Hearing of the Senate Finance Committee. Subject: "Carried Interest Part III: Pension Issues"

Interview

HEARING OF THE SENATE FINANCE COMMITTEE
SUBJECT: "CARRIED INTEREST PART III: PENSION ISSUES"

SEN. MARIA CANTWELL (D-WA): Thank you, Mr. Chairman.

And Mr. Read, I think the CalPERS' experience has been similar to what the Washington State Investment Board has experienced in the past, so thank you for your testimony and insights.

We all know that private equity has outperformed the public equities. Are you concerned about the impact of credit and the credit crunch and the impact that that might have on those investments in the future?

MR. READ: The answer is yes, but there is also a complex interplay that's going on.

We've seen, for instance, a tightening of credit, which has been more difficult for some of our private equity partners and hedge funds. It has also allowed us to succeed in other transactions because we are not a leveraged player in general. And so we've been able to succeed in other areas because of the change in the cost of capital and in credit.

So what ends up happening is that -- something that hurts us in one side can benefit us with some of our other investments. It's one of the -- so we do have a concern about changes in credit and the cost of credit, but it's, you know, both bad and good.

SEN. CANTWELL: I know that's not the subject of today's hearing, but how do you think that they should best plan for that as it relates to these changes in policy? I mean, do you think they should consider it a more risky environment or --

MR. READ: What we've noticed is and what we've been particularly impressed by in the private equity community is their creativity, much more so than in many other sectors, many of the traditional sectors -- that they have an eye, both in terms of geography and in terms of structuring, for identifying some of the most attractive investment opportunities.

So one of the interesting points to us and why we view them as key partners for us is that we believe they have a very good sense for credit and the amount of credit that they can take and maintain, but also it's something which, as that becomes more expensive, they'll contract and they'll move into other ways to make money.

SEN. CANTWELL: Thank you.

Mr. Auerbach, thank you for elaborating on your last dialogue with Senator Ensign about your testimony and your focus on long-term capital gains.

How would you suggest, since this is all a very delicate balance here -- I don't think there's any policy discussion that we don't have on this committee that isn't a "pull the string here and get an effect there" challenge for us -- how would you suggest that this committee might approach this -- dealing with carried forward interest but the larger issues of our tax problem as it relates to entrepreneurship?

How would you suggest we best tackle that in a way that would be constructive?

MR. AUERBACH: Well, I think if you're thinking about entrepreneurship in particular, there are two approaches here one can think of, and one is a lower long-term capital gains rate. Another approach would be a much more targeted approach, such as the 1993 capital gains exclusion for new small business equity, such as the Section 144 -- sorry, Section 1244 provision for more liberal treatment of losses for small companies.

Entrepreneurship is very important in the economy, but it represents a very small -- it accounts for a very small share of the capital gains that are realized in any given year. And so a long-term capital gains differential is a pretty blunt instrument to be using to encourage entrepreneurship.

So I think if entrepreneurship is the objective -- spurring entrepreneurship is the objective, then measures targeted more closely toward entrepreneurship would be much more efficient methods of encouraging that activity.

SEN. CANTWELL: And I don't mean to be obtuse, but when you say "entrepreneurship," what are you referring to?

MR. AUERBACH: New companies, private equity, if you like, new companies, fast-growing sectors of the economy as opposed to more mature, bread-and-butter sectors of the economy -- smaller businesses, newer business, emerging industries.

SEN. CANTWELL: Isn't in an information age access to capital even more critical than in an industrial age as it relates to spurring more entrepreneurship?

MR. AUERBACH: Sure.

SEN. CANTWELL: So would you say it's more important today that we get this tax policy right as it relates to spurring entrepreneurship in the --

MR. AUERBACH: I think there are many reasons why it's more important today. It's more important for that reason. It's also more important given the fiscal challenges that we face -- that to whatever extent we find that we need to raise taxes in the future. I know that's something that's easier for a witness to mention than a member.

SEN. BAUCUS: Thank you, Senator, very much.

We have very limited time left before the vote, and so I'm going to have to truncate things a bit.

SEN. CANTWELL: I thank the chairman for the hearing.

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