Romney’s VERY Private Equity (with UPDATE)
By now there’s been a lot of discussion in the media about the Vanity Fair and Associated Press exposés of Romney’s and his wife’s offshore bank accounts, to the limited extent that information about them is publicly available. Romney is now likening overseas bank accounts and shell/money-laundering corporations to investing in real overseas companies—as if investments in overseas companies guarantee profit rather than loss in the same way that Bain and its executives usually were guaranteed profits, through financial-transaction fees and “consulting” fees they arranged for themselves irrespective of whether the acquisitioned company made money or instead collapsed under the weight of the debt Bain forced it to incur, in large part, in order to pay Bain those fees. And as if personal profits from overseas investments aren’t taxable here in the United States unless those profits are stored in bank accounts elsewhere.
Romney’s refusal to disclose enough specifics about these foreign bank accounts, where the money actually came from and under what circumstances, and how it has been invested gives new meaning to the term “private equity,” at least in Romney’s case. And this refusal, too, has been and will continue to be widely discussed.
But there’s one aspect of the investigative reports that I think has not been given enough attention and analysis: that Romney’s IRA account from his 15 years as CEO of Bain Capital—a period of time when annual IRA investments could be no more than $2,000—now has assets of more than $100 million. The Vanity Fair article quotes an expert that the author consulted as saying he believes that they only way that this could have happened would be if Romney significantly undervalued the actual value of the assets he was placing into that account. Paul Krugman in his New York Times column on Monday discussed the IRA and said there were conceivable legal ways to accomplish this but, because of the secrecy, no way for the public to know whether these wealth was accumulated legally or not.
Krugman didn’t discuss how this could have happened legally, so I’m wondering: what kinds of investments would there have to have been for this money to have so wildly metastasized? Apple stock? If so, how much Apple stock? Precious-metal funds? A quiet Louvre heist?
But there’s another issue concerning Romney’s and Bain’s peculiar brand of investment—this one involving the realdefinition of private equity, not the pun one I used in the title of this post—that also hasn’t received enough media attention: the difference between Bain-style private equity and Silicon Valley-style venture capital. That difference being the one I alluded to above regarding the investor’s forcing the invested-in company to borrow large sums from banks and use some of the borrowed money or some of its profits to pay huge fees to the investor. Or, in Bain’s case, apparently, not to all the investors, just to the investment company itself and to its executives—thus eliminating, for them, the usual risk inherent in capitalist investment. You know; the risk so vaunted by uber-capitalist-advocates like Romney. Not to mention Romney himself.
Slate writer Will Oremus has an article there today in which he argues that the real difference between the federal government as an angel investor in startups such as Solyndra and private venture capitalists is that the former can only recoup its investment, while the latter can make substantial—sometimes huge—profits.
But venture capitalists, unlike Bain and its executives, also can lose all or some of their investment, just as the government can. ((Does Andreesson Horwitz load up the startups it invests in with huge bank debt and use some of the loan money to pay the venture capitalist firm huge financial-transaction and consulting fees?)* Just as there’s a difference between Silicon Valley-type venture capitalism and Bain-style private equity—something that Obama should point out—there’s a difference between making off like a bandit and being one.
UPDATE: Well, as implied in my reply to a comment below, I was unaware that Romney was the sole owner of Bain; I thought Bain was a closely-held corporation in which Romney was the main, but not the sole, shareholder. But a jaw-dropping Boston Globe investigative report today, titled “Mitt Romney stayed at Bain 3 years longer than he stated,” makes clear—among, um, other things—that Romney was the sole owner of Bain.
ALSO: On the subject of what types of investments Romney would have to have placed in his Bain-years IRA in order for it to have gained so much wealth, I just emailed Paul Krugman at his Princeton email address, told him about my post and about the speculation in the comments by Mike and Kaleberg, and asked whether he could write on his blog or even in his column about the various possibilities. So … we’ll see ….
*Parenthetical added on 7/12 at 11:15 a.m. Should have included it in the original yesterday. Couldn’t resist adding it now.
Beverly, I understand the process describing the manner by which the “investment bank” like Bain can load the taken over corporation with debt for the purpose of paying itself large fees and guarantee itself a profit regardless of the success of the take over. Please be more specific as to who the losers are in this game. Are there other investors that lose when the corporation goes under? What did the banks do about the unpaid debt of the corporation given that the debt had not been used to purchase assets, but was instead taken out of the corporation by the investment company?
