Rifts are opening up among the financial elite.
Michael Moritz, a partner from Sequoia Capital, penned a New York Times op-ed that blasts fellow private equity big dog Steve Schwarzman of Blackstone for cottoning up to Trump and for making his living from squeezing American workers and benefiting from the carried interest tax loophole, which allows investment titans to get what would ordinarily labor income taxed at more favorable capital gains tax rates.
Even among private equity overlords, Schwarzman is an unattractive character. I met him in 1985, after he had just started Blackstone with Pete Peterson. While Schwarzman had been a top mergers & acquisitions pro, he and Peterson had no private equity experience but were nevertheless raising a leveraged buyout fund. McKinsey had approached the pair about handling a particularly sensitive and high profile transaction. I’ve never seen such an open display of greed in a formal business meeting. It was even more surprising given the era and that Peterson and Schwarzman seemed completely lacking in awareness or concern about the message they were conveying. In that respect, he and Trump are well matched.
Schwarzman has continued to make unseemly displays, the most famous when he declared that getting rid of the tax carried interest tax break on which his wealth depended would be like the Nazis invading Poland. He later tried walking that back. He also had a $6 million 60th birthday party, which raise a few eyebrows.
Let us not forget that leveraged buyout funds, which crashed in the 1990-1991 downturn, succeeded in wrapping themselves in the more virtuous mantle of venture capital by rebranding themselves as “private equity” in the mid 1990s. But the strategies do have meaningful differences. Venture capital over time has rarely beaten the stock market net of fees, save when you are doing the measurement in the right part of the tech cycle. But aside from their recent questionable habits of getting young entrepreneur wannabes to work in near-sweathshop conditions, they can fancy themselves to be on the right side of the Hippocratic Oath, “Do no harm” by virtue of not using leverage, or firing people to earn their returns. Of course, we need to turn our eyes from precariat-increasing disruptions like Uber and other “gig economy” plays.
Nevertheless, Moritz, who has given over $150 million to universities to support lower-income students1, is on the money when he blasts Schwarzman, who has started talking up the problem of stagnant and low incomes in America, but blames it post-crisis regulatory overreach (no, I am not making that up). From Stephen Schwarzman’s Bad Business Advice in the New York Times:
Mr. Schwarzman has flourished during the four decades that the people Mr. Trump purports to represent have languished. In the pursuit once known as leveraged buyouts — before some marketing genius fastened on “private equity” as a way to disguise the fact that the business still rests on a mountain of debt — Mr. Schwarzman and his brethren have become symbols for the economic inequality that Mr. Trump deplored during his campaign. They are able to borrow billions and deduct interest payments from their corporate tax bills while $75,000-a-year wage earners in Ohio, Michigan or Pennsylvania are unable to secure a mortgage and get no tax break on their monthly rent.
Just like Mr. Trump’s real-estate business, groups like Blackstone rely on enormous debt to prop up their business. The playbook for any of their acquisitions is to gain 100 percent control by financing the purchase of a company with a small down payment and a heap of debt secured not (heaven forbid) by their own savings or houses, but by the business they are looking to acquire. They then cut costs — which almost always means making sizable layoffs at the company they’re taking over — and figure out a way to reward themselves financially…
Perhaps, after Friday’s meeting, traveling together aboard Air Force One to Mr. Trump’s club in Florida, Mr. Schwarzman explained to Mr. Trump that he could make America great again by employing the same tactics Blackstone used after its $4.1 billion acquisition in 2006 of Travelport, a travel-reservations business that within a year of the purchase had laid off 841 workers, or 10 percent of its work force.
The story of this fiasco is enough to make anyone weep: Laid-off workers were forced to sell their homes; others lost their health insurance and postponed plans to start a family; some were stuck on unemployment lines. Even more brazenly, Blackstone, seven months after its investment, layered more debt on Travelport, which it used to pay itself back for the original purchase. Travelport subsequently underwent two restructurings of its debt.
Moritz also points out that getting rid of the carried interest loophole is nowhere to be found on Schwarzman’s list of “deregulation”, when Trump had promised to abolish it during his campaign. Moritz called for making private equity principals personally liable for the debt they pile on investee companies.
