Dark money comes into the light

When Securities and Exchange Commission chair Gary Gensler was in charge of the Commodity Futures Trading Commission during the administration of Barack Obama, it became known as the little regulatory agency that could. Gensler reined in the futures and options markets in dozens of ways, passing far more new rules and regulations than any of his peers.

When he took over the SEC roughly one year ago, I wrote that we should expect big changes. And last week, they came, with new rules shining much-needed light on the private markets, which have raised more capital than public ones for the past decade. For more on that, check out my latest column.

As a former Goldman Sachs partner who also served in the Treasury department during the administration of Bill Clinton, Gensler is a powerful financial cop precisely because he’s a “born-again” regulator. At Goldman, he worked under financial deregulator and former US Treasury secretary Robert Rubin. He then became an under-secretary to Rubin’s successor, Larry Summers, who passed the Commodity Futures Modernization Act. This was the law that exempted credit default swaps, which exploded the global economy during the financial crisis of 2008, from regulation. Gensler carries a lot of guilt about what that team did, and didn’t do, in the run-up to the subprime mortgage crisis. He knows where all the bodies are buried, and is slowly but surely unearthing them.

I think the rise of private equity and the utter lack of regulation in the sector until a few days ago shows how the financial crisis never really ended — it just morphed into something new. Instead of banks bullying customers, even big ones, it’s now the private equity shops who have control. As Andrew Park, senior policy analyst at Americans for Financial Reform (which has done great work on the risks of investing with private equity, see here), put it to me last week: “When pension funds ask for fees, and more specific accounting standards, private equity funds laugh in their face. Even though it’s their money, the current marketplace denies them this basic information that they need to make allocation decisions on behalf of retirees.”

For more of what they aren’t telling us, as well as some of the rather BS responses from the funds themselves, take a look at a paper entitled “An Inconvenient Fact: Private Equity Returns & The Billionaire Factory”, by Oxford academic Ludovic Phalippou, who must be Stephen Schwarzman’s very least favourite person. He estimates that since 2006, the majority of private equity firms either met or underperformed the index — and took home $370bn in carry fees for the privilege.

I’ve done a fair bit of reporting on the effects of private equity in the housing market and some of the asymmetries it has caused (see senator Sherrod Brown railing about that in the banking committee hearings last week). But I’m going to be spending more time digging into private equity’s role in the ridiculous default rate level on loans in the for-profit education business (which companies like Apollo have been in, right along with our former president) and also healthcare, which private equity firms are piling into. I have a dermatologist friend who recently sold his practice to a private equity firm, but couldn’t bear to stay on after because management forced him to cut the amount of time spent with patients in half, and focus more on scale and less on people.

Eileen Appelbaum, who is the co-director of the Center for Economic and Policy Research in Washington and one of the top academics looking at private equity, noted in recent Senate testimony that “the effects of Covid-19 and proposed spending in President Joe Biden’s Build Back Better bill have fuelled private equity’s already considerable interest in home healthcare, hospice services and behavioural health — the latter to treat both victims of the opioid crisis and those suffering mental health problems caused by the isolation and disruption of the pandemic”.

Why does the idea of Leon Black or Stephen Schwarzman focusing on post-Covid health issues make me feel more depressed? Is healthcare going to become the new subprime, with surprise billing, crushing debt, and sub-par treatment? Our system is complicated and patchy as it is. But Peter, the larger issue is what I’d like your take on. Do you agree with folks who say that we’ve never left the great financial crisis? With debt at record levels, and the Federal Reserve about to raise rates significantly, where will you be looking for financial risk?

Recommended reading

• Rose Adams’ smart piece in The American Prospect highlights how supply chain disruptions favour large companies. This is absolutely true. What’s interesting is that in some ways, big companies also cause supply chain issues — too much concentration means less resiliency when things go down.

• Colin Wright’s advice in The Wall Street Journal that when asked for our pronouns, we shouldn’t answer, will provoke many, but I think it raises important questions about how the whole conversation about gender, sexual identity and language is playing out.

• Ugh to all this disturbing news in The New York Times about book bans. I wish the people banning Maus (one of the world’s most wonderful graphic novels) would read this piece in The Wall Street Journal noting that when opinions, even ones that some people find hateful, are banned, it tends to actually entrench the views that the banners want to shift.

• What’s not to like about a Lunch with the FT in the metaverse with John Thornhill and David Chalmers.

Peter Spiegel responds

Your belief that private equity is a “morphing of the financial crisis into something new” is something that I worry about a lot, especially as an editor at a financial news organisation. One of the FT’s smartest markets reporters once said to me that every big financial crisis is caused by over-leverage. That was certainly true of the 2008 great recession (triggered by over-leverage in the housing market), and the 2010 eurozone crisis (triggered by over-leverage in sovereign debt). 

Because of aggressive quantitative easing from every big central bank, we’ve now lived through a decade of almost free money. And, as you noted, that has produced unprecedented borrowing. It’s not just the US; the IMF found that 2020 produced the biggest global surge in debt since the second world war, with about half of it in the private sector. Post-financial crisis regulations have meant that traditional commercial lenders have mostly been shut out of the kinds of high-risk loans that roiled the global economy 15 years ago. But there is mounting evidence that private equity has become the lender of choice for those same borrowers.

As just one example, the FT’s Mark Vandevelde wrote two years ago about GSO Capital Partners, the lending arm of the world’s biggest private equity group Blackstone, and how it had taken over huge chunks of the lending business that used to be done by the regulated banking sector. If you take aggressive lending by private equity and pair it with light-touch regulation and very low interest rates — well, what happens when those rates start to go up, as they are starting to do now?

Warren Buffett once famously said that it’s only when the tide goes out that you discover who has been swimming naked. The tide is beginning to go out. Private equity has undoubtedly been lending to a lot of naked swimmers.

Edward Luce is on book leave and will return in mid-March.

Your feedback

And now a word from our Swampians . . . 

In response to: ‘The Ukraine crisis’ new F-word: Finlandisation’:
“What Peter said is absolutely correct, and needs repeating at every opportunity. Ukraine is a sovereign country and it’s for its people to make their own decisions. Further any concerns about security need to be addressed diplomatically, not by military manoeuvres or threats. However the problems of the Russian invasion of Crimea and the Donbas have still not been resolved. The Russian position assumes that they are irreversible but the EU and Nato should not necessarily take a similar view. They need to be part of any solution about Ukraine security.” — Mike Rossiter, London, England

“As a Finn, what irritates me the most is the perception of Finland as a country between east and west. Finland is part of western culture historically, politically, economically, language-wise, religion-wise and militarily. Historically, what we now call Finland emerged gradually as the eastern half of Sweden. In fact, my Finnish home region Ostrobothnia has spent more centuries as part of Sweden than has Lund, an old Swedish university town in Scania. Although Sweden lost its eastern half in 1809, the Swedish constitution of 1789 was not replaced in Finland until 1919 when Finland got its first own constitution. During the second world war, Finland successfully fought for western civilisation in the battlefield and was not occupied by any foreign power, including the Soviet army. I think the only really long-term lesson that you can learn from a millennium of Swedish and Finnish experiences is that you must be prepared to use your own and western military force to defend your western culture in the face of aggression from the east.” — Petri Mäntysaari, Vasa, Finland