This is Master's in Business with Barry Ridholds on Bloomberg Radio. This week on the podcast, I have an extra special guest. Gretchen Morgensen is the Pulitzer Prize winning investigative journalist for The Wall Street Journal and The New York Times. She currently works at NBC News as an investigative reporter. She has worked at Money Magazine, Forbes, worth all over the place. Her last book was a bestseller, Reckless Endangerment is all
about the mortgage crisis. The current book is called These Are the Plunderers. How private Equity runs and recks America. That's a little bit of a sensationalistic headline. When we spoke, the focus and conversation is really emphasizes the largest of the large private equity firms. Yes, there's a legitimate need and use for private equities, especially in mid markets where, to be blunt, Wall Street has just abandoned that space and gone up market, creating a vacuum. But we talk
about some really fascinating things. Thirty percent of operating rooms are managed and run by doctors employed by private equity. That's a shocking number. We looked at everything from retail to nursing, homes, to hospitals, to insurance companies to manufacturers. Really, private equity used to be a small, outperforming sector of alternatives. It's now become giant, dominated by four firms, and no longer generating outsize returns. It's really a kind of fascinating
aspect of this. As it's become more and more mainstream, it appears some of the performance advantages may have gone away. Anyway, Gretchen is a legend on Wall Street. She's won Lobe Awards and just about every other journalistic award there is. So when she dives into a space, really she does not any stone on turn. I found this to be really interesting conversation, and I think you will also, so, with no further ado, my conversation with NBC's Gretchen Morgansen.
So let's talk a little bit about your kind of interesting career. You start as an assistant editor at Vogue magazine in the late seventies. How do you go from that to being a financial columnist?
Okay, well, first of all, assistant editor is a little strong. I was a secretary, and I got the job because I could type more than thirty five words a minute. Okay, So I was just out of college, brand new to New York. I had graduated from a small liberal arts college in the Midwest, and my eyes were as big as saucers as I came into New York. It was the only job I could get. I wanted to be a journalist. This was back in the Watergate days, and you know, it was kind of exciting to think about
possibly being a reporter. So that's my idea. Of course, the silence from my job applications to the New York Times, to Daily News, you name it was it was the silence was deafening. So Vogue was it?
So you didn't stay a secretary of Vogue for very long though.
Well, I sort of worked my way up, if you can call it that, to writing their personal finance column, which nobody read, by the way, at Vogue.
At Vogue, why they just wanted to have a little Hey, let's speak to women in our magazine.
Yes, so I think they sold it against an ad page, to be honest with you. But anyway, so it was very you know, basic instruction, and I really enjoyed doing that. And so I interviewed people, met a lot of folks, and then I was making very ten thousand dollars a year.
That's big money in the seven No really, not really, that wasn't even big money in the fifties years. Yeah, thing is that? Is that what led you to your interest in Wall Street?
Yes, so I said to myself, I don't have a rich dad, I don't have a rich husband. I'm going to have to make it on my own, and so what can I do? At about that time, Wall Street was battling a sex discrimination case with the EEOC. They had not hired enough women on the street this is the early eighties.
Returned, Oh, thank goodness that got resolved. Yeah, now that we have gender parody.
Well not quite, but it's better than it was anyways, definitely better. So they had to hire they had to start hiring women because they lost that case. And so I applied to the big brokerage firms as a salesman Dean Witter, Merrill Lynch Prudential Base at the time, and I got a job at Dean Witter. And the reason I got the job was because I killed it on the phone test.
Really, well, you had been doing some journalism beforehand, so you're not afraid to ask people questions, right, So this is in the eighties and the beginning of the huge bull market, not that anyone knew in eighty two that strap yourself in the next eighteen years are going to be a rocket ship.
Wait wait, wait. When I sat down in my chair at Dean Witter Reynolds, the Dow Jones Industrial average was at seven hundred and eighty one.
Still under a thousand. That's unbelievable.
So by the way, it made it hard to sell stocks because people were still in the looking backward phase. They weren't looking forward. But August nineteen eighty two, you're too young to remember that.
Oh no, I have a vivid recollection.
Was when the turn came and it was sort of like, okay, stocks are way too cheap. This is where you want to.
Be seven pe back then, right seven.
Pe on the SMP, and it was, you know, that was the turning point. So I was really well positioned for that move.
And you stayed at Dean Water for what three four years? How long were you there?
I stayed three years. I lived through the bear market that you don't remember of nineteen eighty three in tech stocks when there were this sort of you know, initial phase of personal computters and computing was becoming big, and they just got way ahead of themselves.
Even calling them tech stocks back then, what was the phrase, you.
Know, I don't know. I think it was text stocks. I mean, anyway, so.
I don't recall that bear market.
Yes, it was bad, it was vicious. It was over the summer of nineteen eighty three, and so I learned the hard way what happens when the stocks that you recommended to people because your firm was saying they would be goodbyes go down and those people lose money.
And I felt bad. It was just not in the next six months.
That's you know, they were ahead of themselves. You know, the euphoria, the momentum was getting too.
Was there euphoria in eighty three?
Yeah? Sure, no kidding, Oh yeah, Eagle Computer. I mean, some of these things were high flyers. And so when you had customers calling you up and saying, oh my gosh, what happened to all my money? It was such a huge trauma for me. I really felt bad, and I sort of felt like, if you have too much of a capacity for guilt, maybe not the right business.
So is that what set you back into journalists?
That's what sent me back. However, I did have it are I was now armed with a lot of information about how the world works on Wall Street.
So that's exactly where I was going to go next. You have a knack for finding some of Wall Street's shadier operations. You've done this your whole career. How important was working as a broker to giving you insight of, Hey, here's how this stuff really works.
