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”.

Now private equity may be a brilliant piece of financial engineering in the Post Milken era, that is useful for reconfiguring older, steady cash flow businesses, but one would be hard put to believe it had anything to do with the American innovation that is driving the Digital Universe. Take the 20 most innovative companies in America, including Apple, Google, Intel, Amazon, Microsoft: private equity has had nothing to do with these companies. Koch Industries (the shining star of Private Equity) may be a brilliant money machine for the Koch’s and their private partners, but it has nothing to do with American Innovation. It makes the most unrecyclable paper towels in the world for God’s sake.

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.

What’s so ironic about Brook’s column is that it was in the America of “40 years ago” that all the core inventions that power the Digital Age were made. Mostly at Bell Labs (picture above), a subsidiary of the monopoly telephone company, A T & T. Because A T & T didn’t have to spend billions on advertising (A T & T spent almost $2 Billion last year), they could dedicate a huge budget to their R & D Lab. As written in The Idea Factory: Bell Labs and the Great Age of American Innovation  the transistor, the microchip, the solar cell, the microwave, the laser, cellular telephony all were invented along with myriad other things we take for granted. The other part of our current world was sponsored by the Government. DARPA financed all of the original Internet Research and deployment.
Of course this whole story goes against the Ayn Rand Myth that so many conservatives live off of. Large corporations in cooperation with great research universities and government funding invented the future. This could not happen in Rand’s universe, or evidently in David Brooks’ either.
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26 Responses to Private Equity Myth

  1. morgan warstler says:

    Babble. Babble. Yawn.

    Good Jesus, the now we have today isn’t as great as it can be because we were so hobbled by the system you wanted to get back to.

    The Internet should have come EARLIER, the price of telecom should have fallen faster.

    Milken HAD TO HAPPEN because the new start up companies the young new companies meant to DESTROY the old companies weren’t being properly valued.

    Man you are an old guy clamoring for the days of your youth, I just can’t get – do you not remember how bad it SUCKED?

    I had to go sit in the editor’s office in the local newspaper to read the newswires because the there wasn’t enough new daily information trucked in Canton.

    Phone calls to South Africa cost $30!

    Jon, you want to tax everyone at the ISP level and give the money to musicians!

    You are off your gourd.


    If it can be copied everyone on the planet deserves a copy for nearly free, no matter what guys like you say.

    If it cannot be copied it must be protected at all costs from guys like you.

    You have it all exactly backwards.

  2. Fentex says:

    Leveraged buyouts are destructive, but they shouldn’t be a threat to any economy where financial businesses aren’t privileged.

    And they aren’t an argument for (or against) public research.

    I agree that this ‘financialization’ of economies is a bad and foolish thing, but that isn’t an argument for anything but not privileging the financial sector – not protecting it from failure, not excluding it from honest regulation, not refusing to enforce legal requirements and let it’s deals stand or fall on their own merits.

    The corruption of legislation and oversight is the problem and is unrelated to choices in research investment. And these are issues are also separate from arguments about liberalisation of regulation itself.

    It is inaccurate to present the oligarchial privileging of some over others as the same argument people have over how much and what sort of regulation is best for free people to maximize their wealth and fund cooperative society.

    It creates a false dichotomy of two choices – either leveraged plundering or strict public control. Those are nuanced positions on several axis of choices in regulation, taxation, representation and investment.

    It is the privatizing of profit and socialization of risk that is the core evil of these deals which needs be dealt to. Other issues of how to proceed present many options and choices.

    Slay the corruption and economies can adapt to a myriad of differing configurations providing they aren’t being eaten by the cancer of corruption.

  3. Jon Taplin says:

    @Morgan-As usual, you put forth your knucklehead notions without any thought for the consequences. In your view, anything that can be turned into digital code has no value (books, music, movies, games). I assume that is because you long ago gave up on any notion that you had any talent and so feel that those with talent should give you their work for free. You define the freeloader. You are such an idiot, I sometimes wonder why I even bother responding to you.

  4. Jon Taplin says:

    @Fentex-I’m not arguing about the regulation of Private Equity. I am just suggesting that David Brooks’ notion that all the benefits of our current age of capitalism flowed from the creative destruction brought on by the corporate raiders. I would argue that the role of venture capital, not private equity was far more determinative of our current age.

