Private Equity Head Tapped to “Fix" US Intelligence Apparatus. Why?

Why should we think the head of a private equity company could effectively “fix” US Intelligence?

It is not apparent that this individual is even remotely qualified to fix the US intelligence apparatus. And it’s debatable that it is even broken, except in the eye of someone who seems afraid the intelligence community might uncover – or already has – information that would embarrass Donald Trump and his campaign associates – or worse.

Trump wants to bring in a crony who supported his election campaign to revamp the US intelligence services. He’s proposed Stephen Feinberg, CEO of private equity firm Cerberus Capital Management. Cerberus – the dogs that guard the gates of Hell. Cerberus reportedly looks for distressed companies to buy on the cheap.

However, running a government agency is very different from running a firm that takes apart businesses. And private equity, (PE), is not just any business.

According to writer Josh Kosman, in Rolling Stone , PE is a “a predatory system created and perpetuated by Wall Street solely to pump its own profits.”

More Jobs for America – Or Fewer?

It’s perverse that a president who campaigned on creating more jobs for America selected a friend in a business that contributes mightily to the decline in US jobs. PE general partners are subsidized by American taxpayers and under increasing regulatory scrutiny for charging hidden, egregious fees to its portfolio companies and investors, chopping American jobs, and often leaving companies bankrupt.

One of the major contributors to loss of jobs in the US, to workers overseas, is …private equity.

In addition, Trump wants to enable Wall Street firms to steer retirement investors in 401(k)s or IRAs into illiquid, long-term PE investments. In my opinion these are highly inappropriate for retirement accounts. Why?

High, opaque commissions and fees that would drain retirement accounts.

PE is very illiquid. You can’t sell it on an open market like a stock or mutual fund.

Income or dividends (if any) are paid on an irregular schedule, in unpredictable amounts.

You can’t divide up or sell a PE holding in order to take Required Minimum Distributions when you must.

Taxes on PE are complex. Often, a PE investor must wait for tax information that doesn't arrive until the 3rd quarter, and defer filing tax until October 15th (but must calculate what’s owed and pay estimated tax by April 15).

Here’s what most people don’t realize about PE:

Trump supporters in the in the Rust-belt, who’ve had a hard time finding new jobs after the crash and decline in US manufacturing due to automation, would be surprised to learn that he's promoting PE managers that routinely cut thousands of US jobs once they take control of a company.

Why? Some of those jobs are gone for good as a PE target company moves to an austerity plan, as most do under PE. Private Equity-owned companies carry a huge amount of debt – even if they were previously debt-free. So they can’t afford as may American workers. Many of the remaining jobs go overseas, where workers are paid a lower wage with fewer benefits. It’s cheaper to employ non-US workers, and cutting expenses is what is important in private equity.

Who benefits from PE?

PE firms are in business to maximize the money flowing from the target company to the General Partners, (GPs), as quickly as possible. To PE firms it’s the short term that matters, not the company, workers or community. There are many myths surrounding PE. One is that it creates jobs. That’s wrong – it’s actually the opposite. PE is a job killer.

Here’s the PE formula:

Find a family-run company that owners would like to make liquid or sell, or a company in a mature industry. (A small number of PE deals involve distressed companies, but it’s a myth that PE looks for distressed companies to buy. PE-owned companies are often more distressed after PE investors “love ’em & leave ‘em.”)

Negotiate an ownership stake – most often via a leveraged buy-out.

Load up the company with an enormous amount of debt to do the acquisition – PE firms use others’ money, not their own. “As a rough rule of thumb, PE-owned businesses operate with about 70% debt and 30% equity. That ratio is basically reversed for public companies, which generally have only about 30% of their capital coming from bonds and other liabilities,” according to Lauren Webber, in The Wall Street Journal .

Pull out all the cash – this goes to the new PE General Partners.

PE owners need enormous fees to manage the company during the austerity imposed by the loss of the cash and the enormous and crushing debt burden. Many millions of dollars a year. Giddyap!

Fire as many employees as you can, and cut other costs relentlessly – close plants, get out of contracts, cut into the bone. Cheapen the product as much as customers will allow; fewer features, cheaper materials, less safe – whatever it takes! That lifetime guarantee – fughettaboutit – Life is short!

Some details about the fees PE firms charge:

Fees to PE General Partners are typically structured so that there is little or no risk to GP. If the deleted cash, unimaginable debt or austerity measures drive a PE portfolio company into bankruptcy – and many do end up bankrupt – oh well. PE General Partners don’t bet their own money – it’s borrowed.

Yet, through some PE slight-of-hand, fees are taxed as if there is investment risk – at capital gains rates, which at 20% are about half of the ordinary income tax rates of 39.6%. And, fees are structured by the GP. That means the GP structures the fees that it pays to itself. No conflicts of interest there, eh? Or are there…

In addition to fees taken out of cash held by or earned by the target company, now hampered by crushing debt, the GM also charges investors in PE a hefty fee. And the investors, as limited partners, generally don’t share in the hefty fees that the GP charges the PE target firm, even though they sometimes promise to share them.

According to a study of fees in PE investing , from the Center for Economic and Policy Research, “Fees, Fees and More Fees: How Private Equity Abuses Its Limited Partners and US Taxpayers,” here are some of the more common fee abuses in PE:

“Private equity general partners (GPs) have misallocated PE firm expenses and inappropriately charged them to investors; have failed to share income from portfolio company monitoring fees with their investors, as stipulated; have waived their fiduciary responsibility to pension funds and other LPs; have manipulated the value of companies in their fund’s portfolio; and have collected transaction fees from portfolio companies without registering as broker-dealers as required by law.”

Not only that, the study continues: “In addition, some of these practices violate the U.S. tax code. Monitoring fees are a tax-deductible expense for the portfolio companies owned by PE funds and greatly reduce the taxes these companies pay. In many cases, however, no monitoring services are actually provided and the payments are actually dividends, which are taxable, that are paid to the private equity firm.”

PE does not belong in the portfolios of America’s retirement investors, period.

And a PE CEO is not qualified to “fix” America’s intelligence agencies. Though if Trump’s goal is to dismantle them... well, a PE guy could do that.