Over the last decade, private equity firms wiped out nearly 600,000 jobs in the retail sector by taking over and bankrupting major retailers like Toys R Us and Payless Shoes. But in that same time, private equity also destroyed companies in healthcare, housing, medicine, and many other industries that affect our everyday lives. Today’s guest, federal prosecutor Brendan Ballou, explains how we can stop private equity’s plan to pillage America.
Brendan Ballou is a federal prosecutor and served as Special Counsel for Private Equity in the Justice Department’s Antitrust Division. Previously, he worked in private practice, and before that, in the National Security Division of the Justice Department, where he advised the White House on counterterrorism and other policies.
Twitter: @brendanballou
Plunder: Private Equity’s Plan to Pillage America https://www.hachettebookgroup.com/titles/brendan-ballou/plunder/9781541702103
Private Equity is Out of Control and Looting America. This Prosecutor Says We Can Fix It. https://www.ineteconomics.org/perspectives/blog/private-equity-is-out-of-control-and-looting-america-this-prosecutor-says-we-can-fix-it
Website: https://pitchforkeconomics.com
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Brendan Ballou:
Private equity, which is this term that I think we’ve all heard, but a lot of us, including myself, didn’t understand, was really taking over a large segment of the American economy.
Nick Hanauer:
Have you ever had this experience where there’s a brand or a thing that you love and all of a sudden, it just starts to get shitty? Dollars to donuts, it was purchased by a private equity company.
David Goldstein:
You’re talking about private equity or piracy. Ahoy there, ahoy there, Nick.
Speaker 4:
From the home offices of Civic Ventures in downtown Seattle, this is Pitchfork Economics with Nick Hanauer, the best place to get the truth about who gets what and why.
Nick Hanauer:
I’m Nick Hanauer, founder of Civic Ventures.
David Goldstein:
I’m David Goldstein, senior fellow at Civic Ventures.
Nick Hanauer:
Goldie, today on the podcast, we get to talk about a subject that’s really near and dear to my heart, which is private equity. I am a capitalist. I continue to be a capitalist, but there are a lot of bad things that happen in the neoliberal form of capitalism that the United States of America has decided to embrace, and nobody better embodies the shittiness of that than my good friends in the private equity industry.
David Goldstein:
You’re talking about private equity or piracy? Ahoy there, ahoy there, Nick. Are we talking about piracy on this episode again?
Nick Hanauer:
Yeah, it is very similar, and private equity is a business model that shouldn’t be bad. It’s quite straightforward. You take some money, you take a little investor money, you borrow some money, you buy a company, and theoretically, you run it better and then sell it for more than you paid.
David Goldstein:
Right. You could be a turnaround artist. You take a struggling company, you put some money into it, you tighten up things. You improve morale, you make it better, it turns more profitable, and then you sell it for a profit. That’s the way-
Nick Hanauer:
That’s what private equity-
David Goldstein:
Industry sells itself. It says it does. That’s what it says it does,
Nick Hanauer:
But that’s not what it actually does anymore, at least in many, many, many circumstances. It’s an industry that has moved from making companies better to making companies worse and extracting profits in that process, and today, we’ve talked about this on the pod before, but today, we get to talk to another expert on this subject, Brendan Ballou, who is actually a federal prosecutor.
He works for the Department of Justice in the antitrust division, and he’s written a book called Plunder: Private Equity’s Plan to Pillage America, and it’s a really important subject, Goldie, because it touches so many people. There’s so many examples of the harm that this business model creates for everyone other than the private equity firms themselves and the owners of the companies who sell out to the private equity firms.
David Goldstein:
There’s estimates that say that over the past decade or so, it may have resulted in the loss of over 600,000 jobs, that it may have shortened as many as 20,000 lives through their business practices. So it’s got a big impact on customers, on workers, on the economy as a whole.
Nick Hanauer:
In preparing for this podcast, I did a little bit of quick research to try to understand whether my anecdotal understanding of the impact of private equity matched with the actual statistics, and it is just astonishing when you look at the retail bankruptcies and the connection to private equity, whether it’s Toys R Us or Payless or Shoe Source or Sports Authority, Fairway just went bankrupt.
