 pur­chase of the hotels from Mas­ter­works for $283 mil­lion, along with an addi­tion­al $274 mil­lion loan in more tra­di­tion­al mortage-backed secu­ri­ties. So as we can see, the cur­rent pre­car­i­ty of Black­stone’s invest­ment is exac­er­bat­ed by the under­ly­ing pri­vate-equi­ty mod­el of pur­chas­ing busi­ness­es and then load­ing them up with debt. And in this case, it appears the busi­ness­es are in such poor shape that the orig­i­nal hold­er of that $61 mil­lion mez­za­nine loan decid­ed to sell it at a dis­count instead of using the option to con­vert it to an equi­ty stake in the prop­er­ties. It points towards the under­ly­ing trend dri­ving this new ‘dequity’ trend: a lot of CRE busi­ness mod­els are still bro­ken.

It’s that bro­ken CRE busi­ness mod­el that has turned tra­di­tion­al bor­row­ing that has hand­ed lenders the kind of lever­age where ‘dequity’ is real­ly the only option for increas­ing­ly des­per­ate CRE bor­row­ers. It’s a sen­ti­ment rather frankly expressed by Geri Borg­er Urgo of New­point Real Estate Cap­i­tal — a new CRE lend­ing plat­form cre­at­ed by pri­vate-equi­ty giant Merid­i­an Cap­i­tal Group a cou­ple of years ago — who put it as fol­lows: “What I think is inter­est­ing about pref right now — and I love the term ‘res­cue cap­i­tal’ — but there is a shift, or maybe a buy­er-beware aspect to it...I don’t want to use the term preda­to­ry financ­ing, but it’s what comes to mind. So we’re see­ing a lot more pow­er being giv­en over to that pref hold­er.”:

Bis­now

As Lend­ing Options Get Scarcer, CRE Play­ers Turn To ‘Dequity’

Sep­tem­ber 20, 2023 Cia­ra Long, Bis­now New York City

With no sign that the Fed­er­al Reserve’s restric­tive­ly high inter­est rates are com­ing down any­time soon, the com­mer­cial real estate indus­try is still look­ing at ways to shake loose financ­ing as lend­ing is set to drop around 40% this year.

One term gain­ing pop­u­lar­i­ty is “dequity,” an ambigu­ous­ly defined mix between debt and equi­ty that devel­op­ers are increas­ing­ly using to fill holes in their cap­i­tal stacks. The fund­ing car­ries increased risk for bor­row­ers — but not enough to dis­cour­age the com­mer­cial real estate sec­tor from using it to plug a gap.

“It is the de fac­to solu­tion to every prob­lem,” Sam Fried­land, a senior vice pres­i­dent at Relat­ed Fund Man­age­ment, the pri­vate equi­ty arm of The Relat­ed Cos., said onstage at Bis­now’s 2023 Nation­al Finance Sum­mit last week.

Dequity is sim­ply “not tak­ing the last dol­lar of risk,” Fried­land said when asked to define the term. By not being the last rung in the cap­i­tal stack, dequity hold­ers are more like­ly to see a return and are in first posi­tion to take over a strug­gling build­ing from a bor­row­er.

“It’s an open term,” he said.

Per­haps helped by its lack of spe­cif­ic def­i­n­i­tion, dequity is tak­ing on momen­tum as a new buzz­word, as both infla­tion­ary pres­sures and the high­est inter­est rates in over a decade are mak­ing it hard­er to hash out tra­di­tion­al loan agree­ments.

Where bor­row­ers would typ­i­cal­ly have been able to replace one senior mort­gage with anoth­er, they are now look­ing at gap or mez­za­nine loans or pre­ferred equi­ty, which all fall under the dequity umbrel­la and give the investors offer­ing it more poten­tial con­trol over the future of their prop­er­ties.

Infla­tion, plus increased costs for oper­a­tions, insur­ance, labor and tax­es, all are mak­ing it dif­fi­cult for tra­di­tion­al deal struc­tures to pen­cil out, Cer­berus Cap­i­tal Man­age­ment Man­ag­ing Direc­tor and Head of Real Estate Pri­vate Cred­it Neha San­ti­a­go said at the event, held at 180 Maid­en Lane in Man­hat­tan’s Finan­cial Dis­trict.

