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The way to understand the response to the pandemic is to recognize that America has been transformed, temporarily, into a planned economy. A planned economy requires central planners directing resources. So who are they and how do they operate? Today I’m going to write about one group of central planners, the fusion of government and the financial sector in the network of funds we call private equity. It’s a notable set of actors making important political decisions under-the-radar as we speak. For instance, private equity funds are making the meaningful political decision to cut doctor pay for those on the front lines of the epidemic, which is a serious public policy choice.

Why? How has our political system come to the point where it becomes ‘rational’ to harm those savings lives in a pandemic?

That’s what I’m going to cover today.

Jared Kushner’s Dollar-a-Year Men

A few days ago, Adam Cancryn and Dan Diamond at Politico published a fascinating story about Jared Kushner’s role in the pandemic response. Kushner is basically running a shadow coordinating unit from the White House, pushing the top civil servants out of the way and cutting deals with private industry to try and organize an aggressive response. It wasn’t just Kushner’s influence that caught my eye, but the network Kushner has pulled around himself to run the response. This network includes Dave Caluori, a partner at private equity fund Welsh Carson Anderson & Stowe, and Andy Slavitt, a former Obama administration official who is now at Town Hall partners. Caluori, according to Politico, is “voluntarily aiding the effort with the help of a couple other Welsh Carson associates.” Meanwhile, Slavitt, though an aggressive media presence, portrays himself as an unofficial coordinator of the national response, regularly updating his audience on the plans of various Governors, Senators, hospital and medical executives to source ventilators or treat patients.

We are in an emergency, and many people draw an analogy to world war mobilization. Both Caluori and Slavitt harken back to a particularly corrupt practice in those eras, what was known as the use of ‘Dollar-a-Year Men.’ This nickname was given to business executives, often from automobile or industrial corporations, employed by government during world wars to facilitate wartime production. Dollar-a-Year men took no salary from government and continued to draw salary from private industry. Despite what seemed to be a charity, the set-up proved enormously controversial. While some Congressmen believed these men offered patriotic service, that was not the general belief. Senator Harry Truman, who oversaw a groundbreaking investigative committee over war profiteering, felt that these men, no matter how well-meaning, should be given no voice over policy, as they were “unable to divorce themselves from their subconscious gravitation to their own industries.”

Unlike the world war buildups, Kushner’s “Dollar-a-Year” men are not a peripheral minor part of the government bureaucracies otherwise run by capable public servants, but central to it. We now have a government where a good chunk of policy is organized directly by private equity executives. Even so, discussion of the role of these men mimics in some ways the debate during the world wars (though this build-up is obviously far more corrupt and incompetent than that during either one of those two wars). Government officials are angry at the managerial chaos induced by Kushner’s network, calling the Kushner group a ‘frat party’. Ethics experts disdain their use of private emails and FreeConferenceCall.com, as evading public records requirements. And of course there is always the potential for self-dealing. Yet there are some who see value, like New York Governor Andrew Cuomo, who lavished praise on Kushner for being “extraordinarily helpful.”

At any rate, you go into a pandemic with the leaders you have, not the leaders you’d like. And one of our key leaders, like it or not, is to be Jared Kushner and his network of private equity executives. These are people who are not shy about rapidly deploying capital, for better or worse.

What is Private Equity?

I wrote up a description of private equity in July, when Elizabeth Warren came out with a plan to reform the sector. I described a private equity fund as “a large unregulated pool of money run by financiers who use that money to invest in, lend to, and/or buy companies and restructure them.” That’s a formal definition, but it’s also a highly ideological social movement that comes out of the modest conglomerate craze of the 1960s and then was transformed by the junk bond mania of the 1980s. Private equity proponents believe that they are removing sloth and waste out of the corporate sector, bringing innovation and productivity to American industry. It is of course a nonsense claim on the merits. Private equity is in fact “a political movement whose goal is extend deep managerial controls from a small group of financiers over the producers in the economy,” yet one more rhetorical cover for aristocracy in the long arc of human history.

There are roughly four thousand private equity funds that control about $5 trillion worth of corporations, which is a sixth of the total value of all public companies. The industry has exploded since 2000; today, the number of private equity owned firms outnumbers the number of public companies, and private equity is more significant as a source of financing than initial public offerings in the stock market.

Both Democratic leaders and Donald Trump are close to private equity barons; in many ways, even before the pandemic, private equity executives have been our real government, choosing where to deploy capital and how corporations are valued and structured. Private equity is one of the more important social forces across the West, a style of business that has been structuring our politics and our commerce since it was super-charged by men like Michael Milken and William Simon the early 1980s.

The goal of private equity isn’t usually to find businesses who need capital to produce better products and services, but to exploit unused pricing power. Sometimes this means taking control of a business that can charge more to customers, but it can also be pricing power used against the taxpayer, workers, investors, or the nation itself. Robert Smith of Vista Equity Partners, for instance, has made billions by buying up mid-level software corporations in niche industries (like Yoga studio software) and raising prices on the small businesses who depend on it. Private equity funds were behind the offshoring craze in the mid-2000s, selling key manufacturing capacity to China. Sycamore Partners, another private equity firm, bought Staples, and then immediately took out a billion dollar special dividend.

