Evil Geniuses: The Unmaking of America: A Recent History (21 page)

Ever easier borrowing was the fundamental change that allowed the financial industry to take over more and more of people’s lives and ever more of the economy. “I think we hit the jackpot,” President Reagan kvelled in 1982 as he signed one of the first big financial deregulation laws, which the Democratic House had passed by three to one. Because people could easily borrow ever more on their credit cards, they saved less and less, assuming ever more risk, living ever closer to the financial edge. In 1970, only one in six households had a general purpose credit card like Mastercard or Visa; by the late 1980s, a majority of Americans had at least one. Starting then and continuing through the end of the century, Americans’ personal debt
excluding
home loans increased twelvefold
,
after inflation. In 1978 the credit card business became much more attractive thanks to a Supreme Court decision that allowed banks to charge credit card interest rates as high as they wanted, regardless of legal maximums in the state where a cardholder lived, by setting up shop in states that were cool—
free markets,
man—with usury.

That 1980s wave of financial industry laissez-faire helped trigger a disaster immediately: savings and loans, the several thousand local banklike entities that specialized in lending to local folks—like Bailey Building and Loan in
It’s a Wonderful Life
—promptly went a little nuts, making too many loans that were too risky, especially to developers of shopping malls and office buildings. Fully half of America’s S&Ls collapsed in less than a decade, and the government had to provide the equivalent of a quarter-trillion dollars to make good on their losses. Yet that crackup did not prompt Washington or Wall Street to sober up and slow down the loose-money craze in finance. The amount of all credit extended to Americans from 1980 to 2007—home mortgages, student debt, car loans, credit cards, and the rest—more than doubled, and the debt owed by the average American
quadrupled
.

Money got easy for people in the middle and toward the bottom, for suckers with credit card and mortgage payments they could barely afford—but also, of course, for people at the top, the financial speculators and middlemen who had other innovating to do.

Such as leveraged buyouts of companies, or LBOs. Until the late 1970s, leveraged buyouts were small-time backwater deals, too skeevy for the old-school Wall Street firms or banks. In the standard version of an LBO, outsiders take over a public company by teaming up with its senior executives, providing a small down payment, and putting up the company’s own assets as collateral to borrow the necessary zillions to buy up all the stock and eliminate the pesky shareholders—that is, taking it private. Then for a while they use the company’s profits to pay themselves and make payments on the debt they used to buy the company. And then they resell the company ASAP to
new
shareholders by taking it public again. It sounds slightly dodgy but unremarkable. Look a little closer, however, and you see why LBOs so often are, in several ways, caricatures of capitalist rapacity.

Companies are supposed to borrow money in order to grow their businesses—to hire more people and buy more equipment and lease more space to make and sell more and better widgets. The whole point of a modern LBO, however, is quite often not the business as a business at all, making a company better and bigger and profitable for the long haul. Rather, the point is the
financing,
quickly enriching the financiers and top management by means of a scheme with a ridiculous tax dodge at its center. The business, whatever it is, is just a pretext for that fast-in-and-out scheme.

The federal tax provision that makes LBOs work is shockingly simple: income is taxable, but interest payments are deductible on tax returns, so when you start using almost all of the LBO’d company’s income to make interest payments, you get to stop paying corporate taxes. Of course, that’s a perversion of the tax code, given that Congress makes interest deductible so that businesses can more easily expand and hire and prosper, not so that financiers (and top executives) can enrich themselves. In fact, what often happens with LBO’d companies is the opposite: in order to afford their huge interest payments on their huge new loans, they lay off employees, sell whatever they can, cut research and development, and otherwise hunker down.

That tax-deductibility trick was nothing new, but a couple of new 1980s factors enabled the mainstreaming of the LBO. Both depended on Wall Street’s new postprudence shamelessness. One was the up-front fees that investment bankers and the rest of the financial elite were skimming off of LBOs, often several percent of a company’s purchase price just for…wheedling, advising, pushing paper, attaching their corporate names to the deal—even though they didn’t actually care about the “long-term success of the new enterprise,” as the Republican treasury secretary admitted at a Senate hearing in the 1980s, a carelessness that he admitted might make LBOs a “financial snipe hunt where the new long-term investors, flashlight in hand, are left holding the bag.”
Funny,
the cabinet member overseeing U.S. finance said,
it’s a con game!

