Private equity plutocracy leaves UK a hostage to fortune in credit crunch

READERS of a certain age will remember Anthony Sampson's path-breaking book Anatomy of Britain, first published in 1962. Over the next four decades, till his death in 2004, Sampson constantly updated his meticulous dissection of who really ran Britain behind the scenes – the civil servants, business tycoons and City bankers.

Sampson was also good at explaining how one decade's fashion in making money turned out to spell the next decade's economic ruin.

Stepping into Sampson's shoes is Robert Peston, the BBC's business editor and pundit-in-chief, whose new book Who Runs Britain? has arrived just in time to serve as a valediction for the collapse of the global credit boom and the City of London's place at its centre.

Sub-titled "How the Super-Rich are Changing Our Lives", Peston's book covers the rise of private equity investment; the billionaires who made their money from it; the Labour government that did everything it could to facilitate London becoming their safe haven, even at the expense of the rest of the UK economy; and the impact it has had on the rest of us – yawning income differentials and disappearing pensions.

Peston is in a good position to comment. Before breaking the Northern Rock story last September, Peston had a meteoric rise through the ranks of British financial journalism. But unlike most business correspondents, he also has a background in political journalism, which makes him uniquely qualified to explain the almost symbiotic relationship between the new private equity entrepreneurs and Gordon Brown's Treasury.

Peston is fascinated by the rise and influence of the new generation of City financiers and the way they have altered the British (and global) economy. In fact, I suspects he is quite in thrall to the panache and ego of it all.

He tells the wonderful tale of Sir Phillip Green, owner of Bhs, addressing Oxford University's Said Business School and spontaneously offering 500,000 from his own wallet to finance the best business ideas from the students.

But despite his admiration for the global financial pyramid that has been constructed over the past decade and a half, Peston is deeply worried about where it is all going. He can't quite bring himself to write the whole era off as a mad hatter's tea party but comments that "we are more vulnerable than perhaps we have been since the 19th century to the advent of rule by an unelected oligarchy" of super-rich "potentates".

What is fascinating about Peston's book is the way it reveals how the rise of private equity financing has radically reshaped the functioning of the UK economy in ways we have not readily grasped. Private equity involves a group of investors putting together a fund to buy and sell whole companies. The buying power of the fund is expanded by borrowing to augment the original fund.

What gave private equity its current lease of life was the rise of a de-regulated, global capital market after the fall of the Iron Curtain. Private equity funds found they could borrow gargantuan sums of money, meaning they could buy – literally – any company they fancied.

The "so what?" is that the private equity partners can buy Company X for 5 billion, using 500 million of their own cash and a loan of 4.5bn. They then restructure Company X and sell it on after a couple of years for 7bn. But the partners get to keep most of the 2bn profit despite having put in only 500m of their own. That's a truly staggering return – and the foundation of the new super-wealthy class Peston says runs Britain. It only needs a compliant government to grant these private equity partners massive tax breaks for a plutocracy to emerge.

The Blair-Brown government went out of its way to attract private equity business to the City of London through just such personal tax advantages. The rational was impeccable: over 70 per cent of the cash borrowed by private equity funds comes from outside the UK. It is thus a machine for massive inward investment in the British economy. Who cares if a few thousand plutocrats get stinking rich if the UK has full employment?

Peston reveals this economic model has dangerous potential flaws. Private equity has become more important than the Stock Exchange in providing capital investment. In the first six months of 2006, UK-based private equity funds raised 11.2bn but companies coming to the stock market raised only just 10.4bn. Relying on external capital rather than our own savings is a hostage to fortune – as the credit crunch may prove.

It is also the case that the private equity firms (run by Peston's foot-loose, foreign plutocrats) are buying British companies essentially from UK pension funds. As a result, the ownership of UK business is being transferred abroad.

Peston asks the very pertinent question as to why our risk-averse pension funds were so incapable of improving the management of the ailing companies they sold for a song to the private equity groups. Had they done so, the pension funds would have reaping the profits themselves – so boosting our pensions.

Peston's book is a racy read, though perhaps not quite in the same analytical league as Sampson's. It ends with a rhetorical question the answer to which will sum up the Blair-Brown years: "Having taken their dividends and cashed in their investments, what is the general benefit of their (the super rich] propensity to recycle their gains into over-priced modern art or control of a football club?"

Britain has bet the economy on its new-fangled financial sector while running down manufacturing more than in America or Europe. But the global credit crunch is now depriving private equity of its borrowing powers. That leaves Britain highly exposed. As for Peston's super rich, they can always escape to the next tax haven that offers them the red carpet treatment.

&149 Who Runs Britain? by Robert Peston; published by Hodder & Stoughton, 20.