What Is Private Equity?

By James Kwak

Recently, a lot of the political debate has been about whether private equity—and by extension Mitt Romney—is good or bad. The argument on one side is that private equity firms are vultures who destroy firms to make money; on the other, that private equity is just capitalism at work, creates value, and creates jobs.

A private equity firm is an asset management company. It creates investment funds that raise most of their money from outside investors (pension funds, insurance companies, rich people, etc.), and then manages those funds. As opposed to a mutual fund, however, instead of buying individual stocks, these funds usually make large investments either in private companies or in public companies that they “take private” (more on that in a minute). While mutual funds and most hedge funds try to make money by guessing where securities prices will go in the future, private equity funds try to make money by taking control of companies and actively managing them. (There is a bit of a spectrum here, since mutual funds and hedge funds can exercise pressure on company management and private equity funds do take minority positions, but that’s the ideal-typical distinction.)

A private equity firm is just a rebranded version of what were called LBO (leveraged buyout shops) in the 1980s, before they got a bad name. The classic transaction is to take over a company by contributing a small amount of equity and borrowing a lot of money. So if a company has $100 in assets, $100 in equity, and no debt, a private equity fund might chip in $20 in equity and then borrow $80 in the credit markets. That $100 in cash goes to buy out all the current shareholders, so the private equity fund now has 100% ownership of a company that has $20 in equity and $80 in debt—and the debt is owed by the company, not the private equity fund. (The 100% ownership means the company’s stock no longer trades, hence the “going private.”) Because of that leverage, small increases in company value mean high returns for the private equity fund: if the company’s value goes up by $20, from $100 to $120, the value of the equity doubles, from $20 to $40, because the burden of debt remains fixed in nominal terms.

The argument for private equity is that it increases the value of companies. In practice, if a company’s market value is $100, the private equity fund will have to pay a premium to buy it—say, $120. Then, for the fund to make money, it has to increase the company’s value up above $120; otherwise, the fund will lose money on the deal. And in principle, if you can take some set of assets and make them worth more than they were worth before, that’s a good thing.

And in a frictionless world, this would be true. But that’s not the world we live in.

The discussion of the power of leverage above should have reminded you of something: the credit bubble and financial crisis. Leverage means higher expected returns, but it also means higher risk, transaction costs, and the potential for looting. So, for example, a private equity fund could use $20 to take 100% control of a company with $120 in assets (by making the company take on $100 in debt). Then it could use that control to liquidate assets and pay itself $30 in cash, giving it an instant 50% return; since there aren’t enough assets left to pay off the creditors, the company could then go bankrupt. Taking a company with ongoing operations and forcing it into bankruptcy generally destroys value, not only because of transaction costs but also because the whole point of a company is to have ongoing operations that are worth more than its assets.

And this happens, though not as nakedly as in the example above. In 2003, for example, THL bought Simmons (the mattress company) for $327 million in cash and $745 million in debt. In 2004, Simmons (now run by THL) issued more debt and paid a $137 million dividend to THL; in 2007, it issued yet more debt and paid a $238 million dividend to THL. Simmons filed for bankruptcy in 2009.

Now, if we had perfect capital markets, this couldn’t happen. Investors would not lend money to a company if they knew that both (a) the cash was going straight through to the private equity fund that owned it and (b) the company would be unable to service the new debt. But if we had perfect capital markets, the housing bubble couldn’t have happened, either. Instead, during the credit bubble, banks were falling over each other trying to lend money into private equity deals, whether as syndicated loans or as bond offerings. There was too much money going into private equity deals just like there was too much money going into mortgage-backed securities, and for the same reasons: bankers whose bonuses were based on up-front fees that were in turn based on deal size; credit rating agencies that were either too clueless or too corrupt to see what was going on; bank sales forces that pushed debt into investors hands; and investors who didn’t read their prospectuses, didn’t understand what they were doing, or had too much faith in Alan Greenspan.

With perfect capital markets and perfect monitoring, private equity firms probably would be a good thing—but so would credit default swaps and collateralized debt obligations. In the real world, it’s much less clear. When it’s easy to make money just by piling on debt and paying yourself hefty “dividends” and “fees,” why go to the bother of actually making a company better? In that case, it’s simply a case of shareholders (private equity funds) taking money from creditors, with employees left as collateral damage.

