Are Private Equity Firms Plundering the U.S. Economy?

This is a story about what some people call piracy.

Hannah HOWARD: These people with only dollar signs as their goal plundered something really wonderful.

And where is this so-called piracy happening?

Sachin KHAJURIA: It’s everywhere. It is possibly your kids’ schools. Could be your employer. It could be the mortgage on your house. Missile-defense systems. It’s everywhere. 

The people who run these operations say they are misunderstood, and that what they’re doing is good for society. Others disagree.

Brendan BALLOU: I suppose if I thought that it was good for society, I wouldn’t have called the book Plunder.

Today on Freakonomics Radio: the rise — and rise — of the private-equity industry.

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Our first guest today has an interesting job:

BALLOU: My name is Brendan Ballou, and I’m a special counsel at the Department of Justice.

Ballou is a prosecutor in the Antitrust Division of the D.O.J. A few years back, he noticed something.

BALLOU: When companies propose to buy big companies, they have to file documents with the Department of Justice Antitrust Division and with the F.T.C. I was looking at those documents, and I was seeing all these acquisitions that were coming in, and they were all companies that are being bought by institutions that I had never heard of, like Blackstone, Carlyle, KKR, Apollo. I never heard of these. And so I started looking into it, and started to learn about the idea of private equity. And suddenly, I realized that they’re buying up everything. And that got me interested in the idea of this book project, which I started putting together in quarantine.

Ballou’s book project has since become an actual book — which, he makes clear, does not represent the views of his employer. The book is called Plunder: Private Equity’s Plan to Pillage America.

BALLOU: The basic business model of private equity is very straightforward. Private-equity firms take a little bit of their own money, some of investors’ money, and a whole lot of borrowed money to buy up companies. They then try to make financial or operational improvements and then flip the company, hopefully for a profit, a few years later.

DUBNER: So, we’ve been doing occasional episodes on this show about private equity over the last several years. Often the downsides, not exclusively. We recently ran a two-part series on how private-equity firms have been buying up veterinary and other pet-care facilities. Now, I have several friends and acquaintances who work in private equity, and they complain to me that I’ve been alarmist, and that the negative associations with private equity are overstated. Of course, it’s in their interest to say that. But when I listened to their explanations — these are nice, prosocial, well-educated people who don’t beat their children or anything like that — I thought, “Well, maybe, maybe they’re right. Maybe I am becoming a little bit hyper about it, or paranoid or panicked.” And then, Brendan, I read your book and I thought, “Oh, my — I’m not nearly paranoid enough.” So let me hear just a sort of opening statement from you about the state of private equity in the U.S.

BALLOU: So, we already described what private equity is, or what the business model is. Let me try to lay out what the basic problem with that business model is. There are three issues with it. First is that private-equity firms tend to buy companies and hold them only for a few years. Second is that they tend to load the companies up they buy with a lot of debt, and then they extract a lot of transaction and management fees from the company. And then the third thing is they tend to be insulated — financially and legally — from the consequences of their actions. When the portfolio firm does something illegal or does something wrong, the private-equity firm itself is rarely held liable. What this means is, when you’ve got short-term thinking, when you’ve got a lot of debt, and a lot of fees, and when you’ve got insulation from responsibility — it leads to all sorts of bad consequences. And you were talking about the series that you’ve been doing on veterinary clinics. Well, my girlfriend actually is a veterinarian and she’s talking about — all these private-equity firms are buying up all the veterinary clinics in the area in which we live. And it leads to — at least as alleged by her friends and folks that I know — leads to diminished quality of care for pets, it leads to increased prices, it leads to less flexibility for workers. And all those are the sorts of things that happen when you own a business only for a few short years, and you don’t have responsibility for what happens in the long term.

DUBNER: Now, there’s a particular argument in the vet-care space — and one story that we heard after we published that series was from a lot of younger vets who say they would like to buy the practice from the founding vet, let’s say, of their practice, but they have such big medical-school debt that they can’t afford to. And that the older vets, even though they’d like to sell the practice to the younger practitioners, they can’t. And therefore, they end up getting enticed to cash out their business by selling to a private-equity firm. In a case like that, do you see any viable solutions?

BALLOU: Well, for something like that, you know, student-debt relief would make a whole lot of difference for young vets to be able to afford these things. Going back to my girlfriend — she’s benefited tremendously from the pause on student-loan repayments. The challenge is not that there’s a lack of interest in owning these things. It’s that the folks who have the money, who actually can own them, don’t have the long-term interest in operating them. 

DUBNER: As you’re describing the problem — or the potential problem — with a pet-care rollup, let’s say, how much of the problem as you see it is private equity per se versus consolidation generally? 

