Rosemary Batt and Eileen Appelbaum
The American Prospect, July 3, 2017
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The Senate confirmed Wilbur Ross as Trump’s new secretary of commerce by a vote of 72 to 27, with Democrats closely divided. Democrats are understandably conflicted over this appointment. A private-equity billionaire, Ross has also done deals with unions. He poses as a friend of labor, a savior of bankrupt companies, a creator of jobs, a turnaround wizard. He can sound like an economic nationalist. Now, as secretary of commerce, he is the architect of government policies to create jobs in this country. What will that mean?
Ross is worth an estimated $2.5 billion to $2.9 billion, according to various industry estimates. He has made his billions by buying up struggling or bankrupt companies on the cheap. He has used bankruptcy laws to dump health and pension benefits for workers when buying distressed companies. He has relied on the North American Free Trade Agreement and the World Trade Organization to offshore manufacturing jobs to Mexico and Asia; and has taken advantage of tax laws that privilege debt-financing and allow private-equity returns to be taxed at the low capital gains rate. Now as the architect of Trump’s infrastructure investment strategy, his stated policy plan would use billions in federal tax dollars to subsidize Wall Street tycoons like himself.
As an early “innovator” in the art of distressed investing, Ross built his skills over 25 years at the New York office of the Rothschild investment bank, where he ran the bankruptcy restructuring unit until he left in the late 1990s. There, he witnessed the revolution in the debt markets, as “junk bonds” were increasingly used to finance highly leveraged buyouts of companies. And as over-leveraged companies collapsed, he saw that bondholders were forced to accept pennies on the dollar. Ross became the leading Wall Street bankruptcy adviser for the worst bankruptcies of the era—and learned that a lot of money could be made as a bottom-feeder. He represented the creditors in the 1990 bankruptcy case against Trump’s Taj Mahal casino, when it went bankrupt after borrowing $675 million in high-risk junk bonds. He brokered the deal that allowed Trump to keep a major stake in the property. According to Ross, “Bondholders are like workers in a factory. … On their own they have no leverage. But if someone pulls them together, they can negotiate with anyone.” Ross organized them, and learned how to turn Chapter 11 bankruptcies into profit-making machines.
With this expertise, he opened the private equity firm WL Ross & Co. in 2000—with $440 million from wealthy backers. In 2001, he launched his first hedge fund, and by 2002 his second private equity fund. His private equity and hedge funds focused entirely on distressed investing—buying up companies that were already bankrupt, or buying the debt of distressed companies headed toward bankruptcy in order to snap them up soon after. His funds were well positioned to pick up the pieces of companies following the 2001 stock market crash, the September 11 attack, and the global recession. By 2003, his private equity firm managed $1.6 billion in assets.
Ross’s strategy was to buy up at least one-third of the debt of a bankrupt company he intended to bid on. The debt could be purchased for pennies on the dollar, and Ross would become the largest creditor, giving him a lot of power in the bankruptcy proceedings. This positioned him as the strongest bidder to take the company out of bankruptcy—paying for the purchase by forgiving the loans he had made to it. At the end of the day, the debt he held would be wiped out, but he would now be the biggest or only shareholder in the company.
Buying companies out of bankruptcy is also profitable because Chapter 11 of the Bankruptcy Code allows a company to reduce its debt to as little as pennies on the dollar and to dump millions or billions in health-care and pension liabilities. Creditors, shareholders, and workers suffer the losses, and the new owner gets valuable assets on the cheap. The logic behind Chapter 11 bankruptcies is to allow otherwise healthy companies to re-emerge and continue to be productive; but in recent decades it has become a path for private equity and hedge funds to get rich quick.
How Ross Does It
One of Ross’s private equity firm’s first targets was the failing steel industry, which he studied for more than two years before going after it in 2002. He negotiated with the United Steelworkers union in 2001 to get his desired concessions. He claimed credit for saving the U.S. steel industry by buying up bankrupt steel companies and rolling them into a platform called the International Steel Group, which he then sold to the Indian-owned multinational Mittal Steel Company in 2005. Union leaders called him a pragmatist—a straight-shooter whom they could deal with—no nonsense, no drama.
