The dangers of a trillion-dollar industry that hardly anyone understands
Brendan Ballou is a federal prosecutor and served as Special Counsel for Private Equity in the Justice Department’s Antitrust Division
Interview by Lynn Parramore
Cross-posted from INET
In his new book, “Plunder: Private Equity’s Plan To Pillage America,” Brendan Ballou, a federal prosecutor who served as Special Counsel for Private Equity in the Justice Department’s Antitrust Division, outlines the dangers of a trillion-dollar industry that hardly anyone understands. He explains how Americans can fight their harmful practices.
One of my favorite NYC restaurants had become understaffed and dirty – a shadow of its former self. I learned an interesting fact: a couple of years ago, a private equity firm had bought the local chain. The same type of firm that had already ruined my beloved neighborhood grocer. The kind that was rapidly taking over vet clinics, dental offices, and gyms on every block – though you wouldn’t know it unless you did some sleuthing.
Price hikes, deteriorating conditions, and poor service — along with a certain slickness of marketing — could be signs that ownership of a business you count on has transferred to one or more firms in a rapidly-expanding Wall Street industry. Names like KKR, Carlyle, and Blackstone tend to fly under the radar, but they’re everywhere, making more money, gaining more influence, and some would argue, wreaking more havoc than anything else on Wall Street.
Federal prosecutor Brendan Ballou provides the scrutiny that an industry with this much economic and political power should invite in his provocative new book, “Plunder: Private Equity’s Plan To Pillage America.” He reveals how private equity will transform our lives over the next decade in ways as profound as Big Tech did in the last, and not for the better unless we change how it does business.
Financier William Simon got the idea for private equity back in the seventies. Simon, a Nixon administration official and right-winger whose heart’s desire was to free finance and corporations from regulation, left Washington to execute the first “leveraged buyout.” He and a partner bought an old greeting card company on mostly borrowed funds, extracted huge fees, and then sold it for enormous profit in a rising market. People like “junk bond king” Michael Milken took notice and started following the model. In the go-go eighties, the Washington Post noted that “greed and debt” had combined to “create the hottest game on Wall Street today.”
Until things went bust. The leveraged buyout industry got a nasty reputation as the “robber barons of the eighties” and retreated.
But there was just too much money to be made. The industry went on to rebrand itself as “private equity” and expanded following the 2008 financial crisis into many of the less regulated corners of finance – some previously occupied by the great investment banks. After yet another run of bad press – you might recall when Mitt Romney’s Bain Capital was denounced as a profiteering predator in the 2012 election — the industry started to rebrand itself once again. Today some of the big firms call themselves “global investment businesses” or “alternative asset management businesses.”
Ballou warns that whatever you call them, many have become incentivized to do great harm to consumers, workers, and taxpayers– and they’re doing it with the help of lavishly-funded political allies.
Advocates say private equity makes companies more efficient when they buy them, but Ballou finds that their real specialty isn’t managing companies – they often screw that up, big-time – but finding legal and regulatory holes that allow them to make profits quickly and shift the risks and costs to somebody else – somebody like you. He criticizes the current business model as far too focused on short-termism and extractive practices.
But, you might ask, isn’t this just capitalism? Nobody said it was pretty.
According to Ballou, this is something different – an industry that has metastasized into a job-killing, business-destroying, community-crushing machine the likes of which we haven’t seen since the money trusts of the nineteenth century. In other words, it’s predatory capitalism on steroids. Most worrisome of all, in Ballou’s view, is the fact that these firms have almost no accountability to the U.S. legal system.
Some liken private equity firms to vultures picking the bones of dying companies, which you could argue is a necessary activity. But Ballou points out that many private equity firms now target healthy companies, leaving them gutted, unproductive, or even bankrupt. Whether it’s Bain, Apollo, or Sun Capital, each firm has its preferred tactics for extracting money from the businesses they buy up, too often hurting the most vulnerable people, like nursing home residents, who can’t fight back. When they buy up rental properties, watch out for evictions. When they target doctors’ offices, expect to pay more for care. They might even be cutting corners at your hospital’s emergency room (the horror stories will make you research your local ER). And they really, really want to get their hands on your 401 (k).
