May 09, 2023
Transcript of Exclusive Talk with Brendan Ballou, Author of Plunder: Private Equity’s Plan to Pillage America
On May 5, The Capitol Forum hosted an exclusive talk with Brendan Ballou to discuss his new book, Plunder: Private Equity’s Plan to Pillage America. Plunder is a startling investigation into the poorly understood, powerful force of private equity that is reshaping the American economy: raising prices, reducing quality, cutting jobs, increasing inequality, and shifting resources from productive parts of the economy to unproductive ones. The full transcript, which has been modified slightly for accuracy, can be found below.
TEDDY DOWNEY: Thank you, everyone, for coming today. I’m Teddy Downey, executive editor here at The Capitol Forum, and we’re all here for the release of Brendan’s new book, Plunder: Private Equity’s Plan to Pillage America. I’ve learned a ton from this book. We spend a tremendous amount of our time looking at companies that have some kind of private equity tie, whether or not we always know it or not because of sort of what we get into in the book.
And so we’re just going to have a Q&A, quick introduction of Brendan. He is a fellow graduate of Columbia University, then went onto Stanford Law School. And then he was at DOJ’s National Security Division advising the White House on counter-terror terrorism policy. And now he’s Special Counsel for Private Equity at the Department of Justice’s Antitrust Division. And so let’s kick things off. Thank you so much for being here.
BRENDAN BALLOU: Thank you for having me.
TEDDY DOWNEY: So maybe you could just tell us, what is private equity? And how big is this industry?
BRENDAN BALLOU: It’s a great question. And among other reasons, because one of my bosses is here, I should make extremely clear that I’m speaking in a clearly personal capacity. And my opinions don’t necessarily reflect those of the Department of Justice. So what is private equity? I think it’s a really good question, and it’s one that I didn’t know the answer to until I was about four months into this project. So I don’t think any of us should feel guilty about not knowing.
The very simple idea is that private equity firms use a little bit of their own money, some investor money, and a whole lot of borrowed money, to buy companies. They then hold them and try to make operational and financial improvements or changes to the company with the aim of selling them for a profit a few years later.
Now you have to have scale. Private equity is a bonus. Last year they spent about $1 trillion on acquisitions in the United States alone. I think for context, I mean, numbers can be more imaginary at that scale. The entire US GDP was about $25 trillion.
TEDDY DOWNEY: And you spend a lot of the book talking about some of the just kind of intrinsic problems with the private equity model. And maybe you could just tell us a little bit about that. Like, what are the things that make it so kind of pernicious just by the very nature of the model and why it’s bad for the companies that they buy out?
BRENDAN BALLOU: Yeah, and because this is like a room of people that are actually expert on these things, I’m kind of curious. Hopefully, this will be more of a dialogue and I’d be curious as to you guys’ reaction.
But to my mind, I think it’s three basic problems. We’ve got private equity firms that tend to hold companies just for a few years, three or five or seven years. They tend to load up the company that they buy with a lot of debt and extract a lot of fees. And they tend to be insulated from liability for the consequences of their actions. But when you’ve got those three problems, short termism, debt and fees and escape from responsibility, it leads to really bad incentives that have bad effects on a whole bunch of different industries.
TEDDY DOWNEY: So maybe we could dig in a little bit more about how they extract that money from their companies.
BRENDAN BALLOU: So there’s a lot of tactics. And again, you know, Paul might have some ideas, Vikas might have some ideas. I’m kind of curious for you guys’ reactions on some of the stuff. But I think there are a couple tactics that private equity firms use pretty regularly that help the private equity firm, but not necessarily the company itself.
The first one, which I’m sure some of you guys are familiar with, would be the sale leaseback. So, a private equity firm buys up Friendly’s diner chain or something like that, and then sells all of the actual stores of Friendly’s and requires Friendly’s to lease the stores back. That brings in a quick bit of money. But now Friendly’s is on the hook for paying the lease indefinitely. That’s one tactic.
