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Obama’s awkward private equity dance

President Obama fired the first salvo with an ad featuring Bain Capital.ASSOCIATED PRESS

It was inevitable that Mitt Romney’s career at Bain Capital would feature prominently in the presidential race, because both candidates need to exploit it in order to win. Romney, who has opted to de-emphasize his term as Massachusetts governor, needs to convince voters that his tenure at the private equity firm imbued him with special skills to fix the weak economy. Obama, who has presided over that economy, must convince them of just the opposite — that Romney’s business skills don’t apply to the presidency and they’d be better off sticking with him. Obama’s reelection, in other words, hinges on discrediting Romney as a viable alternative. That means going after Bain and private equity.

Last week brought the opening salvo, a brutal ad that depicts Romney as having heartlessly bankrupted a Kansas City steel company in his lust for profits. A laid-off worker in the ad calls him a "vampire."

To reporters, Obama's political advisers repeatedly emphasize the "values" that Romney demonstrated in his business career, implying that there is something untoward or even unethical about his former career. The clearest expression of this came on Wednesday night from Obama's chief strategist, David Axelrod, who took to Twitter to declare: "Loading companies w debt, outsourcing jobs, offshoring accts, slashing wages & benefits & profiting off bankruptcies not experience US needs."


Romney has made himself vulnerable to such attacks by intentionally mischaracterizing his work for Bain as having been geared in some meaningful way toward creating jobs — he claims, implausibly, to have created 100,000 — rather than simply maximizing profits for his investors, as was really the case.

Still, it's odd to see private equity suddenly elevated to a pivotal national issue. "This is not a distraction," Obama insisted on Monday. "This is what this campaign is going to be about."

The reason why it's odd is that Obama has given no prior indication of being troubled by the industry's practices or made any obvious attempt to change them. Private equity didn't factor in the 2010 Dodd-Frank banking reform law, nor does it pose enough of a threat to worry financial reformers today. "It's a predatory business model which is unappealing and undesirable," says Dennis Kelleher, president and CEO of Better Markets, a nonprofit that promotes the public interest in financial matters. "But it doesn't pose a systemic threat, and there's no risk of bailouts arising from its activities, so taxpayers are not at risk from it."

That doesn't mean that reforms aren't possible or desirable. Private equity typically entails borrowing money to acquire underperforming companies, which firms like Bain Capital then try to improve and flip for a profit. The US tax code subsidizes and encourages this borrowing by privileging corporate debt over equity — it's fully deductible. This gives private equity an incentive to lever up their acquisitions with debt, yielding big profits when things work out, but destabilizing and bankrupting companies when they don't.


Obama has proposed two measures that would affect private equity. The first is eliminating the carried-interest loophole that allows executives like Romney to pay an extremely low rate of tax by claiming their earnings as capital gains rather than ordinary income. The second measure, not even a formal proposal but a suggestion contained in the president's Framework for Business Tax Reform last February, is to address the tax disparity between debt and equity, which would give firms like Bain less incentive to borrow.

But these measures aren't intended to change the industry's business practices; rather, they are simply ways for the government to raise more revenue.

Campaign rhetoric aside, it's not even clear that the industry needs new rules or regulations to curb its borrowing. "In the 1980s, it wasn't unusual for a private equity deal to be 90 percent debt," says Steven Kaplan, a finance professor at the University of Chicago Booth School of Business. "By the 1990s, it was down to 70 or 80 percent. Today, the typical deal is 60 percent debt, which is not even as much leverage as most people use to buy their house." And what caused this change? "After so many deals defaulted in the early 1990s," Kaplan says, "lenders got wise."


It's not yet clear what effect Obama's attacks will have.

But his own views about private equity seem much more benign than those of his advisers. On the same day that his ad rolled out, Obama was attending a fundraiser in New York City — hosted by a prominent private equity executive.

Joshua Green is national correspondent for Bloomberg Businessweek. Follow him on Twitter @JoshuaGreen.