Parents worried about this past week’s report on dangerous knock-off toys sold online once could have shopped at Toys ‘R’ Us instead. But the popular toy chain went under several years ago after it was loaded up with unmanageable debt by private equity firms.
What happened at Toys ‘R’ Us and countless other companies illustrates why more rules are needed to govern private equity firms. Too often, the firms load up companies they buy with mountains of debt, which the companies must repay with money that should go back into their businesses.
The private equity firms promise their investors hefty returns, which often means slashing costs at the companies they buy. Other financial legerdemain includes taking out loans the purchased company must repay and selling off assets to pay the private equity firms and their investors, while hurting the company. It’s trickle-up economics, on a grand scale.
Illinois State Treasurer Michael W. Frerichs, who recently testified about such abuses in Washington, says outdated regulations treat private equity firms as a small, boutique part of the economy even as their share of the economy has mushroomed.
“We need to rein in harmful behaviors by bad actors,” Frerichs said. “If your model is destroying profitable companies, that isn’t very good for society.”
Right now, nothing prevents private equity firms from loading companies they buy with debt, paying enormous fees to insiders with borrowed money and then leaving the company in bankruptcy.
Legal loopholes lead to ‘raider capitalism’
Private equity firms play an important role in the financial system. When they are run properly, they invest in companies that provide good returns for pension funds, university endowments and other investors. Private equity can infuse companies with the capital and management services they need to help them prosper.
But sometimes, firms use legal loopholes to drain resources out of companies, leaving workers and their communities in the lurch while enriching themselves. If profitable companies are undervalued because of declining revenues, they make inviting targets. Even when companies survive, workers can lose jobs, see their pay cut, get fewer benefits, have more work piled on them and be mired in a hostile workplace. Many a onetime factory or company town wishes private equity firms had never come to visit.
“It is like raider capitalism on steroids,” former 47th Ward Ald. Ameya Pawar, a fellow with the Open Society Foundations and the Economic Security Project, told us.
New regulations are increasingly important because private equity is gaining an ever-larger share of the economy. From 2018 to 2020, the number of workers laboring under private equity investors increased by 33%, even as U.S. employment dropped by 4.5%.
From 2015 to 2019, private equity firms owned about two-thirds of the retail companies that went into bankruptcy. Meanwhile, hiding behind opaque reports, some private equity firms offload the costs of high salaries and private jets onto their investors.
“Unless we rein in their greed, we can expect more of the same in the future,” says U.S. Rep. Jesus Garcia, D-Ill.
Garcia says he intends to reintroduce his Reward Work Act soon, which would end the practice of stock buy-backs meant to enrich investors at the expense of employees, among other reforms. And he is co-sponsoring legislation called the Stop Wall Street Looting Act, which has been reintroduced in Congress. It would require private equity firms and their general partners to share responsibility for debt, legal judgments, pension-related obligations and liabilities of companies they control. It also would require more transparency and would end tax subsidies for sky-high leverage and end favored tax treatment for carried interest, a major source of revenue for private equity firms. Carried interest reform was dropped out of President Joe Biden’s Build Back Better legislation.
Private equity and hedge funds poured more than $625 million into the 2020 campaign cycles, according to a study by Americans for Financial Reform, which might explain why Congress has had trouble enacting reforms.
But city, county and state governments can help by refusing to invest in private equity firms that don’t prioritize the public good. Elected officials should insist the firms be more transparent about their actual fees and the total cost of investment.
Private equity firms are here to stay. More of them ought to help average people, not hurt them.
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