November 15, 2009 by Joshua M Brown
There’s a book out called “The Buyout of America: How Private Equity Will Cause the Next Great Credit Crisis” and before you derisively sneer at what at first sounds like hysterical hyperbole in the subtitle, consider this bit of logic from Josh Kosman writing in today’s New York Post:
“You better sit down,” the secretary says. “I’ve got bad news…”
The Treasury Secretary is talking about private equity. It’s not the private equity firms themselves but the companies they own that are defaulting. During the boom years of 2001-07, private investors bought thousands of US companies. They did it by having the acquired companies take on enormous loans using the same cheap credit that fueled the housing boom. That debt is now starting to come due.
“Considering what we have already been through, how bad can it be?” Obama asks.
Now here’s where things get interesting. In the hypothetical scenario, the writer does not for a minute think that the private equity firms themselves are in trouble (or perhaps he is simply dismissing the importance of them in the equation). Rather, the crisis he is about to allude to concerns the underlying companies owned by these funds, and there are thousands of them:
“Well,” says the Treasury Secretary, “PE firms own companies that employ 7.5 million Americans. Half of those companies, with 3.75 million workers, will collapse, between 2012 and 2015. Assuming that those businesses file for bankruptcy and fire only 50 percent of their workers, that leaves 1.875 million out of jobs.
“To put that in perspective, Mr. President, NAFTA caused the displacement of fewer than 1 million workers, and only a slightly higher 2.6 million people lost jobs in 2008 when the recession took hold.
“A spike in unemployment will mean more people will lose their homes in foreclosure, and the resulting nosedive in consumer spending will threaten other businesses. The bankruptcies will also hit the banks that have financed LBOs and the hedge funds, pensions and insurers who have bought many of those loans from them.”
“Is this bigger than the sub-prime crisis?”
“It is similar in size to the sub-prime meltdown. In 2007, there were $1.3 trillion of outstanding sub-prime mortgages. As a result of leveraged buyouts, US companies owe about $1 trillion.
You’re probably not laughing now. I personally did not have a handle on just how big the world of private equity had gotten but now I’ve got about trillion reasons to look into this stuff.
Do yourself a favor and head over to the Post to read the rest:
The Next Bubble (NYP)
[...] The Coming Private Equity Default Crisis Joshua Brown (hat tip Crocodile Chuck) [...]
This argument seems very flawed. First, when a firm files for bankruptcy, it is to fix its capital structure. I do not doubt that firms will need bankruptcy protection as CDOs are typically where their debt is held and these funds may be unable to roll the maturities – bankruptcies however will not be seen in 2011 – the more aggressive leverage levels did not take place until 2006 and 2007 and this debt has a 7 year maturity on it – the defaults will not begin en masse until 2013.
With that said, if growth does not come to these companies they will seek additional cost cuts prior to the maturity of their debt. This will keep unemployment high – but I highly doubt that this means 50% of people will lose their jobs at these companies. Then the firm would not be able to sustain its current revenue and be more likely to default. I would say the figure is more like 20% which is why unemployment will remain elevated for some time, but the peak spoken of in this article is far overstated.
private equity was THE way for the nouveau riche to behave as they were KKR… instead, they’ve heavily heavily leveraged once good companies in order to feed their egos and suck out cash… thus profiting themselves but bankrupting and ruining a vast number of good companies… and continuing to destroy the economic engine of the country…
[...] the companies that are held by private equity firms come into some serious trouble?Close Forward this [...]
In addition to Anonymous’ good comments about the faulty 50% layoff assumption, this article assumes that default = bankruptcy. That’s another flawed assumption. The Boston Consulting report estimates that 50 percent of PE-owned companies will default on their debt. That is certainly within the realm of possibility. But there are many different flavors of default, and none of them inevitably lead to a BK.
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