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The kingdom of private equity

These Are the Plunderers: How Private Equity Runs—and Wrecks—America by Gretchen Morgenson and Joshua Rosner. Simon & Schuster, 381 pages. 2023.

Our Lives in Their Portfolios: Why Asset Managers Own the World by Brett Christophers. Verso, 310 pages. 2023.

A specter is haunting capitalism: the specter of financialization. Industrial capitalism—the capitalism of “dark Satanic mills”—was bad enough, but it had certain redeeming features: in a word (well, two words), people and place. Factory work may have been grueling and dangerous, but workers sometimes acquired genuine skills, and being under one roof made it easier for them to organize and strike. Factories were often tied, by custom and tradition as well as logistics, to one place, making it harder to simply pack up and move in the face of worker dissatisfaction or government regulation.

To put the contrast at its simplest and starkest: industrial capitalism made money by making things; financial capitalism makes money by fiddling with figures. Sometimes, at least, old-fashioned capitalism produced—along with pollution, workplace injuries, and grinding exploitation—useful things: food, clothing, housing, transportation, books, and other necessities of life. Financial capitalism merely siphons money upward, from the suckers to the sharps.

Marxism predicted that because of competition and technological development, it would eventually prove more and more difficult to make a profit through the relatively straightforward activity of industrial capitalism. It looked for a while—from the mid-1940s to the mid-1970s—as though capitalism had proven Marxism wrong. Under the benign guidance of the Bretton Woods Agreement, which used capital controls and fixed exchange rates to promote international economic stability and discourage rapid capital movements and currency speculation, the United States and Europe enjoyed an almost idyllic prosperity in those three decades. But then American companies began to feel the effects of European and Japanese competition. They didn’t like it, so they pressured the Nixon administration to scrap the accords. Wall Street, which the Bretton Woods rules had kept on a leash, sensed its opportunity and also lobbied hard—and successfully.

The result was a tsunami of speculation over the next few decades, enabled by wave after wave of financial deregulation. The latter was a joint product of fierce lobbying by financial institutions and the ascendancy of laissez faire ideology—also called “neoliberalism”—embraced by Ronald Reagan and Margaret Thatcher and subsequently by Bill Clinton and Tony Blair. The idiocy was bipartisan: Clinton and Obama were as clueless as their Republican counterparts.

Among these “reforms”—each of them a dagger aimed at the heart of a sane and fair economy—were: allowing commercial banks, which handle the public’s money, to take many of the same risks as investment banks, which handle investors’ money; lowering banks’ minimum reserve requirements, freeing them to use more of their funds for speculative purposes; allowing pension funds, insurance companies, and savings-and-loan associations (S&Ls) to make high-risk investments; facilitating corporate takeovers; approving new and risky financial instruments like credit default swaps, collateralized debt obligations, derivatives, and mortgage-based securities; and most important, removing all restrictions on the movement of speculative capital, while using the International Monetary Fund (IMF) to force unwilling countries to comply. Together these changes, as the noted economics journalist Robert Kuttner observed, forced governments “to run their economies less in service of steady growth, decent distribution, and full employment—and more to keep the trust of financial speculators, who tended to prize high interest rates, limited social outlays, low taxes on capital, and balanced budgets.”

Keynes, a principal architect of the Bretton Woods Agreement, warned: “Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation.” That was indeed the position roughly fifty years after Keynes’s death, and the predictable consequences followed. S&Ls were invited to make more adventurous investments in the 1980s. They did, and within a decade a third of them failed. The cost of the bailout was $160 billion. In the 1990s, a hedge fund named Long-Term Capital Management claimed to have discovered an algorithm that would reduce investment risk to nearly zero. For four years it was wildly successful, attracting $125 billion from investors. In 1998 its luck ran out. Judging that its failure would crash the stock market and bring down dozens of banks, the government organized an emergency rescue. The 2007–2008 crisis was an epic clusterfuck, involving nearly everyone in both the financial and political systems, though special blame should be attached to supreme con man Alan Greenspan, who persuaded everyone in government to repose unlimited confidence in the wisdom of the financial markets. Through it all, the Justice Department was asleep at the wheel. During the wild and woolly ten years before the 2008 crash, bank fraud referrals for criminal prosecution decreased by 95 percent.

