Taking a deep dive into global finance, private equity and a coming recession with Nicholas Shaxson, author of The Finance Curse
By Julie Reynolds
If you want to understand the mechanics of why and how Alden Global Capital can blithely strip-mine America’s local newspapers for personal profit, it helps to know two terms: “offshore tax haven” and “wealth extraction.”
OK, I’ll throw in one more: “Limited Liability Corporations.”
With a worldwide recession surely looming, the sustainability of heavily indebted U.S. news chains has become even more precarious. After all, they’ve already been stripped to the bone by private equity firms like Alden.
And the go-to expert on all this is Nicholas Shaxson.
You can read my earlier story about his findings here, but if you want a deeper dive into how this takes place in a global context, read on.
Shaxson’s 2011 book Treasure Islands: Uncovering the Damage of Offshore Banking and Tax Havens takes readers on “a riveting journey from Moscow to London to Switzerland to Delaware,” as its publisher says. Offshore tax evasion, he argues, has cost the United States $100 billion in lost revenue each year. That’s in addition to the obvious transparency issues it raises in the case of a U.S. media owner like Alden.
Last year, his book The Finance Curse: How Global Finance is Making Us All Poorer was published in the U.S. by Grove Atlantic. Shaxson, formerly a correspondent for the Financial Times and The Economist, posits that we’ve been led to believe that international big finance is all about “wealth creation,” when in fact it’s really a conveyance for wealth extraction.
The Finance Curse includes a full chapter about Alden — owner of Digital First/MNG newspapers and now a controlling interest in Tribune Publishing— and its devastating impact on local news in the United States.
Interestingly, Alden and its numerous funds are all incorporated in Delaware and the Cayman Islands.
I spoke with Shaxson by phone from his home in Berlin. Below is a transcript of our interview that has been edited for length and clarity.
JR: What made you think about including a company like Alden in The Finance Curse? There are a lot of examples in the U.S. of hedge funds going after other essential things, like health care. Why journalism and why Alden?
NS: The book itself encompasses such a grand, huge area, that it was always going to be a fairly eclectic choice what I was going to pick as examples. Alden I thought particularly interesting because I see Alden as a kind of mixture between a hedge fund and private equity. It does kind of hedge-fundy things like messing around in the debt markets and arbitrage and stuff like that, but it also uses that to buy and control companies that are doing real things in the real economy. So that was pretty interesting.
Private equity I have a particular bugbear about because it very much epitomizes the kind of wealth extraction — as opposed to wealth creation — that is right at the heart of the Finance Curse thesis.
They set about single-mindedly buying up a company and then identifying each one of that company’s stakeholders. Tithe stakeholders would be the workers, for example, the pension fund, the suppliers, and the taxpayers as well. And all the different stakeholders of that company then get kind of milked.
They’ll buy something — a company that hasn’t run its financial affairs through tax havens, for example — and they’ll go and engineer all that and suck some money away from taxpayers. They’ll say that maybe the workers are being paid too much or the unions are too strong, or the pension fund is too generous. And then they’ll go after those and squeeze some more out.
They might pay their suppliers later, or put on more onerous conditions, or they might go into a market niche and say, “Look, there’s six companies in this niche. Let’s buy all of them, and let’s get some market power, some sort of monopolization.” That’s the core of what private equity does. They call it shareholder value or maximizing returns, but it is very much an extractive strategy. It’s not a productive thing. None of this financial engineering leads to real entrepreneurialism or productivity or useful stuff. It’s all milking or extracting.
Alden was particularly interesting because it’s in the media sector. I’m a journalist by background, and it goes so clearly to the heart of democracy. What they’re doing is tinkering with one of the very foundations of democracy.
I think a lot of people see what’s going on with private equity firms in rather abstract terms. I wanted to really make the point that this is messing with one of the pillars of democracy. So that’s why Alden was interesting.
I could have stumbled across another company that may have been just as interesting — I’ve just been reading about a private equity firm that has locked up the entire cheerleading industry.
JR: What the…?
NS: There’s this guy called Matt Stoller. He just published a book called Goliath, and he’s got a newsletter which he sends around and his latest one is on cheerleading, and it’s just absolutely insane what’s going on.
I could have chosen loads of companies, but Alden — somehow it really gripped me.
JR: You’re familiar with Alden taking money from the newspaper chains and investing it in these retail operations that then declared bankruptcy and shut down, like Fred’s pharmacies and Payless ShoeSource.
I’m wondering if you have any insight as to how they make money in that situation. If they’re buying a company, the stock is maybe $12 a share, and by the time Alden is done, it’s worthless. So where are they getting their money?
NS: I cannot comment specifically about these cases because I haven’t been looking at them recently. But in general terms, the biggest trick is you, as a private equity firm, you’re playing with limited liability laws. And other people’s money.
I’ll start with the other peoples’ money. So what you’re doing — you, the mogul, the titan running the show — you buy up a company. But you don’t buy it with your own money, you buy it with someone else’s money. So you get other investors to come in alongside you and you put in a little bit of your own money. Typically, in private equity, it has been about 2 percent of the total pot.