According to the Vanity Fair article, the non-Bain-partner investors lost money when a company that a particular Bain fund invested in closed and filed for bankruptcy, but Bain itself and its partners—or at least its executives—came out with net gains, sometimes substantial ones, because they already had received so much money in transaction fees and consulting fees. As for whether the bankrupt company paid back all or some of the bank loans, the article didn’t say. That would have been decided in the bankruptcy proceeding. But in several instances, it was the inability to repay the hefty loans out of the company’s gross profits that caused the firm to shutter and file for bankruptcy.
At least that’s what I understand from reading that article and a few others during the last few months.
1) My guess is that Romney loaded his IRA with $2000 worth of warrants, options or some other such vehicle which were associated with an empty or low value corporation. Then, all he had to do was transfer assets to that corporation, then exercise the warrants. The original valuation could be quite low, maybe 1/100 a cent per share, but after assets were moved into the corporation it could easily be worth tens or hundreds of millions. It’s pretty straight forward bookkeeping. Companies do this sort of thing all the time. Lord knows I was tempted to do something like this after a friend died and her warrants vested, but I was acting as an executor, a fiduciary, not a principal, so I couldn’t design a proper shell without risking the immediate vesting status.
2) An interesting example would be to romney Apple. Apple has huge cash on hand and a good positive cash flow. With interest rates at 5 or 6% it could easily pay for its own purchase. It would make sense for a raider to buy a controlling interest in Apple, then load it with debt based on its cash flow and declare a huge dividend. If they restructured the stock properly, they could ice out the minority shareholders completely. Look at how Zuckerman handled Facebook stock. The main trick is getting a big enough loan up front. Sheer size is some protection, but Apple is a sore tempting target. I believe that Apple management is aware of this risk which is why they recently declared a dividend, to lower their takeover profile. It’s an implicit threat that they would act in the face of a takeover.
3) So Vanity Fair says that Bain was structured as a limited partnership. Supposedly this places the general partners at more risk than the limited partners, but when the goal was liquidation, as it was at Bain, the general partners can see to it that they are paid up front. I’ve invested in limited partnerships in the past, sometimes to make money, sometimes to lose money or restructure cash flow to lower my tax bill. (Limited partnerships do all sorts of transformations on money. They’re the Higgs boson of financial structures.) For all I know, Bain was supposed to generate a profile of gains and losses, maybe to move income around in time and convert a regular income stream into capital gains which could be covered by the losses generated.
I’m no expert on tax law, but I’m pretty sure the big profits don’t have to be all due to fees. In fact, I suspect there’s more money to be made another way:
1. Bain buys Target Company.
2. Bain creates Shell Company A and Shell Company B. Shell Company B gets a piece of the intangible assets of the Target Company (goodwill, a patent, the logo, or something along those lines) that is worth very little at Target Company’s current level of revenues. Shell Company A gets the rest of Target Company. Shell Company B, virtually worthless, goes into the IRA.
3. Shell Company A, the new owner of the Target Company, borrows a lot of money citing the expertise of Bain in turning companies around.
4. Using borrowed money, Target Company expands operations boosting revenues.
5. Increased revenues get attributed primarily to the intangible assets of Shell Company B, and thus collects rents from Shell Company A equal to most of the increased revenues. (Note that profitability is not required – merely an increase in revenues which are easy to generate with borrowed money.)
6. Repeat steps 3, 4, and 5 as often as you can until the merry go round stops.
7. Shell Company A, the holding company which owns Target Company, goes bankrupt. In final bit of milkage, Shell Company B waits in line with other creditors for some of the proceeds of the forced sale of the assets of Shell Company A.
Re: Romney’s IRA contributions, there was a WSJ article in the past several days that talked about them – they were often a special share class of the PE deals that Bain invested in, where the majority of the value of the company was assigned to the other share class. There are examples of these “low-value class” shares making 600% in several years.
The tax strategy (made sense at the time, less so now) was to put these high(?)-risk, high-reward share classes in your IRA, and your mandatory allocation of the other (lower risk, lower reward) share class in to your taxable brokerage account.
The article quotes tax professionals who question the aggressiveness of the Bain share class valuations.
Thanks, Steve. I wrote up a response that was too long to post as a comment, so I turned it into a separate post. I just posted it.
Mitt regards the middle class worker, the only one way out for whom is applying for bad credit installment loans online, as expendable chattel. He only evaluates businesses with respect to ways to maximize profit margins for the benefit of upper management and the major investors. Behavior which most people would regard as unethical is quickly dismissed by Romney and other corporate bullies as being shrewd. Legal? Probably, but just because you have the right to do a thing does not necessarily make it the right thing to do.