So what should we make of the private equity kings themselves, since this whole debate is really about Mitt Romney? The good ones are good at making money for their investors (the people who invest in their funds), which in practice means a combination of both improving undervalued companies and raiding them to transfer cash from the company treasury to their funds. In this respect, I’m not sure they’re that different from most of the class of people we call “bankers”: they do a job that is good for society in principle, but in practice is more ambiguous; some contribute more to society than they take out, some take out more than they contribute.

I have no idea which category Mitt Romney falls into. Personally, I’m less concerned about the fact that he was a Bain Capital executive than by (a) his positions on virtually every significant policy issue and (b) the fact that many of those positions have complete shifted since he was governor of Massachusetts.

65 thoughts on “What Is Private Equity?

  1. I just want to correct a nomenclature issue: private equity is not synonymous with leveraged buy-outs. PE can also include venture capital, distressed debt, and mezzanine financing. Like many things which get marketed and politicized, some PE firms are exclusively LBO, but this is not the universally accepted case within finance. CalPERS, for instance, includes VC into their PE department.

  2. James:

    A few points:

    > When you have PE firm people in charge of a company and their “primary fiduciary responsibility” is to maximize return to their investors (which usually includes those investors running the PE firm) then there is always the “fiduciary responsibility” to maximize the profits – be it short or long term.

    If the long term prospects are less profitable than the short term prospects then it is the “responsibility” of the PE firm’s operators to, in essence, loot the company and maximize return. This is easy to understand regardless of how repugnant it may be. The moral hazard here is obvious.

    > The same exact model is in play with health insurance companies. When I hear Obama or Sibelius (sp?) or anyone else hold up a medical:loss ratio of 80 as a good thing… when historically it was in the mid 90s before Wall Street’s mandate of insurance companies’ primary fiduciary responsibility to their shareholders (and quarterly profit reports to meet or exceed analysts’ expectations), I become sickened by the lack of honest discourse regarding the raw profit motives of insurance companies. I agree with Wendell Potter who stated that the Insurance companies profit and please Wall St. by NOT providing actual health insurance coverage.

    I am sure you are aware of these facts (I read 13 Bankers and can attest to your recognition of the problems that exist in the world – your eyes and mind are open.).

    As for health care, I am a small government progressive who believes that the big bully in the schoolyard (government in this metaphor) has his way until he makes a fatal error in judgement and the smaller victims (will of the majority) can assert themselves OR the bully destroys everyone in the schoolyard and everyone loses a lot (bloody revolution) with an uncertain outcome.

    But I also believe that government should only do what the private sector cannot do or does not do well. The private model of medicine has failed to serve the needs of the US. So I acquiesce to the Socialist model of health care ala Europe and Canada with the understanding and concession that it will grow the size government.

    > I think the better questions (and answers) that should be addressed concern how to constructively remove the profit motive from endeavors where the profit motives subvert or pervert the stated goal of the endeavor – such as we have today in US medicine. Removing the influence of money as Prof. Lessig has proposed is an good place to start.

    > Lastly, how about contrasting the “Private equity” function versus the “Public equity” function via AIG, GM, etc… and Kenneth Fineberg’s lavishing of millions upon those executives with public money? Where does the fiduciary responsibility to the Public shareholder rank in these instances? It seems less important than the return to the executives whom the government oversees!

  3. Gingrich, Romney and Paul between them, appear to include 100% of the options to challenge Obama for the Presidency, so discussing Romney’s history seems to be a good thing. Surely however we could do more.

    Why not test these four to try to try and predict how they would respond to the opportunity the Presidency would give them. For instance a look a Romney’s track record shows that he might have been a moderate who got some good things done. Is this a fair judgement? I could understand an argument that suggested that a Private Entity Fund Manager is about sensing an opportunity and taking action. This is a useful political skill that Obama, for one, doesn’t seem to have.

    Clearly we can largely forget about political policy pronouncements. Any candidate that told the truth while campaigning would be attacked by the media as a hopeless romantic. Paul has already suffered from this and IMO would have suffered more if he had spoken more plainly on economic matters. But we can learn much from peoples history. People generally don’t change.

    We could use psychometric testing to predict how they would respond to a crisis. We could use modelling to examine the issues. We could create probable responses based on historic tendency. People who delegate tend to have more stable organisations. They also take much longer to respond to a crisis.