Very important, very I mean you really saw the inner workings. You know, how the sausage is made, as they say, And so I would see how the over the counter desk, over the counterstock desk would push stocks and you know, encourage brokers to sell them, put a lot of commission in them to move them because some big seller was coming into the market. And you know, it just struck me. There were a couple of things about it that I
just kept seeing how it really was. The customer was not being put first, and there were, of course the conflicted analysts that I then wrote about years later. I saw that firsthand and was, you know, my customers were harmed by that as well.
So let's put a little sunshine. Let's put a little lipstick on this pig here it is. It's forty years later, the fiduciary side of the street, which was tiny in the eighties, is now not only large, but one of the fastest growing segments. While we're not even remotely close to gender parody, it's certainly better than it was.
It's better than it was to spare. You don't have strippers coming in for people's birthday parties like I saw when I was a broker.
Okay, unbelievable.
Yeah, yeah, I saw it with my own eyes.
I tell people who are the younger guys in the office, go watch boiler Room, go watch Wolf of Wall Street. They it's cinema verite. It just rings so and that world is gone. It's like the bad part. It's good that it's gone. But there were some good aspects of that, Like there were training programs. They taught people what's a stock, what's a bond. They used to do that at the bigger firms. Those are like tiny classes. Now, oh really, they don't do that anymore. Yeah, they do it, but
just not what it was. So around the same time you transition from Wall Street to journalism, the LBL boom starts to take off. It becomes all the rage. What were you thinking at the time, Hey, I'm gonna write a book in forty years or were you thinking this is interesting or here comes problems? How did you see it back then?
Back then? You know, it really just looked like a very reasonable response to a decade or so of undervalued stocks, right the nineteen seventies stocks were in the tank, you know, the death of equities, you remember to cover, and so it looked like it was really a pretty reasonable reaction to what had been years of undervalue in the stock market. So the initial phase of LBOs were not as not as pernicious as they are now because they were actually
taking over companies that had value. You know, they're sitting there in the stock price that you could see, like you mentioned the seven price earnings ratio. Yeah, so it really was a little it was reasonable, It made sense. It was a natural kind of outcome of what had happened before.
So we're going to talk a lot more about the book. These are the plunderers, but I have to mention the run of names that you really focus on in the book. These obviously aren't all of private equity. There's a whole lot hundreds of other companies, but Apollo, Blackstone, Carlisle and KKR really seems to be the key focus. Is it their size, their sector, the way they practice their business? What led you to those four?
Well, it's their size first, Barry. I mean, these are the leaders of the pack. These are the folks that and the firms that set the tone, lead the way other people mimic them. I mean, KKR was behind the big Cahuna deal of the nineteen late nineteen eighties, r j R Nibisco. So this is a group of firms and people that really were there at the creation of what we now call private equity, and they do it in such size and in such scope that they have
enormous impact. And that's why we're focusing on them. Yes, there are many, many private equity firms, but these really are the folks who set the tone.
And you mentioned barbarians at the Gate in the book, which focused on the KKR takeover of RJR Nimbisco. That was sort of unfathomable at the time that someone could buy a giant publicly traded company strictly with low cost debt. Did that change the game going forward at that Once r J or Nabisco was in play, does that mean anybody is in play? How did that affect what took place over the next few decades.
Yeah, and it also concerned Congress, as you remember, they had hearings about it. I mean, it was such a gargantuan deal at the time that it really made a lot of people nervous. And you know, there were studies done about what these deals would mean for workers, for pensions, and it really was sort of the beginning of questioning
what the impact of these deals would be. But they just kept going, kept going, and there really was a sense during the late eighties, especially after the crash of nineteen eighty seven, that we really don't want to meddle with this. Let's just let the market take its course. In fact, I think Secretary of the Treasury at the time said the Mark it will, you know, work out these things and they will not become a problem.
Yeah, the market always works these things out eventually, but that eventually can take longer right then expected. You mentioned they had a big impact, and they had a large effect that they also generated a lot of fees and a lot of moneies. What were the dollars like for these mega deals like r j AR Nibisco.
Well, at the time, it sounded big but if you look back on it now, I don't know. I think there was there's a number we have in the book, maybe seventy million dollars or something in fees tokake care. I mean, that's like not even around the right, that's pocket chat, that's not that's walking around money.
Right.
So, you know, it's just gotten so so so much bigger erys as you know, the markets and the capitol pools have gotten so much bigger.
Well we'll talk a little bit later about how as these companies got bigger, Wall Street got bigger, and it's kind of created a void underneath. But it's really really interesting to see where all this began at a time and when nobody really wanted a lot of these companies. They were some of these firms were, you know, all but left for debt. So you start the book with the line that kind of cracked me up. Let the looting begin. So let's start there. Where did this all begin?
And when did it move from hey, we're going to help finance these companies that can't seem to get finance to full on piracy and looting.
Well, there are a couple of things that happen early on that sort of you see the beginnings of that. These are that these takeovers are not only designed to find companies that are maybe undervalued or underperforming, we can whip them into shape and then sell them later. That while they're doing that, while they're monitoring them, while they are looking at them, streamlining them, you know, improving their operations, there are a lot of fees to be extracted from
these companies. So for starters, private equity firms will often put people on the company's board, and sometimes those board memberships will deliver earnings to those board members. Okay, you also had this thing called monitoring fees, where a company that was purchased by a private equity fund or firm would have to pay the firm fees for its monitoring, for its oversight, for its management expertise that it was providing to the company. Now, that makes sense because you know,
they took over the company. There's presumably plus they're presumably very good at managing, and they know what they're doing, and they have a goal of selling it, you know, at a profit later. However, the monitoring fees had this really kind of abusive element to them. They typically structured as ten year contracts, so the company would agree to pay over ten years a certain amount of monitoring fees every year to the private equity.
Firm, regardless of profitability or.
