23. Marrying the Devil in Texas
Prof: Okay let’s get
started. It occurred to me over the
break that Goldman Sachs gets some bad press.
Is there–has anybody read the
piece in Rolling Stone? Okay can–these–where are the
hand microphones? Do we have the hand microphones?
Matt Taibi of Rolling Stone called Goldman Sachs a–
I might get this quote wrong, but it’s something along the
lines of “A great vampire squid relentlessly jamming its
blood funnel into anything that smells like money.”
Prof: I think that’s an
exact quote. Student: Yeah.
Prof: We should have
tried that out on Paolo. Now it also reminds me of the
passage in Richard Posner’s book,
to the effect that we can no more blame the financiers for
the wreckage of the credit markets than we could blame a
lion for eating a zebra, and there’s an odd
discontinuity here. When you look at Goldman Sachs
internally, through the eyes of one of its very senior partners,
the ethical component is big. There’s a huge component about
integrity and meeting one’s obligations and delivering the
highest quality product on the market,
and at the same time, Goldman is vulnerable to the
view that it took inordinate advantage of the taxpayers in
the recent debacle. Now how would they defend
themselves? They would say–one thing they
would say is, “We didn’t want to take
the money. Hank Paulson told us we had to
take the money,” because the stigma which would
otherwise fall on the banks which took the money would cause
further disruption and meltdown; that’s one thing they would say.
have you noticed what they’re doing to–in the way of
charitable activities just lately?
Anybody notice the announcement?
$500 million dollars in help to
10,000 small businesses. Does that strike you as a big
gesture or a little gesture? Tal, what do you think?
Student: Well as a
percent of their revenues, profits, or even just the
amount they pay out in bonuses every year,
I would say that’s a very little gesture.
Prof: That’s a very
little gesture. I agree.
From a public relations point
of view, if they multiplied it by ten so it’s five billion,
would it do them more good? Them, not the world,
not the country, them.
Student: I think that
adding a couple more zeroes would probably make a bit of a
difference in public opinion, but I don’t know if it would
fully make up for the perceived damage that they caused in the
public’s consciousness. Prof: Okay so my own
intuition is that it wouldn’t do them a lot of good.
That the public doesn’t think
quantitatively, some opinion leaders do,
but most people $500 million sounds like an awful lot of
money and five billion doesn’t sound like ten times as much,
so they’re probably not far off in the number they chose if the
object is public relations, which I think it is.
How many–are there people here
who think that the government ought to compel them to give
back a bigger chunk of capital, put it out there in some
charitable way or give it back to the taxpayers.
Anybody of that view?
Okay so you’re unanimous which
is rare in a group this size. Does that mean that you think
there’s no ought to it, or does it mean that the
process by which the government would do that strikes you as not
a good one? Who’s got a–rescue me here
guys I’m drowning. Student: There is a big
difference between what you should do and what the
government can make you do. I don’t think that there’s any
reason any large corporation should be forced to donate to
charity, unless it’s like a sort of ad
hoc tax randomly applied to them,
and that seems like a>
and we don’t want to go there.
Prof: Okay so it
probably would violate the Constitution if we created The
Goldman Sachs Retribution Act. I agree with that.
So we’re coming to the end of
the course, and what I want to do is today
to add one more case, one which allows us to look at
the interface between capital, the environment,
and government in the TXU v.
EDF case which you’ve all looked at and which is
structured so that you could invest a whole week in it if you
were willing to trace out every strand in the web page.
Then on Wednesday I’m going to
do a recap of the course, as if on a motorcycle,
and finish with a central case which will form the basis for
your final exam essay, and since it’s going to count
for 70% of the final, I’m sure we’ll have 100%
attendance during the last twenty minutes of class,
and I’ll give you the reading assignment in advance.
It is the–Leasing the Rain,
it’s the– the reading is the William
Finnegan piece from The New Yorker about the
privatization of the water supply of Cochabamba,
Bolivia by an American corporation known as Bechtel.
And the essay question–I’ll
formulate it at the end of class Wednesday,
asks you to work through that story as somebody who has
learned something about capitalism in this course.
Okay so now,
marrying the devil and the one difficulty with this case is
that it’s full of acronyms, and these are the most
important, or most immediately important of the acronyms,
and can anybody here quickly recite the full names of every
one of these? Who wants to be a show off?
