re-upping this, originally posted January 13. ~eds
I was telling someone earlier this week about my good friend Newt Gingrich. You didn’t know he was one of my friends? Neither did I, until I saw his television commercial attacking Mitt Romney for being a vulture capitalist. For at least five years, a lot of us in Leftist Blogoland have been decrying the equity extraction and asset stripping practices of people like Mitt Romney, the former CEO of Bain Capital. We’ve been joined in this crusade by writers with libertarian beliefs, and some of them, like Karl Denninger, are far more direct than we have ever been in calling a crime a crime, and demanding prison terms for the people who helped destroy America’s productive manufacturing base.
Now we have Newt Gingrich challenging Mitt Romney’s claim that he was a venture capitalist, creating jobs while he saved companies from certain bankruptcy. Newt sees it differently; he asks in his ad if it is acceptable for someone to come in to a community, manipulate people’s lives for the worse, and ”œwalk off with the money.” Others have joined in on the Mitt Romney bashing. Ron Paul has said that the business practices of people like Mitt Romney have nothing to do with free market capitalism, and it was Rick Perry who has come up with the phrase ”œvulture capitalist”.
There are plenty of people in South Carolina, where Newt Gingrich’s ad is now running, who have wondered what happened to all the well-paying jobs, particularly in areas like textiles and furniture manufacturing that used to be mainstays of the local economy. Those jobs are gone, and people are much poorer for it, but wealthy individuals like Mitt Romney, who were temporary stewards of these declining companies for 18 ”“ 24 months, are much richer. How did that happen?
The Leveraged Buyout Game
To understand how Mitt Romney and Bain Capital earned their money, it is best to hear what one of the insiders of the business has said about the way Mitt Romney operated. Steve Schwarzman is one of the principal founders and owners of Blackstone Group, Wall Street’s largest leveraged buyout firm.
”œThe first investment we made in private equity was a joint deal with Mitt Romney at Bain,” Steve Schwarzman, the co-founder and chairman of the Blackstone Group, told Bloomberg Television in November. ”œWe made about 16 times profit. The second deal we did, Mitt led that one – we did that deal at Blackstone and we invited him to be the minority partner and we made 24 times our money. In finance, that’s a way to make friends.
The most important part of this statement is at the very end, where Mr. Schwarzman describes how to make friends on Wall Street. We’ll get to that in a minute. For the moment, let’s concentrate on investments that earn 16 times or 24 times profit. This means if you invest $100, you are going to receive $1,600 to $2,400 back, or in Mr. Schwarzman’s terms, $10,000,000 will get you at least $160,000,000 in return.
These are not the sort of investment returns you or I are familiar with. These are not even 16% or 24% returns on investment, which would be very generous in this day and age of zero percentage rates. These are 1,500% returns or more. You can’t earn these sorts of returns in a free market economy, at least not consistently. You might get lucky once or twice, but not deal after deal after deal, as Mitt Romney was able to do through Bain Capital. To earn this sort of wealth consistently, you have to game the system in some way. You have to operate outside of capitalism, and outside of free and open markets.
The pattern Mitt Romney and Steve Schwarzman followed evolved from the 1970s when leveraged buyouts were first developed by Michael Milken. In those days, the investors took over a company, retired all the public stock in order to make the company privately owned, used tremendous amounts of debt both to purchase the company and ”œfix it up”, and then after five years brought the company back into the public sphere by issuing common stock and cashing out their profits.
Nobody in the business today waits five years to get their money out; by 2000 the game had been transformed and the goal became to cash out as fast as possible and go on to the next deal. In order to accelerate the payout period, it is now necessary for the buyout specialists to guarantee they receive outsized profits, rather than risk waiting for the market to reward the ”œenhanced value” the leveraged buyout is supposedly bringing to the company in the first place.
Here are the basic steps Bain Capital and other leverage buyout firms take in order to get their guaranteed 1,500% return in 18 to 24 months:
1) Neutralize a possible battle with the board of directors of the target company by giving them preferential personal benefits from the buyout. Starting with the CEO, the buyout firm offers him a guaranteed role as CEO of the new, private company. He and his fellow executives receive a generous allotment of private ownership shares, which will make them very wealthy once the firm is brought back to public ownership. Similar arrangements are made with key members of the board of directors.