But the steel deal came at a heavy price: Ross made $4.5 billion—14 times his investment, and exactly equal to what retirees lost in pension and health-care benefits. In February 2002, he used his bankruptcy strategy to buy several LTV steel facilities that were in liquidation, so he didn’t have to assume health or pension costs. He paid $90 million in cash plus $235 million in assumed liabilities—that is, the deal was 75 percent debt. That payment equaled 3.6 percent of the $2.5 billion value of the assets on the books. After several more buyouts of bankrupt mills in 2003 and 2004, he controlled 20 percent of the industry. Ross bought the mills on condition that health coverage for retirees and those workers targeted for layoff would be eliminated, and that pension liabilities would be shifted to the federal Pension Benefit Guaranty Corporation (PBGC), with workers receiving substantially lower benefits than they otherwise would have. His turnaround of the companies also depended on government trade protections: Ross was aware that then-President George W. Bush was about to impose tariffs on imported steel to offset illegal dumping by foreign steelmakers. A 30 percent tariff went into effect in March 2002—a month after his initial steel mill acquisitions—providing a critical window for Ross to restart steel production.
Ross repeated this strategy in the textile industry. In 2001, he identified Burlington Industries as a potential target. Through his hedge fund, he started selling the Burlington stock short. When the company filed for bankruptcy in 2003, he had positioned himself to buy up the remaining bonds (which had fallen to 11 cents on the dollar), allowing him to become the company’s largest bondholder and to take over the company. His next textile acquisition was the bankrupt Cone Mills, where he positioned himself as both a major bondholder and bidder on its assets. Board members and stockholders accused him of a conflict of interest, arguing that he pushed the company into an unnecessary bankruptcy in order to buy it up cheaply. But Ross prevailed. In both cases, debt was slashed, the mills resumed operations, and a portion of workers returned to their jobs—but only after Ross extracted major union concessions and shifted pension liabilities to the PBGC. These companies became the platform for the International Textile Group, which Ross later sold in 2016 to the private equity firm Platinum Equity for an undisclosed amount.
In 2003, he used the same tactics to move into coal. Ross formed Newcoal LLC and expressed interest in buying the non-union operations of Horizon Natural Resources—but not its six union properties. The United Mine Workers of America charged that Ross conspired with Horizon to orchestrate the bankruptcy. Horizon, which had about $1 billion in assets and $1 billion in debt, sought a Chapter 11 bankruptcy to protect itself from its creditors. It also asked the judge to void its union contracts on the grounds that they prevented the company from finding potential buyers. In an unprecedented decision, the judge agreed, ruling that Horizon did not have to honor the guaranteed health-care benefits for 800 active and 3,000 retired coal miners. This allowed Horizon to sell about two dozen mines to Ross for only $786 million. Ross bought additional coal properties and rolled them into the International Coal Group, forming the fifth-largest coal company in the United States. In 2011, Ross sold the corporation for $3.4 billion to Arch Coal, which went bankrupt four years later.
In sum, there is nothing in Wilbur Ross’s record to suggest that he really cares about U.S. workers. He has no ideological position vis-à-vis unions, labor, or U.S. economic development. A deal is a deal—as long as it pays him high returns.
Supporting Free Trade to Offshore Jobs
While Ross supported protectionism when it came to the steel industry, he flipped to a free-trade advocate for his auto and textile empires. His supporters refer to his approach to trade as “pragmatic” and “flexible.”
