While Mitt Romney was the head of Bain Capital, the firm purchased a company called Worldwide Grinding Systems. What happened next is precisely the kind of finance “innovation” that Romney’s opponents have been criticizing. Bain Capital put up $8 million to buy the company, then loaded it down with hundreds of millions of dollars of debt. Bain then paid itself a $36.1 billion dividend, and eventually declared the company bankrupt. They got a nice return on the investment, but their creditors lost a lot of money, 750 people lost their jobs, and the pension obligations of the company were shifted to the federal government.
No one can be certain of Bain’s intentions here, but it sure looks like a strategic bankruptcy. Private equity firms like Bain can buy up companies, borrow a bunch of money on the company’s balance sheet, use that money to pay out dividends to themselves, then protect the assets they shifted out of the company once it has gone bankrupt. This seems like a really shady practice of course, but there is nothing that prevents it from happening.
Others have already written about the questionable nature of these sorts of strategic bankruptcies, but what strikes me about them is how they compare to the way we handle student loan bankruptcies in the United States. Right now, people with student loan debt can almost never discharge that debt through bankruptcy. The government will even confiscate Social Security checks to pay off the student loan debts of those who are still carrying them into retirement.
Why the asymmetry in bankruptcy laws? The usual reason given against allowing student bankruptcies is that they could be used strategically to discharge debts that the student really could afford to pay off. One can imagine for instance an unscrupulous student accumulating $30,000 of loan debt, graduating, then filing for bankruptcy to discharge it. They get to keep the education they have received as it cannot really be taken out of their heads, but they never have to pay for it.
This is not functionally different from what Bain Capital did here. Both the student and Bain buy up something — a company or education services — with borrowed money, then use what they bought up to shift valuable assets — money or education — to themselves, then declare bankruptcy while shielding the valuable asset from creditors. Those who bought up the bonds Bain Capital sold to load the company down with debt did so knowing the risks, but so do those who loan to students. Traditionally, we would say that it is on the creditors to assess the risk of bankruptcy, and decide for themselves whether they are willing to take it.
With student loans however, we protect the creditors from almost all risk by making bankruptcy basically impossible. When Bain Capital loads a company down with debt, they take no risk at all. They use that debt to pay out a dividend to themselves, and at that point anything else that happens is just extra. If the company fails, they have already made their pile. If the company succeeds and they can sell it, then they get even more. Students however aren’t so lucky. Students who attend four-year universities pursue degrees in fields that may very well be extinct by the time they graduate. The economy might also take a nosedive, leaving them with no place to find work, a position in which many students today find themselves.
Once again then, one has to wonder why on earth there is an asymmetry here. If Bain Capital can pursue what appear to be strategic bankruptcies, then why can’t students? I suspect students are far less likely to abuse the system that way than a private equity firm, yet our laws treat them as if they are dangerously likely to strategically default. The cynical way to understand this asymmetry is pretty straight-forward of course. Student loans are taken out by middle-income and lower-income folks. Private equity firms are run and owned by higher-income folks. Is it any wonder why one has a more difficult set of bankruptcy laws to deal with than the other?