    There is much we could learn if we tried. Anything to avoid watching Fox or CNN.

  4. @Blackeyebart – Please psycho-metric test this man’s (Kucinich) character flaws that prevent him from being a credible candidate:

    “….When Dennis Kucinich refused to turn over Cleveland Public Power to the One Percent, they decided to kill Dennis. Not kill Dennis’s political career. Kill Dennis.

    You don’t have to take my word for it. You can read the chilling account in the Cleveland Free Times cover story, which includes quotes from the police interview with the hit man.

    The plan was to shoot Dennis in the head, during the Columbus Day Parade. The Cleveland Cosa Nostra brought in a professional hit man from Maryland to do the hit. The hit man bought an untraceable rifle, and came to Cleveland.

    Why didn’t the hit man kill Dennis? Because on Columbus Day, an ulcer in Dennis’s stomach burst. Dennis spent that day in the hospital, not in the parade. Or the morgue.

    The hit man then staked out Tony’s Diner, an old rail car converted into a greasy spoon restaurant, on the corner of Lorain Avenue and West 117th. Dennis liked to eat breakfast there.

    But then the banks found that they could force the City of Cleveland into bankruptcy, and force Dennis Kucinich out of office. So the hit was called off.

    (By the way, of the thousands of people who have served as mayor in the United States, only three have been assassinated. Mayor Carter Harrison of Chicago, the hero of the Haymarket Riots, was killed by a disgruntled office seeker. Mayor Anton Cermak, also of Chicago, was killed by a bullet intended for FDR. And, as you may recall, San Francisco Supervisor Dan White killed Mayor George Moscone, and Harvey Milk.)

    In order to save Cleveland’s municipal power company, Dennis Kucinich stuck his neck out so far that the banks and the Mafia tried to kill him. For the people of Cleveland, Dennis put his life on the line.

    If the One Percent is so angry at you that they want to take you out, and they’re willing to enlist the Mafia to do it, then you are doing one heckuva good job for The People.

    So I’m asking you again, as I did yesterday. Please do whatever you can do to help Dennis Kucinich, before the absentee ballots get mailed out in his district next Tuesday. And click here to do it.

    Because Dennis Kucinich is a hero. A real-life hero….”

    The Hit Man holds promise as a candidate, though…persistence…focus…ruthlessness to get things done…

  5. Seems that the banks’ shortsightedness is an issue unto itself. I’m more concerned about the many ways that PE firms can socialize the losses that they create or magnify.

    First up: the employees’ pensions, and it seems that firms more than a bit behind on their funds make especially attractive targets. Neither current pensioners, nor vested employees, get to vote, even with their feet, on an LBO. Yet, they can lose all. (Well, not exactly all: the PBGC will take a couple of pennies of the hit for them.)

    State unemployment funds — aren’t they usually experience-rated, and self funded? That makes other neighbor companies the victims of the PE cashectomy. Not exactly a capitalist-friendly externality.

    Lots of other claimants come bankruptcy time: vendors, tax authorities (we, the people), oftentimes a long list of balance sheet liabilities have been converted to goose eggs by the financial geniuses.

    Overall, this strikes me as the same sort of sharp-eyed arbitrage as is often the norm in business today, except this one exploits one of the great financial institutions, our society’s grant of both limited liability and bankruptcy protection. I’d sure like to figure out a rider on either the debt or equity side that at least restricted serial offenders from being able to empty out the public purse.

  6. Now, if we had perfect capital markets, this couldn’t happen. Investors would not lend money to a company if they knew that both (a) the cash was going straight through to the private equity fund that owned it and (b) the company would be unable to service the new debt.

    I was in the high yield market for a long time and I can assure you that in all prospectuses there’s a use of funds disclosure, and while the disclosure might have waffled which alerted the reader to see what the dividend covenants allowed (often a lot), and more recently the disclosure stated right up front that a dividend payment was contemplated. And indeed, there was even a carve out specifically allowing one of $X.
    The buyers of this debt knew what was going on, they were just stupid enough to believe the company could support the extra debt. It’s called reaching for yield.
    A pure case of caveat emptor.