But most important to making the formerly disreputable LBO take off was a new way to finance the takeovers—by means of the formerly disreputable junk bond. Junk bonds had been what happened to good bonds when the issuing corporations got into trouble, causing the big rating firms to downgrade the bonds, which meant the corporations had to pay higher interest to people who bought their bonds. But then in the late 1970s, the young Los Angeles investment banker Mike Milken started creating and issuing risky bonds
as
junk bonds, from scratch, thereby creating a white-hot new financial subindustry.
^*3
During just the first half of the 1980s, the market for junk bonds grew sixfold, to the equivalent of $94 billion a year, and more than a thousand different junk bonds were issued—half of which wound up defaulting, failing to pay the money due when it was due to the bond owners. Junk bonds are like car manufacturers deciding to start making and marketing lines of brand-new designated lemons—cheaper parts, shoddily manufactured, much more liable to break down or crash, but
so
inexpensive
.

Funded with junk bonds or not, a typical LBO was a conceptually new sort of acquisition, more brazen and shameless in its selfishness and greed—indifferent outsiders offering to make a few executive collaborators very rich as long as they were up for abandoning their fellow employees and the company itself if necessary. Most people agree that short-term thinking has become a chronic problem for business, for the economy, for society—yet unabashed short-termism is the
point
of an LBO, the financiers’ optimal outcome being to take over, make a fortune, and disappear as quickly as they can.

One of the godfathers of this fast-and-loose new game was Henry Kravis, whose Manhattan firm Kohlberg Kravis Roberts got the craze going in 1979 by investing a cash down payment equivalent to $4 million to use $1
billion
in junk bonds and other debt to take over an obscure Fortune 500 company. One of the most spectacular early LBOs was undertaken by former treasury secretary William Simon after he left government to propagandize for the right and the rich, and to get very rich. (By his account, he was still in public service—because, as he’d testified to a Senate committee, “If you really want to help the poor, help the rich.”) In 1982 he bought a greeting card company by borrowing the equivalent of $140 million and putting up less than $1 million of his own money. A year later, right after paying himself a special dividend of $1 million from the company’s cash, he took the company public again, selling the shares of stock for $800 million, out of which he personally got the equivalent of about $177 million, and bade farewell to the greeting card industry.

The rush was
really
on. The respectable banks and insurance companies were now eagerly in the game. A respectable-sounding new term of art was adopted,
private equity
.
^*4
In just five years, 1984 through 1988, the equivalent of almost $400 billion worth of LBO schemes were pulled off, ten times the value of the deals of the previous six years. In 1989 KKR took over the cigarette and snack company RJR Nabisco for the equivalent of more than $50 billion—still the biggest LBO ever, by far. That deal was the subject of the book (and the TV movie)
Barbarians at the Gate
. Everyone agreed afterward that Kravis and KKR paid way too much. On the other hand,
who cares
when the cash you’re putting up is only a few tens of millions, less than one-tenth of one percent of the purchase price? But wait,
that’s not all:
just for helping to make the deal happen and advising others snuffling and gulping at the trough, KKR also received in
fees,
up front, the equivalent of more than $800 million. Which was standard, the new normal.

Very full disclosure: I know Henry Kravis. That is, for several years I ridiculed him publicly, and for a couple of years right after that, I insubordinately worked for him. Let me explain.

Spy,
the satirical magazine that I cofounded and edited during the late 1980s and early ’90s, focused much of our journalism and ridicule on the rich and powerful and celebrated, especially in New York. As it happened,
Spy
never published a feature story about Kravis or KKR, but he was a recurring secondary character. We referred to him variously as “dwarfish takeover maniac Harry Kravis,” “overleveraged buyout hustler Henry Kravis,” “tiny eighties relic Henry Kravis,” and, after he bought Nabisco, “groceries commissar Henry Kravis” and “Shredded Wheat king Henry Kravis,” who was willing to “pay billions of dollars for nothing more than a few brand names and some junk food.” He was also among the fifty-eight rich people who received $1.11 “refund” checks from
Spy
’s fake National Refund Clearinghouse, and each time they cashed one, received another, smaller check with a new fake explanation; Kravis was one of the thirteen semifinalists who cashed a $0.64 check, but in the final round he failed to cash a $0.13 check.
^*5

Anyhow, shortly after leaving
Spy,
I became editor-in-chief of the weekly
New York
magazine—which Henry Kravis and KKR had recently acquired (from Rupert Murdoch) for their new media company, K-III Communications. I assume that if publication archives had been digitally searchable back then, I wouldn’t have been hired.