BALLOU: That’s a great question. Consolidation is its own unique challenge. And the solution historically has been antitrust laws. You can buy a business, you can buy a couple of businesses, but the more and more that you buy in a single product and geographic market, the more market power you obtain, and that gives you power to raise prices and depress pay and cut quality care, and all of these sorts of things. That’s what the antitrust laws are designed to address. You’ve got a particular challenge with the rollups that private-equity firms execute, in that a lot of them are with very small businesses. You then also have the problems of private equity compounding the challenges that rollups create, which is that a traditional company might buy another business with cash; private-equity firms do this with debt. They do it with debt that, not them, but that the company they buy takes on. And so what that means is you’ve got a business that’s getting rolled up, and so it’s getting bigger and bigger and getting more market power — but oftentimes, it’s going to hold a lot more debt, which means that it’s got to execute ever-riskier or ever-worse business tactics, just to stay in business.

DUBNER: What’s the best way to think about private-equity-controlled firms as a share of the U.S. economy? 

BALLOU: So it’s a little bit apples to oranges, but private equity, in 2021 had $1.2 trillion in acquisitions, and the U.S. G.D.P. was about $25 trillion. That’s not to say that it was one-25th of the economy, but just to give you a relative sense of scale.

DUBNER: What about, let’s say, private-equity firms’ portfolio companies’ employment size?

BALLOU: So KKR, Blackstone, and Carlyle, the three largest private-equity firms, each have roughly a half million employees or more. If you considered each firm’s portfolio companies together, they would be the third-, fourth-, and fifth-largest employers in America, after only Walmart and Amazon.

DUBNER: You went to college at Columbia in New York, correct? 

BALLOU: Yup.

DUBNER: Studied what?

BALLOU: Studied philosophy. I wouldn’t recommend it to anybody.

DUBNER: Okay. But then law school at Stanford Law, correct? 

BALLOU: Exactly.

DUBNER: I’m guessing that between those two degrees, that you have plenty of friends who work in private equity. Is that the case?

BALLOU: I have various friends who are in finance, and I think that they’re all wonderful people. My argument about private equity isn’t about the people that are in the industry. It’s about the business model.

DUBNER: Don’t people create business models? 

BALLOU: I think that’s a question for a historian or a sociologist —

DUBNER: Hey, you just told us you’re a philosophy major — 

BALLOU: No, you know, it’s a slightly different argument. Private equity’s critics and defenders focus on the people that run private-equity firms. For the people that support private equity, they’re masters of the universe. For people that oppose them, they’re cartoon villains. I would argue that that’s strategically the wrong focus, because it suggests that all you need to do is change the people and you change the business. What I’m trying to explain is that the laws that we’ve created around this business model create incentives that lead to all sorts of disastrous outcomes. And it’s really extraordinary. I think that there are few industries that have been more successful in pushing their agenda through every facet and lever of government. Private-equity firms and investment firms have given something like $900 million to federal candidates since 1990. One of the things that I think people don’t necessarily recognize, or maybe they’re inured to, is the extraordinary extent to which private-equity firms have been able to bring in the brightest lights of government into the industry. We’re talking about secretaries of state, Treasury, defense, a C.I.A. director, several generals — 

DUBNER: Former S.E.C. chairs? 

BALLOU: S.E.C. chairmen. 

DUBNER: Speakers of the House? 

BALLOU: Two speakers of the House, so far. And it’s not just the bright-light names of government that go into private equity, it’s sort of the below-the-fold people as well. If you look at the lobbying disclosure forms of any of the large private-equity firms, it’s filled with chiefs of staff, legislative directors. And it just means that when private equity approaches somebody in government, it’s often a friendly face. And when somebody is thinking about maybe leaving government, they’ve got a place that they can go to.

DUBNER: I find that most even pretty smart people I know who don’t work near finance or private equity don’t really have any sense of what private equity is — that it’s operated, I don’t want to say in the shadows, but certainly outside of the spotlight for a long time. Your book threatens to change that. Was that an intention? 

BALLOU: I confess that I did not know what private equity was probably until after I got this book deal. But explaining what private equity is, is deliberately hard because private-equity firms often obscure what they do. 

DUBNER: Most of your evidence in this book has been previously reported in places like The New York Times, The Wall Street Journal, many local newspapers, all of which you cite very generously, I have to say. In other words, for anyone who has wanted to see what’s going on with private equity, the story’s been out there for a while. So tell me what you’re adding to the story.

BALLOU: The challenge that we’ve got is that these stories tend to be specific to an industry. So you hear about what private equity is doing in veterinary clinics. You hear about what they’re doing in nursing homes. You hear about what they’re doing in prison services or single-family homes — the list can go on and on. A lot of what will draw a private-equity firm to a given company or to a given industry is stable and reliable cash flow, because they’re buying the company with debt, so they need to be able to service the debt, so they need some consistent money coming in the door. What I was trying to explain is that these stories are united by a common thread. And that thread is the laws and regulations that shape private equity and that create their incentives. The example that I keep going to is Carlyle’s acquisition of ManorCare. So the Carlyle Group is a private-equity firm, one of the largest, and it bought HCR ManorCare, which is the second-largest nursing-home chain in America. Carlyle bought the company with a lot of debt that ManorCare had to service, and as a result, they slashed staffing, health-code violations spiked, complaints by residents rose.