  7. I appreciate this blog’s explanation of the meaning of financial terms that are too often thrown about without really defining them adequately.
    What I don’t understand is this: If I take on a loan to buy out a house (i.e., buy a house for investment), make some improvements, than rent and collect the rents, but than default on the mortgage, I would assume in most states the banks can go after my other assets, making this business plan a non-starter. How is it that one can be the owner of a company and not be responsible for the companies debts – that is, the owner goes through bankruptcy and ALL the owners assets are in play? What is the rationale for allowing such a situation? Or am I misunderstanding the liabilities of the private equity company?

  8. Yes it would be great to have a world where everything was consumed so effectively that there was no need to even defecate, and all was so squishy clean that vultures had no place… but that’s not how things are… and in case of the companies turned into consumed carcasses by the private equity companies, the most important question is, who paid for it all?… and most frequently it was all pure private payments… Add all these transactions up since the beginnings of time, and the direct cost for the taxpayers does probably not come to the cost of one single TAARP.

    James Kwak says “Now, if we had perfect capital markets, this couldn’t happen” and he is right. What he and Simon Johnson keeps on ignoring though, for reasons I cannot understand, is that one of the greatest market imperfections ever, the one that caused this crisis, was the regulators allowing banks to hold different amounts of capital against assets with different perceived risks, even though they must have known that the perceived risks had already been cleared for by the banks, by mean of interest rates charged and amounts lent or invested.

    What if terrorist infiltrated bank regulations? Would that not be more something for the Homeland Security than for the SEC and the FED? http://bit.ly/xdSQLn

    Stop the crazy nannies! Occupy Basel! http://bit.ly/dFRiMs

  9. fresno dan;

    Not sure that the banks can go after your other assets. It is the case in so in some states – they’re called “recourse states”. So it depends where you live. You might have seen the phrase the phrase” jingle mail”. Homeowners who want to walk away from a mortgage can just mail the keys back to the bank. There is no recourse against the borrower’s other assets. I think in the US more states are ” non-recourse” in this way than there are “recourse states”. Canadian mortgages, by comparison, are all “recourse” based.

    As for the private equity deals, they set up separate companies for each new acquisition and arrange separate loans for each deal, The banks then have recourse only to the assets that have been put into each individual new company.

  10. How is this different from rape, gang rape, by B school trained pirates, masquerading under pretense of doing good for ailing enterprise?

    Kwak sys: “When it’s easy to make money just by piling on debt and paying yourself hefty “dividends” and “fees,” why go to the bother of actually making a company better? In that case, it’s simply a case of shareholders (private equity funds) taking money from creditors, with employees left as collateral damage.”

    Willard and his ilk can take all their ill-begotten gains…..and cram them. Just stop pretending you’re something other than parasite-gangbangers.

  11. Annie.
    Thank you very much. Once in my life, long time ago, I knew John Reed and I truly liked him, and I am so glad listening to him admitting and not shying away.

  12. Is Romney a “Captain of Industry” or Rich “Vulture Capitalist”?

    BP, Massey Energy, Goldman Sachs, AIG, Toyota, and Johnson & Johnson have all provided
    extraordinarily dramatic and shocking examples of big business failure and breakdown in productive functions and activities.
    Some argue that these represent just “Black Swan Events.” Then, there are those, some of whom are in “Occupy Wall Street,” “99% of Americans” and even the “Tea Party” are protesting what they consider serious and major defects and flaws in modern corporate capitalism with extremely excessive power held by the giant multinational conglomerates and the super rich and the “super PACs” and the “vulture capitalists” from all over the world. Competition and freedom of choice are discouraged and depressed by monopoly and oligopoly and plutocracy in the marketplace. Can greed go too far? Those who consult and respect scripture can be guided by Matthew 21:12-17, Mark 11:15-19, Luke 19:45-48, and John 2:13-16.

    There have been demands for more and better government regulation and it does seem such regulation may be forthcoming, despite Republican efforts to kill government action in the name of “liberty” and “free markets, free enterprise, and free competition.”
    However, please let me suggest that for capitalism to serve the public and
    “to work” our future business leaders must be better prepared. We must call on our schools of business and finance to teach and emphasize the importance of social values and responsibility
    and the critical role of “captain of industry.”

    “Captain of industry” was a term originally used in the United Kingdom during the Industrial Revolution describing a business leader whose means of amassing a personal fortune contributes positively to the country in some way. This may have been through increased productivity, expansion of markets, providing MORE JOBS, or acts of philanthropy. This contrasts with robber baron, a term used to describe a business leader using political means to achieve their ends.”