Oh yes, no, it was absolutely de rigor. They did it every year top line. So if the private equity firm sold the company after five years, the company still had to pay, still had to cough up the remaining five year contractual obligation of paying those monitorings.
Now, wouldn't that just whoever's a purchaser knows this is happening. Doesn't that just lower the cost the purchase price by that much? Maybe it's a liaity on the books, but.
Still it goes to these people. It is money for nothing.
It's good to be the case.
They are not doing the monitoring, and yet they're being paid to do the monitoring.
So there are other fees like that that just sort of away at the stability of a company.
Well I think I'm trying to think, oh well, okay, Well, first of all, the big fee that really ends up and this is not a fee to the private equity firm. But the big problem with many of these deals is the debt interest costs. Okay, so when the private equity firm takes over a company, they pile on a lot of debt on the company. It's expenses increase dramatically to pay those debt expenses, and oftentimes the companies will extract the firms, I mean, will extract money in the form
of what's called dividend recapitalizations. They will load the company with debt and then they'll take money out almost immediately, and that's just kind of a way of stripping the company of well.
In other words, when you say that they load the company with debt, they're borrowing a lot of capital. So now the company is sitting with this cash with an offsetting liability, meaning the company that's been purchased and the pe owner slash manager will take fees out of that.
Well, they take the dividend recapitalization, meaning that they take a portion of what debt they've raised in cash for themselves as a payout to themselves.
And who's lending this money to the company.
The banks could be Wall Street, could be private debt folks, but.
It's this is very often securitized and sold off into the market.
It can be collateralized loan obligations. Now it's big private debt. But so you had these dividend recaps. In two thousand and seven, firms extracted the private equity firms extracted twenty billion dollars from companies in the form of dividend recapitalizations, and by twenty twenty one they were extracting seventy billion in div and recapitalizations. Now that's money that a company has to pay back, right the debt that was raised to cover it.
And it's not going into what the company's doing.
And it's not going into the company's operations, and it has an interest cost associated with it. So that's another piece of the puzzle that I think is worth.
So we talked earlier about RJ or Nibisco. When you look at the history of the eighties and even nineties era LBOs, they seem to be a lot of lesser known, not necessarily consumer facing companies, transport and logistics and manufacturing like r JR is kind of one of the first names that the average person would know. How did that transition take place? What were most of the eighties era LBOs focused on. These were really way under the radar
sort of things. It's only later, or at least in the book you described that it's only later that it's household brands and retailers and names we know. Explain that a little bit if you would.
Well, I think what was going on again we talked a little bit about this earlier, is that these were the companies that were most undervalued. Remember, we were coming out of a very bad recession, and so probably what you had at that time, or you know, the industrial companies were the ones that were harmed, you know, very very much by the recession, and so their price earnings ratios were probably below the S and P average of seven, and so that might have been why they were taking
over and focusing more on them. But again, as this practice and process sort of morphed into something else, it became more about some of the big name companies that you know. Now. A big pivotal moment was when the junk bond market crashed in the early nineties. This was after the SNL crisis. SNL's had been persued to buy a lot of junk bonds. The market turned. Milkin and Drexel Burnham collapsed and failed. So you had this huge
market maker and junk bonds disappear. Junk bond market went really into the toilet, and that also then created a lot of distress in the market for companies that had borrowed from the junk bond market, and now you had those companies trading at very low prices. So again it was a distress situation that these companies took advantage of.
So how do you draw a distinction between LBO brands of private equity, the thing that some people call vulture capitalism, and credible mid market banking and merchant banking that is really one of the few sources of capital for these mid sized companies. Given that Wall Street started chasing all the big.
Firms, Well, I think you know, there is a right way and the wrong way to do this business, and certainly there are many firms doing the right thing. As far as what that might mean, Okay, less debt. Okay, the debt that is levied onto these companies is can be very damaging. And right now, Barry, we're going through a period of rising interest rates and companies are experiencing distress because much of this debt is floating, it's not fixed.
And so what you need to remember is that the costs associated with borrowing money as a company when interest rates are zero is a different story than when interest rates are five so that is a huge part of the puzzle. So how about putting a little more equity into these deals instead of so much debt. How about putting more of your own skin in the game kind of a thing. And I think, you know, the massive layoffs that often occur her are very detrimental. I think
that the asset stripping that has also occurred. Pensions, for instance, are sold off. Overfunded pensions get sold off and that goes, you know, into the private equity firm instead of into the company itself. So I think you can avoid some of these practices very easily. You don't maybe get the returns that you do when you have all those pieces
of the puzzle in place. But I think right now we have to think about this as is it a sustainable business model that you fire a lot of workers, that you strip pensions and health benefits, that you levy the debt on these companies, and that you want to sell them in five years, which is short termism you know that we often sort of deplore in the stock market. Is that is that really a business model that can work for the long haul.
So when private equity really was ramping up in the eighties and nineties. It was essentially an institutional allocation. This wasn't a mom and pop investment. Today that's changed. It's really attracting a lot of retail dollars. How is that working out?
Well, you know, it's interesting. For years decades, as you say, this was a investing strategy that was limited to sophisticated investors, you know, high network individuals, people who could you know, take it stand the fact that it's opaque, that it has high fees, that it is you know, not quite as investing in an S and P five hundred stock
fund and not that simple. But now it is encroaching onto the mom and pop in four O one k's the Labor Department under Donald Trump did open the door for private equity to get into for a one case. It had been prevented, had been barred from that before because of this fiduciary duty idea and also because of the opacity of these instruments. But so yes, you have it starting to seep into what we might call the
high net worth retail market. You know, some of these the Blackstone b reat is a perfect example of that. That's a real estate investment trust that is a Blackstone entity, and it has really done a lot to attract the kind of high net worth retail customers into that. So, you know, I think the private equity sees this as an opportunity because they're not really growing the institutional aspect
of their business. Pension funds perhaps maybe aren't growing as much as they need them to, and so this is a ripe market for them.