The Washington Consensus, embodying the neoliberal dogma of market sovereignty, was forced on the rest of the world through the mechanism of “structural adjustments,” a set of conditions tacked onto all loans by the IMF. Latin American countries were encouraged to borrow heavily from U.S. banks after the 1973 oil shock. When interest rates increased later in the decade, those countries were badly squeezed; Washington and the IMF urged still more deregulation. The continent’s economies were devastated; the 1980s are known in Latin America as the “Lost Decade.” In 1997, in Thailand, Indonesia, the Philippines, and South Korea, the same causes—large and risky debts to U.S. banks and subsequent interest-rate fluctuations—produced similar results: economic contraction, redoubled exhortations to accommodate foreign investors, and warnings not to try to regulate capital flows. By the 2000s, Europe had caught the neoliberal contagion: in the wake of the 2008 crisis, the weaker, more heavily indebted economies—Greece, Italy, Portugal, and Spain—were forced to endure crushing austerity rather than default. Financialization was a global plague.

Slash, Burn, and Churn

In the 1960s, a brave new idea was born, which ushered in a brave new world. Traders figured out how to buy things without money. More precisely, they realized that you could borrow the money to buy the thing while using the thing itself as collateral. They could buy a company with borrowed money, using the company’s assets as collateral for the loan. They then transferred the debt to the company, which in effect had to pay for its own hijacking, and eventually sold it for a tidy profit. In the 1960s, when Jerome Kohlberg, a finance executive at Bear Stearns & Co., started to see the possibilities, it was called “bootstrap financing.” By the mid-1970s, when Kohlberg set up a company with Henry Kravis and George Roberts, it was known as the leveraged buyout (LBO).

The leveraged buyout was the key to the magic kingdom of private equity.

The leveraged buyout was the key to the magic kingdom of private equity. But LBOs leave casualties. To service its new debt, the acquired company often must cut costs drastically. This usually means firing workers and managers and overworking those who remain, selling off divisions, renegotiating contracts with suppliers, halting environmental mitigation, and eliminating philanthropy and community service. And even then, many companies failed—a significant proportion of companies acquired in LBOs went bankrupt.

Fortunately, it was discovered around this time that workers, suppliers, and communities don’t matter. In the wake of Milton Friedman’s famous and influential 1972 pronouncement that corporations have no other obligations than to maximize profits, several business school professors further honed neoliberalism into an operational formula: the fiduciary duty of every employee is always and only to increase the firm’s share price. This “shareholder value theory,” which exalted the interests of investors over all others—indeed recognized no other interests at all—afforded the intellectual and moral scaffolding of the private equity revolution.

Two excellent new books narrate, with complementary approaches, the alarming story of private equity’s kudzu-like growth. These Are the Plunderers: How Private Equity Runs—and Wrecks—America by Pulitzer-Prize-winning reporter Gretchen Morgenson and her longtime writing partner Joshua Rosner provides blow-by-blow case histories, reconstructing tactics, analyzing legal conflicts, and affording the victims of private equity depredations a face and a voice. (Private equity executives are generally faceless and rarely speak except to issue pro forma denials of everything through their extremely expensive lawyers.)

Morgenson and Rosner offer a précis of the private equity playbook:

A highly performing operation is taken over and crippled with heavy debt taken on to pay for its acquisition. . . . Real estate and other assets are stripped and sold, paying off those in control. Pensions are slashed and employees fired or their jobs moved offshore. Decimated, the company flails and the financiers head to their next triumph.

An academic study found that around 20 percent of large, private-equity-acquired companies were bankrupt within ten years, compared with 2 percent of all other companies. Another study looked at ten thousand companies acquired by private equity firms over a thirty-year period and found that employment declined between 13 and 16 percent. A 2019 study found that “over the previous decade almost 600,000 people lost their jobs as retailers as retail collapsed after being bought by private equity.”

Doctors and nurses at private-equity-owned health-care facilities were routinely suspended or fired for protesting inadequate staffing or equipment—not unrelated, probably, to the 10 percent higher fatality rate in private equity-owned nursing homes. Hospital and nursing home charges at such facilities often increase sharply; so do rents for private equity tenants, leading to frequent mass evictions. Private equity Medicare reimbursement fraud is rampant, but Justice Department investigations can’t keep up.

