Is, as Gingrich implies, private equity investment and all it entails such a bad thing, or is it perhaps a very good thing, all things considered? Let's explore the situation.
Private equity firms like Bain often invest in struggling or start-up companies with the specific objective of making such investments highly profitable for their investors. In other words, they do it to make money.
If the companies in which these private equity firms invest later become successful, then the private equity firm (like Bain Capital) will be able to sell its stock at a big profit to public investors. Of course, if the company fails, the investment fails and investors lose their money. These high risk private equity investments usually bring either high rewards or failure to the private equity investors.
It's a high risk, high reward proposition. That's the way free markets work. The higher the risk taken, the higher the potential reward. The key word in the preceding sentence is potential.
Alongside these private equity investors, public employee pension fund managers frequently invest their funds' money seeking high investment returns as well. By so doing, they hope to realize an outsized return on investment in order to help pay public employee pension benefits to retirees.
Thus, private equity firms and public pension plans, sometimes referred to as the odd couple of investing, often join together to invest in privately owned companies. {Please don't tell Newt Gingrich and Barack Obama, but layoffs and plant closures are often necessary to make the companies successful investments.} Accordingly, public employee retirees benefit from private sector competition and creative destruction at work.
A good example of such an investment would be a start-up company, a struggling privately owned company or perhaps even a successful division of a larger publicly held company.
Private equity companies like Bain invest to help start-up or buy the company or division, then use competent management to take steps to make the company profitable and viable. As that happens, the then viable company's shares are sold to the investing public.
As with any high risk undertaking, the venture may or may not turn out to be a good investment. If it does, the Bain (or similar companies) investment return will be substantial. If not, the loss will be substantial as well. The quality of installed management will often, but not always, make the difference between the investment's success and failure.
Wall St.'s Odd Couple and Their Quest to Unlock Riches describes the somewhat unique relationship between public pension funds and private equity firms:
"Private equity and public pensions are one of Wall Street’s most peculiar love affairs. Recently, the two have tried to become even closer. But don’t get mushy — this relationship is about money, not romance.
Public pensions pay billions in fees to private equity. The question is whether it is worth it.
Private equity’s first date with public pensions was in 1981, when the Oregon Investment Council, the manager of Oregon’s pension fund, invested along with Kohlberg Kravis Roberts & Company to buy the retailer Fred Meyer.
Since then, the two have been inseparable, and pension funds have at times made up more than 50 percent of private equity’s financing. It’s an odd pairing: the millions of working-class Americans who rely on public pensions have invested billions with the private equity industry, which in exchange has made billions for these pension funds."
Why do the public pension funds invest so much money with these free market oriented private equity firms? Well, they do it to make money. Come to think of it, that's exactly why Bain invests, too. Listen up, Newt:
"At the same time, pension plans everywhere are also desperate for yield. Pension plans are reportedly underfinanced by anywhere from $700 billion to as much as $4 trillion, depending on the calculations. Poor returns over the last few years have not helped. Over the last five years, the average state and local pension fund has returned 4.7 percent, according to Callan Associates.
Pension plans hope to make up these lost years and reach performance targets that in some cases are still set at a hopeful 7 to 8 percent a year. Private equity has traditionally been a high-performing asset class, and shifting more assets into this and other alternative investments like hedge funds is seen as a possible solution. Wilshire & Associates recently found that the average pension fund had increased its allocation to private equity to 8.8 percent in 2010 from 3 percent in 2000."
Our nation's overall well being depends in large part upon the performance of the private sector in the global economy. That in turn depends on having strong U.S. based companies as successful competitors in a global free market system. If our U.S. companies are successful, of course, our private sector's employees will tend to do well, too. That's obvious.
What's not always obvious, or not seen, as Bastiat would suggest ("Seeing What's Foreseeable ..." post dated Dec. 14) is what this means to public employees or the government sector generally.
So here's the sometimes foreseeable but often "not seen" part of the story. Profitable and successful private sector companies doing well will pay employees well and as a result there will be sufficient tax receipts for government to pay for its operations, including payments to public employees for their salaries, pensions and health care. That "unseen" money comes from the successful part of the private sector.
Public employee pension fund managers have thoroughly internalized the "seen and unseen" connection between profitable private sector companies' performance and the public sector employees' well being.
If that's the case, and it is, then why can't smart people like Newt and Barack figure it out?
Politics sucks.
Thanks. Bob.
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