Main Street

Sharks

There were 457,000 initial claims for unemployment insurance in the week ending March 13, according to the report released this morning by the Department of Labor. While those numbers are definitely lower than a year ago, they are still 43 percent higher than they were for the same period before the recession. And because only about one-third of those officially unemployed are receiving unemployment benefits, the total of newly jobless workers is certainly higher than the 457,000 in the initial claims report.

So what’s going on? For one thing, while last month’s jobs report showed we’re still treading water, as Gretchen Morgenson reported in last Sunday’s New York Times, beneath the surface lurk the private equity sharks.

Using a specific, albeit foreign example, Ms. Morgenson writes:

WHENEVER savvy private equity firms sell debt in the companies they own, buyer beware.

That’s the lesson — learned the hard way — for bondholders in Wind Hellas, a Greek mobile phone operator whose parent company defaulted on some of its debt payments last November.

A once-healthy company that is Greece’s third-largest mobile phone operator, Wind Hellas was taken over in a 2005 buyout by two global private equity giants: Apax Partners out of London and the Texas Pacific Group, led by David Bonderman. The two firms larded Wind Hellas with debt before selling it off just two years after they bought it.

Noting that Wind Hellas filed for bankruptcy protection last fall, Ms. Morgenson quotes one of the firm’s largest bondholders on what went wrong:

Bertrand des Pallières, the chief executive of SPQR Capital, a London investment firm, was one of the larger bondholders in Wind Hellas. He says the decision by Apax and T.P.G. to heap debt onto the company while simultaneously extracting so much cash from it ultimately contributed mightily to its woes.

“The private equity industry always pitches how constructive it is as an investor force to create jobs and growth,” says Mr. des Pallières. “But there are private equity funds that get rich by breaking companies and making others poor — whether they are creditors, states or employees.”

The article, well worth reading in its entirety, goes on to describe how the private equity firms engineered a series of leveraging steps that increased the bought-out company’s debt while simultaneously extracting sizable amounts of its cash flow to ensure that they got paid back — at everyone else’s expense. The article concludes, quoting Mr. des Pallières:

“Private equity and banking can be very constructive functions of the economy, but they will destroy this industry if the leading players do not regulate themselves,” he says.

Given the abysmal record of financial firms regulating themselves in the U.S., one might expect that the nearly 2,500 private equity firms based here would be a focus of the latest financial regulatory reform proposal.

Nope.

Under the proposal, hedge fund managers in charge of more than $100 million will be required to register with the Securities and Exchange Commission and to disclose information to a new systemic risk regulator. But venture capital and private equity fund advisers are exempt from that requirement.

And as the Wall Street Journal reports the private equity guys are down with that.

Private-equity and venture-capital funds appear to have largely escaped the regulatory net closing in on many other types of financial institutions in the revised financial-reform bill unveiled Monday by Senate Banking Committee Chairman Chris Dodd (D., Conn.).

Dodd’s bill represents an “excellent approach,” said Doug Lowenstein, president of the Private Equity Council, a trade group whose members include the largest private-equity firms.

Maybe not so excellent, when you take into account the latest in The New York Times series “Payback Time” that Laura picked up on yesterday.

… the approaching scramble for corporate financing could strain the broader economy as jobs are cut, consumer spending is scaled back and credit is tightened for both consumers and businesses.

Private equity firms and many nonfinancial companies were able to borrow on easy terms until the credit crisis hit in 2007, but not until 2012 does the long-delayed reckoning begin for a series of leveraged buyouts and other deals that preceded the crisis.

That is because the record number of bonds and loans that were issued to finance those transactions typically come due in five to seven years, said Diane Vazza, head of global fixed-income research at Standard & Poor’s.

In addition, she said, many companies whose debt matured in 2009 and 2010 have been able to extend their loans, but the extra breathing room is only adding to the bill for 2012 and after.

The result is a potential financial doomsday, or what bond analysts call a maturity wall.

Not wanting to expose themselves to the risks of hitting that maturity wall, private equity firms are extracting what they can from the companies they took over in order to pay themselves back first. By siphoning off cash flow, they leave less cash available for company payrolls, operating expenses and inventories. That’s why many companies that were buy-out targets in the pre-recession days are now experiencing a second contraction. While not as severe as the mass layoffs and wholesale restructuring that firms engaged in during late 2008 and 2009, the ongoing contraction in many firms now is more “surgical”. Instead of the “last in, first out” approach which resulted in many more less-experienced and younger workers being laid off, now it’s increasingly more experienced, higher-paid and older workers who are losing their jobs.

And since those workers tend to have families and more financial responsibilities, the consequences can be devastating.

In the pre-recession, pre-credit crisis days many companies, including many mid-sized privately-held ones, viewed the influx of capital from private equity firms as a blessing. And, as long as the overall economy was riding the wave of false “bubble” wealth, companies bought by private equity groups were able to finance their own expansions.

But that just served to hide the story taking place behind the scenes. Because when the private equity guys step in, they start by putting their people on the company’s Board. Then they do some tinkering with the executive personnel. That’s when the moving vans pull up. It’s as if some rich deal-makers moved into your house. They rearrange the furniture. Then they set up shop in the bedrooms. Pretty soon Aunt Tillie is sleeping out on the screened porch and the family’s only allowed to come to the table once a day. And more and more of your funds are going to them in some form of debt payment.

Then you lose your job.

Meanwhile the private equity guys make out like bandits.

That’s why right now we should make them pay.

Tags: financial regulation, unemployment