It’s called
New York,
founded to focus on New York City, so naturally we covered Wall Street. Two years into my tenure, we published a great cover story on the internal battles at one of the elite investment banks. It reflected badly on its star executive, who’d talked to the writer quite candidly and was pushed out of his firm not long afterward. When the article appeared, Kravis invited me to breakfast at his enormous Park Avenue apartment. The story had made him very uncomfortable, he said, so now he wanted
New York
to stop covering Wall Street entirely. I explained why that would be unwise and politely declined his request. When I told my actual bosses at the publishing company about it, they told me to “ignore Henry.” Which I did. A few months later, we ran a story about the imminent 1996 presidential election featuring a cover photo of the Republican nominee with his eyes closed and the headline
BOB DOLE, WAKE UP
!
Kravis was his campaign’s deputy finance chairman, had hosted a birthday fundraiser for him, and had recently donated $250,000 to the GOP, so he was included in a
FAT-CAT CATALOGUE
sidebar. A week later I was fired.

The subtitle of
Barbarians at the Gate
is
The Fall of RJR Nabisco:
the company wasn’t improved by the takeover, it
fell,
got broken up to no particular point, and in the end, apart from those remarkable up-front fees—
unlocked value
is one of the financiers’ terms of art that emerged in the 1980s, like when a safe is unlocked in an amazing heist—the deal didn’t do well for Kravis and KKR. A problem with leveraged buyouts and other private equity takeovers, and with financialization in general, is that so often the main point isn’t to create enterprises of lasting value, enabling particular businesses (or American capitalism or American citizens) to prosper for the long term. It is to obtain those fees, the vigorish, and to score by making
this deal,
and then another deal, and another, because greed is good, kill them all, and let the invisible hand sort it out.

As I was beginning this book in 2017, I noticed that big, familiar retail chains were all going under—Toys “R” Us, Payless, The Limited, Gymboree, and many more. Then I noticed that each of them had been subjected to a leveraged buyout, finally choked and smothered by debt piled on by temporary private equity owners. The list of solid, profitable American companies unnecessarily wrecked this way since then is extremely long.

The story of one familiar company, not yet gone, is illustrative as a capsule history of the evolution of American capitalism from ingenuity and grit and social benefit to passionless, pointless, wasteful, endless financial whoredom in LBO hell. In the late 1800s a tinkerer in Wisconsin named Simmons found a way to mass-produce spring mattresses, then cut costs and prices by 90 percent. His son took over and introduced the Beautyrest brand, then the grandson managed to keep the company going through the Depression, when the stock lost 99.9 percent of its value—and then Simmons thrived again for decades. During the 1970s, along with so much of U.S. manufacturing, things started going a bit south for Simmons Bedding, the great-grandson was purged, the company was sold to the conglomerate Gulf + Western, and then in 1985 it was taken over in an LBO by…William Simon, freshly retired from the greeting card racket.

Over the next two decades, Simmons was sold and resold a half-dozen more times, going private and public again and again, accumulating more and more debt, from the equivalent of $300 million in 1991 to the $1.6 billion it owed when it finally entered bankruptcy during the Great Recession. In the course of the 2009 bankruptcy to reorganize the company, a quarter of the workforce was cut loose, more than a thousand employees, and people who’d bought the company’s bonds were out hundreds of millions. Then in 2012 Simmons was acquired out of bankruptcy by
another
financial firm, which owned Serta Mattress, and two years after that, yet another financial firm took over the combined company. It didn’t quite constitute a monopoly, because there was still one other big mattress company, Sealy, controlled at the time by…KKR. Between its first leveraged buyout and its (first) bankruptcy, Simmons’s succession of short-term financial-firm owners sucked $1 billion out of the company in fees and profits.