Morgenson and Rosner recount numerous horror stories, with a wealth of grisly detail. The centerpiece of their account is the destruction of a giant insurance company, Executive Life of California. The company had bought billions of dollars of high-interest, high-risk bonds from Drexel Burnham Lambert, a firm later found guilty of insider trading, fraud, and other financial crimes and forced out of business. One of Drexel’s crimes was misrepresenting its junk bonds, so no one knew exactly how to value Executive Life’s massive bond portfolio. Enter Leon Black, cofounder of the Apollo Fund and a former Drexel executive. He knew very well how much each of the company’s bonds were worth, and if he could take over the company, that knowledge would be worth billions. Through a process “labyrinthine in its complexity” (indeed, this reviewer is still struggling to understand it), and aided by a bumbling state Insurance Commissioner, Apollo acquired Executive Life, keeping its bonds and shucking off its insurance portfolio to a small, spun-off corporation. Apollo made a $2 billion profit on the bonds; Executive Life’s more than three hundred thousand policyholders lost, Morgenson and Rosner report, $3.9 billion in payouts.

De-Risky Business

Brett Christophers is an academic rather than a journalist, and his approach in Our Lives in Their Portfolios is more analytical than that of We Are the Plunderers, though equally compelling. He proposes restricting the term “private equity” to the shares of companies that are not publicly traded, rather than to the investment firms—Apollo, Blackstone, Carlyle, KKR, et al.—that take them private but also take over companies that remain publicly traded. All the funds organized by these buyout artists, whether their equity is public or private, are called “asset-manager funds.” Using these definitions, only $5 trillion worldwide is managed as private equity. Of the remaining $98 trillion of assets under management, around 90 percent are financial assets—stocks and bonds. The other 10 percent is the world of “real assets,” physical and social.

With an energy and ingenuity worthy of a less sordid purpose, the plunderers have crafted a marvelously efficient machine for enriching themselves and have persuaded (or bribed) the political class not to interfere.

Asset manager funds buy highways, ports, water systems, energy (including wind and solar), farmlands, power generation facilities, waste management facilities, telecommunications, transportation systems, municipal parking meters and parking garages, single-family and multi-family housing, childcare centers, medical practices, nursing homes—anything with a cash flow. Adding financial to real assets, asset managers control more than 40 percent of the world’s wealth, including more and more of the essential physical and social infrastructure of modern life. This is something new under the sun, Christophers claims: “a society in which the key physical systems supporting social life and its reproduction—so-called ‘real assets’—are increasingly owned by institutional investors [pension funds, insurance companies, university endowments] specifically through the mediation of dedicated asset managers [the plunderers] and their investment funds.” He calls it “asset-manager society.”

How did it come about? Two large developments paved the way. The first was the 2008 financial crisis, and in particular its aftermath: several years of rock-bottom interest rates. Pension funds and insurance companies, though traditionally conservative, needed some returns in order to meet their obligations, and neither bonds nor money market funds were offering much. These institutions did not have the financial expertise to make complicated (i.e., tax-avoidant) large-scale investments or the technical expertise to manage acquired companies or facilities. Asset-management investment funds were a perfect fit, and since their buyout financing relied heavily on debt, low interest rates were like high-octane fuel.

The second development, previously noted, was ideological. At first in the United States and the UK, then in Canada, Australia, and Europe, market fundamentalism—the belief that states could do nothing right and that the profit motive was invariably more efficient—led to the privatization of many traditionally public functions: building and maintaining highways and bridges; housing; elder care and nursing homes; water and sewer systems; energy production and distribution; and others. So bold were the privateers, so self-effacing were the public authorities, and so browbeaten were developing countries by the IMF that many investment fund managers demanded and received a guarantee against losses, a practice called “de-risking.” Another investor-friendly arrangement was the public-private partnership, which frequently guaranteed the fund a minimum revenue or pledged capital spending.