The founders of these companies have become absurdly rich – we’re talking multi-multi-billionaires — so their power in American politics is tremendous. Not only do they influence the political system — increasingly, they are the political system. Just ask men like Timothy Geithner, Newt Gingrich, Paul Ryan, and David Petraeus, all now working in private equity. It’s more than a revolving door between Washington and Wall Street. As Forbes magazine highlights, it’s a “passionate love affair.”
Free from pesky regulations and out of reach of the law, the private equity industry has become so wildly profitable that celebrities like Will Smith and sports stars like Serena Williams are tripping over each other to get in on the action. Last year, Kim Kardashian announced a partnership with a former Carlyle partner to start her own private equity firm!
This trillion-dollar industry owns companies employing millions of Americans, and, Ballou argues, it is hurting us with the active assistance of our government. In the following interview, the prosecutor shares with the Institute for New Economic Thinking his insights and prescriptions for getting this industry under control. (Ballou’s book, and this interview, are made in his personal capacity and do not necessarily reflect the views of the Department of Justice).
Lynn Parramore: Private equity is something of a mystery to most people. What do we need to understand about these firms and what they’re up to?
Brendan Ballou: “Private equity” is a term that people might be embarrassed to say they don’t really have a clear idea about. I confess that I didn’t until after I started writing the book.
The basic business model is actually very simple. A private equity firm uses a little bit of its own money, a little bit of investors’ money, and a whole lot of borrowed money to buy companies. Then it tries to impose operational or financial changes with the ambition of selling them for a profit a few years later.
It’s a simple idea but it has three basic problems. One is that private equity firms tend to invest in the short term to get a return on their investment in just a few years. The second is that they tend to load up the companies that they buy with a lot of debt and extract a lot of fees from them. The third is that private equity firms tend not to be held legally responsible for the actions of their portfolio companies.
All this means you’re on a very short timeline with a very risky leverage model and you’re not necessarily going to be held responsible if things go bad, leading to business strategies that can be very extractive and hurt consumers and employees.
LP: This industry, known as “leveraged buyouts” in the eighties, got a negative image and retreated for a while. After rebranding, the model re-emerged as “private equity,” which took off and expanded into whole new areas after the 2008 financial crisis. Why should be concerned about this expansion?
BB: Private equity firms are increasingly taking on the role that the great investment banks used to have before the crisis. For instance, they have moved into private credit, which is an alternative to the public stock market. A company can get a large loan without necessarily making the sort of disclosures that you would have on the public capital market.
The challenge is that private equity firms are vastly less regulated than investment banks, which are generally considered either banks or bank holding companies. What this means is that private equity firms are doing a lot of the work that these companies did prior to the financial crisis. but they’re doing it with even less oversight.
LP: That doesn’t sound good.
BB: It’s concerning. One of the really interesting things to see is how private equity firms often don’t even describe themselves as private equity firms anymore.
LP: There’s the rebranding again. It’s hard for the public to follow what they’re doing, isn’t it, despite the fact that they’ve become a huge part of the economy?
BB: Yes. Some now call themselves “alternative investment managers.” One industry observer said that “Blackstone remind[s] me of Goldman Sachs in the 1990s—every time you see a new business that is growing, that is where they are.” That really stuck with me.
LP: And the business school grads who used to want to work for Goldman Sachs now rush to join KKR and Blackstone.
BB: That’s true. The idea is that the leading private equity firms are really the financial innovators in the way that the name-brand financial institutions, the Goldman Sachses, the J.P. Morgans of the world, used to be. Institutions like Goldman Sachs may still capture the public attention, but private equity firms may be where the action’s at.
LP: Some of the things we learn about this industry in your book seem really contrary to how we normally expect businesses to work. It’s striking that private equity firms can thrive even when the companies they buy fail. In fact, as you point out, sometimes they even want the company to fail. Why would you bankrupt a business you’ve bought?
BB: It’s a really fascinating part of the law and one that far too few people understand. The basic story here is that private equity firms are able to use strategic bankruptcies to slough off obligations they don’t want to pay — pension obligations in particular.
