Private equity firms -- Blowing next stock market bubble?
May 30, 2007
Many economic analysts now say that private equity firms, like the Blackstone Group, are driving the global stock market to new records, and perhaps creating a bubble. These firms take private equity positions in large corporations, taking them off the stock market, but not before running up the stock price of the companies they are planning to purchase. Private equity firms get their money from other private investors, governments (like China), pension funds, and loans from banks.
An increasing number of the bank loans that private equity firms take out are large “covenant-lite” loans. Covenant-lite loans are just that - light in the covenants, or restrictions, that banks place upon the borrowers. Without covenants, companies can lose lots of money before the bank notices. Think of these as the corporate twin to the interest-only loans and subprime mortgages that have helped cause the demise of the U.S. housing market.
What increases the risk is that most of these loans are sold by the banks to other investors. The result is that:
- the banks don’t care if the loans are good or not, because someone else is stuck with the bad loan.
- The impact of these loans going sour will be felt in all financial sectors, not just banks.
What the private equity bubble means:
With central banks raising interest rates, and the U.S. economy slowing, global stock markets should be declining, not reaching new highs. Instead, the increase of private equity firms’ use of “covenant-lite” loans means that more money is being pumped into the stock market by these funds buying corporate equities and taking the companies private. This is much like the junk bond bubble in the ‘80’s, the tech bubble in 2000, and the subprime mortgage mess this year.
Action steps:
If you have any money that you need to live on in the next five years, make sure it is in money market funds or even commodities, not stocks. No one knows when the bubble will burst, and I can’t even be sure it will, but if you have money you can’t afford to lose, park it in a safe place until we find out if the current stock market is a bull, a bear...or a bubble.
Source: Barron’s Online “Global Bull Rides Boom in Loose Lending,” May 24, 2007; Bloomberg, “LBO firms pay most for loans in five years,” August 1, 2006; Financial Times, “Covenant lite loans attract buy-out groups,” April 10, 2007.
Private Equity Bubble Related Articles:
China invests $3B in U.S. company, 5/23/07
Gold hedges against the stock market, 4/11/07
Global risks shifting to you, 3/28/07
Global stock markets decline, 3/7/07
The growth of hedge funds, 6/10/06
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