Morgan Stanley canceled its Christmas parties this year. The November 3, 2008, New York Times wrote about on the trading floor of the New York Stock Exchange: “Of the 1,366 broker’s licenses available for an annual fee of $40,000, only 553 are being used. In 2006 there were 3,534 people working on the floor; today there are 1,273…‘The stress now is the lack of business,’ says Benedict Willis III, 48, a senior broker who started here in 1982. Moments later he is interrupted by applause. It is the sound of a lost job: a floor broker of 20 years has just been laid off from a major firm, and now his colleagues are showing their respect.” The laid off trader escaped to the bar across the street.
Other “professionals” on the Street – the big “private equity” funds I’ve written about in the past – remember the days when they looked for “undervalued” public companies with lots of free cash flow that they could buy. Why? Because companies with free cash flow can carry debt, and being able to carry lots of debt meant you could borrow lots of money. Buying a company that had borrowing power meant you could put a small sum down, much less than normal, and cause the acquired company to borrow itself into oblivion to finance the rest of the purchase price. They called it “leveraging” – pushing a company to the edge of its borrowing ability to finance its own purchase.
For public shareholders of the acquired company, they enjoyed the premium paid to take that stock off their hands. They were long gone when the private equity firm stepped in to “create efficiencies of scale,” “eliminate the dead wood,” “spin-off” valuable assets and lay off the “unnecessary” layers of actual workers. Their goal? To “flip” that company back into the marketplace – leaner, meaner and at a significantly higher share price. The profit trail was long and glorious. Young MBAs and senior partners of these private equity firms worked long hard hours and were paid king’s ransoms for their services. Many billionaires were made. Leveraging was king!
Sound familiar? A bit like the subprime borrowers who took on massive debt with little or no down? Almost, with one huge difference. On Wall Street, the debt was not incurred by the private equity firm – that pleasure was relegated to the “asset” (the acquired company). With all that free cash flow, servicing the debt might have been fine in a growth marketplace, but just like the subprime debacle, when the markets crashed and no one could take a company back public, as the “asset” sat on a private equity shelf, the debt still had to be serviced.
The private equity firms now have “assets” with lower values, but they’ll still be around for the long haul, but those “assets”… well… the names of the acquired companies, many listed in the Times, are brands we all know, including: Neiman Marcus, Metro-Goldwyn-Mayer, Toys “R” Us, resorts like Harrah’s Entertainment and lenders like GMAC, the financing arm of General Motors as well as a few that have already filed for bankruptcy like Linens ’n Things, Mervyn’s and Steve & Barry’s. Private equity firms, until a few finally went public, were built by investments from very wealthy individuals, investment funds and, most sadly, money from pension funds.
Because they were built on the investments of “big boys,” private equity was one of the least regulated categories in the financial sector. And now, as these “assets” lose revenues in a terrible market, all that debt has to be restructured in a world that no longer allows pigs free access to the debt trough.
The Times continued with this quote: “There’s absolutely going to be a lot of pain to go around [in the world of private equity and their "assets"],” said Josh Lerner, a professor of investment banking at Harvard Business School. “The big question is how apocalyptic it will be.” Same issue that killed Lehman, Bear Stearns, subprime borrowers with little down, and a whole host of companies and people who thought that growth never ends.
It would have been okay if the negative impact stuck only to those who caused the problem, but now, people who never borrowed too much, worked hard for a living and bought their dream homes on a solid basis, are watching their pensions erode, their jobs disappearing, their businesses fail for lack of credit and their home values crash (sometimes losing the homes in a foreclosure resulting from a job loss). So much for “free market deregulation.” When we fix the system as we must, overleveraging – for both people and companies – has to be toast!
I’m Peter Dekom, and please vote tomorrow. It is a very important election.
Posts
No comments:
Post a Comment