How to Get Beyond Private Equity’s Parasite Economy

Reader Lance N pointed me to an article on private equity by Eric Garland, a trend maven. I must confess that I’m skeptical of that breed (too many of them rely on devising clever buzz phrases to describe leading edge conventional wisdom), but even people who knew the transactions Garland discusses in his post were impressed with his grasp.

Garland uses the story of how the tender ministrations of Bain Capital pushed the music big box retailer Guitar Center into the bankruptcy-equivalent of a restructuring as a window into, as he puts it:

…how a small number of citizens can subvert every product made, every job offered, and every purchase decision – and how we can regain control of our lives, starting with the musical instrument industry.

We’ve been focusing on the investor side of private equity in our recent posts because its influence and its ability to maintain unheard-of levels of secrecy depends on the belief that long-term investors like pension funds can’t afford not to invest as much as they possibly can, after allowing for liquidity and diversification needs, in PE, because it is widely believed to deliver superior returns. But life insurers who also have long-term investment horizons, are for the most part not large investors in this strategy, because the rating agencies regard it as too risky for them to tie up all that much capital in it (as in they need more liquidity). So if the ratings agencies discourage investment in PE, and life insurers manage to do without it, pray tell why is it perceived to be necessary? The answer, of course, lies in pricing, or more precisely, the aggressive return assumptions that are widely used in defined benefit plans.*

And while we continue digging into the details that the private equity industry has worked so hard to shroud in secrecy, it’s important not to lose sight of the real economy consequences of this well-orchestrated wealth transfer scheme.

By Eric Garland, a writer and speaker who deals with the megatrends that affect society, economics and national security, with a special focus on the impact on ordinary people. Cross posted from his blog

It is the middle of the night between Friday and Saturday, and I am thinking about Guitar Center.

parasite economyIf the above sentence appears strange to you, we are in the same boat. I do not know how bizarre and random your life appears to you, but mine is definitely some sort of mysterious fractal. About four months ago, I was elected by the Internet to the position of United Nations Ambassador to Guitar Center. I made a simple, off hand comment about how I was surprised that the company was doing poorly despite all of the gear I bought there, and then the two separate streams of my life – music and business analysis – slammed together. Thousands of people began conflating my life as a somewhat decent bassist with my expertise in strategic forecasting. Now, with every development in the musical instrument industry, I have a flurry of emails and phonecalls from all levels of the business. It is surprising, fun, and as I now discover, significant of a much larger story.

I never paid too much attention to the musical instrument (MI) business in my profession of strategic analysis; it simply does not represent enough cash flow to have significance in national economies. For example, the global MI industry is around $13 billion a year. I used to do high-level analysis of the market for antipsychotic medication, something most people know nothing about, which has the same annual sales revenue in the US alone. My only interest in musical instruments was for pleasure, so when I was suddenly elected The People’s Analyst of the Industry, (current salary: $0) I had a lot of catching up to do.

After much deliberation, I see the MI industry as a microcosm of every other problem in the global economy. To borrow from the analysis of Thomas Piketty in his brilliant “Capital in the 21st Century,” the monied interests of society have expanded their reach such that they can concentrate and dominate almost every area of human endeavor, and the deleterious effects are now evident to all.

In the end, this story isn’t about a big box music chain, but how a small number of citizens can subvert every product made, every job offered, and every purchase decision – and how we can regain control of our lives, starting with the musical instrument industry.

News on Guitar Center’s Finances – and What it Means

If you are a regular reader you know that I have been keeping close tabs on the finances of the Westlake, CA-based retail behemoth. Had their executives never made visits to my Facebook page, I never would have thought that it was worth any research, but my experience is that if you see unusually emotional behavior from technocrats, a bigger story lurks. Confirming my instincts, a perfunctory analysis of the company’s finances showed gargantuan debt structure and a liquidity crisis (also known as being broke.) Because the company is/was owned by a holding company created by private equity firm Bain Capital, it was impossible for me to deduce exactly the structure of their ownership and debt covenants. To summarize the story for those who don’t have a taste for corporate finance, just imagine you had $65,000 in credit card debt financed at a crappy rate, and that you made around $80,000 a year. Things on the horizon would look bleak, and you would be forced to either change your lifestyle or declare bankruptcy and get a fresh start. As such, irrespective of the contradictions inherent in the big box model and the general draining of wealth from their supposed middle class customers, I figured that these guys would be lucky to make it a few more months.

The other shoe dropped a few weeks back when the main holder of Guitar Center’s debt, Ares Capital Management, stepped up to take ownership in place of future bond payments. The business media reports this arrangement as an alternative to bankruptcy, which sounds about right. I expected as much, because this model is in a slow death spiral, and the only way to extract the millions of dollars owed will be to run the Bain playbook, only harder and faster. As such, my forecast is for the $500 – 600 million of inventory to be sold at cheap prices while employees and vendors get squeezed for every nickel. This is no different than the past six years of company management, according to my sources, it’s just that this time, there is a time-sensitive goal – to get the most money out before the whole thing collapses.

The latest update: More details about the Bain-Ares handoff came out around 48 hours ago. They revolve, unsurprisingly, around a restructuring of senior PIK (payment in kind) notes that offered money up front with huge balloon payments on the back end. Under the current deals, GC would owe over $950 million in 2017 alone, an amount that would be impossible to pay off. I was skeptical about any form of refinancing, since the ratings agencies have compared their debt to scratchers tickets. But Ares is charging ahead and is preparing a bond offering to the market despite all the hullaboo:

Westlake Village, Calif.-based Guitar Center is further revamping its capital structure by launching an offering of $940 million in senior notes that will be used to repay debt connected to its buyout.

The proposed offering will include $615 million in senior secured first-lien notes, which Taylor said she expects will price around 6%, as well as $325 million in senior unsecured notes, which Taylor expects will price around 8%.

Moody’s rated the proposed secured notes at B3 and proposed unsecured notes at Caa1 in a March 25 report.

Guitar Center would use the proceeds from the notes offering to repay a $675 million term loan that backed its Bain buyout. The term loan, which is priced at Libor plus 600 basis points and matures on April 9, 2017, had $617.5 million outstanding at Sept. 30, according to a regulatory filing.

Guitar Center would also repay a portion of its $375 million in 11.5% senior unsecured notes due Oct. 15, 2017.

So Moody’s is still calling GC’s debt “subprime,” for those of you who remember that term from a little financial crisis a few years back – but that doesn’t mean that it won’t find a buyer. In fact today I saw news of GC’s bond issuance tucked in between some other deals from an online publication that follows the corporate bond market for traders:

Guitar Center’s two tranches followed suit. The 6.5% secured notes due 2019 and 9.625% unsecured notes due 2020 were both pegged at 98.5/99 this morning, from 98.9 at offer apiece, according to sources. Bank of America led the bookrunner quartet, with issuance under Rule 144A for life. As reported, the deal is part of a broad recapitalization effort whereby vintage-2007 buyout loans and some bonds held by Ares Management are repaid in full, a portion of cash-pay opco bonds are swapped into equity, and all holdco PIK notes are swapped into holdco equity.

Then, it hit me. I think I threw my head back and laughed. Chances are, Ares Capital Management will find buyers for Guitar Center debt at 6 – 9% interest, because for financiers today, higher risk just means higher returns, not actual risk –  just like back in the mid-2000s. Because of wealth concentrated in the financial sector, the dynamic is almost identical to what destroyed the mortgage market: Complexity obfuscated the true risk of financial instruments, which was being fobbed off onto other parties until the whole thing blew up.

