Kaufman Sees ‘Upheaval’ From LBOs

Henry Kaufman, one of Wall Street’s leading economists, told the House Ways and Means Committee on Wednesday that, if leveraged buyouts are left unchecked, they will create a financial-industrial complex that will cause “a major upheaval in our economic and financial way of life.”

Offering the committee a pessimistic vision of the future, Kaufman predicted that the traditional American separation between the business and financial worlds would be erased as banks assume an ever greater role in financing the mergers, acquisitions and buyouts that are sweeping the nation.

‘Governmental Intrusion’

“Out of that will emerge a financial-industrial complex wherein financial institutions and industrial corporations become increasingly interwoven, rather than separate, distinct entities,” Kaufman said. He likened such an economy to those in West Germany and Japan, where major banks play a crucial role in corporate decision making.

“That amalgam will invite various forms of governmental intrusion, culminating in direct government participation in business through bailouts of corporations that fall into severe financial difficulties,” he said.

Kaufman, who last year ended a long association with Salomon Bros. to start his own firm, warned that huge corporate debt levels created by the leveraged buyout craze would undermine many companies in the next recession.

He asserted that the recent wave of LBOs, with their emphasis on hostile takeovers, has distorted the stock market, weakened the ability of debt-laden corporations to compete overseas and cost the government money because of the tax deductibility of interest paid on debt.

Kaufman testified as the committee, chaired by Rep. Dan Rostenkowski (D-Ill.), continued to wrestle with the intricacies of LBOs and the question of how to control them.

Pros, Cons of Buyouts

The House panel has heard the pros and cons of LBOs.

Some of the pros: They create higher values for stockholders; they yield more productive companies, and they improve inefficient managements.

Some cons: LBOs are driven by the desire of lawyers and investment bankers to earn big fees; they merely reshuffle assets rather than improve economic efficiency, and they result in layoffs and disruptions to employees, suppliers and customers.

Trying to weave a path between those opposing views, committee members are discussing measures that would limit the tax incentives for buyouts--or at least try to prevent buyouts when the risks are unduly high. Among the ideas that have been discussed is imposing tighter federal supervision over banks that participate in financing LBOs.

Former Treasury Secretary W. Michael Blumenthal, chairman of Unisys Corp., told the House panel that not all business consolidations are bad--including the merger of Burroughs Corp. and Sperry Corp. that created Unisys--but said some are. He defined a bad LBO as one that has left a firm with “razor-thin” levels of cash to cover the debts taken on in the deal.

Short-Term Gains Sought

“These LBOs frequently are the result of financial manipulations for short-term gains but without any identifiable purpose in mind,” he said.

Blumenthal and Kaufman said they favored eliminating the disparity between the tax treatment of corporate debt--the interest is all deductible--and dividends, which are taxed twice at the corporate and stockholder levels.

Both said they favored doing away with the double taxation on dividends but agreed that was unlikely to happen because it would cost $20 billion to $40 billion.

Kaufman said he did not favor limits on interest deductions on corporate debt because the task would be too complicated.

Blumenthal said it might be possible to limit interest deductions on certain junk bonds--in an extension of current tax laws. But he said care was needed to avoid putting U.S. companies at a disadvantage with foreign competitors.