kleptoparasites & buccaneers (19.3.98, update 22,11.09)

Private, national & common wealth in the post-socialism/capitalism era
Bewildered by what's been happening, both nationally and globally, in the wake of the fall of the Berlin Wall?
I.e. where the unwittingly weakened nation-state - formerly a bulwark against plain-levelling & globalization -
no longer tempers the social, economic & other pitfalls foreseen by Marx, Gramsci, Minsky, McCulley,etc.
Where - as the Laffer & Rider Curves illustrate in the tax & the social fields - excessive poor/rich gradients
upset the social fabric, wash away fertility factors with uncontrolled erosive powers & contribute to famine.
Where indeed, as Patrick Martin pointed out, monopolistic capitalism and the associated reckless greed
are no longer kept in check by Adam Smith' invisible hand, i.e. by the balance of contradictory interests.
And where the capacity for self-correction is increasingly inhibited by loss of freedom, mooring & orientation
which led to market frenzies & false alpha birds feeding on hype & bubbles, reminiscent of the Roaring 20s.
IMF & FATF estimate black funds (drugs, tax evasion etc) to be 2-5% of world's GDP (2006: $960-2400bn).
An IMF Report indicates these funds to be increasingly chased under anti-terrorism & ever flimsier pretexts.
Courtesy by the IV Reich's Secret Service, the world has indeed been made hostage of ill-considered rules
which impede more legitimate business than crime. For big time money laundering, the US Treasury set the
standard in 2001 with its 31% confiscatory backup withholding tax on unidentified investors in US securities,
turning foreign bankers from trustees of clients into IRS agents (qualified intermediaries) subject to US laws.
Private equity & hedge funds thus found a government-sponsored access to black funds, while the latters'
entry into subprime markets was also eased by the Internet. Results: predatory lending & systemic risks.
Society's organization needs re-thinking with Plato, G.Duttweiler, M,Yunus, J.M.Arizmendiarrieta etc.
For man's evolution may only be stressed by technological leaps but not accelerated beyond natural limits.
Return on investment rates above productivity gains/organic growth are not sustainable, predatory & usuric.
If driven by managers, lawyers & funds on the back of other stakeholders, M&As are thus Ponzi schemes
where shareholder value adepts can maraud with stacked Monopoly cards, helped by micro-economic laws.
Like compulsory social insurance systems whose doom is delayed or obscured only by inflation, war, etc.
And where the cunniest operators are state-supported by myopic magistrates hood-winked into fiscal deals.
Gary J. Aguirre's US Senate testimony details fraud & market mechanics which were at work before 1929,
e.g. Ponzi structures, unregulated pools of money, siphoning from unsuspecting mutual fund investors, and
abuse-prone market dominance: hedge funds' $1.5 trillion drive half of the $28 trillion NYSE's daily trading.
Tongue-in-cheek, Warren Buffet famously opined: "derivatives are financial weapons of mass destruction";
yet, under increasing performance & compliance pressures, some bankers still see a future in fee hunting.
Society wised up against churning of accounts by undelicate trustees, but not yet against macro-parasitism
which feasts on ignorance, sucks & devours a firm's life-preserving substance, & weakens society's pillars.
Which turns economic rat races into societal tailspins with early burn-outs & senior citizens being wasted,
& instills values causing youth to be educated out of sync, resulting in drug, violence & €1000 generations.
With profit-driven quarterly thinking & cost-cuttings also eroding due infrastructure maintenance & renewal,
& democracy's promises ridiculed by Fatf, EU & UN bureaucratic lawmaking as if Berlin Wall fell eastwards.
So why not thinking things over & “Revisiting Das Kapital while some dance on the Titanic”? Iconoclast

The growing influence of private equity companies was strongly attacked by global coalitions of trade unionists yesterday as they used the gathering of executives from some of the world's biggest companies to condemn "corporate greed".
Phillip Jennings, general secretary of the UNI global union - which has 15 million members in 150 countries - said organised labour had come to Davos with the intention of forcing the activities of private companies into the spotlight.

"They are like a global vacuum cleaner hoovering up assets any place, anywhere, any time and we want to bring them out of the shadows," Mr Jennings told a press conference. "They should no longer consider themselves untouchable."

He said unions intended to press the European Union and the G8 to force private companies to abide by established rules of corporate governance, adding that there would also be union pressure on pension funds financing the purchases of public companies by private concerns. "Unions need to be aware that the money they are paying into pension funds is feeding the beast that may devour them," Mr Jennings said.

A long period of growth coupled with low interest rates and rising stock markets has created the conditions for private entrepreneurs to borrow money for takeover bids. Private equity companies were responsible for one fifth of last year's $3.8 trillion (£1.9 trillion) worth of mergers and acquisitions, with supporters of the process saying it leads to more efficient and profitable companies.

Unions said yesterday, however, that private equity companies were "sweating assets" and that the rates of return expected by the new private entrepreneurs were incompatible either with good corporate governance or the fight against climate change. "The philosophy is buy it, strip it and flip it," Mr Jennings said. "It's all about value extraction and not value creation."

Richard Lambert, the director general of the CBI, said the private equity model could be "extremely efficient" but that the growing importance of private equity companies would inevitably lead to more public scrutiny of their activities.

"Private equity companies are now a significant part of the economy in the UK. Around 10% of people working in the private sector are employed by firms that are organised on a private equity basis. In the US [the private equity firm] Blackstone is one of the top 15 employers," he said. "These firms, which have been operating very much in the dark, are going to have to come out and discuss what they are doing. They have to engage with the public and shareholder groups in a more active way than in the past," he added.