Addi­tion­al­ly, own­ers and investors are fac­ing slow­ing rent growth across asset class­es and mar­kets. There’s also down­ward pres­sure on net oper­at­ing income, as well as more than a tril­lion dol­lars of debt matu­ri­ties com­ing due in the U.S. over the next 12 months, she said.

“You put all those ingre­di­ents into the shak­er and shake it out, and then you pour out what is a pret­ty unsa­vory cock­tail,” San­ti­a­go said. “That is what is putting a lot of pres­sure on val­u­a­tions today.”

Those cir­cum­stances cre­ate a ripe envi­ron­ment for dequity to step in, Geor­gette Chap­man Phillips, dean of the Col­lege of Busi­ness at Lehigh Uni­ver­si­ty and author of a 2005 paper on dequity, told Bis­now by phone.

“What was worth $100 two years ago is worth 50 bucks now. What’s the loan-to-val­ue ratio on that?” she said. “Loans are under­wa­ter, peo­ple are walk­ing away. It’s anoth­er reck­on­ing moment.”

There’s no recipe for what makes a dequity deal, Chap­man Phillips said. Tra­di­tion­al debt arrange­ments give lenders the pow­er to demand a cer­tain amount of pay­ment at a cer­tain point in time, while tra­di­tion­al equi­ty agree­ments give the own­er pow­er to shape a prop­er­ty’s deci­sions. Dequity means cre­at­ing a mix­ture of both, depend­ing on the par­tic­i­pants’ appetite for risk.

Tak­ing a dequity posi­tion can be equiv­a­lent to a pre­ferred equi­ty or res­cue cap­i­tal posi­tion, experts said onstage. Dequity invest­ments can offer the best risk-adjust­ed returns in today’s mar­ket — bet­ter even than a com­mon equi­ty posi­tion, San­ti­a­go said.

“When bor­row­ers — par­tic­u­lar­ly well-cap­i­tal­ized bor­row­ers — go to price those last [sub­or­di­nate] debt dol­lars, those are often pric­ing at returns high­er than what equi­ty is pro­ject­ed to make on a trans­ac­tion,” she said.

...

Pri­vate equi­ty play­ers are also look­ing at acquir­ing dequity posi­tions in dis­tressed prop­er­ties to put them in pole posi­tion to take con­trol of prop­er­ties.

Mas­ter­works Devel­op­ment last month bought a dis­count­ed note on a $61M mez­za­nine loan belong­ing to a port­fo­lio of dis­tressed Black­stone-owned hotels, The Real Deal report­ed. This month, 3650 REIT orig­i­nat­ed a $103M mez­za­nine loan to recap­i­tal­ize a joint ven­ture-owned res­i­den­tial port­fo­lio across Louisiana, South Car­oli­na, Geor­gia and Ten­nessee. The loan, pro­vid­ed to David Wern­er Invest­ments, Onyx Part­ners and Carl­ton Asso­ciates with an ini­tial 24-month term, allows the spon­sors to recap­i­tal­ize the portfolio’s exist­ing equi­ty struc­ture.

These types of deals are becom­ing more fre­quent because under the cur­rent eco­nom­ic con­di­tions, equi­ty seems too risky and debt is offer­ing returns that are too mea­ger to attract investors, Fried­land said onstage.

...

The long-await­ed dis­tress may not appear in the way that experts were pre­dict­ing last year. Instead, bor­row­ers are fac­ing cir­cum­stances where they may just need more time to help an asset that is stressed rather than a solu­tion for dis­tress, Ben­tall GreenOak Man­ag­ing Direc­tor and Head of U.S. Debt Abbe Fran­chot Borok said onstage.

“We are start­ing to see ... an abil­i­ty to trans­act in that res­cue cap­i­tal [pre­ferred equi­ty] space — so, not true dis­tress, but assets the bor­row­er just needs some more time and to get through the volatil­i­ty,” she said. “I do think there’s going to be some inter­est­ing oppor­tu­ni­ties there.”