When he invested in distressed steel and textiles, he lobbied for and applauded Bush’s protectionist tariff against foreign dumping of cheap steel, and he argued against China’s entry into the WTO. He helped found a powerful protectionist lobbying group—the Free Trade for America Coalition—made up of an odd mix of corporations, labor unions, and agribusiness. But when he moved into the auto-parts industry in the mid-2000s, he favored free trade—the kind that exposes U.S. workers to unfettered global competition. He supported NAFTA and took advantage of the deal to offshore jobs to Mexico and other countries. He also became a key lobbyist and organizer of industrialists to support the passage of the Central America Free Trade Agreement (CAFTA)—basically extending NAFTA to Caribbean and Central American countries.
Taking advantage of these free-trade agreements, Ross formed the International Automotive Components (IAC) Group in 2006, a platform that merged the auto interior businesses of Collins & Aikman and the Lear Corporation. Soon after, he began offshoring jobs to Mexico and China. In one case, when the union at a Pennsylvania auto-parts factory refused to accept concessions of more than 25 percent of workers’ pay and benefits, Ross shuttered the plant and sent the jobs offshore. But even when unions made concessions, Ross sent at least a portion of production abroad. A year after the formation of IAC, his plant in Hermosillo, Mexico, employed 1,700 workers. By 2015, Ross’s company had eight factories in Mexico and expected production there to continue to expand. At that time, Ross boasted in an interview that he had built IAC through 14 acquisitions—“all distressed”—and employed 27,000 employees in 17 countries. Ross made similar choices for his textile plants. After buying textile plants out of bankruptcy, extracting union concessions, and dumping health and pension benefits, he nonetheless built new factories in Mexico, China, and Vietnam—creating jobs there, not at home.
Now, as commerce secretary, Ross will oversee the International Trade Administration (ITA), responsible for trade deals such as NAFTA. Ross has seemingly flipped his position on trade again—now backing Trump’s campaign pledge to renegotiate trade deals that will protect and restore blue-collar jobs in communities decimated by the kind of offshoring that Ross himself grew rich on. In his confirmation hearings, Ross said that his first priority was to undo NAFTA, increase U.S. exports, and bring jobs back to the United States.
But the initial details of the Trump reforms suggest the opposite. A draft letter from acting U.S. Trade Representative Stephen Vaughn to Congress, leaked on March 30, provided details on the Trump administration’s approach to reformulating NAFTA. That approach would largely benefit investors and large corporations—not workers. According to the letter, the administration planned to tweak NAFTA to move it closer to the provisions included in the Trans-Pacific Partnership (TPP) agreement that Trump trashed as a candidate and disavowed as president.
The changes, for example, would make NAFTA’s provisions on copyright and e-commerce mirror those in the TPP. The United States wants NAFTA to require stronger laws on the enforcement of intellectual property rights and to require NAFTA countries to eliminate national laws that impede cross-border data flows or digital trade in goods and services. The administration also intends to keep the controversial Investor-State Dispute Settlement (ISDS) provisions of NAFTA, which allow foreign companies to challenge legislation and court decisions that go against their financial interests in special tribunals. These changes would increase, not decrease, protection of the interests of American multinational corporations and, if anything, would enhance the advantages realized by multinationals in offshoring jobs. These changes could also hurt consumers, for example, by bolstering the high price of drugs. Provisions that would protect the interests of blue-collar workers were striking in their absence. The administration backed away from the leaked draft letter as soon as public scrutiny emerged, but its contents are suggestive of the direction that Ross and his colleagues want to go in as they renegotiate NAFTA’s terms. On May 18, the Trump administration triggered the 90-day countdown to renegotiation talks, which ends on August 16.
Making Money Every Which Way
Wilbur Ross’s private equity firm had estimated assets under management of $8 billion in 2013, according to PitchBook, an industry research and data analytics firm. At the time, his firm had raised $8.6 billion in 12 investment funds over a 15-year period—54 percent of those investments from public pension funds. The firm had a total of 56 total investments and 39 active investments on its books. It had moved out of basic industries like steel, coal, auto parts, and textiles, and into more lucrative sectors like international shipping and financial services.