Complexity: the financial structure of this operation seems absurdly complex given their business of selling guitar amps. To truly understand the structure of the Guitar Center business, I have had to consult professionals with a much deeper expertise – CEOs, CFOs, people with masters degrees in finance. Almost every one has looked at various details of the company and said, “That’s a pink zebra right there,” or, “Wow, I’ve maybe heard of that kind of thing one other time.” To understand some of their SEC filings, I had to drag up papers from the finance department of the Wharton School of Business. When you look up the corporate structure from which Bain Capital invested in Guitar Center, you find it (as of 2009) located as 3.34% of a billion-dollar investment corporation based offshore in the Cayman Islands, wedged into a financial partnership structure with a dozen other corporations.

In my experience, complexity of this sort is meant to keep casual analysts, regulators and journalists guessing – not unlike what we saw with the mortgage market eight years ago. And just so I had a good active comparator, I pulled the annual report for ExxonMobil, a company with a $290 billion market cap. Compared to GC, its filings are a relative oasis of simplicity and clarity, with the whole business laid out and finances making basic sense without enormous leaps of logic. Then again, it’s easier when you’re profitable.

Risk: None of the guys behind this deal have what Nassim Nicholas Taleb calls “skin in the game.” Nobody making decisions will lose their family fortune if it goes badly, and everybody in management stands to make substantial fees, bonuses and salaries. You see, Guitar Center used to be a musical instrument company, but now it is just one more imperial outpost for the spare financial capital of the top 0.1% of the population. For the people now supplying GC with liquidity, risk is a tool for cash flow, not a concern for survival.

When I recognized how much the financial markets have become like 2006, I finally figured out why some other financier could shell out $50 or $100 or $300 million for Guitar Center junk bonds.  For the customers of private equity, a few million isn’t that much money. These investors actually need some higher-risk assets in their portfolio, rather than let their money sit around in a zero-interest rate environment. They might be like Warren Buffett and already have huge stakes in sensible things like Too-Big-To-Fail banks, railroads or Coca-Cola. This just rounds out their overall position. Make 6-9% with the chance that the company could finally go tits-up? Why not! If it pays out, then great, and if it doesn’t – tax write off!

You know who else thought like that? The people who set the mortgage market on fire just a few years ago. They made a fortune by structuring finance in such a way that investments produced income irrespective of their true value. They could not have cared less about whether the end result was old people thrown out of their homes or eight million unemployed – that was someone else’s risk. Their risk got hedged by the taxpayer who would bail out the industry so long as the collapse was big enough, so building a decent, functional economy was besides the point.

This is the logic at play with Guitar Center. Financial parasites have taken over the host company and could not care less about the industry itself. They install some CEO who used to be selling DVD players. They swap private equity firms in and out. It doesn’t matter – it’s just another place for loose capital to suck out a few extra dollars or a tax break. After all, the entire value of the company is less than what JPMorgan paid in fines last year without breaking a sweat.

In the final analysis, this is less about business sense and more about business domination. There are dozens of industries that have been locked up by a few players in this way: mortgages, cars, pharmaceuticals, retail, you name it. Since the chances of antitrust suits under “leaders” like George W Bush and Barack Obama are so low, the tiny tranche of society with all the money can run a time-worn playbook – consolidate companies, squeeze vendors, push manufacturing overseas, lower wages, wash, rinse, repeat, discard. The numbers of the business – which suck in GC’s case – do not matter as much as control of yet another industry. As long as you have dominance over an industry, your positions are hedged for risk automatically because there is no other game in town – or at least people believe that. In the meantime, you get management fees, income from bonds, the occasional IPO payout.

And if not, you move on to the next group of suckers.

Time to Return the Musical Instrument Business to its Human Roots

All of this cold-blooded nonsense stands in stark contrast to the amazing people I have met in every other corner of the industry, including the actual long-time employees of Guitar Center who have reached out to me. I have had the tremendous honor to speak with inventors, entrepreneurs, retailers and fellow musicians about current events and I have been astonished by their intelligence, kindness, creativity and overall sense of humanity. All of this is diminished by the presence of these rapacious colonialists and it is time for them to take their leave of our economy, starting with the musical instrument industry.

Music, you see, is about about way more than just money – it is about a crazy, primal, uncontrollable passion. Most people who have dedicated their lives to music realize that it is an irrational thing – a little unhealthy but strangely fulfilling. The “industry” is actually a culture built by men and women who obsess over the rich sound of analog synthesizers; the warm thud of Leo Fender’s Precision bass; the sublime beauty of the sunburst on a vintage Les Paul; the roar of a Marshall amplifier; the silky vocals behind Neumann tube microphones. Note the prevalence of family names in these company names – the real industry was built on the artistic endeavors of individual geniuses who acted out of pure inspiration, not banks. Financial return represents but a small fraction of the motivation behind the involvement of the vast majority of people in the musical instrument business.

Yet for Bain Capital and Ares Capital, it is 100% of the reason for their involvement – and that is not good enough for the rest of civilization. As the weeks have worn on, I find myself resolute in what should be done. It is time to convince the financial parasites to leave us alone. Massive changes to the tax code need to make labor and entrepreneurship more valuable than financial trickery, but in the meantime, you can help as an individual. I recommend that you refuse to buy as much as a guitar pick from any company currently owned by a private equity firm, or any financial entity that does not come from the music industry itself. Your purchasing decisions will decide whether these financiers will continue to dominate this industry, because if they cannot achieve a return on these bonds, they will move on. The revenue that has been consolidated through complex debt structures will return to the rest of the industry. It will mean new businesses and new jobs. In just one small way, life will get better.

This is not about size; there are big companies that are great to work with. It isn’t about corporations; that is just a legal structure. And while it is great to work with local retailers, there are online vendors run by real people with something special to offer who simply choose not to pay rent every month to a physical space. This is simply a movement against parasites. It is about taking the tiny fraction of society with the spare capital to ruin people’s lives in exchange for a few bucks and telling them that enough is enough.

It will require considerable effort to reform critical sectors of the economy such as financial services, manufacturing, and healthcare. The musical instrument industry is small enough that we can return it to health and use it as an example of the authentic economies that we can create in the future. What happens next is up to you.

* It’s common to demonize public pension funds, which manage the retirement assets of state employees, for these assumptions. But they are not the ones who come up with them. Retirement fund management is an big exercise in liability avoidance.

The funds hire pension fund consultants who provide the return assumptions and advise them on their asset allocation strategies. And it is also critical to note that public pension funds and the remaining private defined benefit plans have pretty much the same return assumptions…..because they hire the same fund consultants. And why might fund consultants have an incentive to provide high return assumptions? High return assumptions are popular, for they lead to lower current funding costs. High return assumptions also require that the pension funds participate as much as possible in risky strategies. Risky strategies are more complex and varied, which gives the fund consultants more to do in evaluating them and thus justifies higher fees.

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  1. R Foreman

    > As long as you have dominance over an industry, your positions are hedged for risk automatically because there is no other game in town

    ..but if you drive that company out of business, and you can’t sell its debt to sucker investors for any price, then you eat a potentially huge loss, and you open a huge market where that company once stood.

    1. HotFlash

      Well, maybe, but an ‘open market’ is not sufficient to make a complex industry. We, who are musical instrument makers, are finding that we cannot get good quality supplies anymore. Was discussing this with a bunch of (classical) musicians and a couple of instrument builders just last night. Every time we get a shipment of , oh, wire or damper felt or something that has been standard for 300 years, it is crappier than the shipment before. It *looks* the same, but it doesn’t perform the same way. Clarinet and oboe players complain that good reed cane is hard to find (a natural product, disappearing b/c cane swamps cleared for resort hotels), our organ builder friend can’t get good quality bellows and pallet leather, our bass player friend says the gut strings he can get now don’t sound as good or last as long, we can’t . I am reading up on making woven felt because we can no longer buy woven felt ribbon of the thickness we prefer — a thing that used to be available in dozens of types, widths, thicknesses and resiliencies, with a woven edge. Now we can get cut edge only, the ‘thick’ is too thin and too floppy for our use.