Why Is Private Equity Unusually Vicious?

The reason private equity can exploit corporate assets with such ruthlessness is because of its legal structure. Private equity buys companies, but puts very little of their own money in deals. PE takes in money from investors, usually insurance or pensions, and invest it. When they buy a company, they will use some of this money, but they often borrow more money to finance the takeover. Then they restructure the portfolio company, pull out dividends if they can, and sell it. PE executives get paid handsomely if the fund makes money, usually a cut of the upside. But those executives do not lose their own capital if they take a loss. That means there’s an incentive to load up with risk, because PE funds are playing with other peoples’ money.

Moreover, when a private equity fund invests, it’s not like a mutual fund or hedge fund; PE usually buys control of a corporation and puts it in its portfolio. PE is exactly like a conglomerate, except somehow the portfolio company isn’t considered a subsidiary. As a result, PE firms don’t have any liability for their portfolio firms. If a portfolio firm goes bankrupt after moving a bunch of money to its private equity owners, those ‘owners’ have no liability and don’t have to give the money back. Often PE funds have consulting side units, and charge large amounts to their portfolio companies, purely as a means to transfer money from the corporation to the PE fund. It is control without responsibility, the ultimate incentive to behave without any concern for damage one might cause. Unsurprisingly, PE-owned firms are ten times more likely to go bankrupt.

PE executives are also socially distant from the subsidiaries they control and don’t pay a price if those subsidiaries go bankruptcy or harm people. They don’t live in the communities they affect, and most people don’t even know private equity billionaires exist even as they make key social decisions over their lives. This is intentional; one private equity billionaire, Steve Feinberg of Cerberus Capital, reportedly said, "If anyone at Cerberus has his picture in the paper and a picture of his apartment, we will do more than fire that person. We will kill him. The jail sentence will be worth it." Investors seek out those PE funds with the highest returns, amplifying the competitive dynamic. As a result, the industry brings out the most ruthless actors in society, those who are politically connected, voraciously greedy, and able to use public relations to remain discrete.

Cerberus, for instance, has on staff former Vice President Dan Quayle and Treasury Secretary John Snow. Feinberg himself heads Trump’s Intelligence Advisory Board. Feinberg got his start under Michael Milken at Drexel, an investment bank whose culture was based on ripping the throat out of the other side of the trade, no matter what.

Private Equity and Pandemic Profiteering

In this pandemic, private equity executives are indeed ripping the throat out of anyone they can, exploiting whatever market power they have. Feinberg’s Cerberus threatened to close down a hospital it owns in Pennsylvania if the state didn’t offer to assume $24 million in expenses. Another private equity baron, Joel Freedman, bought Philadelphia’s Hahnemann University Hospital in 2018, in a comical display of greed. This hospital served the poor, and Freedman closed it down so he could use the land to build luxury apartments. When the city recently asked to use the empty hospital during the pandemic, Freedman demanded $1M/month in rent. (He also got a substantial tax break in the bailout bill.)

Then there are the pay cuts for doctors and nurses on the front lines. For a variety of sleazy reasons, PE funds own physician staffing services, which means doctors in American hospitals are often employed not by the hospital directly but by a third party firm. This pandemic is radically cutting the profitability of hospitals, because hospitals are reducing the more lucrative procedures in favor of treating Coronavirus patients. So these firms are pushing pay cuts to their own doctors. Interestingly, one of the private equity firms surfacing in these articles as an owner of physician staffing surfaces is Welsh, Carson, Anderson, & Stowe, whose staff, led by partner Dave Caluori, is assisting Jared Kushner’s pandemic response team as Dollar-a-Year men.

The reduction in compensation to physicians seem to be happening across the board. KKR, one of the giants of private equity, is considering cuts of up to a third in pay for doctors through its own subsidiary, Envision Healthcare Corp. There are other problems, such as this story by Lee Fang, in which a private equity owned firm exported 55 tons of respiratory equipment two weeks ago, a testament to the poor planning of the Trump administration when mixed with the goal of maximizing revenue. I suspect that there are plenty of private equity firms involved in the lucrative middlemen trading around personal protective equipment.

The point here isn’t to denigrate private equity, but to point out that the legal structure of the business model leads to an excessively risky and rapacious way of organizing resource deployment, and this is especially notable in a national emergency.

Private Equity in a Depression

Going forward, if the rules for private equity remain as loose as they are, the impact on our economy of a pandemic and a financial model will likely lead towards a further consolidation of power in the hands of those who have capital and the means to deploy it. That said, the first order of business for most private equity funds is not to invest, but to stabilize their portfolio companies, to salvage what they can after a good amount of corporate value evaporated in the crash.