There’s also dividend recapitalizations, which are where they buy the company and then require the company to borrow money to pay the private equity firm’s fellow investors a dividend. There are other tactics like strategic bankruptcy, which are a way to swap off pension obligations onto quasi‑government agencies, roll up strategies which private equity firms are sort of enamored by, a whole bunch of other things. It’s not to say that everything that a private equity firm does is necessarily extractive or bad. But because of the incentives that we were just talking about, I think that they are inclined toward some of these tactics that are more extractive rather than less.
TEDDY DOWNEY: And can you talk a little bit about the workers and that? Because one of the things that we get into – maybe I’m skipping ahead here — but getting rid of the pension obligations, which is like so ironic. Because they’re getting money, as you point out, while a lot of pension funds that might screw over people and their pensions. But maybe you can talk a little bit about that also, that strategy. Because it’s not just the company itself, but really the human workers.
BRENDAN BALLOU: Yeah, so this is a younger crowd. So I assume none of us actually have pensions, right? Okay. So we’ve all got 401Ks or nothing. So for those people that do have pensions, one thing that private equity firms will do is have these strategic bankruptcies. And I just mentioned Friendly’s. I’ll use that as an example.
So in 2007, Sun Capital bought up the diner chain Friendly’s. They then executed a lot of the tactics that we just talked about. So, did a sale leaseback. They did a dividend recapitalization. They laid off staff. Ultimately, they push Friendly’s into bankruptcy. And here’s where things were kind of interesting is Friendly’s was owned by Sun Capital, but Sun Capital was also Friendly’s largest lender. And what was interesting about that is normally when somebody goes into bankruptcy ‑ — ‑I don’t know if there are any bankruptcy lawyers in the crowd –‑‑ the debtor becomes the owner of the company. And so because they’re the top and the bottom of the food chain here, by going into bankruptcy, they flipped the ownership. And so, Sun Capital is able to sell Friendly’s from itself to itself. And why do they do that? They do it so that they can push off the pension obligations of the company onto Pension Benefit Guaranty Corporation.
So by pushing off the obligations onto the PBGC, suddenly Sun Capital wasn’t responsible for those obligations. Instead, they were the responsibility of the government and Sun Capital got to walk away while still owning the company. So that’s one example. Research suggests that that’s been done at least 50 times over 15 years. So it’s a fairly common and fairly successful tactic.
TEDDY DOWNEY: And let’s talk about some of these industries. One of the first ones you get into actually, I have a personal connection to it. My uncle brought that false claims case against Manor Care that got dropped by DOJ.
BRENDAN BALLOU: Really?
TEDDY DOWNEY: Yeah. So we have a personally very painful memory of that going awry. But maybe you can talk a little bit about the health care. We spent a lot of our time on health care. Health care takes up a couple of chapters in the book. Maybe you can talk a little bit about private equity role in health care, which I think, even for somebody who studies it 24 hours a day basically, I was surprised.
BRENDAN BALLOU: Yeah, does anybody here work on health care specifically? Okay. So you guys like jump in here and sort of correct me on something. I want to give like one or two examples of private equity in health care.
So the one that actually starts the book is HCR Manor Care. So in 2006 or 2007, Carlyle, which is I think the second largest private equity chain in America, bought up HCR Manor Care, which was a gigantic nursing home facility, and they did a lot of the tactics that we were just talking about. Did a lease back, did a recapitalization. They executed a lot of transaction and management fees. They slashed the staff of the other nursing home chains. Health care violations spiked. Somebody at the facility dies. And after she dies – basically, the facility was understaffed. She had to go to the bathroom by herself. She hit her head and she died of a subdural hematoma. Her family sues Carlyle, but Carlyle has the case against it dismissed.
And what it says is, oh, no, no. We don’t technically own Manor Care. We merely advise on a series of funds, with limited partners, through a series of shell corporations that own the assets Manor Care. And that was enough to confuse the judge and actually get the case against Carlyle dismissed. That family never got recompense from Carlyle itself. And I’m curious if you guys have seen sort of similar stories happen in health care.
