There must be few thoughts to console former Royal Bank of Scotland boss Sir Fred Goodwin as he looks back over the tatters of his career. There won’t be many publishers asking for his memoirs, nor universities asking him to take up a chancellorship. Still, there’s one. The backlash over his pension will look like nothing more than a mild disagreement between friends compared with the political storm about to erupt over the private-equity industry.
It’s already obvious to anyone who cares to look that the next, and potentially most painful, stage of the credit crunch will be the collapse of a string of firms owned by the buy-out funds. The signs are there, just as they were in the banking industry six months ago. And yet, with extraordinary and reckless negligence, the City and the government are keeping their heads buried resolutely in the sand, taking few steps to stave off the trouble ahead. There will no doubt be a heavy price to pay for that carelessness. This week, the warning lights of trouble ahead have been flashing bright red.
On Monday, Candover, a pioneer of the private-equity industry, and one of its smartest players, reported a truly terrible set of results. It cancelled its dividend, scrapped plans to invest in a fresh fund, and said it was looking at job cuts. Its shares have fallen from £22 as recently as last August to just over £2 now. The news is just as grim elsewhere. KKR said this week the value of its publicly quoted funds dropped by a third in the latest quarter. And 3i has watched its shares slump from a peak of £11 to less than £2 now. In America, shares in Blackstone, the world’s biggest quoted private-equity group, have fallen from $30 to less than $5 now.
No one should be in any doubt about why that is. The buyout business was partly about taking control of tired businesses run by timid and lazy managements and freshening them up with smart, new ideas. But it was mostly about clever financial engineering. The funds loaded up company balance sheets with lots of debts, sliced and diced it a dozen different ways, then sold it on to hundreds of different institutions, all the while generating huge fees for the funds themselves and their bankers. If you think subprime mortgages are complicated, trying unpicking the average private-equity deal.
Inevitably, there will be collapses. In a deep recession, the one thing a company needs, just like an individual, is a strong balance sheet. They need plenty of equity, adequate capitalisation, and the ability to ramp up borrowing to get through the lean years. Very few of the businesses owned by buy-out funds are in that kind of shape. Some will be able to re-structure their balance sheets, swapping debt back into equity. But that’s a lot easier in theory than in practice. Bond holders won’t want to take the losses it will inevitably involve. Amid the arguments and recriminations, companies will collapse into insolvency.
When this happens, the anger will make the outrage over banking bonuses look mild. If a few derivatives traders lose their jobs, it doesn’t matter much. Only the lap-dancing clubs of EC1 really suffer. But the private-equity firms own huge companies, employing tens of thousands of people, including the likes of Iceland, the AA, Kwik Fit and Travelodge. Jobs will be lost, houses will be repossessed, and pensions will be destroyed. On some estimates, as many as one in five private-sector workers in Britain are ultimately employed by the buy-out funds. The impact on ordinary people’s lives will be huge.
Neither the industry or the government will escape the fall-out. The funds have been paying their partners a fortune during the boom years. If you think the RBS board rewards itself generously, then you’ve never taken a look at a private-equity firm. Sir Ronald Cohen of Apax has made an estimated £260m from the industry. Guy Hands of Terra Firma has made an estimated £160m. Damon Buffini, of Permira, is worth an estimated £150m. Lower down, there are dozens of middle-ranking executives who have accumulated fortunes running into millions. If, as seems likely, it becomes clear that those fortunes were made by manipulating balance sheets, and leaving them in such poor shape that thousands of people lose their jobs, there will be a lot of anger out there.
The government won’t be able to escape the blame either – and nor will it deserve to. Gordon Brown has long been the private-equity industry’s best friend. Cohen bankrolled his leadership campaign. Buffini has been a key adviser. And while it is a myth that the private-equity industry gets special tax breaks (it simply manipulates the existing rules better than most people), there is no question that, as chancellor, Brown tolerated tax wheezes that allowed the industry to flourish.
He could have done far more to regulate its growth. As a result, he can hardly complain if his government gets caught up in the backlash once companies start crashing down. If, as he claims, he was trying to ‘save’ the economy, he’d be trying to stave off the looming crisis now. Instead, either through ignorance or carelessness, it is being ignored – at least until the first major insolvency hits the headlines.