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Is private equity too big to fail? Our pension system depends on asset-stripping plutocrats

'Greed is good'. Credit: Wall Street/20th Century Fox

'Greed is good'. Credit: Wall Street/20th Century Fox


October 26, 2023   6 mins

When people think of the one percent, they tend to enter the realm of mythology: conjuring up images of decadent dinner parties on private islands and dogs being flown around the world in private jets. This is far from the truth. If you really want to know who they are, a good place to start is in the hidden depths of the private equity funds that have flourished with their ascent. What you’ll discover there may surprise you.

Despite its origins in the post-Second World War period, the history of private equity really begins in the Eighties, the decade in which Western countries abandoned Keynesian economic management for the small-state ethos of the neoliberal regime. Coincident with this turn was the start of a long trend of rising economic inequality. This was driven by two broad changes: the rise of the developing world, led by China, which reduced inequality between rich and poor countries. And the widening of inequality within countries, as newly liberated business owners were empowered to drive down wage bills and drive up profits. When plotted onto a graph, the result was the elephant curve. It provided a visual illustration of how, since 1980, the global one percent captured twice as much of global growth as the bottom 50%.

With ever-swelling pools of capital, this rising international class changed the way they managed their wealth. Having previously invested largely at home, spearheading the growth of national economies, the one percent globalised, shifting capital offshore to exploit the even higher returns of low-wage economies. While this stimulated the rise of a middle class in the developing world — the middle “hump” of the elephant — it also fuelled the deindustrialisation of Western countries. The working classes were shattered, one consequence being the “deaths of despair” that have been chronicled by Anne Case and Angus Deaton.

Profits, however, surged. This gave owners both more capital to invest but also, in an environment where deregulation was underway, more liberty to deploy their capital in aggressive ways. There arose a new breed of owner who was “private” in that they took over publicly-listed firms, often using borrowed money, then removed them from the stock exchange and the prying eyes of shareholders. Thereby free to do as they pleased, they could lay off workers, close shops, sell assets or transfer any debts they had used to buy the firm onto its books. The leveraged buyout was born, and the Eighties corporate raider would go on to be immortalised in the character of Wall Street’s Gordon Gekko, his “greed is good” mantra embodying the ethos of the neoliberal age.

Like the fictitious Gekko, neoliberal intellectuals maintained that enlightened self-interest, as they preferred to call it, would ultimately benefit everyone. As Bill Clinton insisted when pushing back against private equity’s critics — perhaps ominously in an interview with that celebrated do-gooder, Harvey Weinstein — private equity was helping to revive sick firms and thereby reinvigorate the economy. The story private equity’s exponents told of its virtues might have been lifted from an Ayn Rand novel, in which visionary entrepreneurs take over a moribund publicly-traded firm, get rid of the risk-averse technocrats running it, then apply the tough love it needs to turn around.

Yet there was a dark side to this new era of plutocracy. While the ascent of such barons seems reminiscent of the Gilded Age, today’s elite tend to favour a different business model from their entrepreneurial Victorian predecessors. Whereas the latter were profiting off the wrenching transition of agricultural societies into industrial ones by building things — in particular, railways — today’s elite appear parasitic by comparison. In many cases, what private equity delivers amounts to asset-stripping or consolidations that leave most people worse off, yet add little new output to the economy. This has been called “conspicuous destruction”.

A popular strategy is to acquire a firm using borrowed money, transfer the debt onto the firm, and then run down the firm to pay hefty dividends. Pioneered in the US airline industry after its late-Seventies deregulation, the Eighties would see Carl Icahn buy Transworld Airlines, load it with debt while paying himself hefty profits, and then gradually sell off its assets until it went bankrupt. That same decade, Frank Lorenzo would acquire Eastern Airlines, transfer its assets to another non-union airline he ran, then shut it down.

Of course, you don’t need a private equity front to do this, as any long-suffering Manchester United supporter will tell you (and Lorenzo similarly kept his companies public). But a big advantage of the private equity model is that, unlike United’s much-reviled owners, the beneficiaries remain hidden from public view. By the time the sewage from a privatised utility shows up on public beaches, or tenants are evicted from a council estate after its new owners convert it to luxury condos, the damage has been done.