And in fact, there’s this fantastic quote by this guy who works for Bloomberg, Joe Nocera, who said, “Have we finally reached the point where we automatically assume that every new retail disaster has been caused by a private equity firm? Yes, I believe we have.” So it’s just private equity firms really just are looters. That’s what they are, and I think it’s just great to have somebody on who’s expert in this field to talk us through how we got here and what we can do to get out from under it. So with that, let’s talk to Brendan.
Brendan Ballou:
My name is Brendan Ballou. I’m a federal prosecutor, though speaking, of course, in my personal capacity, and I am the author of Plunder: Private Equity’s Plan to Pillage America.
Nick Hanauer:
Give us a little background on you and how you found your way to caring about private equity.
David Goldstein:
And characterizing them as pirates.
Brendan Ballou:
Yes. Well, so I was working in the antitrust division of the Justice Department in 2020, and I’m still at DOJ. One of the things that a lot of people don’t know is when big companies file to get bought by one another, they have to send some information to the Justice Department to the FTC, and I was going through these filings and it just seemed like every company that was getting bought up was getting bought up by these firms that I had never heard of.
Blackstone and Carlisle and KKR and so forth, and these institutions seemed like mysteries to me and so I just started looking into them and it just seemed like private equity, which is this term that I think we’ve all heard, but a lot of us, including myself, didn’t understand, was really taking over a large segment of the American economy and so I wanted to find out why and what the consequences were.
Nick Hanauer:
Explain to our listeners, and we have actually talked about private equity before because it’s such a scourge, but reacquaint our listeners with what it is and how it works.
Brendan Ballou:
Of course. The basic business model of private equity is pretty straightforward. Private equity firms use a little bit of their own money, some investor money, and a whole lot of borrowed money to buy up companies. They then want to make financial or operational changes to the companies with the aim of selling them for a profit a few years later. So it’s a very straightforward business model, but because of various legal structures that we have around private equity, our tax laws, our liability laws, and a whole lot else, there are incentives that often mean that the companies that these private equity firms buy have really bad consequences, bad consequences for consumers, bad consequences for workers, sometimes bad consequences for the companies themselves.
David Goldstein:
So you’re talking about for us old guys, we used to call these leveraged buyouts and it’s like Gordon Gekko from the movie Wall Street, right? Greed is good and all that.
Brendan Ballou:
Yeah, and I always try to emphasize Gordon Gekko said greed is good and I think a lot of folks, when they are critical of private equity, tend to focus on the people that are running the private equity firms. My critique tends to be a little bit more about the legal structures that we’ve got that allow private equity firms to do what they do. I don’t think we’re going to fundamentally change human nature anytime soon, but we can try to shape our laws so that our basic instincts to make money are channeled into productive uses rather than unproductive ones.
Nick Hanauer:
Yeah. And so I think it’s fair to say in the interest of full transparency, I have a lot of exposure to this business model and these processes and I participated to a large degree. In theory, this is not necessarily evil. There is a case where you can use a little of your money, a little of investors’ money and some borrowed money to buy a business, materially improve its circumstances by managing it better, and then sell it at a profit. That is a possible outcome.
David Goldstein:
Yeah. Nick, that’s one possible outcome, or you could use other people’s money to buy a company, load it up with debt, drive it into bankruptcy, and offload its pension obligations,
Nick Hanauer:
Correct.
David Goldstein:
While earning huge amounts of fees and other things, and you come out ahead no matter what happens. Have I characterized that correctly, Brendan?
Brendan Ballou:
Well, I agree that with Nick’s point, that there is always a role for finance to play in the economy. If you are trying to build a new factory, you’re trying to hire new workers, you need somebody that’s willing to invest the money and take the risk on your plan. So this isn’t a criticism of finance. The challenge that we’ve got is that the private equity business model really has three basic legal challenges. One is that firms tend to invest just for a few years, so they have a very short term perspective.