I’m sure there are fifty people
who can do it. Okay I’ll–let’s put them into
three bins. This is the most obscure,
Texas Climate Initiative, and Jim Marsden who is the
video star of the case is president of that,
and he is the regional head of EDF,
The Environmental Defense Fund for Texas,
and The Natural Resources Defense Council is a–
is parallel to the EDF; a little harder edge and
important–then in the gray box in the middle we have the target
firms in the private equity takeover.
It’s just one firm really,
it’s TXU, but the focus strategically is on TXU plus.
It is on the expanded
generation capacity that TXU has announced,
and that expanded generation capacity is on the lower edge
from an environmental point of view.
It relies on conventional
technology, which no one thought at the
time, was the best available technology for coal-fired
generation of electric current. While we’re at it,
the parts of an electric utility company are three:
generation, transmission, and sales or distribution.
Transmission is the long lines,
and distribution is the last mile of lines,
and the financial connection, the contractual connection with
the customer. Then on the right we’ve got KKR
and TPG and these are both large and very aggressive private
equity firms. KKR is most famous for the
Reynolds/Nabisco, RJR Nabisco takeover,
which is characterized at length in Barbarians at the
Gate, and Texas Pacific is actually the more interesting of
the two, from the point of view of this
case. Is there anybody who can snap
to an obvious conclusion about the difference between the two?
Okay we’ll draw it out in a few
minutes. The TXU expansion 8,600
megawatts added, that’s a–just under a 50%
increment to the firm’s total generating capacity.
Ten or $11 billion dollars in
costs, somewhere between $50 billion
and $2 billion of that are budgeted to controls of
pollution, and it’s pretty murky in the
case and pretty murky in fact just how much of it–
how much of the capital can be construed as pollution control.
They promise a 20% cut in
emissions–what do they mean by that?
Who thought that one through?
20% cut in emissions,
we’re going to add 47% to our total generating capacity,
and we’re going to cut emissions by 20%,
what exactly is the claim? Does it mean–yes.
Student: I’m not sure
what TXU promised exactly, but there are two ways you can
do that. You can artificially–you can
buy carbon credits and reduce your emissions,
like, technically on paper. You can also retrofit some coal
plants and see– so that emissions are kind of
sequestered underground, like there are certain
technologies that allow you to do that,
so that’s some ways that you can cut emissions.
Those are both valid points,
but I’m still a little unclear about how much soot is going to
come out the end of the pipe. Yes.
Student: I guess the
other potential difference is whether the 20% cut is in total
emissions or if it’s per unit generated,
so if it’s per unit generated there would still be a larger
final percentage of emissions, but it would be like less per
unit. Prof: Yeah I think it
has to be normed in that way. It has to be a unit rate of
emission so that these plants are,
on average, quite a lot better than the old plants,
though still not state of the art, and the claim is that we’re
going to drive the aggregate emission rate per megawatt down
by 20%. They’re using old sites.
They plan to use old sites
where they’ve already got a plant.
Anybody figure out why they
would say a thing like that? Well–yes.
Student: If you’re
building a new site it requires a lot more regulatory approval
to a green field site I guess. Prof: Yeah.
A green field site,
you’ve got a whole round of permitting, and there are a
couple of other advantages. One is that the NIMBY politics,
“not in my backyard politics,”
are over in those areas. You’ve already been through it,
and if you can come back to people and say,
“This is a less disruptive plant than the old one,”
that’s a pretty good start, and even if people aren’t much
taken by that, if you’ve been–if the
management has been intelligent they will have built a network
of local relationships, which they would have to build
anew on a green field site. Finally there’s an
infrastructure reason, that the transmission lines
required to transport the current produced will already be
in place, and that’s both an economic and
a political plus. Then at the end of this they
throw in a 10% discount to their customers,
and that discount is a non-sequitur in the
environmental discussion, but it’s not a non-sequitur in
the actual case, because TXU is in trouble on
two political fronts at once. It is a monopoly seller of
current and it has– it is–it has wired the state
of Texas politically, and there is a populist revolt
against that, and the populist revolt takes
the form of criticizing the ultimate pricing at the
household level. Now if we look at the case from
Austin, Texas we’ve got all these small
things, upper right,
that are federal government, and we’ve got all these big
things locally that are state politics and government.
You’ve got Texas state
government where–how’s TXU doing with Governor Perry during
all this? Is Perry a populist who wants
to beat up on them? No, they own Perry.
I may overstate a little but
they pretty much own Governor Perry.
