by Jason Kelly
Then there’s the impact that transcends dollars and cents and gets to common sense. The prolonged fight obscured nearly every other issue that private equity needed to bring to Washington’s attention. Friendly visits to Capitol Hill to talk about private equity’s benefit to local and state economies were derailed by discussions around carried interest. The hubbub deepened mistrust around other initiatives, including a burst of interest by private-equity firms in buying struggling banks during 2009. After allowing a small handful of deals including IndyMac and BankUnited, federal regulators quickly damped enthusiasm for more deals through tightened regulations aimed squarely at private equity.
Private equity is far from out of the woods in terms of Congress. When President Obama unveiled his framework for tax reform ahead of the 2012 election, he proposed not only changing the tax treatment for carried interest, but eliminating the deductibility of interest. In Washington, the renamed Private Equity Growth Capital Council, having chased carried interest from its inception, already was assembling its arguments around that issue. The strategy was part of a broader effort to expand the industry’s reach that began with the group expanding its membership beyond the handful of largest firms to a growing body of research around employment and economic benefits it ascribed to private equity.
While Washington was reluctant to let buyout firms be part of the banking solution, its actions around financial reform have clearly not identified the industry as part of the problem. To the contrary: Lawmakers and regulators have so far pursued a new regulatory regime that allows private-equity firms with grander ambitions to accelerate those plans.
The industry has found perhaps an unlikely ally in Paul Volcker. The former chairman of the Federal Reserve lent his name to a key piece of reform, the Volcker Rule, a central tenet of the Dodd-Frank legislation aimed at preventing another financial meltdown and series of bailouts.
The Volcker Rule at its most basic seeks to limit what big banks can do with their money, thereby diminishing the risk they can take as federally insured, deposit taking institutions. That means strict limits on what’s known as proprietary trading and principal investments. During the early part of this century, a number of banks, most notably Goldman Sachs, grew their investing arms into massive institutions in their own right. Goldman’s 2007 private-equity fund totaled about $20 billion, second only in history to Blackstone’s $21.7 billion raised that same year. Under Volcker, Goldman is effectively out of that business, at least to anything close to the extent that it was. The same goes for Morgan Stanley, JPMorgan, and Bank of America.
If they’re losing, who’s winning? Blackstone, Carlyle, and KKR. Not only are the firms losing major competitors, they have an opportunity to snap up the profitable units the banks have to shed, or the teams that run those strategies. KKR in early 2011 hired a team of ex-Goldman traders led by Robert Howard to start Kravis’s and Roberts’s first-ever long/short hedge fund.
Blackstone is on the constant hunt for acquisitions, albeit selectively. Through purchases like GSO Capital in 2008, it has bulked up its credit unit. With Wall Street in disarray, Blackstone’s hedge fund solutions unit, which finds hedge funds for clients to invest in, has become the biggest such business in the world. Schwarzman is bolstering his restructuring and M&A advice division, seeking to feed a broader need for unbiased counsel amid lingering questions about Wall Street banks. Says an executive at a competitor: “Blackstone wants to be Goldman Jr.”
Notes
1. Andrew Ross Sorkin, “A Professor’s Word on the Buyout Battle,” New York Times Dealbook, October 3, 2007.
2. Lisa Lerer, “Professor’s Proposal Angers Wall Street,” Politico, October 30, 2007. www.politico.com/news/stories/1007/6594.html
3. Victor Fleischer, “Two and Twenty: Taxing Partnership Profits in Private Equity Funds,” New York University Law Review, 2008; University of Colorado Law Legal Studies Research Paper No. 06-27; UCLA School of Law, Law-Econ Research Paper No. 06-11. Available at SSRN: http://ssrn.com/abstract=892440
4. Cristina Alesci and Jason Kelly, “Romney Reports Income from Funds at Goldman Sachs, Golden Gate.” Bloomberg News, January 25, 2012.
