Tag Archives: Politics

Aside

First of all, how come nobody told me that Richard Posner and Gary Becker had their own blog? I have never referenced Becker in this blog, but he is a big hitter economist of the Chicago school. But I have … Continue reading

Private Equity Parallels the Mortgage Business

I’ve been trying to ignore all the discussion in the presidential campaign about Bain Capital and leveraged buyouts and private equity, but pull is too strong and I can no longer resist. Must….write…blog…entry.

First off, let me say that buyouts* are neither inherently good nor bad. People who are completely bashing buyouts as inevitably bad, as rapacious tools for the 1%, are simply wrong. People who are utterly defending buyouts as inevitably good, as the perfect form of free market capitalism, are also wrong. I mean, duh. Nothing as complicated as a buyout is going to just be good or just be bad.

Good: having a buyer focus a complacent or bloated company on its core products is often very productive. Bad: having a buyer stop investing in R&D and shut down pensions while continuing to pay itself fees and dividends is often very troubling.**

Rather than delve more into the good or the bad, I do want to point out one thing that isn’t often mentioned: how similar the buyout business is to the mortgage business as practiced on Wall Street. Both businesses are leveraged gambles with the government picking up at least some of the tab if you lose. We all know how Wall Street borrowed massively to bet on mortgage-backed securities. And they made jillions, paying out huge bonuses, until it went wrong, and the government bailed all of Wall Street out. Heads they win, tails we lose.

Buyout barons have a similar deal. Not quite as good, but similar. They borrow heavily to amplify the returns on their deals. If it goes well, they make tons; that is why Mitt Romney is so rich. But if it goes poorly, the Bains and KKRs of the world get to walk away, using the government bankruptcy code, and leaving the workers’ pension plan in the hands of the Pension Benefit Guaranty Program, a government agency. I don’t want to overstate the case: sometimes private equity firms lose money on bad deals. They don’t fully socialize their losses. But their losses are limited to that deal; the structure is such that they can walk away from bad deals.

In the meantime, they are borrowing against the assets of the company and paying themselves dividends with the money. You might say “they can’t be applying too much leverage, or banks wouldn’t lend them the money.” Sure, just like banks would never give mortgages to pool cleaners who made $25,000 per year. Oh wait, they did, repeatedly. To quote Mike Konczal, who is quoting Josh Mason, “It was a common trope in accounts of the housing bubble that greedy or shortsighted homeowners were extracting equity from their houses with second mortgages or cash-out refinancings to pay for extra consumption. What nobody mentioned was that the rentier class had been doing this longer, and on a much larger scale, to the country’s productive enterprises.”

Finally, I should also note that buyouts are structured as giant tax dodges. Again, this is not inherently bad; we expect companies and investors to legally minimize their taxes. But the fact is that a big part of the value of buyouts is their tax efficiency. That is why buyout firms continually sell companies to each other in a round robin of tax avoidance; they aren’t all adding “operational value.” There is only so much a bunch of ex-investment bankers can do to change the operations of a company, but each time a company is sold there is a new set of tax avoidance strategies.

How does this work? First of all, because interest payments are tax deductible, the leverage applied in a buyout is essentially subsidized. Much like homeowners are encouraged to take out larger home loans by the tax deductibility of mortgage interest, buyout firms are encouraged to leverage up as much as possible. This enables the company’s operating income be used on debt payments, amplifying returns, rather than going into taxable income. In addition, at the time of acquisitions, assets of the company can be written up to fair market value and then depreciated, with the non-cash depreciation expense also tax-deductible. That step-up in asset value at acquisition is precisely why buyout firms keep flipping companies to each other. In a perfect deal, the post-acquisition company will have taxable income below zero, but positive cash flow. In other words, regardless of whatever operational improvements a buyout firm might implement, a huge part of the value that accrues to that buyout firm is due to financial engineering, specifically financial structuring to avoid taxes.

* I will use the term “buyouts” here, which are usually leveraged but don’t need to be. Since “private equity” also refers to venture capital, I will avoid using that term.

** From a recent Vanity Fair article:
“According to Kosman, “Bain and Goldman—after putting down only $85 million … made out like bandits—a $280 million profit.” Dade’s debt rose to more than $870 million. Romney had left operational management of Bain that year, though his disclosures show that he owned 16.5 percent of the Bain partnership responsible for the Dade investment until at least 2001.
Quite soon, however, a fragile Dade faced adverse conditions in the currency markets, and it had to start in effect cannibalizing itself, cutting into the core of its business. It filed for bankruptcy in August 2002 and Bain Capital departed. When Dade emerged from bankruptcy, its new owners invested in long-term R&D, and it flourished again.”

The Fakery of Paul Ryan

Like most (all?) Washington politicians, Paul Ryan is a liar and a hypocrite. Read about it here. Skip to page 6 for the ultimate example of Ryan’s nearly pathological fakery.

Can Congress Change Its Culture?

