Opinion

The Great Debate

Are the big banks winning?

The Dodd-Frank Act to re-regulate the big banks was intentionally tough. It was passed in the wake of the 2008-2009 financial crash to end cowboy banking; require far more capital  and much less leverage, and rein in the trading-desk geniuses who pumped up serial bubbles. Since Congress is a poor forum for crafting such a complex statute, the details were left to the expert regulatory agencies.

The big banks pay lip-service to the goals of Dodd-Frank — but they’re mounting bitter, rearguard actions in federal courts to block meaningful constraints and regulations on procedural and other grounds. This is an ominous turn of events, since these banks have the legal firepower to overwhelm budget-constrained U.S. regulatory agencies.

While Dodd-Frank is aimed at preventing another cycle of bubble-and-bust, shrinking the financial sector is crucial for other reasons. One is a mass of evidence demonstrating that hyper-financialized economies have lower growth. Another is the appalling ethical record of large financial companies. The chance of making huge paydays by risking other people’s money, it seems, can sometimes derange moral compasses.

First, the pro-growth argument for clamping down on the banks: Once the financial sector achieves a certain size, its continued expansion reduces economic growth, according to a new study by two senior economists at the Bank for International Settlements, Stephen Cecchetti and Enisse Kharroubi, using a large international data base stretching back more than 30 years.

Their conclusions are unambiguous. No country can achieve a high rate of growth without a well-functioning financial system. China, for example, lacks a deep system of consumer finance, forcing it into a lop-sided development strategy. The result is the creation of dangerous imbalances that could threaten continued rapid growth.

Why Romney can’t defend capitalism

When Fox News worries out loud that Mitt Romney’s failure to account for his time at Bain and his personal tax affairs may represent his Swiftboat moment, it is plain the Republican presidential bid has careened offtrack. The Bain attacks are “part of a strategy by Team Obama to turn Romney’s biggest perceived strength – his business experience – into his biggest weakness,” writes Fox’s Juan Williams. “Romney needs to come clean or his hopes of being president will end long before Election Day.”

How has Romney come so close to bungling his big chance, even before he has been nominated by his party? He appeared to be in an ideal position to turn his experience as a businessman into a winning political narrative. During these jobless economic doldrums, Romney might have become a champion of capitalism, explaining how private enterprise works and how it creates jobs.

His problem is that his time at Bain is not a classic story of heroic capitalism at work. Instead of an old-school entrepreneur with a good idea who raises funds to employ Americans to make a product that sells successfully around the world, Romney took distraught companies, charged them hefty fees, fired workers, and set the stumbling enterprise off in a new direction, laden with debt. Some companies prospered, some failed. Some gave Americans new jobs, some sent jobs overseas.

Mitt Romney, the Schrodinger’s Cat of private equity

Mitt Romney is a quantum CEO, the Schrödinger’s Cat of private equity: From 1999 to 2002, he both was and was not the chief executive officer and sole owner of a powerful Bain Capital investment fund. After that period, Romney’s surrogates explain, he “retroactively” retired from this post. But, as Schrödinger’s famous thought experiment reminds us, just because you find a retroactively dead cat doesn’t mean he wasn’t previously simultaneously alive and dead.

While the two presidential campaigns tussle over this paradox, the real shame is how willing Romney and his defenders are to tolerate this bending of the truth, heretofore confined to particle physics. It’s another insight into the increasingly murky culture of American capitalism.

While Romney has claimed at times he was retired from Bain Capital during the period, he also signed documents filed with the Securities and Exchange Commission attesting that he was the “sole stockholder, sole director, Chief Executive Officer, Managing Director and President” of a multimillion-dollar investment fund.

from James Saft:

Private equity wins, U.S. creditors lose

James Saft is a Reuters columnist. The opinions expressed are his own.

The move to reform taxation of billions of dollars in so-called carried interest paid to hedge fund and private equity executives is dead and prominent among the mourners should be investors in U.S. debt.

A country that can't even get it together to ensure that some of its highest paid people pay as much proportionally in tax as their secretaries and personal trainers is a country with very little hope of effecting meaningful budgetary reform.

Suffice to say that the long bond didn't sell off on news that U.S. Senate Finance Committee Chairman Max Baucus has dropped a higher carried interest provision from his since-defeated tax bill, a sign that the Democrats have effectively given up hope of the measure. The news should, however, make holders of U.S. debt even more willing to sell to the Federal Reserve, currently buying Treasuries often and in size. The script has been written for tax and spending reform over the next two years and for lenders to the U.S. the story does not end happily.

