A friend of mine retired from an IT executive job and she and her husband decided to become wealthy capitalists in their retirement. Since the evils of capitalism are a frequent topic here on FtB, maybe it’s a good idea to do a quick explainer of how a few of those evils work. These are the simple ones, and I’ll describe them as cleanly as I can so you can understand what’s going on when you hear about it elsewhere.
The basic idea of asset stripping is that if you can find anything that is worth more than its owners realize you buy it for what they think it’s worth, sell it, and then are left with a profit. This is not “theft” it’s just “the seller mis-priced what they were selling” so it’s moral behavior for capitalists. In fact, it’s practically sanctified behavior.
Let’s take an example: XYZ Framis Corp has been a family-run business for 75 years and is a solid player in the global framis market. They have been pretty profitable for those 75 years, have good relations with the unionized workers, and have built up a well-funded pension fund. In fact, because the founders believe that laborers should be cared for in their old age, there is nearly $25,000,000 in the pension fund. An asset stripper notices this, and notices the market price of XYZ Framis Corp shares takes a dip; the company’s market capitalization drops. Let’s say XYZ Framis Corp shares total value is $250,000,000. One day it drops to $200,000,000 because the stock market is having a bad day. A group of asset strippers borrow $200,000,000 on a short-term loan then buy a controlling interest in XYZ Framis Corp – let’s say they buy it all (to keep things simple) – they’ve just bought $275,000,000 for $200,000,000. So they immediately start firing workers, sell off the tooling and facility, and pocket the $25,000,000 in the pension fund. Then they sell the remains of the company for whatever they can get for it – anything in the $200,000,000 range will do. What they really wanted was the pension fund. Then they pay off whoever loaned the $200,000,000 and they have a tidy profit; they have done no actual work, added no value to anything, destroyed a profitable business, and killed off all the framis-making jobs in the USA.
Capitalist apologists might say that the asset strippers just made the global framis market more efficient. But that’s bullshit – it was really all about legally stealing the $25,000,000 pension fund without doing any work for it except signing papers and doing some handshakes. Time left over for a round of golf.
When a Chinese company rises to prominence in the global framis market following the unexpected collapse of XYZ Framis Corp, capitalist apologists point to China and say “they stole our jobs!”
The amount of additional money you can borrow against an asset is called your “leverage.” So, a “leveraged buy-out” is when you buy a business using another business as collateral. In a bit I’ll explain what leveraged buy-outs look like if you’re collecting trailer parks. The “junk bond king” Michael Milken, who has now reinvented himself as a multi-hundred millionaire philanthropist, popularized the “leveraged buy-out” in the late 70s and 80s, and triggered a huge bubble in asset values as everyone inflated what their assets were worth, so they could get bigger loans to buy bigger assets. It all collapsed and a lot of people lost everything. As happens to the small fish that swim with the big sharks in capitalism.
Asset stripping happens in lots of ways at lots of levels. My father used to turn purple with rage when he’d see old books (like a volume of Diderot’s encyclopedia) in art stores that had had the illustrations cut out, framed, and sold as individual art-works. If you can buy a copy of the encyclopedia for $1,000 and it has 200 illustrations in it that you can get $25 apiece for, you’ve just made $4,000. It was just a dumb old book, right?
Here’s another term: “margin call.” Let’s say you buy the encyclopedia with a $1,000 loan from your fellow capitalist buddy. Here’s a trick: you use the encyclopedia as collateral for buying the encyclopedia! So you tell Capitalist Bob “hey Bob, lend me $1,000 for a year. I’ll pay you back $1,250 at the end of the year.” and Capitalist Bob says “what is your collateral for that loan?” (good capitalists don’t trust eachother) You say, “I have a copy of Diderot’s encyclopedia worth $1,000.” He loans you the money, you buy the encyclopedia, sign a contract with Capitalist Bob that at the end of the year he gets $1,250 or he ‘forecloses’ on your encyclopedia. Then you get out a mat-cutter and start whacking pages out of the poor, unfortunate book. Capitalists refer to this as “margining out” – you’re gambling that you can make enough to pay back the loan on time, and that everything from then on will be profit. But suppose nobody wants to buy the pictures; you’re margined out and Capitalist Bob calls and says, “hey, it’s time for my money or the book.” That’s a margin call. It’s when the value of the assets you used to secure a loan have changed, and are no longer worth the price of the loan. Capitalist Bob is going to send Ivan the Bonecrusher over to visit you if you don’t come up with the cash.
When talking about real estate loans that’s what people are talking about when they say they are “under water” on a loan: I buy a house for $1,000,000 and then borrow $750,000 against the house so I can start a methamphetamine business. But the feds raid my meth lab and I lose all my assets. Now I ‘own’ $250,000 of a $1,000,000 house. But – because this is a messed-up story about capitalism, it turns out that the $1,000,000 house is built on top of a toxic waste dump that the seller neglected to mention to me. The best I could get if I sold it would be $100,000. I am now “under water” by $650,000 because if I sell the house I still have to pay off the loan, but my asset’s value re-adjusted and now I am screwed. Then comes the “margin call” when Max The Merciless – the guy I borrowed the money from – discovers that my meth lab was busted and I no longer have assets enough to collateralize my loan.