It goes back to the sort of fundamental incentive problems that we’ve got with private equity, which is if you can insulate yourself from responsibility, you’ve got control of these companies, but don’t actually have to be responsible for the consequences. It leads to bad outcomes like this.
TEDDY DOWNEY: I want to come back to this when we start talking about solutions. Because of the convoluted nature of how they distanced themselves from the portfolio companies to avoid legal liability, I think is something we’re going to want to come back to. Let’s stay on Carlyle for a second because I think it gets us … ‑this is a Washington group. If you live in Washington, you’ve probably come across the extreme wealth that Carlyle has. And I went to a private high school and I’d say almost half the kids have some relatives that work at Carlyle at this point. If you look at the biggest house in the neighborhood, typically it’s someone from Carlyle.
BRENDAN BALLOU: Yeah, we all chose the wrong career.
TEDDY DOWNEY: Yeah. I hear you. But you go into a little bit about Carlyle, how it got started. I think that’s a good way of coming into this discussion about why they’re so politically protected and why it’s so hard to come at them from a legal or legislative change aspect.
BRENDAN BALLOU: Yeah, Carlyle is really interesting. Carlyle’s a Washington institution at this point. And it was started by this really interesting guy, David Rubenstein. You’ve probably seen him giving money to the Smithsonian or the National Parks or something like that. He had a really interesting upbringing. He grows up in working class Baltimore. He’s the son of a postal worker. He works his way through college and law school. And he has this sort of like natural gift for becoming friends with powerful people. And he works his way into Democratic politics and he actually becomes the Deputy Domestic Policy Adviser for President Carter at age 27.
And so he has this meteoric career until obviously Reagan wins and he’s out of job. And he’s sort of in this career wilderness for like ten years until he and a couple of friends invent what becomes the Carlyle Group. And I think their real innovation as a private equity firm, because they’re not based in New York, they’re based in Washington, is they’re like our specialty is going to be hiring former government officials. And their first hire is Frank Carlucci, the former Secretary of Defense. And they realized that by hiring these people, it brings in investor money. Because it turns out investors like to talk to former Secretaries of Defense and things like that.
And it also is potentially helpful in doing deals. After they get Carlucci, they buy a CaterAir, which is like an airline food company, and they bring in a then young and not so successful George W. Bush on the board. And so they sort of have this mixture of money and power that proves tremendously successful. Carlyle has at various times, I think, has now employed Secretary of State, Secretary of Treasury, Chairman of Federal Communications, Chairman of the SEC, I think a Senator or two. They’ve done very well for themselves. And though I think private equity ‑‑ well, I think Carlyle is probably the most successful one that sort of modeled, it is far from the only one.
If you look at the bench of people that are working for private equity firms, I think you’ve got four Secretaries of the Treasury. So two out of three, President Obama’s Treasury Secretaries now work for private equity firms, a Bush Treasury Secretary and Trump’s Treasury Secretary, a Vice President, the last two, I think, Republican Speakers of the House work for private equity firms and any number of Senators and Congresspeople. So I think even by the measures of sort of Washington sort of lobbying and influence, like private equity has excelled.
I mean, for those of you guys that are lawyers or work for lawyers, it’s really interesting how private equity has transformed big law. Which it was already supporting large corporations. But I spent two and a half years at a large defense law firm. And each week, they’ll send out a little email that says here’s all the new matters that came out. There’s a section for litigation, a section for arbitration, a section for mergers and acquisitions. There was a dedicated section for private equity. It was always the largest every week. And that was not unique. You know, whole firms, they do profiles on this stuff. Like transformation firms like Kirkland, which really are sort of in the business of private equity was sort of like a run side of litigation department. It’s really interesting.
TEDDY DOWNEY: Yeah, that was a really ‑‑ again, I spent a lot of time looking at law firms and what law firms are up to. I learned a lot from that. You tell a really interesting story about surprise billing and the fight to stop surprise billing. I think that kind of gives a real world example of what we were just talking about. Would you mind telling that story of the legislative process around that?
