Senate report: How private equity ‘gutted’ dozens of U.S. hospitals

Thanks to modern tricks of financial engineering, investors can prosper even when the underlying business is failing.

A closed sign on the grounds of Boston’s Carney Hospital. (Steven Senne/AP)

Guest column by Bethany McLean

October 17, 2024 at 9:11 a.m. EDT

Last month, Sen. Edward J. Markey (D-Mass.) released a report detailing what happens when a hospital chain runs out of money: In short, people suffer and die.

The chain in question, Steward Health Care, is headquartered in Dallas but owned more than 30 hospitals throughout the United States and once billed itself as the country’s largest private for-profit hospital chain. Last May, Steward declared bankruptcy, which kicked off congressional hearings and Markey’s investigation. The company announced its intent to sell its hospitals, but finding new owners has not always been easy. That’s triggered massive distress in the communities these hospitals serve.

The problems at Steward began long before the bankruptcy. Over the years, the company has closed some half a dozen hospitals, leaving patients without health care and providers without jobs. As chronicled in Markey’s report, patients at Steward hospitals were left without care at “vastly” higher rates than the national average; death rates for conditions like heart failure at Steward-owned hospitals increased even as they decreased nationwide. Then, there were the bat infestations, the sewage seeping from broken pipes, the lack of essential supplies like linens and IV tubing, and the barrage of lawsuits from vendors over unpaid bills.

Markey’s report notes that at Steward-owned Carney Hospital in Dorchester, Mass., the quality of care fell so steeply that some workers began referring to the hospital as “Carnage” Hospital. A Boston Globe investigation found that Steward’s hospitals have been among the most troubled in the country, receiving a disproportionate share of warnings for dangerous safety lapses from federal authorities.

Part of Steward’s financial distress can be traced to a series of deals it made starting in 2016 to sell all of the real estate once owned by its hospitals to a real estate investment trust called Medical Properties Trust, or MPT. From 2016 to 2022, according to a company report, MPT acquired a net $3.3 billion of real estate underlying 34 Steward facilities. MPT then leased the real estate back to Steward. This forced the hospitals to pay rent on land they’d previously owned. As a result, Steward had an annual rent burden of almost $400 million, according to Rob Simone, an analyst at Hedgeye Research who has followed the MPT and Steward saga for years.

That deal was orchestrated by Cerberus, the private equity firm that formed Steward in 2010. Cerberus made its original investment — in Carney and five other Boston nonprofits — amid widespread investor enthusiasm for the profit gusher many thought would come from patients newly insured by the Affordable Care Act. But the expected gusher didn’t materialize, and the hospitals struggled. Selling the real estate allowed Cerberus to pay one of its funds a $484 million dividend, according to an investor document obtained by Bloomberg, thereby extracting a win from an investment that otherwise would have failed.

Of course, saddling already struggling hospitals with new rent did not help matters. Or, as Markey’s report put it, the hospitals were “gutted”: “These decisions to extract maximum short-term profits caused such financial insecurity for the hospitals that they crumbled.”

Cerberus has argued that both its original investment and this deal enabled Steward to invest money in the hospitals that it otherwise wouldn’t have had. But one contemporaneous account suggests the deal was designed to serve Cerberus’s financial interests, not Steward’s patients. Cerberus had considered selling Steward, a publication called the Deal Pipeline wrote in 2016, but “in light of there being no logical buyout scenario,” the deal with MPT was a “means to give Cerberus some liquidity, lighten its capital burden and recover the original investment it made almost six years ago.”

Cerberus finally extricated itself from Steward in 2021, when MPT loaned Steward’s operating team $335 million to buy out Cerberus. In total, Cerberus has said it made roughly $800 million on its investment in Steward, more than tripling its original investment, even as the hospitals themselves were hemorrhaging cash.

Steward did not respond to requests for comment. Cerberus pointed to the company’s written response to Markey’s report, which said that “throughout the entire period that Cerberus was invested in Steward, the company was at all times solvent and had more than sufficient cash and liquidity.” But shortly after Cerberus was out, Steward filed a request to delay repaying pandemic-era federal loans, citing “extreme financial hardship.”

It would be easy to point an angry finger at Cerberus in this situation. There’s a reason Markey titled his report, “How Corporate Greed Hurt Patients, Health Workers, and Communities.”

But this is simply what private equity funds do. They owe a fiduciary duty to their investors to maximize the bottom line. It’s like the old fable about the scorpion who persuades the frog to carry it across the river and stings the frog midstream. Why? the frog asks as they both drown. “It’s in my nature,” the scorpion replies.

If you let private equity buy a health care business, you run the risk that profits are going to come before patients. That’s the nature of private equity. And right now, private equity firms are buying health care companies in record numbers.

Investments in health care have grown from less than $5 billion in 2000 to more than $120 billion in 2019, according to work done by the Eileen Appelbaum, co-director of the Center for Economic Policy and Research, and Cornell professor Rosemary Batt; private equity owned hospitals now account for approximately one in five for-profit hospitals in the United States.

If modern capitalism worked in real life the way it does in beautiful theory, this would be great! Smart investors are betting that their capital can make a business better, and the only way the bottom line should improve is if everyone wins. And if the investors fail, well, they lose their investment. Right?

Wrong, as the Steward example shows. Thanks to modern financial engineering tricks, investors can prosper even if the underlying business is failing. In addition to these real estate deals — known as “sale-leasebacks” — a private equity firm can add more debt to a company it controls to pay itself a dividend — a trick known as “dividend recapitalizations.”

“Cerberus generated a home-run multiple on an unsuccessful investment,” Richard Mortell, a longtime real estate investor who has also studied Steward and MPT, told me. “That’s not the way capitalism is supposed to work.”

To put it differently, the scorpion that is private equity keeps itself afloat even as the frog it killed dies. Nature, at least, has a brutal fairness that modern capitalism lacks.

When it goes wrong and the company can’t be allowed to fail, as happened with banks during the 2008 global financial crisis, taxpayers are on the hook. Massachusetts has so far pumped $72 million into Steward in an effort to meet payrolls and keep the doors open to patients, and the governor’s office has said it will spend $417 million more over the next three years to support five hospitals being sold to not-for-profit buyers. Private equity titans make fortunes; taxpayers pick up the pieces.

There’s a growing body of evidence that Steward is not the exception — that private equity’s involvement is not making health care better. A review of more than 55 studies cited in Markey’s report found that private equity investments were associated with up to 32 percent higher costs to patients and insurers. Another study found that private equity-acquired hospitals have lower staff-to-patient ratios and less experienced or licensed staff than other hospitals. A recent Harvard Medical School study of Medicare patients at hospitals before and after private equity acquisition found that patients suffered 25 percent more hospital-acquired complications, including 27 percent more falls and 38 percent more bloodstream infections, post-acquisition. And so on.

Policymakers could impose conditions on private equity firms that buy health care companies. Markey has proposed the Health Over Wealth Act, which he says would create accountability and transparency. But a version of this was done in Steward’s case: The Massachusetts Attorney General approved the deal contingent on Steward submitting to five years of state monitoring and fulfilling various obligations, including keeping hospitals open and prohibiting dividend recapitalizations. A year after the oversight ended, the real estate sales began. Clever financiers will always find a new way to extract money, one regulators don’t foresee.

The only real solution is to pass laws preventing private equity ownership of certain critical businesses. Extractive capitalism should flourish only where it can’t kill people.

Bethany McLean is a veteran business journalist. Her latest book, “The Big Fail,” examines how American capitalism left the nation ill-prepared to respond to the coronavirus pandemic.