No, Bain Did Not Get a ‘Bailout’

Left-wing blogs and Mitt Romney’s presidential-primary rivals — and who can tell those apart this week? — have charged that Bain & Company, the firm Romney once headed, was the beneficiary of not one but two bailouts: one from the FDIC, and one from the federal Pension Benefit Guaranty Corporation. These allegations are nakedly false.

A little background: Romney began his career at Bain Consulting in 1977 and then led the effort to spin off a separate company, Bain Capital, a private-equity firm, in 1984. He was good at it: During Romney’s years at the firm, its average annual return on investments was 113 percent. But back at the mother ship, Bain & Company, things were not going as well. There were disputes among the senior leadership, and there was the usual Wall Street horror show of irresponsible debt. It was a classic case of corporate self-dealing — in fact it is a textbook case, as a number of analysts have pointed out, and you can read all about it in The Governance of Professional Service Firms.

Basically, what happened was the founder, Bill Bain, and other senior executives wanted to cash out their ownership in the company, but it is really hard to sell consulting firms, because they don’t have a lot of assets other than smart people and expertise. They got somebody to value the firm at a price that allowed them to sell 30 percent of it for $200 million, and split the cash up among themselves. The “buyer” in this case, though, wasn’t really a buyer: The partners created an Employee Stock Ownership Plan (ESOP), which borrowed the $200 million and took the senior partners’ equity on the behalf of the junior partners. (If the junior partners did not think this was a good idea, nobody was much listening to them.) It was your classic strategy of taking some cash in hand while leveraging up the firm on overly optimistic assumptions about future growth, kind of like American public finances writ small.

The inevitable happened, as the inevitable does: The firm did not grow as quickly as planned, cash became tight, and the debt service on that borrowed $200 million — $25 million a year — soon began to look like it might be too much to support. The firm also owed money to other creditors, including $38 million to the Bank of New England, which was itself in trouble. (More about that in a bit.)

Bear in mind, this happened before Mitt Romney’s watch. In 1991, he was asked to return to Bain & Company to clean up this mess, which he did, with what basically all witnesses describe as an awesome display of technocratic competence.

Romney may have caught flak for saying that he likes being able to fire people, but at Bain he showed that he knows how to handle underperforming executives — including his old boss and mentor, Bill Bain. Romney wrested control of the firm from the senior partners who had run it onto the rocks, and twisted their arms into returning more than $100 million in cash and securities. In return for his doing so, many of Bain’s creditors agreed to write down some of the firm’s debts. When somebody owes you money, the last thing you want is for him to go into bankruptcy — better to get back 85 cents on the dollar of what you’re owed than to get back $0.00. Among the Bain debts written down was that owed to the Bank of New England, which had by that time gone bust and been taken over by the FDIC. Bain’s sole involvement with the FDIC in the matter was that the regulator, acting as receiver for a failed bank (i.e., doing its job) agreed to a run-of-the-mill debt writedown, like any number of creditors do any given day of the week.

The free-market purists among you might believe that there should be no such thing as an FDIC, but that is, at this point, a philosophical question. The FDIC, as I have argued in National Review, is the best-performing financial regulator we have, and what it does is the opposite of bailing out institutions. Bailouts are retrospective, cooked up after a company gets into trouble. What the FDIC does is prospective, ensuring that banks can cover their deposits and providing insurance in case of insolvency. Bailouts involve transferring taxpayers’ money to banks; the FDIC charges banks a fee (essentially an insurance premium) for its services. It is, in other words, exactly the kind of institution we wish we had in place to prevent bailouts. The FDIC is not perfect, but it gets the job done.

The Pension Benefit Guaranty Corporation is a similar organization: It charges pension funds a fee and guarantees pension benefits in the event that a fund becomes insolvent. That was the case with GS Technologies, a failed steel mill in which Bain was a major shareholder. When the company collapsed in 2001 (after Romney had left Bain, incidentally), its pension fund was severely underfunded, and the PBGC ponied up $44 million to make sure that pension checks got cut. Which is to say, the PBGC did what the PBGC was there to do. The PBGC is a less well-run organization than the FDIC, and its standards probably ought to be higher than they are, but those facts do not tell us anything about Bain’s investment in GS Technologies.

One might argue that the PBGC creates a moral hazard, encouraging managements to intentionally underfund pensions while offloading the risk onto the federal agency, but it would be difficult to make the case that this describes Bain’s actions in the GS Technologies case. Simply put, the U.S. steel industry got wiped out by lean and wily foreign competitors in those years: Half of the U.S. steel industry went belly-up around the turn of the century. Bain had both good luck and bad luck with its steel investments. Some of the firms thrived, and some did not. That is the nature of investing, which is another word for risk-taking.

If anything, Romney’s record in the Bain turnaround looks even better on closer examination — money was clawed back from no-account executives, and ownership of the firm was transferred to the general partners from the senior partners who led the company to disaster. Whatever else it was, it was nothing like a “bailout.”

— Kevin D. Williamson is a deputy managing editor of National Review.


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