Yeah, clearly four oh one K is now much estra growing part of the allocation landscape then, either direct benefits or pensions that that, if anything, that side of the street is treating shrinking dramatically. Let's talk about some of the new areas that private equity seems to be playing in the book talks about emergency care and er rooms that have been privatized. I always think of er and those sort of emergency services as a service as a
community good, not a for profit model. Am I naive and not realizing we could monetize emergencies or should this be kept out of private asset allocators hands?
This is a really really crucial question for the whole private equity industry. Now they have seized on healthcare as a huge industry to really dive into to invest in and you know why that is because it's seventeen percent of gross domestic products. So it's a big, big pool, okay, of potential money. So you have private equity rolling up doctors practices, you have private equity going into dermatology practices, imaging MRI Mriyes, anesthesiology is another big one, and yes,
emergency departments. Emergency departments is another. And the difficulty with healthcare is that you are not supposed to put profits ahead of patients.
So let's talk about hospitals. I don't understand how all these not for profit hospitals get purchased and rolled up into a chain of not for profit hospitals that are managed for profitability. That seems to be, you know, counterintuitive. Tell us a little bit about what's.
Going on now we're really talking about, Perry, is the staffing companies that staff the hospitals. Okay, So private equity is not buying the emergency departments. What private equity is doing is operating the emergency departments.
Similar hotels operate for the hospital.
Okay. And it's like any staffing company. You know, you're a big whatever, you hire a staff and company to help you find people. Okay, So there are two major players in emergency departments. One is Team Health and the other is in Vision. Envision is owned by KKR and Team Health is Blackstone, and they control and other smaller private equity firms control forty percent of the nation's emergency departments. Now you don't know this. When you go to the
emergency department, the hospital hires them. Of course, they say to the hospital, we're going to improve your profitability. We're going to help you, you know, make more money. We're gonna you know, they'll say, improve patient care. But the doctors that I have spoken to in emergency medicine say that's absolutely not the case. That when the private equity firms come in, they tell them how to do their business, They tell them how to code for patient billings.
Well, they're medical experts, aren't they private equity. Don't they have a specialty in emergency care?
I know, I think they have.
They have a special so they're financers.
I'm sorry, Yes, they have a specialty financing.
But and you know, this is a horrife. I have to tell you. I don't have problem with private equity pushing into real estate and other areas, but emergency rooms seems if.
You're talking about you know, the coffee and donut, you know, the private equity owns. Okay, if you don't like the coffee and the donut, you'll go somewhere else. But if you're in need of an emergency department and this is the only one in your town and you have to go there and it's run by a private equity firm that is putting profits ahead of patients, that's a problem.
And this has become very big, not necessarily in big cities, but in the South, in rural areas, in places that have very limited healthcare options and a shortage of doctors. It's not like there's the option of saying, oh, I don't like Southwestern General, I'm going to go to Northeastern General and that's a better emergency room. This is usually one of the only games in town.
Is absolutely. Absolutely rural hospitals have really been hit by this practice. The other thing very is that they don't put the name on the door now over the emergency department. They don't say Team Health is here, or they don't say Envision or KKR or Blackstone is running this, And so try to find out if your emergency department is run by one of these companies. It's very difficult to do so again, it's opaque. Again, the consumer does not
know that this is happening. And so much of what private equity has taken over is kind of like this a stealth takeover because they don't put their names on the door.
So let's talk about senior living. Since when are old folks homes? A profit center? Tell us about that?
This is perhaps the biggest crisis I think, and it really became very evident in a twenty twenty one study by academics I think University of Chicago, you pen NYU that studied long term mortality at nursing homes that were owned by private equity and compared that with nursing homes.
There's so much more efficient. Their mortality rates have to be much better, right.
There's so much more efficient because maybe they hire fewer people to take care of the residents, that the mortality rate is higher, the mortality a little higher. Ten percent.
Really, that's a big number.
Ten percent. And so these academics found that there were twenty thousand lives that they said were lost because at private equity owned nursing homes, nursing facilities, and so you have the situation the academic said, where the focus, the extreme focus on cost cutting meant lower staffs meant you know, lesser care essentially translated to lesser care. And this was just a striking, striking study of the difference between and they were comparing it to other for profit nursing homes.
So this was not just for profit versus nonprofit. This was private equity for profit and nonprofit.
How did private equity healthcare, senior living nursing homes eers hospitals do during the COVID pandemic.
Well, they did very well because they got a lot of cares Act money from the government.
I mean, how did the care itself, how did they perform during the pandemic?
Well, as you know, healthcare was a disaster, and partly because we were so unprepared for the pandemic. And I would argue Barry that one of the reasons we were so unprepared was because healthcare had been a focus of private equity since really the mid two thousands. Okay, so HCA perfect example, that's a company that went private in
an LBO. And so what you had is these firms, again focusing on cost cutting, and so they were not likely to you know, stockpile ppe masks to buy ventilators to prepare for a pandemic, and inform.
That's the full cost money.
That costs money, and it's money that sits on a shelf. And these guys don't like money sitting on a shelf. And so you know, you have this. You actually had a study in Congress that had, you know, what might happen if we were to experience a pandemic, and it's this is back in two thousand and five or six, and it said we need to stockpile more than you know when.
You had the Gate study in what twenty fifteen saying the same thing, just in time. Inventory doesn't work during a pandemic. You can't get things. It turned out to be very accurate, right.
And so, but all those years leading up to twenty twenty, when the whole you know, world collapsed in March, all those years leading up to it, we had kind of a draining of healthcare, a bleeding of healthcare companies because getting the fat out, cutting the costs down.