But just like two cock­tails in a row might leave some with a headache the next day, dequity’s risk cock­tail might intro­duce com­pli­ca­tions down the line for bor­row­ers.

“What I think is inter­est­ing about pref right now — and I love the term ‘res­cue cap­i­tal’ — but there is a shift, or maybe a buy­er-beware aspect to it,” said Geri Borg­er Urgo, New­point Real Estate Capital’s head of pro­duc­tion. “I don’t want to use the term preda­to­ry financ­ing, but it’s what comes to mind. So we’re see­ing a lot more pow­er being giv­en over to that pref hold­er.”

One of the down­sides could be that a bank­rupt­cy court may have a dif­fer­ent opin­ion over what the loan’s struc­ture means for asset own­er­ship if dis­putes reach the courts, Chap­man Phillips said.

Still, she said, it’s a tool that could ease cir­cum­stances cur­rent­ly faced by lenders and bor­row­ers alike.

“Any­thing that allows a more flu­id exchange of val­ue is good,” she said. “The last thing you want is a rigid mar­ket, because then nobody can move.”

———–

“As Lend­ing Options Get Scarcer, CRE Play­ers Turn To ‘Dequity’” by Cia­ra Long; Bis­now; 09/20/2023

““What I think is inter­est­ing about pref right now — and I love the term ‘res­cue cap­i­tal’ — but there is a shift, or maybe a buy­er-beware aspect to it,” said Geri Borg­er Urgo, New­point Real Estate Capital’s head of pro­duc­tion. “I don’t want to use the term preda­to­ry financ­ing, but it’s what comes to mind. So we’re see­ing a lot more pow­er being giv­en over to that pref hold­er.””

Yes, the bor­row­ing land­scape for CRE devel­op­ers has become so unfa­vor­able for bor­row­ers that ‘dequity’ — describ­ing a form of bor­row­ing that can result in lenders gain­ing equi­ty stakes in invest­ments — has become the new buzz­word. It’s now the de fac­to ‘solu­tion’ for a sec­tor fac­ing increas­ing bor­row­ing costs and who have no oth­er option. But don’t call it preda­to­ry financ­ing:

...
One term gain­ing pop­u­lar­i­ty is “dequity,” an ambigu­ous­ly defined mix between debt and equi­ty that devel­op­ers are increas­ing­ly using to fill holes in their cap­i­tal stacks. The fund­ing car­ries increased risk for bor­row­ers — but not enough to dis­cour­age the com­mer­cial real estate sec­tor from using it to plug a gap.

“It is the de fac­to solu­tion to every prob­lem,” Sam Fried­land, a senior vice pres­i­dent at Relat­ed Fund Man­age­ment, the pri­vate equi­ty arm of The Relat­ed Cos., said onstage at Bis­now’s 2023 Nation­al Finance Sum­mit last week.

Dequity is sim­ply “not tak­ing the last dol­lar of risk,” Fried­land said when asked to define the term. By not being the last rung in the cap­i­tal stack, dequity hold­ers are more like­ly to see a return and are in first posi­tion to take over a strug­gling build­ing from a bor­row­er.

“It’s an open term,” he said.

Per­haps helped by its lack of spe­cif­ic def­i­n­i­tion, dequity is tak­ing on momen­tum as a new buzz­word, as both infla­tion­ary pres­sures and the high­est inter­est rates in over a decade are mak­ing it hard­er to hash out tra­di­tion­al loan agree­ments.

Where bor­row­ers would typ­i­cal­ly have been able to replace one senior mort­gage with anoth­er, they are now look­ing at gap or mez­za­nine loans or pre­ferred equi­ty, which all fall under the dequity umbrel­la and give the investors offer­ing it more poten­tial con­trol over the future of their prop­er­ties.

...

Tak­ing a dequity posi­tion can be equiv­a­lent to a pre­ferred equi­ty or res­cue cap­i­tal posi­tion, experts said onstage. Dequity invest­ments can offer the best risk-adjust­ed returns in today’s mar­ket — bet­ter even than a com­mon equi­ty posi­tion, San­ti­a­go said.