2) Buy up a majority of the common and voting stock of the company. Once 51% or more of the public stock is sold to the buyout firm, the game is over, and with management and the board intimately involved in the buyout, there is little chance that a shareholder revolt will erupt to prevent the takeover.
3) Install the new management team and make sure the buyout firm has a majority of the shares in the private company, and a majority of seats on the new board of directors, giving it full voting control.
4) Join the Globalization movement in a big way, by closing down as many manufacturing plants as possible and moving manufacturing to China, Thailand, Mexico, etc. Force unions to accept renegotiation of their contracts in order for the company to impose lower salaries, benefits, and retirement obligations on the workers. Impose these reductions automatically on non-union employees, firing as many of them as necessary, and cancelling benefit programs altogether where possible. When it comes to health care benefits, for example, the goal is to get as many workers on a 39 hour week so they are considered part time and not eligible for health care. The local emergency rooms can bear this burden rather than the company.
5) Take control over the pension plan and change the assumption of future annual returns from 8% to something like 10% or even 12%. Never mind that actual annual returns have been running at 3% at best ”“ everyone knows the stock market produces at least 8% annual returns in the long run. With a much higher return assumption, you discover that the pension plan is now overfunded, so you can bring $250 million of the plan’s reserves back into retained earnings for the company.
6) Borrow at least $1.0 billion whether you need it or not. Say it is for a rainy day.
7) After about a year, with all these cuts in expenses, the company is beginning to show some profits. Therefore, declare a $500 million dividend for the owners, i.e., for the buyout fund. Take this money directly out of retained earnings, which means the $250 million pension plan savings are de facto transferred to the pockets of the leveraged buyout owners, and $250 million of the proceeds from the loan are given to the owners as well (debt which the company still has to pay back).
8) By 18 months, the profitability is respectable, but more important, the return on equity is looking great. This is because the equity in the company has been dramatically reduced through fat dividends to the owners. The leverage ratio ”“ the amount of debt compared to equity ”“ is looking horrible, but the stock market doesn’t look at leverage. The stock market only looks at profitability and the return on equity. Therefore, it is time to cash in and sell out. The buyout firm arranges for an IPO ”“ an initial public offering of common stock. Wall Street firms like Goldman Sachs and JP Morgan get a very generous 7% of the proceeds of an IPO, so they have every incentive to get as much stock sold as possible at the highest price possible. They hype the new stock to the public, and the IPO is a big success. The leveraged buyout firm says ”œadios” to the employees, communities, customers and new shareholders of the company, which by now is financially much weaker than it was before and less able to survive in the market.
Mitt Romney’s Job Creation Myth
Given that an integral component of the leveraged buyout process is the elimination of jobs, how can Mitt Romney claim he created 100,000 jobs in his career at Bain Capital? The fact is, he can’t, and he’s not merely distorting his record, he is outright lying. Romney refers to such ”œclients” as Staples and Sports Authority as examples of his ability to help manufacturing expand and hire more people. Using very generous assumptions, and a very long time line, it is possible that some of the companies that survived the leveraged buyout process managed to turn into job-growth machines. Such companies are few and far between in the leveraged buyout world.
If you take into account all the people fired immediately after the company went private, and then add in all the people who lost their jobs after manufacturing was outsourced overseas, many hundreds of thousands of workers were unemployed as a result of Romney’s ”œassistance” in helping his clients become leaner and meaner. The Wall Street Journal did a study of Bain Capital’s buyout record when Mitt Romney was CEO, and found that fully 22% of the companies they bought went bankrupt within a few years of being brought back into public ownership. These companies alone represent hundreds of thousands of employees left without work.
The best that Mitt Romney can argue is that even more of his buyout clients would have gone bankrupt if he hadn’t intervened to help them. Here too, the record says otherwise. What killed the 22% of companies that did not survive was leverage ”“ the heavy amounts of debt that Bain Capital left them with and that ultimately posed too great a burden for the company to bear. The companies that did survive turned out to be weak performers in the long run, precisely because they could not get out of the debt burden they were given at their rebirth.