So I'm going to ask you a question now, but it applies to insurance also, which we haven't we'll talk about in a minute, But there are regulatory agencies at the federal level. Well, every state has a medical board. How does this sort of four care profit with a much worse mortality rate and much worse health outcomes, how do they get by the state regulators? It would you would imagine that statewide regulatory medical boards wouldn't really tolerate this.
This is a sixty four trillion dollar question, Barry, and I would love for you to ask every state attorney general, for instance, why haven't you gone after for profit medicine. There is there are statutes in more than thirty states across the country that bar what's called the corporate practice
of medicine. And these laws came into effect, you know, one hundred years ago when you had you know, quack medicine show guys you know, out there selling you know, crazy chures for everything, and they decided, these states decided that you can't have profits potentially coming ahead of patient care. And so doctors actually have to run these organizations. And that is supposedly going to keep from a problem of
putting profits ahead of patients. But very very very few state ags have enforced laws against the corporate practice of medicine. And when they do bring cases. They are so tiny and so minimalistic in the risk slap that they deliver to these companies that it really is not even a cost of doing business. And so it's just like, okay, fine, I'll do it again and even bigger next time.
So let's talk insurance. The insurance policy stuff seems just absolutely egregious. How did private equity step into the insurance area? Again? A very heavy regulated industry with separate, very robust statewide oversight panels and boards. What's going on in the world of insurance.
Well, I'm very interested to hear you say. It's very robust on the state side.
At least that's how it's presented. Talk to people who try and get licensed to do insurance things, or if there's a failure to pay out a policy in the litigation that follows, there seems to be some options for policyholders, especially if you have a receptive governor or a state attorney general who can apply pressure through these insurance boards. Although maybe I'm living in the past.
Well, I think it's spotty. Let's just say that there are some states where the regulation is aggressive, but there are a lot where it is not. And as you might guess some of these companies flock to the one to the states where the oversight is more of the minimalistic. Now, the problem with insurance companies being owned by private equity is that you can understand why they want to own them because this is a pool of assets. It's a pool of money that they can really generate immense profits on.
And it's unlike banks. It's not fast money or hot money. It isn't likely to leave quickly berry like we've seen in some of the recent bank problems. So insurance companies are really huge pools of very stable money for these companies, for these private equity companies. And it's interesting because you're supposed to in insurance be very conservative and most I think most people who buy insurance policies really would prefer that they're ensure be a conservative entity that not taking risks.
We're not swinging for the fences here. You know. Yeah, if I can get a higher yield, that's awesome, but I really want to know that I'm going to get a payout when it comes time for my claim. So what these companies are doing is buying these insurance companies. They're also buying up pension assets very So a corporation has a pension, let's say it's Lockheed, Bristol Myers or a couple, and the private equity firm will buy those
pension obligations. Lockheed or Bristol Myers gets it off their books, they're happy. They transfer the risk that those obligations had for them, and the private equity firm takes over that risk. But now you don't have the pension benefit gearing corporation backing you if the pension should fail.
So a company could just get out from under the PBG by selling it to a third party.
Correct. It's called a pension risk transfer, and they have been happening like crazy. And private equity firms are the ones doing a lot of the pension risk transfers.
That's really interesting.
And so you have pensioners at Bristol Myers or Lockheed or Cores as another who are really relying on private equity to do the right thing for their pensions going forward, for their retirement, for their payouts when they need them. And that I think is something that we really don't
understand the entire nature of. And unfortunately we'll see we may see some problems with rising interest rates if some of the investments that these private equity firms have made in their insurance companies start having problems.
Are these arms length investments meaning you manage this as a fiduciary on behalf of the pensioner. You can't then turn around and festoon that pension filled with whatever junk paper you're selling to the street, or does that happen?
That does happen? Now, they do have to disclose in their statutory filings with the insurance regulators how much of their investment portfolio in the insurance company is related transactions or related stocks or bonds or mortgages or whatever. So they do have to disclose that. But I'm gonna guess that very few people read those disclosures.
Huh. Quite interesting. Let's talk about the insurance deal of the century. What's going on with Executive Life, What happened there and how did that go off the rails.
Executive Life is where we start sort of the book, because it was such a such a massive failure, and of course it was coming at the time of the junk bond collapse.
But this was a triple a highly regarded insurance company beforehand, this.
Was a highly rated insurance company had the highest rating, but it was run by a guy who was kind of what we used to call in the old days a gunslinger. He was a guy who was more of a risk taker than your average insurance company executive. And he bought a ton of junk bonds from Drexel. He was one of their top clients when they were selling, you know, these bonds of slightly you know, lower quality, lesser, slightly,
lesser known companies. He was there to buy. Okay, so his firm, his insurance company, had a ton of junk bonds, and when that market turned it was dire.
So this was really separate from private equity. This was just bad stud ward ship by an insurance executive who should be conservative. And again the question where the regulators when a conservative insurance company is buying junk I mean, it's right there in the name. They don't even hide it, junk bonds. What happened with the executive life they blow up?
They blow up. The Department of Insurance for the State of California was at the time run by John Garrimndi, who is now a representative in the House of Representatives from California in Washington, and he was just brand new in the job. It was a new elected position. Prior to that it had been appointees of the government of governor.
But we have to run to ye to run that could go right anyway.
So he won the big job, and the minute he got in the door, it was, you know, junk bonds were you know, cratering, and everybody was concerned about executive life and would it be able to to pay its policy holders, and so he seized the company. Now keep in mind, Burry, that he seesed it probably at or very near the bottom. Okay, So junk bonds were starting
to come back after he seized it. And so if it had been worked out another way, it's possible, like a reorganization, it's possible that the policy holders might not have lost what they ended up losing.
What was the haircut the policy holder?
You know, it's still to this day we don't know, but it certainly is in the three or four billion dollar maybe.
Does that look like a third half a big chunk though it was.
