Glass-Steagall and Private Equity: Fact and Fiction

The "success" of private equity must mean that everyone must be an entrepreneur, an engineer or an M.B.A. "Change" that worked in the conditions of the '70s must be the solution in times that even Brooks admits are "radically different."
This post was published on the now-closed HuffPost Contributor platform. Contributors control their own work and posted freely to our site. If you need to flag this entry as abusive, send us an email.

Two New York Times columns offered some pushback to Democratic talking points Tuesday. Andrew Ross Sorkin took aim at the deep belief that the repeal of Glass-Steagall was somehow key to the financial crisis. And David Brooks, following the criticisms and clarifications of Newark Mayor Corey Booker on Democratic attacks on Mitt Romney's time at Bain Capital, offered a different interpretation of the historical facts that led to the rise of the leveraged buyout as a staple of American capitalism. Technically, both Sorkin and Brooks are far closer to the truth than the overheated politics of Glass-Steagall and private equity would suggest. But there is reductionism and distortion everywhere on these two issues that long ago were untethered from historical realities.

Start with Brooks and private equity. Private equity arose in the midst of a floundering '70s economy, with mounting overseas competition and the dominance of large, in Brooks' language, "bloated and sluggish companies." It's an overstatement to say that "something astonishing happened. Financiers, private equity firms and bare-knuckled corporate executives initiated a series of reforms and transformations." In reality, a handful of financiers recognized the possibilities in the tax code of the deductibility of interest and that stock prices were dirt-cheap. They moved to exploit that opportunity, pioneering the leveraged buyout, particularly at first among smaller, more mature, cash-flow-heavy companies. Only later did the ideologues produce rationales amidst the usual chatter of transformation, which is the GOP version of revolution: that LBOs were channeling capital from less efficient to more efficient uses, from big entrenched businesses to dynamic entrepreneurs. (Similarly, Michael Milken at Drexel Burnham Lambert recognized the gap between junk bond rates and their default rates -- and pounced. He had no idea at the start that this would kick off a huge change-of-control frenzy and fuel private equity.)

Generally, private equity provided capital to many companies that needed it, whether to restructure, expand or acquire new technology. In the broadest historical view, it's difficult to definitively say what private equity did for the macroeconomy: Overseas competition still mounted, productivity lagged, and it did not prevent the hollowing out of manufacturing, or increasing income inequality. What can be said with greater certainty can also be said about the bailout and stimulus: The situation would have undoubtedly been far worse without it. If there were job losses with private equity, there would have been greater job losses without it. Yes, folks got rich off private equity. Yes, some companies failed. But if today you eliminated private capital, you would rip out the heart of the middle market. Like junk, it's an accepted and essential part of corporate finance.

Where does Brooks go wrong? He slaps the usual ideological reductionism onto his historical parable. He essentially repeats the catechism that justified private equity, junk, high compensation, an "ownership society." Private equity is not just a useful technique for shifting capital to efficient uses; it's a powerful metaphor that must infuse all things. It becomes politicized. Private capital must be opposed to the public (or vice versa). Some opening of the markets must lead to even freer markets. "Freedom" becomes fetishized; more is always better. The "success" of private equity must mean that everyone must be an entrepreneur, an engineer or an M.B.A. "Change" that worked in the conditions of the '70s must be the solution in times that even Brooks admits are "radically different." Private equity was accompanied by a fraying of the safety net and the rise of inequality. It wasn't the only factor, but it played a role in a complex historical unfolding. Yes, layoffs, bankruptcy and even liquidations are inevitable, certainly in manufacturing and given the rise of global competition and a consumption-driven economy. The worst thing to be said about Romney after a failure like GST is that, despite his great wealth, he walked away from those workers: He felt no responsibility. He did his best. That's the way the game is played. Besides, isn't it the government's responsibility to help those left behind?

Sorkin is also right about Glass-Steagall. Its historical genesis was far more complex and contingent than the widespread meme. It's collapse was not fast but quite slow. Like private equity, it was part of a wider set of trends, and its repeal certainly fueled the race toward size, interconnection and leverage throughout the entire system. It's greatest "crime" was circumstantial: It was part of a larger move to deregulation. Sorkin, to his credit, called up Elizabeth Warren, running for the Senate in Massachusetts and calling for a new Glass-Steagall, to ask her if she thought the crisis or losses at J.P. Morgan Chase would have been avoided if it had never been repealed. "The answer," she said, "is probably 'No' to both." A little later, she elaborates, admitting that Glass-Steagall "is an easy issue for the public to understand and 'you can build public attention behind.' "

That is a remarkable admission (which she'll probably be scrambling to neutralize). Warren is confessing to something that Brooks ignores. There is the historical reality, all complicated and contingent: a change in regulation, the development of an investment technique. And then there is the political interpretation -- the things ordinary voters grab onto as they rush by, many of them first launched by political ideologues and pundits, amplified by the operatives and the media. Warren seems to be admitting that Glass-Steagall is particularly useful not because it played a major causal role in the meltdown, but because enough folks think it did: It's a potent symbol. You can build support. Finance may be too big and too reckless. But do the ends justify the means? Do we nurture the distortion, simply to get policies we believe in? Private equity has grown up to become an essential part of corporate finance. That should be undeniable, though not an invitation to laissez faire -- but in the political discourse, which always simplifies and distorts, that's not the case (as it wasn't, by the way, in the Republican primaries either). The victim of all this is the middle ground, the nuance, the balance. There are few things more complex, and more fundamental, than the economy, both financial and real. That may well be its greatest weakness.

This post was previously published on TheDeal.com.

Robert Teitelman is editor in chief of The Deal magazine.

Popular in the Community

Close

What's Hot