The Looting Our Politicians Don't Condemn

Over the last couple of days, we've seen politicians, most notably President Obama, condemn the acts of looting that have taken place amidst the protests against the miscarriage of justice in Ferguson and the systemic racial biases and abuses in policing. However, not all looting is created equal in the eyes of our politicians. While many will condemn what they'll be seeing on CNN this week, they are mostly quite fine with a larger-scale epidemic of looting.

For instance, if looting a Burger King is bad, then one would think that looting the whole company should be even worse.

In 2002, Goldman Sachs, along with two private equity firms, TGP and ... hmmm ... Bain Capital, teamed up to buy Burger King. This is exactly the kind of situation private equity firms like to trumpet: taking over a downtrodden company and nursing it back to health. And to get them their due, Burger King’s new owners did some good, stabilizing both the company and the franchisees, many of whom were in worse shape than Burger King itself.

But the private equity investors also cut themselves an incredibly sweet deal. Their $1.5 billion purchase price included only $210 million of their own money; the rest was borrowed. They immediately began taking out tens of millions of dollars in fees. Four years later, they took Burger King public. But, first, they rewarded themselves with a $448 million dividend. In all, according to The Wall Street Journal, “the firms received $511 million in dividend, fees, expense reimbursements and interest” — while still retaining a 76 percent stake.

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In 2010, Bain, Goldman and TPG cashed out, selling Burger King to 3G Capital, for $3.3 billion. In sum, the original private equity troika reaped a fortune by selling a company that was in nearly as much trouble as it had been when they first bought it. Surely this represents the apotheosis of financial engineering.

What has 3G done? According to Howard Penney, the managing director at Hedgeye, it has prettied up the pig by laying off a large percentage of the staff in Burger King’s Miami headquarters. Burger King’s owners grew earnings, he said, “by cutting expenses. They have not improved the business one iota.” And, of course, 3G pulled out fees and dividends, too. In all, Penney wrote recently, private equity firms have taken for themselves “$1 billion or more in capital that could have been used to improve the company’s relative standing versus its competitors, many of whom Burger King struggles to keep up with.”

Private equity is, in its essence, legalized looting. But we don't see politicians condemn it, except occasionally in campaign rhetoric never designed to be matched with meaningful reforms. And then there's the issue of the looting of pension funds, often ignored as a scandal because both Democrats and Republicans are doing it.

Matt Taibbi had an excellent expose on this in Rolling Stone last year. I recommend that you read it in full if you have not done so already. Here are the key themes:

1)     Many states and cities have been under-paying or non-paying their required contributions into public pension funds for years, causing massive shortfalls that are seldom reported upon by local outlets.

2)     As a solution to the fiscal crises, unions and voters are being told that a key solution is seeking higher yields or more diversity through "alternative investments," whose high fees cost nearly as much as the cuts being demanded of workers, making this a pretty straightforward wealth transfer. A series of other middlemen are also in on this game, siphoning off millions in fees from states that are publicly claiming to be broke.

3)     Many of the "alternative investments" these funds end up putting their money in are hedge funds or PE funds run by men and women who have lobbied politically against traditional union pension plans in the past, meaning union members have been giving away millions of their own retirement money essentially to fund political movements against them.

And here's a quick example from Rhode Island, where the white-collared looter's best friend--Gina Raimondo--recently became governor:

Nor did anyone know that part of Raimondo's strategy for saving money involved handing more than $1 billion – 14 percent of the state fund – to hedge funds, including a trio of well-known New York-based funds: Dan Loeb's Third Point Capital was given $66 million, Ken Garschina's Mason Capital got $64 million and $70 million went to Paul Singer's Elliott Management. The funds now stood collectively to be paid tens of millions in fees every single year by the already overburdened taxpayers of her ostensibly flat-broke state. Felicitously, Loeb, Garschina and Singer serve on the board of the Manhattan Institute, a prominent conservative think tank with a history of supporting benefit-slashing reforms. The institute named Raimondo its 2011 "Urban Innovator" of the year.

The state's workers, in other words, were being forced to subsidize their own political disenfranchisement, coughing up at least $200 million to members of a group that had supported anti-labor laws. Later, when Edward Siedle, a former SEC lawyer, asked Raimondo in a column for Forbes.com how much the state was paying in fees to these hedge funds, she first claimed she didn't know. Raimondo later told the Providence Journal she was contractually obliged to defer to hedge funds on the release of "proprietary" information, which immediately prompted a letter in protest from a series of freaked-out interest groups. Under pressure, the state later released some fee information, but the information was originally kept hidden, even from the workers themselves. "When I asked, I was basically hammered," says Marcia Reback, a former sixth-grade schoolteacher and retired Providence Teachers Union president who serves as the lone union rep on Rhode Island's nine-member State Investment Commission. "I couldn't get any information about the actual costs."

And Wall Street has also been looting local governments. The recent situation of Chicago Public Schools is illustrative:

CPS took out a series of auction rate securities, which they then linked together with interest rate swaps, and the idea was, it was pitched to CPS as a way to get a cheaper interest rate than taking out a traditional fixed-rate bond. A hypothetical example would be that if you were to take out a fixed-rate bond it might cost you 8 percent and the banks were basically saying that if you do this complicated scheme that involves all these auction rate securities and interest rate swaps and a few other things, you can essentially lock in a synthetic fixed rate of 6 percent, which is cheaper than 8 percent, and so you can save some money.

The problem was that there were a lot of risks associated with this. For instance, the 6 percent was not really a 6 percent. The synthetic fixed was actually not fixed because there were other variables in there that made it so that you weren’t really getting a fixed rate. There are traditional costs that were not properly represented to CPS. One of the other problems that existed in particular was that when the banks projected cost savings, they compared the deal to a more expensive one that CPS wouldn’t have gotten, so in this case it’s as though they made a cost-saving projection that was predicated on the idea that CPS would pay 9 percent otherwise, when, in reality, CPS would have paid 8 percent. They inflated the cost of the alternative to make it seem like a better deal.

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In reality, the bigger thing is that — and this is the part that’s often lost on public officials, unfortunately — when Wall Street banks are pitching deals their No. 1 goal is not to save money for taxpayers. Their No. 1 goal is to maximize profits for themselves. In this hypothetical situation where a bank says, “You can get a fixed rate for 8 percent or a synthetic fixed for 6 percent,” the reason they’re steering you towards the 6 percent deal is that they get to charge more fees because that deal is more complex. In a traditional fixed-rate bond, if the interest rate is 8 percent the banks get to charge some fees upfront for underwriting the bond but that interest, over time, is going to the bondholders and not back to the banks. In a synthetic fixed-rate structure, the interest that’s going to go to bondholders is much, much lower and the rest of the money is actually going to the banks.

The reason why they push you into these structures that have more complex transactions and more individual deals built into them is that with each of these deals, banks get to charge fees and collect more of that money for themselves instead of it going to bondholders or anywhere else. That’s the piece that’s often lost on public officials, is that no, the bank is not looking to do you a favor. They’re looking to maximize their own profits and, ultimately, those profits are coming at the expense of taxpayers.

For an analysis of this particular epidemic of looting (and recommendations about how to fix it), check out the Roosevelt Institute's new report "Dirty Deals: How Wall Street’s Predatory Deals Hurt Taxpayers and What We Can Do About It." 

Those who loot municipalities or companies don't end up in jail. They're more likely to get a cabinet appointment.