In the oil sector, which has been savaged, billionaire Sam Zell and private-equity firm Colony Capital are doing what financiers are good at doing when they make a bad investment. They just refused to go through with it and are saying ‘sue me.’

I suspect that this kind of hardball will go on everywhere. As one contact told me, “I am hearing rumblings that a ton of Private Equities are gonna instruct their portfolio companies to not even try to service their debt until this is over… basically forced mass forbearance for PE owned companies via capital strike.” This isn’t necessarily a bad thing; I’ve heard similarly that these companies aren’t going to be paying rent either. Basically private equity is going to enforce a new set of terms to lenders, economy-wide. Although to the extent PE owns real estate, and many funds do, I suspect they will be assertive in enforcing their claims as creditors. It’s always about exploiting market power to the hilt.

Private equity funds aren’t just seeking to save the investments they already have, but to get access to more capital to invest in a period where asset prices are quite low. As Euromoney magazine put it in a headline, “Private equity can be the big winner from Covid-19 sell-off." And to get access to more capital, they are using the single most important tool in the arsenal of a private equity fund: political connections. They want a slice of that massive bailout passed two weeks ago.

There are two giant pots of money in the pandemic response legislation that suit the needs of these financiers. The smaller pot is the $349 billion Paycheck Protection Program lending/grant program to small businesses. Private equity portfolio companies shouldn’t be able to access this money because they aren’t actually independent small businesses, they are subsidiaries of a larger entity, like divisions of a conglomerate. Still, PE titans have gotten Securities and Exchange Chairman Jay Clayton to lobby the Trump administration to loosen the rules that block them from this program.

The other far more significant pot of money are the unlimited credit lines from the Federal Reserve. NBC news reported that Apollo Global Management, which had lent $185 million to Kushner's real estate corporation in 2017, recently contacted Kushner and asked to be allowed to borrow money from the Fed against its riskier investments. In other words, PE firms are salivating at the ability to borrow cheap government money and gamble with it. They are also likely to try and stick the Fed with debt they know is going to be worthless, to get bailed out for bad investments.

So private equity firms, after they save their portfolio companies, are likely to use low cost government credit to restructure the economy. This is already beginning to happen. Entertainment and arcade chain Dave and Busters is exploring taking what looks like a significant investment from private equity funds, as have car e-commerce platform Carvana, payment firm EVO Payments and online real estate broker Redfin. This kind of ramp-up for acquisitions won’t happen instantly; mostly PE firms are trying to deal with the immediate crisis. But after they begin to peer over the horizon, unless they are stopped through antitrust rules or changes to financial regulation, every nook and cranny of our economy will be re-engineered to maximize the leverage of a small group of financiers.

What’s the difference with World War II “Dollar-a-Year” men?

In some ways, it’s natural to have private equity deploying capital in a pandemic; these are the people comfortable with doing so. And one could argue that if Dollar-a-Year men served the nation during World War 2, and that worked out, then this new experiment will work out as well.

To that point, I’ll offer a couple of observations. First, it’s not World War II, and our corporate, military and government leaders aren’t remotely as competent and effective as they were then. There are simply too many differences in the form of government, bureaucratic competence, and the leadership style of policymakers to even offer reasonable context between America in 2020 and America during World War 2. Second, Dollar-a-Year men were not in control in either world war, the government had powerful and effective bureaucracies in both the civilian and military sides. The military produced many of its own weapons, and the American government had a deep understanding of the nation’s productive capacity.

Finally, unlike industrial leaders during World War II, private equity executives today are divorced from the process of production. Henry Ford was a deeply dangerous and autocratic man, but he did actually build cars and the River Rouge factory was a marvel of engineering. By contrast, Jared Kushner is a coddled second generation slumlord. His contacts are similarly divorced from the real world. Caluori went from Brown University to investment banking and then health care investing, Slavitt from Wharton to Goldman Sachs investment banking to McKinsey to health insurance to the Obama administration to private equity. These men speak the language of public relations and finance, not production, treatment, or logistics. Moreover, unlike the era during World War II, there are few strong unions today, so the expertise of organized workers is mostly missing (and when it’s not, the results are usually excellent).

So I can’t see our new central planners organizing our response in a particularly coherent way, even though they probably do want to do so. The incentives, mindset, training, operational capacity, and legal frameworks just won’t lead them to make good social decisions. That said, the rapaciousness of private equity is known to our political leaders and increasingly to the public, so I doubt what they do will remain hidden or discrete. In the next issue of BIG, I’ll offer you some reasons for hope. These central planners are not going to operate without a real political challenge.

Thanks for reading. And if you liked this essay, you can sign up here for more issues of BIG, a newsletter on how to restore fair commerce, innovation and democracy. If you want to a book to hunker down with while sheltering in place, read my book, Goliath: The 100-Year War Between Monopoly Power and Democracy.

cheers,

Matt Stoller

P.S. Doctors are already furious at their health care and hospital executives. This comic is going around in medical circles.