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Sunday, September 2, 2012

Romney's Bain Rescue

It is becoming increasingly clear that there is no such thing as a "good" (i.e. capable) businessman when it comes to running large financial companies.  Somehow, the very nature of that enterprise -- making money from (other people's) money -- creates incentives for risk-taking, and the risk-takers who win are always rewarded in terms of (a) winning, and (b) higher compensation.  In other words, the lucky rise to the top at disproportionate rates -- possibly at the expense of moderation or even understanding -- and eventually the luck always runs out.

How could anybody, no matter how capable, run a business like that?

Which is why there are no superstar financial CEOs.

Jamie Dimon was until he wasn't.

Sandy Weill was until he wasn't.

Robert Rubin was until he wasn't.

And several other bumblers were until they weren't as well.

So when Romney claims to have been a capable CEO of such a business, you have to take that with a grain of salt.  In the "The Federal Bailout That Saved Mitt Romney" in the Sept. 13 2012 of Rolling Stone, Tim Dickinson uses government documents to attempt to disprove Romney's own mythology about himself.

As will become clear as you read the rest of this post, as I read Dickinson's article more closely, I think Dickinson overstates the case against Romney, and is also missing key facts that would help readers judge whether what Romney did was defensible.

The bottom line, as I understand it, is that Bill Bain spun off "Bain Capital" (a private equity firm) from "Bain and Company" (a consulting firm) in 1984, and put Romney in charge of Bain Capital.  Mr. Bain and his cronies then looted Bain and Company for money to plow into Bain Capital, leaving Bain and Company $200 million in debt.

As an aside, this has always baffled me -- how is it that consulting firms (and law firms for that matter) wind up having so much debt?  Presumably they make their money by providing consulting services; what need is there for borrowing money?  When the press reports on debts like these, are they failing to mention some underlying physical assets or real estate?  Here's a quote from the article:

"To free up money to invest in the new business, founder Bill Bain and his partners cashed out much of their stock in the consulting firm – leaving it saddled with about $200 million in debt. (Romney, though not a founder, reportedly profited from the deal.) "People will tell you that Bill raped the place clean, was greedy, didn't know when to stop," a former Bain consultant later conceded. "Did they take too much out of the firm? You bet.""

So that's interesting.  Can I start a company, give myself all its stock, and then borrow $200 million dollars to get the company going, and then "cash out" my stock -- i.e. sell my stock back to the company for $200 million" and walk away?  Nice work if you can get it -- although there were doubtless a few more steps in Bain's process, this seems to be exactly what the founders did.  But of course the article doesn't specify exactly how much of the $200 million they took out (see below, it was at least $25 million).

End of aside.

Things went from bad to worse at Bain and Company when in the late 1980s a Bain consultant was implicated in a London financial scandal, and the recession hit.  Romney was then put in charge of Bain and Company -- which, as above, was suffering from a damaged reputation, founder looting, and a recession --  and he now claims to have rescued it.

The article explains how he did it.

The choice for Bain & Co. and its creditors was whether to let Bain go bankrupt (in which case the creditors would get to divide Bain's looted assets), or whether something could be done to enable Bain to keep going, so that it could eventually honor its debts to the creditors (or at least pay the creditors more than they would have gotten out of a bankruptcy).

Romney apparently started off well:  according to the article, "He persuaded the founders to return $25 million of the cash they had raided from Bain & Company and forgive $75 million in debt, in return for protection from most future liabilities."

Another aside:  The reference to debt-forgiveness by the founders is somewhat puzzling, and I don't think it has an antecedent basis in the article.  Perhaps it means that the founders hadn't really taken out a full $200 million -- this suggests that they took out at least $25 million, and also managed to set things up so that the company still owed them money as creditors.  This also suggests that the $200 million initially reported in the article included $75 million lent by the founders.

End other aside.

This suggests that Romney might well have "repaired" whatever damage Bain had inflicted on itself through the looting.

Unfortunately, the article is woefully short on numbers from here on in, just referring to "massive debt" but noting that the company was "flush with cash" because of the money put in by the founders.  The article tells us that Romney consolidated its remaining debts with four banks, one of which was owned by the FDIC and was owed $30.6 million (this is where Romney's claim that he saved taxpayers $30 million comes from).