Ultimately, at least one person died in ManorCare’s care, a woman named Annie Salley. And when her family tried to sue ManorCare and Carlyle, a really interesting thing happened. In court filings, the private-equity firm said, “Oh, no, no. We are not technically the owner of ManorCare. We, in fact, merely advise a series of funds whose limited partners through a series of shell corporations ultimately own the assets of ManorCare. We’re not the ones to blame here.” Now, that’s sort of a legal sleight of hand, because in public statements, Carlyle had said it bought it. In effect, it seems to have had operational control over the nursing home, and it certainly loaded up the nursing home with all the debt that led to the kinds of consequences that resulted in Ms. Salley’s death. But because of fairly obscure legal doctrines, like piercing the corporate veil, they were able to get the case against it dismissed. And so what I hope that example shows is that there are lots of laws out there, lots of regulations that essentially give private-equity firms operational control over the companies they buy but very little responsibility when things go poorly. 

DUBNER: In terms of making things so complicated that almost no one, even government prosecutors, can really figure out their organizations — it reminds me of this old saying, it might have been W.C. Fields, “If you can’t dazzle them with brilliance, baffle them with bullshit.” I’m curious if that’s a strategic move, the degree to which things are byzantine? 

BALLOU: One of the private-equity industry’s great accomplishments is they’ve made their work seem so normal and so boring. I honestly think part of it’s esthetic — you know, that the folks that run private-equity firms wear nice suits, they, you know, have tortoise-shell glasses, they went to a lot of great schools and all these sorts of things. I think that there’s something about the private equity industry in that it’s managed to present itself as so boring in a lot of ways, or so opaque, that it’s been more successful even than other financial firms. If you compare this to investment banks, which are highly regulated either as banks or bank-holding companies, which is not to say that those companies have not been successful sort of in a lobbying effort, I think generally, people have failed to lay a glove on private equity. 

The private-equity industry has been dominated by American firms, and one of the industry’s pioneers is named David Rubenstein. He was a co-founder of the Carlyle Group, and was for many years its co-C.E.O. Rubenstein appears frequently in Brendan Ballou’s book. We asked Rubenstein for an interview for this episode, but he declined; we asked more than 20 other private-equity C.E.O.s and partners, and they too declined. But we did speak with Rubenstein back in 2018 for a series we called “The Secret Life of a C.E.O.” If you want to hear the full interview with Rubenstein, that’s episode 322. I asked Brendan Ballou for his impressions of Rubenstein.

BALLOU: The first is that I actually ran into him in a park once while I was in the middle of writing the book. It’s a little bit like meeting a celebrity. I was sort of gobsmacked. And I didn’t know — I didn’t know what to say to him.

DUBNER: So what’d you say? 

BALLOU: I didn’t say anything. All I heard him say was, “$8 million,” as he was walking by to somebody else.

DUBNER: He’s on his cell phone or he’s just talking to himself?

BALLOU: He was talking to an older woman, perhaps his wife or something like that. Rubenstein is a really interesting character. He’s a striver who came up from working-class Baltimore. He’s phenomenally successful at building relationships with folks in politics and ultimately becomes an advisor to President Jimmy Carter, I believe at age 27. He has this sort of monk-like aura in the White House. He works harder than anyone, is incredibly dedicated to the President, and works on a huge range of topics. But ultimately, for him, tragedy strikes — Carter isn’t reelected, and he’s sort of thrown into the wind, and has to figure out what he’s going to do with himself. And he stumbles upon private equity and a particular sort of angle that has been phenomenally successful for him, which is finding and hiring ex-government officials to come work for them. Their first was former secretary of defense Frank Carlucci. And they figure out that there’s a real draw for investors to meet these government officials. 

DUBNER: Now, David Rubenstein has a reputation as a really good businessperson who has been around a long time and who in the last bunch of years has charitably used some of his personal billions to buy historical treasures that he then shares with the public — rare copies of documents like the Magna Carta, the Declaration of Independence, and so on. So how do you view that? Is that just reputation laundering? Is that a fortune built from plunder? Or is that the well-spent fortune of a man who worked hard and played by the rules? 

BALLOU: At the risk of being repetitive, I think that David Rubenstein personally is a very nice man. I’ve listened to a lot of interviews with him to try to get a sense of the person. And I instinctively like him. He has a wry sense of humor that a lot of business executives don’t. I think he has a self-awareness that I find very charming. And I’m very impressed by the considerable donations he’s made to a whole range of causes. The challenge is that we’ve got some examples of Carlyle making its money by essentially eviscerating some of the companies that it buys.

