Risk Arbitrage Redux

When I began investing decades ago, one of the earliest versions of hedge fund strategies was to simultaneously buy the stock of a “target” company in a takeover and sell the stock in the company that was doing the purchase. While not nearly as profitable on a percentage basis as guessing ahead of time which company will be taken over, it nearly always works.

There was a profit to be made as long as the deal got completed, something that usually happened and usually resulted in a 10% or higher return in a couple of months.

Today I saw evidence of the modern version — making political contributions to “freshmen” politicos to help them retire campaign debt.  How cool is that?  Lobbyists who seldom make political contributions to challengers can endear themselves to the winner after the election, yet before they get sworn in. The lobbyists can put their money to work on newcomers without having to take the large risk that they’ll lose to the incumbents.

This brings to mind a book topic I’ve been trying to figure out how to research.

The premise of the book is that, for the largest companies, no matter what business they’re in, the single highest return on investment they can make is spending money on lobbyists.

The steady increase in pay for lobbyists right through the recession that crushed almost every other profession’s payscale should give us a clue.  So should the steadily increasing cost of elections.

And then there’s the massive difference between the supposedly high corporate tax rate (35%) in America and the actual amount paid by US corporations (roughly 15%).  When GE earns multiple billions but pays zero in corporate income tax, you can see that they are getting a massive return on the millions they spend with lobbyists and politicos.

Or look at Wall Street and the banks.  After engineering the collapse that crushed savers and borrowers alike, they made out like bandits.  They even got their pet politicians to turn to them to “help” write the regulations to fix the problem.  How much is that worth?  It sure beats the profit margins in taking in deposits and lending to people or small businesses, right?

Just to be clear, the return on political investments isn’t limited to the big national issues, either.  In fact, much smaller contributions to state legislators can be an even better percentage return.  Does anyone doubt that a thousand dollars contributed to a state legislator in a relatively small state gets that lawmaker’s attention?  Throw in a “force multiplier” like the legislative language clearinghouse called ALEC, and a five-figure investment can return tens of millions in profit.

Here’s how it might work.

If I ran a prison-for-profit company, the kind of prisoners I’d like to hold would be the non-violent kind.  For example, casual laborers from Mexico and Central America that walked across the border to look for work.  If I could get the contract for holding them while the INS works through its backlog of cases, and simultaneously get several states to pass laws that turn every traffic stop into a potential “customer” for my service, it would be a home run.

Maybe I would even write a law that might become Arizona’s SB 1070, a law that could be replicated around the country using the ALEC clearing house for legislative language.  The beauty of the plan is that the lawmakers I make my contributions to are already very likely to want to take action against the “illegals” they see waiting at bus stops early every morning hoping to get work from landscapers.

Chances are that the profit from a handful of detainees pays back every dime I would spend getting this result.  If I ended up with thousands of detainees in custody, my return on investment might be near infinite.

Nice.

If you ever wondered why spending goes up so much when “small government conservatives” take over, this is why.  They fall into the trap of believing that giving contracts to private companies will save money.  But when they hire for-profit companies to perform what they think are important functions that government should provide (eg security, defense, immigration control, education, infrastructure maintenance, hospital management, insurance or guaranteed loan payment processing, etc.) they fail to connect the most important dots.

For-profit companies exist to maximize profits.  In fact, nearly every company has profit growth targets that quadruple inflation, that triple GDP growth, that exceed population growth by a factor of ten.

Is it any wonder that government spending goes up faster than our citizens’ income when the corporate income for government contractors keeps growing at double digits?

When I heard that the impending hostage crisis over funding the government and increasing the the debt limit was likely to result in 800,000 civilian employees of the Defense Department being furloughed, I had no trouble understanding why we spend more on defense than the next ten or fifteen largest military powers combined. Eisenhower warned us.  We should have listened.

Using the government as the marketing arm for a company’s services and as that company’s collection agency or customer is the easiest way to make sure profits flow and grow for years to come.

The key to ensuring that revenue and profit stream is to “help” write the laws that create those contracts, and the tax code that makes sure those profits don’t get taxed.

I recently read that the compensation for the many thousands of lobbyists in the DC metro area topped $700,000 per year, beating the average paycheck at Goldman Sachs.  Given the return on investment, you can see why.

With so many newly minted Senators and Congressmen still in debt from their elections, the lobbyists are lining up to help with $5,000 checks.  Anybody willing to make a guess as to the return on investment from those checks?  I’ll bet it beats the 10% or 15% from old-fashioned risk arbitrage in the stock market.

hh

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