Private Equity Myth
As many of you know, David Brooks is one of the few conservative columnists that I regard highly. But occasionally he writes something that is so boneheaded, it makes you wonder. Such a column was his defense of Mitt Romney and the Private Equity Business this week. Here is Brooks.
Forty years ago, corporate America was bloated, sluggish and losing ground to competitors in Japan and beyond. But then something astonishing happened. Financiers, private equity firms and bare-knuckled corporate executives initiated a series of reforms and transformations.
The process was brutal and involved streamlining and layoffs. But, at the end of it, American businesses emerged leaner, quicker and more efficient.
This version of the 1980′s could have been written by one the hundreds of Lobbyists deployed by the Private Equity Industry in Washington. That was probably where Brooks “researched” his story. The real history of the era is quite different.The 1980′s was the start of the financialization of American business, with it’s wave of complex financial instruments that only a quantum math scholar could decipher. Writing after the Great Depression of the 1930’s, the economist Joseph Schumpeter spoke of “vanishing investment opportunities” by which he meant that the enormous growth of productivity, combined with the oligopolistic pricing structures of American capitalism generated a growing surplus which went beyond the capacity of system to absorb it. As I researched this post I began to wonder if Schumpeter’s concern still applied to the American economy and certainly Ben Bernanke in a 2005 speech called “The Global Saving Glut”, seemed to believe so. American capitalism had always been a boom and bust cycle as an historian of the Panics of 1837, 1857, 1869, 1873, 1893, 1903, 1907, and 1929 would know. However, by the late 1960’s economists had come to believe that fiscal and monetary policy had eliminated the extremes of the business cycle. But by the mid 1970’s, after the Arab oil embargo, the American economy began to fall into a condition known as Stagflation—a brutal combination of business stagnation and unemployment mixed with the inflation brought on by rapidly rising energy prices.
The low return on equities left institutional investors dissatisfied until a financial Svengali by the name of Michael Milken arrived on the scene in late 1978 at the firm of Drexel Burnham Lambert. The solution to the ailing American business economy was simple Milken stated. What was needed was leverage: much more debt to each dollar of equity to “juice” the returns. And since many of the companies Milken wanted to work his magic on were considered less than credit-worthy, Milken invented his own currency: the Junk Bond.
What followed was an orgy of corporate raids and leveraged buyouts, all financed by a circle of Savings and Loans that loved the Junk Bond 11% coupon and were confident that Milken would always keep the market for the bonds liquid. Thus began the financialization of the American economy. Whereas the conventional capital structure of the American corporation had been relatively conservative, now any corporation that wasn’t leveraged to the gills would find itself a target of Milken’s Raiders. I saw this first hand in the spring of 1984 at Walt Disney when I was working as an independent producer on the lot and in the subsequent months when I worked to “save the Mouse”.
The reason America is in a good place today is that companies like Apple , Intel and Google spend Billions on R & D. But you look at the history of most leveraged buyouts (the technical term for private equity transactions), and one of the first budgets to be slashed (in order to pay for the huge debt) is R & D. That’s why Nabisco is an also ran company. The LBO killed new product innovation.