Thursday, July 12, 2007

The Private Equity Industry--Billionaire Vultures Strip Your Bones

Some of you may have read my post on how Wall Street is destroying the value of pension funds by investing their money in mortgage-backed securities based on subprime mortgages, which are mortgages granted to people with lousy or no credit. To make a long story short, many pension funds for middle class workers such as teachers and policemen invested in these securities, which are now looking like the German mark during the Weimar Republic, where 1 million marks couldn't buy you a loaf of bread.

Private equity firms use these kinds of bonds to buy public companies, strip them to the bone by firing everyone, then resell the companies at a handsome profit. These deals are known as leveraged buyouts, leverage meaning debt. In other words, in order for a private equity firm such as Blackstone or Kravis Kohlberg to buy, for instance, Chrysler for $65 billion dollars, they borrow $2000 for every $100 they put in, then use the combined $2100 to buy Chrysler. (Not all of Chrysler. Just giving this as an example of how they operate.) Private equity firms don't risk any of their own money, they use Other People's Money (OPM) to make these deals, collect the profits, and pay capital gains tax rates on them (15%). Everyone else including the secretaries at their firms pay 35% on their income.

Why is this important? Because Congress is trying to bring the private equity tax rate in line with ordinary income and tax it at 35% instead of 15%. This makes the private equity firms very upset. Right now, Henry R. Kravis, billionaire founder of the corporate buyout movement, is roaming the halls of Congress, hoping to kill the legislation that would raise his taxes and those of other investment firm executives.

He sees private equity enterprises as good for the little guy, citing examples of how his firm produced many jobs by turning around troubled businesses. The lower tax rate benefits all Americans, he insists, and the increase in tax rates would harm American competitiveness abroad. When asked if the higher tax rates would affect pension fund returns, first he said no, then an adviser to KK said he believed the legislation could have an adverse effect on pension fund returns.

$15 billion per month of tax payer money goes to pay for the wars in Iraq and Afghanistan. The Democrats are looking for additional revenue to help finance educational tax credits, broaden health programs for lower-income families and other initiatives to improve the lot of the American people.

The Big Moment for this tax legislation will come when the Joint Committe on Taxation in Congress estimates how much money the proposals would raise if they became law.

Henry Kravis has some good connections, though.

Kravis' ties to the Bush family go back decades, to the time when his father was friends with Senator Prescott Bush, the president's grandfather.
The private equity firms have hired an army of lobbyists to fight this legislation. They call it unpatriotic. Wayne Berman, managing director at Ogilvy Government Relations and a major Republican fundraiser, said, "It will be ...a fight about the fairness of capital gains having a lower tax rate. It will be about rewarding risk and recognizing when you reward risk you create economic growth." Then he growses about capital's enemy, labor. "This is about politics. This is about the AFL-CIO's longstanding policy objectives of ending the beneficial tax treatment of risk versus the treatment of wages from work. It is not about Steve Schwarzman's birthday party."

Who the hell is Steve Schwarzman and what about his birthday party? As reported in the Times and on Page Six of the Post on 2/14/07, glittering guests such as John Thain, the Chief Executive of the New York Stock Exchange Group which operates the NYSE, Donald & Melania Trump, Barbara Walters and Vernon Jordan were there. It was held at the Seventh Regiment Armory, which is a huge space on Park Avenue, decorated like the Hall of Mirrors at Versailles. There were non-stop gourmet meals, free flowing wine and a $1,000,000 concert by Rod Stewart. The party was estimated to cost $3 million.

Steve Schwarzman, is the Chairman of Blackstone, a prominent private equity firm. The party celebrated his 60th birthday like a coronation. He is an active Republican donor with tentacles into the worlds of finance, politics and the arts. Maybe he's not too much like the little guy. As Damon Silvers, associate general counsel at the AFL-CIO, which has been lobbying in support of increasing the tax rates, said:

The tax subsidy to the wealthiest Americans created by these lower rates on equity funds is a significant drain on the ability to do important things for the good of the country. The top 25 individuals in the industry got paid over $10 billion taxed at 15%. These 25 people got paid 3 times the amount that was paid to all 80,000 people who teach in the New York City schools, and they paid roughly one-half to one-third taxes on a percentage basis.

An article in the Times blog Dealbook from 3/11/07 mentions the pending legislation introduced by Charles Grassley (R-IA), the ranking Republican on the Senate Finance Comittee, which will tax the enormous fees that the private equity firms take on the profit of investments as ordinary income instead of as a capital gain. The question is, should the 20% fees that private equity firms collect from the profits of its investments be considered capital gains or as regular income? The writer says of course, no doubt about it:

The Internal Revenue Service should clearly be considering it regular income. After all, [the private equity firms'] own money is not at risk--it's a fee. (By contrast, when they invest their own money in the funds, the profit is obviously a capital gain.)

Let's be honest: it is a charade that private equity firms have claimed their 20% performance fees at the lower capital gains rate. To qualify, they invest a nominal amount of their own money to demonstrate that they have put something at risk, but it's a ruse. They are paying capital gains rates for doing their job, which should be taxed at the regular income rate.

You would think that all the buyout kings who wear American flags on their suit lapels would be proud to pay a big tax bill.

The reason I bring up this lengthy explanation is that I want this tax legislation passed. Unfortunately, private equity firms are swimming in cash. They have strong connections with both parties. They gave millions to presidential and Congressional campaigns. They are counting on the support of powerful Democratic lawmakers who rely on Wall Street as a major source of political contributions. They include Senators Chuck Shumer and Chris Dodd, and Representative Rahm Emanuel. The Congressmen have not taken a public position on the bills.

Let them know we know which way the wind blows. If Congress sells us out on this golden opportunity to fund our programs, then money does buy influence (duh!).

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