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Europe must rein in the power of private equity

Started by Richard Mellor, March 16, 2007, 09:38:13 am

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Richard Mellor

As I was reading this I just assumed it was from the pen of one of the more astute and sober bourgeois strategists.  But it is from a major British labor leader.  Having no independent ideas of their own however, worker's leaders like Brendan Barber, can only echo the views of one section of the capitalist class or another.

The serious concern an increasing section of the capitalist class has over the growth of private equity is stressed here by Barber and he offers their solutions; more regulatuion.

In the US, the labor leaders are not yet as concerned as their European colleagues as they are even more wed to free market policies and have lots of investments they see doing well.

Private equity, that raised outside of the normal structures, is growing in size, is much more secret and receives major tax breaks. It does not have to answer to shareholders and produce quarterly reports and much of it is highly leveraged.  The recent takeover of the Texas utility by KKR included some $12 billion in debt.  It is a major worry and receives daily coverage in the big business press.  The capitalists do expect certain rules to apply in the course of their plunder of the wealth workers create; they don't want speculators and mavericks killing the goose that lays the golden egg.

Richard Mellor

Europe must rein in the power of private equity

By Brendan Barber

Published: March 15 2007 18:45 | Last updated: March 15 2007 18:45

Unions from across the advanced economies will meet today in Paris to discuss what to do about private equity. We are not the only ones concerned; unions have been winning support from some surprising quarters.

A flurry of public relations initiatives and reviews shows that the sector is growing worried. The decision of Ed Balls, economic secretary to the Treasury in the UK, to investigate shareholder debt is significant. The Treasury select committee's inquiry will pose tough questions. In Germany, the government is already proposing limits on the tax relief that can be claimed on interest repayments.

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But the significance of the union meeting today is that it is the start of an international campaign to regulate private equity and hedge fund investment. An early target will be Angela Merkel, German chancellor, as chair of the forthcoming Group of Eight leading industrialised nations summit. It will go on to call for a common European Union approach. There are measures that individual governments can take, but the rise of private equity is a symptom of globalisation. The public policy response must also be supranational.

Before deciding what is required, it is important to identify the problem. The private equity industry says that there is nothing particularly different or special about what it does. It is just an inevitable - if rather effective and efficient - part of a market economy.

Yet this is a naive and dangerous view of modern economies. Each is a bit different, but at their heart is a balance between the undoubted prosperity markets deliver and measures to protect against the instability and damage that they can also wreak. That is why we expect companies to pay tax, to be transparent in the way they operate and why we regulate markets to guard against instability. Al*though the UK is somewhat lacking, it is why there are public policy instruments to encourage long-termism and socially responsible corporate behaviour.

Of course, the traditional role of venture capital in providing investment for start-ups is vital. Some companies have gone private genuinely to escape stock market short-termism. But neither of these is feeding the current controversy. Instead, the recent growth in private equity acquisitions looks more and more like a way of getting round the social contract at the heart of our market economies. Investors pay a lot less tax, keep things secret and, through high gearing, have introduced great potential instability. Creative destruction may be an inevitable part of a market economy, but private equity often seems to lead to straightforward destruction with nothing creative about it, apart from some of the accountancy.

Yet this does not matter if it produces a long-term gain in prosperity, private equity supporters say. Returns are all down to the innovation and discipline they introduce to the management of distressed companies. Yet few who have studied the area agree. High returns are quickly produced by ruthlessly reducing companies to their core functions, the maximum exploitation of tax relief and off-shoring, and saddling companies with added debt. Companies are treated simply as collections of assets to be bought and sold, not as social institutions or as long-term wealth creators.

This has been made easy by low interest rates, economic stability and willing investors and lenders. Yet only those ignorant of economic history can believe it can continue forever. The key question for policymakers is what will happen when conditions change. At the very least the growth of debt-financed investment will make any landing considerably harder. At worst a speculative bubble will burst and, while employees will pay the heaviest price, they will not be the only victims. Lenders will see that they have ended up bearing the risk without sharing in the massive returns. Pension fund losses could affect millions. The unpleasant part of boom and bust could return.

These wider threats are why this is not just a trade union issue and why we need to see rapid international action. The issues are undoubtedly complex and the response will need to match that, but the purpose is clear - to stop private equity providing mega-bucks for a few at the expense of the social contract that ensures at least some stability and equity. The rumours that ever larger British brands such as J. Sainsbury, Boots, British Airways, ICI and Morrisons are in the private equity frame show that this is increasingly urgent. There are high political stakes in this and if it all ends in tears, people will want someone to blame.

The writer is general-secretary of the UK Trades Union Congress

Copyright The Financial Times Limited 2007