Elizabeth Warren has been telling us for some years now that what ails American capitalism is private equity. It’s an odd thing to blame, to be sure, committed and empowered shareholders for making companies go bust. But that’s her idea and she’s sticking with it. So much so that she actually proposes trying to do something about it:
Elizabeth Warren’s latest Wall Street enemy: private equity
The Massachusetts Democrat says she wants to stop “Wall Street looting.”
One problem with this idea is that even if she’s right she’s still wrong. Her idea being that people buy a company to stop the value out of it and leave the husked she’ll to die. OK, that could also be called asset stripping. A noble and honourable calling.
For our aim in the economy is to have economic assets – land, labour, capital if you like – employed by those who can make best use of them. After all, our aim is to make the best use of our scarce resources so as to be able to maximise our satiation of human desires and wants from them. So, if someone’s screwing up by not adding much value, or worse making a loss and thus subtracting value in general, we want them to stop. Further, we want those scarce resources to now be redistributed to those who can make better use of them. That is, by definition, we desire asset stripping. Pull under- or mal- used assets out of their current shell where they are being under- or mal- used and send them off to where they will be used better.
Cool, that’s the way we get richer. Moving a scarce resource to a higher valued use is the very definition of creating wealth.
But now let us ponder if she’s wrong. Instead of this private equity being that asset stripping, let us think on whether it might be that private equity is the last change, the Hail Mary pass, before the asset stripping happens.
Stopping Legalized Looting
We should start by transforming the private equity industry — the poster child for financial firms that suck value out of the economy.
Private equity firms raise money from investors, kick in a little of their own, and then borrow tons more to buy other companies. Sometimes the companies do well. But far too often, the private equity firms are like vampires — bleeding the company dry and walking away enriched even as the company succumbs.
As her example:
Consider ShopKo, a discount retailer founded in 1961. By the end of 2005, it had more than 350 stores. Then, the private equity firm Sun Capital took over, loading Shopko up with more than a billion dollars of debt. Sun Capital soon forced Shopko to sell one of its most valuable assets — its real estate — requiring the company to lease back its own stores. Sun Capital made ShopKo pay it a $50 million dividend and quarterly consulting fees of $1 million. It made Shopko pay an additional 1% consulting fee on certain transactions — which meant the company had to pay Sun Capital an extra $500,000 fee for the honor of paying it that $50 million dividend.
When the company finally crumbled and filed for bankruptcy, hundreds of workers lost their jobs and didn’t even receive the severance pay they had earned through their work. But Sun Capital walked away with a juicy profit.
The Shopko story isn’t unique. A study found private equity-owned firms accounted for 61% of the retail jobs lost and planned for elimination in 2016 and 2017. That has hurt communities across the country — particularly communities of color that disproportionately rely on retail jobs.
Well, what would we need to if not refute at least cast doubt on this story? We’d need a retailer that goes down, slashes jobs and so on, without there being even the merest taint of private equity involvement, wouldn’t we? At which point, enter JC Penney:
JC Penney, the more than 100-year old US department store chain, filed for bankruptcy on Friday, making it the latest business to hit bottom amid the coronavirus pandemic.
The chain, known for selling family apparel, cosmetics and jewelry, is the latest in a series of victims of the pandemic-induced economic downturn. With its 850 stores and almost 90,000 workers, it is also reportedly the largest retail casualty so far.
The Covid-19 fallout represented a final blow to the company, which had been struggling for some time.
Nothing to do with private equity at all.
So, how might we explain all of this? Well, the useful and obvious explanation is that we’re going through a technological change. Peoples’ buying habits are changing – the internet – and so the old way of doing things no longer fits. As is usual with the internet it is disintermediating and so traffic and sales are flowing away from the agglomerators – the department stores – and toward the single issue specialists. Shrug, that’s just what is happening. And private equity – other than being that last Hail Mary pass to try and delay, defer or even avoid it – has nothing to do with it.
As is also true of her other example:
Private equity is also wiping out local and regional newspapers with the same playbook: buying papers for cheap, slashing the staff to cut costs, and bleeding the company with fees and dividends. When the papers fail, members of the press lose their jobs and communities lose valuable sources of local news coverage.
American newspapers were based on regional monopolies – the country’s just too large to ship physical newsprint all that far every day. The internet both disintermediates – the classifieds, jobs ads and so on that produced a third of the average income are long gone – and also destroys distance. So, the industry is changing in fundamental ways.
And yes, papers have gone bust without private equity getting anywhere near them.
That is, Elizabeth Warren is full of…..well, full of, but we knew that, right?