So, asset stripping and margining out are basically forms of gambling. If you’re rich already, you can play these sorts of games without danger because even if you lose you have enough assets somewhere else that you can survive if you’re margined out and one of your loans goes underwater. That’s what Mitt Romney’s Bain Capital was: a large pile of money that served as a base of collateral from which Romney could buy businesses, strip their assets, break them apart, and sell the shattered remains. You know those jobs everyone’s talking about? That’s what Bain Capital is exactly not about: it created a job for Mitt Romney and some lawyers, and otherwise it just shut businesses down. It’s the business equivalent of buying a beautiful book and cutting out the pages with illustrations, then throwing the pages which are just text in the dumpster.
Then, you have the roll-up experts. That’s what my friend did when she retired: she bought a trailer park. It wasn’t a very big one, and it wasn’t a very nice one, but it was what she and her husband could afford to gamble on. Then, they invested some money in making it look better: paint, driveways, some landscaping, and a property code that all the trailers had to look good. So let’s say she bought the trailer park for $750,000 and spends $100,000 prettying it up. That’s mighty pretty. Then, she goes to the bank to get a loan to buy another trailer park, up the road; it’s worth $1,500,000. So she gets the first trailer park assessed as worth $1,250,000 and gets a loan for the second trailer park with the first trailer park as collateral. If you’ve done the math you noticed there’s $250,000 missing – she took a home equity loan against her house for that (margining herself out a bit) and is paying $2,000/month on that home equity loan. Then, she raises the prices on all the denizens of the two trailer parks – it doesn’t take much – until she’s bringing in $5,000 more per month. Clever, huh? In 10 months she’s paid off the home equity loan and can buy the trailer park over the hill by cleaning up the second trailer park a bit, and doing the same routine. Last time I checked with her, she owned most of the trailer parks in a large area, and had raised the prices just a little bit, at all of them. When the financial crisis hit and interest rates dropped, she re-financed all the debt on all the trailer parks and her profit margins were high enough that she’s probably paid them all off, now.
I know another guy who did a roll-up and it was brilliant; he is now quite wealthy. His big realization was this: the cost of diesel fuel is going up and will never come back down. From that, he concluded that the cost of shipping gravel for construction and lawn and garden decoration was going to be affected by the cost of diesel fuel. He looked around and found an area that was turning into nice suburbs and had a lot of high-end homes being built – and bought the local gravel pit/quarry. Then, he raised prices sharply and blamed the cost of fuel. He played his gamble perfectly: none of the builders were willing to pay the additional fuel cost and time to have gravel and rock trucked in from another county so they complained and passed the cost on to their customers. The result was that his gravel pit started bringing in a lot more money, which made it worth more on paper so he used the first gravel pit as collateral to buy the only other gravel pit in the county. Then, he controlled the price of gravel and as long as diesel fuel costs went up, he could raise the price per ton to the point where it was just what the market would bear, below the point where it was cost-justified to truck gravel in from 30 miles away. You know what happens next: he bought another gravel pit.
What usually happens with these deals is that someone comes up with the idea, does it, and makes a ton of money. Then, a few more people do it, and the marks catch on, realize that they haven’t been valuing their assets correctly, and raise the prices (aka: “a market correction”) – as soon as it’s no longer possible to buy assets that are undervalued, there’s no point in these types of manipulations because the cost of entry is the same as the value of the exit, so there’s no easy money to squeeze out of the system. That’s really the important thing to understand: none of these shenanigans add any value to anything. It’s just squeezing out profits that people had overlooked – perhaps because they were, you know, trying to build a sustainable business that had happy employees. Capitalism’s efficiency comes mostly from squeezing out that happiness – hey, it’s “unrealized assets” baby.
I tell you these little stories to explain how metastatic capitalism spreads like cancer and destroys businesses and magnifies inequality by taking advantage of poor people who aren’t mobile enough to leave and find another trailer park. Or, the union workers at XYZ Framis Corp, who thought they had a pension and a steady job, suddenly find “their jobs stolen by the Chinese.” Or, why some commodity prices suddenly spike for no apparent reason. Remember ENRON? That was a commodity roll-up in the energy market: an energy company that kept getting bigger and valuing itself higher and higher so it could buy more small companies. These things work as long as nobody reads the books carefully.
And now you know why Donald Trump keeps people from looking at his books. He’s probably a billionaire in terms of deliberately inflated asset values, but what is he actually worth? This morning, I had a bowel movement that was probably worth more than Donald Trump, if you balanced his assets against his debts and risk. If you’ve been reading between the lines, Jared Kushner’s real estate portfolio is margined out and he’s sweating because he’s got a loan on a property that he’s not being able to sell in order to cover the cost of servicing his leverage. In other words: he’s a gambler and right now he’s losing and everyone knows he’s losing so they’re all watching to see what happens. Capitalists are like sharks; they love to watch one of their own fumble so they can rip them apart in a bloody scrimmage that leaves everyone grabbing at chunks of meat. Then they go for a round of golf.
Adam Curtis did a great documentary about the first generation of asset strippers, called The Mayfair Set. It’s got a lot of familiar characters from the 1980s in it but it’s London/England-centric.
It’s fascinating stuff. Curtis charts how Britain’s real estate market and industry were gutted by asset stripping capitalists, who leapt in when the government lost power because of the downturn in value of the Pound Sterling in the 70s and 80s. I don’t recall if it has the story of George Soros’ run on the Bank of England (I think it does) but … Soros basically triggered a margin call on the Bank of England and the government had to turn on the printing press to prevent a collapse, which basically made Soros’ options against the Bank of England become worth real money.
Is this interesting to you? If it is, shall I explain options and derivatives next?