Magazine article The American Prospect

Mitt Romney, Hero of Finance

Magazine article The American Prospect

Mitt Romney, Hero of Finance

Article excerpt

"Creative destruction" is Mitt Romney's best defense for his career in private equity and the trail of displaced workers some of his ventures left behind. The idea comes from the economist Joseph Schumpeter, who argued that capitalism generates economic growth through "gales of creative destruction" that sweep away obsolete technologies and products. As Romney's advocates have it, that's what his firm, Bain Capital, has advanced--painful economic changes that are essential to a rising standard of living.

If Romney made his fortune that way, he deserves the praise that some conservatives have lavished on him for contributing to American competitiveness. But that isn't the whole story. Much of the work of Bain and other private-equity firms has little to do with the kind of wrenching Schumpeterian change that contributes to growth, still less to the job creation for which Romney claims credit.

Technological innovation was at the heart of Schumpeter's vision, and no one today objects to the role of venture capital in financing tech startups or to the re-engineering of businesses to take advantage of new technology. Reorganizing firms to exploit special provisions in tax, securities, and bankruptcy laws is a different proposition. That kind of restructuring can be immensely profitable, transferring wealth to investors while making no positive contribution to growth and employment.

The standard operating procedure for private equity has been to buy firms, take them private, and load them up with debt. By taking them private, the new owners escape from the securities laws, which apply only to publicly traded companies. By loading them with debt, they cut the companies' taxes because the interest is fully deductible from profits, and they use those tax savings to pay themselves generous fees and dividends. If an over-leveraged enterprise then fails, they take it into bankruptcy, firing workers and stiffing creditors even though their own firm has already pocketed large gains. And because private-equity partners can receive those gains as "carried interest" (taxed only at 15 percent), they benefit from special legal advantages in yet one more way.

This kind of restructuring doesn't just siphon off wealth; it can also interfere with genuine innovation because debt-burdened companies are sometimes starved for capital to invest in new technologies and products. Private equity has generally sought a high return with a quick exit instead of providing patient capital for long-term gains. …

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