Screwy Capitalism: When a Hedge Fund Runs a Profitable Company into Bankruptcy
by John Lawrence
Hedge funds are leveraged buyout artists. They borrow huge sums of money in order to buy up all the outstanding stock of some company. Then they make that company, not the hedge fund, responsible for repaying the debt. In many cases they can't do it and so go bankrupt. Meanwhile, the hedge fund managers have paid themselves handsomely out of the borrowed money which again is money owed to Wall Street banks by the company not the hedge fund managers. Another name for hedge funds is private equity funds. The game is the same. Borrow in such a way that the borrowers are not responsible for the debt. This is not what capitalism is all about, but is what it's morphed into.
Instead of investors taking risk, the useful work of private equity, they make risk for others, what John MacIntosh called its malevolent doppelganger. After stripping the company of any asset that can be stuffed into the pockets of the hedge fund or private equity managers, the risk associated with the weakened company is largely borne by its employees, suppliers and customers who get little (if anything) in return.
This is exactly what happened to Toys R Us recently. The Toys "R" Us debacle began in 2005 when private equity firms bought the company for $7.5 billion. Over the last 12 years, this original "take private" deal has probably sucked more than $5 billion out of the company: $470 million in "advisory" fees and interest to the private equity firms and $4.8 billion ($400 million per year for 12 years) in interest on the acquisition debt plus the tens of millions of dollars in legal fees Toys "R" Us will spend in bankruptcy. (It's ironic that the investors who bankrupted the company won't be paying any of these fees.) Yet despite a tough retail environment, Toys "R" Us actually made $460 million from selling toys in 2016 but that didn't help much since all of it -- 100% -- went to pay interest on the debt.
The media portrays the Toys R Us bankruptcy as the plight of brick and mortar stores being handed their lunch by online retailers such as Amazon. Nothing could be further from the truth. The bankruptcy had to do with a transfer of money from the 99% such as the employees and suppliers to the 1%, the bankers, lawyers and financiers. Since all the interest paid was tax deductable, taxpayers also got screwed.
The extreme perversity of this situation is that the borrowers of money are not on the hook to pay it back. If you borrow money to buy a car or a house, you are on the hook. Not so when the borrowed money is used to buy a company. The limited liability corporate structure developed in the mid-19th century as a "corporate veil" to encourage investors to put money into companies is what allows investors to take money out without being on the hook. This law can and should be changed so that hedge and private equity funds cannot bankrupt companies, load them with debt, screw the employees, make them take less in wages, destroy their unions and raid the pension funds. A country that allows this to happen is intent on increasing the economic divide between rich and poor.
These leveraged buyout artists are nothing but parasites preying on and destroying companies for their own profits. They do nothing constructive in the process!
A sane economic system would not let this happen. You can have a system which encourages entrepreneurship and economic growth without the perverse economic ramifications of American capitalism.