But the majority of the money in this pot will be other investors’ — it might be a pension fund or mutual fund or an offshore fund. There may be offshore investors who want to come in and invest in something specific. You build this big pot of investible money. And then you go out and buy stuff with that pot. You’re basically only putting down like 2 percent of this pot, so you can’t lose very much.
While that company is still afloat, you are each year creaming all sorts of fees off that operation. You take typically 2 percent of the value of that investment each year.
JR: That’s called management fees, right?
NS: Yes. Almost without having to lift a finger, you take 2 percent each year. It’s kind of unearned easy money. You say this is for running your offices and telephones or whatever, but at the end of the day it’s a huge amount of money. If you’ve got a $10 billion pot of other people’s money, and you’re taking 2 percent out of that, it’s $200 million.
If you’ve only put down 2 percent of the fund yourself and you keep that operation going for a year, you’ve got your money back. Plus, if that performs very well and it produces fabulous returns, which sometimes they do, you then take 20 percent of the excess returns. So there’s some extra money there.
JR: How else do they extract money beside these fees?
NS: You will buy up a company, and then you will load it up with debt. You’ll get that company to borrow a lot of money. So imagine I’m a private equity person and I buy a shoe manufacturer and it costs me 50 million dollars. I could then say to the manager of that company that they can incentivize themselves with special remuneration schemes.
You’d get that company to borrow 50 million dollars — it’s a healthy company, making plenty of money selling shoes, and the bankers will lend to it. You then say, “You borrow that 50 million dollars, and pay me, the new owner, 50 million dollars.” So I’ve now got a company that effectively cost my pot 50 million dollars, and that company has now paid me 50 million dollars. So I essentially got it for free.
And you can then juice this up with all sorts of other monies and make even more out of it. And if that highly indebted company goes bankrupt, you’ve already made your money. You’ve already got your money back, so it hasn’t really cost you anything. And you’ve been creaming fees off these other investors who came in alongside you. Even though you spent 50 million dollars and it’s gone bankrupt, you’ve ended up walking away with a profit.
The key thing about the borrowing is that the loan is on the shoulders of the company that you bought. It is not on your shoulders. So if you owe the creditors a bunch of money, if that company collapsed, it’s not you, the private equity firm, that owes that money. It’s the company that’s gone bankrupt.
So the creditors will have to take the hit.
JR: What is the justification to the board of directors of the shoe company? That you borrow 50 million and just give it to me?
NS: The private equity firm will say, “We own you and if you don’t do this, we’ll fire you.” That’s one way.
Or they may incentivize them. Quite often, savvy firms don’t want to be bought up by private equity raiders. There might be people on the board who are in opposition to this kind of strategy, but the private equity firms will often just sign a deal and say, “If you let us buy you out, we’ll give you, Manager A, a share of the winnings.”
JR: So they pay them off.
NS: On an ideological level, they don’t tend to make very strong justifications. The original “shareholder value” ideology that was first really pumped by Milton Friedman and subsequently sharpened by a guy called Michael Jensen would be the kind of justifications that have been used.
JR: I’ve seen that phrase in particular used by Alden.
NS: The “shareholder value” thing is that as long as managers focus laser-like on making profits and paying dividends, everything will be well. That’s the kind of ideology that has been dominant, particularly since the mid-1970s. But it’s a kind of corruption of the whole capitalist system that has become fairly widely accepted.
One of the problems is that people who haven’t thought too hard about these things look at these billionaires and think, “Oh look! Successful people, very rich people, are bringing money into the economy. Wealth creation!” — without really understanding how they got that money.
JR: So even the people participating in this have their heads in the sand? Is that what you’re saying?
NS: No, I’m talking about the general public — really, I’m talking about voters. When people say, “Why isn’t there more of an outcry about this kind of stuff?” the outcry is usually among a group of relatively narrow elites who sort of understand what’s going on and look to this.
Elizabeth Warren has put forward the Stop Wall Street Looting Act, which looks quite deeply at these practices by private equity firms. Bernie (Sanders) may have been doing the same thing. I think people are waking up. You know, people don’t tend to understand how this stuff works, it’s quite complicated, so I think busy people just don’t really question it.
And I think it is time that this did get questioned.
JR: How can we know which wealth extraction strategies a company like Alden is using?
NS: I found Alden so opaque that I found it really hard to find out any good information about them. I could only say some quite speculative things. One of the things that private equity firms do — and this goes back to the other people’s money thing — is to try and Hoover up as much money from overseas as possible through tax havens, through things like blocker corporations in the Cayman Islands, which are kind of conduits for money coming from other countries.
What these blocker corporations do is strip out information, so any kind of financial information becomes secret, so you don’t know who the co-investors are, who the people are delivering the other peoples’ money. I — maybe a bit foolishly — speculated that a lot of dirty money does come into private equity firms. A lot of this “other people’s money,” this co-investment money, is from all sorts of shady individuals from around the world coming into the United States. That is a generic thing; people in tax havens have told me all about it. I linked a bit of speculation to, could this be the case with Alden?
JR: I remember that, yeah.
