MRSA
and Private Equity
For both there is a cure!
By J.M. Hamilton (11-7-10)
Several interesting titles came to mind for this week’s
editorial, among them: Private Equity, the Killer Whales of
Capitalism, or Private Equity & Saturated Fat, Clogging the
Arteries of Commerce and the Economic Recovery. But hey, I have
nothing against Killer Whales, who are only acting out their role in nature by
culling out the weak and infirm from the seal population. And saturated
fat is absolutely benign compared to private equity. At least with
a little will power we can avoid saturated fat. Private equity, on the
other hand, is more pernicious, insidious and prevalent in our society; that is
to say, private equity is much more analogous to the super-bug, MRSA or methicillin-resistant staphylococcus aureus. Besides, the government’s concern about MRSA, and required
intervention into market place, nearly completes the hook, and allows this
piece to run full circle.
Government Intervention into the Market Place: Democrats,
Republicans and Bears! Oh My!
The Times ran a story this week, Antibiotics Research Subsidies Weighed by U.S., where for once, we may actually have both
Democrats and Republicans coming to agreement that government intervention into
the market place might be a positive thing. Its seems as though MRSA, and
assorted superbugs, are overthrowing and growing beyond the reach of medicine;
and Big Pharma has more profitable endeavors to pursue (like adding vitamins to
medicines, so that patents and monopolistic profits can be extended), than
developing new antibiotics to fight MRSA and his deadly friends. Funny
how the most ardent Laissez Faire Capitalist becomes all “lovey” about
government, when the market falls on its ass, and there’s a life threatening
crisis at hand.
Seems as though both Democrats and Republicans
want to throw all kinds of financial incentives, tax breaks, and other assorted
financial goodies, Big Pharma’s way (on top of the multitude of breaks
Big Pharma already receives), so what would transpire in a more perfectly
capitalist system, can now happen through government intervention into a
oligopolistic market place. Unfortunately, as usual, government is
attacking the symptom of the problem (Big Pharma intransigence and greed),
instead of the problem (Monopolies authorized by our government), essentially
applying a band aid to the boil on the skin instead of addressing and attacking
the MRSA that lurks beneath the boil.
Adam Smith and an “Absurd Tax”
We’ll eventually get to private equity, but
first a quick visit to our friend Adam Smith. Mr. Smith warned about the
pernicious tendency of capitalism to metastasize into monopoly, when he wrote:
(The interests)… “in any
particular branch of trade or manufactures, is always in some respects
different from, and even opposite to, that of the public. To widen
the market and narrow the competition, is always in the interests of the
dealers… and can serve only to enable dealers, by raising their profits above
what they would naturally be, to levy, for their own benefit, an absurd tax
upon the rest of their fellow citizens. The proposal of any new law or
regulation of commerce which comes from this order (Merchants, Dealers,
Monopolies), ought always to be listened to with great precaution, and ought
never be adopted till after having been long and carefully examined, not only
with the most scrupulous, but with the most suspicious attention.”
No way. Adam Smith, a free market
deity, nearly 235 years ago warned that monopolistic profits are a tax on
society, and warned about capitalism’s tendency toward combination? And
as this blog has written about (see Monopolies and Double Standards, Et Al.)
monopoly can only occur by the grant and authority of the government.
And hence, the market place failure we are now witnessing: Having created
the oligopoly, Big Pharma, the government now has to go begging this oppressive
power for core and fundamental medicine. Had the government not
allowed Big Pharma to consolidate and grow so powerful, there would be many
varied entities and entrants in the pharmaceutical market place, each seeking
out their own niche, presumably one of these would have been antibiotics to
keep up with superbugs. Instead, we have a few powerful actors, Big
Pharma, who can hold out for compounded government largess, at the expense of
the tax payer and general welfare of society, before developing drugs that
would otherwise, most likely, be developed in a less monopolistic market
sector.
“This is market place failure,” states
California Democrat Mr. Waxman in the Times article.
Indeed, Mr. Waxman, but rather than throw yet more tax payer money at Big
Pharma (in the form of financial incentives and tax breaks), perhaps the real
solution is the break up the pharmaceutical cartel, so that there are more
players to address life threatening disease and illness?
How the Game is Played
Enter private equity…. Shadow banking’s co-evil
twin. Private Equity makes its money by acquiring, merging, leveraging up
perfectly healthy companies and corporations with colossal amounts of debt,
front loading profits, extracting huge management fees, of course taking a
portion of the profits (if any) from the targeted company, tax deductibility on
the massive debt, and even enjoys the kicker of special tax break, under the
guise of “carry forward.” Private equity further guarantees profitability
by sealing itself off from loss by creating LLC funds and holding companies;
hence, profits can flow up, but losses and bankruptcy may stay below with the
LLC. But the really big pay off occurs when the private equity company
takes the acquired firm and flips it, by taking it public (IPO), merging it
with another company (M&A), or tossing said company to another private equity
firm (to be leveraged up and “debted up” all the more), much as a pack of Orcas
does with baby seals. Of course, private equity, like MRSA, goes barely
unnoticed when things are going along swimmingly; but when the economy heads
south or the bubble bursts, all that leverage, and the debt service load, tends
to tear a company apart at the seams, to the detriment of: society,
management, investors, employees, bond or debt holders, vendors of the bankrupt
company, and the tax base.