The lower- and middle-income Americans who voted for Mr. Trump in droves would do well to listen hard to what Mr. Schwarzman is advising. They’ll hear the sound of dollars being sucked out of their pockets and slipped into the wallets of the 1 percent.
Sadly, it’s a given that the doings of Steve Schwarzman, and the significance of his role as the head of Trump’s business council, is unlikely to be well reported in the heartlands, or even outside financial centers. And that isn’t just the fault of the press. Private equity has never done a lot of media spending, so it is one of the few large corporate interests that newspapers, particularly back in the 1990s and early 2000s, before newsrooms were starved of revenues, could have taken on.
But as we and others have stressed, the left stopped being interested in economics long ago, and the Democrats became the party of Big Finance around the time when the rebranded private equity was getting its mojo back. So the Democrats have played a large role in helping keep the role of private equity in crushing American workers, and in particular breaking unions, less visible than it should have been. So it should not be surprised that it is reaping the whirlwind.
1 Moritz, who comes from a poor background, hasn’t always been on the side of the angels. He gave nearly $50,000 to support a San Francisco ballot measure to clear homeless encampments.
Spot on Yves and Moritz!!
I hear talk from politicians every once in a while about eliminating the carried interest loophole – but it never is more than talk. I have heard that the loophole is an incentive for people to invest. What a crock.
Carried interest is blatantly wrong.
My understanding is that there are two aspects to the carried interest provision.
The original provision as I understand it is that gains on money that you had invested in a fund or partnership could be carried forward without being taxed until they were realized. My understanding is that this is important in real estate in particular and is useful in encouraging real estate investment. I see some logic to this as this is an inherently risky business with large up front capital expenditures required (usually leveraged) with a reasonable likelihood of losing everything.
However, the carried interest provision got bastardized with the explosive growth of hedge funds over the past 30 years where the “at risk” performance fee (often 20% of profits although both the profits and percentage are declining these days) was re-characterized as the fund manager’s “invested capital” if it was left in the hedge fund. This is where it has gone off the rails. The performance fee is one aspect of their total fee paid to them by their investors to manage their money – generally speaking they are not “at risk” in that they simply don’t get a performance fee if the fund loses money instead of actually losing money like their investors do. The performance fee is not money that the manager took out of another account or borrowed to put into the fund. This is simply the existing investors giving him a bonus from their profits and is a fee. For everybody else in the real world, an at risk performance cash bonus is treated as ordinary income. For the hedge fund manager, it is deferred capital gains that is untaxed until it is realized years later allowing for compounding of the untaxed amount.
A fairer treatment would be to tax the performance fee as ordinary income as it is received. Whatever he then leaves in the fund after taxation is treated as carried interest for future tax returns, similar to the other investors in the fund. My understanding is that this change could be made with a simple rule change by the IRS as it is simply an interpretation of the tax law, not a fundamental right codified into the tax law by Congress. However, massive campaign contributions by hedge fund and private equity moguls have ensured that there is no political will to move this change forward.
It is interesting that Trump told the nation he would save social security and medicare because “you made a deal a long time ago” for those benefits to be secured. As we know from the MSM, Hillary was talking to Blackstone/Schwartzman about imposing an increase in the fica tax of 3% and this amount was to be skimmed off and given to private equity to “manage”. So both things are interesting because Trump could be protecting, grandfathering, his own deferred tax deals with promises of protecting SS/Medicare. And Schwartzman is in the perfect position to devise a skim of social security with an increase in fica. So that going forward Blackstone and its ilk will have a means of revenue and thus surviving.
Trump probably has real carried interest which is similar to simply holding onto stock in a taxable account for a long time so you don’t pay capital gains. Trump’s carried interest is probably the original type of carried interest designed to make real estate investments like holding onto stock. So, the change to wipe out carried interest interpretation of performance fees in hedge and PE funds would probably not change his tax structure. If the entire carried interest provision for real estate types of investments was wiped out, then most real estate developers in the country would be significantly impacted.
I think eliminating the PE and hedge fund carried interest for performance fees could be eliminated overnight and the US economy would not even blink. Wiping out the real estate carried interest provision would probably have unpredictable ripple effects that would take several years to fully play out but could significantly impact the real estate and construction industries. That would need to be thought through carefully.