The second is that they are able to load up companies with a lot of debt and they’re able to extract a lot of fees, and the third thing, and this is what interests me the most as a lawyer, is private equity firms are enormously successful at insulating themselves from liability for the consequences of their actions, and so what that means is when you’ve got a business model that’s focused on the short term, that relies on a lot of debt and extracts a lot of fees, and that can walk away if things go poorly, that creates an incentive system that is often bad for employees, for customers, for companies,
Nick Hanauer:
Yeah. It’s only good for two classes of people. It’s good for the private equity players and it’s good for the previous owners who get to extract maximum value from the enterprise.
Brendan Ballou:
I’m glad that you hit on that point because I get asked fairly often, why do companies sell themselves to private equity firms, and I always say it may or may not be a successful transaction for the company in the long term, but it often is very successful for the executives who often have an equity stake in the company and they get to essentially cash out when the private equity firm buys it, and so that often, not always, but often explains why companies agree to be purchased by these firms.
Nick Hanauer:
The private equity players, in my experience, often will pay the highest price, and there’s a reason for that, which is that for them, it’s all upside and very little downside. So they can afford to pay more because they take comparatively smaller risks than if you just came along and paid all capital, for example, for a business and owned it outright and had all the liabilities that you effectively owned it in that way, and you’re more expert than me, Brendan.
But I have had a lot of experience with this. The fastest and easiest way to improve the financial condition short term of a company is to take it out on the workers and take it out on the customers in terms of product quality, which is why it is so common for a company that makes great products to all of a sudden, have you ever had this experience where there’s a brand or a thing that you love and all of a sudden, it just starts to get shitty? Dollars to donuts, it was purchased by a private equity company.
Brendan Ballou:
Well, what often happens is you’ve got a very short investment horizon, you need to make a return very quickly. It’s not necessarily going to make sense for you as a private equity firm to be investing in the long-term health of the company, investing in research and development and investing in your workforce and so forth, or even really investing in your customers. Sometimes it makes a lot of sense to jack up prices or lower the quality of care at a business because that might hurt you in a few years.
But if you’re trying to make a profit in 12 or 24 months, oftentimes, that makes a lot of sense and so it’s really interesting to see how this plays out just across industries, whether it’s private equity firms buying up veterinary clinics and then there are complaints about quality of care or buying up in human medicine, dermatology practices, and then buying needles that were allegedly so cheap that they would break off in people’s arms. These are abstract incentives, but they have very practical consequences for people.
Nick Hanauer:
Right. Or for example, buying my family’s very successful manufacturer of bed pillows and down comforters and bankrupting it within one year, which we owned this business for, I don’t know, 80 years or something like that, and my brother and I were doing other things. I’m doing this, he’s running a professional soccer team. My younger brother owns the Seattle Sounders, so neither of us had the time to put into the family business so we wanted to sell it, sold it to a competitor owned by a private equity firm, and the thing was gone within 12 months. It was just shocking and shameful and they were clearly dishonest about the circumstances that we were putting our former employees in.
Brendan Ballou:
I don’t know if this is what happened with your company’s bankruptcy, but as we’re talking about bankruptcy more generally, it really is interesting the extent to which private equity firms I think have really succeeded in the bankruptcy process even when their companies do not necessarily. One example that I always return to is Sun Capital’s acquisition of Friendly’s, the dining chain in the northeast. They bought the company, pushed it into bankruptcy, but then also became the company’s largest lender, and by doing that, normally when you own a company, it goes bankrupt, you lose the company.
By also being the company’s lender, they were able to sell Friendly’s from itself to itself, which was this weird magic trick, and the result of that magic trick was that they were able to push off the company’s pension obligations onto a quasi-government agency called the Pension Benefit Guarantee Corporation, and so it meant that the private equity firm was able to hold onto the diner chain, but the people that lost were the employees and the retirees who were really depending on a reliable retirement. So it’s very interesting that I think private equity firms’ expertise oftentimes, not always, but oftentimes is less in managing a company and more in managing and navigating our legal processes.
David Goldstein:
You argue in your book that this should be illegal, what they did. We need to change the law to prevent that from being a legal avenue of profit taking.