The Texas Business for Clean
Air is a not all together surprising alliance of business
groups which are opposed to TXU on this,
on environmental grounds, sometimes for self serving
business reasons and other times,
I think, because it’s what senior management thinks is
right. You’ve got Texans for Public
Justice and they’re not so much about the environment as about
the rates. You’ve got a state senator
named Troy Frazier who is making a name for himself statewide by
attacking TXU on the, mostly on the rate side,
but he’s also willing to take up the environmental side.
You’ve got The Texas Climate
Initiative and the EDF, which are closely intertwined
in the personality of Jim Marston.
What did you think of Marston?
If you went all the way through
the case you’ve heard him, I don’t know,
five or seven times in video, seem like an able guy?
Thumbs up if you think that,
thumbs down if you don’t think that.
Hmm…we’ve got ninety-five
abstentions. He’s an able guy,
he’s a very able guy, but he is a–he has a very soft
style of argument. He never seems to be a jump
ahead of you in the argument. He’s also, in a very laid back
way, asking your opinion,
as if he hadn’t really figured out where he wanted to go,
and that may be partly for our benefit because he was working
for the school of management in preparing for the case,
but it’s also probably part of his natural style.
PUCT, Public Utility Commission
of Texas, and Texas Commission on Environmental Quality;
I almost missed that one myself. These are the two principle
regulatory bodies in the case and Association of Electric
Companies of Texas; you can imagine who they are
and what the TXU’s role is. It’s a classic interest
association and then you got populist–[Video 20:35-22:50.]
Okay so any of you guys ever done a protest of that type?
You just don’t look like street
theatre types. Do you think that’s effective?
You’re shaking your heads and I
think there are two sides to the question.
Let’s start in the negative
here. Student: I mean,
I just feel as though it’s not going to get the companies to
change their positions really, so what’s–I mean,
yes, it might stir up a little public disapproval for a couple
of days, but that’s not really going to
change behavior. Prof: Okay so as a
direct strategy for changing the behavior of companies,
it goes nowhere. We agree.
Is there any other way in which
it might be of service to the cause these people are pursuing?
Here and then here.
Student: If you can get
media coverage of it, it tends to have a more
dramatic effect on public opinion.
I was working on a political
campaign where we sent out something that was short enough,
a picture in The Washington Post, and so I at least from
personal experience, think that it does have the
potential. Probably not to affect the
direct response of the people who you’re calling out,
but that there can be larger implications for how other
people view the situation. Prof: Okay so the
clear–the media are the target and then who would we most
likely influence with this sort of thing?
Anybody want to elaborate
further? Yes, Sasha.
Student: I think what
the companies really worry about is that they’re clients are
going to be sensitive to the negative press and change
companies. Prof: Absolutely.
That’s–TXU customer voter base
is part of this and both of those nouns are important,
and they are both voters and customers,
and they may not have many places to go as customers but as
voters, the perception within
regulatory and legislative groups in Austin would be an
important consideration. I personally don’t think that
this kind of demonstration is hugely effective,
but it does kind of raise the temperature of the issue and
make it salient to decision makers in government.
Now in–on the–if we switch
from Austin to Washington, the actors get to be different
and the EPA, and The Federal Energy
Regulatory Commission, and the key people in Congress
like Henry Waxman or Senators Bingaman and Boxer,
become big players, and the EDF and the NRDF,
Natural Resource Defense Fund, become well staffed.
They would each have fifty or
so staff people in Washington and become a major presence,
and the question in front of KKR and Texas Pacific hinges on
what? Why do they–why are they
messing around with all these environmental groups?
It would sound like,
from a purely economic point of view,
to be a waste of time and yet from an entirely rational
economic point of view, it isn’t a waste of time.
Well let’s look–let’s go to
Wall Street. The private equity business in
2007 there were 794 large private equity transactions
during that year, adding up to about $800
billion, so they average about $1 billion a piece.
they’re up about 450% to 500% from 2000 to 2007,
and it’s a period when capital is abundant and cheap,
so the–it is in every sense boom time for private equity.
The–you’ve got three sets of
players as seen from Wall Street.