In 2007, Sun Capital bought up Friendly’s, the ice cream and diner chain. They sold off the assets. There were layoffs. Ultimately, they pushed the company into bankruptcy. But Sun Capital was both the owner of Friendly’s and its largest creditor. Now, normally when a company goes bankrupt, the owner of that company loses control of it. But because Sun Capital was both the owner and the largest lender, it’s like they got to flip the script. They moved ownership from one part of the private equity firm to another part. So they managed to hold onto control of Friendly’s. But why then did they do the bankruptcy? So they could slough off the pension obligations, which were eventually taken over by the quasi-government agency, the Pension Benefit Guarantee Corporation [PBGC].
LP: So Sun Capital was off the hook for the cost of paying employees the pensions they were promised. What happens to those workers? Who else does this strategy hurt?
BB: The PBGC, which now has to pay down those pensions, is funded in large part by other pension plans. So it’s other, more responsible companies, that end up having to pay the cost of the private equity firm’s strategic move. Sometimes the PBGC isn’t able to pay all of the pension, so the pensioners can lose their pensions or have their benefits reduced. The retirees lose out.
More broadly, when private equity firms engage in these risky strategies or view a company as more valuable for its component parts than it is whole, often you see very large layoffs in companies and whole industries. This is one of the big challenges. In the retail sector, the Center for Popular Democracy estimated that private equity firms are responsible for about 600,000 layoffs in the past decade. That was during a time when the retail industry was actually growing and adding jobs. Risky strategies, coupled with extractive tactics and the occasional benefits of bankruptcy, hurt not just retirees, but workers, and ultimately consumers.
LP: So in essence, private equity firms can buy up companies and then charge them for the privilege of being looted, or even destroyed.
BB: That’s pretty much it. Often private equity firms make their money from the companies they buy through “management fees” that the company has to pay every quarter or every year for the privilege of being owned by them. They also charge transaction fees, so if the private equity firm directs the company to sell its own assets, a portion of the sale actually goes directly to the private equity firm – not even the firm’s investors. Then there are what are called “dividend recapitalizations” – that’s when the portfolio companies are borrowing money to pay dividends to the owner – in this case, the private equity firm. It’s like being able to use someone else’s credit card. Somebody else borrows the money that they ultimately give to you but they are the ones on the hook for paying.
A big part of the private equity business model benefits from extractive fees that it places on its own companies.
LP: As you point out in the book, things may work out well for a few executives at the top of the purchased company, but everyone else bears substantial costs. Do taxpayers end up footing some of the bill?
BB: There’s a cost to taxpayers. One of the things that was surprising to me about private equity firms is that they often target industries that are highly regulated or those where a big chunk of the money comes from the government. An industry that’s really popular with private equity, and one that has been getting a lot of necessary media coverage, is the nursing home industry.
LP: The story of what private equity has done to nursing homes is among the most disturbing in your book. Why did private equity target nursing homes?
BB: For private equity, part of the appeal of industries like nursing homes is that government funds are an extremely stable source of income. They can rely on the money coming in from Medicare and Medicaid every month. It’s also a situation where private equity’s influence can be really helpful. One of the smartest things private equity invests in is not just companies, but people. If you look at who these firms have hired, it includes secretaries of state, secretaries of defense, speakers of the house, generals, a CIA director, even a vice president. These sorts of people and relationships can be very helpful when it comes to working in highly regulated environments.
What initially frustrated me, and one of the inspirations for the book, was the Carlyle Group’s acquisition of HCR ManorCare, which was the second-largest nursing home chain in America. In 2007, Carlyle bought the company, loaded it up with debt and forced it to sell its assets, making its investment back through various transactions and management fees. While all this was happening, ManorCare was forced to cut back on costs. Health code violations spiked. Eventually, the company went bankrupt, but when people tried to hold Carlyle accountable, they failed.
