Investing in War • Center of Public Integrity #CarlyleGroup #iraq #afghanistan #911truth

Originally Published on November 18, 2004

Source: The Center for Public Integrity

A dozen companies in which Carlyle had a controlling interest netted more than $9.3 billion in contracts.

Overall, six private investment firms, including Carlyle, received nearly $14 billion in Pentagon deals between 1998 and 2003. (See related report, “The Sincerest Form of Flattery.”)

From its founding in 1987, the Carlyle Group has pioneered investing in the defense and national security markets, and through its takeover of companies with billions of dollars in defense contracts became one of the U.S. military’s top vendors, ranking among better known defense firms like Lockheed Martin, Boeing Co., Raytheon Co., Northrop Grumman and General Dynamics.

Unlike those firms, however, the Carlyle Group itself is not a manufacturer. It offers no services directly to the Pentagon, and has no defense contracts. Rather, it manages investments—some $18.4 billion from 600 individuals and entities in 55 countries, according to its Web site. The firm’s business is making money for these investors, the vast majority of whose identities are not disclosed to the Securities and Exchange Commission or other government bodies.

Though Carlyle itself has won no contracts, the companies it has owned or controlled have done billions of dollars worth of business with the Pentagon. The Carlyle unit that brought in the largest share—$5.8 billion—was United Defense Inc., which manufactures combat vehicles, artillery, naval guns, missile launchers and precision munitions. United Defense also owns the country’s largest non-nuclear ship repair, modernization, overhaul and conversion company, United States Marine Repair Inc. Its most famous product may well be the Bradley fighting vehicle. United Defense brought in more than 60 percent of Carlyle’s defense business.

Carlyle took United Defense public in 2001; by April 2004 it had sold all its shares in the company.

Lear Siegler Services, a leading contractor in aircraft logistics support, maintenance, pilot training and ground support, received contracts worth more than $1 billion. Carlyle sold the company in August 2002.

Southwest Marine Inc. also received contracts worth more than $1 billion since 1998, and Norfolk Shipbuilding & Drydock received contracts worth $827 million. In 1998, Carlyle merged these two companies into United States Marine Repair.

Vought Aircraft Industries, a large subcontractor doing work for military cargo planes, bombers, and fighters, received contracts worth $85 million. Vought is among the few defense contractors that the Carlyle Group has not sold.

Among other private equity firms, New York-based Veritas Capital Management firm that employs many former high-ranking military officials received Pentagon contracts to the tune of more than $2.2 billion. Veritas is the 41st ranked defense contractor.

Companies under the ownership of Vectura Holding Co., another New York-based group, got deals to the tune of $1 billion, while companies controlled by Berkshire Hathaway, led by billionaire investor Warren Buffett, won contracts worth $688 million. Companies owned by Green Equity Investors II LP ($275 million) and Gores Technology Group ($153 million) also received substantial defense money.

New market

Private equity firms did not have any significant presence in the defense industry until the end of the Cold War. Traditionally, the Defense Department depended on mega contractors such as Boeing Corp., Lockheed Martin and Raytheon for weapons and services. But since the 1990s, the military has increasingly outsourced to private contractors a variety of jobs and services, ranging from planning of operations to the supply of linguistic services. A U.S. government decision in the 1990s to encourage small-business participation in contracts also contributed to the expansion of the market for smaller, privately-owned companies.

The Carlyle Group acquired controlling interests in several underperforming defense contractors, installed its own management teams and revitalized the companies, in part by landing big Pentagon contracts. Then, they sold the contractors to other investors for a large profit.

“There have always been [private equities] that went in with management and bankrolled management,” said Stuart McCutchan, editor of Defense Mergers & Acquisitions. “What Carlyle has done differently is they have taken it to a new level both in terms of size and in terms of being committed to an entire sector.”

“Carlyle is the biggest single success in Washington of a venture capital firm,” Dr. Loren B. Thompson Jr., a national security expert at the libertarian Lexington Institute, said.