You’ve got private equity
firms, the target firms, and the business services
organizations, mainly investment banks which
catalyze transactions of this kind and the takeover of TXU is
a megadeal. It is the biggest transaction
of its kind ever so it gets a lot of attention and offers to
be very profitable. The institutional investors,
shown upper left in the blue box,
are limited partners in the funds created by organizations
like KKR and Texas Pacific, and from their point of view,
this is one of the highest yielding asset classes in their
portfolio, and David Swenson,
for example of Yale, one of the things he did with
the Yale portfolio which made it grow so much faster after he
came then it had grown at any time in the university’s
history, was to shift a great deal of
capital away from publicly traded securities into private
equity funds which differ– they differ–the biggest
difference between how well investment companies do with
stocks and bonds on the one side,
and private equity on the other, is the difference between
the smart money and average money.
In the stock market the
difference between very smart money and fairly dumb money is a
few percentage points. The difference in private
equity between the smartest money and fairly dumb money is
enormous, and so if an institutional
investor like Yale, Harvard, or the big pension
funds, can get into private equity with smart money,
hire smart management, invest with people like Texas
Pacific and KKR, the opportunity to beat the
market in a big way is a very ripe one and that’s the heart of
this deal. Now from a sociological point
of view, the people who run these
companies are pretty far away from the green world,
which centers in major metropolitan areas,
and is populated by well to do activists,
and their 501(c)(3) corporations,
of which the ones in play today are examples.
Now, the Pacific Group is a
little different from KKR in its relationship to those groups,
because it has one key player in William Riley,
who had been the head of the EPA before and who is agreeing,
and he gave–he gives Texas Pacific a relationship to this
world which KKR pretty much doesn’t have.
who is one of the founders of Texas Pacific,
is Harvard educated and kind of part of this world.
If you begin tracking
personalities in these funds, Frances Beinecke,
she of Yale fame, is the head of Natural
Resources Defense Fund– I don’t know why I put C’s
instead of F’s on the end of this–
the slides. She’s the head of that,
and a terrifically potent leader,
and the reason the privileged access to do this case came to
the Yale School of Management, has something to do with that
particular connection. There is a cultural divide
here, it is– these are quite different views
of the world and if we compare 501(c)(3) corporations with
regular public or not publicly– publicly traded or not publicly
traded corporations, we get some sharp contrasts.
The business corporations are
pursuing profit. The 501(c)(3)’s are pursuing a
cause. The attitude to risk is far
more aggressive among the businesses.
The boards are accountable to,
mainly to major investors on the business side,
and to donors on the 501(c)(3) side except that in the really
big old 501(c)(3)’s; they’re accountable to no one
because the donor is dead. The Carnegie Corporation,
for example, where my wife is a chief
investment officer, Andrew Carnegie hasn’t paid any
attention to their ledgers in some time,
and it actually creates an enormous amount of free play at
top management and board levels. The management culture on the
business side is far more aggressive than on–
among the non-profits and top management compensation in–
particularly in private equity is high and variable and Jim
would– Jim pointed out to me that–Jim
Alexander pointed out to me this morning that when I say high and
variable the variability may or may not be well-tied to actual
performance. You can get a lot of
compensation for just sitting in the right chair during a bull
market and many people have. On the non-profit side it–the
compensation is relatively modest and more or less
invariant with performance. Take for instance,
Beinecke, there was a to do in this same year because somebody
published– their top salaries are also
published and her salary of $252,000 was published,
and there was a populist outcry. Now by private equity standards
that’s not a lot of money. Even by not–people on the
investment side in organizations like this make three or four,
or ten times that, but the general norm in
non-profits is– how many–are there people here
who plan to become non-profiteers?
Okay, well the one thing you
have to do is take a zero off when you think about
compensation. More or less it’s–that’s about
the ratio and its considerable, so these are two very different
classes or organizations. Here we have Fred Krupp of The
Natural Resources and Henry Kravitz, and I’ll bet not one of
you is in doubt about which is which.
The pictures are–they get the
point across, and why on earth would people
on this side be so interested in participation from people on
this side? Sasha, again.
Student: If you ask
them to do something with the business that makes them more
money ultimately, then it’s a good deal.
Prof: You nailed it,
and not one iota of direct concern for the environment is
required to back that up. Right?
So what’s the biggest problem
about TXU? Why is it–what–if you’re
going to sit down and calculate the risks from KKR and Texas
Pacific’s point of view of taking over this firm,
what would the main risks be? They would be–would they be
that the technology will fail? Would they be that consumer
demand for electric power will suddenly go away?
Would they be that a new
entrant will come in; a large new entrant will come
in, and begin to compete with lower prices?
None of those things are
imaginable. None of those are imaginable.
