Evan Davis on... financial innovation

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There’s good and bad in everything, and that’s true in finance as in every other area of life, and it’s true also of private equity. Private equity’s had a rather bad name in recent years because it did get distracted by returns, enormous returns generated by financial engineering. Companies would borrow large amounts of money, buy companies with it, and then they couldn’t sustain the debt they’d taken out so the companies would go bust or the debt would have to be rescheduled - that was what was bad about private equity.

But just because that was bad doesn’t mean it’s all bad; what private equity has going for it is, it means there’s somebody, a person, an investor or a company investing, whose job and life depends on making the subject of the investment a flourishing organisation, and sometimes for companies it’s much better to have one owner looking after you and whose job is to look after you than to have a multiplicity of shareholders, institutions who haven’t got the time of day for you and who perhaps are buying or selling shares on quite a short-term basis.

Indeed the German model of capitalism, the Rhineland capitalism, is often said to be rather good because it doesn’t involve people buying and selling shares on the stock market so often. It often involves concentrated owners holding stocks for the long-term with an interest, a real interest in the companies they hold. So one way to think about private equity is it was the German model of capitalism brought to Anglo-Saxon capitalism, it did its bit, then went way too far as Anglo-Saxon financial engineering caught on and then spectacularly bust.

But we shouldn’t see it, shouldn’t throw the baby out with the bathwater. Now the boom and the bust in private equity is over maybe it’s time for a calm reflection on the advantages as well as the disadvantages of that industry to settle into a modestly sized one exploiting all the good it can do. That’s my view. You can join the debate with the Open University.