As was the case in the original Gilded Age, today’s barons benefit from the collusion of politicians. The shift to a neoliberal policy regime made credit easier to access, deregulated the way businesses operated, and sold off state assets in the name of greater efficiency. A little-known fact of the era of low taxes is that governments were able to contain their spending by selling off the family jewels, then spending the proceeds. As a result, most Western governments now show a net negative worth on their balance sheets. Given that private equity has been a keen participant in this transfer of state assets to private hands, it looks like a terminal phase of Western capitalism, as public spaces are run down to line private pockets and poor people are squeezed hard to support the rich in their glamorous lifestyles.

But it’s actually more complicated than that. Although the growth of private equity has coincided with widening inequality, the latter has not been the sole driver of the industry. There’s another thing that has accompanied the rise of private equity: ageing societies.

When Margaret Thatcher and Ronald Reagan were elected, roughly a tenth of the population in developed countries were retired. Today that share has doubled. Meanwhile, improved health and nutrition have meant that people are living longer. Whereas the average life expectancy in Western countries was about 10 years past retirement in 1980, today that figure has more than doubled. Several Western societies have now crossed the threshold beyond which some people spend more time collecting a pension than they did working for it.

As a result, more and more people now have to be supported by a workforce which, in relative terms, is contracting. This would be challenging enough. What makes it even tougher for Western governments is that the growth of labour productivity, which was rising steadily throughout the post-war period, has now slowed to a crawl. So the hope that fewer workers could support more people by producing more is looking decidedly Pollyannish. Instead, more must be squeezed from the working population.

This can only go on for so long before something breaks. One obvious solution is to reform the pension system, by reducing benefits or raising retirement ages. But given that pensioners are among the most politically engaged in the population, politicians shy away from such decisions. Instead, they’ve tended to move in the opposite direction, as Britain has done by raising benefits. Western governments have funded the increased largesse with tax rises or cuts to other public services and, to bolster private pensions that get no state funding, policies that juice returns on asset markets, such as the loose monetary policies, privatisation and deregulation that have transferred assets to private equity.

In recent years, pension funds have collectively become the biggest investors in private equity. When tenants of a London council estate organised a rebellion against their eviction, they discovered that the new landlords were a private equity firm owned by American pension funds. Canadian pension funds occupy a similar role in Britain’s privatised water utilities, which have allowed sewage to flow into seas and rivers. In effect, tenants and workers are getting squeezed in no small measure to keep retired teachers and civil servants in the style to which they’ve grown accustomed.

It always astounds people, but it’s true: the one percent don’t exist in mythology but in our neighbourhoods, dining alongside us at our favourite restaurants and bumping into us as they walk their dogs. That’s because, statistically, any homeowner with a defined-benefit pension is part of the one percent that sits atop the global economy.

Life has recently become more difficult for private equity, as central banks abandon their easy-money policies. Returns are falling and new money is drying up, but demands for cash from investors continue. As a result, private equity firms are resorting to increasingly opaque deals, such as transferring assets across their own funds, to meet investor demands for cash. Given how unregulated private equity is, it could be storing up some nasty surprises should the markets turn sharply.

Private equity is thus coming into the crosshairs of politicians and regulators. As our leaders come face to face with the pension funds that invest in private equity, they will confront tough choices. Would private equity be too big to fail? Nobody wants to be blamed for pensioners being told their monthly payments will be frozen for the foreseeable future — but the alternative, of boosting fund values with the time-worn method of easy-money policies, looks ever less likely in an environment of persistent inflation. Major problems may therefore be brewing in the pension industry.

Indeed, pension pots would be a possible target for a tax raid, as collapsing public services across developed economies are forcing politicians to fund spending rises. Before singling them out, though, it’s worth noting that while the one percent have benefited more than most of us from the neoliberal age, their gains pale in comparison to the 0.1%. If we’re to start taxing the rich more, this would be the better place to look.

Whether or not politicians want to tackle topics such as inter-generational justice or the sustainability of the pension system, events in markets may force the question of retirement’s future onto the public agenda. Higher interest rates have begun to knock down asset values and hit profits. If this continues, fund managers will eventually have to deliver the news to their clients. That may turn out to be the nastiest surprise private equity is storing up.