5. Howard Mustoe, “Don’t Criticize Romney’s Taxes, Carlyle Group’s Rubenstein Says,” Bloomberg News, January 25, 2012.
6. Michael Marois and Cristina Alesci, “CalPERS’s Dear Calls Private Equity Tax Break ‘Indefensible,’” Bloomberg News, February 14, 2012.
Chapter 11
It’s a Steve, Steve, Steve World
Inside Blackstone
My first official day on the private-equity beat coincided with Blackstone’s annual media dinner, which in 2007 was held at Daniel, a posh restaurant on New York’s Upper East Side. The off-the-record gathering was meant to mix the reporters who wrote about the firm on a regular basis with Blackstone’s top managers in a more relaxed setting than a conference room.
For me, it was more like sensory overload. I’d barely begun to recognize the names of the big firms, who ran them, and what they owned. I barely knew who Steve Schwarzman was. Being the newest guy on the beat, I didn’t rate a seat at his table, but a Blackstone rep was nice enough to provide an introduction after dinner. Told I was the new Bloomberg reporter and it was in fact my first day, he looked at me, looked around the lavish party, and said with a twinkle in his eye and a subversive humor I’d come to learn was a signature, “Every day is like this.”
In a nod to the new frugality, Blackstone in 2009 switched the dinners to the Waldorf-Astoria, which it clearly pointed out on the invitation was a “Blackstone portfolio company” through its ownership of Hilton. In 2011, the firm opted to have a series of smaller dinners at its headquarters to give meaningful access to more Blackstone executives across its lines of business.
The Daniel dinners had a nice symbolism for Schwarzman. He and Blackstone co-founder Peter G. Peterson held some of the seminal conversations related to the firm in the space that now belongs to Daniel, long before it was among Manhattan’s fanciest dining spots. In the mid-1980s, it was the cafeteria of the former Mayfair Hotel. The two men met there most mornings for breakfast to discuss plans for the new firm.1
The name itself came from a Schwarzman brainstorm. Given that each of their names was too long, he proposed putting together English translations of each of their names, black for Schwarz, stone for Peter, or petra.
David Carey and John Morris’s book on the firm, King of Capital, provides an excellent and thorough history of Blackstone, chronicling the trials and tribulations of the early days as Schwarzman and Peterson found it difficult to translate their earlier success at Lehman into a hybrid advisor/investor through its emergence into the massive firm it is today.
Peterson is now retired from Blackstone and working full-time on his foundation, which is focused on increasing public awareness of what he describes as the country’s urgent long-term fiscal challenges, a long-standing passion. During a conversation, he recalled those early difficulties. “One of the hardest periods of my life was raising the money for the first fund,” he said, describing how he plumbed his bulging Rolodex for connections, “there was nearly always a personal relationship.”
That translated to deals, as well. Blackstone’s initial approach was to team with a well-known corporation, tapping that Rolodex cultivated when Peterson was the chief executive of Bell & Howell, the U.S. Secretary of Commerce and the head of Lehman Brothers. Going in with a company had a couple of benefits: Would-be sellers took the offer more seriously, and it also helped assuage worries that Blackstone was a corporate raider looking to dismantle what it bought for a quick buck. “By aligning yourself with blue-chip firms, you were instantly the white knight,” JPMorgan’s Jimmy Lee said. Blackstone also offered the chance at times to hang on to a slice of the unit being divested, helping the selling CEO avoid potential embarrassment of selling too cheap and watching Blackstone reap huge profits down the line.
It’s undeniable that the biggest private-equ
ity firms today stand as financial behemoths given what they own and their expansion into areas beyond buying companies with borrowed money. Blackstone is the furthest along in that regard, and it was a strategy in part born of fear.