A big chunk for many people, you know, I mean I know of some cases where it was forty percent haircut for some policy holders. Right, it's very hard to you know, getting numbers on this stuff. They really don't want to help.
Tell us about the crazy rule that said, okay, now we're going to shred all the documents related to this. What the hell was that?
Well, okay, so let's just remember this happened in nineteen ninety one. Okay, the insurance department took it over in nineteen ninety one. Then we had Apollo Leon Black's new firm after he flees from Drexel.
The record is burning Grexel collapse, Grexel collapse, which arguably he didn't have anything to do with that was mostly Milkin's.
No, he was not in the junk bond area. He was a corporate finance person, so he was raising money for these companies.
So did he flee or did he just say, hey, let's go launch our own Yeah, let's.
Go launch our own company, right, But I mean, it was obviously a dire circumstance. So anyway, long story short, he ends up getting a hold of this huge junk bond portfolio, which was a lot of paper that he had put into Fred Carr's that's the name of the guy who ran Executive Life that paper that Apollo really knew what it was.
They was a salesperson and a financer.
He was the finance guy, right, and so he knew the numbers, he knew the companies, and so he knew that they were just distressed and that they could be restructured and reorganized. And so he buys this portfolio of John so Way.
He's New York based, right, he's New York based and executive life is in California. But because of the relationship with Drexel, he approaches California and says, we'd like to buy this junk paper or did they hold an auction? How did it go?
Well, it was with a French bank. Actually they were representing the bank. They were acting as the investment manager for the bank, and so it was going to be taken over by this French bank. But anyway, so the Department of Insurance sold it, sold the company cheap to on the cheap absolutely absolutely, and so the people that bought it in this case, the French bank and Apollo were able to ride the recovery of those junk bonds.
So when California sells this is there on behalf of the policyholder, right, that's right? Is there any mandate? Hey, you have to pay ninety cents on the dollar at least, or or there any requirements. They're selling it inexpensively. What riders is California attaching it to the new owners on behalf of the people the California Insurance Board is supposed to be operating on.
Well, California at the time said we think this is a great deal. You're going to get at least ninety cents on the dollar. Everybody is going to get at least ninety cents on the dollar. And that is their story, and they're sticking to that, and that's what they say.
They didn't require that as part of the purchase.
Well, that's what they said was going to happen as part of the purchase.
I can't say all sorts of things. But until I sign a contract that says I guarantee that I will pay ninety cents out to each shareholder at a minimum, it's just words.
Yeah. Well, what happened was a lot of people did not get ninety cents on the dollar. And there were quite a few people who are very who are up in arms, who wanted, you know, to be this to be investigated. But you know, it is sort of a moment in time that you look at and you say, this is what can happen if an insurance company takes risks with their policyholders' money.
Right, This all goes back to the gunslinger as opposed to a conservative operator. There are a couple of other regulatory questions that come up that I'm always sort of fascinated about. The first is the performance reporting for private equity. There have been lots of criticism from within Wall Street that at best it's aggressive and at worst it's just
a fantasy. If you're committing capital to private equity, you don't care when they do the purchase the sort of internal rate of return to the endowments and pensions who put money into private equity. They don't care about that, But that seems to be the way they report. Tell us a little bit about how performance numbers are ginned up. I don't even know how to describe it.
Well, these are private companies, not the firms themselves. They're publicly traded, as you know, but when they buy a company and put it into a fund, it's a private company. And so how they mark the value of that company is you know, there's leeway there, Barry. They can value it a certain way that. Let's just say the stock market wouldn't value it.
But you're valuing it specifically how you're purchasing it, and then if it's sold five years later, that's a hard dollar.
Correct.
Why is there so much wiggle room in.
Between because you haven't had a mark, you haven't had a buyer, I tell you exactly what it's worth until the end of the line when you actually do buy the company.
Huh. Really interesting. And let's talk about tax loopholes. How on earth is there still a carried interest tax loophole for private equity, hedge funds and venture capital. You're talking about a teeny tiny fraction of old taxpayers. Why the special treatment?
It started out I think as a special treatment for real estate, and it sort of morphed into this bigger, bigger thing as the private equity venture world expanded. And it essentially is that the managers executives of these companies just to end up paying a far far lower rate on their very beneficent payouts than you or I do. And it's a loophole that people have tried to get
rid of for decades. We've had congressional hearings about it, and yet it continues to stay on the books, and boy they cry blood murder when it comes time for people to say, look, maybe we should rethink this and not let these guys be I mean, it's like a billionaire minting machine to have this kind of a lower tax rate on these folks.
Who wants to pay thirty seven percent when you could pay essentially twenty three percent. Right, of course they're spending money on lobbyists, right, cut my taxes in half? Where do I sign up for that?
Yeah?
Oh wait, I don't have access to that.
Really, start a private equity firm, Barry.
So here's what we'll do. We'll start a private equity farm. We'll buy pensions and just put it in the S and P five hundred and cost us five BIPs to manage it. It'll be there's a lot of fat there if he approaches it that way. So let's talk about a little bit of pushback. I've seen some criticisms and some stuff. I want to get your your take on it. First.
We touched on this earlier. Aren't the big firms and the LBOs the lever buyouts very different than the middle market smaller private equity firms that provide capital and equity to small companies. How do we you know, aren't you painting with too broad a brush? Goes some of the criticism.
Well, if you look at these firms, these folks, these these really titans of industry, right, They're celebrated in the business pages, they are you know, on TV all the time. I mean, these are the people leading the way on this industry. Now, again, there are others who are doing it right and doing it in a better way, yes, but what you want to focus on. These are the folks that's at the tone. These are the folks that say,
here's how we're going to operate this. And these are the folks that do have the biggest impact Barry because of their size, and so that's why we really want to focus on them. So when you have, you know, two firms controlling thirty percent of emergency departments in this country, that's a lot, you know, That's why you focus on the big firms. They have the big impact, and so that's why we're doing that.