John Rapley is an author and academic who divides his time between London, Johannesburg and Ottawa. His books include Why Empires Fall: Rome, America and the Future of the West (with Peter Heather, Penguin, 2023) and Twilight of the Money Gods: Economics as a religion (Simon & Schuster, 2017).

jarapley

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David McKee
David McKee
8 months ago

Interesting argument: governments deregulate and privatise, private equity seizes its chance to devour these assets, leaving ruin and destruction in their wake. So the rich few get richer, and the poor many get poorer.

Is it true? It’s relevant the Rapley is a paid-up Remoaner. It blinds him to a number of things. The public sector has grown enormously. And regulation has grown by leaps and bounds – not least in the EU. Big companies love regulation. They can afford the costs of regulation relatively easily. Smaller companies, which might supplant the big boys, struggle with red tape. Big, complacent companies become untouchable, and so the economy stagnates.

Martin Butler
Martin Butler
8 months ago
Reply to  David McKee

It’s what’s known as an ad hominim. He’s a paid up remoaner so the argument must be invalid! I’d love you to go through the argument point by point and show how he’s wrong. Private Equity firms are big companies do they love regulation?
The truth that is emerging more and more is that globalised free-market capitalism, with little regulation – also known as neo-liberalism – is bad news for most. Particularly in the west. Far from leading to the free-market fantasy of lots of well run efficient little firms in perfect competition with fairly paid employees, it actually produces monopolies (look at Google) assets stripping, (read article), opaque financial devices(2007 crash), and a massive inequalities. It also tends toward socialisation of risk and the privatisation of profit – the too big to fail syndrome.

mike otter
mike otter
8 months ago
Reply to  Martin Butler

The issueis complex – they love regulations that are easy to swerve or can be bought off, and if they can do neither they simply head to a jurisdiction where they can. The rise of private equity is an economic evolutionary strategy as were PLCs and state -capitalist entities before them. Their tenure isn’t perpetual and they will in turn be replaced by the evolution of another model.

Last edited 8 months ago by mike otter
Martin Butler
Martin Butler
8 months ago
Reply to  mike otter

Really don’t think we can predict the future. Talking of ‘evolution’ makes it sound like the inevitable march of progress towards something better. Don’t think you have any reason for that kind of optimism.

David McKee
David McKee
8 months ago
Reply to  Martin Butler

Ad hominem? It’s a fair question. If he had been discussing grand opera, yes of course it would have been an unfair personal attack – which is what ad hominem is. In this instance, it helps to explain why Rapley left out evidence which was not so helpful to his case.

Matt M
Matt M
8 months ago

This article doesn’t tally with my experience of PE firms. My company was acquired by a PE firm, held for 7 years and then sold into private ownership. The PE company did replace some of the management and brought in new people who were more efficient and experienced (aka getting rid of the dead wood). But they were interested in growing the company’s revenue and profits so that it was an attractive proposition for a new buyer. They certainly didn’t asset strip it in any way. Nor load it up with excess debt (which would have made it unattractive).
The experience from my view as an employee was a positive one. I think the idea of private equity as asset strippers is very dated and was probably never really true.
Also the rot about dumping sewage in the sea should be a red-flag for any reader. It is well known that our Victorian sewage system cannot cope with heavy rain storms without flushing sewage into the water courses. The cost and disruption of fixing this issue is prohibitive. Not flushing would mean sewage backing up into peoples homes. All governments have allowed this to happen for over a hundred years. It isn’t the fault of the current owners. If anything the fault lies with the huge increase in population which puts greater pressure on the system.

Last edited 8 months ago by Matt M
Peter B
Peter B
8 months ago
Reply to  Matt M

I suspect there’s a very wide spectrum of private equity firms and some indeed are doing something useful. It’s certainly a way of sorting out companies that have fallen into bad habits.
But I equally suspect that the majority of PE activity these days is not value creating and is more a parasitic fee-extracting activity – basically another form of rent-seeking that thrived in the era of artificially cheap money.
Other things being equal, I’d rather see private companies run as PLCs than private equity with the reporting and transparency that ought to (but doesn’t always) provide.
Pensions are a world wide car crash that’s going to hit us over the next 20 years. The article is certainly correct about that.