BRENDAN BALLOU: Yeah, maybe you guys can add some color on where we are in the regulations. I’ll tee it up and if you guys can tell us where we are on the regulation side. So, surprise billing, intuitively make sense to folks just so that we set a baseline of what we need here. So surprise billing, it’s when you go to a hospital. You go to a hospital that’s in-network. You’ve done your planning, all this kind of stuff. But it turns out that the doctor or the nurse or whoever actually works in that hospital is not in your network. And instead of having to pay $2,000, you have to pay $50,000 or $100,000 or whatever happens to be. Paul, who’s from Canada, is silently thinking in horror at the system that we have in the United States.
BRENDAN BALLOU: Yeah. But this has been sort of legislatively a no brainer to solve, but it’s been impossible to solve. You know, we’ve been, I think, pushing forward on legislation on this for a decade or something like that. And we got close to a solution in 2019. You reported on this at the time.
PAUL: I reported on it at the time.
BRENDAN BALLOU: So you guys know. Let’s say just an unnamed member of Congress got a $31,000 donation from Blackstone and very quickly scuttled the consensus deal, a deal that was a bipartisan deal with the Trump administration. It was really kind of an extraordinary thing. Ultimately, some legislation passes, but it doesn’t solve the underlying issue. It just pushes it to arbitration. And as I understand it, I’m hoping that — I promise I’ll stop talking here –‑‑ is like, as I understand it, now that we moved from legislation to regulation, the members of Congress who received very large donations from leading private equity firms are pushing very aggressively to help shape that regulation and to shape sort of the interpretation of the legislative history on it. I don’t know if there’s more color on that.
AUDIENCE MEMBER: Yeah… all we write about is the “No Surprises Act”…. CMS has talked about some enforcement like ramping up some of the enforcement or specifically kind of the timeline and whatnot that they allow people to comment on complaints.
TEDDY DOWNEY: Vikas, we’ve written about those.
VIKAS KUMAR: Yes, the arbitration provision keeps getting appealed or contested in courts. And so the arbitrations get put on hold. So there’s a massive backlog. I think they’re still trying to figure out the parameters and how it’s supposed to work. But in theory, the law exists and it is supposed to be working, but it remains to be seen.
BRENDAN BALLOU: And it carves out ambulances, which is one of the dominant industries for private equity. So the industry’s fingerprints are all over the legislation in really interesting ways.
TEDDY DOWNEY: My father’s here and he knows a little bit about Congress being awash in donations from big business. Did private equity, when you were there, and your colleagues, how big was private equity? Is this a recent phenomenon? And I kind of want to drag you into this.
THOMAS DOWNEY: In the 18 years that I was in Congress, which was a long time ago. When I got there in 1975 and left in 1993, lobbying was important, but it’s nothing like it is today. And then in the 21 years after that, when I ran a lobbying consulting business, private equity became increasingly more important. And what’s more interesting, I think, Blackstone and State Street, all of them have large numbers of people, either on retainer or as specific matters come up, they hire additional people.
So I think that’s changed. But what’s also changed is that the lobbying business has become much more capitalistic. And now a member who recruits another lobbyist to a firm –‑‑ Omnicom’s the best example of this. Omnicom owns dozens of different firms. They then get a piece of the action of that person. So it’s like a little bit of a pyramid scheme. So there’s an enormous incentive not only to lobby but to get other people to lobby. So I can’t speak specifically to the point of private equity. But back in the day, Henry Kravis, and others, went around and explained how important they were to people. And many people actually believed them.
BRENDAN BALLOU: I’ve got a couple of questions, if that’s okay. I don’t know if you saw this, but there was an article in Politico this week about private equity firms investing in lobbying shops. And I’m kind of curious, just anecdotally, it seems like private equity has been extremely successful in this sort of the fights that it picks. And I’m wondering, like, is that true? And so why do you think that is?