    We must have business leaders who
    are “captains of industry” and whose character. commitment, and
    vision extend beyond just maximizing profits!
    Such leaders might model a great football coach such as Alabama’s Paul “Bear” Bryant who played to “WIN” but also to protect, promote, and develop the INTEGRITY of the game itself.
    Please see:

  13. Just heard from an old friend who just inherited 10 millon dollars!
    Wants to know how to invest the money. He’s a dentist with a successful practice.
    His financial situation is very sound and comfortable.
    I have sent him to an attorney and financial advisor to set up a “blind trust.”
    I said think “Mitt Romney” and let free enterprise and capitalism really work.
    I told him to instruct the trust manager to MAXIMIZE PROFITS AND RETURNS.
    Avoid puny “socially responsible” funds and investments.
    Be mean toward anything “green.” Stay away from “environmentally favorable” industry.
    Tell the manager to favor investments in tobacco, beer and alcohol, gaming including online gaming, oil, coal and gas, finance, firearms, intelligence/military technology, private prisons, pornography, educational testing, and health care. Apple is “ok” for now, but is challenged by more and fiercer competition.
    The dentist is a deacon at a large Baptist church
    So, I told him to strike out Matthew 25:14-30 and Luke 19:12-27 from his Bible–out of date for modern finance and corporate capitalism, might cause dissonance.
    Truly, I am a wise and smart friend.
    Thank you, Mitt Romney.
    He has my vote, Newt!!!

  14. The Buyout of America: How Private Equity Will Cause the Next Great Credit Crisis
    Josh Kosman (Author)

  15. Private Equity Is Debt Fueled Job Destruction Tax Scheme- Inside Story, The Schwarzman Eight

  16. Hostile Takeover: How Big Money and Corruption Conquered Our Government–And How We Take It Back [Paperback]
    David Sirota (Author)

  17. The following is a ranking of the largest private equity firms published in 2011. The ranking was compiled by Private Equity International, which reveals that the world’s 50 largest private equity direct investment programs have raised in excess of US$325 billion since 2006.[1] A previous ranking had been published in 2007.[2]

    The list includes “very few venture capital firms”, which tend to be “smaller” than their “leveraged buyout” counterparts; for a list of those see List of venture capital firms.


  18. http://www.independent.ie/business/world/private-equity-firms-rush-to-dubai-hoping-for-a-miracle-1499674.html
    Private equity firms rush to Dubai hoping for a miracle

    Thursday October 16 2008

    “Private equity executives from the United States and across the Middle East have descended on Dubai this week to seek out investment partners and deals during one of the most tumultuous periods in the industry’s history.

    The three-day annual Super Return Middle East conference coincides with extreme volatility in the financial markets and a credit freeze that has only exacerbated the inability of the firms to access financing for leveraged buyouts.


    Attendees will be watching addresses from Wall Street moguls such as KKR’s Henry Kravis, Carlyle’s David Rubenstein and Blackstone Group’s Steve Schwarzman for signs of how US private equity will ride out the storm and the investment opportunities they see emerging.

    From the Middle East, the focus will be on private equity and sovereign wealth funds,…”

  19. @Bruce E. Woych “the world’s 50 largest private equity direct investment programs have raised in excess of US$325 billion since 2006”

    Is that a lot considering that one country, besides all taxes collected, raised like more than US7 trillion in those same years?

  20. It’s called something else besides *private equity* in Russia :-)

    Cather’s mitt spent his whole life STALKING businesses in the USA to see what he could get out of them – the very definition of predator.

    And do we really want to ADD to the chaos in the world by putting up a 1% on the world stage to represent his own personal interests – which means that he would NOT separate church and state to get more for ME ME ME…

  21. StewartPrague”Now, if we had perfect capital markets, this couldn’t happen. Investors would not lend money to a company if they knew that both (a) the cash was going straight through to the private equity fund that owned it and (b) the company would be unable to service the new debt.”

    NIcely done.

    Just like the fraudulent MBS practices of Wall Street, the LBO game seems to have been only possible through an imperfection or corruption of the markets. Defense of these practices as some sort of defense of free markets is just ridiculous unless you believe in some sort of totally unregulated “Wild, Wild West” version of the markets where fraud, theft, robbery and market manipulation are all okay.

