The Private Equity Scam

Here is a point no one in influence has made, at least loudly enough to be heard.

Private equity is a scam.

In making this point I’m not saying that private equity breaks any current laws. I don’t think  it does.

But the whole point of private equity is to get around regulations, and I firmly believe this point will be addressed within a few years.

Consider how private equity works. Well-heeled investors place large
sums of money into management under a contract with the company
directors. In many ways it’s just like a mutual fund, or even a public
equity firm like Berkshire-Hathaway.

The difference is that there is no public regulation of private equity
firms. This enables private equity to do many things which public
companies and mutual funds cannot do. Their books become entirely
opaque. Market manipulations which would land a public company director
in jail may go unremarked upon.

This is the problem. The original intent behind private firms, as I was
taught, is that they have a small number of owners. Once you have a
large number of owners, you have to make periodic public reports to the
SEC. What reports are the private equity firms making?

Private equity firms also manipulate the market. They drive up shares
in public companies. They can also drive these share prices down, and
they don’t have to disclose a thing. They can also invest in a wide
variety of instruments without disclosure, something no public company
can do.

So you have greatly lowered costs, greatly reduced government scrutiny,
and an enormous opportunity for making mischief, all mixed together in
one delicious corporate shell. Delicious, that is, if you’re running or
investing in a private equity firm.

Opportunities are offered to private equity that no retail investor can
hope to get in on. It’s all perfectly legal now, but so were many forms
of market manipulation in the 1920s. The creation of the SEC in 1934
was designed to end those market manipulations.

And so, I believe, will it be for private equity firms. It’s just a
shame that no one is looking into them, which means it may take a crash
on the order of the 1929 stock market crash for these problems to come
to light.

Which brings me to a very important point, namely the purpose of regulation.

Conservatives, and private equity investors, hate the word regulation.
They consider it to be bureaucratic interference in private affairs,
and in fact it is. But regulations also provide an enormous benefit to
the regulated, in that they enforce ethics which keep the regulated
well-away from actions which might cause real damage, and which might
sic the criminal law on folks.

When regulations are ignored, or where they don’t exist, the inevitable
result is that real laws are broken. People die, and in time people have to go
to jail for killing them. You can manipulate the criminal law for only so long before
politics intervenes, and if not politics revolution, which can destroy
everything you built in the course of ignoring regulation.

Regulation of the financial markets  is like a circuit
breaker or a fuse. The circuit breaker blows well before there can be a
fire. No circuit breaker and you’re heading for trouble, big trouble.
It’s inevitable.

So too with private equity. It’s the dot-boom of this decade, and it’s going to dot-bomb.