Diversification is Blackstone’s long-term business plan, executives there say, in part because of the terror of watching Lehman Brothers collapse around them—the first time, in the mid-1980s. Peterson, who had come to hold various positions at Lehman Brothers including the top job, had lost a series of nasty battles with Lew Glucksman over the future of the firm that ultimately led to Peterson’s departure. After Lehman limped into a sale to American Express, a white-knight scenario that Lehman hotshot Schwarzman helped engineer, the younger banker reunited with Peterson.
The two men, scarred by their experience at Lehman, were determined that no one would ever be able to stage a coup of any sort at their new firm. They consolidated power between the two of them, power that now rests firmly with Schwarzman alone, following Peterson’s retirement after the IPO. They also were unwilling to rely too much on any one business for profits and ultimately for the firm’s existence. “There is a real refugee mentality,” says J. Tomilson Hill, the firm’s vice chairman who now runs the hedge fund solutions business, Blackstone’s biggest unit by assets under management. A former top Lehman executive himself, he joined Blackstone in 1993. “There’s a feeling it could all go away at any moment, and that’s because of the experience at Lehman.”
Peterson, who’d become CEO of Lehman only to watch it flirt with extinction three weeks into his tenure because of a series of bad trades, said, “There are certain lessons from an experience like that. One of them is we had to be risk averse, particularly given our very limited equity capital.”
Private equity made Blackstone famous and its founders and many other senior executives very rich. Based on several measures, from assets under management to profit, private equity is no longer what Blackstone mostly does. The ethos of that drive ties to a man who has come to symbolize all the superlatives, good and bad, of the industry.
Every discussion of Blackstone still begins and ends with Schwarzman. He remains the face of Blackstone and arguably the defining figure for the entire industry at the moment. What Kravis was in the late 1980s and early 1990s, by virtue of the RJR Nabisco deal, Barbarians at the Gate, and his high-profile social and charitable life in Manhattan, Schwarzman was for the first decade of this century, and remains so. What has separated Schwarzman from his peers in part is the ambition to create a long-lasting firm, with private equity as but a piece. “Steve first and foremost thinks of himself as a businessman, while others would say they are first and foremost deal guys or private-equity guys,” Hill said.
Even peers who roll their eyes at his occasional eyebrow-raising public remarks concede he has built the single most powerful company in the business. “There’s Blackstone, and then there’s everyone else,” one manager told me.
In the era of Twitter, blogs, and constant instant commentary, Schwarzman is shorthand for the private equity industry and its excesses, real and perceived. A posting in the online magazine Salon in September 2011 referred to him as “a living symbol of post-industrial late capitalism’s gaudy depravity.”2 Later in 2011, no less than Matt Taibbi, the Rolling Stone writer who famously described Goldman Sachs as “a great vampire squid wrapped around the face of humanity” characterized Schwarzman thusly: “one of the more uniquely abhorrent, self-congratulating jerks in the entire world.”3
What perpetuates Schwarzman’s profile is his tendency to go off script. At a meeting in July 2010 for a nonprofit organization, he drew an unfortunate comparison between private equity’s fight with Washington over tax policy and World War II. “It’s war,” Newsweek reported him saying. “It’s like when Hitler invaded Poland in 1939.”4 Schwarzman later apologized.
Gaffes like that make it more difficult for Schwarzman to achieve the statesman-like role he’s told people around him he aspires to.
Schwarzman grew up with his parents and two younger twin brothers in the Philadelphia suburb of Abington. In high school he was a basketball player as well as a star runner. He told the New Yorker’s James B. Stewart about a time he slipped during a cross-country race, broke his wrist, finished in record-setting time, then went to the hospital. The football stadium at the school is named after him.5
Since then he has built a sprawling global empire with more than $190 billion in assets from a $400,000 investment, in a matter of a couple of decades. He lives in a Park Avenue apartment once occupied by Rockefellers. He has achieved enough wealth to have the nation’s most famous library—the Main Branch of the New York Public Library—renamed the Stephen A. Schwarzman Building in honor of his contribution of $100 million toward the building’s renovation and expansion.