And Hillary’s top advisor was from BlackRock, an offshoot of the Blackstone Group (founded by Peterson and Schwarzman with Rockefeller seed money, just as Carlyle Group was originally seeded by the Mellon family).
Interesting to note that Peterson was or is David Rockefeller’s protégé while Schwarzman was Skull & Bones at Yale, recommended by upperclassman, George W. Bush.
And what private bank gave free office space to aspiring presidential candidate in the early 1990s (Bill Clinton from Arkansas)? None other than the Blackstone Group, whose founder, Peter G. Peterson would later be appointed to Clinton’s commission to “end welfare as we know it.”
Peterson’s institute, the Peterson Institute (aptly named, ‘natch), has long supported the end of Social Security, Medicare, Medicaid and the offshoring of all American jobs, while his Peterson Foundation established some sort of “austerity” group at the New America Foundation (although I hear that’s been renamed, but who bothers with them anymore, anyway?).
And interesting enough, those several marches about six years or so back, the national immigration marches, were organized by Spanish-language radio stations which were owned by the Blackstone Group — each and everytime they knocked the subject of warrantless wiretapping off the front pages. Sen. Jay Rockefeller was a proponent of such and received much accolades from AT&T for his support.
Glass House: The 1% Economy and the Shattering of the All-American Town by Brian Alexander
The Buyout of America by Josh Kosman
Private Equity at Work by Eileen Appelbaum
Outsourcing America by Ron Hira
Time to change dividend taxation to avoid double-taxation. Then to restrict or abolish interest deductibility against tax by forcing Debt for Equity Conversion in over-leveraged entities.
Special Dividends should face Special Tax Rates.
“WASHINGTON, July 29, 2007 — June was a busy month for Senator Charles E. Schumer. On the phone, at large parties and small gatherings around the nation, he raised more than $1 million from the booming private equity and hedge fund industries for the Democratic Senatorial Campaign Committee, of which he is chairman.”
“But there is another way Mr. Schumer has been busy with hedge fund and private equity managers, an important part of his constituency in New York. He has been reassuring them that he will resist an effort led by members of his own party to single out the industry with a plan that would more than double the taxes on the enormous profits reaped by its executives.”
“But in the case of the tax proposals, the strategy behind Mr. Schumer’s efforts is putting to the test another set of principles he is known for. He has regularly portrayed himself as a progressive politician who identifies with the struggles of the middle class and is sharply critical of the selfish “plutocrats” who he says control the Republican Party.”
Schumer has had 9 years to reconsider this position.
But he is powerful in the Democratic party, partially due to his fundraising power.
I suspect the Democrats will follow the Obama strategy, give well crafted speeches and behind the scenes preserve the status quo.
there is an amazing video clip of Schumer from about ten years ago where he launches into the carried interest loophole. It must of been when he first learned of it and he was clearly outraged by the unfairness of it. At the time he must not have fully realized who it benefited. In any case someone must have made it clear to him and he has really never been heard from again on the issue.
Can you send us the link please?
Chuck Schumer is quite a phenomenon. On Feb. 2 I commented about him, and pointed out that there are several pages devoted to him in the book Winner-Take-All Politics: How Washington Made the Rich Richer–And Turned Its Back on the Middle Class, by Jacob Hacker & Paul Pierson, published in 2010. From page 228:
When someone is shown to have some similarities to the notorious Phil Gramm, we know there’s a big problem.
Yeah, it worked great for Obama but not so much for the rest of the Democratic Party. The big O was one smooth talking, eloquent, post- racial, liar with a beautiful family. Schumer, not so much. Even with MSNBC personalities blasting 24/7 “Resist!” smoke cannons, reptiles like Schumer are going to have a much harder time getting away with their old tricks since Trump essentially stole their schtick: pretend to represent the working class then mug the working class to assist the oligarchy.
Thanks for the post, Yves. Yes most citizens are completely unaware of the inequity in PE, if you will, and how these rapacious greed-heads have carefully crafted the tax codes to enable them to rip us all off and keep workers wages ultra low.
A $6million birthday party? Guess that makes Malcolm Forbes lavish 70th birthday party look like the equivalent of a Chuck-E-Cheese birthday party by comparison?
Gah. Nothing will change. Schumer’s not gonna get offa that golden gravy train. You can bank on that.
Trump’s fans in the heartland have no idea how very much they’ve been conned. Drain the swamp, my azz.