So why isn’t this just a
license to print money? The answer to that is that the
regulatory risk is substantial at both the federal and state
levels, much more substantial at the
federal level, and that the process by which
the environmental groups would in effect bless or kosher the
transaction is a way of limiting political risk.
The EDF is all about the cause
of the environment and their claim is that lobbying work
they’ve done in the years from 2001 to 2008 will diminish
diesel pollution by nearly 90% by 2030,
and that’s their business. Their business is to get the
government to compel companies to pollute less.
Fred Krupp at Davos in the year
of the case, this is not in the case:
“The smartest companies can see over the horizon and
anticipate consumer demands. That’s why the EDF has been
able to team with– team up with ALCOA,
DuPont, Caterpillar, GE, Duke Energy,
BP America, and others on a plan that could cut greenhouse
gas emissions by 60% to 80% by 2050.
The plan is a jobs winner as
well as an environmental winner.”
So organizations like these are
brokers in which they cut deals with businesses,
and the businesses they cut the deals with are ones which have a
higher than average capacity to withstand tighter regulation.
GE with Eco Imagination, you’ve all heard of that?
If you watch television for any
period as long as an hour you have been saturated with that
message, and why can GE do that? Well why does it have to do it?
What’s GE’s long-term
reputation for environmental pollution?
It is that they filled the
Hudson River with PCB’s fifty years ago,
and it’s important to them to get us off that topic and to
think of them in a different way.
Second, they compete in Europe
for the manufacture of electrically powered equipment,
and the regs in Europe are much tighter than they are here from
an environmental point of view, so they have developed a
technology to meet much higher standards.
They’ve got it already in the
kit, and so from their point of view, it is actually a corporate
strategy play to encourage the feds to raise the bar.
Cap and trade,
I’m running out of time here, cap and trade diagram–the
interesting side fact that cap and trade in the EU basically
fizzled, and it fizzled because the caps
that were put on the countries were not low enough to make
people go out and buy credits. They were set in a very gentle
political way and the market for cap and trade depends on people
having to break the caps and buy credits to make up for that,
and the caps were set so high that it didn’t produce the
desired effect. I don’t know why that slide is
there. Now let’s think about outcomes.
We’ve got on the vertical
dimension, Green World,
and on the horizontal dimension Green Paper,
and the four big quadrants–the four quadrants of this space
define points we could think about in looking at what the
risks and possibilities of this are for these two classes of
organizations. Down here, emissions are high
and profits are low is a catastrophe on both dimensions
and the likelihood of both of those things happening is very
small. The story where you have both
high emissions and high profits, this is the most worrying
category from the point of view of the EDF.
This would constitute green
washing which has become a really important epithet in the
politics of the environment, where they’re blessing
something which is a pretend benefit to the environment,
and here is the disaster from the point of view of KKR and
Texas Pacific, where you have both low
emissions and low profits and do you think KKR and Texas Pacific
enter into this relationship fearing the risk that EDF and
The Natural Resources Defense Fund will encourage the
imposition of standard so Draconian that they can’t make a
living? Well no, they wouldn’t have
chosen EDF as the lead agency if EDF were of the same temperament
as the street theatre we saw in the video.
They chose EDF because they
think they can cut a plausible and constructive bargain with
them which leads, not upper left but upper right
in the diagram, for emissions decrease in a
substantial degree and profits remain high.
This slide is in the–is from
the case and it’s the full inventory of exactions that Jim
Marston and EDF people consider in looking at the case,
and they call it the blue sky concessions,
because it’s perfectly clear they’re not going to get all of
these, but they want some of them and
they get some of them, and they also get quite a lot
of symbolic buy in so that by the current year 2009,
KKR is offering an investment portfolio which it calls the
green portfolio, and this consists not of
companies that are going to devote themselves to producing
environmental products, but rather to companies which
produce other products. For example,
in Biomet, produce medical devices but where they sign onto
the proposition that they will make their production process
far greener than it was before, so that I as an investor can
buy into the green fund, and expect market rates of
return and think that on the side I’m doing a little bit of
good for the environment. [Video 46:37-47:08.]
Okay so–and they all went to the beach and had a swell
afternoon. The–okay so that’s the last
case we’re going to do, except the one for your final,
and what I hope you’ll do for Wednesday is read the Finnegan
piece with some care. He’s a brilliant writer.
I got to know him personally
when he came to write about violent kids in New Haven twenty
years ago, and it’s a beautifully written
piece and it’s a compelling story,
and also begin reviewing your notes for the big picture flow
of the course.