Simon Blanchard
Simon Blanchard
8 months ago

Thank you for this article. It clearly explains the root cause of all our modern problems. Yes, all. It seems to me that wealth distribution should be a bell curve with small numbers of ultra rich and ultra poor at each end. The bulge should be in the middle. We currently have a near horizontal line that rises exponentially at the end. We can argue about the actual shape of the bell, but that’s what a healthy society would look like. We now have a situation so dire that taxpayers subsidise workers in full time employment and a UBI is being seriously considered. It’s not coincidence that we’re governed by hedge fund managers.

Richard Calhoun
Richard Calhoun
8 months ago

No, Simon, it clearly misses the elephant in the room.
The Big State is the root of all our economic and social problems driven by welfarism

Nell Clover
Nell Clover
8 months ago

The Adam Curtis documentary “The Mayfair Set” from 1999 provides a fascinating introduction to the characters who began the hyper-financialisation of pension funds and how it unfolded. It is no less relevant nearly quarter of a century later.

Adam Curtis was able even then to see the opening of a generational social schism caused by financial mercenaries leveraging large blue collar pension funds to destroy blue collar jobs in the West. He wasn’t alone.

The documentary ends with one of those mercenaries, James Goldsmith, living to regret the damage being wrought to the nation state, and the loss of power of states to act in the interests of their citizens. In response, he formed the Referendum Party, forerunner of the Brexit Party.

Now the Reform Party, it is perhaps the political siren for the destruction of the nation state, the breakdown of social cohesiveness, and above all the impotence of democracies in the face of the unaccountable and reductive force of globalised finance Goldsmith and others helped create using our pension funds.

All revolutions eat their children…

Last edited 8 months ago by Nell Clover
Allison Barrows
Allison Barrows
8 months ago

What is this thing called a “pension?” My husband and I have been self-employed in the arts for over 40 years. There is no “retirement” for us, no young workers are paying us to hit the golf course and take vacations to the islands.
The only people I know who get paid not to work are public-sector employees, like teachers and others municipally employed. Their scam is to retire at a relatively early age, collect money from people like me, and get another public-sector gig they will collect another pension from. It’s called double-dipping and it’s quite common.
My feeling has always been wanna get paid? Earn it. Want to protect yourself when you’re no longer able to earn? Save and invest from a very early age. Buy land and other assets. Live within your means. Don’t be a bl**dy parasite.

Billy Bob
Billy Bob
8 months ago

You’ll get a state pension when you hit retirement age paid for by the generation that follows you, at which time you’ll be a parasite too

Billy Bob
Billy Bob
8 months ago
Reply to  Billy Bob

Why the downvotes? Do those people not plan on collecting the pension when they’re eligible? I know I will be

Allison Barrows
Allison Barrows
8 months ago
Reply to  Billy Bob

What are you talking about? I don’t get a “state pension”. If you’re referring to the Social Security I have been forced to pay since my first job at age 16, that f*cking money is mine, confiscated and misspent by the government against my will.

Gary Taylor
Gary Taylor
8 months ago

I work in M&A and PE have been my clients for 20 years. While there have certainly been specific instances I couldn’t defend, the modal PE firm is more interested in putting a rocket up management’s arse and forcing/incentivising them to grow the business faster; clear out the deadwood on day 1 for sure, and outsource bullshit jobs, but then grow the business which ideally creates more high value jobs in the medium term.
And the water sewage point is a complete distraction – overflow hasn’t gone up. *reported* overflow has gone up since the Tories forced the water companies to install monitoring tools.

A R
A R
8 months ago
Reply to  Gary Taylor

But is ‘growing the business faster’ necessarily a good thing? Financial statements do not account for externalities so rising TO and profits don’t necessarily indicate a well run business – we all know putting off capital expenditure raises profit in the short term but what long term damage is being done once the sharks sell?
A great example right now are the water companies. The amount of capital investment required to bring the infra up to date would have meant no returns to investors for the past 30 years. Now the water company P&L/BS may look great but who is paying for cut off water, leaking pipes and enfliuent flowing into seas and rivers? I don’t see those costs being accouned for in the P&L – if they were then there again would be no reserves to pay dividends to shareholders.
So lets get real about what the numbers show and what they don’t.