Ross represents a class of people who put their own individual interests first, above all else. Their gains come at the expense of others—not only workers, suppliers, or creditors, but their own investors as well. While Ross was profiteering from bankruptcy proceedings at the expense of creditors and taking health and pension benefits from workers, he was mistreating his own investors as well. Like many private equity general partners, Ross began using a scheme known as a “management fee waiver” to extract extra cash from his private equity fund. In these fee-waiver agreements with his limited partners, Ross agreed to waive a portion of the investors’ management fees in exchange for giving himself a priority claim on the fund’s profits. In addition, he promised the investors a share of the fees that Ross required his portfolio companies to pay. Through this sleight of hand, Ross could turn the taxes on management fees (taxed at the corporate income rate of up to 39 percent) into capital gains taxes (paid at 20 percent). The limited partners went along with this scheme only to find out that Ross cheated them out of their fair share of portfolio company fees. Between 2001 and 2011, Ross kept $10.4 million in fees that he should have returned to the limited partners, according to the Securities and Exchange Commission. An SEC enforcement action required Ross to return the fees, but without admitting guilt; and the SEC charged him a modest $2.3 million penalty.
Ross’s behavior as the general partner of a private equity fund was not unusual. The private equity model relies on taking risks using other people’s money. Private equity general partners (GPs) typically put up less than 2 percent of the equity in an investment fund while the limited partners put up 98 percent. Yet the GPs pocket a disproportionate share of the returns—20 percent of the profits over a given hurdle. They also require limited partners to pay an annual 2 percent management fee over the ten-year life of the fund, and require portfolio companies to pay millions in monitoring, advisory, and transactions fees, often for services never rendered.
Ross’s continued investment in Diamond S Shipping has raised concerns over conflicts of interest since he took over as commerce secretary. The company’s 12 crude-oil tankers and 33 refined-product tankers are subject to environmental regulations by the National Oceanic and Atmospheric Administration, a Commerce Department agency.
In assuming the job of secretary of commerce, Ross has divested himself of the vast majority of his investments as well as seats on corporate boards, to reduce conflicts of interest. But he will not divest his stake in his most valuable recent investments, most notably in real-estate financing and in the international shipping industry, an industry that he is now charged with overseeing. He is maintaining his investment in Diamond S Shipping, which he tried to take public in 2014, but failed to get the price he needed. The company’s fleet includes 12 crude-oil tankers and 33 refined-product tankers. During his confirmation hearings, Ross was questioned about conflicts of interest arising from his investments in oil tankers, which may pose environmental risks to the oceans, which Commerce also oversees through the National Oceanic and Atmospheric Administration. When pushed, he only agreed to recuse himself from conflicts if they directly involved his own fleet of ships—a response that did not satisfy environmentalists or some Democrats.
Moreover, his remaining investments completely lack transparency. His funds are registered in the Cayman Islands, with little or no information about which private companies or industries he continues to invest in. When private equity GPs buy companies, they take them private and are free to manage them without government oversight or even accountability to their investors, who are not privy to the details of how the portfolio company is managed or how fund returns are evaluated. Private equity firms themselves are required to submit only minimal annual reports to the SEC; under the Dodd-Frank Act, these are not available to the public. So it is still unclear what types of conflicts of interest remain for Ross as he oversees the monitoring and enforcement of industry standards and regulations.
Privatizing Infrastructure with Public Dollars
As commerce secretary, Ross will be the architect and administrator of Trump’s infrastructure investment plan. Already, before Trump was elected, he teamed up with Peter Navarro, now director of the White House National Trade Council, to devise an infrastructure development plan for the administration. The plan relies heavily on private-sector investment, which they believe will reach up to a trillion dollars over a ten-year period. In June, Trump announced that his “trillion dollar” infrastructure program would include $200 billion in public money and $800 billion in tax-subsidized private investment. But even that $200 billion, when we subtract Trump’s $139 billion in planned budget cuts for transportation infrastructure, boils down to just $61 billion.
