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How private equity cheats pensions at workers’ expense

Spoiler: It’s all about public policy

July 9, 2015 2:00AM ET

It’s time for American workers to understand the game of private equity, because it’s being played at their expense, thanks to rules put in place by Congress.

Here’s how the game currently works: Workers sell their jobs, pensions and futures, for little to nothing in return. The buyers are those masters of unproductive capital acquisition, private-equity funds.

Their game is short term. Companies are acquired with lots of borrowed money. (Congress incentivizes this by making interest a tax-deductible business expense.) Some of the borrowed money is almost immediately used to repay the general partner and some other investors so they end up with a cost-free stake. If your equity stake costs less than zero, your returns are infinite.

The remaining equity in such deals comes primarily from pension funds — that is, from workers.

To pay back the borrowed money, private-equity funds sell assets, such as operations others covet, and reduce inventory. They often separate ownership of buildings, which can be depreciated and thus generate valuable tax deductions, from the underlying land, which cannot be depreciated. Sometimes this land is sold to friends and associates, who charge rents for the buildings. Perhaps most important, private-equity funds typically shut down traditional defined-benefit pension plans.

Much of the pension money in private equity comes from public employee pension funds, the ones that politicians in many states have been failing to fund, resulting in not enough assets to pay benefits that the workers earned.

These shortfalls put pressure on pension fund managers to find ways to earn higher rates of return, which of course means taking on more risk. One way to reduce such risk is to get rid of private-sector pension plans because that lowers costs to the owners, though at a huge and delayed cost to private-sector workers. It also adds to the risks of future state welfare costs for destitute older people.

Most workers, public and private, do not know this because we fail to teach children and even most college students basic economics, much less how the law effects compensation, worker rights and the time value of money invested prudently.

Private equity is the greedy child of the 1980s leveraged buyout deals that used debt to acquire companies, stripping them of assets and workers. Leveraged buyouts made a very few very rich at the expense of millions of workers.

Government policy does more than make these deals possible. Congress actually favors such deals in myriad ways, to the detriment of large numbers of Americans.

Public policy currently enriches private equity at the expense of workers, favors debt over equity and creates an environment in which workers unknowingly finance the people who are ruining their lives.

The awful effects of laws that favor private equity are explored in a new paper from the Edmund J. Safra Center for Ethics at Harvard University. In “A Bad Man’s Guide to Private Equity and Pensions,” Elizabeth Lewis shows how public policy enables private equity to ravage. She is especially critical of the 2005 changes to federal bankruptcy law passed under an Orwellian name, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.

Lewis told me that as she delved into private equity, “what struck me was how it all depends on public policy — tax policy, partnership accounting rules, the preferences for debt over equity. It’s like following a yellow brick road.”

But the private-equity people don’t build an Emerald City. “They don’t build anything, but they do exploit this American mythology and tap into this belief in the heroic businessman who pulls capital to himself. What people do not see is that private equity is pulling capital away from” workers, she said. There is no exchange, just taking.

Lewis is not the first to take note of this, but she does so in a way that is concise and easy to grasp.

Last year the book “Private Equity at Work: When Wall Street Manages Main Street” by economist Eileen Applebaum and industrial relations scholar Rosemary Batt explored these issues in nuanced detail.

They documented the economic carnage from private equity. Compare it to a feast at which the hosts carve off the best parts of the turkey, strip the remaining meat from the carcass and serve scraps to their guests.

If you ask the private-equity folks about this, they have a standard reply: Everything we do is within what the law allows.

One thing the law allows is the use of that 2005 bankruptcy statute to kill pension plans, often shifting costs to the federal Pension Benefit Guaranty Corp. Under the law, inadequate deposits to pension plans — a subtle form of wage theft — are of little significance. But the code enables new owners to borrow against company assets, pay themselves a huge dividend from the loan proceeds and keep the money.

“Because the law views private-equity firms as investors rather than employers, private-equity owners are not held accountable for their actions in ways that public corporations are,” Applebaum and Batt note. “And their actions are not transparent because private-equity-owned companies are not regulated by the Securities and Exchange Commission.”

This is a problem with a solution: Rewrite the laws that favor asset strippers, company flippers and dividends financed with loans to favor building wealth by adding value.

Why does the law favor stripping turkeys instead of raising them? The answer, of course, is the campaign finance system. Senators and representatives as well as presidents must serve the interests of the political donor class or lose their power. Workers have hardly any influence, especially now that Big Labor’s political contributions have shrunk to a small fraction of what the financial industry spends on influence in Washington.

Public policy currently enriches private equity at the expense of workers, favors debt over equity and creates an environment in which workers unknowingly finance the people who are ruining their lives. This practice can change, but it starts with people understanding how the game is rigged against them and forcing their representatives to change the rules.

David Cay Johnston, an investigative reporter who won a Pulitzer Prize while at The New York Times, teaches business, tax and property law of the ancient world at the Syracuse University College of Law. He is the best-selling author of “Perfectly Legal,” “Free Lunch” and “The Fine Print” and the editor of the new anthology “Divided: The Perils of Our Growing Inequality.”

The views expressed in this article are the author's own and do not necessarily reflect Al Jazeera America's editorial policy.

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