The story that gets me concerns a specific resident of a ManorCare facility. She struggled to go to the bathroom by herself, but nevertheless was forced to do so and fell and hit her head. She ultimately died of a subdural hematoma – bleeding of the brain. When her family sued Carlyle for wrongful death, the firm managed to get the case dismissed by arguing that technically they were not the owner of ManorCare, but merely advised a series of funds that, through several shell companies, ultimately owned the nursing home. That was enough for the court, which dismissed the case against Carlyle. The firm was never held responsible. This story epitomized for me how often private equity firms are able to exert control over a company and extract assets from it, but then when things go wrong they can walk away without consequence.
LP: And the consequences can sometimes be fatal.
BB: They can be enormous, and sometimes they can be fatal. There has been a crucial study suggesting that private equity ownership is responsible for an estimated 20,000 premature deaths over a decade and a half. It’s just extraordinary.
And listen to the devastating stories of people who lost their jobs. For example, Toys-“R”-Us was bought by private equity firms [Vornado, KKR and Bain Capital] that loaded it up with debt and eventually forced it into bankruptcy. The situation for employees was heartbreaking, made more so by the fact that the executives the private equity firms installed in Toys-“R”-Us allegedly managed to give themselves multi-million dollar bonuses just days before pushing the company into bankruptcy. It suggests that at least some of these firms are taking an awfully narrow view of their responsibilities to their customers, to their employees, to society as a whole.
LP: The amount of money involved in this industry is really mind-boggling. We might think that the CEO of Goldman Sachs makes a good income, but that’s just a small fraction of what the CEOs of the big private equity firms are pulling in.
BB: Yes! I don’t want to say that the leadership of Goldman Sachs is underpaid, but the CEO there makes about one-tenth of what the leader of Blackstone makes. It’s just an order of magnitude difference. There’s so much more money coming in than out of private equity firms. In fact, Blackstone and KKR have ambitions to have one trillion dollars in assets under management each in the coming years.
LP. A trillion each? Wow.
BB: I think in 2021, which was something of a high watermark for the industry because of low-interest rates, there were $1.2 trillion in private equity acquisitions. The entire U.S. GDP is about $25 trillion. It’s not a perfect comparison, but we’re talking about a pretty significant part of the American economy.
LP: Another thing that seems counterintuitive is that private equity firms often move to sue the customers of the companies they buy. And perversely, while they can sue the customers — often working class and poor people – those customers can’t sue them because of forced arbitration agreements. What’s going on here?
BB: I think it goes back to the problem of investing for the short term. When you invest in the long term, you care about your customers. You care about them coming back. You care about them succeeding. But if your goal is to make a profit, to sell the company in just a few years, you’re going to take a far more extractive and aggressive approach.
A woman in Baltimore who made about $800 a month received a check from a payday lender (one owned by a private equity firm) that she could cash in exchange for paying it back with interest. It was more than she could afford and she had to pay an exorbitant rate for cashing the check. But when she tried to sue the payday lender, she was forced to go into arbitration, which is notoriously difficult for plaintiffs to succeed on. Conversely, if the payday lender were to sue her, they would be able to use all the machinery of the state or even the federal court system. This would allow the firm, if they were successful, to garnish wages from any bank account that she has.
This problem is bigger than private equity, but it’s a pretty astounding double standard where customers are forced into often defendant-friendly arbitration but the big companies themselves can rely on the machinery of the ordinary justice system.
One more example—there’s a really interesting comparison of two payday lenders, one of which was bought by a private equity firm and one which wasn’t. The payday lender bought by private equity had a huge spike in the number of cases that it was bringing against its own customers. It appeared it was actually part of the business model of the firm to be more aggressive with the people it was servicing. That may be successful in getting money in the short term, but I doubt it’s particularly fruitful in generating the long-term goodwill of the customer base.
LP: It seems like everyone is becoming affected by this in some way — when we go to the dentist, buy an insurance policy, take a trip to the emergency room. Private equity is even involved in drinking water in some places (very dirty water as you mention in your book). Yet they still manage to operate under the radar.
BB: Exactly. It’s still shocking to me. The names of private equity firms like Apollo, KKR, Carlyle, and Blackstone are mysteries to most people and yet they and other private equity firms surround you and shape your life. If you go to the veterinarian, to the OBGYN, if you go to buy contact lenses, or even, as you mentioned, pay for your tap water, there’s a chance that you are paying private equity for that privilege. It’s sometimes surprising to find out that a private equity firm owns a company that you love or used to love.