As mentioned, the article says that the company was "flush with cash" as a result of Bain's having given up some of the looted money, and then says:

"Under normal circumstances, such ample reserves would have made liquidating Bain an attractive option: Creditors could simply divvy up the stockpiled cash and be done with the troubled firm."

But there's no clear support for this.  All the reader can see is that the company might have gotten $25 million in "cash" from Bain etc.  But as far as I can tell, it was still at least $100 million in debt.  So creditors divvying it up in bankruptcy would get only 25 cents on the dollar.  WE NEED MORE NUMBERS!

There article goes on to explain the negotiation:

"But Bain had inserted a poison pill in its loan agreement with the banks: Instead of being required to use its cash to pay back the firm's creditors, the money could be pocketed by Bain executives in the form of fat bonuses – starting with VPs making $200,000 and up. "The company can deplete its cash balances by making officer-bonus payments," the FDIC lamented, "and still be in compliance with the loan documents."

"What's more, the bonus loophole gave Romney a perverse form of leverage: If the banks and the FDIC didn't give in to his demands and forgive much of Bain's debts, Romney would raid the firm's coffers, pushing it into the very bankruptcy that the loan agreement had been intended to avert. The losers in this game would not only be Bain's creditors – including the federal government – but the firm's nearly 1,000 employees worldwide.  {PF Note: now, just a few words after saying the company should have been liquidated, Dickinson is worried about the Bain employees who would lose their jobs in a liquidation]


"In March 1992, according to the FDIC documents, Romney approached the banks and played the bonus card. Allow Bain to pay off its debt at a deep discount, he demanded – just 35 cents on the dollar. Otherwise, the "majority" of the firm's "excess cash" would "be available for the bonus pool to its officers at a vice president level and above.""

We just don't have the numbers to really assess this.  But if the "cash" on hand was $25 million, I guess the fact that he could pay out "the majority" of it in bankruptcy suggests that he could have paid more than $12.5 million in bonuses, rather than let the creditors have it.

I have to admit if I were in his position, I would have played the same card.  If I was a shareholder in Bain, I would hope that whoever was in charge of that negotiation would have played that card.  It's a negotiation, after all.  But we still don't know how exactly the 35 cents on the dollar compared with a bankruptcy return.  As above, it appears that even without paying the bonuses, a bankruptcy might have resulted in only 25 cents on the dollar.  So 35 cents might have been reasonably generous (and would have allowed the 1000 Bain employees to keep their jobs).

And it's also pretty interesting that the four remaining banks -- the creditors at issue here -- were willing to permit Bain to put that "poison pill" into their agreements.  You would think that if they had had any negotiating sense, they wouldn't have done that.  It's really the carelessness of those banks (plus the FDIC) that's to blame for Romney's negotiating tactic.

"The next month, when the banks balked at the deal, Romney decided to prove he wasn't bluffing. "As the bank group did not accept the proposal from Bain," the records show, "Bain's senior management has decided to go forth with the distribution of bonuses." (Bain's lawyers redacted the amount of the executive payouts, and the Romney campaign refused to comment on whether Romney himself received a bonus.)

"Romney's decision to place executive compensation over fiscal responsibility immediately put Bain on the ropes. By that July, FDIC analysts reported, Bain had so little money left that "the company will actually run out of cash and default on the existing debt structure" as early as 1995. If that happened, Bain employees and American consumers would take the hit – an alternative that analysts considered "catastrophic."

"But Romney didn't dole out all of Bain's cash as bonuses right away. According to a record from May 1992, he set aside some of the money to put one last squeeze on the firm's creditors. Romney now demanded that the banks and the government agree to a deal that was even less favorable than the last – to retire Bain's debts "at a price up to but not exceeding 30 cents on the dollar.""

So this is all part of the negotiation -- yes, Romney put Bain on the ropes [although query whether Bain wasn't already on the ropes], but only because the banks refused to accept his initial offer of 35 cents on the dollar.