There are horror stories in Our Lives in their Portfolios too. Asset manager KKR paid the city of Bayonne, New Jersey, $150 million, plus a promise to undertake capital improvements, in exchange for revenues from its water system over a forty-year period. After four years, rates had risen more than 17 percent, no improvements had been made, and KKR sold its interest for a 36 percent profit. The Carlyle Group entered a similar agreement with Missoula, Montana. It, too, sold its interest after five years for a large profit, leaving the water system in such bad shape that the city repossessed it under eminent domain. Were these unfortunate episodes just exceptions? “The answer,” Christophers responds emphatically, “is no; [they are] the norm. [His italics.] The costs incurred by residents and by the state in Bayonne and Missoula . . . are not accidental. Rather, they are the more or less inevitable upshot of core features of the model by which asset-manager society operates. They are, in short, a feature, not a bug.”

But even more worrisome than these misfires and machinations, Christophers argues, is the fundamental mismatch between the asset-manager model and the real assets they are increasingly taking over. Asset managers prefer to invest in parts of large, integrated assets rather than the whole, since it is easier to isolate risk-and-return profiles. The result is often a patchwork with, for example, different owners of transmission and distribution assets within power systems, or of the pipes and the water within a water system. It is no way to manage infrastructure, Christophers warns. “Configuring assets such as transportation networks or energy systems in such a way as to insure a steady flow of income for private investors” threatens governments’ necessary “freedom . . . to plan and shape the built environment in an orderly, coherent, and socially beneficial fashion.”

An Asset of You and Me

Beyond exacerbating America’s already grotesque economic inequality and upending (or ending) the lives of workers, tenants, hospital patients, and nursing home residents, private equity inflicts a more subtle, insidious harm on American society. As radical critics have pointed out all the way back to the nineteenth-century Populists, a minimum of autonomy and control in the chief spheres of life is essential to achieving a balanced relationship to authority, neither belligerent nor servile, which in turn is a prerequisite to effective democratic citizenship. Industrialization, to which Populism was a response, was the first setback to America’s two-hundred-year tradition of popular economic independence. The post-World War II destruction of the family farm was another. The Reaganite/neoliberal destruction of labor unions was yet another. Private equity, by removing ownership and authority even further from the worker than the corporation did, paralyzes its subjects still more. Often the worker cannot even learn where their orders come from, much less confront their source. Distance and abstraction do not merely disempower; they infantilize. Such a workforce is no longer a fit democratic citizenry, the only force capable of taking on the financial juggernaut.

It will probably take an entity their own size to curb the financial industry’s drive to own the world.

There is something perversely impressive about private equity. With an energy and ingenuity worthy of a less sordid purpose, the plunderers have crafted a marvelously efficient machine for enriching themselves and have persuaded (or bribed) the political class not to interfere. If threatened, they will undoubtedly warn that the economy will collapse without them—that is, after all, how the banks got away with it last time. And who, in any case, is going to threaten them? A fragmented, dispossessed workforce that doesn’t even know where to find its bosses?

The epigraph of Our Lives in Their Portfolios is a line from the CEO of Brookfield Asset Management, one of the world’s largest: “What we do is behind the scenes. Nobody knows we’re there.” By and large, nobody does. It’s true of government too. I only learned from Morgenson and Rosner that Jerome Powell, the current chairman of the Fed, who spent $750 billion to save the corporate bond market, where private equity feeds, is himself a former private equity executive.

It will probably take an entity their own size to curb the financial industry’s drive to own the world. Sweden, Denmark, South Korea, and a few other states have fought at least some of the plunderers’ worst abuses. The chance that the pirates’ stronghold and base of operations, the United States, will do the same seems pretty slight. There’s a glimmer of hope that the greed of the vampires will finally repel their own customers. The huge fees they charge their institutional investors (according to Morgenson and Rosner, a 2015 SEC study found that 50 percent of private equity fees were improper or not properly disclosed), together with the high percentage they take of the profits, has led some of those investors to commission studies comparing how well they did with private equity compared with how well they would have done putting the money into an index fund. It turns out to be a dead heat.

Maybe these investors will go on strike. Or maybe the United States, UK, EU, Canada, and Australia will wiggle out from under the industry’s thumb and rein in its egregious tax and other legal privileges. Or maybe the rest of us will see through the mystifications and navigate the political obstacle course they and their legislative allies will undoubtedly throw up to keep us from holding them accountable. If not, then we’ll all be assets someday.