Burton Tallen
Burton Tallen
8 months ago

This is the sort of crap you get when a career academic posts on a topic he has absolutely no experience in, because he is trying to drum up interest in his recently published book. Beware the career academic with no practical experience.

Colin McC
Colin McC
8 months ago
Reply to  Burton Tallen

Ah, the need to listen to the “practical men”.
“Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist” – Keynes

Perry de Havilland
Perry de Havilland
8 months ago

The state needs to spend significantly less & let the broad economy grow, rather than smothering it in green regulation & taxes. Start by cutting taxes on small business in half (or more) & see what happens to the dying high streets.
It’s really not rocket science. Any ‘solution’ that does focus on that is just more Blue Blairite or Red Blairite blather.

j watson
j watson
8 months ago

Really good Article, albeit I do recognise plays straight to my own bias on the core of so many of our problems – not capitalism per se but the way in which we allow it to function in the self serving interest of a v small minority..
We often read on Unherd, whether in articles or comments, twaddle about some Leftish Elite Metro Blob. Here in fact is the real Elite, hidden and discrete, the 0.1% Author refers to who have a further 1% critically dependent and compromised.

Andrew R
Andrew R
8 months ago
Reply to  j watson

The “Leftish Elite Metro Blob” are in academia, Civil Service, Quangos, NGOs, Think Tanks and charities who are equally vampiric. Not particularly productive, increasing in size and remit, swallowing high salaries and benefits. Walking away with large redundancy payments and pensions mostly at the tax payers expense or the largesse from the billionaire class they are supposed to despise.

Unelected bodies working hand in hand with Government and multinational companies to impose ideologies that have no mandate from the electorate.

j watson
j watson
8 months ago
Reply to  Andrew R

Think Tanks you mention AR – how conversant are you with 55 Tufton St and it’s specific location for the Westminister Lobby? Maybe check it out and ponder..
Of course any ballooning in Quango etc size the last 13yrs down to those in charge…who of course are a Tory/Right Wing Govt. And amongst other brainwaves Brexit added a while additional tier of bureaucracy needing administration.
I do appreciate it won’t stop you seeking someone undefined to blame. It’s a reflex in some that never dies.

Last edited 8 months ago by j watson
Andrew R
Andrew R
8 months ago
Reply to  j watson

Nice try, I don’t care for think tanks whether they are on the Right or the Left. As for Quangoes they’re a by-product of the Thatcher Government, an unintended consequence who blossomed under New Labour as they fitted their ideology perfectly. As for Brexit, I don’t have a position on it, it’s happened.

I’ve already pointed out who’s to blame, I didn’t have to look to hard. So yet more strawmanning and deflection, it’s a reflex in some that never dies 🙂

j watson
j watson
8 months ago
Reply to  Andrew R

Oh yes, apols I forgot Blair is to blame isn’t he, (even though not been in power for 16 years). I have to keep remembering who in the commentariat sticks with that one. I’ll try not to ask any tricky questions or make suggestions. I can tell it’s frustrating.

Andrew R
Andrew R
8 months ago
Reply to  j watson

I pointed out that the Thatcher government created Quangos, long before Blair. You don’t ask any tricky questions just post stupid comments,. Yes it is frustrating for me having to reply repeatedly to such rubbush.

Here’s a link on Wikipedia on fallacies, scroll down to “Intentional Fallacies”. You must have used every single one of these.

https://en.m.wikipedia.org/wiki/Fallacy

Andrew R
Andrew R
8 months ago
Reply to  j watson

From that Wikipedia link discussing Intentional Fallacies, the final paragraph:

“When someone uses logical fallacies intentionally to mislead in academic, political, or other high-stakes contexts, the breach of trust calls into question the authority and intellectual integrity of that person”.

That’ll be you.

Chauncey Gardiner
Chauncey Gardiner
8 months ago

“Pioneered in the US airline industry after its late-Seventies deregulation, the Eighties would see Carl Icahn buy Transworld Airlines, load it with debt while paying himself hefty profits, and then gradually sell off its assets until it went bankrupt.”
Is the ultimate proposition that private equity tends to destroy value? Is destroying value a very clever way of absconding with wealth? Hmm.
And what happens to those “stripped assets”? Do they just disappear in a blackhole? Not really. Someone redeploys them and endeavors to generate stuff we value.
The story here is very incomplete.

