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NRO’s domestic-policy blog, by Reihan Salam.

The Awkward Attack on Bain Capital



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By now, you’ve no doubt seen the Obama campaign’s very well-produced advertisement attacking Mitt Romney and Bain Capital for its management of GST Steel, a manufacturer of steel rods that went bust in the early 2000s. The advertisement features a series of men, most of them steelworkers, decrying the vampire-like tactics of Bain Capital. There are a few obvious problems with the advertisement, however, as Robert Costa has noted here at NRO. One of the president’s top bundlers, Jonathan Lavine, has been a senior employee at Bain Capital for some years, and he was present during the period in which GST Steel went under. Mitt Romney was not, having left Bain Capital in 1999. This doesn’t mean that Romney had nothing to do with GST Steel’s failure, of course.

It is also true that GST Steel was part of a larger global steel industry that has gone through significant structural change, a subject Avik Roy has discussed in the context of another steel plant acquired by Bain Capital:

Beginning in 1959, American consumers of steel, such as the automakers, resolved to become less vulnerable to future disruptions in their supply of raw materials. For the first time, they began importing steel from abroad in significant quantities. They found that steel from emerging economies like Japan and South Korea was just as good as American steel, but much cheaper.

By the 1970s, the American steel industry was hemorrhaging business to foreign competitors. Manufacturers compensated by laying off workers, but this created a new problem. Experiencing the same dynamic that federal entitlements do today, manufacturers were faced with a growing number of retirees’ bloated pension costs and benefits, which they were funding with output from a shrinking number of active workers.

The Carter administration, aiming to prop up the industry, gave $300 million in loan guarantees to five steel companies. (Ironically, the largest recipient of Carter bailout funds, Wisconsin Steel, went bankrupt soon after due to a labor strike at one of their main customers.)

Successive presidents also tried, and failed, to prop up the steel industry. Ronald Reagan imposed quotas on imported steel. Bill Clinton provided $1 billion in loan guarantees to the industry. George W. Bush enacted tariffs on foreign steel. None of it worked. Over a seven-year period in the 1990s, more than 40 U.S. steel manufacturers went belly-up. Nearly all were union shops.

It is possible that employees at GST Steel believe that the steel industry was providing lifetime employment as late as the 1990s, yet that seems at least somewhat implausible given these larger currents. As of now, the U.S. accounts for 5.6% of the world’s crude steel production against 45.5% for China. Employment levels in the steel industry have been decreasing sharply in the U.S., thanks in large part to increasing productivity. Indeed, employment levels in China’s steel industry have also declined for much the same reason. 

These larger currents are complicated, and have in no sense undermined the effectiveness of the Obama campaign’s attack. What has undermined its effectiveness is the fact that Steven Rattner, who led President Obama’s effort to restructure GM and Chrysler, has described the attacks on Bain Capital as unfair. Moreover, the president released his attack ad on the same day that he was attending a fundraiser hosted by Hamilton James, president of the Blackstone Group, a private equity firm led by the controversial Romney backer Steve Schwarzman.

So the Obama campaign has taken a more nuanced line, as Reid Pillifant reports in Capital New York:

“No one is challenging Romney’s right to run his business as he saw fit, and no one is questioning the private-equity industry as a whole,” said deputy campaign manager Stephanie Cutter, who was joined on the call by a former employee at the steel mill and the workers’ lead negotiator at the company. “That’s not what this is about. This is about whether the lessons and values Romney drew from his time as a buyout specialist, what those values are, what they tell us about what type of president Romney would be, and whether the voters want that in the Oval Office.”

But it’s not easy to delineate the “lessons and values” Romney will have learned from his days in private equity from the broader industry practices.

This is kind of clever. We’re not attacking the private-equity industry as a whole. Rather, we are attacking the lessons and values associated with experience in the private-equity industry and instead (presumably) endorsing the lessons and values associated with the leadership of large public sector organizations.

Yet the attacks on Bain Capital from the Obama campaign have to date centered on leverage, e.g., the following from David Axelrod, as reported by Joshua Green of Bloomberg Businessweek

Here’s an Axelrod riff that will soon be very familiar: “When you look at his career in business, which is the credential that he’s hung his hat on, there’s no evidence of that. His business career was not about job creation. It was about wealth creation for himself and his partners, and often it came through vehicles like outsourcing, leveraging companies with debt, bankrupting companies and making money off of those bankruptcies. Oftentimes that cost jobs, and certainly wages and benefits. It didn’t create them. There’s nothing in his business record that would suggest that he’s a champion of creating an economy that works for the middle class.”

My sense, and I could be wrong, is that leveraging companies with debt is a fairly common practice across U.S. corporations, not just those acquired by the private-equity industry. As Arpit Gupta recently observed in this space, private equity firms seem to be better at protecting firms they acquire from default than comparable firms. And as Steve Kaplan and Per Stromberg have found, PE-owned firms are actually somewhat less likely to go bankrupt than the set of all corporate bond issuers. 

But as Josh Barro has argued, President Obama’s signature tax proposal, the Buffett Rule, will actually make leveraging companies with debt an even more attractive strategy:

[T]he proposal will significantly exacerbate a negative feature of our tax code: the preference for corporate debt finance over equity finance.

A corporation deducts interest payments before calculating its taxable income, and then an individual owner of corporate debt pays tax on interest payments at ordinary income rates. On the other hand, a corporation pays tax on profits after interest expense. These after-tax profits are either distributed to shareholders, who pay tax on the dividends; or they are retained, in which case the stock price rises and shareholders pay tax on capital gains.

Because interest is taxed only once and profits are taxed twice, corporations take on more debt than they would in absence of the tax distortion. The distortion is mitigated by the fact that dividends and capital gains are taxed at lower rates than interest income. Because the Buffett Rule would raise capital gains and dividend tax rates and, in many cases, lower the effective tax rate on interest, corporations would face even more incentive to overleverage themselves.

There is an irony here: one of the criticisms of Mitt Romney’s record at Bain Capital is that private equity firms put unhealthy amounts of leverage on the firms they acquire in order to exploit the favorable tax treatment of debt. The Buffett Rule would make that strategy even more attractive.

It should be said that Josh believes that Mitt Romney’s tax policy is misguided, largely because he believes (and he makes a convincing case) that the U.S. federal government needs to raise more revenue — indeed, he is even more critical of Romney than Obama on this front because Romney has proposed much deeper tax cuts. It seems fairly clear, however, that Buffett Rule would exacerbate existing distortions in favor of borrowing. I touch on some of these issues, including Josh’s insight, in my latest column for The Daily.

One thing to keep in mind: the attacks on Bain Capital launched during the Republican primary elections in South Carolina and Florida were hilariously bad and easily undermined. I had assumed that the Obama campaign, with its army of employees and its crack research staff, would have done a much better job.

But now the attack on Bain Capital amounts to this: Stephanie Cutter is not comfortable with the lessons Mitt Romney learned from having led an enterprise that aimed to resuscitate failing firms in declining industries by introducing new management techniques, supercharging incentives, etc., to raise productivity and profits. The reason she is not comfortable with this is that this process often involved job losses. Given that public sector inefficiency is a fairly serious problem, this is a revealing position to take — and I’ll bet that it will have considerable political resonance, though it’s not clear if it will appeal to swingable independents or just voters who would always have been hard for a Republican presidential candidate to reach. The advertisement prominently features white men with a working class cultural demeanor, which gives us a sense of who the Obama campaign is trying to reach.  



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