And now this:

"The FDIC considered finding a buyer to take over its loans to Bain, but analysts concluded that "Bain has no value as a going concern." And the government wasn't likely to get much out of Bain if it allowed the firm to go bankrupt: The loan agreement engineered by Romney had left the FDIC "virtually unsecured" on the $30.6 million it was owed by Bain. "Once bonuses are paid," the analysts warned, "all members of the bank group believe this company will dissolve during 1993.""

I can't help but resent the line "the loan agreement engineered by Romney."  There were two parties to that agreement, and this was at exactly the time that the FDIC had the very most leverage.  And yet its lawyers apparently allowed the poison pill provisions, and otherwise left the taxpayers "virtually unsecured" on their $30.6 million.  The article gives a hint as to how this might have happened -- the head of the FDIC was Bill Seidman, an old crony of Romney's father's, and Romney had  given a  former FDIC bank examiner a senior executive at Bain position a month before closing on the loan agreement (but there's no indication of when the guy worked at FDIC -- also I'm not sure why this would motivate the people left behind at the FDIC to negotiate a bad agreement).

Towards the end of the article, we get some numbers that might have been helpful sooner:

"In the end, the government surrendered. At the time, The Boston Globe cited bankers dismissing the bailout as "relatively routine" – but the federal documents reveal it was anything but. The FDIC agreed to accept nearly $5 million in cash to retire $15 million in Bain's debt – an immediate government bailout of $10 million. All told, the FDIC estimated it would recoup just $14 million of the $30 million that Romney's firm owed the government.

"It was a raw deal – but Romney's threat to loot his own firm had left the government with no other choice. If the FDIC had pushed Bain into bankruptcy, the records reveal, the agency would have recouped just $3.56 million from the firm."

Again, the "other choice" would have been to negotiate a better agreement.  And also, this would seem to confirm my suspicion above that even apart from the poison pill, and even when the company was "flush with cash" bankruptcy would not have been the best option.  The result was that the government (apparently) got 14 million back on 30.6 million, which is over 45 cents on the dollar, which is more than Romney ever offered.

And now for the last two paragraphs:

"But while taxpayers did not finance the bailout, the debt forgiven by the government was booked as a loss to the FDIC – and then recouped through higher insurance premiums from banks. And banks, of course, are notorious for finding ways to pass their costs along to customers, usually in the form of higher fees. Thanks to the nature of the market, in other words, the bailout negotiated by Romney ultimately wound up being paid by the American people."

Yes, banks are notorious for increasing fees (and if you've been reading this blog, you'll know I've been victimized by some of them), but that's very different from a taxpayer-funded bailout.  The fees fall disproportionately on members of the public who are too clueless to notice or avoid them -- modern capitalism at work.

"Even as consumers took a loss, however, a small group of investors wound up getting a good deal in the bailout. Bain Capital – the very firm that had triggered the crisis in the first place – walked away with $4 million. That was the fee it charged Bain & Company for loaning the consulting firm the services of its chief executive – one Willard Mitt Romney."

We also don't have enough facts to assess this.  Obviously Romney provided significant value to Bain and Company by saving it from liquidation.  But was there really $4 million in cash in Bain and Company available for this?  Did the FDIC have to approve it?

Now let's take a quick look at how the Romney campaign characterizes the Bain & Co. rescue:

"In 1990, Mitt Romney's former firm, Bain & Company, was in a dire situation. It was on the brink of collapse. The leaders of Bain & Co. asked Romney to come back to the firm to lead it out of the precipitous fall it was experiencing. His return to the company provided an instantaneous morale boost for the employees that recognized Romney's leadership capabilities and his strong record of turning around companies. He reined in spending, made executives more financially accountable, and put the focus back on customer service.

"Bain & Co.'s turnaround was an incredible success: In just a year, a company on the brink had returned to profitability. Mitt Romney not only saved thousands of jobs, but also set the firm on a course to be one of the largest and most successful management consulting firms in the world. Today, Boston-based Bain & Co. has more than 5,000 employees - including 3,500 consultants - and is ranked #1 on multiple "best places to work" lists."

Ok, that's a bit vague and it doesn't mention the negotiating tactic (and the payout of executive bonuses).  But it doesn't seem to be untrue . . . . .

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