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Creative Destruction - Grounding Their Ideas in the Essence of the Story (image: riabaeck, flickr)
No one reads Washington Post editorials for their astute economic analysis. The paper did not surprise readers with its balanced discussion of private equity today.
While the paper is right to point out that whether private equity firms directly increase or decrease employment is not a good measure of whether they are beneficial to the economy, it totally overlooked the main issues surrounding private equity and its impact on the economy. The question is whether the high profits earned by the partners are primarily due to increasing economic efficiency or to rents earned by dumping costs on others.
As noted here, it is standard practice for private equity to load firms with debt. This means that taxable profits are turned into tax-deductible interest payments. The difference can be a gain to Bain and other private equity firms, but it is coming at the expense of taxpayers.
In the same vein, private equity companies often engage in complex asset shifting. This can leave a heavily indebted firm with few valuable assets. If it eventually goes bankrupt, the creditors collect little money because the private equity company has transferred the assets with value into an independent company. This can also mean big profits for Bain and other private equity companies, but this is not a gain to the economy.
Another frequent game of private equity companies is to dump pension obligations on the Pension Benefit Guarantee Corporation. The reduction in liabilities can mean big profits for Bain and other private equity companies, but does not provide any benefit to the economy.
These are the sorts of issues that appear in serious discussions of the benefits of private equity.
The Post piece also included the bizarre assertion that:
“Probably it [private equity] is one feature of U.S. capitalism that makes our system more flexible and capable of ‘creative destruction’ than Europe’s.”
This is bizarre because the U.S. economy is not obviously more flexible and capable of “creative destruction” than Europe’s economy, as people familiar with the productivity data know.
Source: OECD.
4 Comments
C’mon Dean. It’s a dirty job but someone’s got to do it. Beside’s those dirty jobs pay real well.
Not a Marxist yet, comrade?
Informative as always.
“private equity firms directly increase or decrease employment is not a good measure of whether they are beneficial to the economy, it totally overlooked the main issues surrounding private equity and its impact on the economy. The question is whether the high profits earned by the partners are primarily due to increasing economic efficiency or to rents earned by dumping costs on others.”
Well the answer is maybe- it is not a black and white answer.
Distressed equity firms that attempt turnarounds via better via better management and fresh equity – such as the firm Chelsea Clinton worked at – get more points for increasing economic efficiency than do firms like Mitt’s that load up new debt, strip assets out, off load pension liabilities to the PBGC, and tell management, go make me some money, and if they don’t make money, force creditors to eat the loans.
Where they are alike is that both usually involve job loss – and possible outsourcing of jobs overseas.
The first move of private equity companies such as Bain is usually to demand wage and benefit concessions from the employees. This reduces the demands on the purchased firm to make it more attractive, but reduces the purchasing power of its employees, thereby impacting the total economy by the diminished amount of spending. That this is not even shown in the overall pattern of impoverishment produced by the Bains is another reflection of how business reports ignore the effects of pillage on the whole.