A New Credit Crisis Brewing

For some time I've been searching for a comprehensive account of how much carnage the Private Equity or Leverage Buy Out (LBO) "industry" has caused America. On occasion I would find an article identifying a particular instance where a company was destroyed after being purchased via a LBO but wanted to learn more.

I finally found the closest thing to what I was looking for in Josh Kosman's book, "The Buyout of America: How Private Equity Will Cause the Next Great Credit Crisis". While the writing and editing aren't the greatest, the gist of the book is both interesting and saddening.

For those who might not be familiar with how Private Equity/LBO firms operate I'll provide a simple 10,000 foot view. Basically these firms raise money from investors, primarily pension funds and other institutional investors, along with wealthy individuals. They use this money to effectively make a down payment to purchase existing, generally successful, businesses. They then saddle the company they are acquiring with massive debt to fund the lion's share of the purchase. They skim money for managing the process, initiating the buyout, overseeing operations and so on. The MO is to take over the company, do whatever it takes to increase earnings in the short term, including firing employees, reducing research and development expenses, lowering the quality of products produced, raising prices, etc. With a short term increase in earnings they will saddle the company with more debt. This debt will go directly to the LBO firm that initiated the transaction via a distribution or dividend. If they can sell the company to someone else (generally another LBO firm, the greater fool theory at its finest) great, if not who cares? As the partners risk nothing between raising investment funds and debt they still make money even when the company ends up in bankruptcy.

Now to cut to the chase. The loose money that has been unleashed on the market by central banks the world over for the past 10 years or so found it's way into LBO deals as one would expect. Currently there is approximately $1 trillion in debt owed by companies owned by LBO firms. The bulk of this debt will be due in 2011-2012. Nearly 3200 companies were purchased via LBO transactions between 2000-2008 in the U.S. These companies employ 7.5 million Americans. That's equivalent to 10% of the U.S. workforce.

Will this trillion dollars in debt be able to be rolled over in 2012? I have no crystal ball to speculate. However, it does shed light why the official policy of the fed and Barry O's administration is to attempt to reflate the bubble rather than let the deflation of it, that is natural, necessary, and arguably inevitable take place. Currently real unemployment is nearly 20% with more job losses to come. What will happen if these debts can't be rolled over? They certainly can't be paid off and the LBO shops that own these companies don't care if they go bankrupt.

To add insult to injury, both former president Bushes, former president Clinton, former House majority leader Dick Gephart, former Republican National Committee chairman Kenneth Mehlman, former Senate majority leader Tom Daschle, former Treasury Secretaries James Baker, Nicholas Brady, Paul O'Neil, and John Snow, (yes 4 former Treasury Secretaries) all have been or are currently on the payrolls of Private Equity firms. Both sides of the political establishment love the idea of destroying American companies and eliminating American jobs, as long as they continue to get rich in the process.