The massive omnibus spending bill released Wednesday included a surprise gift to the private-equity industry, which is one of the most powerful players in the financial sector. When this bill passes, it will add another layer of risk to a system already poised to become less stable after the Senate passed its bipartisan bank-deregulation bill earlier this month.
Defenders of that Senate bill at times argued the deregulation was a one-off needed to satisfy a hungry industry. But here we are, just days later, dismantling rules designed to prevent another financial crisis.
The rider in the omnibus, called the “Small Business Credit Availability Act,” has really nothing to do with small business. It loosens restrictions on a class of investment firms known as Business Development Companies (BDCs). These are mostly just accounting fictions; BDCs are tax-exempt vehicles largely created, owned, and operated by private-equity firms. These entities raise money through stock exchanges and are supposed to provide capital for small- and medium-sized businesses. In reality, many of their holdings are in financial companies and exotic derivatives.
With this provision, BDCs could borrow twice as much money as they hold in equity, compared to a 1:1 relationship under current rules. This increase in leverage increases returns and risk—if you gamble with someone else’s money and win, you make more for yourself, but if you lose, you have nothing to pay back the lenders. Americans for Financial Reform adds that the leverage in the corporate holdings of BDCs is already 5:1 or greater. So this would enable BDCs to borrow at least $10 for every $1 in equity.
While this is bad news for ordinary investors in BDC stock, who will be more at risk of losing their investments, it’s great for the private equity players who own BDCs and charge fees to those investors. Ares Capital, one of the largest BDC parent companies, spent $1.44 million between 2012 and 2015 lobbying for this change, according to the labor union UniteHere. Apollo and Carlyle Group, two private-equity giants, would also benefit. Bloomberg puts the potential profit increase at 20 percent.
That’s a windfall for investment firms that have a knack for destroying companies. Toys “R” Us, liquidating its stores despite a significant market share in toy sales, is owned by private equity. So is Claire’s, which just filed for bankruptcy, and other recent bankruptcy victims like Payless, The Limited, Wet Seal, Gymboree, Tops Markets, and Southeastern Grocers, parent company of Winn-Dixie. The common thread here is that these companies are loaded with debt and starved of the resources to maneuver and adapt to a changing retail environment. Why would we want to enrich the private-equity predators who burdened them with that debt, sucked out their profits with management and advisory fees, and left their carcasses by the side of the road?