Carried interest and the big lie

As an investment strategy, making private equity and hedge fund managers rich is a probable loser. As a tax policy, it is a guaranteed one.

The U.S. House of Representatives passed a bill last week that would raise the taxes that private equity and other investment managers pay on “carried interest,” their share of the takings when a holding such as a startup or turnaround is sold at a profit.

Carried interest is currently taxed at the lower capital gains rate, meaning that many private equity barons can pay less in tax than the people who clean their swimming pools or mind their children. This is patently unjust. Carried interest is compensation for labor, earned income in other words, rather than gains on capital that might be lost.

from Commentaries:

The Top Secret PE Exit Strategy

The problem with being a private equity investor is that you're subject to long lockups for withdrawing money--sometimes up to 5 years.

That wasn't much of an issue back in the halcyon days for PE firms--say three or four years ago--when investors could regularly look forward to high double-digit rates of returns. But today those long lockups are feeling like balls-and-chains, with PE firms having to take writedowns on their portfolio investments and investors seeing returns sag. 

Of course, one way an investor can try to get out a PE fund is by selling his or her limited partnership interest at a discount in the secondary market. But the trouble with the secondary market is that a PE firm's masters must sign-off on any transfer of an ownership interest. In good times, PE firms usually don't object much. But in hard times,  the PE overlords are reluctant to approvate partnership transfers--especially if they are sold at a considerable discount.

3i in distress, please give generously

REUTERS– Neil Collins is a Reuters columnist. The views expressed are his own –

Were 3i a normal investment company, its directors would be laughed off the board if they proposed raising new equity at a whacking great discount to net asset value.

Upbeat noises about a strengthened balance sheet, future access to the debt markets (sic) or the glittering new investment prospects ahead wouldn’t make a blind bit of difference. The board would have to go.

from The Great Debate UK:

Don’t say aye, aye to 3i

REUTERS-- Neil Collins is a Reuters columnist. The opinions expressed are his own --

It's hardly surprising that the shareholders in 3i, the listed private equity group, are deeply unhappy at the prospect of having to return 700 million pounds of the 1.75 billion pounds of capital they have received from the company in recent years.

The board has got itself into a hole. That paid-out capital, plus a further 400 million pounds in share buy-backs, was largely financed with borrowed money, and those debts are now coming up for repayment.

A 550 million euro convertible bond launched in August 2003 was designed to provide fresh equity, but it had to be rolled into a 430 million pound convertible bond, and the conversion terms are now pie in the sky. That bond falls due in 2011.

from DealZone:

Pay-to-play funds scandal: Time for a change

primackDan Primack is the editor of peHUB, a Thomson Reuters publication.

The New York State Pension Fund kickback scandal is making new headlines. The Wall Street Journal reported that Steven Rattner, the head of the Obama administratino's auto task force, was one of the executives involved with payments that are under scrutiny, citing a person familiar with the matter.

On Thursday, New York State Attorney General Andrew Cuomo filed a criminal complaint against Raymond Harding, former chair of New York’s Liberal Party, for scheming with the already-indicted David Loglisci and Hank Morris. Cuomo also coaxed a guilty plea and financial remuneration out of Barrett Wissman, a crooked former hedge fund manager.

All of this got me to thinking more about the issue of raising fund capital from public pension systems, a process that often is just begging to be corrupted. Inexperienced and smaller general partners (GPs) can have real difficulty getting in front of a pension system’s investment staff, because there is rarely a transparent or streamlined process.

The future is smaller for private equity

Margaret Doyle– Margaret Doyle is a Reuters columnist. The opinions expressed are her own –

Investors’ faith in banks may be reviving, but 2009 is shaping up as a year of reckoning for private equity. Two of Europe’s most prominent listed buyout funds — Candover Investments and SVG Capital — are considering their options, with sale or dismemberment a serious prospect.

How the mighty are fallen! For more than a decade, the listed PE funds outperformed the market, and the managers earned rich fees nicknamed “2 and 20″ — 2 percent of funds under management and 20 percent of performance above a certain benchmark. But that outperformance has disappeared in little more than a year with many funds languishing in the “90 percent club” of shares that trade for less than 10 percent of their peak. Funds are blaming a killer combination of lousy returns, a debt drought and an investors’ strike.

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