Companies Blackstone owns directly, as well as insights gleaned from real estate, credit, and equity markets by its various arms, give the firm the potential to analyze the global economy as well as just about anyone. The chairman and CEO of such a firm has the potential to be an important voice.
To that end, Schwarzman has taken to writing the occasional op-ed piece to share his views of the world, including a piece in the Financial Times in September 2011 under the headline, “An olive branch to Obama: I will share the pain.” Schwarzman, while criticizing politicians for portraying financial firms as “villains” in the wake of the economic crisis, preached a message of shared sacrifice in pursuit of smaller deficits and job growth.6
Since he derives at least part of his importance from his professional perch, burnishing Blackstone’s reputation and appearance becomes that much more important. Part of Blackstone President Tony James’s role, in addition to growing the firm and taking it public, has been to professionalize it, a key element in the evolution of all the private-equity firms.
Blackstone, once a cult-of-personality partnership, now has the trappings and constrictions of a grown-up corporation. During 2010 and 2011, Blackstone renovated its headquarters, upgrading its surprisingly worn offices. Many a visitor had scratched his head at the seeming inconsistency of Schwarzman’s lavish shows of personal wealth and the holes in Blackstone’s carpet.
Now visitors to Blackstone bypass the general public’s security desk for an enclosed Blackstone-only reception area with its own couches and dedicated attendants. The firm’s main lobby on the 43rd floor has lovely views looking north over Manhattan’s Upper East Side stretching into Harlem and the Bronx. Down the hall is the “lunch room,” where Blackstone employees gather each day for complimentary food made in-house.
The jewel of the new headquarters, though, is the boardroom, which for a private-equity firm is far from ceremonial. This is where everyone of any importance spends some or most of their Mondays, taking part in the weekly rundown of what deals stand where and any other pressing matters.
The senior members of the firm sit at the table, which has built in, voice-activated microphones jutting up at every seat. Junior executives sit on settees against the two long walls. The real innovation is what might be called “Steve Vision,” the screens that emerge from the ceiling all around the room to pull in the other offices from around the world via videoconference.
On a mid-October evening in 2011, hours removed from a quarterly conference call with investors, Schwarzman was at the Waldorf-Astoria, two blocks south of his office, clad in tails and a white tie, schmoozing Catholic priests, politicians, and bank executives ahead of a very different kind of speech for him.
This event was an odd confluence of Schwarzman’s worlds. The Alfred E. Smith Foundation Dinner is an annual gathering meant to raise money for Catholic children’s charities and honor the late governor of New York, who had been, back in 1928, the first Catholic nominee for U.S. president. Schwarzman has directed a surprising amount of his philanthropy toward Catholic charities in New York, so here was a Jewish guy from Philadelphia giving a speech whose past orators have included almost every major party�
�s Presidential candidate, plus Bob Hope and Beverly Sills. In an additional twist, the standing venue for the dinner, the Waldorf-Astoria, is a Blackstone property. Surely, this was the first time the owner of the hotel was the headliner.
Mayor Michael Bloomberg, New York Governor Andrew Cuomo, Bank of America CEO Brian Moynihan, JPMorgan’s Jimmy Lee, and two dozen other religious, financial, and political luminaries sat alongside Schwarzman and his wife Christine, who is Catholic. The whole event had a throwback feel, from the multi-tiered dais on the stage to the dress code (the important men wore tails, while the rank-and-file guests were in black tie) to the opulent room, with its balconies overlooking the ballroom. Waiters, whose average age suggested they may have served Al Smith himself, smoothly delivered hunks of medium-rare beef tenderloin and filled glasses with red wine.
The Smith dinner has evolved into a New York institution with a Washington edge, especially in an election year (which this was not, giving Schwarzman an opportunity to take center stage; the previous year, he’d also sat on the dais, within chatting distance of both Barack Obama and John McCain). In a town that sees a dozen such dinners a night in midtown alone, this one feels different, in part because of its eclectic draw and long history.