DUBNER: Yeah, I wanted to ask you about the Plaza del Rey mobile home park in California that was a Carlyle investment. Can you give me that story quickly?

BALLOU: So, this is an area where private-equity firms have been getting increasingly active, is mobile homes. Carlyle bought the Plaza del Rey mobile home park in the Bay Area outside of San Jose, and the park was something of a pocket of affordability in an otherwise unaffordable area of the country. Now, the really important thing about the mobile-home business model is mobile homes generally are not in fact mobile. They’re sealed to the ground, often with concrete. And they’re often the only source of wealth for the person that lives in them. So what’ll happen is a person will buy a mobile home, either with cash or with a mortgage, and then they’ll pay a lot fee for the park in which it’s sitting. Now, after Carlyle bought up Plaza del Rey, it dramatically hiked the lot fees to a level that was completely unaffordable for a lot of the residents. This had two effects for the residents. One, it increased how much that they had to pay every month to the owner, and ultimately to Carlyle. At the same time, it eviscerated the equity that they had built up in their homes because it meant that other people wouldn’t be able to buy those homes. And it meant that they were taking not only the residents’ income, but their wealth.

As Ballou writes in Plunder, this led the residents of Plaza del Rey to ask their city council to impose rent controls.

BALLOU: And if you read the reporting on this and talk to the folks that were involved in this — there’s a really sort of tragic sense in which they’re completely outgunned. Carlyle’s bringing in executives to these city council meetings, explaining their positions. Meanwhile, the residents are collecting cans to try to afford a lawyer. There’s a quote, I think, in the L.A. Times, that they finally collected enough cans to have a third hour with a lawyer. This ultimately proved to be, at least according to public reporting, extremely profitable for Carlyle, which was able to sell the park for a significant profit to another investor just a few years later.

Coming up: what happened when one of New York’s most beloved, most distinctive grocery stores got the private-equity treatment?

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When I moved to New York City, many years ago, I thought it was a ridiculous place to live. Too crowded, too chaotic, too expensive. And then I found a grocery store called Fairway, on the Upper West Side of Manhattan. Its slogan was “Like No Other Market.” Fairway was also crowded and chaotic — but not very expensive, and it was wonderful. At least if you like food, which I did, and do. It sounds crazy to say that one grocery store could make an entire city more livable, but Fairway did.

HOWARD: It was a dizzying, gorgeous cornucopia of all these things, some of which you’d recognize, some of which you’d have absolutely no clue what you were looking at. Like, a million kinds of apples that I had never heard of before. For me, the cheese section was the soul of the place. There were 300 cheeses behind the counter. The olive oils were amazing and plentiful, and a million kinds of vinegar, and tins of preserved fish. They were really pioneers at finding new things, finding things from around the world, finding people starting new food brands.

That is Hannah Howard. She’s a food writer, who also fell in love with Fairway.

HOWARD: It really was its own thing. A lot of times when I start to talk about all the amazing food, people think something fancy, and it was really the opposite of fancy. It was always busy. So we’re in Manhattan, and there’s always, like, an angry grandmother with a shopping cart who is not shy about ramming over you. And there was a sort of treasure-hunt vibe where you never knew what you were going to discover. There were always these ropes of garlic and brussels sprouts before that was something I would see everywhere. 

When Howard graduated from college, she knew she somehow wanted to work with food. She tried the restaurant industry, and didn’t like it.

HOWARD: Yeah, I think it wasn’t as creative as I hoped it would be. And at the time, I was doing a little bit of freelance writing including a series about food entrepreneurs. And one of the people I interviewed was Steven Jenkins, who was one of the V.P.’s at Fairway Market. He was the cheese guy. He was waxing poetic about a lot of his journeys. You know, when you probably were visiting Fairway, it was newer to have some of these cheeses — European cheeses, Goudas, and the fresh mozzarella — and he was discovering them and smuggling them in his suitcase. And I just asked him, I was like, “Hey, are you guys hiring?”

This was in 2011. Howard did get hired by Fairway; and she started out at the cheese counter.

HOWARD: And my timing was great because they were growing at this point. They had just been purchased by the private-equity firm, Sterling.

It was actually a few years earlier that Sterling Investment Partners — based in Westport, Connecticut — had made a big investment in Fairway. By then Fairway had already added a few locations beyond the original one, and the goal was to become a big chain.

HOWARD: We were growing so fast, and so short-staffed. So it was kind of like an all-hands-on-deck-all-the-time situation. They told us, “We have 10 stores now, and we’re going to have 15 stores next year, and we’re going to be like Whole Foods, we’re going to be all around the country. We’re going to be this huge brand synonymous with great food.” And that was exciting and hopeful.