  5. JTMcPhee says:

    @Jon Taplin
    One might ask, as things seemingly get increasingly squirrelly and mortal, what kind of money creation and flow is likely to keep us from species suicide in the always-just-over-the-horizon-beyond-the-storm-clouds-and-fog-of-war next age?

  6. morgan warstler says:

    @Jon Taplin

    No, I very much know it has value, I just think that the profit level is naturally fixed, and then the more people who consume it, the less it costs per person to consume.

    Jon this is just DIGITAL ECON 101, ask yourself what would happen if food can be copied.

    Seriously. That answers your question.

    Say we could copy steak and arugula and great beer and bread etc.

    We wouldn’t want farmers to starve, but we’d also want everyone on the planet to have whatever food they wanted.

    You’d FREAK OUT if we could copy steak, and didn’t let everyone have it.

    Art is part of information and information is FREEDOM.


    The point is that art hasn’t suffered since the Internet, it has flourished… Jon if you spent a week at SXSW in Austin with Pappy and I, you’d have access to more good music than you had at Woodstock.

    It is literally overwhelming. 2000 bands on 200 stages over 5 nights.

    The crazy thing is the all the great acts are the little guys, the headliners are always a yawner.

    And this all adds up to a surge in ticket prices since 1998.

    Why? because the barrier to entry to become a “fan” of the band is zero.

    So there are 10x as many fans clamoring to buy the tickets.


    Or look at China, India and Africa where they have NEVER PAID for music. Does music suffer there?

    Anyhoo Jon, like most things you are a self-interested guy who wants to seek rents from everyone else.

    Call me an idiot all you want, but up above, those are facts, and those facts strung together make an argument, and that argument it kicks your ass.


    Jon you know a lot of old musician, lots of guitar players. One of your readers here, he makes guitars, do you make a bunch of calls promoting him?

    Just asking.

  7. len says:

    To keep it tidy, the role of IBM was not insignificant. Take a trip to IBM Almaden and take the tour. Digital was another (the VAX/VMS did more to bring computing to the network age than any other machine with possibly the exception of the Apollo).

    Believe it or not, Apple’s role is largely insignificant by comparison to IBM. It doesn’t fit in your creative myth, but it is the fact. The IBM PC made the web possible. The MAC turned it into a spoiler’s backyard rotisserie.

    Otherwise, spot on. Private equity has served to destroy more than it ever built. Venture capital builds but then it takes for itself and has the same effect on the lives of the real creators of the jobs: the designers and implementors. The best companies do what the best families do: sweat for it, keep the spending in line with the income and focus on the tasks at hand instead of pursuing growth for its own sake. The most destructive lie foisted on business in the last fifty years is “we work for the stockholders, not the customers”.

  8. John Papola says:


    I hope the administration is at least paying you for your near-daily campaigning and lock-step repetition of talking points. Sheesh.

    Meanwhile, Peter Orzag went from Obama OMB director to Citigroup VP of cronyism, Tim Geithner is still Treasury secretary, Jon Corzine is still bundling for the campaign, Rahm Emmanuel (Wall Street and GSEs) was replaced by Bill Daley (JP Morgan) who was replaced by Jack Lew (Citigroup) as Obama’s chief of staff. Obama has literally surrounded himself by Wall Street cronies.

    But yeah. Party on… or bring it on… or whatever the team sports fraud lingo is. Because only Silicon Valley has done any innovation at all in the past 30 years. Our entire economy is composed of digital goods. There’s been NO innovation in manufacturing processes, global supply chains, telecom, consumer goods design, automobiles, heavy industrial machining, or the rest of our 15 trillion dollar economy. And of course we know this because Koch Industries isn’t in silicon valley and therefore anything similar to Koch’s bread-and-butter resources and physical goods businesses can’t have anything good at all because they’re the real cronies, not the long list of actual cronies I noted above. Right? Right? Wait.. let me check the Axelrod memo… yeah… that’s what he said. I mean, that’s the truth!

    Sigh. I haven’t registered to vote yet in Texas. I don’t think I’m going to bother. There’s no good vote for me to cast.

  9. Fentex says:

    I haven’t registered to vote yet in Texas. I don’t think I’m going to bother. There’s no good vote for me to cast.

