Forgetting basic economics

A post 5/19/2014 at the Center for Economic and Policy Research:

Summers’ Review of Piketty’s Book Gets Private Equity Wrong

Article by Eileen Appelbaum and Rosemary Batt

(Click title to see the article).

My Response:

This article is premised on the ideological assumption that PE firms are evil parasites. Summers is not wrong, managers are paid according to their ability to generate returns on company assets – including the use of leverage. There are too many stakeholders involved for this business model to be as horrible as claimed by the article.

“Moreover, the millions of dollars in management fees they collect from limited partners further amplify their earnings regardless of how the PE fund performs.” 

Limited Partners have a small appetite for losses and large investment funds demand significant returns. Any PE fund that lost money for its limited partners over an extended period would quickly go out of business – they must be profitable in order to attract new capital and retain investors. Clearly, a fund with poor performance would lose its clients, earning no management fees.

“PE firms continue to collect these fees even as their portfolio companies head toward bankruptcy.” 

Some businesses fail, but the majority of PE investments avoid bankruptcy. Again, if PE firms drove their investments into bankruptcy, two things would follow: 1) limited partners would stop investing; and, 2) banks and creditors would stop lending. Given that creditors are willing to buy the debt (or banks are willing to lend it), the logical assumption is that the majority of the PE firms investments are successfully able to manage the debt service.

There are many more economic problems within this article.

Most PE investments are able to: 1) service the debt, 2) reward limited partners, 3) reward general partners, and 4) maintain stakeholder relationships.

Next time, just come out to say that you feel ideologically that PE firms are rentiers who’s behavior is repugnant because it steals. However, you don’t even say who you feel is being damaged in this arrangement. You only lament that the 1% managers are getting richer and that the PE investments serve only the PE firm’s goals. In most cases, however, the businesses in which PE firms invest would likely cease to exist without that investment – meaning all the stakeholders(employees, community, suppliers, managers) would be let go. So what is the problem that PE firms service their own interests? Are we not all in the business of maximizing our utility?