Since the giant bank bailout and historic recession set off by the Crash of 2007-08, experts have increasingly wondered whether all the "financial engineering" out of Wall Street adds any overall value to the economy. Or whether, on the other hand, all this financial "innovation" -- super-complex derivatives, credit default swaps and such -- is mainly just a clever way for a few fat-cats to get rich together, usually at the public's expense. According to some studies, the costs of repeated bailouts and downturns triggered by Wall Street manias are so great that they add up to far more over the long run than any added value brought by Wall Street. Among those leading the charge against fancy finance is former Fed Chairman Paul Volcker, who said back in 2009 that he had not found one "shred of neutral evidence" that tied financial innovation to "the growth of the economy."
A microcosm of this debate is occurring over the sort of financial engineering that was Mitt Romney's specialty: the "private equity" business. The term "private equity" sounds respectable enough, but it is really just a euphemism for the old leveraged buyout deals we remember from the 1980s, the barbarians-at-the-gate era of corporate raiders like T. Boone Pickens and Henry Kravis. After junk-bond king Michael Milken, who funded a lot of those takeovers, went to jail, the industry decided to rename itself in order to remove the taint.
This is Mitt Romney's true world, as I write in a forthcoming article in National Journal. Romney was a brilliant LBO buccaneer who specialized in buying up firms by taking on a lot of debt, using the target firm as collateral. He would then try to make the firm profitable, sometimes by breaking it up or slashing jobs, to the point where Bain and its investors could leverage up further--get banks to lend them more, in other words-- and quickly pay themselves off out of that new debt. That would ensure a profit for Bain investors whether or not the companies themselves succeeded in the long run. Often, burdened by all that debt, these bought-out companies did not succeed, costing thousands of jobs as they were downsized, sold off and shuttered. Other times they did very well, as in the case of Sports Authority and Domino's Pizza. But those outcomes--and certainly overall job creation--mattered little to Bain's business model, which was all about paying back investors.
These tactics made Mitt Romney one of the richest men ever to run for president. And for decades, Wall Street has sold this business model to companies--and the public--the way Gordon Gekko once did in the movie Wall Street. "Greed is good," Gekko famously said, because he and his fellow corporate raiders make the businesses they take over more efficient. "I am not a destroyer of companies. I am a liberator of them!" Gekko says. Romney has said similar things on the campaign trail, claiming to have rescued failing companies and created tens of thousands of jobs.
But here's something closer to reality: In a paper published by the National Bureau of Economic Research in 2008, Stanford economists Phillip Leslie and Paul Oyer concluded that there is "little evidence" that companies taken over by private-equity firms like Bain "outperform public firms in profitability or operational efficiency." Those results, the authors conclude, "raise questions about the value created by private equity." In other words, the kinds of deals Bain and other corporate raiders engage in may amount to ... just more financial engineering.
That doesn't mean Bain Capital added no value to the overall U.S. economy--it certainly did. Romney started Bain from nothing and turned it into a respected giant of the private-equity industry, with total assets under management amounting to about $65 billion today. Bain has enriched its many loyal investors, including pension funds and college endowments. But the question of how Bain really did this goes to the heart of Romney's seeming inability, on the campaign trail, to cite any reliable data about how many jobs Bain created, or even to make a persuasive case that he has helped to create, more broadly, wealth for the U.S. economy. Truth is, no one knows how many jobs are created by private-equity firms, because no one in the business cares: it's an irrelevant data point.
To be sure, as one of the most successful capitalists ever to run for president, Romney still has a good argument to make to the American people: not only did he create wealth for his investors, he's clearly a numbers whiz who's handy with a budget, as he proved in doing about 100 deals with Bain. But he's not going to make that case well unless he talks more forthrightly about the kind of business he really was in.
The LBO business, euphemized as private equity, is still not very pretty. At Bain, Romney was "a very effective leader--a very effective leader of a bunch of sharks," says Liaquat Ahamed, author of the Pulitzer Prize-winning book Lords of Finance. Romney, of course, wouldn't put it that way, but he doesn't have to. According to David Rosenbloom, a well-known tax attorney and the former international tax counsel at the Treasury Department, Romney could explain his business history "pretty straightforwardly: Bain Capital creates wealth, not jobs. But the guy never really says the common-sense, obvious answer to things."
Perhaps he feels he doesn't need to, with the latest polls showing that President Obama is losing more ground in his favorable ratings, especially on the question of who can best manage the economy. But by remaining largely silent, or glossing over Bain's true business, Romney is taking a big risk of allowing himself to be negatively defined by the Obama campaign, in much the same way the Republicans painted an unresponsive John Kerry as a vacillating wimp in 2004, and an equally flummoxed Michael Dukakis as weak on crime in 1988. In what is still a deadlocked election, can Romney afford that?