Choosing battles

The image of private equity firms on both sides of the Atlantic asking for bailout money weakens the industry’s position on the carried interest debate, writes Christopher Witkowsky.

Private equity’s fight against tax rises on carried interest will be significantly diminished now that several firms have gone looking for government handouts to rescue dying portfolio companies.

Cerberus Capital Management, for example, has asked the US government for $10 billion to fund a merger of the firm’s ailing portfolio company Chrysler with General Motors. The government has declined to fund the deal, according to media reports.

Cerberus-led GMAC Financial Services, which has been bleeding money, is attempting to convert into a bank holding company, which would qualify the company to take part in the US government’s $250 billion bank bailout, giving it much-needed cash to continue operating.


The US government also stepped in to help PNC Financial Services buy Corsair Capital-backed National City. PNC is buying National City for $5.2 billion, and the government will take a $7.7 billion stake in the combined companies. Corsair bought a $985 million stake in National City in April and watched as the Cleveland-based bank’s market capitalisation significantly shrank. Corsair said it will be made whole on its investment because of the deal.

In Germany, JC Flowers-backed Hypo Real Estate has been receiving routine injections from the German government to keep operating. The company is waiting on a €50 billion cash injection from Germany, and in the meantime has received €15 billion to tide it over. In June, Flowers and private equity firm Grove International, working with Japan-based Shinsei Bank, invested €1.1 billion in Hypo for up to 24.13 percent of the firm’s shares.

The industry, particularly in the US, will have a tough time selling the idea that the tax rate on carried interest should remain low now that some of its major players are asking for taxpayer funds to solve their problems. It’s yet another blow in the PR battle that heated up starting in 2006.

Then, at the height of its power, the US private equity industry lobbied hard to stall a proposed law in the US Congress that would have taxed carried interest at the 35 percent rate paid on ordinary income rather than the 15 percent rate levied on long-term capital gains.

Private equity won the battle, but times have changed in a number of respects, and the carry debate will return. If Senator Barack Obama and a large clutch of Democratic lawmakers win the elections tomorrow, there will be even fewer defenders of carried interest in Washington.