Democratic critics are right to expose the job-killing activity of private-equity firm Bain Capital, formerly run by Mitt Romney, the presumptive Republican presidential nominee. But if critics wish to do anything other than make a quickly forgotten partisan point in the 2012 election cage fight, they need to come clean about the "rest of the story," as radio commentator Paul Harvey used to say.
First, what is private equity? Put simply, it's a way to finance economic activity outside of traditional stock and bond markets. As the term is normally used, private equity includes several very different types of investments. First among them is venture capital, the raising of money for new commercial ideas and companies. Facebook and Zynga were nurtured with venture capital. Proponents of private equity like to emphasize venture capital, the epicenter of which is the Bay Area, from which many successful companies have emerged. Second, private equity is often a way to raise money to purchase large assets, such as buying tracts of land on speculation. Unfortunately, casino-like wagers are common in California, and public employees and employers will pay well into the future for spectacular mistakes made in this area by CalPERS, the country's largest public-employee-benefit fund.
The most contentious type of private equity involves the purchase, and, later, sale or bankruptcy, of existing companies. The buyouts are mainly financed using debt, taxpayer-provided dollars, and "OPM" — other people's money. This activity, often known by the term "leveraged buyouts," is featured in the campaign ads attacking Romney's Bain Capital. In leveraged buyouts, the private-equity firm claims it can conduct financial alchemy, turning companies into economic dynamos. Private-equity gurus may have high IQs and spotless academic pedigrees, but they seldom know more than the folks in the company. Consequently, the outcomes are nearly always bad for workers, communities, and taxpayers — as the "efficiencies" come out of the hides of these three groups.
Hedge funds, often thought of as private equity, are really alternative investment cousins. Hedge-fund mangers generally make roulette-like bets against companies, currencies, and countries, thinking they know whether the ball will land on red or black. The results often exacerbate social problems, like those in Greece today. These funds are sometimes laughingly renamed "absolute return strategies," as if they could always produce positive returns for investors.
Whatever the proper definition, private equity in practice exists for one reason — it is a gigantic fee machine, siphoning the capital that has been built up in companies and portfolios and transferring it to the private equity moguls and, occasionally, their investors. Private equity is an integral part of the finance outrages that have wreaked havoc in our communities. Except for some venture capitalists, and a smattering of private-equity firms that consider communities and workers first, most private-equity moguls get paid princely sums whether the investments win, lose, or draw. The normal fee is "2 and 20" — 2 percent of the total committed investment each year and 20 percent of any profits. Losses all go to the investors, who hit the private-equity jackpot about as often as convenience store patrons win the Mega Millions jackpot.
To retain its advantages, private-equity money is spread around the political barnyard. All of the political elite is in on the action — Democratic and Republican. Bill Clinton gave the first turbo-charge to the game, welding a large part of the private-equity establishment onto the Democratic Party. Clinton then colluded with luminaries like then-Texas Senator Phil Gramm and his wife Wendy to establish regulatory and tax advantages. President Obama and the leaders of both parties within the Beltway are continuing the bipartisan support. But wait, you say, "Aren't you being too hard on President Obama? Isn't he spotlighting the job-killing activities of Romney's Bain Capital?" Maybe, but in a stunning piece of political theater, as the anti-Bain commercials were beginning to air this month, the president was at the Park Avenue penthouse of a private-equity mogul, praising the work of these tycoons and collecting more than $2 million in campaign funds.
Hypocrisy in service to electoral success is so common today that there is little news here. But for progressives, an unpleasant truth was recently revealed by Cory Booker, the mayor of Newark, New Jersey and a rising star in the Democratic Party. Booker, who, like many Democratic bigwigs, is cozy with private-equity types, questioned the Democratic electoral focus on Bain, since the money that the private-equity job-killers use for their efforts comes from pension funds and unions. Say what? Money from pension funds of union workers goes to corporate raiders? Sadly, the answer is yes. In spite of the anti-Bain pronouncements of labor leaders, billions of dollars saved for the health care and pensions of workers are funneled to private-equity moguls. From CalPERS and CalSTRS to pensions for Bay Area grocery store workers and East Coast hospital workers, union representatives sit on boards that are seduced by the lies and blandishments offered by the private equity mafia.
Many in the labor movement know this, but given the right wing attacks on workers' pensions, they are unwilling to come clean so as not to give any ammo to the anti-pension austerity crowd. But if the union movement is concerned about its credibility with the "moveable middle," as the dynamic young AFL-CIO Secretary-Treasurer Liz Shuler argues it must be, the union movement needs to stand against hypocrisy, not practice it. Only then can it be relevant and healthy.
Private equity is like dynamite. It may be helpful in some circumstances, but without extraordinary oversight it can hurt people and devastate communities. Investment and finance are essential for a wide range of societal needs, from power generation to health care and retirement. But given the ability that financial activity has to produce large-scale mayhem, private equity should be regulated even more closely than other sectors of the economy.
There is an historical antecedent to look to here. At the turn of the 19th century, our country was in a debate as to what to do about serious accidents that were obviously the fault of those engaged in dangerous activity, but for which the victims had no recourse in existing legal and regulatory schemes. In response, the legal rule of "Rylands" — the concept of strict liability borrowed from English law — was eventually adopted throughout the country. Under Rylands, if you are engaged in abnormally dangerous activity, like the handling of dynamite, you are strictly responsible for any adverse consequences, whether or not you were negligent.
So what should be done about private equity if its use is an abnormally dangerous activity? First, the tax and regulatory advantages should be eliminated. There is no reason that taxpayers should promote and finance destructive deals. Second, the government should mandate real disclosure of the monetary gains reaped by private equity moguls, the consequences of their activity, and the true returns that investors receive. Corporate raiders are often successful because they can hide, through dizzying levels of complexity, the real effects of what they do and the real financial returns created. Employee pension funds give their money to these private-equity moguls, not because trustees are stupid or have poor morals, but because they are surrounded by a bought-and-paid-for former army of "researchers" and investment consultants who counsel that only private-equity alchemy can produce needed financial returns. All evidence that shows the dazzling promises of "alternative investments" are false, like Simon Lack's devastating critique in his recent book, The Hedge Fund Mirage, is derided by industry and ignored by those who should know better.
Finally, those associated with private equity must take personal responsibility. When investments are made that kill jobs and communities, it would not be that hard to set up a system to force those who are responsible to pay for needed unemployment assistance, health care, real job training, and to compensate the communities for lost tax revenues. All involved should personally have to pay for this, from the private-equity experts to the pension fund administrators who hire them and the trustees who approve the job-killing investments. Maybe then all these folks would admit the downstream effects of their actions and focus on investments that create good jobs and build healthy communities.