THOMAS DOWNEY: Yeah, I mean, the margins can be quite high on a lobbying firm. Especially with the big tech companies, hire everyone. We got hired once by one of the big pharmaceutical companies and I attended the first meeting and the room was filled with all of my competitors. And they had just decided to hire everybody. Because it was cheaper for them to hire a dozen, or in this case two dozen, lobbying firms and not have to worry about having the other side represented. That… that was shocking.
And what I found when we were importuned over the years by Omnicom to join them and they made it quite attractive. Because a lobbying firm, you know, there’s normally a monthly retainer. But if you’re part of a larger entity, you’ve gotten stock options and you grow with them, they can acquire you with cash and stock… And as you continue to perform, your equity position increases. So that your pay day is in part being acquired. So it’s not surprising that they’re doing that. They have the money to do it. The margins are good. The incentive is there. The problem, of course, is that the American people look at the Congress of the United States as being wholly owned subsidiaries of the corporations and the lobbyists that exist. And the sad thing is they’re not alone.
BRENDAN BALLOU: I don’t want to hijack this, if I can just —
TEDDY DOWNEY: Yeah, go ahead.
BRENDAN BALLOU: On the legal side of this, you know, we talk about sort of like running the table here. I mean, one of the stories that was most astounding to me was some capital litigating the Scott Brass pension, which this maybe too obscure even for this crowd. But basically, it was a fight over basically whether Sun Capital was going to have to pay some pension obligations. And the total amount at issue was $4 million, which is a lot for probably everybody in this room. But for Sun Capital, it was like a rounding error. They spent 12 years litigating this issue. I am certain that — they employed Kirkland Ellis. They had various lawyers that were subsequently representing Trump in the impeachment inquiries and things like that. I’m sure they spent more than $4 million fighting this entire thing. But it was worth it to them to have the law interpreted in that way rather than ever risk it.
THOMAS DOWNEY: I’m not surprised.
TEDDY DOWNEY: There’s another aspect of this, which is like we’re talking about like what’s a big lobbying campaign? Like $10 million a year? Or $30 million a year? I mean, in the book, we’re talking about tens of millions of dollars a year. They’re settling false claims cases as cost of doing business in the hundreds of millions of dollars. So maybe you could tell us a story about how legal bills are just the cost of doing business. I think that kind comes up a lot in our reporting. But I thought that you had a lot of examples of it in the book.
BRENDAN BALLOU: Yeah, I mean, well, the interesting thing is, I mean, a lot of times they don’t have to pay anything, right? You know, it’s like Atrium Health Care is a really interesting example where Blackstone buys up Atrium, which sells noninvasive ventilators, the kind that don’t need to go down your throat, which you may remember became very in demand in March 2020. Blackstone bought up Atrium. And then did all the normal tactics. And Atrium you started asking very aggressive sales tactics to such an extent that, as alleged by the Department of Justice and subsequent settlement, Atrium was billing Medicare for noninvasive ventilators that they never sold, and knew they never sold.
Ultimately, the Department of Justice settles without an admission of guilt for, I think, $40.5 million. Blackstone made, I think, $200 million from Atrium in fees alone. And so, in subsequent commentaries, I mean, I think they were literally using… One of the commentators said, this is just the cost of doing business. So it seems like it doesn’t bother them, at least some of these firms.
TEDDY DOWNEY: Yeah, there is one firm that has an interesting story when it comes to the prison payphone issue. I think that gets a little bit into the Securus story as well and I think it could be a good transition to how we, you know, your proposals for how to address the problems here. But can you walk us through the prison payphone issue as why it’s attractive to private equity, the private equity firm that was involved and the pressure campaign afterwards?
BRENDAN BALLOU: Yeah, prison phones are really interesting. So I think one of sort of the surprising things about researching this project is, I think in a lot of ways ‑‑ this is not true of every private equity firm, but many ‑‑ is that they don’t target industries that service wealthy people, buy instead target working class or poor people. And I think the reason is that that these industries are ones where people don’t really have alternatives. You know, if you’re going to communicate with somebody outside of a prison, you have to use one of these phones.
