Perhaps the most devastating political legacy of the 2008 financial crisis was the feeling of much of the American population that the system was rigged. Owners and taxpayers gained the upper hand, while big banks were bailed out and “no one was jailed”, as financial reform campaigners still frequently point out.
The US Federal Reserve’s well-intentioned but necessarily inadequate (when not combined with smart fiscal policy) quantitative easing program raised wages modestly, but inflated asset prices sharply. The rich have become richer and inequality has increased. And while the formal banking system was largely brought to heel, money – like risk – faded into the shadows.
These less regulated areas of finance, like private equity, hedge funds and venture capital, have exploded to a value of $18 billion, with more capital raised in private markets over the past decade. than in public markets.
For example, the Securities and Exchange Commission’s announcement last week of increased regulation of private markets – including audits of private funds, greater transparency around fees and performance measures, a ban on preferential terms for different investors, etc. – was welcome and much needed. This is a sign that progress has been made. Regulators such as SEC Chairman Gary Gensler, who deserves praise for the energy with which he pursues not only private market regulation but also cryptocurrencies and cybersecurity risks, are trying to get ahead of the next crisis before it happens.
Yet the rise of these markets, which now account for a significant portion of investment by retirement plans, state pensions, and nonprofit and academic endowments in the United States, also illustrates how policymakers and politicians have failed since the crisis to put finance back at the service of the real economy. Wall Street is not primarily a helper for Main Street, as it once was. It is the tail that wags the dog.
No sector illustrates this better than private equity, which has grown rich in recent years, in part, by exploiting the devastation left by the subprime mortgage crisis. Large corporations have been able to acquire properties at rock bottom prices, outbidding not only individuals, but also other large and more regulated institutional players in the housing market, including large banks.
The story of private equity making eye-watering profits by buying foreclosed properties is now well known. But it continues to spark outrage, as evidenced by last week’s session of the Senate Banking, Housing, and Urban Affairs Committee, which examined how large institutional landlords have changed the housing market. “Investors are raising rents by 50%, issuing eviction notices and letting toxic mold and pest infestations fester, all in the name of their own bottom line,” said committee chairman Sherrod Brown.
I have seen many properties of this type with my own eyes and to be honest I have also seen some well maintained rental homes owned by PE (although these tend to be in more affluent areas where tenants can pay more). But the fact that a multinational private equity firm could become the biggest owner in the country is something that a lot of Americans just don’t like. This illustrates too starkly how financial markets seem to exist in a closed loop of service to themselves.
As Eileen Appelbaum, co-director of the Center for Economic and Policy Research, put it in her influential book with Rosemary Batt, Private equity at workthe rise of private equity represents “a fundamental shift in the concept of American business — from viewing it as a productive enterprise and a stable institution serving the needs of a wide range of stakeholders, to a vision of it as a collection of assets to be bought and sold with the sole aim of maximizing shareholder value”.
Why would public pension funds (which now account for 35% of private equity capital) invest in a way that could hurt their own pensioners by driving up rents? Partly because they are desperate to keep yields as high as they promised in times when it will get tougher.
It may or may not be a smart decision. Despite strong recent performance, academic research shows that historical returns often do not outperform or even match the broader market after taking huge carry charges. Either way, principal-agent issues make it unlikely that a pension fund manager tasked with choosing investments would raise their hand to say what most of us intuitively know, which is that he it is better to put our money in an index fund. and forget it.
I suspect there will be increasing political attention to how, nearly 15 years after the start of the subprime crisis, the relationship between finance and the real economy still needs to be rebalanced. In recent years, private funds have shifted from housing to education and healthcare (it should be noted that apart from the recent Covid-related economic disruptions, these areas are two of the main drivers of inflation long-term). Already, there are stories of how private investors seeking higher returns have increased costs and reduced the quality of care.
I am not optimistic about the end of these stories. The light the SEC has shed on the financial gloom is a bright spot in an otherwise troubling story.
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