Brendan Ballou:
Yeah. On the bankruptcy issue specifically, I’m not a bankruptcy lawyer so any bankruptcy lawyer will be shaking their head here, but there are a couple tactics that they use called 363 sales, credit bidding and so forth, and those tactics are perfectly appropriate in certain circumstances, but I think that they’re getting, speaking personally, I think they’re being used in a way right now that probably is not consistent with the intention of the bankruptcy laws and certainly is working out for the private equity firms, but not necessarily for employees and retirees.
David Goldstein:
So the average American, no matter how much they go bankrupt, they can’t discharge their student loans because moral hazard, but if you’re a private equity, you can get rid of your pension obligations just like that.
Brendan Ballou:
Yeah. Well, it’s interesting because what I’ve seen is private equity firms really have access to some of the, if not the best legal counsel in America, then certainly the best compensated legal counsel. I think a lot of the large law firms right now, private equity firms are really their leading businesses or their leading clients, and as a result, they’ve just got the firepower to litigate a lot of issues that ordinary people don’t.
Going back to Sun Capital, which we were just talking about, I was following a case that they had litigating over whether they had to pay out $4.5 million in retirement benefits. $4.5 million for a private equity firm when you’ve got billions in assets under management is a rounding error, but because they had the ability to do this and I think because they wanted to literally set a precedent, they were willing to spend I think 10 years litigating this issue and were ultimately successful, and you just don’t have that kind of ability on the other side of these issues.
David Goldstein:
And the interesting about this, Brendan, is you point out that this really isn’t new, what’s going on now. This is very much like the trusts of the Gilded Age.
Brendan Ballou:
Yeah, it’s interesting. I think every 20 years or so, America invents a business model that’s got some misaligned incentives, whether you’re talking about private equity firms today, subprime lenders 20 years ago, savings and loan associations 40 years ago, conglomerates 60 years ago, trusts 100 years ago. It’s interesting in that I think there’s a real legal similarity between private equity firms.
And the trust of the gilded age in which they’re these institutions where you have centralized financial and operational control over disparate businesses, but not necessarily commensurate legal responsibility for those actions, and so it means that I think there’s a lot more financial control over our economy today than there was perhaps 40 years ago, and we’re approaching back to the model that we had during the Gilded Age.
David Goldstein:
Right. And I think an important point you make about the Gilded Age, about the trusts is that this wasn’t where the innovation was coming from. The innovation had come in the decades prior. This was a late stage capitalism. Now we’re going to consolidate these industries and consolidate profits and control, and it actually led to an era of economic stagnation.
Brendan Ballou:
Yeah, it’s super interesting. I remember Louis Brandeis in Other People’s Money relays this quote about when the steel trust was created, a lawyer who was present there said something to the effect of, with that signature, the United States’ steel industry is in the hands of men who know nothing about it, that often, these trusts were essentially created and controlled by financiers, not by people with operational experience in steel, railroads, tobacco, sugar, and so forth.
And so I think that there is a risk of history repeating itself or at least rhyming here, that we have an industry, the private equity industry, which is spending over a trillion dollars buying businesses every year. For comparison, the entire US GDP is $25 trillion. We’ve got an industry that is largely run by people not with operational experience, experience in engineering, sales, marketing, logistics and so forth, but experience in financing, and when you have that, I think it changes how companies are run and often, it changes how effectively they’re run.
Nick Hanauer:
It might be useful for you to describe how private equity firms make money. The problem, of course, is not just selling the enterprise successfully because if that’s what they had to do in order to make money, the incentive structures would be very different. So explain that.
Brendan Ballou:
Private equity firms, like a lot of the financial industry, are typically compensated under what’s called a two and twenty model, which means that they get 2% of the money of all the assets that they’re managing. So all the investors who gave them money, they get to take 2% of that every year, and then they get 20% of the profits after they reach a certain threshold, and that’s reasonable enough as it is. It means that if the company makes money, then the private equity firm should make money as well, but there are a lot of asterisks or complications to that that really change the private equity firm’s business model so that its incentives aren’t necessarily aligned with the companies they buy or even necessarily with the investors who give them money.
