Shady Financial Engineering: Not Just For Private Equity

A blog about business and economics.
Jan. 13 2012 10:35 AM

Shady Financial Engineering: Not Just For Private Equity

SAN FRANCISCO - SEPTEMBER 20: (L-R) Pacific Gas & Electric (PG&E) senior vice president of engineering and operations Ed Salas, PG&E senior vice president of energy delivery Geisha Williams, PG&E president Chris Johns and PG&E CEO Peter Darbee speak during a news conference at the company's headquarters on September 20, 2010 in San Francisco, California.

Photo by Justin Sullivan/Getty Images

Perhaps the most compelling critique I've heard of the private equity industry is that oftentimes these transactions involve getting rich through financial engineering rather than actual improvements in underlying business practices. Fair enough. But it's hardly as if this is unheard-of in the exciting realm of the publicly traded firm. Here (via Atrios) is a tale from Pacific Gas & Electric:

Pacific Gas and Electric Co. diverted more than $100 million in gas safety and operations money collected from customers over a 15-year period and spent it for other purposes, including profit for stockholders and bonuses for executives, according to a pair of state-ordered reports released Thursday.
But in 2007, Congress passed a law (actually, they inserted a provision in the Iraq War Funding bill) that specially allowed airlines to use a discount rate of 8.25 percent. A higher discount rate means fewer assets are needed to cover a given set of benefits, and therefore lower contributions into the pension fund are required. Essentially, this law allowed cash-strapped airlines to borrow money from their pension funds to keep themselves afloat.

I would further note that over and above borrowing from the pension fund, American Airlines went to great lengths to lever-up as much as possible by taking up loans backed by physical assets like airplanes. Then they declared bankrutpcy with over $4 billion in cash in the bank, not so much because they "couldn't" pay their bills as that it was simply more financially viable to go into bankruptcy to shed some of these pension obligations (and otherwise stiff unions) before the discount rate jig was up.

Socially destructive business practices are a real problem, but they're not unique to one particular form of corporate organization.

Matthew Yglesias is the executive editor of Vox and author of The Rent Is Too Damn High.



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