And so this was an industry that became very attractive to private equity, two firms now control dominant prison phone service companies out there. And they were charging, as alleged, exorbitant rates, at some point $25 for a 15 minute call. So this became a national issue, partly because Tom Gores runs Platinum Equity, which is one of the prison service private equity firms. And he made the mistake of buying the Detroit Pistons. And so suddenly, he started getting a lot of national attention. And he realized that.
Well, Bianca Tylek, an organization called Worth Rises, launched an extraordinarily effective advocacy campaign against Gores and against Platinum Equity. And they launched a campaign at a local level, at a national level, and targeted investors. At a local level, what they did is they started passing legislation, first in San Francisco, then in Connecticut, then in New York City, basically saying you guys have to charge phone services at cost. So they passed the legislation.
Then they started going after the pension funds that invest in Platinum Equity and actually convinced at least one pension fund not to invest more with them because of sort of the ethical questions about these prison phone services. And then they moved nationally and actually were able to push legislation through Congress last year that actually gives the FCC new rulemaking authority to set caps on prison phone costs.
So I think that part of that is because they have just an extraordinarily dynamic leader. Bianca Tylek is just a world class organizer, I think. But they also were very focused and also thought about different levers, you know, beyond just going to Congress and writing your congressman. No offense, congressperson. But that there are a lot of different levers that they were able to pull in order to effect change on this issue.
TEDDY DOWNEY: And you talk a little bit in the book about, sort of a big theme in the book, that preying on poor people is part of it as well. Because they don’t have the means to fight back. They’re sort of up against the wall. Talk a little bit more about that. Just why poor people are so attractive to private equity investors,
BRENDAN BALLOU: Well, I don’t want to make it as a universal statement.
TEDDY DOWNEY: Next, we’ll go to a good private equity firm.
BRENDAN BALLOU: Okay. Yes, it’s Friday afternoon. We don’t want to be too much of a downer. So it goes back to what I was saying. You know, that it’s about where can they find industries where they don’t have a cap figuratively, or in the case of prisons, sort of a literally captive audience.
One of the more interesting examples, to go back to Carlyle, is mobile homes, which have become very attractive to private equity firms. So mobile homes are a bit of a misnomer because they are very rarely actually mobile. They’re usually sort of sealed on concrete where they sit. And so a mobile homeowner really pays two fees. One is the mortgage on the structure and then the other is a lot fee to the owner of the mobile park.
So Carlyle started buying up mobile home parks and raising the monthly lot fee, I think in some cases – please don’t quote me on this — ‑‑ I think it was something like doubling the lot rents on at least one of these parks. This had sort of a doubly bad effect for residents. One, because now they had to pay double the lot rent. But because they have to pay double the lot rent, the house is decreasing in value. And the estimate is that for every $100 increase in monthly rent, it reduced the equity of the home by $10,000.
So they were taking the residents’ income from the rent, but that was also decreasing their wealth because of the rent increase. Carlyle ultimately sold that particular mobile home park, which was sort of in the Bay Area. And again, somebody will need to fact check. I believe that they doubled their investment in something like four years. But when you read the reporting on this, when the L.A. Times did a really good continuing story about that purchase, they’re talking about the residents and how their lives were affected by this. And they were collecting cans in order to pay for a lawyer to meet with Carlyle. You know, they talked about they got enough cans for a third hour with the lawyer. So, you know, there’s just a dramatic imbalance of power in some of these industries. There better be a lighter, you know.
TEDDY DOWNEY: We’ll get into how things can change in a second. But there’s another wrinkle in the mobile home story that Fannie and Freddie were manipulated by private equity to sell them back foreclosed on homes. Is that too depressing to talk about that? Yeah, the Washington involvement, obviously.
BRENDAN BALLOU: Yeah, I think this was primarily single family rentals. So in 2008, we’re sort of in the depths of the financial crisis. You know, hundreds of thousands of people’s mortgages were underwater. You know, they owed more than their house was worth. A lot of people, a lot of companies said, well, the rational thing to do in that circumstance is to temporarily lower the principal on people’s mortgages. It makes it rational for people to stay. It reduces the number of evictions. It sort of prevents the ripple effect that happens in neighborhoods where, you know, you have a foreclosed home, everything else’s home loses value.