“When bor­row­ers — par­tic­u­lar­ly well-cap­i­tal­ized bor­row­ers — go to price those last [sub­or­di­nate] debt dol­lars, those are often pric­ing at returns high­er than what equi­ty is pro­ject­ed to make on a trans­ac­tion,” she said.
...

And while we should expect deep-pock­et­ed play­ers like the pri­vate-equi­ty sec­tor to be sali­vat­ing on the side­lines wait­ing for an oppor­tu­ni­ty to play the role of a pre­ferred lender, there’s also no avoid the real­i­ty that pri­vate-equi­ty remains one of the biggest exist­ing CRE investors. In oth­er words, if ‘dequity’ is the new hot trend in CRE, that almost cer­tain­ly means a large num­ber of pri­vate-equi­ty investors are on the ‘wrong’ side of this trend too:

...
Pri­vate equi­ty play­ers are also look­ing at acquir­ing dequity posi­tions in dis­tressed prop­er­ties to put them in pole posi­tion to take con­trol of prop­er­ties.

Mas­ter­works Devel­op­ment last month bought a dis­count­ed note on a $61M mez­za­nine loan belong­ing to a port­fo­lio of dis­tressed Black­stone-owned hotels, The Real Deal report­ed. This month, 3650 REIT orig­i­nat­ed a $103M mez­za­nine loan to recap­i­tal­ize a joint ven­ture-owned res­i­den­tial port­fo­lio across Louisiana, South Car­oli­na, Geor­gia and Ten­nessee. The loan, pro­vid­ed to David Wern­er Invest­ments, Onyx Part­ners and Carl­ton Asso­ciates with an ini­tial 24-month term, allows the spon­sors to recap­i­tal­ize the portfolio’s exist­ing equi­ty struc­ture.

These types of deals are becom­ing more fre­quent because under the cur­rent eco­nom­ic con­di­tions, equi­ty seems too risky and debt is offer­ing returns that are too mea­ger to attract investors, Fried­land said onstage.
...

A mez­za­nine loan bought at a dis­count. It’s like a dis­tilled exam­ple of ‘dequity’ in action. Keep in mind that this was­n’t a new­ly issued mez­za­nine loan but instead, as we’re going to see in the fol­low­ing arti­cle, an exist­ing loan issued in 2017. And that means some­one else was already hold­ing the loan held the loan and decid­ed to sell it at a dis­count to Mas­ter­works instead of trig­ger­ing the con­ver­sion to equi­ty. It’s a poten­tial­ly sig­nif­i­cant clue as to the busi­ness prospects for these prop­er­ties.

And don’t for­get, when we see dis­count­ed mez­za­nine loans issued on prop­er­ty held by a Black­stone real estate fund, it’s Black­stone’s clients who are ulti­mate­ly on the short-end of this deal should those loans get con­vert­ed into equi­ty. Clients that almost cer­tain­ly include Black­stone’s many pen­sion fund clients.
Also don’t for­get that these ‘dequity’ deals may save bor­row­ers from more dras­tic mea­sures in the short-run, but at a cost to the long-term yield on the invest­ment. Mez­za­nine loans tend to be much high­er inter­est than more tra­di­tion­al forms of bor­row­ing. So we should prob­a­bly expect the long-term side-effects on invest­ment yields from this grow­ing ‘dequity’ trend to only show up years from now. Like­ly in the form of reduced future yields for pri­vate-equi­ty’s pen­sion fund clients in many case.

And as we can see when we take a clos­er took at that ‘dequity’ deal Black­stone secured last month for its ail­ing hotels, the pri­vate-equi­ty group oper­at­ing as the preda­tor in this case, Mas­ter­works Devel­op­ment, is actu­al­ly the same pri­vate-equi­ty com­pa­ny that sold Black­stone the now-ail­ing hotels back in 2016 in a deal Black­stone financed, in part, with the $61 mil­lion mez­za­nine loan at the time.