I think the ubiquitous nature of private equity can sometimes lead to a certain level of despair for people who think and care about these issues. But I just urge people to try to hold those feelings back. Private equity advocates want you to believe that no reforms are possible. But the mere act of optimism, the belief that you can make a positive change, is pretty revolutionary. It’s necessary if we’re going to actually change the model.
LP: Some have argued that private equity firms shouldn’t even exist. What’s your take?
BB: The world doesn’t need private equity firms to just end. What we need is to change their incentives because we’ve got a business model that’s leading to a whole host of problems for customers and employees.
Whether you call it private equity or something else, the basic project of giving money to companies so that they can grow and thrive is a necessary part of our economy. But the private equity business model has evolved, essentially because of legal incentives, to focus on the short term, to load companies up with debt, to extract fees, and to evade financial and legal liability for their actions. Once you have that, you have bad consequences, whether it’s in nursing homes, prisons, single-family rentals, or what have you. You see all these tales of woe happening across industries and it’s because of those three basic problems I’ve described. If you change those incentives, private equity could be ultimately helpful.
LP: You state in the book that “it’s as if private equity firms and their allies have built a justice system to their liking.” How do we deal with that?
BB: Private equity’s influence pervades not just the machinery of the court, but every level and layer of government, at the federal, state, and local levels. Whether it’s getting favorable contracts for prison health care and phone services, or getting tracts of foreclosed homes from Fannie Mae and Freddie Mac, or protecting the carried interest loophole in Congress, private equity has been enormously successful in achieving its legislative and legal agenda. That said, this has happened before and ordinary people have solved it.
LP: How so?
BB: In a lot of ways, the basic model of private equity is very similar to the trusts of the late 19th century and early 20th century. The trust movement was an effort to rapidly combine small businesses into single entities that could be operated centrally. Today we’ve sort of forgotten that this wasn’t the beginning of a period of American industrialization, but actually something at the end. A lot of the big movements in terms of innovation in steel, oil, sugar, tobacco, and so forth were actually happening in the immediate aftermath of the Civil War. But then, as the trusts were combining, there was a huge amount of economic stagnation and a lack of innovation. Yet ultimately, the Populist movement and later the Progressive movement constrained the powers of the trusts and helped to usher in a genuine people-centered movement in American politics. We got the creation of the most important anti-trust laws, labor laws, a progressive tax system, environmental laws, the creation of the Federal Trade Commission and the Federal Reserve – a whole swath of things that constrained corporate power for several generations. It was enormously successful until a series of legal revolutions in the 1970s.
Past isn’t necessarily prologue, but we have an example in American history where tremendously powerful economic and financial concerns were constrained by popular movements. If we’ve done it once, perhaps we can do it again.
LP: So there’s reason for optimism?
BB: Yes. I think that the worst effects of the private equity business model can be constrained. This is a human creation. If we created these broken incentives, we can fix them. We’ve got a challenge, which is that private equity and investment firms have given an estimated 900 million dollars to federal officials and candidates since 1990. That said, whether it’s action in Congress or elsewhere, there are numerous levers of power people can act on. It could be Congress, but it could also be states and localities. It could be federal agencies like the SEC, Health and Human Services, the Treasury Department, and so forth. But it can also be through state attorneys general and litigation. So there’s a role for activists to play.
All of which is to say that there are a lot of different avenues that people who care about these issues can pursue to change the private equity business model.
LP: What’s the first thing you would do to change private equity?
BB: I would want private equity firms to be held legally responsible for the actions of companies they control.
LP: Like some kind of fiduciary duty?
BB: Exactly. You can align responsibilities so that private equity firms are responsible for their actions. That would fundamentally change incentives and make their business moves a lot less destructive in a whole range of industries. We can act through a bunch of different levers to get this done. States and local entities can make sure that the portfolio businesses that have their primary business in their jurisdiction are held responsible. We don’t have to wait on one institution, whether it’s Congress, the executive branch, or a given agency. There are plenty of ways to move forward.
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