Thursday, January 19, 2012

Our Bain Capital problem

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Exclusive - Joe Nocera Extended Interview Pt. 1
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This is the first part of Jon Stewart's extended interview with Joe Nocera, business columnist at the New York Times (here are part 2 and part 3).

I don't usually post these. Normally, I don't even watch them. But I thought this was interesting, and I just had to blog about it. Believe it or not, that ungodly long post I wrote earlier today was merely an introduction to this one. (I promise that this post won't be quite so long.)

That was about Bain Capital as a political problem for Mitt Romney. This is about why we should all have problems with Bain Capital, at least to some extent. Note that I'm not an expert in private equity investments, far from it. And I don't want to pretend otherwise. So please keep that in mind.

According to Wikipedia, Bain Capital is an asset management and financial services company which specializes in private equity and venture capital deals, as well as other investments. Romney has taken criticism primarily from Bain Capital's leveraged buyouts, I think (and also because he's a very wealthy man who apparently pays little in taxes and wants to cut taxes even further for rich people like himself).

Leveraged buyouts occur when wealthy investors acquire control of a company by borrowing most of the purchase price, generally using the assets of the company they're acquiring as collateral for the loan. Usually it's a troubled company, because they're cheap. But the buyers end up with a troubled company and an enormous debt.

You might well wonder how that would pay. Typically, the new owners don't plan to run the company, or not for long. They'll try to get the company back on its feet, and that usually involves slashing costs - laying off workers and closing factories - as well as selling off parts of the company (or sometimes buying other companies to merge with it). Then they'll try to sell the company and start over again somewhere else.

Meanwhile, they generally suck all the money they can out of the company. They pay themselves lavish management fees, while loading up the company with debt. If they're unsuccessful, the company will go bankrupt, and they'll lose their ownership stake. But they'll keep their multimillion dollar fees.

And they probably won't have much of an ownership stake by then, anyway, since they'll have loaded the company with so much debt. It's like owning a house with an enormous mortgage. If you walk away from that, the bank will likely lose more than you will, since you won't have much cash in it.

If they're successful, they'll sell the company to someone else. And it might survive and even thrive. But it will have to make interest payments on that debt. That's an extra cost, of course, which probably didn't go to investing in the company itself, but only to enrich the leveraged buyout people.

I want to acknowledge, right from the start, that there are good things about this kind of economic activity. It's tough when people lose their jobs. It's tough when businesses fail. But, overall, it's a very good thing that business can fail.

American business has been strong because it continually reinvents itself. Some businesses thrive, others go bankrupt. Some businesses are purchased, others purchase them. Businesses merge or sell off pieces of themselves. Creative destruction is a very good thing, in general.

And yes, it's a good thing that people can be laid off or fired. It's hard on them, of course. No one wants to lose  his job, and it can be positively disastrous for some people. But what does that mean?

It doesn't mean that we should guarantee lifetime employment, because the cure would end up worse than the disease. Instead, it's just a very good reason to have a strong social safety net. And it's probably a good reason to have adult education and training programs, too.

Maintaining a dynamic business environment, keeping that creative destruction, is a good thing, despite the very real costs to very real human beings. But that's where things start to get a little weird, at least when it comes to right-wing thinking.

The same people who shrug off the firing of thousands of workers typically don't want to spend a nickel on a social safety net which would help them get back on their feet. At the same time, wealthy executives make sure that their own contracts includes a "golden parachute," so they won't suffer even if they're fired for poor performance.

And when it comes to leveraged buyouts, it's almost a win/win. Even companies that went bankrupt still produced a huge profit for Bain Capital, because they weren't the ones left holding the bag. Here's an example:

According to this information from the Boston Globe, Bain Capital used only $5 million of its own money to buy Ampad (American Pad & Paper). Seven years later, the company went bankrupt. Ampad's workers lost their jobs, and Ampad's stockholders ended up with nothing.

But Bain Capital made more than $100 million on the whole thing. Not a bad return on a $5 million investment, huh? A 2,000 percent return in just seven years? True, the story of this apparently cost Romney a U.S. Senate seat. But other than that, they made out like bandits. And this was one of their failed investments! And yeah, it's all legal, too.

In fact, it's not just legal, we actively encourage it by giving these wealthy investors a huge break on their taxes. For one thing (I mean, in addition to myriad deductions and loopholes), we let these people pay the long-term capital gains rate on their fees, and that reaches a maximum of 15 percent (a minimum of zero).