      A mature industry like musical instrument building is not a monocrop, it’s more like a forest ecosystem, and once logged out for a quick profit, replacing it it not so easy as just replanting trees.

  2. allcoppedout

    I sympathise. The story though is very old. This is Jurgen Habermas’ communicative versus systemic rationality (1984). I miss the days when I could visit a cricket bat maker and he would whip one up to my specification (to no improvement on my on field performance).

    The problem isn’t just finance and this private equity stuff clearly has origins in asset-stripping and price-fixing with centuries of history. We abolished retail price maintenance in about 1970 in this half of USUK, screwing small retailers. In Malaysia they recently legislated to keep out supermarkets to protect these retailers (cold stores). My local convenience store is twice the price of supermarkets.

    Garland is right, but also arguing old rot, much as, say. HRM is personnel management in a new bottle. Not buying from vile PE firms is as vapid as ‘buy British’ campaigns or not buying underwear made by a woman beaten in a sweatshop. Garland is short on how, long on nostalgia. There is nothing new in this.

    Not heard the term trend maven before. Buzz words on leading edge? Good Lord, this is just another story of the demise on the corner shop. Even Hollywood films have made these points. The whole idea we can control the means of production by consumer choice has failed entirely. We need a much deeper war against the financial cavaliers. Good grief, this is upper-class twaddle of the kind exchanged by those buying free-trade coffee who get the beggars removed from supermarket grounds. If any of this is relevant to real change I’ll bare my ass in Burton’s window. The world is safe. Burtons already went the way of private equity reconstruction. So did engineering firms so big they had their own railway systems. I sympathise and buy my grandson’s guitar picks in a lovely little local shop. The sky thus falls on giant transnational finance …

    1. Moneta

      The thing is that over the last few decades, M&A has managed to create value. However, we are now getting to the point where these big corporations’ business models make no sense and bailouts will be required in every sector of the economy, not just banking.

      We are witnessing the hockey stick effect… when we bailed out the banks we hit the blade part… now we need to see how many more sectors we will bailout to prop up guaranteed pensions.

      1. allcoppedout

        The worry that M & A was making profit at the expense of organic growth goes back at least to the time I worked for a predator (Hanson) for a short time in the 80s Moneta. Your point is well made otherwise. The problem is partly that efficiency has such a compelling logic. We need far more effective arguments that subsume what we might call decent business housekeeping to the construction of a decent society.

          1. Moneta

            I wrote:
            and bailouts will be required in every sector of the economy
            What I meant was that I predict an increasing number of failures which will force us to consider bailouts.

            I don’t believe bailouts of failed businesses are a good response but time will tell if we go that route or not…

          2. tim s

            It would be simple if “we” actually did the bailouts. The fact that “we” are completely excluded from these dealings is the problem.

            1. susan the other

              I feel that this parasite, this disease, cannot be cured by any means. Last nite I watched CSPAN as the lovely Mr. Forman, our representative negotiator for the TPP, defended his progress in front of congress. The New Jersey senator or rep (don’t know which, I was sleepy) almost read him the riot act because US employment and industry has been so decimated by 3 decades of the nonsense free trade creates. And Mr Forman was quick to flush with anger and his eyes flashed. He’s creepy. He clearly has another agenda. To my point, then, as long as there is unregulated “free” international trade this domestic destruction can continue because the rich will not be hurt if we 99%ers protest or boycott. Only if we throw a monkey wrench in the free trade works will we ever make progress.

        1. Jim A

          The question is, why do people continue to overpay for these companies, or bonds from these companies after PE firms have loaded them down with unpayable debt? We really can’t prevent PE firms from buying publicly traded stock, and not buying products from companies owned by PE firms doesn’t change their core business which is asset stripping. But if people wouldn’t overpay for the shit that they’ve left behind, debt loading and asset stripping would cease to be profitable propositions.

          1. Rob

            I think that your underlying assumption is wrong. PE firms sometimes overpay, and we hear about it in high profile instances. The reality is , however,that most deals are successful, but are less newsworthy. And firms which overpay consistently go out of business quickly.

      2. Alejandro

        The hockey stick effect is a metaphor for exponential “growth”. Nothing in reality “grows” exponentially, in perpetuity.- it’s mostly cyclical and is best represented by the S-curve, where the INITIAL stages of growth is roughly exponential.- but then it saturates, growth slows, and when it matures, growth stops. The similitude at the initial stages is what makes it insidious, non-threatening and so difficult to grasp (to me). If we superimpose the exponential function f(x) =2^x (finance/financial claims/magic of compound interest) and the S-curve (Economy-with real world carrying capacity limits) it becomes obvious that the two eventually begin to diverge. When this divergence becomes widely obvious, it’s called a “Recession”. When “our” institutions are (or seem) incapable of ad-JUST-ing, it used to be called “Depression” and more recently “Austerity”, which are euphemisms for institutional and systemic Predation.

  3. Cal

    This article would really mean something and could affect tens of thousands of people who like music if the author could just write it in such a fashion so that the Average Joe could understand what he is talking about.

    As long as financial articles are written so that only insiders understand them, people who know, what for example “senior notes” are, the majority of the population will never get it and will certainly never do anything about it in their pattern of voting, purchasing or potential populist activities.

    1. Moneta

      A few years ago, while trying to convince an audience that the US was in a bubble, I asked by better half how I should structure my presentation. His recommendation was that I keep it to 3 points max because I always talk too much. That’s when I realized there was nothing I could do. Most people would need at least 5 university course to understand what is happening AND to believe it.

      I realized that we would need to go through millions of personal epiphanies until we got to the tipping point. This writer has obviously joined the epiphany group.

      He’s trying to find solution using consumer behavior but the solution is to get the tipping point in epiphanies.

      1. Banger

        Audiences, even audiences of one, are more focused on style than substance at least initially. I believe you can present complex ideas to audiences if you challenge the audience sometimes by saying really outrageous things because most people are in various stages of sleep.

        I like your words “tipping point in epiphanies”–it brings to mind the “edge of chaos” a phrase I like to use. For real change to occur we have to live closer to tipping points at least of our consciousness because we live at a time when conventional thinking is producing nothing of value about the world we live in. We live at a time where conventional roads, conventional solutions just have very little meaning.

        1. Cal

          “Most people would need at least 5 university course to understand what is happening AND to believe it.”
          I took Econ 101 in college decades ago. Have been reading Naked Capitalism since about a year after it premiered. That’s how I have learned, through slow looking up terms over many years and lots of reading and making notes.

          Charles Hugh Smith is the closest thing that I can find to the Classics Comic Books version of the economy. Yves is serious reading. Sadly, I think that videos are better at explaining such things to a lay audience, or perhaps, a flayed audience, than text is. For example the Mike Malone series on Youtube about the fed.

          You know those little tear off tabs that people put on the bottom of Missing Cat posters on bulletin boards? I hand out dozens a day for Naked Capitalism and Charles Smith and a few other sites whenever I hear someone complaining about their economic lot in life. Have dozens of friends so versed and boy are they getting mad.

          1. hunkerdown

            Sadly, I think that videos are better at explaining such things to a lay audience,

            Such as Annie Leonard and The Story of Broke?

      2. nobody

        “Most people would need at least 5 university course to understand what is happening AND to believe it.”

