The national debate over private equity so far has hinged on the question of whether experience in the field qualifies Mitt Romney, the former Bain Capital executive, for the presidency. But a more vexing, and largely unanswered, question lies just beneath the surface: How is it, exactly, that an investment company can make millions even as the company it's ostensibly trying to turn around goes bust?
For that answer, we turned to what may seem like a less-than-reliable source: Tony Soprano.
The investors profit, it turns out, not despite the failure of the company, but in fact because of it.
In the organized crime world, the business practice is known as a bust out. A group of investors -- in Soprano's case, an entire family -- looks for companies that have a strong underlying business but are in distress thanks to heavy debt burdens. The investors then take over the company. In the mob's case, the family presents the business with a very high-interest loan -- an offer which, under the financial circumstances, is difficult to refuse -- and effectively takes control of the company with the threat of physical violence. Private equity investors, by contrast, buy control of the company's board by purchasing the firm's stock. But for both private equity firms and the mafia, investors use their control of the firm to take on more debt, while at the same time cutting costs by laying off workers.
Cash from the loans and cost savings are funneled back to the investors. This looting continues until the company can't pay its debts. When it finally collapses, the company files for bankruptcy to extinguish the debt -- but private equity investors, as well as mobsters, get to keep the gains they've already reaped.
Mark Galeotti, one of the leading experts in transnational organized crime, said it's a familiar tactic above ground and below it. "It's one of the classic tactics of organized crime," Galeotti, a New York University professor, told HuffPost. "You exploit it as far as you can and when you have essentially squeezed every possible bit of value out of it, you burn it. In organized crime's case, I mean that literally, whereas with private equity, it's planned bankruptcy. But essentially you dispose of it in as convenient a way as possible, and then you walk away."
Private equity isn't always this rapacious. Investors often oversee healthy restructurings that re-set struggling firms on stronger footing. But mafia-esque looting of productive enterprises has always been a part of the private equity business that has a terrible reputation, a stain that the industry has repeatedly attempted to remove with creative marketing efforts. Today, the industry is trying to replace common pejorative terms for its business, such as "corporate raider" and "vulture funds," with new phrases, such as "growth capital."
The difference between a "Sopranos"-style buyout and one executed by Bain Capital, Galeotti said, has to do with the mob's willingness to use illicit capital and unregulated violence to accomplish its goal. "Private equity firms, in the main, while there are exceptions, basically operate within the letter of the law, if not the spirit. What they do is legal. It can't be challenged in the courts even if it runs against, sort of, the notion of the social contract," Galeotti said. "Whereas organized crime, if they have to kill someone, or if they have to use dirty money to do it, they'll do it. So it's the methodology that is different. But if you actually think about, Well, what are they doing? How are they doing it? And what's the end result? There, it's strikingly similar."
Romney has been reluctant recently to delve too deeply into his private equity background, as the Obama administration has hammered the GOP candidate for profiting even while workers were left jobless -- in some cases, obligations for such workers' pensions were then met by the government, and the cost foisted on the taxpayer. On Wednesday, Romney declined twice to say whether he welcomed a full discussion of the nature of private equity. Instead, he accused President Obama of not understanding how private enterprise works. "Having been in the private sector for twenty-five years gives me a perspective on how jobs are created – that someone who's never spent a day in the private sector, like President Obama, simply doesn’t understand," Romney told Time magazine.
But if voters do come to understand private equity, the discussion might not end well for Romney. Capitalism unbounded by regulation can be an ugly thing. Galeotti pointed to Russia, where a barely existent regulatory regime has allowed an extreme version of the free market to flourish.
"There you actually have a much, much closer connection between finance and criminality, in that a lot of the organized crime groupings are very strongly operating within the sort-of-legitimate financial sector. Particularly there you have the phenomenon of what's called raiding, which is basically -- you don't even bother giving the loan, you find ways of forcing the company into your ownership, usually by bribing a judge to authenticate some document that says you've been given this by the original owner," Galeotti said. "In some cases, when they take over working businesses, they keep them as working businesses and skim the profits. But more often, precisely, it's these kind of short-term, squeeze-and-burn type ventures. You take over a company, use it, and then you discard it however you can."
The Obama campaign has recently raised the profile of private equity by highlighting the bankruptcy of Ampad, an office supply company that was busted out by Bain Capital. The company went bankrupt, while Bain investors made roughly $100 million.
The squeeze and burn has been dramatized both by "The Sopranos" and the film "Goodfellas," where mobsters take control of companies and run up their credit.
When one hapless victim, a man with a healthy sporting goods store and a corrosive gambling addiction, asks Soprano how the process will end, the fictional mob boss is ready with a precise answer.
"Planned bankruptcy," Soprano tells him.