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.


Tuesday Reads: Gordon Gekko for President?

Good morning! Today is the New Hampshire primary. We’ll live blog the returns later tonight. As of last night, Gordon Gekko Mitt Romney had a big lead in the polls, with Ron Paul second and John Huntsman and Rick Santorum tied for third place.

Romney, the former governor of neighboring Massachusetts, holds a 24 percentage point lead over his closest rival, with 41 percent of likely Republican primary voters indicating they’d vote for him, the WMUR New Hampshire Primary Poll said.

U.S. Rep. Ron Paul from Texas was favored by 17 percent of likely primary voters, followed by former Utah Gov. Jon Huntsman and former U.S. Sen. Rick Santorum of Pennsylvania, each with 11 percent, and former House Speaker Newt Gingrich collecting 8 percent.

Several polls indicated Gingrich would finish in the top three.

“All of the candidates behind Romney have a good chance finishing anywhere between second and fifth place,” said Andrew Smith, director of the UNH Survey Center in Durham.

Yesterday Romney stepped in it again when he told an audience that he really likes firing people.

The final day of campaigning saw Romney under fire for a comment about health insurance that quickly became fodder for criticism.

Asked about the issue in Nashua, New Hampshire, Romney said he wanted a person to be able to own his or her own policy “and perhaps keep it the rest of their life.”

“That means the insurance company will have the incentive to keep you healthy. It also means if you don’t like what they do, you can fire them,” he said.

“I like being able to fire people who provide services to me,” Romney added. “If someone doesn’t give me the good service I need, I want to say I am going to get somebody else to provide that service to me.”

Romney complained that everyone was taking his remarks out of context, but when you’re a former corporate raider worth $250 million, it’s probably a good idea to watch what you say about putting people out of work.

Anyway, the latest meme about Romney is that he’s Gordon Gekko brought to life. I think it’s a pretty good comparison. I don’t know if you recall the quote from the recent Vanity Fair profile of Romney that I included in a recent post:

Romney described himself as driven by a core economic credo, that capitalism is a form of “creative destruction.” This theory, espoused in the 1940s by the economist Joseph Schumpeter and later touted by former Federal Reserve Board chairman Alan Greenspan, holds that business must exist in a state of ceaseless revolution. A thriving economy changes from within, Schumpeter wrote in his landmark book, Capitalism, Socialism and Democracy, “incessantly destroying the old one, incessantly creating a new one.” But as even the theory’s proponents acknowledged, such destruction could bankrupt companies, upending lives and communities, and raise questions about society’s role in softening some of the harsher consequences.

Romney, for his part, contrasted the capitalistic benefits of creative destruction with what happened in controlled economies, in which jobs might be protected but productivity and competitiveness falters. Far better, Romney wrote in his book No Apology, “for governments to stand aside and allow the creative destruction inherent in a free economy.” He acknowledged that it is “unquestionably stressful—on workers, managers, owners, bankers, suppliers, customers, and the communities that surround the affected businesses.” But it was necessary to rebuild a moribund company and economy.

That sure sounds Gekko-like, doesn’t it?

Yesterday, Rick Klein of ABC News addressed the Romney/Gekko issue.

Virtually all of Romney’s rivals are now sensing a powerful issue. Jon Huntsman said today that the firing comment shows that Romney is “completely out of touch” with the American economy.

Rick Perry, skipping ahead a state, is calling it the “ultimate insult for Mitt Romney to come to South Carolina and tell you he feels your pain, because he caused it.”

Gingrich is equating Romney’s business style with finding “clever legal ways to loot a company.” Rick Santorum’s stump speech includes a line about not needing a CEO as president, and he suggested at ABC’s Saturday night debate in New Hampshire that Romney’s background calls into question whether he “can inspire and paint a positive vision for this country.”

Romney hasn’t made matters easier for himself as he’s tried to connect with voters on the economy. The son of a millionaire business titan said over the weekend: “I know what it’s like to worry about whether or not you are going to get fired.”

Klein claims it’s too late for any of this to affect the New Hampshire primary results. I wouldn’t be so sure. New Hampshirites are famous for making up their minds at the last minute. Remember Hillary’s surprise win in 2008?

