Monday, January 2, 2017

Behind Monopoly Power Stands Private Equity


ProPublica reported:

American industry is more highly concentrated than at any time since the gilded age.
Insider economist Larry Summers blamed this on "monopoly power," missing the impact of private equity underwriters, a chief buyer and integrator of companies.  President Bill Clinton privatized government security checks, which enable The Carlyle Group to profit more than once from its stake in U.S.I.S.   PEUs became ubiquitous the last few decades. 

Mergers peaked last year at $2 trillion in the U.S. The top 50 companies in a majority of American industries gained share between 1997 and 2012.
A common PEU tactic is to buy a company and add acquisitions to it over time. The Carlyle Group's assets under management grew from $3.3 billion in 2000 to $170.2 billion at the end of 2012.  Likely a number of the companies gaining market share over the fifteen year people were PEU owned.

While the impact of this wave of mergers is much debated, prominent economists such as Lawrence Summers and Joseph Stiglitz suggest that it is one important reason why, even as corporate profits hit records, economic growth is slow, wages are stagnant, business formation is halting, and productivity is lagging. “Only the monopoly-power story can convincingly account” for high business profits and low corporate investment, Summers wrote earlier this year.
PEU practices can account for high business profits and low corporate investment. Private equity underwriters prioritize interest, dividends and management/deal fees over capital and human resource investments.  Money is frequently spent on interest expenses several orders higher than pre-buyout levels.  Once cash begins to build it's spun off to PEU sponsors as dividends.

The story highlighted the role of economic consultants in facilitating mergers and buyouts.
  
Economists who specialize in antitrust — affiliated with Chicago, Harvard, Princeton, the University of California, Berkeley, and other prestigious universities — reshaped their field through scholarly work showing that mergers create efficiencies of scale that benefit consumers. But they reap their most lucrative paydays by lending their academic authority to mergers their corporate clients propose. Corporate lawyers hire them from Compass Lexecon and half a dozen other firms to sway the government by documenting that a merger won’t be “anti-competitive”: in other words, that it won’t raise retail prices, stifle innovation, or restrict product offerings. Their optimistic forecasts, though, often turn out to be wrong, and the mergers they champion may be hurting the economy.
The piece noted the role Jonathan and Peter Orszag have in facilitating deals.   Peter Orszag became Lazard's Managing Director and Vice Chair of Investment Banking in February 2016.  The World Economic Forum highlights Lazard's role in mergers and acquisitions.

Lazard's website shows two pages of deal consulting for The Carlyle Group.

Any merger over a certain dollar size — currently, $78 million — requires government approval. The government passes most mergers without question. On rare occasions, it requests more data from the merging parties. Then the companies often hire consulting firms to produce economic analyses supporting the deal.
Peter Orszag, former Obama OMB Chief, is a good fit for Lazard.  Federal News Radio reported in 2012:

Private equity involvement in the government contracting market has grown during the past few years, with major players including Carlyle Group, Cerberus Capital Management and others buying consulting, information technology and logistics vendors.

Brother Jonathan is Managing Director for Compass Lexecon, the premier economic consulting firm on antitrust/mergers.

At Orszag’s urging, the firm relaxed its conflict of interest rules, according to multiple people who have worked with or for Compass. Now, Compass Lexecon experts can, and do, advise both sides in disputes.  

Compass economists can reach very different answers to the same question, depending on who is paying them.
Compass Lexecon's July 2016 annual letter shows work on behalf of private equity firms.  There a a number of notable items in the company's list of accomplishments.

1.  Compass helped Goldman Sachs go free in September 2015 on bad RMBS investments from 2006-2007.  Goldman settled with the Justice Department for $5 billion "related to Goldman’s conduct in the packaging, securitization, marketing, sale and issuance of residential mortgage-backed securities (RMBS) between 2005 and 2007."

Goldman has today acknowledged that, “Goldman received information indicating that, for certain loan pools, significant percentages of the loans reviewed did not conform to the representations made to investors about the pools of loans to be securitized.”
2.  Jon Orszag's Compass Lexecon aided Citigroup with an RMBS settlement.  Brother Peter served as Vice Chairman of Global Banking for Citi at the time of the $1.125 billion settlement.

3.  The ultimate irony was Compass' work on behalf of BP for its May 2010 Oil Spew in the Gulf of Mexico.  They helped BP with Deepwater Horizon Oil Spill Phase III Litigation.  OMB Chief Peter Orszag helped BP's risk management after rig explosion by low balling the amount of oil spewing from the wellhead.

Compass Lexecon was retained by counsel for British Petroleum (BP) to analyze corporate governance issues and the economic implications of the magnitude of BP’s fines under the Clean Water Act (CWA) relating to the Deepwater Horizon oil spill.  BP later settled with the United States.
4.  Compass helped defend PEU Thomas H. Lee's private equity fee abuse case with the SEC.  Naked Capitalism took the other side by asking for public pension refunds.

5.  The firm aided four private equity firms in squeezing more money from the buyout of Dole Foods. Compass Lexeco worked for Merion Capital Group, Magnetar Capital, Hudson Bay Capital Management and Fortress Investment Group, LLC.  Dole and its predecessor United Fruit had a rich history of government assistance, such that President Eisenhower overthrew a foreign government (Guatemala) to benefit the banana grower.

I thank ProPublica for enlightening me on the role economic consultants play in buyouts, the majority of which today have a private equity link.  I believe the insidious connection between the billionaire boys and corporate sponsored government led to the two decade decline in income for the common person and the outsized enrichment for club members, like the Orszag brothers.

A mere decade ago President George W. Bush lectured the world that democracy requires a rising middle class.  PEU power led to the dismantling of America's middle class.   Larry Summers is once again defending the insider club and not listening to "outsiders."

Update 1-15-17:  Nine men have as much money as half the world.   That's a change from 62 men last year.  Wealth concentration continues for the monopoly PEU class. 

Update 1-20-17:  Carlyle co-founder David Rubenstein spoke to WSJ at Davos.