Private Equity and the Next Credit Crisis

My September Book Lust column included a preview of Josh Kosman’s book, The Buyout of America: How Private Equity Will Cause the Next Great Credit Crisis, which was released this month.

Monday I heard Kosman interviewed by Fresh Air’s Terry Gross (on NPR affiliates everywhere).

FASCINATING STUFF, including:

• How interest tax deductibility allows private equity (PE)  firms to dodge about $70b in federal taxes
• Why you can’t buy a two-sided mattress any longer
• Why PE  likes the hospital industry (and what it could mean to you if your local provider is bought by PE)
• PE firms (including the companies they own) are the largest employers in the country; even larger than Walmart (by a mile)
• Four of eight former treasury secretaries now in PE.  John Snow (under G. W.  Bush) is now at Cerberus which finagled bailout funds for its company, GMAC, by turning it into a bank (even though it didn’t have capital reserve requirements of “real” banks)
• Buyouts are facilitated by Collateralized Loan Obligations  (CLOs), the private equity version of the mortgage industry’s Collaterelized Debt Obligations (CDOs)
• Returns to PE  investors are below that of the S&P 500

SCARY STUFF, including:

• The conservative Boston Consulting Group estimates that half the companies owned by PE will default on their loans or go into bankruptcy
• If these companies lay off half their employees (which is reasonable) another 1.9m people will be out of work, which will ripple through the economy in consumer spending, mortgage foreclosures and so forth
• The trillion in bad debt will freeze lending everywhere
• Of the current 11% corporate loan default rate, 50% has PE involvement. Tsunami of defaults has begun

Prescription

Kosman would like to eliminate interest tax deductibility for corporate takeovers. This would make LBOs unprofitable and end the industry.

Why is the end of private equity considered a good thing?  Don’t buyout firms improve companies? According to Kosman,  PE firms only put down about 20% of the purchase price, then use CLOs to fund the remaining 80%. The acquired company has to service the debt out of profits instead of spending that money on R&D and other capital expenditures. PE has a 4-5 year horizon on its exit, so they’re not running companies for the long haul.  Theoretically, everyone’s supposed to win with PE, but the record shows that few do.

The Obama administration is reportedly looking into this.  Paul Volker is charged with considering the whole tax code, including tax deductibility of interest for buyouts.

Writing Prompts for Blogs and Newsletters:

• Here’s your chance to defend PE, and the enabling triumvirate of i-bankers,  hedge funds and ratings agencies!
• Do you work for a pension fund that invested in CLOs? How will you assure participants that YOUR CLOs will perform in spite of the 11% corporate loan default rate Kosman cites?
• GMAC fired its CEO this week. Do you regret giving TARP money to this non-diversified auto lender-cum-bank?
• Do you have a better idea for recouping the estimated $70b in federal taxes lost to PE deals than dis-allowing interest deductibility? Are we in for a national value-added tax or sales tax?

My NPR 3-minute Fiction Entry

I entered NPR’s Three Minute Fiction contest.  The rules are straightforward: using a prescribed first sentence, write a short story in less than 600 words. If I’m the big winner, I’ll be interviewed and have my story read on-air during Weekend All Things Considered and receive an autographed copy of the book “How Fiction Works” by  The New Yorker’s James Wood, who’s judging the contest.

Here’s my submission:

The nurse left work at five o’clock.  He knew what he was doing, leaving mid-shift, but it was time for a change. A mid-shift departure would make change inevitable.

Leaving the employee parking lot, he waived at the attendant and switched on the news.  More reports of layoffs, expiring unemployment benefits, bank failures…yet, he’d walked out.  Mid-shift.

Pulling into the potholed parking lot, he scanned the fenced-in runs to see if it really was Scamp they’d brought in.  “Puppy prison,” he’d called it when his parents took him to the pound to choose a dog for his 8^th birthday.

Prison. Maybe he’d apply for a job at a prison – plenty of job security in a growth industry like that. Maybe he could get a job working on death row, keeping the guys alive until the state could have its justice. He might enjoy working with those who’d accepted their ultimate fate, for a change.

Just an hour before, he’d advised the Johnson family that without a Do Not Resuscitate Order on file, the staff was obliged to keep their mother alive if possible.  Of course he didn’t go running to an administrator just because Mrs. Johnson’s daughter slapped him, but his former co-workers would draw the conclusion that it was the “Johnson family incident” that finally took him over the edge.  Cardiology was notorious for unruly family outbursts. Was it because there was usually no time to plan?

Death row. Opening the door to Puppy Prison he wondered how many they’d gassed today.  The uniformed clerk looked up from her filing and smiled as if she worked at Dairy Queen, not Auschwitz. “Here to pick out a pet?”

“No, my vet called to say you might have picked up my dog – a beagle mix with an attitude.”

“Oh, yes, good thing he had a rabies tag. C’mon back.”

Fifteen minutes later and $50 lighter, he and Scamp merged back into traffic.  Fondling Scamp’s notched ear from a long-ago-lost battle, he mused what a perfect match they were – their sweet faces belied a tendency to pick fights they couldn’t win.

Moving his hand to his own lightly-califlowered ear, acquired four days after he’d started the job he’d just essentially quit, he felt the irony that in that case, he’d tried keep a patient from taking his own life. God, that guy was strong. A monster.

Swerving to miss a kid on a skateboard, the sudden jolt swept Scamp and the cell phone onto the passenger floor.  Scamp was no worse for the wear, but the nurse wondered if this was the last tumble for his old phone. He’d resisted replacing it because all the new phones had features he didn’t want.  “Simplicity” was his new watchword.  Life had gotten too complicated.

After a traffic report, NPR ran a story on the nation’s death panel hysteria. Yeah, everyone’s a little crazy right now. The living take their lives and the dieing want to prolong theirs. Whatever happened to the role of Providence in these things?

Pulling into his driveway alongside the lime green Beetle driven by the home health aide, he was glad his father was past noticing the early hour of his arrival. Pop’s days and nights were indistinguishable to him now.

Scamp pushed past his master. Trotting straight to the living room where they’d set up Pop’s hospital bed, the dog uncharacteristically stopped and whimpered.  The aide looked up; “I’m so sorry,” she sobbed, “I tried calling your cell phone ten minutes ago.”