DUBNER: Were you involved in the physical opening of new stores as well?

HOWARD: I was, just because everyone was. The whole team was. I gave a lot of tours to bankers who were part of the I.P.O., to show them around, and explain what we were up to. 

That’s right: Sterling was planning an I.P.O., an initial public offering of Fairway stock, to recoup its investment. This was in 2013. So how did a single, beloved, chaotic food market on the Upper West Side turn into the epicenter of an I.P.O.? Okay, let’s take a step back, to the time before Fairway had taken on a private-equity partner. The company was owned by three families. The key family, for the purpose of this story, is the Glickberg family, the founders.

HOWARD: The Glickbergs were involved, in that they were always around. Howie Glickberg was there. His son Dan Glickberg was there, and there was a lot of talk about if he was going to become the next leader, and the next face of the company.

DUBNER: How would you describe the Glickbergs as businesspeople, as keepers of this tradition, and so on?

HOWARD: They cared about the brand. They cared about their people. But I think there was also — like, kind of that famous, grumpy New York gruff exterior. There was definitely nothing warm and fuzzy going on.

Dan GLICKBERG: My God, my dad at his peak, he would walk through a store, and he would point at every single little thing that was wrong. Everybody in the business used to say, “If Howie’s not talking to you, that means you’re doing a good job.”

And that is Howie’s son, Dan Glickberg.

GLICKBERG: I am a venture-capital investor, former grocery guru. 

His father was the one who brought in Sterling Investment Partners.

GLICKBERG: Yeah. So essentially what happened was there’s three partners, three equal partners in the business. And one of the partners called up my dad one day. What my dad’s partner told him was, “I’m moving down to South Carolina. You can send my checks down there from now on.” 

The partner wanted not only to retire, but to cash out of the business.

GLICKBERG: My dad was always pretty risk-averse. And he was definitely debt-averse. So there was no way he was going to go to a bank and take out a loan to buy out his partner. So that’s when they started having the discussions with private equity.

And that’s how Sterling Investment Partners, in a deal valued at $150 million, wound up with an 80 percent stake in Fairway. The Glickbergs, who still owned around 10 percent, were running the day-to-day. But the day-to-day became much more complicated as they began opening new stores.

GLICKBERG: Sterling absolutely were not grocery-operating experts. And the one thing I would say is that, if you’re going to get into a brick-and-mortar-retail business like grocery that has extremely slim margins, you better have some experience, or you better be able to go into your phone book and find some people that have a lot of experience.

Sterling followed the standard private-equity playbook, and had Fairway take on even more debt — beyond the debt from Sterling’s initial investment — in order to fund the expansion.

GLICKBERG: I think when they went public, they had $200 million in debt, maybe more than $200 million in debt.

The I.P.O. was successful, especially for Sterling. They received nearly half of the new money; Howie Glickberg also got a big check, and Dan Glickberg made some money too. But Dan Glickberg decided to leave Fairway just before the I.P.O. He thought they were headed for trouble. One piece of evidence: Fairway had negative same-store sales.

GLICKBERG: So, negative same-store sales are when your sales this year are lower than when they were the previous year. We were burning a ton of capital. We were probably still spending too much building out each individual store. And all of those different pieces really brought us to bankruptcy, because there was no way that we were ever going to be able to position the business in a way to stabilize it, and then grow sales in order to pay off that debt.

Fairway declared bankruptcy in 2016. By then, there were 15 stores. Sterling wound down its investment, while Fairway kept operating under new ownership. But in 2020, it declared bankruptcy again.

GLICKBERG: Fairway Market is now owned by Village Super Market. There are four stores left. 

HOWARD: They’re serviceable places to buy some things that you might need. But they are no longer the site of glory and excitement. 

That’s Hannah Howard again.

HOWARD: The old Fairway is to the current Fairway as — let me think. Like, the best live music you’ve ever been to versus the annoying toy that your baby has that plays a jingle.

GLICKBERG: There is blame to go all around here. It’s not blame on my family. It’s not blame on management. It’s not blame on our private-equity partners. It’s blame to everybody. Like, we screwed this up. We screwed it up, all of us. We were just completely reactionary to any issue that popped up in the business rather than being proactive and saying, “Hey, here’s how we’re going to put systems in place, so Howie doesn’t have to walk through the stores and point out, ‘Hey, we have an inventory problem there, no price tags, why is that employee just standing in the corner with his hat on backwards?’” Like, we didn’t have any management systems in place. I think from a private-equity perspective, I think that they raised pricing way too much, because that’s the easy thing to do, right? They didn’t have the right big picture either. It was really just a race to the bottom at that point. 

HOWARD: I think fundamentally, these people, with just dollar signs as their goal, plundered something really wonderful. 

