The Bane of Bain

I have to write about this.  The recent media hoopla surrounding Cory Booker’s comments about Bain Capital just put me over the top.  I guess it’s just an occupational hazard with me. I teach this stuff. I study this stuff. I know the difference between venture capital, capital angels, and corporate raiders.  I’m wondering how many politicians actually grok this.  Oddly enough, Romney’s Republican primary rivals knew the difference before they were forced to tow the Romney line.  I did watch Newt Gingrich last night on Piers Morgan (only because Lama was here and it was on)  and he doesn’t seem to be able to fully embrace the Bain Mission.The best Gingrich could say was it was a better job than any thing Obama has done. He said something obligatory about Obama raiding the tax payer’s funds.   Gingrich still knows what Romney did is not from the positive ledger side of equity capital firms.

Venture capitalists are wonders to be hold and represent the best of the best.  These guys take on tremendous amounts of risk and usually bring a lot of business acumen to a start up firm.  Frequently, start up firms are high tech and ran by nerdy scientists who are great in labs and on computers.  They known nothing of financing, bringing products to market, or monetizing an investment.  This is a true partnership of great minds and money.  This is not what Mitt Romney did when he was CEO of Bain Capital.  Romney’s firm could’ve been a contender in the angel category except that’s not what he did either.  Warren Buffet has been an angel investor many times. Romney’s firm basically ran like a pack of hyenas to a company that was struggling and used the law to extract its life force.

Ralph B reminded me of several articles that have been out there written by financial economist wonks like me explaining why Romney never got a hero’s welcome in the past and should not get a pass right now.  Putting corporate raiders into the same pile as the rest of equity capital firms is like saying cancer is just basically another cell that exists in your body.

Here’s three excellent points by Konczal on why Romney isn’t an angel or a venture capital hero.  Romney’s firm played the sociopathological side of the equity capital game. They were serial killers.

1. Tax/regulatory loopholes. I did an interview with Josh Kosman, author of The Buyout of America, where he argued that the whole point of the enterprise is to game tax law loopholes. Private equity “saw that you could buy a company through a leveraged buyout and radically reduce its tax rate. The company then could use those savings to pay off the increase in its debt loads. For every dollar that the company paid off in debt, your equity value rises by that same dollar, as long as the value of the company remains the same.”

A recent paper from the University of Chicago looking at private equity found that “a reasonable estimate of the value of lower taxes due to increased leverage for the 1980s might be 10 to 20 percent of firm value,” which is value that comes from taxpayers to private equity as a result of the tax code.

That’s one thing in an industry with large and predictable cash flows. But after those low-hanging fruits were picked, as Kosman explained, “firms are taken over in very volatile industries. And they are taking on debts where they have to pay 15 times their cash flow over seven years — they are way over-levered.”

This critique has power as far as it goes. But let’s combine it with another issue.

2. Risk-shifting among parts of the firm. Traditional “creative destruction” is about putting rivals out of business with better products and techniques. Leveraged buyouts and private equity are about something different, something that exists within a single firm. This is often described as putting new techniques into place, firing people and divisions that are not performing, and generally making the firm more efficient.

The critique here is that, instead of making the firm more efficient, it often simply shifts the risks into different places. As Peter Róna, head of the IBJ Schroder Bank & Trust in New York, described it in 1989:

The very foundation of the LBO is the current actual distribution of hypothetical future cash flows. If the hypothesis (including the author’s net present value discounted at the relevant cost of capital) tums out to be wrong, the shareholders have the cash and everyone else is left with a carcass. “Creating shareholder value” and “unlocking billions” consists of shifting the risk of future uncertainty to others, namely, the corporation and its current creditors, customers, and employees…

The notion that underleveraging a corporation can cause problems is neither new nor unfounded. What is new is the assertion that shareholders shouid set the proper leverage because, motivated by maximizing the return on their investment, they will ensure efficiency of all factors of production. This hypothesis requires much more rigorous proof than Jensen’s episodic arguments… although Jensen denies it, the maximization of shareholder returns must take place, at least in part, at someone else’s expense.

Shareholders gain, but at the expense of other stakeholders in the firm. This isn’t the normal winner/loser dynamic, where some suffer in the short-term to do what’s best for the long-term. Here the long-term suffers to create short-term winners. Once again, this issue becomes problematic when combined with another critique.

3. Dividend looting. The theory behind private equity, as Róna caught above, is that it requires shareholders to be the proper and most efficient group to set the leverage ratio. But what if, instead of setting leverage for the long term to make the firm more efficient, shareholders simply use additional debt to pay themselves, regardless of the health of the firm? As Josh Kosman put it:

If you look at the dividends stuff that private equity firms do, and Bain is one of the worst offenders, if you increase the short-term earnings of a company you then use those new earnings to borrow more money. That money goes right back to the private equity firm in dividends, making it quite a quick profit. More importantly, most companies can’t handle that debt load twice. Just as they are in a position to reduce debt, they are getting hit with maximum leverage again. It’s very hard for companies to take that hit twice…

The initial private equity model was that you would make money by reselling your company or taking it public, not by levering it a second time…Right after this goes on for a few years, you’ve starved your firm of human and operating capital. Five years later, when the private equity leaves, the company will collapse — you can’t starve a company for that long. This is what the history of private equity shows.