In 1997, for example, the group made a 650-percent profit when it sold BDM International Inc., a McLean, Va., defense contractor. And in December 2001, Carlyle sold off the majority of its holdings in United Defense Inc. Altogether, Carlyle earned $1 billion in profit from the United Defense investment.

A windfall of war

The group cashed out many of its investments when the stock of defense companies rose dramatically in the aftermath of September 11 and the buildups to the Afghanistan and Iraq wars.

“Defense properties are too expensive these days,” explained Carlyle spokesman Chris Ullman.

In 1997, Carlyle liked the price of United Defense, and beat out General Dynamics and Alliant Techsystems, which also coveted the underperforming artillery firm. General Dynamics bid more than Carlyle offered for the company, but potentially faced a lengthy, drawn out antitrust battle if it acquired United Defense. Carlyle ended up winning the bid.

Carlyle finally sold its stakes in United after taking it public in the aftermath of the September 11 attacks. The Washington Post called the hugely successful public offering “one of the most successful single venture investments of recent years.”

But United did not seem all that lucrative before September 11.

“They [Carlyle] were really kind of in a pickle with United Defense,” McCutchan said. “They wanted to cash out on the equity. There wasn’t much money to be made… When 9/11 happened and the defense budget took off, suddenly they had a winner on their hands.”

Even Carlyle, which typically does not disclose its financial and operational details, crowed over the sale.

“It was one of Carlyle’s best investments,” Carlyle’s Ullman told the Center. “We did make more than a billion dollars on that deal, and we are very pleased that we served our investors quite well.”

The reason Carlyle’s defense portfolio is lean at the moment is the high value of defense firms, thanks in part to the ongoing U.S. wars. “If there comes a time when defense properties are priced in a way that we think makes sense for private equity investors, then we will certainly consider investing more of our dollars in that sector,” Ullman told the Center.

Investment expertise

Carlyle has a diversified portfolio, focusing its investments in sectors that have heavy government regulation and contracting—defense, telecommunications and banking. Carlyle has matched its investments with the expertise of high ranking government officials, whom the firm has courted almost from its inception.

It was under the leadership of former Defense Secretary Frank Carlucci—first as a managing director, from 1989 to 1993, and as chairman from 1993 to 2003—that Carlyle grew from a small private equity to a global investment giant, and became a major player among defense contractors.

Other former government officials who have recent or current ties to the firm include former British Prime Minister John Major and former Philippines President Fidel Ramos; former Office of Management and Budget director Richard Darman; former Clinton chief of staff Thomas F. “Mack” McLarty; former Securities and Exchange Commission chairman Arthur Levitt and former Federal Communications Commission chairman William E. Kennard. Former Secretary of State James Baker works for the firm, as did his former boss, President George H.W. Bush, who was an adviser for the firm’s Asian investment funds until he left Carlyle in 2003.

Critics have long denounced Carlyle’s practice of recruiting former high-ranking government officials at the same time as it invests in companies regulated by their former agencies, dubbing it “access capitalism.” For example, Kennard, who served as Bill Clinton’s FCC chairman, is now managing director for Carlyle’s global telecommunications and media group, directing the firm’s business investments in companies he regulated.

“Carlyle would never have gotten to the level that it is at today had it not been for this premeditated commingling of business and politics,” said Dan Briody, author of The Iron Triangle: Inside the Secret World of the Carlyle Group, a book that takes a critical look at the rise of the firm.

One of Carlyle’s most controversial hirings was of former president Bush to serve as a senior adviser for its “Asia advisory board.”

“The fact that George H.W. Bush was working for them while his son was president, while his son, in fact, was dramatically increasing defense spending—that seems to me one of the most blatant conflicts of interests in history,” Briody said.