Witness a record number of business failures in
this country in the last couple of years, possibly half of them pushed over the
edge by their recent, or present liaison, with private equity. From the
NY Times story, Profits for Buyout Firms as Company Debt Soared (10-5-09),
we get the following:
“A disproportionate
number of the companies that were acquired during that frenzy are now
struggling with the enormous debts. More than half the roughly 220 companies
that have defaulted on their debt in some form this year were either owned at
one time or are still controlled by private equity firms, according to analysts
at Standard & Poor’s. Among them are household names like Harrah’s Entertainment and Six Flags, the
theme park operator.”
Gee… all those tax breaks and special
considerations, do you think private equity has some ties to the Federal
Government? You bet. Why look no further than the occupations of
our recent Treasury Secretaries:
*Mr. Henry Paulson (Bush Administration) former
Goldman Sachs, CEO and creator of TARP. Say no more.
*John W. Snow (Bush Administration) now a member
of Cerberus Capital Management Groups, private equity, and the fine folks who
helped bring Chrysler down.
*Larry Summers (Clinton Administration),
lieutenant of Robert Rubin, and a key player in the deregulation of the
derivatives industry. The derivatives industry will and does,
undoubtedly, play a significant role in private equity, and yet another round
of M&A activity to come.
*Robert Rubin (Clinton Administration): Goldman
Sachs, Citigroup, both of which ran and supported private equity operations.
Alone, of our recent Treasury Secretaries, Paul
O’Neill (Bush Administration) stands out as a man of fiscal integrity, a man
who bucked the Bush tax cuts and the neo-cons, and a man who did not come from,
or return to, investment banking and private equity. Perhaps that’s why
Mr. O’Neill was let go? As for Mr. Summers, the derivatives he has
championed over the years play a unique role in private equity, by allowing
investments banks, and private equity, itself, to hedge their bets against targets
for acquisition. Derivatives can secure profits for debt holders, if a
takeover target fails, so that, depending upon the deal, and the subsequent
financial results, the investors, private equity, banks and bondholder, may
actually have an incentive to see the target fail or enter into
bankruptcy. As we can see in our on-going financial crisis, Wall Street
makes money coming and going (lose, win or draw), and if the system blows up,
well there’s always Uncle Sam ready to offer a bailout.
Fed Reserve and QE2:
The mother’s milk of private equity is cheap
liquidity. We are talking tons of money sloshing around, like the kind we
see right now under QE 1 and QE2. Private Equity has enjoyed peak
periods, during bubbles, and massive monetary easing, like that seen in the mid
to late eighties courtesy of Fed Chairman Alan Greenspan, and the earlier part
of this decade, again under the auspices of the Fed, commanded yet again, by
Mr. Alan Greenspan. During these periods private equity awash with easy
money, courtesy of investors and friends in the banking industry, runs around
preying upon companies, leveraging them, merging them, and most stock analyst’s
favorite, creating “synergy” and “economies of scale”…. All code for
down-sizing, layoffs, and organizational restructuring.
At a macro level, as companies merge or fall
prey to their massive debt load, private equity plays a critical role in the
consolidation of industry and markets, that is to say, the creation of
monopolies and oligopolies, not unlike what we see with Big Pharma, and
problems associated with Big Pharma, like MRSA.
These monolithic business entities
have tremendous problems with risk management, as we saw with B.P. earlier this
year, and often end up performing poorly for their stockholders and
society.
And the Fed’s and Treasury’s role in all
this? Well presently, the Treasury finds itself in the ownership of a car
company, and several financial institutions. What better way for the Fed
and Treasury to divest themselves of these entities, than to print money, flood
the market with cheap liquidity, drive down bond yields and treasury yields,
and drive unwilling participants back into the stock market…. So that the Fed
can exit, stage left, from its forays into the private sector. TARP
might, officially, then be proclaimed an economic/government success, and the
preeminence of “Too Big to Fail,” as a government policy, upheld.
Of course, an intended or unintended consequence
of massive liquidity, and lower bond yields, is to drive investors into junk
bonds, and riskier investment vehicles, such as hedge and private equity
funds. Again, all the mother's milk of private equity….so that at a time
of record unemployment in this country, and with the Fed printed money so fast
that the printing presses are beginning to smoke, we can reasonably expect more
job killing raids by private equity in the market place. Merger and
acquisition activity should soar.
The Bottom Line:
Merger and acquisition activity, as well as, the
taxation and regulation of private equity, like monopolies themselves, all fall
under government purview. One quick way for government to arrest rising
unemployment is to slow merger and acquisition activity (via Justice, SEC and
the FTC), and tax private equity at the appropriate rate all businesses face,
and eliminate the tax deductibility of debt; all the better for the government
to address unemployment, MRSA and intransigent industries, such as Big Pharma,
who are literally holding public health hostage, so that they can, possibly,
extract further financial concessions from our government.
Private equity, too, has a role to play.
Perhaps instead of becoming a contractionary force in our economy, it can be a
force for good, by deploying its capital toward new ventures and start-ups that
create jobs and opportunity, instead of the elimination of same.
At the end of the day, MRSA is a growing life
taker and a threat to the nation’s health; likewise, private equity, in its
present incarnation, is a threat to society, business, the consumer, management
and employees, and our nation’s economic health. For both there is a
cure.
Copyright JM Hamilton Publishing 2013
