A closer look at private equity

piece published over at Bloomberg a few days ago has turned some heads for its less-than-flattering depiction of some of the practices deployed by Mitt Romney during his time at the helm of Bain Capital.  Its author, Anthony Luzzatto Gardner, works for the London-based private equity fund Palamon Capital Partners.

Go take a look for yourself, but, long story short, Bain made most of its money not through turning around failing companies as Romney usually suggests (e.g., eliminating inefficiencies, improving fundamentals), but rather by using a series of accounting tricks — most notably taking advantage of the tax code’s special treatment of debt — to prop up balance sheets in order to extract generous dividends for Bain’s investors.  Gardner summarizes:

What’s clear […] is that Romney was fabulously successful in generating high returns for [Bain’s] investors. He did so, in large part, through heavy use of tax-deductible debt, usually to finance outsized dividends for the firm’s partners and investors. When some of the investments went bad, workers and creditors felt most of the pain. Romney privatized the gains and socialized the losses. [emphasis mine]

What’s less clear is how his skills are relevant to the job of overseeing the U.S. economy, strengthening competitiveness and looking out for the welfare of the general public, especially the middle class.

What’s definitely clear is that the world of private equity is a confusing one.  Two basic questions — how it works and what it does — are points of contention.

These two short videos provide a pretty good overview of the two schools of thought.  I highly recommend taking a look at both.

The first is from the perspective of the Private Equity Growth Capital Council, a DC-based pro-private equity lobbying group.  Not surprisingly, they paint a pretty picture.

The second take, from left-of-center economist and Secretary of Labor under President Clinton, Robert Reich, is less enthusiastic about the industry. (The Bloomberg piece focuses on Reich’s steps 4-7).

So — in simplified terms — if there are generally two ways to do private equity — one that genuinely improves companies, and one that uses smoke and mirrors to enrich investors with little regard for companies’ well-being — the question is clear:  Which was practiced by Romney’s Bain?  On this question, Gardner doesn’t equivocate:

President Barack Obama is correct in distinguishing the patient creation of value for the benefit of investors through genuine operational improvements and growth — the true mission of private equity — from the form of rigged capitalism that was practiced by some in the industry in the past when debt was cheap and plentiful.

While Bain Capital wasn’t alone in using financial engineering to turbo-charge its returns, it was among the most aggressive under Romney’s leadership. Enriching investors by taking leveraged bets isn’t a qualification for a job requiring long-term vision and concern for public welfare. It is appropriate to point that out to voters. [emphasis mine]

Appropriate, indeed.


About Hammertime
Georgetown sophomore, Job Creator.

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