    I very much disagree with this attitude. If a class of people hold such an idea then their interests will only become increasingly marginalised and unrepresented.

    If a politican ever asks you what they need to do to win your vote, and the answer is “I may vote if you do this..” they’ll stop listening because people who are assured of voting for someone are more valuable to them than someone who needs to be convinced to vote at all.

    And they are asking these questions constantly through proxies and researchers in polls and focus groups and we are answering in public forums and private bitch sessions where us, our friends and acquaintances spread ideas and decisions.

    It is not noble nor responsible to sigh and damn them all as blaggards and thieves and surrender the field to enemies who will only be pleased to see foes flee in the face of their influence.

    As my father summarised it for me as a youth, “if you don’t vote, you’ve no right to complain about the result”.

    Elections aren’t about choosing the best conceivable person for the job, they’re an imperfect compromise to limit abuse of power and every elector has a responsibility to exercise their best judgement and vote for the best candidate, even if it means swallowing some bile.

  10. morgan warstler says:

    @John Papola

    Go vote for Cruz. I debated him all through college, he’s a true believer, but he’s definitely a small govt. conservative..

  11. John Papola says:

    I will probably register when I get around to it so that I can vote in the local elections. But my other activities are worth dramatically more to democratic progress than my personal vote. My personal vote is virtually worthless.

  12. morgan warstler says:

    @John Papola

    ah but if you vote, then you can get on a jury and force them let a pot smoker go free. besides you might need to run for office some day.

  13. John Papola says:

    PS… I will be voting for Gary Johnson for president if he’s on the ballot. Man… now I feel like I’m REALLY making a DIFFERENCE!

  14. Rick Turner says:

    Thank god I’m too sullied to ever run for anything other than wastebasket emptier…

  15. len says:

    @Rick Turner

    Of the things I’ve lost, I miss my reputation least.

    Objectivism fails in the notion that it is the individual who is the source of innovation and greatness in a free market. In fact, there are no free markets and a person who withdraws from interaction with a society soon has nothing to think about. It is the seeming paradox of a woman who wants to be judged on the content of her character and not her bra while shopping for a push-up. We cannot escape the need to interact to discover what is of the most value to us or others. If we believe the recourse is to only interact with the best, we soon become archaeologists or apologists or dammed liars.

    Creativity is not the art of working with the finest; it is taking what is at hand and making it fine. God started with mud and however you feel about the results, even a mudball polished well will shine. It is not a matter of quality of substance; it is a matter of investment of effort.

  16. len says:

    Another missing piece from Jon’s piece that goes to the heart of the Objectivist vs Progressive debate is the critical role of standards in creating the world of abundant opportunity for the motivated individual (objectivists and progressives are of the same currency). This one keeps the NSA threat folks up at night because of the problems of buying standards-based components at the lowest cost without understanding how easy it is to put malware in both software and hardware. Still without the rise even if transitory of dominant standards created the engineered results of lab innovations.

    Standards ARE the controllers in open markets but designing them is quite hard and the timing of fielding them critical to the success. Too early, fail. Too late, stagnation. Pick the wrong members of the committee, fail. Pick the right members with the wrong motivations, fail. Understanding how to win in this domain opens a window into the randian lofty goals and how they can turn innovation into just another bowl of tapioca. Standards have to come about at precisely the moment the market opens AMONG product lines (it has nothing to do with lofty motivations; it has everything to do with the practical realities of complex products that must be integrated at a price point).

    Apple only uses standards it owns just as IBM once did until it published a standard it couldn’t protect, cared very little about and lost control of to those willing to steal it because they knew how to use it: SGML. Silicon Graphics gave away Open Inventor and it became VRML. VRML is said to have failed but it never goes away. WebGL is said to be winning but so far there are no products worth owning. Again, a push up bra has utility but don’t offer it up as a triumph of feminism. Understanding why one could use one and still advocate against limiting opportunity based on gender is.

  17. len says:

    And if you want the article that frosts the most noses here and elsewhere (tim bray is seething and nick carr enjoys that), here it is:

    A long but worthwhile read even if as a musician/composer after reading it, you burn your studio and take up selling servers. Best line even if an aside:

    The genius of Steve Jobs was that he was not afraid to be greedy.

