We Didn't Start the Fire

[This post originally appeared at The Epicurean Dealmaker on December 7, 2009. It is reproduced here in its entirety.]

Rob Slolom: "Wow. Eight Oscars, 400 million dollars at the box office, and you saved Tugg Speedman's career."
Les Grossman: "I couldn't have done it without you."
Rob Slolom: "Really?"
Les Grossman: "No, dickhead. Of course I could. A nutless monkey could do your job. Now, go get drunk and take credit at all the parties."
Rob Slolom: "I wouldn't do that."
Les Grossman: "Ah ... joking. "
Rob Slolom: "Ah, there he is! Funny. You're a funny guy."
Les Grossman: "Yeah. But seriously, a nutless monkey could do your job."

— Tropic Thunder

For what it is worth, O Dearly Beloved, you cannot count me among the rabid, spittle-flecked populists who lump private equity plutocrats in with venal investment bankers, clueless commercial bankers, meretricious mortgage brokers, and Nancy Pelosi's manicurist as the principal agents of our current economic desuetude. While it is true that many of these would-be Captains of Industry did purchase companies at preposterously high valuations in 2006 and 2007 at the orgiastic climax of the Sino-Greenspan credit bubble, the most the majority of these hapless boobs can be accused of is getting their wee-wees caught in the woodchipper of mistaken opportunity.

Vast herds of professional morons in the fixed income investor community apparently thought it was a brilliant idea to offer virtually limitless quantities of debt at virtually invisible interest rates with virtually zero credit protection to picayune ex-investment bankers so the latter could snap up the flower of American (and global) industry at 250% of retail. With limited exceptions, said PE types said "What the hell," and signed on the dotted line. After all, their fiduciary and professional duty to their own investors is simply to maximize returns on contributed capital. And, in the unexpected case their investments went belly up, the PE professionals and their limited partners could just hand over the keys to the failed portfolio companies to their embarrassed lenders. What was not to like?

Of course, many of the overlevered companies owned by private equity firms are now struggling or have failed entirely. Hundreds if not thousands of employees who worked at these investments have been laid off, and thousands if not millions of citizens whose pension funds or universities invested in their shitty debt have taken it in the neck. But caveat emptor, eh?

Like many other participants in the Great Financial Clusterfuck of 2008, private equity professionals helped make things worse for everybody through the unholy combination of personal greed, institutional incentives toward excessive debt, and general shortsighted arrogance, but they did not cause the crisis. Furthermore, I do believe the version of the private equity model which focuses on making substantive operational and strategic improvements to portfolio companies—rather than just levering them up the wazoo and hoping for the best—is a valid and effective alternative investment strategy in this economy. Many companies can be materially improved by the tender ministrations of a cigar-chomping five-foot-four inch sadist who would just as soon waterboard a manager as look at him. And they were.

* * *

Paragons of Sweat Equity Capitalism or not, private equity professionals are coming under the legislative microscope along with all the other financiers and hangers on who wear suits that cost more than the average Congressman's car. But in their case, the focus of regulatory reform is taxation, particularly that form of personal taxation peculiar to our hobbyist industrialists and known to all and sundry as carried interest.

I will let Floyd Norris explain:

The “carried interest” tax break lets private equity partners claim that their compensation is really long-term capital gains, since they are allocated percentages of the profits earned by their investments.

The Ways and Means Committee wants to end that, and today a trade group, the Private Equity Council, protested:

“Raising taxes on growth investments by private equity, real estate and many other partnerships just doesn’t make sense — particularly in this time of fragile economic recovery and continuing joblessness. By more than doubling the tax rate, the carried interest proposal will discourage investment; deprive many American businesses of the capital they need to survive and grow; and jeopardize critical job creation opportunities.”

Uh, no. I call bullshit.

We have been down this goat path before (masochists see "Related reading," below), and I remain utterly unconvinced that raising the personal taxes of a couple thousand billionaires, multi-millionaires, and would-be millionaires on the fruits of their labor would have any effect whatsoever on the ability of corporations to find private equity backers for their businesses. After all, the entities which provide approximately 95% of the equity which these Scrooge McDucks play with—pension funds, university endowments, and other large institutional investors—are either tax exempt or completely indifferent to the plight of their PE portfolio managers. And if a couple hundred of these quackers decide to take their (relatively) paltry marbles off the table and stalk off in a huff to endless champagne and chlamydia on the French Riviera, I don't think anyone will miss them.

Then there's the whole "fairness" issue. I will let Mr. Norris expound his view:

Personally, I am not sure that capital gains should get tax breaks anyway. But for private equity partners, who are earning huge sums of money by their skill at investing other people’s money, it seems particularly inappropriate. They earn money from their labor, just like the rest of us.

May I suggest a simple rule to be considered by Congress. “No executive should pay a lower tax rate than the rate paid by the person who cleans the executive’s office.”

There, that should set a few sardonic memoirists' blood boiling.

* * *

On the other hand, I seem to recall reading that the CBO estimated the aggregate proceeds to Treasury from taxing Steve Schwarzman and his fellow übermenschen like normal human beings would only amount to a few billion dollars over several years. So it's not like we're gonna recover the money we've pissed down the drain at Citibank and AIG by picking Henry Kravis's pocket. But then again, every dollar counts, and if I can avoid paying a few more shekels in taxes because we decide to stop treating pencil-necked MBAs like Andrew fucking Carnegie, I will be more than satisfied.

And if the private equity plutocrats don't like it, I would point them to the immortal words of yet another flaming asshole of my acquaintance: "That's baseball."

Related reading:
Tax Breaks for Everyone! (June 14, 2007)
J'accuse (June 15, 2007)
J'accuse, Part Deux (June 27, 2007)
The Taxman Cometh (July 11, 2007)
B(ogus Ta)X (July 13, 2007)

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