        Well then maybe somebody needs to develop that course, make it available online, and get busy with a guerrilla marketing campaign.

        1. allcoppedout

          We’d probably have to embed the programming into video games and some new films and series. Action Man and Kick Boxing Lady do modern monetary theory kind if stuff.

          1. hunkerdown

            Could it be that the durable popular attachment to economic Darwinism is reinforced by both the positive popular perception of and the captivating engagement inherent in competitive gaming? Or, put another way, does the form constrain the discourse? Can cooperation even be compellingly gamified outside of the competitive team framework?

            There is almost certainly an ulterior motive of public opinion management in Hollywood’s insistence upon technical measures to enforce their distribution boundaries.

      3. Demeter

        Do we need the masses, or just enough first-responders to spread the word downward? Yes, I can understand the article, because I’ve been studying up for it all my life, with greater intensity since 2000, when the world fell apart around here. But I can explain it to others not at my level…something that an expert wouldn’t have the time or personal knowledge to do.

        This is the power of the internet…to educate and disseminate difficult subjects in popular and digestible format, by processing the information through successive, popularizing commentators. It is people-power, at its finest.

        And if the root of the message gets lost, follow the tree back to the root…

  4. Moneta

    Large DB plans are contributing to the gutting of the middle class. Those employees/retirees with a DB plan benefit from guaranteed returns in excess of 6%. If investments go bust, they get a bailout. This pension structure is contributing to the gross mismanagement of companies and stimulating M&A. In the meantime, all the others with DC plans bear the full risk.

    We need to suffocate Wall Street and convert these large DB plans into pay-as-you-go.

    1. Yves Smith Post author

      No, you have it backwards. Unduly high return expectations, supplied by pension fund consultants to whom the funds must defer for liability reasons, provided conveniently too high return targets. That led to underfunding, which led to returns-chasing, which made the pension fund consultant even more important, since picking among hedge fund and PE strategies is much more complicated than deciding stocks v. bonds v. real estate v. cash v. foreign stock v. foreign bonds.

      Everything these guys did was on the advice of experts, with the exception of some colossal self-inflicted wounds, like Christie Todd Whitman starting the proud New Jersey tradition of underfunding even relative to the fund consultants’ cheery forecasts.

      The whole structure is corrupt but it does not have to be. As I said, life insurers invest for similar long time horizons and they aren’t in a mess. This is not inherent to defined benefit plans, it’s all the agency problems involved in how it’s done in the US.

      1. Moneta

        I don’t disagree with anything you just wrote except your backwards comment because what I see is a case of “what came first the chicken or the egg?”. We are stuck in a vicious cycle.

        The consultants are actuaries who always look in the rearview mirror. That is their training. I can tell you now that their assumptions for the next decade are based on the last decade’s correlation’s matrix… mixed with politics. Hmmm…

        I have over 20 years of experience reading plan policies. Many small players are grossly underfunded and looking for ways to get rid of their plans. However, laws stipulate you can’t close it until it is funded. So either they are looking for ways to fund it asap or to push off the day of reckoning as far as possible hoping for a miracle or a change in pension laws that would help them.

        To limit pension cost volatility, they are doing whatever it takes. They are immunizing their bond portfolios (essentially going long when rates are at historical lows) and increasing alternative investments (pricing can be better controlled thanks to appraisals). Most are asking for funding delays (5 instead of 10 years).

        Assumptions are still mostly optimistic meaning that further funding problems still lie ahead. But generous market returns and benefit changes (COLA cuts) have helped pension funding in 2013… many plans have managed to achieve a funded status and something like 30% of plans are looking to close their plans or transfer the liabilities to insurers.

        From what I see, some plans are OK and a large percentage are not. And there is a huge game of kick-the-can going on.

        IMO, most in the top 15-20% still believe in the system because it has treated them well. And this includes the consultants, the portfolio managers and those with a guaranteed pension. Until this group understands there is a problem, tweaking is futile.

        If we had the guts to fix the agency problems, many pensions would instantly get cut. That is one of the reasons why we are stuck in this rut.

        1. McMike

          I disagree. As a former pension board member, I can assure you that the consultants are members of the Wall Street elite. They are salesmen, not actuaries. Often it is the firms themselves who are advising pension funds to buy their products. That is certainly the case with PE firms.

          Pension boards pay handsomely for advice from self-interested firms, then they follow it, then they are on the golf course by noon. That is the norm, and it would in fact be legal suicide not to follow it.

          1. Moneta

            Here in Canada, the consulting firms hire the actuaries who graduate top of their class. When I started in the early 90s, we called them the actuaries, now we call them the consultants. The young ones do the grunt work and as they move up the ladder, they fall into sales.

            Every sector has fallen prey to the salesperson. If you want to make money go into sales. Even if a doctor focuses more on sales, it is still a medial practice.

            Frankly, I don’t see why you are disagreeing with me.

            1. McMike

              I am in agreement with Yves’s post. You stated your disagreement with her. Hence my disagreement with you.

          2. larry

            McM, why exactly would it be legal suicide to go against this trend? I’m sure this is obvious to you, but I know nothing about this area. I’m not trying to be obscurantist.

      2. susan the other

        My usual non-sequitir here: can pension funds of an international corporation or conglomerate be sustained for previous domestic retirees if that fund was merged with a bigger, international entity? So our pension benefits continue to grow if all the commerce leaves the couintry (as it is doing)?

      3. lee

        As a retired employee of a mutual life insurer I can attest that they’ve done right by me and many like me.

    2. lee

      I have a defined benefit pension from a 175 year old mutual life insurance company that has been keeping me modestly comfortable for years now and my 401(k) plan, in addition to a variety of mutual funds, offers a guaranteed interest option that has been earning over 5% since the ’08 crash and more than that prior to same without benefit of government funds. Frankly, I don’t know how they do it (I was in the sales not investments or actuarial) but from before the civil war they have met their obligations, including dividends to policyholders, through thick and thin. One thing besides sound management comes immediately to mind (they pulled out of higher risk assets in ’07 because they deemed the market “irrational”): there are no stockholders so profits are shared among policyholders. My god, I sound like an advertisement. Apologies to one and all.

  5. Dan Kervick

    This is very interesting, but I don’t feel like I really understand the nature of the scheme. Garland’s main point seems to be that in the new world of finance, there is no actual risk in investing in high-yield unsecured notes, because:

    This just rounds out their overall position. Make 6-9% with the chance that the company could finally go tits-up? Why not! If it pays out, then great, and if it doesn’t – tax write off!

    But how does that work, exactly? I tend to think of tax write offs, generally speaking, as ways of avoiding losing more money, not as ways of making money. Obviously there are clever techniques for making money from the tax system – at least one often hears about them. But how do they work exactly? How is it exactly that the investors in these unsecured notes make money either way? Are the notes being bundled and securitized? Is there some sucker down the road – besides the employees of the company – who will be left holding the bag? That is are we talking Ponzi scheme? Or instead a sure-thing investment that comes from bleeding employees and pension funds dry?

    The bottom line, it seems to me, is that there is a class of extremely wealthy ultra-investors who, whatever their current place of residence, have no country, no loyalties to anything but their own personal estates and no moral commitments to any cause other than “stay out of my way.” Many of these people have decided America is a lost cause and have decided to cash out of the US rather than invest in it, to strip and dismantle its assets and take the proceeds to their private enclaves protected by the new militarized police. For them, the entire world is like those security containers people buy at auction on television.

    1. Yves Smith Post author

      The people who are buying this stuff are using Other People’s Money. So you have the classic issue that Keynes wrote about, if you are ruined (or in this case, ruin someone else) in a conventional manner, no one will blame you. But these guys are much more cynical and bonus-cycle driven about their “conventional” behavior.