GLICKBERG: A lot of people have blamed private equity. Very few people have blamed management. And I think at the end of the day — what I really want to say is an apology. I want to apologize to our customers. I want to apologize to our employees, who worked so hard to make the Fairway experience what it was. And that’s not an apology from me. It’s really an apology from my family. And it’s also an apology from our private-equity partners, because we’ve never said that. 

We asked Sterling Investment Partners for a statement. They said, “Sterling never sold any of its stock in Fairway following the I.P.O.” and that “Sterling did not even recover the full amount it had invested in Fairway.” Additionally, they said, “the firm sought to act responsibly and honorably throughout its involvement with Fairway, its employees, and customers.” Coming up: a private-equity insider on what the industry gets right — and where it’s going. Also: what is Brendan Ballou’s endgame?

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Sachin Khajuria spent eight years at Apollo Global Management, one the world’s largest private-equity firms.

KHAJURIA: I was a partner before the I.P.O., and invested for the flagship funds across private equity, distressed, across the capital structure, working in a team of partners and other employees to deploy significant funds in different parts of the world. You know, a great experience.

These days, Khajuria is investing his own money, and he has written a book, called Two and Twenty: How the Masters of Private Equity Always Win. “Two and Twenty” refers to how private-equity firms get paid: a 2 percent fee on the assets they manage, and 20 percent of the investment profits. From the title, it may seem as if Khajuria has come to bury the industry that made him rich. But that’s not the case. I asked him to describe the mission of his book.

KHAJURIA: The mission is, first, to make everyone aware that private equity is not alternative. It is mainstream. It’s everywhere. It is possibly your kids’ schools, might be owned by private equity, could be your employer, could be the mortgage on your house, could be the road that you drive on, could be the real estate you live in. Pet care, your dating app. If you liked the movie Top Gun, one of the fighter-jet schools is owned by private equity. This is a $12 trillion industry today. And I think going forward in the 2030s, this could be a $20 trillion-plus industry. That’s assets under management, that’s unlevered. Add a little bit of leverage and you’re talking tens of trillions of purchasing power. People are going to have soon the choice about whether to invest in private equity in retail. 

“Retail” meaning the way regular people invest, maybe buying a mutual fund through their brokerage account or 401(k). Most of the money that flows to private-equity firms today comes from professionals and institutions — like sovereign-wealth funds, pension funds, university endowments. Retail investors typically aren’t allowed to invest in private equity — although the industry has been leaning on regulators to change those rules. Such a change would align nicely with Khajuria’s mission.

KHAJURIA: Everyone should be better educated about this because it’s coming, if it’s not already at your door. You know about Apple, you know about Microsoft, Amazon, Tesla, consumer electronics and so on — you know all about that. You don’t really know enough, probably, as an individual about Blackstone, Carlyle, KKR. These are the giants of the industry. And you should. For a lot of people, it’s still a very opaque industry. And when you have opacity or a lack of transparency — or perceived lack of transparency — you have a lot of worry about what’s really happening behind the curtain. 

Khajuria’s main argument is that private-equity firms are simply very good at making a lot of money. Why? One key, he says, is a mastery of complexity.

KHAJURIA: If you think about most of our modern lives, we’re looking for simplification. “Is there an app for this?” “I want the book that gives me five principles on how to run my life.” It’s actually the opposite in private investment. It’s like, “Well, hang on a minute, what are people running from? What’s just too hard?” And hard can be defined in lots of ways. “This business is a good business, but it tripped up, the management messed it up. Oh, my God, is it going to die? So much work. I don’t know.” Or, “This is a disruptive industry, yeah, but is it just a fad, you know? Is crypto coming? Is it going? Is it real? So much work.” “The world is melting down. There’s a financial crisis. Oh my God, this guy wants to buy an insurance company. What? But didn’t an insurance company just go bust? So much work.” In that lies value. Complexity is a source of value with private investing. 

DUBNER: So there has been quite a bit of academic research about the downstream effects of private-equity investing, much of it negative. On the employee side, there’s research about wages, work conditions, about longevity once a private-equity firm takes over a company. And then on the consumer side, too, especially when we’re talking about healthcare, which has become a big area for private equity — nursing homes, hospitals, doctors’ practices, on and on. Many of the outcomes there have also been argued to be significantly negative. I would think that’s a major concern for anyone, even if they’re just a retiree looking for an investment. But I didn’t read about any of that in your book. Why not? 

KHAJURIA: So it was important in all the cases we looked at for them to be pretty much personal examples. And, happily, I wasn’t involved in any of the ones that you mentioned that had those downstream ill effects. If you look on Bloomberg, if you look on the business press, you’ll find lots of articles about large public companies doing things in a way that they shouldn’t — whether it’s Amazon with wages or it’s this hospital with this, that, the other — you see lots. I think it’s very important not to confuse the style of investing with corporate behavior. Is there something intrinsic about private-markets investing that does all these bad things? No. Is there something intrinsic about private investing that is vastly superior in all circumstances to public investing? No, of course not.