So in addition to the 2% of money that they get from all the assets they manage every year, they also typically are able to extract what are called management fees and transaction fees from the companies they own. So the transaction fee means that whenever the business does some big deal, they get a cut of that money, and so if they sell their real estate, for instance, they might get a percentage of that and that’s often why private equity firms will ask nursing home chains to sell their assets or retailers to sell their stores and lease them back because they get these transaction fees. They also get management fees, which is basically a fee that they pay for, that the company pays for the privilege of being owned by the private equity firm.
And the important distinction here, I know this is a little in the weeds, is the private equity firm gets 100% of those fees, but it only gets 20% of the profits. So what that means is the private equity firm often is incentivized to essentially extract money from the company it owns whether or not that ultimately helps the company in the long run. That can go to extreme limits sometimes. One thing that’s fairly common is what’s called a dividend recapitalization, which is the private equity firm will essentially direct the company to borrow money to pay the private equity firm a profit.
So it’s a little bit like getting to use somebody else’s credit card to pay yourself because if the company then goes bankrupt, the private equity firm may or may not have to pay that money back. So that’s a very long answer to a short and straightforward question, but what it’s meant to illustrate is that private equity firms sometimes have ways to make money, even if the company does terribly or even if the-
Nick Hanauer:
Right. And this is the core of where it gets really shitty and evil, correct?
Brendan Ballou:
Well, as a government employee, I wouldn’t swear, but I think it gets to the core of the problem here, which is they’ve got all these ways to extract money, and then on the flip side, when things go poorly, they are often able to escape legal liability. The book starts with this story about Carlisle buying a HCR ManorCare, which is this large nursing home chain, and then they execute a lot of tactics like sale leasebacks and cutting staff and so forth.
But when health code violations spike and when a resident actually dies in an understaffed facility, the family isn’t able to recover any money from the private equity firm because the private equity firm is able to say in court, we don’t technically own the nursing home chain. We merely advise a series of funds whose limited partners through several shell companies ultimately own the nursing home chain, and that was enough to confuse the judge and get the case dismissed, and what it means is you’ve got all these tactics for extracting money, but when push comes to shove and somebody tries to hold a private equity firm legally liable for what happens, oftentimes, there’s no recourse and they get to walk away.
Nick Hanauer:
The world is littered with the refuse of this business model, is it not? There are almost, it just feels like, and I actually don’t know the statistics, but you show me a company going bankrupt and I’ll show you a company that has been levered to the moon by private equity firms. Bed Bath and Beyond is a recent example, Toys R Us being a canonical example. Do you know the statistics better than I do?
Brendan Ballou:
Yeah. We’ve got one study out there that had this really interesting comparison that was looking at a cross-section of companies in the US economy and they estimate that about 2% of the companies, I believe, over a 10-year period went bankrupt, but similarly sized private equity owned companies, 20% went bankrupt over the same period of time. So private equity firms were responsible for a tenfold increase in the chance that a company is going to go bankrupt.
David Goldstein:
It’s almost as if loading a company up with debt isn’t good for business, almost.
Nick Hanauer:
So Brendan, what should we do?
Brendan Ballou:
So I wanted to convey a message of hope here, and I don’t want us to be pollyannish about here, overly optimistic, but there’s a lot of things that we need to do and there’s a lot of things that we can do. At core, I mentioned the three problems with the private equity business model about thinking for the short term, over-reliance on debt and fees, and insulation from liability. If you can change those, you can make private equity firms a productive part of the economy, and so how do you do that? Obviously, Congress is one avenue and there’s been important legislation proposed there.
But there’s also a lot of different levers of power here, whether you’re talking about federal regulators like the SEC, the Treasury and the Federal Reserve, states that could limit the use of some of the tactics that we’ve been talking about like dividend recapitalizations and sale leasebacks for companies that are headquartered or have a presence in their jurisdictions. Local activists have actually been enormously successful at getting action on private equity firms in specific industries, whether we’re talking about getting rulemaking on minimum staffing criteria in nursing homes.
Or in prison services where private equity has been enormously involved, getting first local, then state and now federal legislation to allow caps on the cost of prison phone calls. So I think that there’s a lot that needs to be done, but there are a lot of different avenues that people can take to do that, and so I just highlight if people are looking to get involved in these sorts of things, your podcast, I think, is doing really important educational work for folks. I think institutions like Americans for Financial Reform, the Private Equity Stakeholder Project, the American Economic Liberties Project, and a whole bunch of other ones are doing really important research advocacy and education work, and I think people might be interested in learning more.