Relying on the private sector poses other problems. Prudent lenders will not lend more than five times the equity in a project undertaken by private investors. That means it would take $167 billion in equity to finance a trillion dollars of infrastructure investment. That’s a lot of money for private investors to come up with, so the Ross-Navarro plan provides an incentive to the private sector—a federal tax credit equal to 82 percent of the equity amount to subsidize investors, at a cost to taxpayers of more than $131 billion. This subsidy interacts with another Trump incentive scheme, which would allow multinational corporations that have parked profits in low-tax countries to pay a much-reduced tax of just 10 percent when they repatriate these profits to the United States. A company that repatriated $1 billion would owe $100 million in taxes. But if it invested $121 million in an infrastructure project, the 82 percent tax credit would wipe out the repatriation tax. The company would have an equity investment of $121 million in an infrastructure project that would pay it dividends over a 20- or 30-year period, and no tax bill.
Private-sector financing also means that only projects that generate significant cash flow—toll roads, bridges, rail systems, airports—are likely to receive funding. Ross and Navarro estimated that infrastructure investment requires an annual return of 9 percent to 10 percent in order to cover “… operating costs, the interest and principal on the debt, and the dividends on the equity.” But infrastructure projects typically yield a return of only 5 percent, according to Tax Foundation Senior Fellow Stephen Entin. As a result, many needs will go unmet. Rebuilding aging public schools, replacing pipes and removing lead from drinking water, or maintaining roads and highways would not meet this criterion.
Finally, the Trump plan, as proposed by Ross and Navarro, would provide “maximum flexibility” to the states—widely understood as code for rolling back labor and environmental protections. This would include the weakening of prevailing wage rules and environmental rules in order to accelerate these investments.
It did not take long for Ross’s fellow private-equity chiefs to recognize the money-making opportunities in this infrastructure investment plan. In late January, Joe Baratta, global head of private equity at Blackstone Group, the largest private equity firm in the world, talked about raising an infrastructure fund of as much as $40 billion in equity. This would be Blackstone’s largest fund ever. And Baratta and Blackstone President Tony James have raised the possibility of achieving returns in the 40 percent range. Plans for this fund have moved closer to implementation. On the heels of Trump’s visit to Saudi Arabia in May, the Saudi Arabia Public Investment Fund committed $20 billion to Blackstone. With the addition of debt-financing, the Blackstone fund is expected to make investments totaling $100 billion. Some private equity firms have already launched large infrastructure funds. Global Infrastructure Partners recently raised $15.8 billion for what is currently the largest infrastructure fund. Brookfield Asset Management Inc. raised $14 billion in 2016 for its third infrastructure fund. These firms are poised to take advantage of huge growth opportunities for infrastructure investing.
Nonetheless, the plan was soon met with skepticism, not only from the left, but also from free-market Republicans who believe there aren’t that many attractive opportunities that will yield the level of returns that private investors demand. But this is expected to change. Infrastructure investment may lead to high returns in the future because key players in the Trump administration are likely to position government agencies to partner with private equity firms to do major infrastructure projects. In addition to Wilbur Ross at Commerce, Trump has appointed Blackstone Group co-founder Stephen Schwarzman to lead the president’s Strategic and Policy Forum; Global Infrastructure Partners’ managing partner, Adebayo Ogunlesi, is also a member of the forum, which advises Trump on how to promote economic growth and jobs, and is expected to focus on infrastructure investment.
As Wilbur Ross takes over Commerce, the real question is how he will use the power of government and taxpayer dollars to subsidize the wealthy class that he is a part of. His decisions in conjunction with the other Trump billionaire agency heads are at risk of locking in longer-term privileges for the investor class that will contribute even more to the growing inequality of wealth and power in the country.
Rosemary Batt is the Alice Hanson Cook Professor of Women and Work at the Industrial and Labor Relations School, Cornell University.
Eileen Appelbaum is a senior economist at the Center for Economic and Policy Research. This article draws on their book, Private Equity at Work: When Wall Street Manages Main Street.