Brady Uneasy Over Merger Debts but Has No Answers

Treasury Secretary Nicholas F. Brady said Tuesday that he and President Bush have a “gnawing feeling” of concern about the wave of loan-financed corporate takeovers but do not plan now to ask for changes in tax law to discourage borrowing.

“I have a growing feeling that we are headed in the wrong direction when so much of our young talent and the nation’s financial resources are aimed at financial engineering,” he told the Senate Finance Committee.

However, he said, “we really don’t have a solution at this time.”

Brady’s remarks reflect the uncertainty in the Administration and in Congress on how to approach the surge of business takeovers and mergers. His carefully hedged lament combined expressions of distress with anxious hopes that businesses will choose on their own to stop amassing mountains of debt in leveraged buyouts before Washington is forced to intervene.

In a separate hearing, Federal Reserve Board Chairman Alan Greenspan expressed similar sentiments about the buyouts. While saying he was concerned about “very sharp increases” in corporate debt, Greenspan told the House Banking Committee that the tax deduction for interest expense on corporate borrowings should not be changed because clever lawyers would only figure out ways to avoid the restrictions. Easing the double taxation of dividends may be desirable, he said, but it would cost Treasury $20 billion to $25 billion a year in revenue.

Borrow Heavily

At the Finance Committee hearing, Brady said: “The question is how far (things) will go--whether the market will self-correct or the government has to take sterner action.”

In leveraged buyouts, a group of investors uses a relatively small amount of cash and large amount of borrowed funds to buy the stock of a public company. After the transaction, the acquired company is burdened with a huge debt, and the new owners sell off portions of the business to help repay it. In the past five years, buyouts have helped increase corporate debt by $160 billion.

Brady’s hesitation to recommend any action to curtail borrowing was matched by the ambivalence of the committee, which is investigating the takeover boom.

“Thank you for a good, solid cautious statement,” panel member Sen. Max Baucus (D-Mont.) said to Brady.

Sen. Lloyd Bentsen (D-Tex.), the chairman, said the committee is seeking a “solution to this problem of debt explosion.” But he immediately retreated, saying: “Not all mergers are bad, and not all acquisitions are bad. We certainly don’t want a cure that’s worse than the disease.”

The tax laws encourage borrowing because interest payments are deductible. Dividends on the other hand, are taxed twice: when the corporation earns a profit and when the stockholders receive their payments.

Brady said he would like to see the tax on dividends eased but said it cannot be done for fear of worsening the budget deficit. “At this juncture, revenue considerations limit our ability to provide fundamental relief from double taxation of corporate income,” he said.

Some executives of companies threatened by buyouts have been pressing the federal government to take action to slow the takeover surge, which has led to the dismemberment of many companies and drastic restructuring of others.

But Congress is wary of sending a threatening signal to investors. A proposal to limit interest deductibility has been cited as one of the causes of the 1987 stock market crash.

Sen. Bob Packwood (R-Ore.), the committee’s ranking Republican, expressed fears that the committee could “undertake something that might make it difficult to remove inept managers.”

Brady said repeatedly that he is uncertain about the wisdom of any government steps. But, he noted, “I have a gnawing feeling; the President has a gnawing feeling.”

Bentsen said a graduated capital gains tax, with lower rates for those who hold stock longer, might be a good idea. Such a “goal is exactly the one we should be aiming for,” said Brady, who noted that the Treasury is studying this tax proposal.

Brady said those mounting takeovers can draw on a ready pool of funds for their activities, currently amounting to about $30 billion. Expanded by borrowing, the $30 billion would support $250 billion to $300 billion in future buyouts.

Offer Quick Profits

Such a sum would make possible 10 mega-deals the size of the $25-billion buyout of RJR Nabisco, which now holds the record for the biggest acquisition in U.S. corporate history.

Buyout deals provide the lure of large, quick profits for the organizing firm, investment bankers, bond underwriters and others, Brady said.

“Sadly, these same parties may have relatively little, if any, investment in the long-term success of the new enterprise,” the Treasury secretary said. “Given this arrangement, it may very well be that the net effect of LBOs is a financial snipe hunt, where the new long-term investors, flashlight in hand, are left holding the bag.”

He lamented the use of corporate pension funds in takeovers, saying businesses are, “in a sense, financing their own extinction.”