June 18, 2007
The Wizard of Oz, back in his Emerald City heyday, never had to step out from behind his curtain. In fact, if not for brave little Toto, that old wizard might still be bloviating.
Our current wizards — the shadowy investors who run Wall Street’s private equity universe — never have to step out from behind their curtains either. They can wheel and deal in the hundreds of billions and, as the managers of privately held companies, never have to disclose how large a fortune they’re pocketing in the process.
Last week, private equity's curtains finally parted, just a wee little bit, and revealed, as one awestruck news reporter put it, a dazzling world of “personal helicopters and take-home earnings running into hundreds of millions of dollars.”
In this week's Too Much, we peer inside this dazzling world. Better wear your shades.
Over the past decade, the number of households in the United States with a private jet has doubled, to more than 50,000. Now some of those households are doubling up on their private jets. Explains an executive at NetJets, a New Jersey-based private jet service: “His and hers jets are still rare, but they are the coming thing.” The most visible separate-jet twosome: Hollywood stars Tom Cruise and Katie Holmes. The 28-year-old Holmes recently sang the praises of having a private jet to call your own in an interview with the London Sunday Times: “It’s like a bus, only quicker.”
You can’t park a private jet in a driveway. That may be why luxury car maker Bentley has introduced its new Azure model, a $337,085 monster motorcar with twice the horsepower of a typical SUV. Bentley has sold 133 Azures in the United States, Forbes reported last week, since the model hit showrooms in December. Bentley, overall, is now offering four models that start at over $200,000. But sticker shock seldom gives pause to the clientele the company covets. Notes Bentley marketing director Stuart McCullough: “If you look at the kind of wealth these people have, the car is not that big a deal. It's not that big a dent on their net worth.”
On Fisher Island, the exclusive condo enclave just off Miami Beach, the typical resident will have a Bentley parked in an underground garage — and a golf cart customized to look like a mini-Mercedes. A union campaign to organize the island’s service workers is now shining a national spotlight on what the New York Times calls “one of the most concentrated pockets of wealth in the nation.” Fisher Island’s 1,400 residents make over twice as much per capita as swells on Manhattan’s swank Upper East Side. Laundry workers at the island’s golf club, meanwhile, make as little as $8.50 an hour. Annual dues at that club run up to $20,000. That's on top of the club's $250,000 entry fee. Few residents actually play a great deal of golf on Fisher Island, mainly because few residents actually live in their $5-$10 million condos year-round. Explains local realtor Larry Rivero: “It’s a fourth home for most of the residents.”
The most difficult service workers to organize? That would probably be the butlers who've graduated from Denver’s Starkey International Institute for Household Management. Aspiring Jeeveses at this “butler boot camp” spend over $13,000 for an eight-week course in “pampering the privileged.” Pampering can pay. A Starkey grad can command $200,000 a year, plus free room and board. And demand for butlers is soaring. Observes Charles MacPherson of the International Guild of Professional Butlers: "If we doubled the number of butlers, they wouldn't be without work.” The curriculum at Starkey covers everything from ironing French cuffs to clipping vintage cigars. Employers, writes Wall Street Journal reporter Robert Frank, can count on every Starkey grad to know “that sable stoles should never be stored in a cedar closet (it dries them out), and that Bentleys should never, ever be run through the car wash.”
A stubborn determination to do right — by the rich. That’s what Connecticut Governor M. Jodi Rell has demonstrated all this spring long. In April, the GOP governor rejected a state lawmaker plan that 
would have hiked the state's top tax rate on income over $250,000 — from 5 to 6.95 percent — and used the resulting revenues to fund tax breaks for average households. In late May, lawmakers came back with a smaller tax hike on Connecticut’s wealthiest, a top rate of 6.5 percent on income over $500,000. Rell nixed that, too. Earlier this month, lawmakers tried still again, with a proposal to drop the new top rate to a mere 5.7 percent. Another rejection from Rell. Her counter offer? Rell’s negotiators asked lawmakers to eliminate the state’s estate tax. Responded an exasperated Connecticut House Speaker James Amann: “That's crazy. They want us to give up all of our taxes and then, in return, give breaks to the rich.” State officials will start cutting public services July 1 if the governor and lawmakers remain unable to cut a budget deal.
Quote of the Week
“Steve Schwarzman should not be paying lower taxes than a firefighter. We believe that tax policy should not redistribute wealth in favor of the wealthiest people.”
Damon Silvers, AFL-CIO associate general counsel, June 14, 2007, announcing labor opposition to the tax loophole that will let the CEO of private equity giant Blackstone pay taxes at less than half the top federal tax rate on high incomes
New Wisdom
on Wealth
Frank Levy and Peter Temin, Inequality and Institutions in 20th Century America, National Bureau of Economic Research. Is inequality growing because some people don't have the skills they need to succeed — or because changes in basic economic policy have tilted the deck against working people? A readable academic discussion.