    Romney was a willing, early participant in the LBO game where the consequence was often that viable companies were drowned in leverage, looted, striped and sold for their marketable assets with thousands of loyal, diligent employees thrown out on to the streets. Now there were instances where companies deserved to be broken up, and at times an LBO was justified, but the LBO practice is burdened with explaining the multiple instances where things seemed to have gone terribly wrong.

    It’s just seems like that too often the baby was thrown out with the bath water, and it’s difficult now, many years later, to tell how sullied Romney was in these schemes. However, when you pair Romney’s somewhat ethically cavalier LBO experience with his continued support for the TBTF bailouts, ZIRP, QE, and all the other obscene FED market manipulations, one does get a very bad taste in one’s mouth.

  22. Nice well written post.

    My takeaway is that an employee is like a company with only one customer. It seems like a good idea to pay attention to the vulnerabilities of your customer.

  23. Down here in the gutter, we call them the robber barrons, cause that’s what one is when you simply can never get enough money. I would beware of anything with an antenna at this point, or a microscope.

  24. The rise of private equity is to a significant extent a product of the failure of the taxation and governance of publicly held firms.

    Private equity largely solves the disconnection between management and ownership that causes public companies to be poorly managed. And, indeed, even the threat of it makes public companies govern themselves better.

    Private equity is also often able to convert the double taxation of publicly held companies, into the single level of taxation of private companies, which increases the after tax return of any profitable company, and provides a means to deduct losses associated with any unprofitable one more readily.

    Most states do have doctrines that expressly prohibit dividend distributions from insolvent corporations, but valuation issues and the ability to foresee future insolvency in a currently solvent corporation limits that. Still, even in a grossly abusive case like Simmons, the creditors (who could have and frequently do insist on covenants in the loan that prevent that kind of conduct) still took a smaller haircut than in the vast majority of bankruptcies.

  25. “So if a company has $100 in assets, $100 in equity, and no debt, a private equity fund might chip in $20 in equity and then borrow $80 in the credit markets. That $100 in cash goes to buy out all the current shareholders, so the private equity fund now has 100% ownership of a company that has $20 in equity and $80 in debt—and the debt is owed by the company, not the private equity fund.”

    So if my neighbor has $100 in assets, a car valued at $100, and no debt, I can chip in $20 in cash and then borrow $80 in the credit markets. That $100 of cash goes to buy my neighbor’s car, so I now have 100% ownership of a $100 car — and the debt is owed by my neighbor, not I who borrowed the funds. That is a pretty darn neat trick, but it still sounds like theft to me.

  26. ohwilleke… Yours is an important reminder that we are not in a world of pure bad against pure good. If we cannot solve the corporate government lacking in better ways, I sure prefer having the private equity wolfs roaming around lazy and arrogant management owners.

  27. An absolutely critical point about private equity that seems to receive no press attention is the myth that it is “private enterprise”. Overwhelmingly, the most important source of investment capital for the strategy comes from the government, in the form of LP (limited partner) commitments from public (government) pension systems and sovereign wealth funds. More than half of the investment capital from U.S. buyout funds comes from these two sources. In this sense, PE firms are little different than heavily subsidized public transit agencies, except that the leaders of PE firms make 500 times more money than transit managers.

  28. *Evil*, so to speak, gets disproportionate benefit from Big Brother, Inc. And when Big Brother, Inc. is also an Inquisition committee to eliminate the *heretics* who have trouble launching pre-emptive wars based on *existential* threats – well, all *hell* breaks loose and GOOD needs to fight back with *all options ont he table*…


    Occupy Town Hall – they’re selling your water and roads and public buildings to the slum lords of the Inquisition who have JUDGES you to deserve to live in a filth that was eliminated over 2000 years ago with the Roman Aqueducts and all ADVANCES since then…you built it and paid for it with taxes – wtf has the *right* to SELL IT as a *private asset*?

  29. @Annie: Nice link… I am going to paste it over to Kwak’s Posting concerning “The End of the Blog” (please check it out over there with some other things I think you will appreciate…Love & Peace: Bruce)

    “The breadth and depth of the information we’re casually volunteering is fueling a burgeoning industry. But no one who’s planning to make money off that data seems to be offering us equity in Big Brother, Inc. in exchange for X-raying our identities.”