      1. profoundlogic

        Exactly! This whole financialization charade is built on the foundation of using other people’s money, and a big reason the Federal Reserve was created. As long as you can use future cash flows to extract the money from an unsuspecting public duped by complexity and obfuscation, you can keep the charade going for quite a long time, at least a 100 years or so apparently.

        Socialize the losses and keep all the gains for yourself. It’s crony capitalism 101.

      2. Dan Kervick

        Nobody blames you because everything is so complex that you can baffle them with bullshit? Or because the people whose money your investing also know it’s a casino crap shoot at bottom and are willing to lose.

        I’ve sometimes wondered if the proliferation of lotteries, casinos, online gambling etc. over the past several decades has seduced the entire country into an easy come, easy go gambler’s mentality, where no one expects security anymore and so no one blames anyone anymore for destroying it.

        When I was a kid, none of that legalized gambling existed – not even lotteries, which were regarded as nothing other than “numbers rackets” and the preserve of the mob, not decent members of society. Gambling was a vice, end of story, and it was supposed to be confined to a safely contained zone in Las Vegas, like nuclear waste. Now gambling is normalized behavior supported by governments and employed as a revenue scheme, imprudent risk-taking is seen as “courageous” in itself and worthy of social esteem and high rewards, and people don’t even blanch at the fact that the ethos of Wall Street is no different than the ethos of Sin City.

        I’ve been thinking of this again recently, because I started re-reading Weber’s The Protestant Ethic and the Spirit of Capitalism. I think the book’s historical analysis is overly high-minded even for its own time. But there was something to it. But that spirit seems completely gone now from the finance sector at least, and all that is left is the predatory hustle.

        1. hunkerdown

          I had a slideshare link sitting in my browser for a while. Some bubblenet bizdev yutz’s presentation titled The Gamification of… Everything? By slide 20 I “found better things to do” as I couldn’t stomach reading the whole thing. I imagine those who have worked on the Snowden docs had similar reactions.

          The thought of sending socialist propaganga to the future by bouncing them off hypothetical radio-reflectors in distant galaxies is a tempting one. My first proposal: “Ensure those who try to separate their outcomes from yours do not receive a second chance to do so.”

    2. McMike

      Yes, I have been trying to figure out where the losses end up – best guess is they get “laundered”: spread out and absorbed by pension funds and retail investors, and by taxpayers, and disseminated into large portfolios, and some of it simply disappears into accounting gimmicks. It’s all funny money anyway.

      I suspect our mistake is assuming that the losses are real, so they must go somewhere, a notion mandated by some Newtonian law of double entry accounting and zero sum justice. But what if the losses are no more real than the money magically conjured for the investments?

      In the meantime, the fees and sweetheart payments sucked out of these deals seems real enough.

      1. cnchal

        The mansions, yachts and Ferraris bought with those fees and sweetheart payments are real. A perfect example of “Trickle Down Economics”.

        1. Alejandro

          After pondering the word “peon”, it dawned on me what actually “trickles” down. Now, when I hear or read the phrase “Trickle Down Economics”, I instinctively grab for my umbrella and spray disinfectant.

      2. TheCatSaid

        Aren’t the real losers the business’s employees & creditors / suppliers to the actual business when it finally goes belly-up?

        Other losers (societal loss, not a financial loss) are the would-be customers who want decent products and decent places to buy from.

        1. McMike

          Ultimately yes.

          Plundering perfectly good companies, crapifying perfectly good industries, is not a zero sum game.

          It is like burning fossil fuels. It took several million years to create, and thirty seconds to burn.

          It is the reason the term “strangling the golden goose” was created.

      3. susan the other

        Losses are profitable for PE dealers. Plus, they never pay a brokerage tax. Great comment McM.

    3. Banger

      I agree with McMike here with one addendum. Investment instruments with high yields lend themselves to mini-bubbles which have a life of their own that create “value” where no value exists at least in the short-term.

    4. Moneta

      Let’s say a big pension fund bought some MBS and other ABS stuff and these defaulted but the Fed did some QE which permitted them to sell their less than stellar investments and with the new cash managed to buy new stuff… that means pensioners get a bailout instead of write-downs.

      1. McMike

        Except pension funds don’t get bailed out. They are for little people. They are to be plundered, not subsidized.

        1. Moneta

          Sorry but the big funds did benefit from the bailouts and QE.

          The problem is that these are fixes are temporary. The big plans are full of companies like this music co. And one after the other, badly managed plans will fold.

          The agency problem should have been dealt with in the 80s but everyone wanted to believe that the US had found the way to convert green into gold. And this belief only intensified with the falling of the wall.

        2. Moneta

          Many little people are still collecting pensions that they would lose if we fixed all the systemic and agency problems.

          Then we would need to replace these with pay as you go pensions…. but we are still very far away from this line of thinking… since most people think we can fix the problems by asking those who created this web of lies to turn it around. We need new people with a new set of eyes but these people have no chance of getting these jobs right now.

          One has to remember that all the agents in this system are still part of the top 20% that is still doing well. No incentive to change right now.

          1. hunkerdown

            WE would need to abstain from submitting to numbers apparently produced in the same factory as tapeworm proglottids and decide that numbers are no longer sufficient cause for not meeting people’s basic needs.

  6. McMike

    Hmm. Boycotts PE firms. Okay. I agree in principle. Please provide a list. And update it daily.

    Alas, If guitar maker companies are anything like power tool manufacturers or organic food producers, then these companies have all long ago been taken over and are in the process of having their brands monetized and goodwill exploited (crapified as Yves says).

    I recall Peavy (just an example) switched to Chinese production a while back. We can assume Gibson and Fender both have been steadily eroding quality in incremental ways, while also creating consumer confusion with their parallel discount lines (surely their ownership long ago passed to corporate raiders).

    A walk through Guitar Center reveals a long line of mostly cosmetic model options and meaningless gadgets, plus an overwhelming array of brands, some of which offer surprisingly inexpensive models ($150 for a guitar? $300 for an amp?!). Key indicator of an industry in the process of crapification.

    How is one to select the pearls from all that swine? How is a casual buyer to know when your favorite old-line or boutique brand has sold out to a PE firm? How is the casual buyer to know that the wood used for that neck is now a little less “choice”, the fingerboard a couple millimeters thinner, the electronics now “lovingly” installed by a suicidal twelve year old Malaysian slave worker? Which one fudged on the kiln time, which one skipped a coat of varnish? Which one devised some way to make the product less robust in as-yet undetectable ways? How is a buyer to know that that Fender amp is cranked out by a firm that doesn’t give a crap if it works or works well, since they only care about marketing. High rates of returns are expected; higher rates of customer malaise and resignation are counted on; who gives a crap: move product, the stuff costs pennies to produce anyway.

    How can I tell which artisan brand is really an artisan brand, which one is in its peak pre-takeover form on the come, which one is now a self cannibalizing PE zombie, and which one is an astroturf fraud from day one?

    Then, having spent scores of hours educating myself about the current state of guitars in order to make a purchase, I must then go home and do the same for power tools, home appliance, food producers, and auto makers. Then clothing makers, shoes, computers, stereo, TV, credit card agreements, bicycle, clock radio, mobile phone…

    1. Watt4Bob

      As someone who owns, and has owned many guitars, vintage, and brand new, American and foreign made, I have to comment on the strange condition of the current market.

      For both Gibson and Fender, the world-wide market leaders, it’s possible to buy a version of every one of their popular models at almost every price point between $99 and $5000.