Cultural change is the recent theme here at Thoughtbasket; I discussed how a company might change its culture, and then how America might change some aspects of its culture. Today I want to look at a particular part of America: Congress. The U.S. Congress seems unable to solve any of the problems facing our country, and consequently has an approval rating of only 11 percent, which is the lowest ever. If a group is unable to complete the sole task it is given (governing, in this case) and thus is held in contempt by its bosses (voters, in this case), then that group probably has a culture problem.

The congressional cultural problem is that the entire institution values reelection instead of service (which is why incumbents are reelected more than 80% of the time). Power is more important than policy. Much like the corporation in my first post on this topic had a culture where everyone thought it was OK to be late for meetings, congress has a culture where everyone thinks that it’s OK to prioritize staying in office over doing the job you were elected to do, which is govern.

We can blame each individual congressman – and believe me, I do – but really, it is the institution and its culture that is truly to blame. Expecting some moronic ex-exterminator who only gets a two-year term to swim against a cultural tide of reelection is probably naïve. So, much like in my efforts to change cultural components in the US as a whole, we need a team approach. John Boehner + Nancy Pelosi = change?

I wrote last year about how John Boehner could be a hero by teaming up with democrats to pass substantive policy that would address the nation’s fiscal problems. Here is another opportunity for heroic action: he could rally all of congress, teaming with his arch enemies, to promote a culture of service instead selfishness.

Is Corporate Culture The Same As Country Culture?

I recently posted about corporate cultures, and how the only way a corporation can change its culture is from the top. Based on some of the feedback I received I’ve decided to expand my scope and explore a larger cultural change: how the United States might change some parts of its culture. For example, one aspect of America’s current culture that seems problematic is that we want all kinds of services (Medicare, Social Security, strong defense, good roads, etc.) but we want the lowest taxes possible. Those two desires are incompatible; a culture that emphasizes taking without giving will prove challenging in the long run.

In my prior post, I discussed that a change in corporate culture requires a CEO who is willing to push that change. In the case of a country, who might play that role? You would naturally think the president, but we know that won’t work. Plenty of recent presidents have talked about changing the culture, but none have succeeded. Hell, none of them could change the culture of a few hundred people in Congress, let alone a whole country. And that’s not really surprising; a country is not a hierarchical structure the way a company is, so people have no reason to necessarily follow what the leader says.

The president could try to lead by example, or by using the bully pulpit, but I can only imagine the furor  that would erupt  if a president (or governor, or senator, or mayor) announced that “OK people, your constant desire to get lots while paying little is complete crap; going forward we are all going to be more realistic.” No, that wouldn’t work at all.

What if all our leaders teamed up? Suppose a whole slew of politicians – national and local, democrat and republican, male and female – got together to announce an initiative aimed at realism. This could be risky, since taking a stand isn’t really what politicians do; they hate being out on limbs by themselves. But that is why they would team up with members of the other party. After all, as I noted in my prior post, cultural change requires leaders to actually lead. Then they could get business leaders on board; everyone from Warren Buffett to Charles Koch. Throw in some celebrities – nothing happens in America without celebrities – and then maybe we’d have something.

It’s possible that this is nothing but a pipe dream. Can we really expect politicians to team up in order to lecture voters? Probably it will never happen. But maybe we should expect more from our leaders.

Ozone Pollution More Dangerous than Previously Thought?

We’ve all heard about the ozone layer, but I reckon that most people know very little about ozone. I knew pretty much nothing about it until I read an article published by the National Bureau of Economic Research which tied ozone levels to reduced worker productivity.

It turns out that ozone is a molecule consisting of three oxygen atoms. It also turns out that ozone is known to cause respiratory problems. It is chock full of free radicals, and ozone doesn’t react well with cells in your lungs. Yuck. Health organizations (EPA, WHO, etc.) set exposure standards levels that should prevent long term effects. Of course, those standards are based on the science at the time of promulgation, and science can change, as is true for all health regulations.

However, as the NBER article shows, sometimes economics can reveal patterns that medicine doesn’t. Economists from UCSD and Columbia studied ozone levels in California’s central valley (a huge farming area) and compared those levels to farmworker productivity. It turns out that increased ozone levels are correlated to decreased productivity. Moreover, this productivity impact happens at levels well below the federal safety standards. So maybe the standards are wrong, and ozone is more toxic than people think.

I admit that this study is a little on the Freakonomics side of things: it runs a regression, sees a correlation and assumes causality. I have been critical of Freakonomics in the past (although not on this blog), because I don’t think you can just regress a boatload of data and then decide that you know why result A happened. There could be all kinds of other factors at play in this data; for example, maybe ozone levels are high when the weather is really hot, and farmworker productivity was down because of the heat, not because of the ozone at all. Hopefully the economists doing the study adjusted for that sort of thing, since zeroing out the noise of exogenous variable is a standard procedure in studies like this, but the article doesn’t say. Any way you look at it, this certainly is an interesting correlation that could bear further study.

As an aside, here is a critique of Freakonomics from the American Scientist; they are more qualified than I am.

Graphical Look at Federal Deficit

Courtesy NY Times