Nick Hanauer:
That’s really fantastic. Two final questions. The first is the benevolent dictator question. If you were in charge specifically, what would you do?
Brendan Ballou:
I would change our corporate, this is a little in the weeds-
Nick Hanauer:
That’s okay.
Brendan Ballou:
But I would change our corporate veil piercing laws, which basically tend to insulate investors like private equity firms from responsibility for the consequences of their actions, and I would say looking to state corporate law in Delaware and elsewhere, I would say if you have effective control over a company, whether by choosing the board of directors, its executives or being able to direct its operations, you can be held legally responsible for the consequences of those actions, and I think if you did that, private equity firms would become much more responsible long-term investors in a way that could actually be helpful for the economy.
David Goldstein:
Yeah. People forget that the whole incorporation process, we limit liability to serve a public good, and if it’s not serving the public good, we don’t need to shield them from liability.
Brendan Ballou:
And I’m not trying to propose a radical critique of limitations on liability. For you and me with our humble 401(k) accounts, it probably makes sense that we’re not liable for the actions of the little companies we invest in, but if you’ve got control over a company, you probably should have a little bit of responsibility.
Nick Hanauer:
Yeah. Interesting. And one final question, why do you do this work?
Brendan Ballou:
I think the challenge of economic justice is one of the defining ones of our time and no matter what issue you care about, whether it’s climate change or gun control or religious freedom or whatever it happens to be, it is harder to make progress on that issue if you don’t have an economy that works for everyone. So that’s why I get excited about these things.
Nick Hanauer:
That’s a fantastic answer. Well, thank you so much for being with us. This was an amazing conversation, and your work is really important and I hope that the book is super successful and people read it and act on it.
Brendan Ballou:
Well, that’s very kind of you guys.
David Goldstein:
The scale of this is shocking, Nick. Brendan mentioned that about $1.2 trillion a year in these leveraged buyouts from private equity out of a $25 trillion economy, and we’ve talked in the past about the trillion plus dollars a year in stock buybacks. A trillion dollars in leverage buyouts, a trillion dollars in stock buybacks, that’s going to add up to real money pretty soon.
Nick Hanauer:
Yeah, absolutely. No, it’s a giant industry and so many of the large features of the neoliberal version of capitalism that we have accepted in this country, it’s not an institution that serves a broad public purpose anymore. It has metastasized into this, piracy is really what it is.
David Goldstein:
You know what? It’s the difference between being a pirate and being a privateer. The difference is that when you’re a privateer, you’re a legal pirate.
Nick Hanauer:
That’s true. That’s true. That’s literally true. That’s true. You got a letter from the king saying, have at it.
David Goldstein:
Yeah, no, yeah. Go ahead and seize those ships and their cargo.
Nick Hanauer:
Yeah, exactly.
David Goldstein:
That’s exactly what this is. So we should just call them privateers. That’s more respectful.
Nick Hanauer:
It is. It is. And it’s a shame because of course, there has to be a role for finance in an economy, and there should certainly be a role or a place for buying companies, improving their circumstances, and selling them for a profit, but it is certainly true that we need to substantially change the laws, norms, and policies that surround this business practice to convert it from the mostly deleterious effects that it has to mostly positive ones, and I think Brendan’s book makes a great contribution to that.
David Goldstein:
As always, we have a bunch of links in the show notes. We recommend you get Brendan’s book, Plunder: Private Equity’s Plan to Pillage America. You can buy it at your local independent bookstore or that big online monopolist if that’s what’s more convenient for you.
Speaker 4:
Pitchfork Economics is produced by Civic Ventures. If you like the show, make sure to subscribe, rate, and review us wherever you get your podcasts. Find us on Twitter and Facebook at Civic Action and Nick Hanauer, follow our writing on Medium at Civic Skunk Works, and peek behind the podcast scenes on Instagram at Pitchfork Economics. As always, from our team at Civic Ventures, thanks for listening. See you next week.