The only tax preference that should be favored is for productive capital investment. Productive capital investment by design produces current and future income. Two things it’s not is financial engineering or carried interest.
PE is a parasite on the U.S. economy. Flush the whole industry down the drain, I say.
Intro in links to today’s articles about how Schwarzman “makes his living” is mildly amusing, although many of the actions of his own and other other private equity firms most certainly are not. According to Forbes, he had an estimated financial net worth of as of the end of last month of $11.6 billion and is listed as a “self-made” deca-billionaire, thereby ignoring the sources of his great wealth while feeding the myth of the individual and individual merit in our society.
I am also concerned about the influence he and his fellow travelers have with the new administration and particularly the related efforts to suspend the fiduciary standard rule, among their many other policy endeavors. Pertinent article from David Dayen in The Intercept yesterday relating to how this policy shift would facilitate the looting of employees’ 401(k) funds, which many people are now relying upon to support themselves economically later in life. Contemptible really:
You should please, please note that there are in fact workers aware of Steve Schwarzman’s destructive influence who are doing their best to take him on. On Thursday members of the Communications Workers of America, who are on strike at the Momentive plant in upstate NY, will be picketing outside Schwarzman’s Park Avenue apartment. Schwarzman only recently sold his stake in Momentive, a chemical processing company; the company is seeking to slash workers’ health care and their pensions. Many of the workers at the plant voted for Trump, but his alliance with Schwarzman is giving them (rightly) second thoughts. Here’s a quote from a recent NY Post story.
“It’s a big concern for me — and I’m a Republican,” said Amber Izzo, 34, a single mom of two young girls. “I never voted before in my life, my first vote was for Trump. I like his straight talk. But then I heard he’s got Schwarzman creating jobs, and I thought, ‘Oh man, that’s a problem.’”
And here’s the text from the Facebook post about tomorrow’s protest. All NC readers in NYC who loathe Schwarzman and all he stands for should be there. (It’s at 740 Park Avenue at 5:30 p.m.) These workers aren’t accepting that “nothing will change” — neither should we.
“President Trump promised to restore good jobs for millions of American workers, and named Wall Street billionaire Stephen Schwarzman Chair of his “Strategic and Policy Forum” on jobs and economic growth to help achieve that promise. Schwarzman is a Wall Street billionaire with a personal fortune of $11.1 billion. His personal pay last year was an astounding $811 million.
He also has a history of driving down workers’ standard of living at the companies he owns…
Momentive, a company that fell prey to Schwarzman’s Wall Street financial interests and helped destroy good jobs, is cutting jobs, pay and benefits for hundreds of workers. Workers at the company have been on strike to stop the cuts since November 2.
Stand with strikers at a rally in NYC on February 9th right outside Schwarzman’s posh Park Avenue apartment to demand good jobs in upstate New York.
Strikers will deliver tens of thousands of petition signatures. Make sure you add your name: momentiveworkers.com/petition/ “
I lost faith in the CWA long ago, when they sold out the concept of unionism.
Am now suspicious of how much the rich and super-rich control things: the organizers for those anti-Trump protests appear to receive their monies from companies which track back to George Soros and the Koch brothers. (Soros has long lobbied against buying American and hiring American, and most days I hear Trump say: “Hire American, buy American!” and we know how bad the Koch brothers are.)
It was three super-rich Saudi Arabian princes who funded those 19 hijackers on 9/11 (some of us actually read those WikiLeaked State Dept. cables and the 28 redacted pages recently released from the 9/11 Commission Report), and too many times protests and events seem to track back to super-rich hidden in the background.
Sanders himself can’t be everywhere, everywhen.
But that might be a good strike and demonstration for Sanders to send some Sander-staffers to.
I think it is blatantly unfair and inaccurate to label Moritz as a “fellow private equity big dog” of Schwarzman.
There is virtually no comparison between the kind of business conducted by the two firms. Sequoia is a traditional venture capital firm that funds new businesses with actual equity while Blackstone is a predatory and parasitic firm composed of financial grifters who utilize the banking system’s ability to gin up money from whole clothe to take over existing productive enterprises. The pirate equity grifters then lay waste to the acquired company as Moritz describes. The banking system benefits from the carnage in the form of fees and hight interest on their leveraged loans. This type of activity is destructive and pernicious, and shouldn’t be tolerated in any sane democratic society. But then again there is nothing sane and democratic about this society.