    Right on the Money!

  30. James,

    As someone currently working in Private Equity, I feel that your explanation of Private Equity is simplistic and elementary at best. Private Equity covers a very broad spectrum. There are Industry roll up funds, VC funds (yes, VC falls under Private Equity umbrella), Growth capital funds, Mezzanine capital funds, Distressed asset funds, etc., etc., etc.

    Yes, there have been examples where PE firms have used far too much leverage with very negative results. In any industry, one can cherry pick a small sampling and try to draw a conclusion from said small sampling. But that is what I call, correlation without causation. But the great thing about the free market is that those firms are rarely rewarded with incremental funds. In Private Equity, there is accountability to the investor. Anyone who believes (or states) otherwise doesn’t know what they speak of. Yet, I am sure that won’t stop those uninformed from doing just that (especially in this comment section).

    Of course, you conveniently overlook the fact that the majority of deals (in terms of volume) are focused on private/family owned companies that are either a) looking for a capital infusion b) to cash out/sell to non-family member or c) in desperate need of both cash infusion and management oversight. How you try to create some form of moral equivalence between Private Equity, credit default swaps and collateralized debt obligations is just plain silly. Dare I say stupid!

    I take great pride in making an above market average for my investors. I find it sad that you seem to want to demonize Private Equity – for no apparent reason.

  31. Mitt Romney linked to major Medicare fraud
    Posted on 2012 January 30

    “Politics really do make strange bedfellows, and we begin by noting that Winning Our Future is a super PAC devoted to the election of Newt Gingrich and bankrolled to the tune of $10 million by the noxious casino mogul and Ziocon Sheldon Adelson,…”


  32. @cmk – “How you try to create some form of moral equivalence between Private Equity, credit default swaps and collateralized debt obligations is just plain silly. Dare I say stupid!”

    Actually, the *equivalence* was enthusiastically embraced by ALL as the *modern* economy that was being held back by Glass-Steagall….meaning that *private* $$$$ was subsidized somewhere along the way by *public utility* $$$$ after the wall came down…

  33. stewartsprague

    Thanks for the response. I am aware of private homeowners being in states that have both recourse and non-recourse loans – I was just using home ownership as a (poor) analogy.
    I guess what I don’t understand, is how the lender to private equity can be unaware of what the borrower intends to do. I would assume lenders, when making a loan, have some idea of the financial strength of the company (the comapny being “bought”). I would also assume that the lender making a loan to the company that is going to buy this other company that is in dire financial staights that the lender would have some idea of the financial assets of the “private equity”
    and would not endanger their money by lending/investing to a private equity firm with no collateral. And by collateral, I assume that if a loan is made to buy something (Widget A), and than that something gets sold, that if the loan goes bad one couldn’t than say, “Hey, you can’t reposess Widget A cause I sold it” – the lender would say, “OK, give me all the money from the sale of Widget A.”

    But on the other hand, mortgage companies knowingly (or naively – does it matter? It is almost worse to have a system that instead of being corrupted by a few criminals is competely populated by idiots – I expect that people handling money are suppose to know what they are doing) originated bad home mortgages, rating agencies didn’t know what they were doing, banks bundled bad mortgages and called them “securities” (that is funny in a sick way), and investors bought this stuff with a level of gullibility that is astounding.
    Maybe the problem with capitalism is that we start with the premise that most people are as intelligent as squirrels…

  34. The bundle game probably came from the law, which states that bonds are to be paid before cops and teachers ect. In order to abide by the law to get paid, mortgages had to be juggled and repackaged so the profits were privatized and the losses socialized. That was the only way to tap the lower classes money, the only other option was Goobers response to needing a loan that required capital widgets. He said to said banker, ” it sounds like your telling me that the only way to get a loan, is if I don’t need one in the first place” Anything beyond that requires a risk ratio to be determined by the banker, its when the banker uses other peoples money that the dreams and derivatives fly.

  35. @annie,

    Running the risk of once again starting a back and forth with you, I must say – I don’t have the foggiest idea what you are saying.

