David Brooks Gets Private Equity Wrong for the Team

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Tuesday, 22 May 2012 03:24

It's clear that the impact of private equity on the economy is going to be one of the central issues in the presidential race given Mitt Romney's boasts about his performance as one of the partners in Bain Capital. President Obama and others have pointed out that private equity firms often leave large numbers of laid-off workers and bankrupt companies in their wake.

To counter this image, David Brooks picked up the cause. He used his column to tell readers that private equity firms turned around the economy, getting inefficient firms up to speed and raising overall growth.

At the most basic level, the facts don't fit Brooks' story. If he wants to credit private equity with turning around the economy then we should have seen the turnaround in productivity growth in the 80s (or at least the beginning) when leveraged buyouts first became a major feature of the U.S. economy. Instead, we had to wait until the mid-90s, long after private equity was well established.

As a practical matter, turning around failing firms is only one way in which private equity companies make money. The most common way they make money is by gaming the tax system. This is done first and foremost by loading companies up with debt. Interest payments on debt, unlike interest payments to shareholders, are tax deductible. By reducing target companies' tax liabilities, private equity firms can make large profits even if they don't do anything to turn around the company.

Private equity companies can also benefit from other forms of financial engineering. They may also be effective at the Facebook trick, over-hyping companies when they issue IPOs, selling them off to suckered investors at an above-market price. While there are undoubtedly cases where private equity actually does turn around failing companies, this seems to be the exception as my colleague Eileen Appelbaum is discovering.

If Governor Romney's record at Bain in turning around companies is better than the record for the industry as a whole then presumably he could release a full list of the companies taken over under his watch and indicate what happened to them subsequent to their takeover. If he opts not to make this information public, then it is likely that the record is not a good one.