And I can not for the life of me understand why anyone other than the “private equity” industry’s public relations firms and principals would utter that word. It’s a term of propaganda and why should we utter and use their preferred terminology. It was called the leverage buyout business for decades for good reason, because that is what it is. It’s like calling torture, enhanced interrogation, why go along with the charade of those trying to obscure their actions?
IIRC back in the 1970s it went by the much more accurate moniker of “asset stripping”. More lipstick, same pig.
Actually back in the early days didn’t do so many predatory deals. They claim to buy struggling and underperforming businesses and turn them around. There was an element of truth to that in the early years. Now the struggling and underperforming businesses are the ones owned by the pirate equity funds who made them that way. The so called turnaround scenario is the exception and that rational is nothing more than an alibi. People who engage in unethical, immoral and criminal behavior always have an alibi.
1. VC firms are investing in all sorts of gig economy deals that are increasing the ranks of the precariat
2. VC firms have such high costs that on average net of fees they deliver no more than the stock market
3. VC firms depict themselves as the drivers of job growth when only about 1% of new businesses are VC funded
4. VC principals are on the whole huge believers in libertarianism and promote that view politically. The PE types are more mixed.
5. And perhaps most important, PE firms that invest in deals of less than $350 million use little leverage and are focusing on increasing growth of their companies. Those investments are usually businesses that have opportunities they can’t execute without outside help, like a regional player who could go national.
The term private equity is now the term of art. You can’t buck standard nomenclature. That is how it is described in databases, the financial media, and by investors like CalPERS.
I think one of the most important VC firms out there is the Dragons Den/Shark Tank TV shows. While they are edited etc., there are still a lot of valuable lessons there for aspiring small business people to learn how to think about a business.
1 and 2 are reasonable points and valid criticisms. 3 may be true as well but they are creating plenty of jobs in the bay area. They seem to fund a lot of idiotic ideas that ultimately fail but until then jobs are created. No comment on point 4. Don’t really agree with point 5 based on personal experience and don’t follow the market well enough to really argue the point. I sold three businesses to PE firms between late 90s and 2010: one with an enterprise value of $190 million, one of $75 million and one at $120 million. In every case they acquirer maxed out on the use of leverage. Buyers: Kohlberg & Co., private equity arm of former Swiss Bank Corp. and Starwood Capital.
as for private equity becoming the term of art, it is just like enhanced interrogation becoming a term of art. It’s textbook propaganda and pathetic when the public lets someone else control the words that come out their mouths. It was not a term of art until the media made it so by using the PE industries preferred phrasing.
If you’re calling the first two points valid criticisms, then this undermines what you said in the first place about there being no comparison. If I’m laid off because of an LBO or walk around in a world infested by 1099 “jobs”, the effect is not that different. Both are perverse systems where market-logic leads and the human need for the basics follows. Both are a unionbuster’s logic. I don’t know if you’re referring to “plenty of jobs” at startup headquarters itself, or if you’re including the gigs. The former is not plenty of jobs – it’s a small number of rarified jobs. The latter is an end run around minimum wage, unionization is usually denied by the Sherman Act, and there is a deep market logic baked into the cake of how most of the apps are coded, for the ones that model a labor market. When there are psychological games being played around self-conception as a business, the optimism of “plenty of jobs” has been turned into something that is ideologically aggressive. These are jobs with a sneer- if you really want to work , we get to work on your ideas. Maybe it’s LBO logic made more granular and applied to human psychology.
One item that has not been mentioned is that the debt holders in a company targeted by a PE firm may see the market value of their holdings decrease as the interest coverage ratio drops as more debt is added and special dividends paid.
I believe that is what happened when Dell was recently taken private.
So the PE firms do not only damage the employees, they may also damage all the pension funds that hold the soon to be depreciate corporate debt securities of the company being taken private.
VC’s can damage only the “sophisticated investors” (maybe CALPers is one?) who decide to invest with the VC as the companies the VC’s fund do not have publicly traded securities (as far as I know).
Theranos may be a good illustration as the financial damage did not extend to the public.