It’s all a reminder that the debt-inten­sive pri­vate-equi­ty strat­e­gy of using large amounts of debt to make high­ly lever­aged acqui­si­tions is an increas­ing­ly dan­ger­ous strat­e­gy as inter­est rates rise and tra­di­tion means of bor­row­ing dry up. It’s also an exam­ple of why one of the big ques­tions loom­ing over this ‘dequity’ trend in CRE mar­ket is whether or not pri­vate-equi­ty — with its deep pock­ets but also deep exist­ing expo­sure to the real estate sec­tor — is going to end up being more preda­tor or prey:

The Real Deal

Mas­ter­works grabs dis­count­ed stake in Blackstone’s Club Quar­ters hotel debt

Lodg­ing chain’s affil­i­ate acquired mez­za­nine posi­tion for less than bal­ance of $61M loan

Aug 2, 2023, 6:23 PM
By Rachel Her­zog

An affil­i­ate of the hotel chain Club Quar­ters is stak­ing out a new posi­tion in the lodg­ing net­work with a dis­count­ed pur­chase of the note to a $61 mil­lion mez­za­nine loan, tied to four strug­gling Black­stone-owned hotels in the down­towns of major cities.

New York-based Mas­ter­works Devel­op­ment, an affil­i­ate of the Club Quar­ters oper­at­ing hotel brand that used to own the hotels, bought the note for the company’s loca­tions in San Fran­cis­co at 424 Clay Street and Chicago’s Loop at 111 West Adams Street, as well as Boston and Philadel­phia assets oper­at­ed by the brand.

The mez­za­nine debt, along with a $274 mil­lion senior CMBS loan against the prop­er­ties, was bor­rowed by the Black­stone fund Black­stone Real Estate Part­ners VII in 2017, with the 1,228-room, four-prop­er­ty port­fo­lio serv­ing as col­lat­er­al. A team led by JLL’s Kevin Davis and Bar­nett Wu pro­cured Mas­ter­works as the buy­er of the mez­za­nine debt, the bro­ker­age announced Wednes­day.

The price Mas­ter­works paid for the note was not dis­closed but was less than Black­stone owed under the orig­i­nal terms of the deal, Davis said in an email. The deal illus­trates the dif­fi­cult posi­tion hotel play­ers and their lenders — espe­cial­ly those more reliant on busi­ness trav­el — were put in by the pan­dem­ic and an incon­sis­tent lodg­ing recov­ery since it eased.

The Black­stone fund bought the four hotels from Mas­ter­works in 2016 for $283 mil­lion.

Blackstone’s $274 mil­lion CMBS loan on the port­fo­lio was trans­ferred to spe­cial ser­vicer CWCap­i­tal in 2020 due to the bor­row­er fac­ing immi­nent mon­e­tary default after it stopped mak­ing debt ser­vice pay­ments and request­ed pan­dem­ic relief, accord­ing to a May 25 report from DBRS Morn­ingstar.

“Accord­ing to the ser­vicer, Black­stone has advised that it is not will­ing to inject addi­tion­al cap­i­tal to fund oper­at­ing expens­es or debt ser­vice pay­ments,” Morn­ingstar said.

Since the first mort­gage is in default, Mas­ter­works has mul­ti­ple options to cash in on its mez­za­nine invest­ment.

It could poten­tial­ly ini­ti­ate a UCC fore­clo­sure that could allow it to take over the Black­stone affil­i­ate that man­ages the port­fo­lio and then attempt to get the first mort­gage on track as the new prop­er­ty own­er while the hotel recov­ery con­tin­ues. Or it could pur­sue a solu­tion that low­ers Blackstone’s loan ser­vice pay­ments enough to let the cur­rent own­er stay in the deal by allow­ing it to resume reg­u­lar pay­ments on the debt pack­age. Black­stone put $8.1 mil­lion worth of equi­ty into the port­fo­lio pur­chase.

...

The port­fo­lio was appraised in Octo­ber with a cumu­la­tive val­ue of $360 mil­lion, a slight bump from May 2021 when it was pegged at $330 mil­lion but still down near­ly 15 per­cent from an esti­mate of $423 mil­lion when the loan was issued in 2017, accord­ing to Morn­ingstar.

