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Private Equity as Public Debt
Financial Capitalism's uncanny resemblance to Soviet-style economics
In today’s Financial Times Iosco chair Jean-Paul Servais, has pressed a regulator’s equivalent of the panic button.
Acknowledging that Private Equity (PE), hedge funds and private finance are “now systemically important” Servais warns of “vulnerability” in the sector and notes there is also “frankly speaking, a little too much confidence that all will be fine.”
If your pension fund dear reader, is invested in the sector, or if you are an employee of a GP’s surgery, a hospital, a nursing home, or the resident of a housing estate acquired by PE - you too must worry about its “vulnerability”, which combined with what Servais calls
a lack of transparency and a changing macro-financial environment
threatens the global economy with systemic failure.
And “systemic failure” here means: we all get hurt by a financial crisis of the system that like lightning, will ricochet around the world.
Thames Water is the poster child for PE investment, debt and risk. It is Britain’s largest water and wastewater services company and is on the brink of bankruptcy. Its failure gives an alarming insight into the potential systemic failure of the whole PE sector - and with it deeper insights into what passes today as “capitalism”.
Privatisation and Debt: the case of Thames Water.
In 1989, back in the heady days when public utilities like water were privatised by the Thatcher government, UK water companies had all of their debt (£5 billion) written off as an inducement to investors in the City of London to buy the utility.
Since then the companies’ collective private debt burden has risen to more than £60 billion - despite managers having ‘saved’ money by not investing in the maintenance of waterworks systems - a requirement of the law - and by pouring sewage in, and polluting the rivers and the sea.
Thames Water was purchased by Macquarie in 2007 at a price of £4.8 billion with debt of £2.8 billion. Over the ten years (2007-17) of Macquarie’s ownership, the company’s debt rose from £3.4 billion to £10.8 billion, and Macquarie ultimately took out £2.7 billion in dividends and £2.2 billion in loans. Since 2017 the company’s debt has grown to £14.5 billion, according to Dr. Sissoko. With interest rates rising the company is on the brink of bankruptcy, well before it addresses the crisis of sewage spills and the contamination of rivers.
Thames Water is a case where investors such as Macquarie have made high returns, at the expense of leaving urban Britain with grossly underinvested waterworks infrastructure.
Someone will have to pay to clean up those rivers. And that someone may well be you, dear reader - as an employee, rate payer, tax payer or pension claimant.
To understand how we’ve arrived at this critical point, bear with me as I take you through the evolution of this story.
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Private Equity and Capitalism - the uncanny resemblance to Soviet economics
Today’s capitalism bears uncomfortable semblance to the Soviet economic system. Three key features I contend, are held in common between the systems. They are:
a) central planning
b) the credits, subsidies and protections provided by central banks to failing ‘enterprises’
c) the requisitioning of surpluses and/or the looting of corporate profits and capital gains by powerful apparatchiks/elites.
In today’s ‘command capitalism’ central planning is conducted by invisible and unaccountable hands in global markets for money, labour, land, energy, food and services. Governments - including the Saudi and Russian governments - can use the the spigot of supply to influence the price of some commodities, but in reality - and as planned by economists and enforced by states - they have only intermittent leverage over global markets and prices. [For more on this see my posts here, and here, and here, and here.]
The second common feature is this: like Russia’s Gosbank (the central bank of the Soviet era) western central bankers provide bailouts, subsidies and guarantees against private losses to investors in corporations. Central bankers - including the supranational governors of the ECB that operate beyond the reach of EU citizens - are in turn backed by the strength of EU economies, and by millions of taxpaying citizens.
Finally and in place of Soviet apparatchiks requisitioning the surpluses of peasants and workers, the global 1% loot corporate profits and capital gains, crippling corporations and immiserating those that work by hand or brain, as I will explain below.
I am not alone in thinking this way about capitalism. Inspiration for this post is from Dr. Carolyn Sissoko’s highly recommended and excellent paper ‘Private Equity’ is a Misnomer: Government Support Has Been Driving the Restructuring of US Corporate Structure and the Transfer of Wealth to Buyout Firms Over the Past 40 Years.
The free market system was planned.
First the central planning part. Here we must recall Karl Polanyi’s famous assertion: “Laissez-faire was planned, planning was not”.
Polanyi argued that the key factors of production - land, labour and money - cannot be regarded as commodities. (Polanyi 2001, p. 147). At essence they are ‘the commons’. For society, for capitalism to turn these factors into commodities requires central planning by a strong, coercive state.
Now, none of us can bear to think of finite, pristine areas of land (a term that embraces nature) or of our own precious human labour, as commodities. But consider briefly and you will quickly conclude that after centuries of slavery, forced and child labour, zero-hours contracts, agency, casual and seasonal workers - capitalism routinely, if not always successfully, often treats labour as a disposable commodity.
By consciously removing regulation of labour standards and by constraining union organising, the state enforces the commodification process.
As to land, Mark Twain had it right. Land is scarce, because “they’re not making it anymore.” That is because land, just like labour or money cannnot be produced or made by capitalist enterprises backed by state enforcers.
Nevertheless they have tried: god knows they have tried. Today there are developers considering whether to destroy whole city suburbs in order to open up land for re-development. [In Europe they are at last meeting resistance, see here, and here.]
It is harder to conceive of money, which is a social technology, a social construct , as a non-commodity, because so much money takes the tangible form of notes and coins, debit and credit cards. This confusion about, and misunderstanding of money is largely down to the economics profession. If you were of a conspiratorial turn of mind - and I of course, am not - then you might think it not accidental that there is so much confusion about the nature of money. The fact is, money originates always, and everywhere as an intangible social construct - a promise to pay - represented by notes and coins, debit and credit cards and many other tangibles.
