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Home Publications Blogs Beat the Press Are Private Equity Firms Evil Doers? Washington Post Edition

Are Private Equity Firms Evil Doers? Washington Post Edition

Wednesday, 11 January 2012 08:06

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 in 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.

Comments (11)Add Comment
Like Rape, Raids by Private Equity Firms are Caused by the Victim
written by izzatzo, January 11, 2012 7:55
Any economist knows that transactions between buyers and sellers are voluntary - not forced.

When a seller over exposes oneself ex anteto intentionally induce a buyer to commit unwanted entry ex post the outcome cannot be conveniently recast in hindsight as rape or raid on an innocent victim.

As Rick Santorum would say, one makes the bed one must lie in ... with others.

Stupid liberals.
written by Luke Lea, January 11, 2012 9:14

It is all about the rules of the game. As long as it is profitable and legal (or even illegal but not prosecuted) it will be done. Changes in trade policy, immigration rates (and enforcement), tax rates (and enforcement), funding of SEC -- those are the kinds of things that are shaping the economy. All made in Washington D.C.
written by Luke Lea, January 11, 2012 9:27

Let me rephrase my comment above: "It is all about the rules of the game. As long as it is profitable and legal (or even illegal but not prosecuted) it will be done. And those that don't lose out in the end.
written by sherparick, January 11, 2012 11:31
One of the more amazing things is the way our elite loves to tell "truthy" stories to themselves about those socialist hell holes in Western and Northern Europe and Japan. It also always escapes their notice that capitalist paragons of Taiwan, Singapore, and Hong Kong have universal health care and public retirement systems. We are ruled by fools.
written by Kat, January 11, 2012 12:45
Certainly Romney's work with Bain will be a centerpiece of Obama's campaign. Anybody would be stupid not to make it so. It would be a wonderful thing if this could be used as a teaching experience featuring Mr. Baker's points (especially the part about pensions). Sadly, I am also certain that most campaign ads featuring Romney's private equity background will be virtually content free. There was once a time when I hoped that Democrats would campaign on facts but now I see they wish to obfuscate almost as much as the Republicans.
The Buyout of America
written by dejiridoo, January 11, 2012 4:29
Josh Kosman released a damning book about private equity firms in 2009 called "The Buyout of America" (Portfolio Hardcover). It's worth a more critical examination in this dicussion--even the Wall Street Journal endorsed it.
written by Bart, January 11, 2012 4:39
"...dump[ing] pension obligations on the Pension Benefit Guarantee Corporation...does not provide any benefit to the economy."

Not only that, but much suffering results.
The Creed of Private Equity Firms
written by Paul, January 11, 2012 8:43
"I like to fire people."

Romney let the cat out of the bag and now everyone knows the truth: Schadenfreude is the operative emotion of Wall Street, even more than greed.

Mitt Romney makes Gordon Gecko look like a piker.
when mafiosi do it
written by paul, January 12, 2012 12:22
It's called a bustout. If you go legit you can do it on a bigger scale, and you don't absolutely have to destroy the company to ensure your profits. But the idea that you're not there to actually operate a business is the same.
written by Mark Jamison, January 12, 2012 4:18
Within this post may be the key to why Mr. Romney refuses to release his tax returns. The reason may not be because he paid an obscenely low percentage on his income. The fact is that Americans can't do math nor do they understand comparative relationships very well. If Mr. Romney paid 10% of his very large income that would still likely result in a pretty large number which the Republican echo chamber could distort.
No, more likely Mr. Romney is reluctant to let us see details because of the vagaries of the tax code combined with the methods of private equity firms. It is quite likely that Mr. Romney was able to convert gains into interest losses which might result in those secret documents showing he had no tax liability.
Now that would be something to be ashamed of and worth hiding.
Mitt Not Born in America?
written by leo from chicago, January 13, 2012 3:44
I have a theory: the reason Mitt isn't showing his tax returns is because they'll show that he wasn't born here. He looks French. That's probably where he comes from.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.