Romney has been expecting the Gordon Gekko comparisons, so you have to wonder why he hasn’t managed to curb some of these Gekko-like remarks.  I guess he just can’t help himself.

Mitt Romney says he knows a photo in which he appears with other executives at Bain Capital LLC posing with cash in their hands, pockets and mouths will be used against him if he wins the Republican presidential nomination.

The 1980s image — called the “Gordon Gekko” photo by some Democrats, a reference to the Michael Douglas character in the movie “Wall Street” — offers an easy attack line at a time of high unemployment and sharp rhetoric against the nation’s top money managers, investors and bankers.

“We posed for a picture, just celebrating the fact that we had raised a lot of money and then we hoped to be able to return it with a good return,” Romney said on “Fox News Sunday.”

Here’s Romney’s defense of the photo on Fox News Sunday.

Andrew Leonard of Salon also discussed the comparison of Romney with Gekko.

Like Gekko, Romney made his fortune buying and selling companies; and like Gekko, he believes that his “greed is good” version of rough-and-tumble creative destruction is a positive force for America, weeding out the bad performers and nurturing lean-and-mean profit engines. If you are looking for the paradigmatic exemplar of the new style of capitalism mogul launched by the Reagan revolution, Romney is your man. Michael Douglas’ Gordon Gekko is merely ersatz.

But what Leonard finds so amazing is that this attack on Romney and his leverage buyouts is being led Newt Gingrich.

The shock is to see Newt Gingrich and his financial backers channeling the Oliver Stone critique so passionately and wholeheartedly. If you have not seen the three-minute advertisement “When Romney Came to Town,” the soon-to-be debuted documentary lambasting Romney as the enemy of the American worker, prepare to be flabbergasted.

“Their greed was only matched by their willingness to do anything to make millions in profits.”

“This film is about one such raider and his firm.”

“His mission: To reap massive rewards for himself and his investors.

“Romney took foreign seed money from Latin America, and began a pattern exploiting dozens of American businesses.”

And so on. Michael Moore doesn’t sting this hard, and MoveOn isn’t this angry. If Romney, as expected, ends up winning the Republican nomination, Obama’s campaign team can relax. Their work has already been done.

Here’s the trailer for the 27-minute documentary that Gingrich backers have purchased.


Politico calls it “the Bain Bomb.”

While conservatives look unlikely to unite around one alternative to Romney, the campaigns themselves are uniting around the theme that the former head of Bain Capital looted companies, tossed people out of jobs and is now exaggerating his success at the venture capital firm.

In the context of this moment in American politics, in which frustration with the privileged is boiling hot, the attack, from Republicans on one side and the Obama campaign on the other, will test Romney. If he ends up looking more like an opportunist who profited for the few than like a man who created jobs for the many, it’s hard to imagine his polls numbers won’t drop.

Conservative bloggers, who generally can’t stand Romney have begun defending him against his rivals attacks, and Dana Millback called Romney “the Scrooge McDuck of the 2012 presidential race. Bloomberg reports that buyout firms are getting nervous about damage to their reputations.

This could be fun to watch. I thought Newt’s attack on Romney yesterday was spot on.

Is Romney full of shit or what? He even makes Newt Gingrich look good. I hope Newt sticks around and continues letting it all hang out. Every single word he said about Romney was the truth.

I’m going to wrap this up with a more serious take on Romney from Robert Reich: Mitt: Son of “Citizen’s United.” I had forgotten that Reich ran for governor of Massachusetts in the the Democratic primary in 2002. Please go read the whole thing and try not to weep while you’re doing it.

As Reich says, Romney is the ultimate big money candidate. He was in 2002, and now with the help of the Roberts Court, he has more money than any candidate ever dreamed of before. If you thought Obama was the candidate of Wall Street–and he was in 2008–Romney is soooo much more so. He has money and connections that make Obama’s fundraising look pathetic. And none of this money even needs to be reported–it could be coming from overseas, even from foreign governments, and we’d never know.

Tonight we’ll find out of any of this barrage of Gordon Gekko/Mitt Romney comparisons will have any effect. I’m rooting for Romney to be taken down a peg. And then on to South Carolina!

Please share your links in the comments, and I hope to see you tonight for the live blog.