So let's talk about wealth inequality. You guys put a lot of blame on private equity for making it worse, But I look at wealth inequality and wage inequality and it's a lot of things. It's it's low wages and a low minimum wage that hasn't gone up in forever. It's corporate tax avoidance, it's the shifting of the tax burden away from the wealthy and away from corporations to the middle class. Aren't we putting too much blame on private equity for exacerbating wealth inequality in America?
Well, the reason we think it's important to include them in the mix is that we haven't really had that discussion. I mean, private equity was not really mentioned as a force in the inequality in the Gulf between rich and poor. In am you know, you would hear about offshoring of jobs. You would hear about companies going to Ireland so that they wouldn't have to pay you know, the high.
Taxes, the double Dutch whatever.
Whatever, and so there has been a lot of discussion. And of course the you know, uh, the defanging or the the diminishment of unions, so you don't have a balance of power between the worker and the corporation. But you look at some of the forces behind those forces, right, So pensions, great example, if you're starting to see private equity firms taking over pensions, you know, and and or
stripping the pensions of the companies that they bankrupt. That is a definite wealth gulf, right, That is a definite impact on every day people main street America that I just don't think we've really examined. So you just have to look behind some of the practices when you have retailing. You know, that's a big force, that a big area that private equity has been very forceful in. You know,
almost six hundred thousand jobs lost in retailing. Now, yes, some of that would have happened with the shift online, but honestly, you know, there have been consequences like that. So you look at that, and then you look at the problems with healthcare and what it's doing to patients, and so I do think that it is a force to be reckoned with here.
Right, So I'm glad you brought up retail. Some of the pushback I've seen is the United States has been wildly over retailed twenty I think in two thousand and seven we had twenty four square feet per capita versus Europe, which was like fourteen and Japan which was like nine. So we really had far more retailers than we knew what to do. We built way too many malls, and ultimately this was going to go through a huge set
of changes anyway. Private equity maybe it accelerated a little bit, but we certainly can't blame the shrinking retail footprint on pe can we.
We could maybe put some of it on them, right? Yeah? And obviously you know, the shift online hurt some folks. Toys r Us as an example of that.
But you know, more recently, Bedbath and Beyond that was a publicly traded company. They hit the wall without private equities help, That's right. So the biggest pushback I've seen is go back to the eighties and nineties when LBOs were first ramping up. Companies went from big to really big.
And as as these big, publicly traded mega companies went up market, the banks, the brokers, all Wall Street chased them and they just created this air pocket, this void underneath where there used to be national banks and national lenders servicing that industry. And they have nobody left to service them. And that vacuum is into what good private
equity has stepped. If it wasn't for the private equity below the four biggest companies, there's very little sources of capital for these one hundred five hundred seven hundred million dollar firms that Wall Street ignores.
Well, I think you have to say then if you're going to say, Okay, they're not these companies are not being banked properly, then that's great if you can get money from private equity, but let's not bankrupt them in the process. I mean, you have studied a study that shows that bankruptcies her you know, far more with companies that are private equitized than it does with other companies.
So I think that you, yes, if you want to have the resources, you know, the capital is not being assigned to these companies, but that doesn't mean that they should be you know, abused, or that some of these practices can't be questioned.
And my one of my favorite parts of the book. You talk about equity ownership and wealth ownership in the United States. In nineteen thirteen, the bottom ninety percent of incomes owned about fifteen percent of the wealthy United States. This is real estate businesses and publicly traded companies. By the eighties that had more than doubled to thirty five percent of the wealth in the US. Was that the peak. What happened with that going forward?
That was the peak. And one of the reasons for that very big, considerable growth, and that was the you know, people were able to have a family without having two wage earners, right, you were able to buy a house, et cetera that moment in time. Also a huge contributor to that was pensions, so corporate pensions that gave a worker reasonable shot at a prosperous retirement, and those started
disappearing in the mid to late eighties. And so that's a big factor in why the wealth held by the main street America, the middle class, the big broad brush America. That's why that has declined.
So here's I think my favorite pushback to the conversation about wealth inequality. And I'm curious as to your thoughts. It's not the top ten percent versus the bottom ninety percent where that big disparity has opened up. It's not even the top one percent versus the bottom ninety nine percent, although that's certainly pretty meaty. It's the top point zero one percent versus even within the top one percent. There's
this massive disparity. We didn't used to have that many billionaires in uber wealthy today versus I don't know, fifty one hundred years ago, how has the distribution of wealth shift in the United States, and what might come out of that going forward.
I just don't think it's a good thing to have this coterie of extreme, extreme wealth at the top of the pyramid. I mean, it's just not healthy. An economy does better if the most people are prosperous, right, and so these you know, multi multi, multi billionaires are really outliers. But it points to a problem with the entire society. And perhaps it's because we lawd wealthy people. But part of it is this tax loophole that really is unfair.
Part of it is some of the practices that really are aggressive and that end up harming companies and workers and pensioners. And let's not forget the huge fees that pensions pay to buy into private equity funds. And for years those private equity funds outperformed the S and P but they no longer do.
So let's hit on that, because that's really interesting. This was a small asset class that, whether it was the ill liquidity premium or just the ability to go places where public markets couldn't, actually did better than the markets. That risk premia seems to have evaporated.
It stopped out performing in like the mid two thousand so, or you know, towards two thousand and eight, and so you really have to wonder what the purpose of the continued infatuation with private equity among pensions is if they can get the same return in a S and P five hundred with five basis points as a cost and total transparency by the way, and a mark to market that you see at the end of every business day
and so you know where you stand. So it's not one of these fuzzy math situations where you don't really know what the value of the fund is because it's got private companies in it that are being marked by individuals, you know, who have an ax to grind in the mark.