And so I think you have to be a lot more nuanced than that, and say, look, if the argument is, “We found that in this, this, and this deal, that all happened to be private-equity deals, these practices were happening that didn’t benefit consumers, communities” — that should not happen. But it should not happen not as a function of being a private-equity investment, one hopes, but more as a matter of corporate life, in the same way that whether you look at Enron or whether you look at A.I.G. or whether you look at Lehman Brothers — none of these things are private-equity, and these things have caused enormous problems over the years. And so you’ve got to be pretty open about it and say, if you find a particular set of individuals or firms doing things they shouldn’t do — of course, that shouldn’t happen, and that should be addressed in the normal course of things. But I don’t think it’s the industry overall. I’ve never been in a meeting where somebody said, “Well, let’s do that. It’s good for us, but it’s bad for somebody else.” No way.

Sachin Khajuria makes a good argument here — that plenty of firms misbehave and fail and crumble without private-equity investments. Brendan Ballou, the Department of Justice lawyer and author of Plunder, is not particularly sympathetic to this argument.

BALLOU: There was a really interesting instance where a private-equity firm bought up a restaurant chain, pushed it into bankruptcy, and ultimately was able to push off the pension obligations of the employees and retirees onto a quasi-government agency. And when asked about this tactic, the co-founder of the private-equity firm said simply, “We don’t make the rules.”

DUBNER: You write that “roughly one in five large companies acquired through leveraged buyouts go bankrupt in a decade. This is vastly more than the roughly 2 percent of comparable companies not acquired by private-equity firms that do.” Can you explain why that happens so often? 

BALLOU: The advocates of the private-equity industry would say that this is essentially inevitable, that private-equity firms buy up risky businesses with the hope of radically transforming them. So it’s only natural that a higher percentage of these businesses fail. Maybe. But a lot of private-equity acquisitions happen with a lot of debt. And then, on top of that, the private-equity firms manage to extract fees from the company that they own. So, management fees every quarter or every year for the privilege being owned by the private equity firm. Dividend recapitalizations, which is the company essentially borrowing money to pay the private-equity firm and its investors.

DUBNER: There’s also the magic of the sale-leaseback, yes?

BALLOU: Yeah. If you live in the Midwest, you might have been familiar with Shopko, which was sort of a Walmart competitor. Sun Capital, a private-equity firm, bought up Shopko and then required Shopko to sell all of its physical stores and then lease the stores back in perpetuity. Now, you can see how that would make a lot of sense if you’re a short-term investor — you get an initial pop of the sale. But it’s tough for the long-term investor because it used to have assets that it could rely on. Now it’s saddled with these long-term lease obligations that it’s going to have to pay. 

DUBNER: If I asked you to write a brief critique of your own book, what would that be?

BALLOU: “Private equity has resulted in thousands of successful deals for hundreds of fabulously successful companies, and Ballou fails to acknowledge or explain that success.”

DUBNER: Okay, so why did you not explain that success more fully? 

BALLOU: My point is not that every private equity deal is a failure. Not even the majority. The problem is that we’ve got a business model whose incentives drive extreme and ultimately bad outcomes. Hopefully this is a bit of a blueprint, there’s a tremendous amount of expertise within the federal government on a whole range of issues. Private equity is just one of them. So I’m hoping that this is a little bit of a blueprint for how we can get people who are really knowledgeable in government to talk publicly about these issues. 

In other words, Ballou is looking for Washington to regulate private equity much more aggressively. The Securities and Exchange Commission did recently take one such step by announcing new rules designed to “transparency, fairness, and accountability” in how private-equity firms report their activities. These rules didn’t go nearly as far as S.E.C. chairman Gary Gensler was hoping for. Even so, Gensler’s S.E.C. is now being sued by the private-equity industry for “exceeding the Commission’s statutory authority.” You can understand why the industry is pushing back against even this relatively minor regulation. They own the keys to a gigantic money-making machine, getting bigger by the day; and if it costs a few million dollars in legal and lobbying fees to keep it running, that might be their best investment yet. The industry also likes to argue that its form of investor-driven capitalism is what keeps the American economy so dynamic, and that it would be dangerous to mess with this formula. Brendan Ballou doesn’t buy that argument, either. His book opens with a quote from the late Supreme Court Justice Louis Brandeis: “We must break the money trust or the money trust will break us.”

