Nowadays, if someone wants to make a lot of money in finance, they don’t go and work for investment banks. The real money to be made is at private equity firms. With most of these firms controlling a huge percentage of the country’s overall GDP and doing so largely unchecked, is it time to take a hard look at the systems that protect and allow these actors to flourish??

Brendan Ballou is special counsel for the U.S. Department of Justice’s Antitrust Division. His book, Plunder: Private Equity's Plan to Pillage America, takes a hard look at the way private equity firms operate and the laws they exploit.

He and Greg discuss what sets private equity firms apart from other financial institutions in America, the ways private equity firms avoid liability when things go wrong, and what reforms are needed to the systems that essentially allowed private equity to become the beast that it is today.

*unSILOed Podcast is produced by University FM.*

Episode Quotes:

Private equity as an institution is unique

05:31: Private equity as an institution is unique for three reasons. One is that private equity owners tend to invest for just a few years, so you're talking about a three, five, or seven-year time horizon. Two is that private equity firms tend to load up the companies they buy with a lot of debt and extract a lot of fees. And the magic trick, as you probably know, a lot of these private equity deals is when they load these companies up with debt; for the acquisition, it's the company that holds the debt, not the private equity firm. So if things go badly, it's the company that's on the hook. It's not the private equity owners and investors. And then the third thing, and this is what really interests me as a lawyer, is private equity firms are enormously successful at insulating themselves legally from the consequences of their portfolio company's actions. So, if something goes wrong at a portfolio company, someone is hurt, or an employee is taken advantage of, whatever it happens to be, it's very hard to hold a private equity firm responsible.

Is private equity an extreme version of capitalism?

03:44: Private equity is an extreme version of capitalism, for better or for worse...It's not an extreme form of capitalism. It's a deviation or a perversion of capitalism by the specific laws and regulations that we have that incentivize short-term term investing, reliance on debt, and insolation from liability. We've created these legal structures that allow certain people to capture all the upside of our economy if things go well, but walk away if they don't.

Short-term gain versus long-term success

12:17: The time frame that you've got for an investment changes your perspective on what you're going to do with it, whether you're going to jack up prices for the short term, even if it means that you're going to lose customers for the long term, underinvest in your employees and your innovation, even if it means that you might be scooped by the competition in a few years, and so forth.

How are private equity firms compensated?

31:00: Private equity firms are compensated on a 2-in-20 model: 2% of the profits above a certain threshold, 20% of the profits above a certain threshold, and 2% of the assets under management every year. The carried interest loophole says that both of those should be treated as capital gains rather than ordinary income, and capital gains are taxed at a lower rate than ordinary income. That's pretty much all the money that a private equity executive typically makes. So, leaders of private equity firms have historically paid a lower tax rate than the firefighters and teachers that they nominally serve.

Show Links:

Recommended Resources:

Other People's Money And How The Bankers Use It by Louis Brandeis
The Modern Corporation and Private Property
Peter Whoriskey’s story on the Carlyle Group for The Washington Post
Worth Rises
SIFIs

Guest Profile:

His Work:

Plunder: Private Equity's Plan to Pillage America

352. The Crackdown on Private Equity feat. Brendan Ballou

unSILOed with Greg LaBlanc