For the 12-month peri­od end­ing Feb­ru­ary 28, the four hotels’ pen­e­tra­tion rate — a mea­sure of how the portfolio’s occu­pan­cy rate and aver­age dai­ly rate com­pare with the com­pe­ti­tion — was 77 per­cent, sug­gest­ing that the prop­er­ties are under­per­form­ing rel­a­tive to their peers.

Still, per­for­mance met­rics have trend­ed up year-over-year since 2020, Morn­ingstar found, though “it is unlike­ly the port­fo­lio will sta­bi­lize to pre-pan­dem­ic fig­ures in the near to medi­um term.” The dis­tress reflects a famil­iar arc as hotels depen­dent on busi­ness trav­el­ers in Chica­go and San Fran­cis­co stare down a longer recov­ery peri­od than lodg­ing geared toward leisure trav­el­ers.

The busi­ness-ori­ent­ed hotel port­fo­lio includes the 346-room prop­er­ty in San Fran­cis­co, which anchors almost 40 per­cent of the allo­cat­ed loan amount, and the 429-room Chica­go hotel, which anchors more than 26 per­cent.

The Chica­go property’s per­for­mance had declined after the loan was issued in 2017 but before the pan­dem­ic, accord­ing to Morn­ingstar. The Loop hotel had an occu­pan­cy rate of almost 83 per­cent when the loan was issued, which dropped below 70 per­cent at the end of 2018, though it rebound­ed to more than 78 per­cent by the end of 2019.

———–

“Mas­ter­works grabs dis­count­ed stake in Blackstone’s Club Quar­ters hotel debt” By Rachel Her­zog; The Real Deal; 08/02/2023

“The Black­stone fund bought the four hotels from Mas­ter­works in 2016 for $283 mil­lion.”

That’s quite an invest­ment per­for­mance: Black­stone buys these four hotels from Mas­ter­works in 2016 for $283 mil­lion. Then imme­di­ate­ly issues the $61 mil­lion in mez­za­nine debt on top of a $274 mil­lion loan against the prop­er­ty. It was the clas­sic pri­vate-equi­ty debt-inten­sive approach to invest­ing. And then the pan­dem­ic hap­pens and the prop­er­ties end up basi­cal­ly going into default. And here we are in 2023 with the prop­er­ties still in default and Mas­ter­works Devel­op­ment in a posi­tion where it could pur­chase that mez­za­nine debt at a dis­count and able to imme­di­ate­ly decide whether it wants to con­vert that mez­za­nine into equi­ty and take over the prop­er­ties itself, or some­how refi­nance the debt and keep Black­stone as a bor­row­er. Either way, this was obvi­ous­ly a great deal for Mas­ter­works. Not so much for Black­stone’s clients, with the val­ue of the port­fo­lio down 15 per­cent from what what it was appraised at in ear­ly 2017 when Black­stone took out that $274 mil­lion loan on its new­ly acquired prop­er­ty:

...
The mez­za­nine debt, along with a $274 mil­lion senior CMBS loan against the prop­er­ties, was bor­rowed by the Black­stone fund Black­stone Real Estate Part­ners VII in 2017, with the 1,228-room, four-prop­er­ty port­fo­lio serv­ing as col­lat­er­al. A team led by JLL’s Kevin Davis and Bar­nett Wu pro­cured Mas­ter­works as the buy­er of the mez­za­nine debt, the bro­ker­age announced Wednes­day.

The price Mas­ter­works paid for the note was not dis­closed but was less than Black­stone owed under the orig­i­nal terms of the deal, Davis said in an email. The deal illus­trates the dif­fi­cult posi­tion hotel play­ers and their lenders — espe­cial­ly those more reliant on busi­ness trav­el — were put in by the pan­dem­ic and an incon­sis­tent lodg­ing recov­ery since it eased.

...

Blackstone’s $274 mil­lion CMBS loan on the port­fo­lio was trans­ferred to spe­cial ser­vicer CWCap­i­tal in 2020 due to the bor­row­er fac­ing immi­nent mon­e­tary default after it stopped mak­ing debt ser­vice pay­ments and request­ed pan­dem­ic relief, accord­ing to a May 25 report from DBRS Morn­ingstar.

