There Ain't No Such Thing As A Free Lunch

I'm coming a bit late to the discussion about the problems with Private Equity buyouts of nursing homes.

Back in on Sept 23rd the NYTimes did an expose which found:

As such investors have acquired nursing homes, they have often reduced costs, increased profits and quickly resold facilities for significant gains. But by many regulatory benchmarks, residents at those nursing homes are worse off, on average, than they were under previous owners, according to an analysis by The New York Times of data collected by government agencies from 2000 to 2006...

....Regulators say residents at these homes have suffered. At facilities owned by private investment firms, residents on average have fared more poorly than occupants of other homes in common problems like depression, loss of mobility and loss of ability to dress and bathe themselves, according to data collected by the Centers for Medicare and Medicaid Services.

...The typical nursing home acquired by a large investment company before 2006 scored worse than national rates in 12 of 14 indicators that regulators use to track ailments of long-term residents. Those ailments include bedsores and easily preventable infections, as well as the need to be restrained. Before they were acquired by private investors, many of those homes scored at or above national averages in similar measurements.

(hat tip to Talk Left)

So let's talk "private equity." PE firms find companies that they can buy and later sell for more than the buying price. This may sound familiar to those of you who were around in the 80's, when there was also a big wave of this sort of activity--although at that time, the main targets were conglomerates whose parts were worth more as separate companies than as part of a larger corporation.

Those who favour PE state that what is occurring is management arbitrage. You find a company that it is badly managed. You go in, fix what's wrong with it and then sell it for a lot more. Voila: profits! But, in principle, you've earned those profits by improving operations of the company.

Of course, the second easiest way to make a company more profitable*, at least in the short term, is to cut costs. Sometimes that's a good thing -- perhaps the company really is spending too much money in various areas for the return it gets. But it can also mean slashing employees and thus slashing services. If you have "lag time" in profits -- that is, if slashing employees and services won't immediately cause an equal or greater reudction in profits; well then, you've just made the company more profitable.

Nursing homes are a great example of this. Cut nurses and reduce care, and there isn't going to be an immediate exodus. It takes time, and there aren't enough nursing home beds anyway. Lousy care is better than no care, or taking grandma back into the house, if that's even feasible. Now cutting care might be, oh, illegal (forget immoral, that's not an issue), but if you're a smart PE firm you've got that covered too:

Private investment companies have made it very difficult for plaintiffs to succeed in court and for regulators to levy chainwide fines by creating complex corporate structures that obscure who controls their nursing homes.

By contrast, publicly owned nursing home chains are essentially required to disclose who controls their facilities in securities filings and other regulatory documents.

So you go in, slash costs, and sell the company, probably by taking it public again. And you make a big profit. A lot of old folks die sooner than they needed to, go into depression, have to be restrained, get bedsores, shit themselves, and so on, but hey: they aren't your parents, and even if they were, well, who knows if you'd even give a damn then. And regardless, no one can figure out who to sue.

(It's interesting that these corporate structures have become this convoluted. The trusts set up in the pre-Depression era were similiar -- they were so intricate and had so many layers that investigators often spent years trying to get to the bottom of them. New Deal laws attempted to make them illegal. I don't know if those laws were repealed, or if lawyers have just figured ways around them. Probably both.)

This leads us to a simple lesson -- some things should be ruled by the profit motive, and other things shouldn't be. If the bottom line is profit, then this sort of behaviour is both logical and rational. Why not give the least care you can get away with and take the cash. It's immoral, but it's not your fiscal duty to maximize morality, now is it?

Organizations like nursing homes should be run on something other than the profit motive. They could be set up as mutual organizations (the residents, or their families, effectively own them), they could be set up as some sort of non-profit organization, or they could be run by government, but since good care and profits are antithetical to each other except over the long term (long enough for you and your parents to spend many years living in hell) the profit motive doesn't work so well here.

But note that bit about "long term" there. You might be able to run these on the profit motive, if, and only if, the same owners are stuck with them long term and are liable for care. When the time it takes to earn a profit is too much shorter than the time it takes for messing up to cost you big time, people get in and out with big money. They see a gap, and they exploit it. This is the same basic problem as we have in the mortgage industry. When banks were stuck with the loans for the life of the loan, they vetted them properly. Now that they aren't, they don't. When banks were on the hook for the life of the loan -- well, you get the idea.

No series of shell companies that make it impossible to sue should be legal. And since nursing care is an industry where the amount of time it takes for negative feedback to impact the bottom line is fairly long, quick swaps of nursing care homes should likewise not be allowed. If you want private enterprise in such areas you have to match the risks and the rewards -- they much match each other evenly, otherwise someone will notice the gap and drive a truck full of cash through it (and over a bunch of old folks).

Smart capitalism is managed capitalism simply because of these sorts of gaps. If you don't want people do horribly immoral things for millions of dollars you have to make sure that either they simply can't, or that the sword of Damocles hangs over their head if they do so.

As for the Private Equity industry, mostly it doesn't create wealth -- PE firms destroy wealth by finding places where they can reduce costs that won't show up until after they're gone. I call it "burning down the house to keep warm." Works, but eventually you've got no house. Of course, if it isn't your house, what do you care?

*For those wondering what the easiest way to make a lot of money in PE is: buy the company, make it take out a huge loan to itself, then give you that money. Then ditch the company. Nice work, if you can get it.

1) Chart from a GAO report.