Barbara Ehrenreich, The Rich Are Making the Poor Poorer, The Nation, June 13, 2007
The biggest name in private equity, the Blackstone Group, is going public. Blackstone’s principals will shortly be offering the investing world’s great unwashed a chance to buy a minority stake in their fabulously profitable enterprise.
To conduct this stock sale, under current law, Blackstone has had to make its first-ever set of earnings disclosures with the federal agency that regulates the buying and selling of publicly traded stocks, the Securities and Exchange Commission.
These required disclosures, made public last Monday, have left jaws hanging all over Wall Street.
Blackstone CEO Steve Schwarzman, the SEC filing announced, pocketed $398 million from his private equity labors last year. His Blackstone management alter ego, former Nixon Commerce Secretary Peter Peterson, pulled in $213 million.
How did Schwarzman and Peterson rake in all this cash? The two have simply been following standard private equity operating procedure. They first borrow billions to buy control over stumbling publicly traded companies, then take these companies private to escape the prying eyes of shareholders and federal regulators.
The next step: The Blackstone financial wizards “restructure” their new corporate pick-ups, often by axing jobs or squeezing wage and pension concessions out of workers.
This work complete, Blackstone then takes its freshly buffed enterprises back onto Wall Street for sale to general public investors — at a huge premium, naturally, over what Blackstone initially paid for the company shares.
Last year, this tried-and-true private equity operating model generated Blackstone $2.27 billion in profits.
Blackstone's executives are now taking the next logical step. They’ve done fantastically well buying and selling other companies. They've realized they can do even better selling off pieces of themselves.
Blackstone’s top execs have filed papers to sell the public 12.3 percent of their company's management arm. That will leave them still firmly in control of Blackstone — and considerably richer.
How much richer? For CEO Schwarzman, the stock sale could bring in as much as $677.2 million. After the sale, Schwarzman will still own a 24 percent chunk of Blackstone, a stake that stands to be worth upwards of $7.7 billion.
Steve Schwarzman, the Blackstone private equity king, lives in a 35-room apartment on Manhattan’s Park Avenue. He also owns, in Florida's Palm Beach, a 11,000-sq.-foot home where he dines on $40-a-claw stone crabs. His 60th birthday party, earlier this year, “featured private performances by Rod Stewart and Patti LaBelle.”
How can Blackstone’s top exec maintain this level of luxury living? First, of course, he's taking home a ton of money every year from Blackstone. But that's only part of the story. Schwarzman isn't just making a ton. He's paying precious little of that ton in taxes.
If your employer were to hike your salary to $1 million a year, you would pay 35 percent of your income over $349,700 in federal income tax. By contrast, private equity executives, on the tens of millions they take in every year, pay taxes at just a 15 percent rate.
The explanation: The bulk of the dollars private equity partners collect come from “performance fees,” the 20 percent they take off the profits they make on the assets they manage. Current tax law treats these fees as a capital gain, taxable at just 15 percent.
This capital gains treatment annually hands private equity power suits $20 million in tax savings on every $100 million in performance fee income they pull in.
That’s apparently not enough. Blackstone is asking federal regulators at the SEC to let the company sell shares as a publicly traded limited partnership, a rarely seen animal in the financial sector.
Gaining this limited partner status would enable Blackstone, as a public company, “to pay the 15 percent tax rate on capital gains rather than the 35 percent corporate rate.”
Two senators, Montana’s Max Baucus and Iowa’s Charles Grassley, last week introduced legislation that would deny the 15 percent capital gains tax rate to private equity firms that go public.
University of Illinois law professor Victor Fleischer, a top tax analyst, calls moves in that direction “overdue.” Existing tax law, he writes in a recently published paper, “allows some of the richest workers in the country to pay tax on their labor income at a low rate.”
The private equity industry, predictably, is fiercely opposing any congressional action on private equity tax rates.
“What I worry about is really the political stuff that’s going on,” Blackstone’s Schwarzman told a private equity conference this past winter. “There are people who are trying to, at a minimum, interfere with what’s going on in private equity business.”
The nerve.
Stat of the Week
The 5,100 full-time employees at Synnex, a California tech firm, are currently generating over $1.5 billion in quarterly revenues. But one Synnex employee, CEO Robert Huang, seems to count a bit more than any other. Huang last year took home pay that equaled 14 percent of his company’s $51.8 million in profits. Across California last year, says the Los Angeles Times, CEOs at 14 major firms pocketed pay that equaled at least 5 percent of company earnings.
Too Much is published by the Council on International and Public Affairs, a nonprofit research and education group founded in 1954.
Office: Suite 3C, 777 United Nations Plaza, New York, NY 10017.
E-mail: editor@toomuchonline.org.
to Too Much