NS: But it is an important question. You don’t know where or who the investors are in many cases. And this could be what the answer is with Alden. But it’s so opaque, you can’t find this kind of stuff out.
Unless you have a Deep Throat, I suppose.
JR: After Alden took over Digital First Media newspapers, the newspapers’ real estate titles were transferred to Twenty Lake Holdings, an Alden subsidiary. And then Twenty Lake either sold the properties on the retail market, or in some cases they leased the properties back to the newspapers — a sale/lease-back.
I’m just wondering — OK, not specifically referring to Alden — how does that happen? How exactly do investors make money this way?
NS: So a standard way of doing it is to separate the business that has property and operations into the property company and the operating company.
What you do then is between the property company and the operating company, you sign a contract or series of contracts that are extremely favorable to the property company.
The operating company will lease those buildings from the property company at exorbitant rates, very high rates that are paying very high rent.
So what you’ve got here now is an operating company, which is much less valuable because they’re having to pay very high rates, and a property company, which is much more valuable, because it’s got this long-term guarantee of large income.
You’ve made a lot of money, because you’ve suddenly made your property company much more valuable than it was.
JR: I see.
NS: If they’re running a shoe business or a newspaper or whatever, they might say, “Well, we can’t afford to pay all these workers, so we’re going to cut everybody’s salaries and fire a bunch of people and make them work in horrible buildings” and all this kind of stuff.
You crunch them right down to make sure you can make all those payments. And if, at the end of the day. the operating company goes bust, well, the private equity firms’ owners have got their money anyway.
JR: And they own the property company outright, so…
NS: They own the property company, or they’ve sold it off at a huge profit.
So that, I suspect, could be what’s going on. Again, I don’t want to say that that’s what’s going on with this case, because I don’t know. But that is typically how the real estate game is played. It’s a very common one.
These techniques go far beyond private equity. Private equity and, to an extent, hedge funds have pioneered these kinds of financial games, and other companies that may not call themselves private equity or hedge funds have started taking up these techniques. So it’s kind of spreading from this sector into other parts of the economy.
JR: A lot of corporations that I’ve investigated over the years, they’ll have a gazillion Limited Liability Corporations for all the real estate transactions. I imagine that conveniently fits in with this way of obfuscating what’s happening.
NS: Yes, absolutely. And with LLCs (in the U.S.), they can be very opaque; whereas in other countries you often can find a lot of financial information about these companies. Often U.S. firms are tied up in tight secrecy. Lots of things are transparent in the U.S., but LLCs can be very problematic. I know when I was looking at Donald Trump’s stuff, it’s kind of like a brick wall. Kind of a tax haven thing almost. In some cases, you can’t find out any more than basic information, if that.
JR: Are there things happening that might slow these trends?
NS: Starting with Reagan, Clinton, the Bushes — including Obama and, of course, Trump — these administrations in many cases cheer-led these trends or failed to do anything meaningful about them.
I think what we’re seeing now from some presidential candidates — and I would highlight Elizabeth Warren and Bernie — there is for the first time a seriousness of doing something really significant about these very, very predatory activities. I think there is at last a recognition.
Overseas, there are different things happening in different countries. German society has long had a great skepticism about what have been called these locusts coming in and harvesting companies. I live in Germany and there was a huge protest about this stuff last year in Berlin — thousands and thousands of people in the streets.
In the U.K. I would say it’s still fairly uncontested. The dominance of the city of London is even stronger than the dominance of Wall Street in the United States. It may surprise Americans to hear that. I am British, even though I live in Germany. The city of London’s financial sector is comparable in size to Wall Street, but it’s diluted in a much smaller democracy.
I think we’re much more likely to see real changes in the United States than we are in the United Kingdom. So we are kind of looking to U.S. leadership to do something about this sort of stuff.
I think if there were to be a change of administration and something serious done about it, this would have very powerful implications around the world and change people’s attitudes. I think the U.S. does need to take a leadership role. Many of these problems originate from the U.S., and we kind of need the U.S. to fix them.
We just had an election (in the U.K.) where the conservatives have won an overwhelming victory. There’s clips of Boris Johnson saying, “No one has stuck up for the bankers as much as I have.” So he’s a real financial sector cheerleader, and I don’t see any hope of this government really going after the financial sector.
I supposed the other possibility of change is if we have a repeat of the global financial crisis. Last time around, the crisis happened but there was such a wide, almost unquestioned consensus that was in favor of “finance and more finance.” And with all these clever hedge funds and private equity folks, there was no alternative ready to be put in place.
I think now if there were to be a big enough crisis, there are a lot of coherent, well-constructed analyses of how things can be done completely differently and in a much, much more society-friendly way.
One of the things I said in my book is that we in Britain are so heavily captured under the thumb of big finance. And it has helped a certain smallish section of the population and harmed a much larger part of the population. And we don’t have the political gumption at the moment to do anything about it, so we kind of need help.
Sorry, I know it’s a bit grim, but you ain’t going to get any help from us, I’m afraid. We need help from the United States.
I don’t know if that’s a message anybody wants to hear.
JR: [laughs] OK, well…we’re on it. At least some of us are.