The biggest difficulty I have with all this political back and forth is that Republicans and Democrats will take money from Wall Street as political donations without really looking at the individual or the firm.  Some private equity firms are value-added.  Others basically remove value from the US economy. Romney falls into the looter baron role.  However, Booker and Obama have both taken political donations from all breeds of these guys. So, they may not have closed down the companies or bootstrapped Yahoo, but they’ve been in on the spoils.

Again, let’s look at what some of Romney’s Republican rivals said.

1. “The idea that you’ve got private equity companies that come in and take companies apart so they can make profits and have people lose their jobs, that’s not what the Republican Party’s about.” — Rick Perry [New York Times, 1/12/12]

2. “The Bain model is to go in at a very low price, borrow an immense amount of money, pay Bain an immense amount of money and leave. I’ll let you decide if that’s really good capitalism. I think that’s exploitation.” — Newt Gingrich [New York Times, 1/17/12]

3. “Instead of trying to work with them to try to find a way to keep the jobs and to get them back on their feet, it’s all about how much money can we make, how quick can we make it, and then get out of town and find the next carcass to feed upon” — Rick Perry [National Journal, 1/10/12]

4. “We find it pretty hard to justify rich people figuring out clever legal ways to loot a company, leaving behind 1,700 families without a job.” — Newt Gingrich [Globe and Mail, 1/9/12]

5. “Now, I have no doubt Mitt Romney was worried about pink slips — whether he was going to have enough of them to hand out because his company, Bain Capital, of all the jobs that they killed” — Rick Perry [New York Times, 1/9/12]

Even the media doesn’t know a damn thing about the variants of equity capital firms. ABC appears to be joining FOX news in spreading stupid tropes and canards.

Private-equity firms aren’t supposed to create jobs; they’re supposed to make money for their investors, which to a large extent include pension funds and university endowments. The companies in which they invest are sometimes on the brink of failure to begin with, and are likely to go bankrupt without outside help. These risky investments often include making decisions like cutting costs and jobs.

But in the little-understood world of private equity, Obama has seized upon a basic formula — Romney and Bain plus companies equals some lost jobs and millions for Romney — to argue that he’s unfit for the Oval Office.

Defending the Bain ad, Obama spokesman Ben LaBolt said the campaign isn’t “questioning the purpose of the private-equity business as a whole.”

“Why did Romney and his partners succeed even if the company failed?” LaBolt asked rhetorically on a conference call.

Probably because private-equity firms don’t necessarily rise and fall with the companies in which they invest. Finance experts explained that faced with a decision over bankruptcy, those firms are obligated to protect their investors, not the workers at the company. Pumping more money into a company that has shown signs of failure isn’t as smart a move business-wise as cutting losses to save investors money.

Actually, angels and venture capitalists do exactly all of that and make money if they do it right.   The above description is just whacked. I’d drum a student out of my corporate finance class that tried to offer this up.  But, the media can print just about any old thing it wants to and get away with it.  Most private equity firms are NOT corporate raiders. There are even funds that do project financing that help Governments build things like dams, highways and universities.  Gordan Gecko’s way of business is not the life blood of the private equity market.  They can provide seed money, start-up money, expansion and development money and a lot of money that isn’t based on gutting existing businesses. Some specialize in transfers of power from a sole owner who is retiring to a new group of owners.  Most don’t drain the firms of capital when they leave either.  Romney was a pirate not some kind of private enterprise swashbuckler.

Enuf said.

Okay, so that’s my lecture\rant for the day.  I’m going back to grading papers now.  That is all.

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27 Comments on “The Bane of Bain”

  1. RalphB says:

    Thank you very much for this excellent post! It confirms what I have believed for over 30 years now. Romney was definitely flying the Jolly Roger during his tenure at Bain.

    • dakinikat says:

      He must really think all of us are stupid to believe anything other than it was what it was.

      • Seriously says:

        He’s stupid to go down this road because there are a lot of victims of Bain out there and they’re not shy about speaking out, and he has nothing to counter with except empty platitudes leftover from the Gilded Age. Nobody really wants to hear that drivel right now. Great post!

      • bostonboomer says:

        The trouble Romney has is that he does think we’re stupid. As Charlie Pierce says, Romney thinks there are two kinds of people–him and the help.

    • bostonboomer says:

      Thanks for this clear explanation. I read that ABC story earlier and it drove me nuts. I’m sure Obama knows what Bain did and does. That story was so condescending to the POTUS.

  2. ANonOMouse says:

    “Romney’s firm played the sociopathological side of the equity capital game. They were serial killers.”

    Thank you Professor. It’s great to read a dissection by someone who knows what’s happening. It seems obvious that Bain came down heavy on the “grab a bargain” then “wring it dry” and “throw it away” side of the ledger.

    I wish someone would do an expose on exactly how (transaction-by-transaction) Bain made money under Romney’s leadership. How many businesses were squeezed dry. how many.employees terminated, how many businesses were bankrupted and exactly how many worker pensions bailouts were foisted onto the taxpayer after Bain took the money and ran.

