Mitt’s Welfare-Driven Vulture Capitalism

When I hosted Steve Rattner at FDL Book Salon, I noted how blind he was to problems of other private equity firms–in the context of the auto bailout, Cerberus. So I was interested in Rattner’s attempt to defend Mitt’s tenure at Bain.

Bain Capital is not now, nor has it ever been, some kind of Gordon Gekko-like, fire-breathing corporate raider that slashed and burned companies, immolating jobs wherever they appear in its path.


Instead, with modest exceptions (keep reading to learn more about these), Bain Capital was a thoroughly respectable — nay, eminent — investment manager that successfully discharged its responsibility of earning high returns for its investors by deploying capital in companies privately rather than by buying shares in the public market. (Hence the name, private equity.)

The point Rattner of course doesn’t delve into is this one: how taxpayers effectively subsidize this process because of tax law.

So what are the question marks (promised above) around the story of Romney and Bain Capital? First, it’s fair game to question the amounts of debt that are sometimes used in leveraged buyouts. While higher debt usually means higher returns — because debt is cheaper than equity, thanks in part to its tax deductibility — it also means higher risk of bankruptcy.

The problem, as private equity guy and public monies-scamming Steve Rattner sees it, is all this debt leads to more bankruptcies.

But what does it mean that all this debt incurs tax advantages?

Thankfully, Rortybomb posted this interview with Josh Kosman, who wrote a book on the topic, to explain it.

Your research has found that, far from being natural, private equity exists largely due to issues with the tax code. Can you explain?

The whole industry started in the mid-to-late 1970s. The original leveraged buyout firms saw that there were no laws against companies taking out loans to finance their own sales, like a mortgage. So when a private equity firms buys a company and puts 20 percent down, and the company puts down 80 percent, the company is responsible for repaying that.

Now the tax angle is that the company can take the interest it pays on its loans off of taxes. That reduces the tax rate of companies after they are acquired in LBOs by about half. Banks, also realizing this tax effect, were willing to finance these deals. At the time, you could also depreciate the assets of the company you were buying — that’s not true today.

They saw that you could buy a company through a leveraged buyout and radically reduce its tax rate. The company then could use those savings to pay off the increase in its debt loads. For every dollar that the company paid off in debt, your equity value rises by that same dollar, as long as the value of the company remains the same.

So the business model is based on a capital structure and tax arbitrage?

Yes. It’s a transfer of wealth as well. It’s taking the wealth of the company and transferring it to the private equity firm, as long as it can pay down its debt.


A recent paper from the University of Chicago looking at private equity found that “a reasonable estimate of the value of lower taxes due to increased leverage for the 1980s might be 10 to 20 percent of firm value,” which is value that comes from taxpayers to private equity as a result of the tax code. Can you talk more about this?

That sounds about right. If you took away this deduction, you’d still have takeovers, but you’d have a lot less leverage and the buyer would be forced to really improve the company in order to make profits. I think that would be a great thing.

The whole interview very accessibly lays out precisely what I was trying to get at the other day: there are aspects of private equity that have bad consequences baked in. And they’re all baked in, in part, precisely because taxpayers are subsidizing the takeovers in the form of tax benefits.

Or welfare, as the creative destructionists ought to call it.

Update: Per prostratedragon, see this Dean Baker diary putting some numbers to this rich person welfare.

11 replies
  1. sd says:

    Is there a positive side to private equity firms? I have yet to find one.

    Private equity firm = asset stripper

    A nice example here: Profits for Buyout Firms as Company Debt Soared
    By Julie Creswell, NY Times, October 4, 2009

    …More than half the roughly 220 companies that have defaulted on their debt in some form [in 2009] were either owned at one time or are still controlled by private equity firms, according to analysts at Standard & Poor’s.

  2. prostratedragon says:

    At FDL there’s a post from Dean Baker that includes a numerical example to show how money can be transferred from taxpayers to the vultures, among other non-value-creating rearrangements.

  3. Gitcheegumee says:

    It would be of interest to review the Wikis on Bain Capital and TPG Capital.

    The intersections (and timings thereof)between Bain, Carlyle, Goldman Sachs and TPG Capital are particularly interesting,imho.

    Bain Capital – Wikipedia, the free encyclopedia

    In July 2002, Bain together with TPG Capital and Goldman Sachs Capital Partners, announced the high profile $2.3 billion leveraged buyout of Burger King from …


    TPG Capital – Wikipedia, the free encyclopedia

    In July 2002, TPG, together with Bain Capital and Goldman Sachs Capital Partners, announced the high profile $2.3 billion leveraged buyout of Burger King from …

    (NOTE: These Wikis have a great deal of info-far beyond just BK .)And,btw, Bain and TPG have /are currently involved in a controversy involving an India based children’s wear company,Lilliput. (I await the Gulliver comments.)

    PE investors Bain Capital and TPG accuses Lilliput owner Sanjeev Narula of fudging accounts; Narula says PE funds trying to stall Rs 850 cr IPO
    Chaitali Chakravarty & Pramugdha Mamgain, ET Bureau Oct 13, 2011, 08.54am ISTTags:
    TPG Capital|TPG|Shriram group|Sanjeev Narula
    NEW DELHI: Six directors and the external auditor of kidswear company Lilliput have resigned, as private equity (PE) investors – Bain Capital and TPG – have accused founder Sanjeev Narula of fudging accounts, who in turn has alleged the PE funds are trying to stall the company’s Rs 850-crore IPO and seize majority control.

    The outbreak of hostilities between the main shareholders has thrown the company in disarray and prompted the board to take the unusual step of disapproving the company’s financial statements for FY11

  4. Gitcheegumee says:


    Lilliput Gets Bain Capital, TPG nod to raise Rs 500 crore – Economic … › Collections › Capital Market

    Dec 6, 2011 – NEW DELHI: Lilliput Kidswear Ltd will raise up to Rs 500 crore through a private placement of shares after miffed shareholders Bain Capital …
    Court orders Bain Capital, TPG to offer shares in Lilliput Kidswear to … › Collections

    Nov 3, 2011 – NEW DELHI: The Delhi High Court on Wednesday restrained private equity investors Bain Capital and TPG from selling their shares in Lilliput …

    PE investors Bain Capital and TPG accuses Lilliput owner Sanjeev … › Collections

    Oct 13, 2011 – NEW DELHI: Six directors and the external auditor of kidswear company Lilliput have resigned, as private equity (PE) investors – Bain Capital …

  5. Bob Schacht says:

    Someone on MSNBC made an interesting point that the debate on Bain & Romney is splitting the business-friendly Republicans into two camps: those partial to traditional business enterprises (i.e., that make real stuff, or provide real services) from those “vulture capitalists” who make their money by stripping assets from the companies they acquire.

    And I have a suggestion for those trying to block Romney’s nomination: Employ the Newt-Ron Bomb!

    Bob in AZ

  6. Sparkles the Iguana says:

    Josh Kosman’s book (The Buyout of America) is worth reading. He says the very high cost of mattresses by Sealy and Simmons (ever notice how ridiculously expensive they are?) is due to PE buyouts; they kept raising prices to increase revenues, even as their market share fell. Between 2012 and 2015, $700 billion in loans borrowed by PE owners will come due. Kosman says this will produce “the next great credit crisis” and plunge many of those companies into bankruptcy.

    It’s hard to get government to rein in PE, though, because the revolving door revolves so reliably. Treasury secretaries Baker, Brady, O’Neill, and Snow all went to PE firms. Bill Clinton and both Bushes have advised PE firms. Barney Frank was a big fan of PE.

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