The head of the FHFA, which regulates Fannie, Freddie, adamantly opposed this. He ultimately went to lobby for the industry. But he refused to institute principal reduction. What Fannie and Freddie did do is they started selling foreclosed homes in bulk to private equity firms. They sold multiple 100 homes at a time. By selling them in tracks, only investors could get those, not individual homebuyers. And so they sold to, ultimately, companies that were owned by Quality, by Blackstone. And then these firms flipped the homes into rather than individually owned into single family rentals.
And so there’s really interesting reporting in academic research about neighborhoods and communities that were particularly affected by the Great Recession, in Atlanta and Las Vegas, Tampa, Florida and so forth, that a lot of the same people live in these neighborhoods. But it’s now people that are living in rental homes and homes that they used to own. And so it’s a process that really has in some ways accelerated broader changes in the nature of ownership in America. I think homeownership in the United States is back down to where it was in the 1980s. This is not confirmed, but I saw at least one allegation that homeownership for African American families is now down to where it was during the civil rights movement. So, for a large swath of America homeownership is just increasingly not an option the way that it once was. I would say Fannie and Freddie was not the decisive force in that, but it appears that it played a role.
TEDDY DOWNEY: And I’ll be quick. This is about the only story I know of a positive outcome. But I’m sure you might have a couple as well. Where there was this private equity firm that looked at all these dilapidated bowling alleys and said, hey, we could modernize this and buy these up and make them nice and people will go bowling again. That seems to me, okay, this seems like a good use of capital, productively revitalize this industry that otherwise just wasn’t working. To me, that’s kind of, all right, that’s a story that you should be able to do that for now, potentially. But do you have any other stories of private equity having a good model? And then would be more optimistic about how we can change the incentives after that?
BRENDAN BALLOU: Yeah, sure. And if anybody has experience here working in private equity who wants to push back on any of this, I would be very interested. Because I do think that there is obviously a role for capital to play in our economy. You know, as long as businesses need to build factories and hire new workers, somebody needs to pay for that and take the risk. So it’s not that private equity needs to cease to exist. It just needs to be made vastly less interesting than it currently is.
So, there are positive stories. The example that we used is Blue Wolf Capital invested in revitalizing a timber mill in rural Arkansas. It essentially shut down in 2008. They bought it up and restarted it. Essentially, they revived the entire economy of the city. But part of the reason that it worked was Blue Wolf took a different approach. Rather than using a lot of debt, they primarily exclusively financed it with equity. So they had their own skin in the game. They also stayed involved in the company. So even after they sold a chunk of their interest, they continued to have sort of buy and hold strategy and they had multiple board members continue to be involved in it. So if you rely less on debt, but you take a longer term approach, generally, the outcome is going to be a lot better.
TEDDY DOWNEY: Yeah, I think, you know, a lot of times it’s easy to kind of get into this idea that there is such a thing as financial innovation and all this innovation and progress around financial wizardry. But really, often what it comes down to is a good type of control is dumb. It’s like I’m giving a loan to a business so they can grow. It’s not the sexiest thing. It’s not any kind of innovation, but it works. Now, you dedicate a lot of the book to talking about solutions here. I’d love to get into some of those that you think or you’re passionate about that you think would really work. And then after that, kind of open things up for questions. I know I’ve monopolized the questions here.
BRENDAN BALLOU: No. Well, obviously the most important thing that anybody can do is buy this book and tell all your friends. But after we accomplish that goal, I think it goes back to the three things that we’re talking about. You know, what are the flaws in the business model? Short term thinking, reliance on debt and fees, insulation from liability. If you change those things, you can make private equity just fold. And there’s a lot of different ways to do that. You know, we can think about legislation in Congress. We can change incentives in the tax code. Or changing our corporations through some laws.