    Romney’s job creation claim has been all over the place, so I’m not even sure he knows what he did at Bain. All he knows for sure is that he’s rich to the tune of one-quarter of a Billion Dollars, and likely more and he pays a lower tax rate than half of America.

    Much or what is wrong in our society today is a pass is given to the mega-wealthy concerning exactly how they make their money, how they skirt taxation, destroy and export jobs and the deference paid to them as ” superior role models” and “people we should strive to emulate”.
    When I look at the distribution of wealth in this country, what I see are greedy oligarchs at the top of the pyramid who have no desire for the pyramid structure to change

  3. RalphB says:

    Personally, we’d be better off if he’d spent more but this does show the GOP up for the shameless liars they are and the population for believing their propaganda.

    WSJ: Obama spending binge never happened

    Government outlays rising at slowest pace since 1950s

    WASHINGTON (MarketWatch) — Of all the falsehoods told about President Barack Obama, the biggest whopper is the one about his reckless spending spree.

    As would-be president Mitt Romney tells it: “I will lead us out of this debt and spending inferno.”

    Almost everyone believes that Obama has presided over a massive increase in federal spending, an “inferno” of spending that threatens our jobs, our businesses and our children’s future. Even Democrats seem to think it’s true.

    But it didn’t happen. Although there was a big stimulus bill under Obama, federal spending is rising at the slowest pace since Dwight Eisenhower brought the Korean War to an end in the 1950s.

    Charts and graphs with circles and arrows on the back at the link ;-)

    • dakinikat says:

      Facts be damned! The Republicans have to rule the day or there are multiple wars on xmas, xtians, families, marriage, business, and all that’s right in the world of rich white men!!!

      • RalphB says:

        I just took a look at the ABC politics site and they’re pushing the GOP pretty hard. Wonder how much of them Bain owns through someone else?

        http://abcnews.go.com/blogs/politics/

      • northwestrain says:

        The last hurrah of the rich white guys.

        More mixed race and non white babies are being born. Plus there are so many of us who are part something or the other but are listed as “white” — because that’s the only option.

        If the talking heads bother to explain using simple English and lots of photos and graphs — EXACTLY — how Romney made all his millions — then voters might get a hint that Bains aka Romney & the GOP can hold a fire sale on tax payer owned stuff.

        Oh wait never mind — time for the actress with the big boobs report.

    • NW Luna says:

      Nice to see a small bit of factual reporting out there. Too bad most of this gets lost in the torrent of sludge writing.

      Thank you for another clear and forthright econ explanation, Dr. Dakinikat!

  4. RalphB says:

    The MSM sucks! Unless you watched Rachel Maddow or read ThinkProgress, you probably didn’t see a word about this.

    Romney Surrogate: Romney’s Experience At Bain Is ‘Fair Game’

    This morning, Mitt Romney surrogate and former New Hampshire Gov. John Sununu (R) said on a conference call organized by the Massachusetts governor’s presidential campaign that Romney’s “entire” business record at Bain Capital should be “fair game,”

    • Seriously says:

      That’s odd. You think they’ve got some strategy up their sleeves or is it just typical ham-fistedness from Sununu?

  5. RalphB says:

    We’ll also see a lot about Romney winning the AR and KY primaries, but probably not much about him losing Minnesota to Ron Paul.

  6. northwestrain says:

    GOP women — or women who really really hate women and enable the rich white dudes who also hate women.

    http://thinkprogress.org/election/2012/05/22/488382/gop-women-caucus/

    These “ladies” get a lower score than a whole lot of male type humans.

    What species do these GOP non males belong to?

    • Fannie says:

      NW – they belong to the Thou species………………as in not smarter than THOU.

  7. Pat Johnson says:

    How much is enough for these people?

    How many homes, cars. yachts, jewelry, paintings, does one need to possess before they can sit back and enjoy it without being called a corporate pig?

    When they finally caught up with Madoff he owned 5 homes plus a penthouse apartment along with one large yacht and a smaller one as well. Two f*cking yachts for god’s sake!

    The issue for those who are supporting Romney from our middle and working class ranks is they see themselves having as much money in the future if the goverment would just get out of the way.

    It’s becoming more of a conscienceless society that prefers to see the poor as an impediment while trading their own souls in the bargain to someday have as much as those robber barons who are sinking this nation into a Third World enterprise.

    • RalphB says:

      It not about more money after a point. That’s just a way to keep score in the sociopath game. So long as anyone else might have more, they can never get enough. Winning.

      • NW Luna says:

        Reminds me of the “hungry ghosts” in some cultures — shades who are still greedy but in the afterlife they have miniscule mouths and cannot gorge themselves anymore and are never satisfied. They have never known anything but greed beyond need.

      • RalphB says:

        I tend to think of them like sociopathic serial killers. They just can’t stop.

  8. List of X says:

    Since Bain does not produce anything (nor helps anyone else produce anything) but exctacts wealth from other companies, then maybe the most accurate description of what Bain does would be “wealth redistribution”…