The state and commodification
To turn money, land and labour into commodities requires the systematic removal of democratically-led state regulation from all three of Polanyi’s factors. These are laws and regulations developed by society over many centuries, and after enormous struggles.
Because of the mighty societal resistance to the commodification of these factors, a strong enforcing state was, and continues to be necessary. The invisible, and very weak hand of the market could not be as coercive.
De-regulation by democratic states - often adopted undemocratically - has led to the rise of globalisation. While many - especially the 1% - have benefitted, the majority in both the global south and north, have not. That imbalance and perceived injustice has in turn fuelled populism and authoritarianism - as people turned to ‘strong men’ for protection from global marakets.
The consequences of deregulation include: the frictionless mobility of capital; the globalisation of money and commodity markets; the rise in private debt triggering periodic global crises; and the re-orientation of central banks - away from the domestic economy, and towards the interests and protection of global capital markets. Other consequences include: the rise of obscene levels of inequality, planetary-wide extraction and degradation of the environment, and the resurgence of far-right and even fascist leaders.
De-regulation, nationalised banks and ‘private’ equity.
Above all, de-regulation of money has led to a world of ‘too-big-to-fail’ banks and ‘shadow banks’.
Today all big banks are financiers to ‘private’ 'equity’ (PE) firms (or are themselves PE businesses) and are backed, subsidised and guaranteed against losses by central bankers and their taxpayers.
This is not a new phenomenon. Banks have been too-big-to-fail and bankers too-big-to-jail for a long time, as Sissoko reveals. The first post-war bank to operate in deregulated markets and to be bailed out was the badly managed Franklin National - in 1973 the 20th largest bank in the US. Franklin’s officers were later to be convicted of fraud - but that did not hinder the Federal Reserve from lending Franklin $1.2 billion as US central bankers stood ready to protect the de-regulated Eurodollar market from US bank failures.
..if a bank was active in the Eurodollar market, it would not be allowed to impose losses on creditors.
writes Sissoko. Later in the 1980s
at least seven of the 10 largest banks in the US would have failed if they had been forced to recognise losses on lending to low-income countries promptly. (FDIC1997:207). …After this a Fed governor would describe US banking as a ‘no failure industry’.
Private Equity firms (including those owned by banks) are not only backed by public central banks, they also often use public funds (i.e. pension or sovereign wealth funds) to finance the buy-out of a corporation ‘taken private’. As I began to read Dr. Sissoko’s paper, this story landed in the Financial Times.
‘Private’ equity and the looting of heavily indebted corporations
Backed by public bail-outs, subsidies and guarantees against losses, funded by public pension and sovereign wealth funds, ‘private’ equity firms and their banking partners are almost guaranteed to make profits and capital gains from their control of more than 10% of the US stock market.
In short, the profits of ‘private’ equity are very much publicly subsidised returns.
As Mark Twain might have remarked: that sure ain’t free market capitalism.
The takeover of the US corporate sector by PE has been remarkable, as Sissoko explains:
Recall that private equity controlled 0% of US companies forty years ago and less than 5% twenty years ago. In short, by the numbers private equity has risen very quickly to control a significant portion of the US corporate landscape, and is positioned to continue displacing the public corporate form at a rapid pace.
How did that happen?
Before, company owners used the corporate form to raise money on the stock market from individual and institutional investors for bold investment projects. That created a separation between the ownership and control of the corporation. Owners managed the company and the capital raised, and shareholders sought to control the company.
A PE leveraged buyout, as Sissoko explains,
is the purchase of a firm that trades on the stock market, ‘taking it private’ but without paying cash for the shares. Instead the buyer/owner puts up about 10% of the price and borrows the remaining 90%. The catch is that the buyer/owner does not owe the debt, instead the target/purchased firm owes the debt. In short, the buyer gets all the advantages of ownership and control of the company, but has no liability whatsoever on the debt used to purchase the company.
In other words, the publicly-backed ‘private’ equity firm dumps debt on the corporation - and then imposes liability for the debt on the company’s bosses, its shareholders, employees and other stakeholders including for example, the residents of nursing homes. At the same time the PE firm makes profits and capital gains from the purchase. That is not just the socialisation of private losses. It is the looting of companies and their employees and stakeholders for capital gains. Sissoko:
In other words, ‘private’ equity and the buyouts that it facilitates are designed to serve as a wealth transfer mechanism from the stakeholders in a corporation (including customers, employees, suppliers and the government) to a small group of financial insiders, the beneficiaries of the ‘billionaire factory’ (Phalippou 2020).
And thanks to de-regulation by governments around the world - that transfer of wealth is entirely ‘legal’.
Sissoko argues that its worse than that.
Whereas the corporate form is a win-win for the economy when it is used to facilitate the raising of funds for large projects that could not otherwise be completed such as railroads or trans-oceanic cables, the corporate form is transformed into a win-lose for the economy when it is used to impose huge debt burdens on otherwise successful corporations.
..The last 50 years have seen a complete transformation of economic structure in high income economies, as mid- and large-tier non-financial corporations have taken on more and more debt…..Recent business failures such as Thames Water or Toys R US illustrate how the past half century’s leveraging of our corporate structure may well have distorted managerial incentives instead of promoting managerial efficiency.
Its not just stakeholders and governments that are robbed.
Its the whole economy. Its you and me.