But there are a lot of other levers that we can pull. On the regulatory side, there’s things like the FCC, the Treasury Department, the Federal Reserve, can do. And we talked about housing. Fannie Mae and Freddie Mac are really powerful factors here. There’s also a lot that can be done at the local level. You know, when we’re talking about insulation from liability – I just mentioned corporate deal doctrines. Generally, that’s state common law. And states can change them.
Jurisdictions can say if you buy a company in our jurisdiction and execute it, if it recapitalizations and workers get laid off, workers can recover. You know, it’s pretty straightforward ideas about holding firms responsible for their actions. You see things that activists and litigants can do to help shape the law in a pretty helpful way. So, feel free to talk to me afterwards. There’s a lot of really useful organizations that are doing really important organizing on this. But I think we just need to think creatively about what are the levers of power for changing things?
TEDDY DOWNEY: Yeah, I’d say one of the things that stood out to me just as a journalist is making it clear to everyone who owns what. We have a product, an energy product. I mean, I don’t know. We don’t have anybody from our Energy Team here. But a good amount of their time is figuring out who owns what well. Because it’s such a complex maze of who owns what, that seems to be something that jumped out at me.
I actually do have one last question here, which is I worked in an investment bank that pioneered 144-As, and it always seemed very bizarre and around IPO and like nontransparent. I was just like, why would any investor want this? But maybe you could talk a little bit. I think the one hidden risk that no one’s really thinking about that like I know as a firm we’re going to start looking into is the sort of private loan market and this alternative to public financing markets and sort of getting in the insurance industry and having a huge hidden role in the economy that injects a lot of risk that no one here really pays a lot of attention to, but is kind of lurking.
BRENDAN BALLOU: Well, you guys are all journalists. So hopefully, you guys are all going to pay attention to this and explain it to everybody else. So just very briefly, private credit is an alternative to the public stock market. You know, it’s essentially investment firms and private equity firms making loans to companies. It’s, almost by definition, vastly less transparent than the public market and vastly less regulated. And there’s increasing reporting, but not nearly enough.
And hopefully, you guys are going to change that on potential systemic risk that private credit plays. Because right now the private credit market is significantly bigger than the entire U.S. stock market. And yet, it receives a fraction of the attention. And then very briefly to wrap up, I’m hoping that folks will not just ask questions, but give comments here.
The other interesting area ‑‑ and I know that folks are doing reporting on this ‑‑ is expansion into insurance. And as private equity firms need more money, they’re increasingly investing in and purchasing insurance companies. And the money, the monthly or quarterly premium that you pay, is increasingly going to be used to finance the various projects for private equity firms. And it’s really interesting increasing reporting about how private equity firms are transferring those assets to offshore affiliates in Bermuda that have potentially lower – not potential, they do have lower capital requirements, and those are the potential systemic risks that that plays. So I’m hoping that there’s going to be interesting work and more reporting on that.
TEDDY DOWNEY: And just to dumb that down for myself, they buy an insurer, get the money from being an insurance company, lower their capital requirements, gamble the float as well. And then if something goes wrong, they just throw their hands up.
AUDIENCE SPEAKER: Yeah, they completely cook the books by moving a huge amount of their liabilities. They reinsure it with a secondary insurance company, the secondary insurance company being a Bermuda based affiliate of the same private equity company. But from the regulatory point of view, all of that is removed from their books. And now they’re free to spend more money in an incredibly reckless way and make even higher ‑‑ much higher risk to go bust.
BRENDAN BALLOU: And there’s the State Guaranty Corporation. Basically the idea is, you know, insurers are kind of like this weird regulatory artifact in a lot of ways in that they are largely regulated by the states and not the federal government. If an insurer essentially becomes insolvent and can’t pay out of the insurance policies, then ultimately the responsibility goes to state guarantee organization, which is a pool that the other insurers in the state have to pay out. So the interesting part about that is if a private equity owned insurer goes insolvent, potentially the insurer will not have to be – I mean, the private equity firm will not have to pay out for the insolvent claim. Rather, it will be other more responsible insurers that will be responsible.