Richard Calhoun
Richard Calhoun
8 months ago

Many inaccuracies in this article and a noticeable reluctance to tackle the real elephant in the room of our economy … namely the BigState
Until we shrink the State we are going nowhere in the UK as an economy.

j watson
j watson
8 months ago

I think we all recognise some wastage in some areas of Government and administration that must be tackled as will otherwise self generate/justify. But out of interest which bits would you prioritise to shrink, how and what sort of choices then to put to folks if an implication?
Intriguingly our military the smallest ever and part of the State, yet the reduction in Civil Servant numbers that occurred early 2010s reversed with interest via Brexit. So a mixed picture with mixed drivers no doubt.

Burton Tallen
Burton Tallen
8 months ago

The author has absolutely no idea how private equity actually works. Making money via “asset stripping” is a myth.

Peter B
Peter B
8 months ago
Reply to  Burton Tallen

Perhaps.
But the real money thse days in PE seems to be made by leveraging companies up with huge debts taken on at low interest rates (about to revert to normal levels) with exorbitant and unjustified “management fees” being extracted by the new PE owners. Who bear no personal risk if the company goes under as a result. No asset stripping is actually required under this new and improved PE method … although that could also be rolled in if desired !

Burton Tallen
Burton Tallen
8 months ago
Reply to  Peter B

What you are describing is actually old PE method. Portcos have been getting levered up for 40 years. What is new is that they actually have a bunch of operating partners that now go in and focus on value creation during the hold period. When the market requires you to buy things at 10-12x ebitda, vs 5-6x in the old days, leverage doesn’t cut it. You have to actually improve it in order to have a successful exit.

Peter B
Peter B
8 months ago
Reply to  Burton Tallen

Possibly – I recall that as the “old method”. But I expect these things go in cycles. I can live with myself not being bang up to date on current financial engineering !
I rather suspect we’re about to discover the downside of mass scale PE over the next decade as the tide goes out. As ever, the solid and well-run businesses may survive it. There’s certainly a lot of dross that needs to fail though.

A R
A R
8 months ago
Reply to  Burton Tallen

Improving the numbers for big companies (which often operate in monopolistic / oligopolisitc markets where customers have little or no choice to remove their custom) is not the same the as improving the quality of product/service that the customer receives. In fact these two objects usually run counter to each other. So I think we have to be very careful to distinguish between ‘the numbers got better’ and ‘the quality of output the customers received got better’. If the latter was true I think we would see far, far fewer complaints on these matters and stories like this article would gain far less traction. Things with a kernel of truth have a kind of power.

Chauncey Gardiner
Chauncey Gardiner
8 months ago
Reply to  Burton Tallen

I suppose one man’s “stripped assets” are another man’s productively redeployed assets.

dave dobbin
dave dobbin
8 months ago

Take a look at the statement of investment principals or annual accounts of most UK DB pension funds and if you see an allocation to PE of more than 5%, i would be surprised and the total number of schemes low.

Many schemes are currently de-risking and making themselves attractive to insurance company buy-outs and the regulation of insurance companies penalises PE, via Solvency II.

Notable that the only 2 schemes mentioned are humongous Nth American schemes and i would be interested to see what % allocation they make. Doubt its in double figures.

Martin Johnson
Martin Johnson
8 months ago

Regarding pensions, in principle, as higher interest rates depress asset values and funded ratios, target investment rates of return can rise (with a lag), eventually more or less equalizing things on a cash flow basis.
The systemic problems of slowing growth and demography are not so easily dealt with.

Richard C
Richard C
6 months ago

There are many big problems in private equity that may prove to be systemic problems but none of them are addressed in this superficial article.
The conflating of the largely discredited “Elephant Curve” together with a grab bag of Corbyn like complaints doesn’t enlighten the reader in any meaningful way.
This article is so poor that I can imagine that many private equity people would circulate it to their critics as a mechanism to deflect from the real risks and problems.

Andy Leeser
Andy Leeser
8 months ago

“A popular strategy is to acquire a firm using borrowed money, transfer the debt onto the firm, and then run down the firm to pay hefty dividends”

utter tosh.