BALLOU: Brandeis’s concerns in the 1910s are almost shockingly similar to the concerns that we’ve got now. Back then, you had the great trusts — the steel monopoly, tobacco and sugar trust, the railroad trusts. And as Brandeis says, the money trust, controlling whole vast swaths of industry. He and others talk about the immiserating effects that this has on people, whether it’s employees dying working for the railroads, while heirs to these fortunes have literal hunts for diamonds on their backyards. But Louis Brandeis and others helped to lead the progressive movement that constrained the powers of the trust. He helped to create the Federal Trade Commission. And there was a huge blossoming of popular, progressive legislation that didn’t destroy capitalism in the slightest. What it did is it constrained the powers of the trust and made the economy far more productive and far more fair.

DUBNER: Can you just name a couple other protections, especially worker protections, that were invoked during that time? 

BALLOU: Yeah, it’s kind of amazing. It’s almost a to-do list for the modern era, whether it’s talking about the first labor laws, the first environmental laws. I don’t want to overstate the progress of that moment. The 1910s were also an era that was incredibly regressive racially. So it’s not a perfect guide, but it does have a certain rhyming quality for the present, in that I think that there is often a sense of — people leap from thinking of private equity or our current political or financial condition as sort of always as it is to sort of a sense of despair, that it can never be changed. And I think Brandeis’s era shows that it can be, because it has been changed before. And the avenues by which we do it are going to have to be a little creative. Yes, action can happen in Congress, but a lot of elected officials receive significant contributions from the industry, as they receive from many other industries. What we can be thinking about in addition to action in Congress is what role can federal regulators take? Whether we’re talking about the Securities and Exchange Commission, the F.T.C., the Treasury Department, Federal Reserve.

But you get the sense the private-equity industry is very well-positioned to fend off any significant regulatory reform. Do you remember the dream that Sachin Khajuria was promoting — to get more retail investors, like regular old 401(k) investors, into the private-equity market? Well, that dream is starting to look real.

BALLOU: So historically, that has not happened because private-equity firms have been concerned about getting sued for irresponsible investments. The government can and recently has largely insulated private-equity firms from those sorts of lawsuits. In 2020, the last administration issued a letter from the Department of Labor, supported by the Securities and Exchange Commission, that essentially said, with some caveats, “If you are a 401(k) fund manager, it’s okay for you to invest in private equity and you cannot successfully be sued for that.” So this was, as I understand it, about a decade-long effort by the private-equity industry to get access to 401(k) funds. Stephen Schwarzman, the head of Blackstone, said — I’m paraphrasing very slightly here — he said, “In every person’s life, you have to have a dream. And my dream is to get access to 401(k) funds.”

DUBNER: Has the money started flowing? 

BALLOU: As I understand, it hasn’t happened yet, but they are working very hard on it.

DUBNER: So you said a minute ago that this was supported by the S.E.C., the Securities and Exchange Commission. The chair of the S.E.C. at the time of that support was who?

BALLOU: Jay Clayton.

DUBNER: Right. And Jay Clayton now is?

BALLOU: The non-executive Chairman of Apollo Global Management.

DUBNER: Which is?

BALLOU: One of the leading private-equity firms.

DUBNER: So what do you expect the average person to think when they hear about that kind of daisy chain?

BALLOU: Clayton — I think he has a genuine belief that private-equity firms have higher rates of return than ordinary investments — stocks, and bonds, and so forth.

DUBNER: And therefore, it’s good for the average investor to have access to that. That’s the theory, right?

BALLOU: Exactly. 

DUBNER: And in reality, what’s your view? Is this move more advantageous to the private-equity industry on average than it is to the average investor?

BALLOU: It’s certainly the case that private-equity firms can often benefit in a way that their own investors don’t. I don’t think that it’s nefarious intent. But it is clear that private-equity firms have just been extraordinarily successful in getting their way on these sorts of obscure regulatory issues.

DUBNER: If I could just ask you to say, like, is private equity on balance good or bad for the operation of our society, how would you start to think about describing that? 

BALLOU: I suppose if I thought that it was good for society, I wouldn’t have called the book Plunder.

DUBNER: Sorry, I forgot to take my anti-obvious pills this morning.

That, again, was Brendan Ballou. And his book is called Plunder: Private Equity’s Plan to Pillage America. Thanks to him, as well as to Sachin Khajuria, whose book is called Two and Twenty: How the Masters of Private Equity Always Win. Thanks also to Hannah Howard and Dan Glickberg for telling us the Fairway story. I would love to hear your thoughts on the private-equity industry. Our email is radio@freakonomics.com.

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Freakonomics Radio is produced by Stitcher and Renbud Radio. This episode was produced by Ryan Kelley. Our staff also includes Alina Kulman, Eleanor Osborne, Elsa Hernandez, Gabriel Roth, Greg Rippin, Jasmin Klinger, Jeremy Johnston, Julie Kanfer, Lyric Bowditch, Morgan Levey, Neal Carruth, Rebecca Lee Douglas, Sarah Lilley, and Zack Lapinski. Our theme song is “Mr. Fortune,” by the Hitchhikers; all the other music was composed by Luis Guerra.