The idea that LBOs carry massive debt that is never paid down, leaving behind “financial zombies on the ragged edge of insolvency,” defies historical principles of LBOs, writes David Stockman. Blackstone’s LBO of Hilton Hotels is one of these “free market defying zombies” – “one global business slump away from bankruptcy.” And it just filed for an IPO.
The founders of the LBO industry – KKR, Blackstone, Apollo, TPG, and Bain Capital – are stuck in giant deals that have turned into debt zombies. The outbreak of mega-LBO mania during 2006–2007 reflected a financial market deformation that sowed recklessness across the entire private equity space. And the debt zombies are still out there.
“Bernanke’s maniacal money printing after the Lehman event catalyzed a virtual stampede back into the very same risk-asset classes which had been reduced to smoldering ruins,” David Stockman writes. It produced the craziest junk-bond binge of all times, allowing the mega-buyouts from before the crisis to survive and pay rich fees to the LBO lords.
In this installment from Chapter 25, “DEALS GONE WILD: Rise of the Debt Zombies,” of his bestseller, David Stockman vivisects the LBO craze before the financial crisis, including the insane and largest ever buyout, Texas mega-utility TXU Corporation – now in bankruptcy. And then there is Goldman….
The $47 billion buyout of TXU was a bet on a truly aberrational price gap between coal and natural gas that couldn’t possibly last, writes David Stockman. “So the largest LBO in history was the ultimate folly of bubble finance.” It generated $1 billion in fees and an “epic $32 billion payday” for shareholders, “including the hedge funds that had front-run the deal.”
During the 14 years since the LTCM crisis, the Fed’s interest rate repression policies have resulted in an inflation-adjusted return on six-month CDs of exactly 0%, David Stockman writes. It revolutionized the saving and investment habits of the wealthiest households. Unlike hapless savers among the middle class, the rich had an escape route.
John Paulson’s hedge funds that broke the sub-prime mortgage market “demonstrate the manner in which momentum-chasing hot money had come to dominate the Wall Street casino,” writes David Stockman as he mercilessly dissects the hedge fund industry. “But then the hot hands went stone cold.”
“At junctures of extreme financial stress, the high level of carry trade funding” that hedge funds use during bubbles “results in violent market reversals,” David Stockman writes. “Wholesale funding evaporates and involuntary asset sales cascade into a bidless abyss.” Hence the collapse of 2000–2003 (45%) and 2008–2009 (55%). Now they’re doing it again.
“As the Fed transformed Wall Street into a casino,” wrote David Stockman, “arrangements for insider speculation took on massive size,” with “hedge fund footings” soaring from $150 billion in 1990 to $3 trillion by the 2007–2008 peak. Trading books of Wall Street banks grew even more explosively. Together, they formed “the fast money complex.”
Unlike mortgage equity withdrawal by households, where the cash windfall was distributed across the middle class, corporate equity withdrawal through buybacks, buyouts, and takeovers resulted in cash distributions to the very top of the economic ladder. Financial engineering: the ATM of the prosperous classes!