How about Champlain – Hudson Power Express (CHPE), a Blackstone deal? Get Quebec to clear-cut several square miles of pristine forest, put up some dams to generate electricity. Renewable energy! Buy a long DC cable, dig up Lake Champlain, then the Hudson River, skirt Indian Point, come ashore in Astoria, buy Stuyvesant Town, plug in! Get Mario’s kid to force through the enviros, the Feds to guarantee the paper, and Stevie keeps his name on the NY Public Library flag-ship.
It’s worth remembering that splits like these are how you can leash and collar big finance. It’s how it was done in the 1930s, as well.
Excellent point! Opens possibilities when the top dogs start scrapping amongst themselves.
Thanks for this. I don’t understand the statement that “the left stopped being interested in economics long ago”. Certainly the Dems and Repubs stopped listening and did their best to sweep under the rug warnings like those from Greg Palast and many others I can’t think of, most likely to be heard on the earlier Democracy Now broadcasts. I know I heard about the coming 2007 crash ten years before it happened from “leftist” sources, and was able to get out from under any liabilities that would have sunk me completely.
Portia, I think it was meant that the Left (which I don’t believe actually exists anymore, hence the election of Trump) is no longer concerned with the economics of the American workers.
And after listening to David Brock recently, it is obvious they are doubling down on their anti-worker/identity politics strategy!
how can you hold your belief that the left no longer exists responsible for the election of Trump???
Why must we continue to classify some Income as merely “ordinary” and give special tax treatment to “capital gain” and “carried interest?” Income is Income.
Asset-stripping has always been a tax-dodge. Investors don’t need to be forced to invest — the first rule of having wealth is to spend only interest and not eat up principal. The only way to have interest is to invest. Interest is simply income — and the Big Lie of a “double tax” on principal is the rich man’s con.
Government should be discouraging the leveraged asset-stripping that has, along with military adventurism, been the downfall of the United States as an egalitarian society, and the three-quarters of the voting-age citizenry who didn’t vote for Clinton understand that the Democrats are more cozy with highwaymen like Schwartzman than even Trump will prove to be.
However, ownership of the mostly New York City-based “news media” is firmly in the camp of tax-dodging capitalists. Only a capitalist like Moritz is even allowed a forum to criticize his class.
Two separate issues in your first sentence. Capital gains is a specific type of income that currently has preferential tax treatment. Carried interest is simply a mechanism for deferring unrealized gains retained in a fund to be taxed at a later date – the actual tax treatment then would be defined by the type of income.
There are vagaries throughout the tax code on deferred vs. not deferred income. TIPs typically have the inflation adjustment treated as income in the year it accrues which is different from the capital gain on a bond or stock. The stocks held in IRAs defer dividends, interest and capital gains and then the whole lot are taxed as ordinary income. Only income that was taxed as ordinary income is eligible to get put into a Roth IRA.
Of the various tax reforms out there, I like the general models that substantially lower corporate taxes (they are moving money around the world to avoid them anyway) and then tax everything at the individual level as ordinary income as it is realized.
The estate tax is essential to prevent massive genetic lotteries and could be something as simple as taxing the entire estate above current exemptions as ordinary income with very few opportunities to move things to trust funds etc. I think the American dream does include building small businesses and farms and handing them off to spouses and children, so the $5-10 million level of exemption fits that. However, I don’t think Americans want to have a landed aristocracy built on massive hereditary wealth so the estate tax should be deliberately disruptive to large estates. Trust funds should be limited to amounts to allow somebody to live comfortably, but not have hundreds of millions stashed away. They should expire very quickly (say 5 years) after the death of the recipient.
Spot-on about the corporate tax (corporations are made up of people — let’s tax individuals taking profit and dividend income, but with truth in the tax basis of share grants as compensation, and encourage domestic reinvestment of undistributed corporate profits) and the estate tax (small farms and businesses aren’t kleptocratic aristocracies like the Trump or Koch empires). I did make a gross over-generalization — for the sake of argument.
We agree here.
. . . and the three-quarters of the voting-age citizenry who didn’t vote for Clinton understand that the Democrats are more cozy with highwaymen like Schwartzman than even Trump will prove to be.
What the voting age citizenry who did not vote know takes quite a leap. And then another bound to know whose downfall Trump will prove to be. . . However, there are many strong candidates in view, eh?