Jesse Eisinger has a smart New York Times column on how Mitt Romney, fittingly perhaps, is running on debt while running against it.
The GOP frontrunner is a former private-equity CEO, of course, which means his business success, the basis of much of his campaign, is owed, so to speak, almost entirely to borrowing scads of money. At the same time, he’s running against the “Obama deficits,” promising to slash the public debt and “refusing to allow any more irresponsible borrowing.”
That makes for some amusing contortions: The guy who loaded struggling companies with tens of millions of dollars in debt to pay his firm special dividends, helping push them into bankruptcy, is the same guy who wrote this in a USA Today op-ed in November:
A point of no return may well be approaching — a decade of huge deficits could drive our principal payments and interest rates beyond our reach while starving the economy of the capital it needs to grow.
I suppose you could say Romney knows whereof he speaks. But he’s hardly had a road to Damascus moment on the ethics of his private-equity past.
Defenses of Romney—I have Slate’s Matthew Yglesias and Nicholas Kristof in mind—from charges that he was a “looter” or “corporate raider” tend to elide the role of debt in an LBO deal, which is particularly glaring since it’s what these deals are all about. To buy a company, a private-equity firm typically borrows from third parties, using the companies’ own assets as collateral, loading the target up with debt, and putting in a relatively small piece of its own capital. PE firms sometimes close the deal and pile on another round of debt to pay themselves a special dividend that ensures themselves a profit.
From then on, it’s a game of “tails I win, heads you lose.” When the process goes this way, and a private-equity firm extracts equity from companies, pushing them toward bankruptcy or making them less competitive because of increased debt obligations, slashes promised pension obligations, dumping others on the government, then it’s fair to call that process, “looting,” or some similar term that describes financial engineering that winds up benefiting the new investors at the expense of the company in question, not matter what the intent to the financial engineers.
A great Reuters investigation two weeks ago showed how this played out in the real world in one instance. Here’s how I described it:
Bain, with partners, bought the steel mill, which already had been shedding jobs for years, for $75 million and then loaded $125 million on it, cashing out a special dividend that gave it an immediate 350 percent profit, though it would later invest about half of that in a failed merger with another plant. By the time that merger was complete and more debt added on, the company’s debt was more than ten times its operating income. Unfortunately, Reuters doesn’t tell us how much the steel company was paying in interest. I’m guessing that interest alone consumed all or almost all of the company’s operating profit.
Similarly censorious language fits when private-equity companies slash labor and investment to increase short-term cash flow so they can sell it off at a higher multiple at the expense of the long-term health of the company. This doesn’t happen with every deal, and sometimes private-equity firms add value to companies. But it happens.
And it happened at Bain under Romney, as reporter Josh Kosman shows in his book, “The Buyout of America: How Private Equity Is Destroying Jobs and Killing the American Economy.” Here’s Kosman in the New York Post on the buyout of one company:
Bain reduced Dade’s research and development spending to 6 to 7 percent of sales, while its peers allocated between 10 and 15 percent. Dade in June 1999 used the savings as part of the basis to borrow $421 million. Dade then turned around and used $365 million from the loan to buy shares from its owners, giving them a 4.3 times return on their investment.
Private-equity’s main financial tool, its reason for being is debt. It doesn’t exist without it. Romney made his fortune with it. He understands it.
So Eisinger’s question is reasonable: Why does a guy who clearly understands the economics of debt, who has loaded up companies with double-digit-interest-rate debt, not think that you should borrow when people will pay you to take their money?
With investors clamoring to have the U.S. government borrow their money at negative real interest, Romney, erstwhile debt-lover and investor, wants the U.S. to shun debt and investment. Eisinger:
L.B.O. firms certainly never think of debt as immoral. When the borrowing is good, private equity is going to grab the money. When Mr. Romney rails against debt, he is running away from his entire career in business.
Which is worth more exploration at the intersection of Washington and Wall Street reporting.
On the other hand, the CBO says Romney’s budget plan would add $180 billion more to the debt in 2015 than current policy would and $600 billion more than the baseline would. Maybe Romney hasn’t kicked the debt habit after all.
Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR’s business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu. Follow him on Twitter at @ryanchittum.