      The strangest part of the situation is that as a certified guitar snob, it is very hard for me to report that for three years now, I have been unable to find a Fender Telecaster that I would prefer over the Chinese made Squire Telecaster. (Fenders second-tier brand)

      My Squire Telecaster was made in China, it’s solid body is made of pine rather than Fender’s usual ash, but my only disappointment with the thing is the Squire name on the headstock.

      This guitar has excellent fit, and finish, feels just like a vintage Fender instrument to any player who understands that sort of thing, and has a remarkable tone due in large part to the pine body that is not available on any of Fenders American-made versions as far as I know. (I have been surprised to find out that a few Nashville studio guitar wizards long ago started having pine-bodied Telecasters made for them for this reason)

      So my favorite guitar cost $199.00, and even going to the most fully stocked high-end store and playing the same model instruments at every point in between $99 and $6000.

      I haven’t found one that I would prefer to my Chinese made Squire in the last three years, and I have been trying. (I’m a snob, I admit, and I would prefer it said Fender on the peg-head)

      It’s the same with every model by virtually every manufacturer, the most popular models are available at $99/$199/$299/$359/$399/$459 etc, all the way to 5 or 10 thousand dollars, but any honest professional would admit that they would be confident that should they lose their favorite guitar mid-tour, they could easily find a decent replacement for 2 or 3 hundred dollars.

      I’m sure this situation was a huge problem for GC even prior to the PE guys getting hold of them.

      But now it seems their days are numbered, and that’s not how things ‘should’ be.

      The world may have always been tough, but things are now totally unreasonable, in large part, for exactly the reasons the author pointed out; the 1% have found a way to leverage our every breath, and it is making life intolerable.

      1. McMike

        That’s an interesting perspective.

        We all know it is true that you can certainly make the same or better product cheaper, if you desire to, if you do it in China.

        But this has not been my experience with either power tools or organic foods.

        Perhaps these guitars are in the initial stage of simulacra, whereby they are equal are better tan what they are imitating. The law of retail entropy tells us that sooner or later the quality must degrade. (i.e. once Gibson and Fender or fully pushed out, there will be no longer be gold standard to imitate),

        I presume that was once true of canned soups and prepared frozen dinners. When these products were first issued, they must have at least approximated the taste and quality of the thing they sought to replace. At this stage, they barely resemble food anymore.

        1. paul

          One thing is that a good gutarist will sound better with a half decent,cheap electric guitar than a bad one with a ‘premium’ one.
          There’s a link wray album cover where everything is from a sear’s catalogue, clothes, shoes and a danelectoro made from hardboard and recycled lipstick tubes.
          Noone sounded better than him.
          Leo Fender and Les Paul got it just about perfect first time. This plus guitarists’ extreme conservatism means they’ve hardly changed in 60 years. They don’t need to.

          1. Watt4Bob

            You are correct on all points sir!

            In the old days it was pretty much Fender or Gibson, Fenders were affordable, and Gibsons were fancy.

            I’ve always heard that Leo Fender was very concerned to make his instruments affordable to the average person.

            Both were top notch as far as quality goes.

            Dan Electros have to be the most bang for the buck possible!

            My first guitar was a $12.50 Silvertone from Sears.

      2. tim s

        Agreed, on this side note. The quality of asian imports has improved in many areas from musical instruments to tools/machines, similarly to how Japanese cars improved greatly from the 60’s (junk) to later decades when they became standards of quality.

        Sometimes fit and finish is a little lacking, but they are getting many things right, looking at it from a technical perspective. I try to not support sweatshop conditions, but will give credit where it is due.

        1. tim s

          I don’t mean to imply that many of these current asian imports have become the standard of quality – far from it. But they are coming close to par in many instances I’ve found.

          1. McMike

            As a formerly loyal Toyota buyer, I can assure you that they cannibalized themselves right on schedule.

        2. paul

          Indeed, its harder to buy a bad guitar than it was 35 years ago.
          Maybe its resistant to crapification because it’s a reasonable size market, few barriers to entry (above the purchasers’ innate conservatism) and the customers have a good understanding of what they’re buying.
          The producers are in that rarest of things, a healthy competitive market, and markets can be great for producing shit you don’t actually need.
          The fate of this large retailer is not really reflected in the production side.

          1. McMike

            I hate to say it, but maybe it’s just early in the process.

            I think we’ll find precedence in what happened to local hardware stores and to hand & power tools. Maybe it is following a different sequence, but I don’t see anything about the guitar business that differentiates it from anything else.

            It may hold out longer due to the selectivity of core consumers and the informal networks of information sharing – making it more difficult to commoditize and to crapify – but in the end, it will succumb to PE raiders and Gresham’s dynamic all the same.

            Perhaps another better analogy is in outdoor gear. Which goes through periods of sell-outs and buy-outs and once formerly highly touted brands turn to cranking out schlock for the masses. There’s still some folks making good stuff at any point in time, but there’s a lot of churn, so it takes constant vigilance to stay on top of it. You cannot assume that the company who made your favorite backpack or hiking bots ten years ago bears even the slightest resemblance to its former self now.

      3. just_kate

        They say it’s the tears of the child laborer who assembled the guitar that make your Squire so lovely.

        1. Watt4Bob

          ‘They’ say a lot of stuff that turns out to be false Kate.

          Here’s link to a video that shows a worker in a Yamaha guitar factory in China;

          Chinese guitar factory

          It looks much like fender’s Corona Ca. plant.

          Making quality musical instruments is not something you can due with abused children.

          1. just_kate

            I didn’t say the workers were abused but they ARE mostly children. tears can also be caused by joy or relief – Hangzhou makes more than just guitars dontyaknow. It would be better if you could buy guitars from the Corona, CA plant if they made what you want re what susan the other comments here about global trade is where I’m coming from too.

            This post is about choosing where to spend your dollars.

      4. Jeff N

        I have an Indonesian Squier Cyclone, and it is absolute garbage.
        All the basic “Fender Telecasters” are made in Mexico. They also offer American-made.
        My highest quality guitar (by far) is a late-1980s Japan-made Fender Strat.

  7. allcoppedout

    Sooner or later all these “investments” are worthless unless someone works to provide what the owners of them want. These workers, quite unreasonably, demand pay beyond the upkeep of the box we give them to live in and the sufficient calories we allow to make up for those lost in work. Our bleeding-heart overseers grant them further pay. Fortunately, our accountant lackeys prove their worth in ensuring this excess pay has to be spent in our company shops at ever rising prices. The trick of selling them their own boxes has proved remarkably adept as we now get returns from the interest they pay. With the company shops’ monopoly and ever increasing prices and scarcity position re boxes, the workers have to borrow money against any box equity they have built up, an infinite source of lending returns for us. The productive ingenuity of these workers knows no bounds, though their ability to believe the fiction this is down to us is a greater infinity. Our own society is now threatened by these workers, thriving under our care and living long enough to receive the pensions we granted them. Now doubters will see the fortitude of my policies of ensuring these ungrateful workers could never own their pensions and the expenditure on consultants using hedge and private equity funds to leave losses in the pensions and massive profits in our beloved 1% Consolidated.
    Yours as ever,

        1. Moneta

          I’m not usually as careful as I should be with my choice of words but this time I used the word general on purpose. ;-)

          1. allcoppedout

            All this before we start working on the vagueness sets Moneta. We’ll really be smiling when we do our vague and diverse prior plausibility assessments. The new SI unit for these, I understand, is to be the ‘craazyman’ (below) expressed in lost guitar picks.

  8. craazyman

    This is empirical proof of the equation we discovered through channeling:

    JOR = L*U*C*K

    Job offering rate = a Lambda factor (sensitivity to uncertainty) X Uncertainty (usually pretty steady) X Capital X K (a constant that makes the math work).