Bush—who joined Carlyle in 1998, before his son, George W. Bush, became president—ended his relationship with the firm in October 2003, Ullman told the Center. But that hasn’t stopped the former president from continuing to give speeches for Carlyle, which he did at a Shanghai event sponsored by the firm in April 2004.

Ullman refused to disclose the remuneration Bush received for his services. “That’s not information that we disclose,” he said. “That’s his personal business. You are certainly welcome to ask him.”

Bush’s office did not respond to the Center’s request for an interview. Written questions faxed to the former president’s Houston office, at an aide’s request, did not elicit any response.

Though none are placed as closely as the president’s father, Carlyle’s other Washington insiders have ties to current Bush administration officials. Current Defense Secretary Donald Rumsfeld and Carlucci went to college together, for example, and Secretary of State Colin Powell was Carlucci’s deputy on the National Security Council in the mid-1980s.

The continued presence of Baker and Carlucci riles critics such as Briody. “If you look at the relationship that Frank Carlucci still maintains with Don Rumsfeld and Colin Powell and the reach that he has to those folks—and he has in fact used that reach in the past and tried to influence decisions those folks were making, decisions that could directly or indirectly affect Carlyle’s fortune,” Briody said.

Carlyle dismisses the notion that Carlucci or any other former government or military leader on its payroll has any conflicts of interest. “Are you aware of any solicitations from [Carlucci] to Secretary Rumsfeld to ask for any particular benefits to United Defense or any of our other portfolio companies?” Ullman said. “All they [Carlyle critics] do is, they say: ‘Oh, Carlucci used to work in the government and he went to college with Donald Rumsfeld, and Carlyle has defense investments, and now Secretary Rumsfeld is secretary of defense. Therefore, there is a conflict of interest.’”

Despite Ullman’s assertions, media accounts have noted occasions when former government officials working for Carlyle have approached the Pentagon brass. For example, Fortune magazine reported in March 2002 that Carlucci had contacted at least two senior Pentagon officials, though Carlyle claimed these contacts did not constitute lobbying.

Ullman added that all former government officials working for Carlyle abide by “all of the conflict of interests rules related to lobbying former colleagues for a year.” He pointed out that the Pentagon had cancelled the Crusader artillery system, produced by United Defense, adding, “So if we are as powerful as everyone thinks, why did they cancel it?”

Rumsfeld announced in May 2002 the termination of the artillery system; until then, the Pentagon had paid United Defense some $2 billion to develop the Crusader.

Researcher Sheetal Doshi contributed to this report.

The value of the revolving door: Political appointees and the stock market • VoxEU/CEPR #Halliburton #Cheney

Originally Published on September 27, 2012

Source: VoxEU/CEPR

The presidential election campaign is in full swing in the US. Whoever wins the presidential race will face the challenge of filling top positions in the federal administration. Since some political appointees traditionally come from the private sector, allegations of conflicts of interest will emerge. But are connected firms really expected to profit? This column sheds light on this issue.

The presidential election campaign is in full swing in the US. Whoever wins the presidential race in November will face the challenge of filling top positions in the federal administration with political appointees. Inevitably, he will tap the reservoir of private-sector experts. And with that, allegations of conflicts of interest will emerge since some appointees come from firms that fall under the regulatory jurisdiction of the respective agency or from firms that may hope to win procurement contract awards. For example, on the very same day that President Obama tightened anti-lobbyist rules, he nominated Raytheon executive William J Lynn III as Deputy Secretary of Defense. The revolving door between industry and government is an old phenomenon but evidence on its consequences is surprisingly scarce. Whether and to what extent firms benefit from the political appointment of one its members largely remains a matter of speculations and anecdotes. This column sheds light on this issue.Preferential treatment against all (institutional) odds?