On the other hand, if you work for a living, you pay income tax rates of 10% to 35%, plus another 7.65% (currently, Obama's temporary payroll tax reduction has dropped that to 5.65%) on payroll taxes on your first $106,800. (Yes, if you're a high-earner, you actually pay a lower effective payroll tax rate than those who make less than that, but that's a subject for another post.)

It's not that all of these people do nothing of value. Good management is valuable. And taking a troubled company and making it profitable is a good thing. But they call these people corporate raiders for a reason. This isn't about good management, certainly not for the long haul. This is about raking off all the cash you can, and then escaping with the loot before the consequences hit home.

Even so, I'm not saying that it should be illegal (not with appropriate safeguards, at least), but why should they pay a lower tax rate than you do? Is this so valuable to our country that we actually need to give them tax breaks?

Jon Stewart and Joe Nocera mention some of these things in that extended interview. As Stewart says, we value capital over labor. We give investors, who tend to be the wealthiest people of our land, a huge tax break from what they'd pay if they worked for a living.

Is that justified? Maybe it is, but why? Why isn't work valued? Why should we deliberately favor the wealthy? (Not just the wealthy, of course, but overwhelmingly so.) Capital gains rates are at record lows these days.

Here's the Center for American Progress:
The benefits of preferential rates for capital gains are enjoyed by the wealthiest Americans because they’re the ones who tend to receive this type of income. More than 70 percent of the benefit goes to taxpayers with annual income of more than $1 million, a group that comprises only about 0.3 percent of all taxpayers.

Our income tax system is designed to be “progressive.” That is, we generally agree that people with higher incomes should pay a greater percentage of their income in federal income taxes, because they can afford to pay more. But because capital gains are concentrated at the highest levels of income and taxed at favorable rates, many of the most affluent taxpayers pay a lower effective tax rate than those beneath them on the income scale.

The low rates on capital gains (and dividends) are the reason why billionaire investor Warren Buffett reportedly pays the lowest-overall tax rate of all the people who work in his office, including his receptionist.

Tax data show that Buffett’s informal office poll is, in fact, representative of average tax burdens. The richest 400 U.S. taxpayers in 2007 paid an effective tax rate of just 16.6 percent. That’s largely because more than two-thirds of this group’s income—which averaged [my emphasis] $345 million—was in the form of capital gains and dividends, while most Americans are paid in salaries and wages.

This select group probably includes some managers of hedge funds and private equity funds, who enjoy another special loophole allowing them to treat most of their investment-management compensation as capital gain instead of ordinary income—vastly lowering their taxes.

As Stewart says, you're called a "socialist" these days for even wondering out loud about these things. In this age of vastly increasing income and wealth disparity, at a time when the 400 richest Americans own more of America than the bottom 50% of us, when the poor are getting poorer and the middle class are struggling, yet the rich are making out like bandits, why can't we even question this?

(TPM - click chart to embiggen)

We can't have a social safety net, because that will make the poor lazy. Yet we should eliminate estate taxes entirely, so that wealthy heirs never have to work for living? Somehow, we're not so concerned about their moral fiber, are we?

And we're right to worry about moral hazard. But why don't we ever worry about moral hazard when it comes to the wealthy? Well, the people who run our country tend to be wealthy. Their friends are wealthy, their business associates are wealthy, and they're quick to recognize the problems of the wealthy.

Now, Democrats at least try to think about the middle class. They may not be very good at it, but at least they usually try. Republicans tend to be nothing but class warriors. They care only for the wealthy.

Creative destruction is a good thing. That's one of real strengths of America's economy. But the pain of it falls entirely on the workers. Meanwhile, we taxpayers actually subsidize these leveraged buyout investors who tend to win even when everyone else loses. Should we be giving those Bain Capital people such huge tax breaks? Is what they do really that valuable to our nation as a whole?

Don't you think they'd be able to make money - maybe not quite so much money - if they had to pay normal tax rates? And is what they do so much more valuable to America than what you do that we have to give them preferential treatment? I just don't see it, myself.

And make no mistake, if they're paying less, you're paying more. If someone else gets a tax break, you help pay for that.

And when it comes to Mitt Romney,... well, anyone who keeps his money in the Cayman Islands, to avoid paying taxes in America, should be disqualified from becoming President of the United States, don't you think? Taxes support our country. Even if you value nothing but the military, you should recognize that it's taxes that pay for it.

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