    L = f[C] where f[C] approaches 1/K*1/C. It turns out that K is the same constant in the equation above. As C increases, L declines at a faster rate than C, which reduces the JOR.

    In this particular case profiled, as C increased, jobs were shed due to the decline in the Lambda factor, even as C increased hugely.

    this makes more sense than you think it does. it should be in a f*cckng textbook at Harvard. hahahahahaha

    Otherwise, they mean so well. It’s like Blanche Dubois in STREETCARE NAMED DESIRE

    “I don’t want realism. I want magic! Yes, yes, magic! I try to give that to people. I misrepresent things to them. I don’t tell the truth, I tell what ought to be the truth. And it that’s sinful, then let me be damned for it!”
    ― Tennessee Williams, A Streetcar Named Desire

    You’re only damned for it when you don’t have “C”.

      1. craazyman

        We can also discover using the same research methodology that:

        economic activity = money X cooperation^2; e=mc^2

        we can discover also that cooperation “c” = f{C}: c = 1/k*1/C; where C = Capital and k = the Capital/Cooperation constant. This is mathematical proof that cooperation decreases at a faster rate then capital increases, which results in a declining JOR when “C” reaches a critical level that operates at a distance on L.

        It’s astonishing, the symmetries! Who can deny these equations possess the aesthetic ring of truth.

        Economists have been searching for a century for their natural laws, as objective as physics, and here they are in these two equations! This should be in a textbook. haha ahahaha ahahahahahaha

          1. craazyman

            You’d have to be pretty weird to think something like this is funny.

            What are you? Some kind of a geek? ;-)

            1. allcoppedout

              Once you’ve intercoursed the regression it’s all tears.
              And then you discover you’ve left out the implications of sourcing guitar picks only from your friendly neighbourhood shop, and the market implications of a grandson who loses more of them in a week than Clapton used in a lifetime.

              Still, e = mc2 may not hold in hydrogen chemistry in space and my cat still lands on her feet. Maybe economics just doesn’t need to be as precise as Craazy would have us think.

  9. sd

    I hope someone writes an equally concise article about what’s happening in the entertainment industry with tax incentives. In Louisiana, the incentives get sold thru brokers and passed to other industries (oil). At a distance, it looks like the Louisiana wants to promote their beautiful state, in fact, taxpayers are handing over their money to an oil industry that has done much to destroy that same beauty (see: BP).

  10. Eeyores enigma

    This article is a prime example of what I have been pointing at as the core issue wrt what is wrong in the world today and why we can’t seem to do anything about it.

    What he points out is true across the board. I have seen it in almost every industry. If you attempt to solve this situation as the author proposes you will impoverish millions and ultimately collapse the economy because this is the economy.

    This is also why nobody knows the true price of anything and how small business is drummed out.

    All money MUST become more money regardless of the cost to humanity and the biosphere and the more you have the more and bigger targets you have. Like that illustration of the little fish being eaten by the bigger fish, being eaten by a bigger fish, and so on, and so on.

    I call it the great global game of musical chairs to the death, and there is nothing darwinian about it.

  11. McWatt

    I sure enjoyed Garland’s take on the music industry that I toiled in for so many years.
    Eric, if you are ever in Chicago, lunch is on me! Any relation to Hamlin?

    “Catch-22 says they can do anything we can’t stop them from doing” Heller

  12. McMike

    Lookie here, yesterday Brookstone went bankrupt.

    Now, while we can reasonably argue that they had a pre-recession niche, it is also a fact that it’s 2005 buy-out follows the PE playbook perfectly, buy a company by saddling it with debt., get the existing executives to play along by granting them huge equity rewards and stay-on bonuses, then milk it.

    Brookstone was forced into this 2014 bankruptcy because… wait for it… because they were unable to make payments on the debt from the 2005 buyout deal.

    Here’s the bio for the PE firm in the deal: “JW Childs is a leading private equity firm based in Boston, Massachusetts specializing in leveraged buyouts and recapitalizations of middle-market growth companies. Since 1995, JWC has invested in 34 companies with a total transaction value of $7.8 billion. JWC currently invests through J.W. Childs Equity Partners III, L.P., an investment fund with total committed capital from leading financial institutions, pension funds, insurance companies and university endowments of $1.75 billion. ”

    Guess who ends up holding the bag?

    Each time the company gets maytagged though a laundry buyout cycle, the players make a killing on fees, and the pension fund investors eat more losses.

  13. Ishmael

    Having been the CFO during a successful LBO in the first of the cycle the problem is LBO firms paying to high of prices because banks and Wall Street is willing to lend to them because their are big fees up front and they will be gone when the crap hits the fan. The way to end this is way it should have ended in 2008. Let the banks fail, let the LBO’s fail (some one will pick up the carcass dirt cheap and make an operating business out of it) and let the PE firms fail. Other wise you have a zombiefied economy which we now have. No one wants to hire or grow because they are all struggling to meet loan requirements. The only companies which soar on Wall Street are those that have no earnings because they do not have any numbers they are held accountable to meet.

    1. Ishmael

      Sorry, just woke up and my English is fairly pitiful in that first statement.

      However, if you look at PE firms and LBO’s the prices became unhinged back in the mid 90’s or so. People saw the money made out of a few successful LBO’s and everyone wanted to do it. The problem is that the money made in an LBO is all in the pricing.

      When the central bank pushes down interest rates to the rates they are currently at or even what the rates were prior to 2008 stupid things happen which have real consequences. Deals get done that destroy good businesses because some smuck at a PE firm can go to his school buddies and buy a company even though he has never owned one and does not have the faintest idea of how to run one. The numbers on the spreadsheet say it can happen.

      Basically the world is insane and until you severally curtail the central banks functions and get them back to being the lenders of last resorts instead of the planners of the economy and get rid of the idiot Keynesian economists running around it will stay insane.

    2. financial matters

      This will be Janet Yellen’s big test when the next crisis hits. Will she remember Bagehot?

      “”1.2 Summary of the Crisis Response and Consequences: A Review of Findings Presented Last Year

      a. Liquidity or Solvency Crisis?

      It has been recognized for well over a century that the central bank must intervene as “lender of last resort” in a crisis. Walter Bagehot explained this as a policy of stopping a run on banks by lending without limit, against good collateral, at a penalty interest rate. This would allow the banks to cover withdrawals so the run would stop. Once deposit insurance was added to the assurance of emergency lending, runs on demand deposits virtually stopped.

      — However, banks have increasingly financed their positions in assets by issuing a combination of uninsured deposits plus very short-term non-deposit liabilities. Hence, the GFC actually began as a run on these non-deposit liabilities, which were largely held by other financial institutions. —

      Suspicions about insolvency led to refusal to roll over short- term liabilities, which then forced institutions to sell assets. In truth, it was not simply a liquidity crisis but rather a solvency crisis brought on by risky and, in many cases, fraudulent practices.””

      and understanding these dynamics for the near future can be very important..

      “”These “too big to fail” institutions are seen by some as “systemically dangerous institutions”—often engaged in risky and even fraudulent practices that endanger the entire financial system.””

      “”If we are correct in our analysis, because the response last time simply propped up a deeply flawed financial structure and because financial system reform will do little to prevent financial institutions from continuing risky practices, another crisis is inevitable—and indeed will likely occur far sooner than most analysts expect.””


      “Finally, it guaranteed debt of Citigroup, and extended loans to insurance giant AIG, both of them insolvent firms deemed too big and too interconnected to fail. In conducting these actions, all in the name of the LLR, the Fed violated the classical model in at least six ways.

