The Obama administration launched a negative ad campaign to discredit the “business experience” of Mitt Romney. But briefly into this campaign, in two successive weeks of the news cycle, two high profile Democrats have refuted the Obama claim. First, Newark Mayor Cory Booker proclaimed that attacking private equity was petty and offensive and Bill Clinton validated Mitt Romney’s business experience as worthy of a president. How could the Obama campaign so badly miss the mark not of the electorate but of its own party stalwarts?
Let’s be analytical with respect to both the Obama claim and the Booker/Clinton perspective. First, the Obama claim is a weak one. He has attempted to position himself as being in favor of leveraged buyouts but says that “just because Romney is good at generating profits for a few investors do not mean that he has the capability to grow jobs for everyone.” It is a weak claim for the following reason: The campaign ads interview common laborers who have been displaced by both failed and successful leveraged buyouts but rather than reinforce their claims, the Obama position digresses to a totally different argument: that success at maximizing profits does not correlate with Romney’s prospective success as president. By doing so, President Obama threw these laborers under the bus.
The argument of the ad is correct. A leveraged buyout is not a new investment. There is no investment in plant or equipment that will generate new products or drive productivity. A leveraged buyout is a risk-return reallocation strategy on an existing asset. There is no societal benefit.
Labor will lose in two ways: there will be layoffs “to make the company more efficient” and their future raises will be substantially below productivity growth. It should be no surprise that middle class wages have stagnated as leveraged buyouts have become more pervasive. Government has lost tax revenue as deductible interest expense on debt has displaced equity in the capital structure. Finally, communities have been decimated as the company shifts production to the least cost facility; this while labor is trapped in underwater real estate. Capital is mobile while labor is trapped.
Why does Bill Clinton defend private equity? Perhaps it is because this speculative investment strategy became grounded in American finance under his watch. In the late 1980s, the high yield bond market grew rapidly as corporate raiders used these securities to takeover companies. Management resisted but the courts proclaimed that a corporation’s loyalty lie only with its stockholders and other stakeholders need not be considered in these transactions.
Congress eliminated the interest expense deduction for non-real estate consumer debt in 1986. It could have acted to eliminate the interest expense for highly-levered transactions and cooled the takeover market but chose not to do so. In 1993, Congress acted to eliminate the tax deductibility for CEO pay packages that exceeded $1 million. Corporate boards responded by awarding more options and skewed management incentives toward more takeovers, not less. The Labor Department should have intervened to make sure that pension plan contributions were made on schedule and the plans fully funded to protect labor.
Today, the pendulum has swung dramatically in favor of capital. Labor’s wages are stagnant and under-employment pervasive. There is $2 trillion of debt associated with leveraged buyouts on the balance sheets of America’s bailed out banks. High yield bond assets, mostly takeover related exceed a trillion dollars. Public companies earn a 16.5 percent return on equity yet retired citizens earn nothing on their savings while the Federal Reserve System subsidizes leveraged buyout debt. This is a huge misallocation of resources. It is a misallocation that free financial markets, absent an activist Federal Reserve, would have likely dealt with long ago.
To make the stench even more unbearable; the cost of student loans, surely a more worthy allocation of our resources than leveraged buyouts are set to double in an environment where the cost of financing for “private equity” has been halved. This misallocation of resources is too much to bear and this has to stop.
The writer lives in North Myrtle Beach.