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Friday Fronts
8 February 2008:
James B Stewart on Stephen A Schwarzman, in The New Yorker.
The question, of course, is not about how you get to spend your money.
Schwarzman’s many friends stoutly defend his right to spend or give away his wealth as he sees fit. I spoke to a number of people who attended the sixtieth-birthday party; most felt that, as one friend put it, “it’s his money, and he should be able to do what he wants with it.” He added, “Isn’t this America?”
The question is this: how are you allowed to earn it?
A number of ways are foreclosed by law. Raising money by fraudulent means is prohibited, as, one hopes, is stealing it. In my lifetime, lotteries have become legal, but opposition to them, although low-key, is widespread, and socio-economically salient: many bright and affluent people who would never buy a lottery ticket themselves, and who regard lotteries, correctly, as a tax on mathematical incompetence, find themselves in the parental position of wishing to protect the ill-informed against their own vulnerability. With their tragically conflicted legacies of moral Puritanism and frontier libertarianism, the people of the United States have never settled the parental hash; so it is all right to prohibit narcotics, but television, which has unquestionably done more damage to the body politic, continues to be regulated only in meaninglessly symbolic ways that leave its audience open to the most astonishing manipulations. (Consider "Swift Boats" and "McCain's black bastard.") Faced with pointlessly destructive financial transactions that not only stop well short of theft but bend to the contemporary obsession with "transparency" and "full disclosure," Americans throw up their hands.
Reading James B Stewart's disappointingly lackluster Profile of Blackstone billionaire Stephen A Schwarzman, one is able to draw one sure conclusion: Blackstone's business — its buying and selling of firms with so-called "private equity" — makes no sense at all other than to take advantage of tax law provisions that never contemplated the use to which entrepreneurs like Mr Schwarzman have (altogether lawfully) put them.
The obvious next step is to change the law. This has been bruited in Congress, but the attempt to tax increases in "private equity" as relatively highly-taxed income, instead of, as currently, low-taxed capital gains has not built up much traction, and it is doubtful that anybody in Washington is sincerely eager to make the change. Trickle-down thinking remains prevalent in the centers of power: if a lot of money is being made, some of it will fall into everyone's pockets. As indeed any lobbyist will attest. Nearly two years ago, I took Princeton professor Alan Blinder to task for his complacency with regard to just how the wealth might be "shared." A handful of us will actually own things, while everyone else will get to take care of the property, for a modest fee. Mr Stewart appears to be blithely unaware of this highly foreseeable endgame.
Lest you think that Mr Schwarzman and his rivals are ingenious "masters of the universe" in possession of economic secrets unknown to the general business public, don't trip over the following observation:
Much as private-equity firms like to extoll the brilliance of their M.B.A.-holding partners and associates, this isn’t a difficult concept, which raises the question of why public companies don’t embrace the same high-leverage, high-profit model. The reason is that private-equity funds exist to generate capital gains, which are taxed at fifteen per cent; public companies focus on earnings, which are taxed at a much higher rate. Public companies are typically valued at a multiple of earnings, and the interest payments associated with high leverage may all but eliminate earnings. Private companies don’t report earnings. Freed from any preoccupation with quarterly earnings reports, private-equity firms like to praise their long-term perspective, but “long term” means between five and seven years, at which point they sell the asset to realize a capital gain and move on to new conquests. Most public companies are managed so as to exist in perpetuity.
As we now know, all of this wealth-producing machinery hums along beautifully when credit is easy and few investors are risk-averse. As such, it is like imposing mahogany furniture that really cannot be left out by the pool in stormy weather. There is a reason why "most public companies are managed to exist in perpetuity." Forget "perpetuity" — their owners merely want to survive the next downturn.
However such intemperate organs as the Wall Street Journal might holler about socialism, it is surely a maxim of the most enlightened capitalism that financial markets, while impotent as to genuine capital growth, can wreak unlimited capital destruction. Only those who haven't heard of the events surrounding October 1929 would think otherwise.
Copyright (c) 2008 Pourover Press