      Fourth, the Fed ignored the classical admonition never to accommodate unsound borrowers when it bailed out insolvent Citigroup and AIG. Judging each firm too big and too interconnected to fail, the Fed argued that it had no choice but to aid in their rescue since each formed the hub of a vast network of counterparty credit interrelationships vital to the financial markets, such that the failure of either firm would have brought about the collapse of the entire financial system.

      Fed policymakers neglected to notice that Bagehot already had examined this argument and had shown that interconnectedness of debtor-creditor relationships and the associated danger of systemic failure constituted no good reason to bail out insolvent firms.Modern bailout critics take Bagehot one step further, contending that insolvent firms should be allowed to fail and go through receivership, recapitalization, and reorganization.

      Although assets will be “marked to market” and revalued to their natural equilibrium levels, nothing real will be lost. The firms’ capital and labor resources as well as their business relationships and specific information on borrowers will still be in place to be put to more effective and less risky uses by their new owners.””


      1. Ishmael

        Will she remember Bagehot?
        Exactly, one of the huge failures of Bernacke! It does not matter how big or interconnected an organization is. Management has already proven they are idiots. They should be thrown out and every email looked at. Soon, you would have fraud charges out of the wahoo or at least Sarbanes charges against everyone of these losers. Over a 1,000 executives got jail time in the S&L melt down. How many did here. That sends a strong message to not do it again.

        Then, people are put in charge of the organization. A cram down is performed which will give the working capital to move forward. The IB part of the bank should be spun off or liquidated the same for various networks etc. The bank should then be broken up into several banks. This was done under T. Roosevelt to JP Morgan before.

        Losses should be paid by the idiot investors and management, the spinoff of the assets into new companies and breaking up of the banks would create more jobs not less.

  14. washunate

    That’s a bizarre asterisk, sweeping aside the responsibility of the people running the institutions.

    This is the main challenge of our time – the mismanagement in our system is pandemic. It’s not localized to a few Evil Corporate Villains. It is in our public institutions, like pension funds, police forces, universities, hospitals, military, regulatory agencies, etc.

    To say that a pension fund’s management didn’t create the investment assumptions is like saying that a surgeon didn’t make the scalpel with which he cut into the wrong organ.

    1. Ishmael

      This is the main challenge of our time – the mismanagement in our system is pandemic.
      One of the most astute comments I have seen in a long time. The rot is interwoven through out the whole system (I am not talking about Capitalism here because what he have in most of the western world is not Capitalism it is Corporatism involving a large number of cartels) and that is why it is going to be very painful to get rid of it. It is kind of like metastasized cancer. It is very hard to remove the cancer without killing the patient.

      1. washunate

        Thanks Ishmael. Diagnosing that rot seems to be the point in time we currently occupy.

        I sympathize that change takes time, but it did surprise me a bit how much Yves seems to embrace the idiot defense in this particular arena. I thought that Enron and Freddie Mac and all the rest had pretty much put that plea out of its misery.

  15. EricT

    After reading the article, it reminded me a lot of the take over of Kaybee Toys, another Bane investment. If I was an investor, I would run away from this investment as fast as I could. It looks like the death nell is coming for guitar center, Bane is hoping the rubes, muppets or marks don’t figure it out before they get rid of the bag.

  16. Watt4Bob

    All-in-all, what Bain is doing to GC, is the exact equivalent of what is known in mafia parlance as a ‘Bust-Out’ wherein the target business is taken over, stripped of all assets, loaded up with debt and ultimately burned to the ground to collect on insurance and possiblly dispose of evidence of the crime.

    Bain Capital; bust-out experts.

  17. mark


    “Quicker production and maximum quality

    The plek pro has been developed for use in guitar production factories and/or service-repair shops as a tool that not only performs precise fret dressing but also assists quality control and R&D. Plek pro speeds up the production process and raises instrument quality to an extremely high and consistent level. It is a computer controlled device that scans and dresses guitars under actual playing conditions, strung and tuned to pitch. This is a major breakthrough since plek pro not only identifies precisely what needs to be done for perfect fretwork but also executes the adjustments itself to deliver perfect results on each instrument.”

  18. Rob

    Can you explain how a restructuring is like a bankruptcy? Bankruptcy involves massive costs (lawyers, advisors, DIP lenders, etc. ) as well as delay and uncertainty which hurt the underlying business. A financial restructuring is a way for the equity and debt holders to take their lumps at a much lower cost and much less harm to the business.

    1. Yves Smith Post author

      Restructuring entails renegotiating the credit agreements, at a minimum. And as you presumably know, it IS often done via a Chapter 13, but a prepack.

  19. phichibe

    i’m another one of the oldsters here who has had dozens of gtrs, synths, & assorted gizmos, a few bought over the decades at GC. just to toss in my two cents:

    1) the bain/GC deal was always baffling to me because by the late 90s it was clear that brick ‘n mortar retail of music instruments was going to be devastated, not just by the amazonification of retail but because the whole music ecosystem was starting a collapse that has not abated in the 15 years since. the whole music making industry has just imploded; i remember reading c. 2004 an article in the NYTimes about hundreds of musos who’d been cut loose by their labels despite formerly having #1 hits in the 90s – the example that i recall was joan osborne, who was so panicked that she’d ditched her ‘lillith fair’/tie-die persona and was living on 1000 calories a day so she could fit into cocktail dresses for her performances. it was that bad and it’s gotten worse (and i don’t think it saved osborne’s career).

    as in any ecosystem when the top fauna start to fade, you know it’s worse for the lower trophic layers. the biggest acts moved to “360” deals with outfits like LiveNation, the labels cut back on the A&R budgets for lower tier and especially new acts, and all this translated into less money in the pockets of musos to spend in GC.

    at the same time, much of the ancillary equipment that goes into music – notably recording equipment, mixing boards, etc, was impacted by Moore’s law the same way PCs have been. what we have seen in the music biz since the late 90s is a cascade of studio closings, session musicians out of work as their contributions are replaced by samples and loops, and every 18 year old with Garageband can overload youtube with mediocre (or worse) music that makes it difficult if not impossible to find the new diamonds out there. an example: in the late 70s to record a 16 track album required approx. $100K of gear (more if the recording was to be the fancy new “digital” recording stuff). by the late 80s the alesis ADAT lowered this point to maybe $10K. by the late 90s you could get a digidesign-based PC or mac setup for a few thousand. now it’s down to Garageband being included for free. a five-year old laptops can simulataneously record 64+ 96kHz/24 bit tracks. the result is that even the biggest studios have closed by the dozen and the smaller studios are just gone. and GC sold lots of stuff into those channels.

    the only thing that makes sense to me about bain’s GC play is that they saw all this coming and figured that they would be positioned to exploit the coming train wreck. the irony is that the only thing that kept the wheels coming off this deal (as with so many other PE deals of the last decade) was that interest rates have been so historically low – first in the post-9/11 panic and then since 2008 as the fed as grappled with the zero lower bound to try to keep the economy from imploding. bain and other PE shops have been like so many of those idiots who bought option-ARM mortgages in the 2000s, only to be proved the smartest (or luckiest) guys in the room due to the depression their profligacy helped spark.

    what a depressing state of affairs.


  20. Chris

    The article on PE is excellent. I’ve now been an employee of 2 companies through 4 rounds of private equity investment.Private equity owners are brutal to employees, including senior managers (who were knocked off with incredible regularity) and generally crapify the business. PE’s primary advantage over other forms of equity (ie their capacity to pay high prices for businesses) comes from tax avoidance and evasion: ie. the tax deductibility of interest payments, aggressive transfer pricing and carried interest. I can’t understand why pension funds would invest, when the overwhelming beneficiaries of all this financial activity are the PE firms and partners.

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