All of these companies wished they had much more equity to help them survive in the marketplace, but the equity was gone ”“ strip mined by Bain Capital and the investors that backed their leveraged buyout raids. This is the record of the leveraged buyout business, going way back to the 1970s when Michael Milken first began loading companies up with debt. It is easy to make a company look temporarily more efficient with lots of debt, but it takes a serious long term toll, as seen in the statistics on corporate debt over the past 40 years. Another way to look at this deterioration in corporate health is to chart the progressively fewer and fewer companies that receive high corporate bond ratings from Moody’s and Standard & Poor’s. Back in the 1970s, more than 65 corporations in the US were rated Aaa; today there are five. Today the majority of corporations carry what is known as a junk debt rating ”“ they are so loaded up with debt that their default risk is three to four times greater than it was forty years ago. No wonder so many companies are constantly looking for ways to squeeze their workers and cut expenses ”“ it’s the only way they can raise the cash to service their enormous debt burden.
The debt binge the US has been on, which has certainly involved not just corporations but government and private individuals, did not happen by accident. It was a result of deliberate policy choices by government and specific actions by financiers. Newt Gingrinch himself says he was part of the original ”œcabal” of advisers to Ronald Reagan that convinced him there was a pain-free way to cut taxes without increasing the deficit. Gingrich says Romney would never had enjoyed the business success he has had in leveraged buyouts if Gingrich and others hadn’t successfully turned the country away from tax and spend politics to borrow and spend politics.
Gingrich is exactly right in this. Tax and spend politics is at least honest ”“ politicians spend what money they can raise in taxes, and they lose office if they tax too much. Borrow and spend politics is completely corrupt and dishonest. It has fed off the Aaa credit rating of the United States, built over 100 years, and now lost as America comes face to face with the economic abyss it is about to plunge into. Borrow and spend politics strips the federal government of its credit-worthiness, just as leverage buyouts strip the hapless corporate victims of their hard-earned equity. Banks took a lesson from all this equity extraction, by stripping homeowners of the equity they had built up over time in their residences.
It’s hard to say which players were the worst of the worst in this game, but the Mitt Romney’s of the world rank very high up there. They didn’t wait for the free market to reward their efforts ”“ they subverted the free market by deliberately plundering corporate equity, thereby destroying companies and destroying jobs. Adam Smith’s invisible hand wasn’t allowed to work here. What took its place was an invisible handshake, or, as Steve Schwarzman put it, people like Mitt Romney created friendships on Wall Street because they could produce 1,500% returns on investment. Other wealthy investors came rushing to shake their hands; banks came rushing to lend them money for the buyout activity; CEOs came rushing to sell out their companies and employees in order to get in on the wealth train that Mitt Romney was engineering; regulators rushed in to approve these transactions or turn a blind eye, because jobs awaited them in the business when their regulatory career ended.
Mitt Romney ranks among the 3,000 wealthiest Americans, a small minority among the 1%. How he got there had nothing to do with capitalism, with free markets, with his ability to create jobs, or his love for America. He got there not as a buccaneer of capitalism, but as a pirate, raping and pillaging his way across the corporate landscape, pulling equity out of one firm after another, and leaving the debt-laden hulks to survive if possible, while thousands of workers were left poorer.
He is going to outright lie about his record. He is already claiming that the ”œpolitics of envy” are at work in the attacks being levied against him. He can certainly suggest that people like Newt Gingrich are being hypocritical ”“ Newt, after all, lusts after the presidency more than he lusts for yet another trophy wife, and he is willing to bare his hypocritical soul for all to see by denouncing the debauched form of capitalism he helped create. Mitt Romney is going to invoke rugged individualism and Ayn Rand, and why not? Wasn’t Dagny Taggart raped by John Galt, as a literary example of the sort of relations between humans that Ayn Rand wanted to glorify?
It is not too much to say that, very much within the philosophy of Ayn Rand, Mitt Romney has spent his business career raping companies, raping employees, and raping communities. Now he has his eyes on the presidency. He has extended an invisible handshake to dozens if not hundreds of donors from the financial industry who have supported his campaign with millions of dollars in donations. These are names Romney has refused to reveal.
What do you think Mitt Romney and his invisible supporters are going to do to America if he wins the presidency?
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