    You write… “Actually, the *equivalence* was enthusiastically embraced by ALL as the *modern* economy that was being held back by Glass-Steagall….meaning that *private* $$$$ was subsidized somewhere along the way by *public utility* $$$$ after the wall came down…”

    While I am no historian of the Glass-Steagall act, I do feel I have a pretty good idea of the impacts it had post repeal. According to my view of history, Glass-Steagall was focused on removing the barriers between I-banks and Commercial banks. Did that act contribute to the financial issues we experienced – yes. Do I agree that it was a primary cause – no. I think a thorough review of the facts/analysis – as Professor Lo has started to do (for transparency sake, I want to be clear that I am a former student of Professor Lo’s and hold him in the highest regard) – shows that there were many things that contributed.

    That said, if you are attempting to define the different banks as “private” (aka I-bank) versus “public utility” (aka Commercial)… well, I get what you are attempting to say but it doesn’t make any sense to me.

    I took issue with this line from Kwak’s post, “With perfect capital markets and perfect monitoring, private equity firms probably would be a good thing—but so would credit default swaps and collateralized debt obligations”. To me, he seems to be saying that we live in an imperfect world (really? you don’t say!) – therefore not only are CDS and CDO bad ideas , but so is Private Equity (hence my moral equivalence comment). Anytime someone paints with such a broad brush alarm bells go off in my mind. To me, people who overly generalize like this due so because of weakness in their intellect and lack of merit in their arguments. See how easy it is to be wrong with broad generalizations ;)

  36. I have had reasons ( many of them) to be suspicious of Private equity just like everyone else because I know the harm that they can bring. But I really feel that there might be a bit of over reach as far as Mitt Romney is concerned. There is really no reason to be sticking him so deep with the PE bill. There is much worse going on in PE and that is what we should be focuisng on.

  37. Romney’s Super PAC shifting to high gear post-Florida. Romney’s chums from Bain and the PE racket in on this.

    I think about all the poor schmucks, USA workers, caught up and spit up in the machinations of these financial deals, and the few who walked away with enormous fortunes…..doesn’t seem right to me.

    It seems like an old John Ford movie, where the desperadoes get the stage coach and the passengers get the dust in the breeze.


    Biggest joke of the decade: Willard Romney CREATED JOBS. ok…..maybe for high end home builders or custom-yacht manufacturers.

    Willard AINT about helping the common folk, take that to any insolvent bank you can find.

  38. @cmk011 – “…While I am no historian of the Glass-Steagall act, I do feel I have a pretty good idea of the impacts it had post repeal. According to my view of history, Glass-Steagall was focused on removing the barriers between I-banks and Commercial banks. Did that act contribute to the financial issues we experienced – yes. Do I agree that it was a primary cause – no….”

    Right, you have a pretty good idea of the impacts it had post repeal. I was talking about the rationalizations made for its repeal. Big difference. Your understanding of *everything* is based on a mathematics genealogy – a master/student monastery – that believes the environment that you are in when reading this blog came out full blown from the head of Medusa – the sacred big bang theory. Meaning, human relationships had nothing to do with any of it. It was all just the numbers…

    So I’m not sure how *sensitive* you are to opening your mind to a *human personality* review of HOW Glass-Steagall was phased out over a 2 year period (exploiting the loophole). Most people hardened in their ideology experience an adverse event like the top of their head blowing off when they catch a glimpse of some other aspect of a truth gaining on them – so I do not want to cause you to explode, therefore, you need to be the judge for whether you can watch this program:


    And once I and C transactions were sloshing around in the primordial bucket of fiat $$$$ together, with only theoretical risk assessments regulating the pond – well, here we are.

    Tax policy should have been changed along with Glass-Steagall – what does a theoretical 20 trillion budget deficit matter when the I and C ooze has given birth to 1.2 quadrillion of *derivatives* – why return to feudalism instead of supporting entrepreneurship for the *producers* of that kind of *wealth* – 1.2 quad…?

  39. The Future of Finance: How Private Equity and Venture Capital Will Shape the Global Economy (Wiley Finance) [Hardcover]
    Dan Schwartz (Author), David Rubenstein (Foreword)

    Level headed and clear, an insider’s perspective that speaks directly to the global content and context of living off sustainable wealth without building up the sales pitch of forward thinking prospectus growth and endless returns.

  40. Two points:

    1. The interest on the debt can be deducted from taxable earnings.

    2. From an IRS point of view payments in excess of accumulated profits and earnings are treated as non-liquidating distributions which result in untaxed reductions in basis or capital gains to the extent beyond basis.

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