Political appointees can treat their former employers preferentially in procurement, regulatory and oversight, or merger and acquisition decisions. Indirectly they can favour their former employers through long-term strategic planning or through better access to decision makers and information. At the same time, there are various institutional safeguards against conflicts of interests, ranging from specific provisions embodied in ethic codes to congressional committees and a vigilant free press. However, it is unclear how effective these safeguards are. Often, political appointees get waivers or simply fail to adhere to the rules. Time and again, political appointees were involved in decisions with immediate consequences for their former employer. For example, Senator Al Gore complained that Gerald Cann was responsible at the Navy for selecting a weapon system that he developed at his former employer General Dynamics: “It is a little wrong to be involved with a weapon system [in industry] and then be put in charge of deciding [at the Department of Defense] what system will replace the one that’s performing the mission now” (cited in Aerospace Daily 1991). Therefore, it is ultimately an empirical question, if firms benefit from political connections.Assessing the value of the revolving door

How can we assess the benefits of the revolving door for affected firms? The benefits of political connections may come in many forms and materialise slowly. Further, political connections are but one among a myriad of factors of firm performance. Finally, successful firms are likely to attract the brightest people who also make attractive nominees for government service. Thus, analysing the effect of political connections is fraught with all sorts of endogeneity and measurement issues. One approach to avoid these problems is to look at stock market reactions to announcements of political appointments. Stock-market reactions are immediate, which makes it easier to relate cause and effect and abstract from confounding factors. Further, stock market reactions are a comprehensive measure of potential benefits. In this vein, Fisman et al. (2006) investigated stock market reactions to news about Cheney and his health of firms with either Cheney or other Halliburton directors on the board of directors. They find no evidence for connections to matter. In contrast, Acemoglu et al. (2010) find large stock market reactions to the nomination of Treasury Secretary Geithner for firms connected to Geithner through his positions as the head of the New York Fed or for firms with personal ties to Geithner. Thus, the previous evidence on the value of political connections in the US is conflicting. More importantly, the two studies are not primarily concerned with the revolving door phenomenon, and mainly analyse other forms of connections.New evidence

In a recent study (Luechinger and Moser 2012), we explicitly look at the value of the revolving door by using unique data on corporate affiliations and announcements of all Senate-confirmed US Defense Department appointees of six administrations. According to the results, investors clearly expect firms to profit from their political connections. The one- and two-day average cumulative abnormal returns amount to 0.82% and 0.84%. These estimates are not driven by important observations, volatile stocks, or industry-wide developments, and placebo events yield no effects. Effects are larger for top government positions and less anticipated announcements, i.e., announcements for which the actual nominee was not rumoured to be the main candidate. Figure 1 below displays the baseline results and the results for the less anticipated events together with the temporal pattern of average cumulative abnormal returns for the four trading weeks prior to and after the announcement day.

Figure 1. Cumulative abnormal returns around announcements of political appointments

Conclusions

Overall, our results suggest that concerns over conflicts of interest voiced by politicians, the press, and government watchdogs are not unfounded. However, our results do not imply that recruiting political appointees from the private sector is necessarily a bad thing. Our results highlight one important cost of doing so but they are silent about potential benefits. Neither do our results suggest that tightening ethics regulations is worthwhile. Already now, they entail substantial compliance costs. But this is unlikely to happen anyway. Whoever wins the presidential race this time, neither of the candidates campaigned on the promise of closing the revolving door.References

Acemoglu, Daron, Simon Johnson, Amir Kermani, James Kwak, and Todd Mitton (2010), “The Value of Political Connections in the US,” mimeo, Harvard University.

Aerospace Daily (1991), “Navy Official Denies Conflict of Interest with Tomahawk Variant,” June 10.

Fisman, David, Ray Fisman, Julia Galef, and Rakesh Khurana (2006), “Estimating the Value of Connections to Vice-president Cheney,” mimeo, Columbia University.

Luechinger, Simon and Christoph Moser (2012), “The Value of the Revolving Door: Political Appointees and the Stock Market,” KOF Working Papers No. 310 and CESifo Working Paper No. 3921.