Really quite interesting, So let me give you one of my curveball questions I like to surprise guests with. So your care your history is Money Magazine in the early mid eighties and then Forbes and then Worth Magazine. But while you were at Forbes in nineteen ninety five, you get tapped to be press secretary for then presidential election candidate Steve Forbes. What was that? Like, how different are political campaigns from covering finance?
Well, when Steve asked me to be his press secretary. It was I thought, wow, this is going to be interesting. You know, I even maybe thought this is going to be fun. Right now, I'm a financial reporter, I am not a Washington reporter, not a political reporter, and so it was I had a different, you know, idea of what it might be like. But anyway, it was a very very tough six months, I can imagine, and you
know it was. So Steve was a candidate that had economic ideas, okay, and one of them was the flat tax, which, by the way, would have gotten rid of lobbyists.
That was big benefles and all.
Those loopholes, right, flat tax. He was also for you know, medical savings accounts and health savings accounts anyway, and so I would have I would explain these concepts. And he was against the double taxation of dividends, which of course we have gotten rid of I think. Anyway, So those were sort of three of his initial ideas, and I would have to explain these to the Washington press corps. The Washington press corps not being financially oriented and probably
not that interested. They were just interested in the horse race. Now you know, Now we had he did very well in New Hampshire, and so for a frenzied moment, it was, you know, like this, you know, maybe he has a chance or a shot. But anyway, it was it was a very trying time for me, but I really became a better journalist because of it.
Well that I was going to go there with that question, what was it like being on the other side of the clamoring that scrum that you always see the photos of. How did that change how you do journalism and view journalists?
Well, I really after that decided that I really wanted to give people a lot more time to respond to my questions. And because I would be asked to answer questions that were quite you know, comprehensive and or tricky, difficult to come up with the answer in you know, like minutes, and so it was very frustrating to not
be able to do that. And so I came away from that experience saying, Okay, from now on, I'm going to give everybody that I'm writing about more time to respond because I don't want to be in that put them in the situation that I was in.
Huh, all right, we only have you for a few more minutes. Let me jump to my favorite questions that we asked all of our guests, starting with tell us what you're streaming, what are you watching listening to? What's keeping you entertained?
What am I streaming? Well, gosh, I really like the BBC show Happy Valley. I don't know if you've seen that. It's a kind of a detective, a pretty tough female detective like that. I like Ted Lasso. I know that's very mundane, but so those are the two right now.
Tell us about mentors who helped shape your career.
Jim Michaels, who was the editor of Forbes magazine. He was a very tough, old newspaper reporter. He was at UPI and he was the guy who broke the story of Gandhi's assassination, so really knew how to do that kind of you know, reporting. But he took his expertise to business and really taught me how to look at businesses, analyze balance sheets, income statements, really do contrarian reporting. He was a guy who didn't want, you know, the conventional wisdom.
He wanted to question the conventional wisdom. He was very difficult, very irascible, very demanding, but you really learned a lot.
Huh interesting. Let's talk about books. What are some of your favorites and what have you been reading recently.
I like nineteenth century fiction, so Anthony Twallop The Way We Live Now, which is a really wonderful book about a tycoon who is, you know, sort of a scoundrel who sells shares in a railroad company that doesn't really exist anyway.
Well, if you want the railroad to exist, that'll cost you more.
Yes, Right now, I'm actually reading a biography of Genghis Khan.
Oh, which one Weatherford Jack Weatherford. It's I'm not sure if that's the one I read, but it's amazing.
Yeah, And you know, that's a who's been kind of us. He was kind of slimed, you know, and you know, as being this terrible you know, marauder and everything, and it's it's a different story altogether. So I'm really enjoying that.
Our last two questions, what sort of advice would you give to a recent college grad who was interested in a career in either investigative journalism or finance.
Well, I would, of course say go with investigative reporting, because I think we need more of it in this country. I think we don't have as much as we need. We have seen newspapers hollowed out, of course, closed down. We've also seen that the costs of you know, associated with investigative reporting. It's not easy. It's not something that happens overnight. So it really is costly, and we've seen
that fewer and fewer of those folks. So I would say, gung ho, if you can get a job doing that, that it is going to be the most fun that you're going to have. And also, so I'm doing a service.
And what do you know about the world of investigative reporting and finance today you wish you knew back in the early eighties when you were first getting started.
Well, let's see, So what's about the world of finance that I wish I knew thirty years ago? Is that it isn't as hard as you think that it isn't. You know, A lot of people come out of college if they're not a financial person, like I was a humanities major, you know, and you have this mental block about numbers. I can't do numbers, or you know, it's not that hard. It really isn't that hard. It's common sense.
Now there are people who are really extra special good at it, but you know it's something that you can can tackle. Don't feel like you have a mental block against finance, and don't think that finance isn't important. Finance is not a backwater is. It touches everyone. It touches everybody in this country. It is political, it is everywhere, and so just don't discount the importance of finance.
Really interesting. Thank you Gretchen for being so generous with your time. We have been speaking with Gretchen Morgensen. She is the author of These Are the Plunderers, How Private Equity Runs and RECs America. If you enjoy this conversation, well be sure and check out any of the previous five hundred we've done over the past I don't know eight years. You can find those on YouTube, iTunes, Spotify,
or wherever you find your favorite podcasts. Sign up for my daily reading list at Rid Halts dot com, follow me on Twitter at Ridholt's follow all of the Bloomberg Family of podcasts at Podcasts. I would be remiss if I did not thank the crack team that helps put these conversations together each week. Sarah Livesey is my audio engineer at Tika of albrun is my project manager. Paris Walt is my producer. Sean Russo is my researcher. I'm
Barry Ridholts. You've been listening to Mass in Business on Bloomberg Radio.