“Accord­ing to the ser­vicer, Black­stone has advised that it is not will­ing to inject addi­tion­al cap­i­tal to fund oper­at­ing expens­es or debt ser­vice pay­ments,” Morn­ingstar said.

Since the first mort­gage is in default, Mas­ter­works has mul­ti­ple options to cash in on its mez­za­nine invest­ment.

It could poten­tial­ly ini­ti­ate a UCC fore­clo­sure that could allow it to take over the Black­stone affil­i­ate that man­ages the port­fo­lio and then attempt to get the first mort­gage on track as the new prop­er­ty own­er while the hotel recov­ery con­tin­ues. Or it could pur­sue a solu­tion that low­ers Blackstone’s loan ser­vice pay­ments enough to let the cur­rent own­er stay in the deal by allow­ing it to resume reg­u­lar pay­ments on the debt pack­age. Black­stone put $8.1 mil­lion worth of equi­ty into the port­fo­lio pur­chase.

...

The port­fo­lio was appraised in Octo­ber with a cumu­la­tive val­ue of $360 mil­lion, a slight bump from May 2021 when it was pegged at $330 mil­lion but still down near­ly 15 per­cent from an esti­mate of $423 mil­lion when the loan was issued in 2017, accord­ing to Morn­ingstar.
...

So what’s Mas­ter­works going to do? Con­vert the debt to equi­ty? The last hold­er of the mez­za­nine debt obvi­ous­ly did­n’t find that to be a tempt­ing option. We’ll see, but the fact that the port­fo­lio of hotels is expect­ed to con­tin­ue to strug­gle “in the near to medi­um term” sug­gests Mas­ter­works might have the option to exe­cute an equi­ty con­ver­sion move for the medi­um term too, not that it nec­es­sar­i­ly has any medi­um term appetite to do so:

...
For the 12-month peri­od end­ing Feb­ru­ary 28, the four hotels’ pen­e­tra­tion rate — a mea­sure of how the portfolio’s occu­pan­cy rate and aver­age dai­ly rate com­pare with the com­pe­ti­tion — was 77 per­cent, sug­gest­ing that the prop­er­ties are under­per­form­ing rel­a­tive to their peers.

Still, per­for­mance met­rics have trend­ed up year-over-year since 2020, Morn­ingstar found, though “it is unlike­ly the port­fo­lio will sta­bi­lize to pre-pan­dem­ic fig­ures in the near to medi­um term.” The dis­tress reflects a famil­iar arc as hotels depen­dent on busi­ness trav­el­ers in Chica­go and San Fran­cis­co stare down a longer recov­ery peri­od than lodg­ing geared toward leisure trav­el­ers.
...

Let’s hope the par­tic­u­lar Black­stone fund behind this now-trou­bled CRE invest­ment was­n’t a bunch of pen­sion funds. And if so, let’s hope the mez­zan­nine financ­ing ends up actu­al­ly help­ing the invest­ment sta­bi­lize itself and does­n’t end up just dilut­ing an already ail­ing invest­ment. Either way, this is just one of a grow­ing num­ber of num­ber of ‘dequity’-financed invest­ments in the CRE space. Invest­ments that will have reduced long-term yields on these invest­ments at best, and pos­si­bly much worse results when this all shakes out in the long run.

It all rais­es anoth­er grim ques­tion for this sec­tor: So are any pen­sion-fund backed pri­vate-equi­ty funds play­ing the role of preda­to­ry lend­ing in this envi­ron­ment? It will be inter­est­ing to see if that ends up hap­pen­ing too, or if the pen­sion funds are most­ly just prey here. On the one hand, it will be kind of awful to learn about pen­sion funds ben­e­fit­ing for preda­to­ry lend­ing prac­tices. But on the oth­er hand, it’s arguably more awful to learn that every­one in this space is engag­ing in preda­to­ry lend­ing except for pen­sion funds who are all on the receiv­ing end. It’s a kind of moral haz­ard that should­n’t have been allowed to devel­op in the first place, but here we are, forced to hope pen­sion funds are oper­at­ing more as preda­tor than prey, while rec­og­niz­ing it’s prob­a­bly the oppo­site.