    A pure randian wabbit hunter if ever there was one at the stag film at eleven.

  18. Jon Taplin says:

    @Len-On standards, I’m a bit over my head, but wasn’t Apple’s QuickTime video just MPEG4?

  19. morgan warstler says:

    Jon right after Intertainer, I spent 3-4 years running around foreign lands trying to get web video streaming to the set top.

    Sigma Designs, was essentially built on piracy, they were the first to put the Divx / Xvid codecs into a DVD chipset… soon every Chinese manufacturer had a DVD player that played “VCD” – so the downloaded movies could get to the TV.

    len, it was supposed to all come together as stanards – MSFT had VC-1 (WMV9) and everybody else thought they’d extract royalties on H.264.

    So the SoC were all written and they were eeking our just enough power for a Mac/Phy layer (to do networking) and Overnight all those videos encoded in WMV sitting online in web sites were going to BE ON TV!

    And BAM! Adobe licensed the On2 VP6 codec and put it into Flash – the web site publishers saw it, and within a year there weren’t any web videos in WMV anymore… and the age of YouTube was upon us.

    All the hardware for low cost set top boxes suddenly had no content. NO CHIPS could play FLV.


    And then finally as the $15-20 GPUs had power to spare (roku, Vudu, etc.) and Google bought YouTube and converted everything to multi-codec…

    GOOG bought On2 and open-sourced VP8.

    A holy cluster-f*ck to my jaundice eye.


    The hysterical thing, and lesson is: the pirates all get together in a IRC chat and decide en mass overnight the new codec will be H.264 for all “new releases” and it just happens.

    Because none of them have a financial interest in IP, they just want to save themselves time!


  20. Fentex says:

    wasn’t Apple’s QuickTime video just MPEG4?

    It’s an implementation of H.264/MPEG-4 (Part 10), a.k.a Advanced Video Codec (AVC) a.k.a MP4.

    An interesting read. Part of it made me think of another benefit that may have accrued from not protecting failing financial businesses;

    At one point David Lowery mentions how expensive financial transaction fees are and muses why don’t the big tech companies try and do something about that (to improve the digital ecosystem)?

    I wonder if financial institutions weren’t privileged and protected would competition drive these transaction prices down, as well as making failed companies available for purchase (not having propped up values) by online companies interested in improving the pipeline from customer to their coffers?

  21. len says:

    Jon, MP3 and 4 are member-only, pay to play specifications to implement. They are standards in that sense of a consortium makes all the decisions, not the customers. They have their place in the sense Ford made that if he had asked the customers what they want, they would have asked for a faster car.

    Still, circling to the outcome of so much economic banter. As JTMC noted, knowing what to measure, how to control and where the course goes or what it avoids is critical. As you know, standards are a stag hunt. Apple is a wabbit hunter. The irony is, it is the sine qua non of objectivist philosophy to consider others first as immoral.

    Is Apple at heart an almost pure expression of Randian philosophy? As David Lowery notes, as a stock holder, Jobs did exactly what he would want. As an indie producer or really any artist, not so much. To be fair, they are not alone in that, simply holding the biggest guns and that contradicts the Randian notion that wealth or advantage obtained by force is also immoral.

    Too much purity desired by progressives and too much risk avoidance by conservatives tends toward a logjam when they both should be logrolling. On the other hand, who is going to feed and develop the next generation of artists? If you could guarantee the ISP user-fee/tax were going to actually get to the artists, eg, restore mechanicals so what happened to Levon is remedied, you may have a public good case.

    Or tax the biggest users. Google, Microsoft, Yahoo, and so on, IOW, the companies that not only field technology, they host and serve content. Unless of course, they are ready to bear the costs of developing the talent. I doubt they have the skills, but they really are the new media moguls. Media taxes did not crush Hollywood.

  22. len says:


    faster horse… old eyes

  23. Rick Turner says:

    I think I finally understand the Papola/Warstler solution to poverty. Just drop the “poverty line” to about $5,000.00 for a single person or $11,000.00 for a family of four, and our national poverty stats will improve dramatically.

  24. Morgan Warstler says:

    This is my solution to poverty, handout reform that pays more and demands more:

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