The unions launched their attack on private equity at Davos in response to what they considered to be a downgrading of labour issues at this year's World Economic Forum. They feared a backlash by the corporations who finance the annual get-together following several years in which unions had successfully pushed their issues up the agenda.

John Evans, general secretary of the trade union body at the Organisation for Economic Cooperation and Development, said that in the US the ratio of chief executives' pay to that of the average production worker had risen from 30 to 1 in 1970 to 500 to 1.

"The share of corporate profits taken as personal compensation by the top five executives in the 1,500 largest US public companies has doubled - from 5% to more than 10% of total corporate profits over the past decade - to a total of more than $40bn a year. That leaves a lot less for reinvestment, for wage increases for ordinary workers, for shareholders, or to fund pension plan liabilities."

Pay for executives will be discussed at a lunch in Davos today, although none of the six speakers will be a trade unionist. Sharan Burrow, president of the International Trade Union Confederation, said corporate greed was the "gorilla in the room" at Davos and that business leaders needed to wake up to growing inequality.

Last year set another record for private equity, with the total value of European private equity-backed deals reaching €178bn (£117.5bn), a 41% increase on 2005. Candover, a pan-European buyout specialist, found that of the €56bn of private equity transactions completed in the last quarter of 2006, €55bn were buyouts.

The private equity boom continued to be boosted by larger deals, with 13 transactions in the final quarter worth more than €1bn. Together, these larger deals made up 70% of the value of the whole European private equity market in the fourth quarter.

Three of these 13 deals took place in the UK: the £1.6bn sale of United Biscuits to Blackstone and PAI Partners, the £1.15bn sale of Birds Eye to Permira and the £559m sale of Gondola Holdings (which runs the Pizza Express and Ask restaurants) to Cinven.

Colin Buffin, managing director of Candover, said: "This has been another remarkable 12 months for private equity, with more and more large scale buyouts driving the growth of the industry."

He remains confident that the private equity market will continue to thrive in 2007 on the back of a strong deal pipeline across Europe.

A possible £8bn bid by a trio of private equity houses for supermarket group J Sainsbury demonstrates just how bold and brave the fast-growing industry has become. If the deal succeeds - and there are plenty of obstacles to a takeover by private equity houses CVC, Blackstone and Kohlberg Kravis Roberts - the supermarket chain would follow United Biscuits, Birds Eye and Pizza Express parent Gondola into private hands.

Success would herald a landmark for the industry as it would be the biggest deal yet in Europe. Failure could prove to be the watershed moment for a business that has started to face critics, even from within the City.

Private equity - and its sister sector venture capital, both of which draw together funds from individuals and corporate investors - shot to prominence in the 1980s when KKR launched a hostile bid for RJR Nabisco - now immortalised in the book The Barbarians at the Gate. In the 1990s and 2000s the business gathered pace, helped by the dotcom boom and bust, but it really flew last year.

About 1.2 million people are employed by private equity firms. Data compiled by the BVCA, the British venture capital and private equity association, shows the business represents 7% of the total annual turnover of the UK financial services industry.

Yet the industry is uncomfortable with public scrutiny despite having lured some high-profile figures - such as U2 singer-cum-poverty fighter Bono, who is linked to Elevation Partners, and John Studzinski, the former HSBC banker, who has pitched up at private equity house Blackstone.

Private equity and venture capital also attracts a wide array of investors - pension funds and university endowments are among the biggest.

Precise figures about the size of investments can be difficult to come by but the INSEAD business school believes there could be up to $300bn (£150bn) "committed capital" in the hands of private equity and it is growing at 200% a year.

High risk
The investors are usually willing to put a small amount of their total funds into investments that are considered high risk but potentially high reward. They are high risk because of the amount of debt employed relative to the amount of equity, but once the debt is paid off, the profits can be huge.

It is the debt - and the idea that private equity firms run businesses for cash to pay that debt off - that is at the root of much of the controversy. But Christoph Zott, associate professor of entrepreneurship at INSEAD, says venture capitalists can bring financial experience and advice that can help a badly managed company. "Debt can be a very strong disciplining device, while taking a company private can shield it from the short-term pressures of public markets."

Other pressures of being listed on stock markets such as disclosing directors' pay and controls can be avoided.

Questions about the seemingly unstoppable business are coming not only from the trades unions worried about job losses but also from City big hitters and even regulators.

Michael Gordon, chief investment officer of Fidelity Investments, said: "What is starting to worry me is when talking to our clients - pension fund trustees - they are seeing private equity as some sort of panacea."

Clients such as pension fund trustees are moving into private equity believing it offers diversification to their investments. Mr Gordon believes it does not. Instead they are taking on higher risks because of the leverage and receiving less information about their investment than they would from listed stocks. They also pay higher fees.

City investors, which fell over themselves to encourage boards to accept bids by private equity firms, are beginning to urge more caution from sitting management teams. Signet and HMV have both been the target of mooted private equity approaches but, so far, bids have not materialised. Estate agency Countrywide survived one private equity takeover attempt last month but yesterday received another.

Laden with debt
Companies that have been listed on the stock market, bought by private equity and then relisted - notably Debenhams - have also done little to win the confidence of investors. Debenhams was taken private in 2003 only to come back to the stock market barely two years later - with a market value greater than it was sold for and laden with debt. Mr Gordon notes this will be one way to measure the success of any Sainsbury's bid. "The Sainsbury's bid will succeed if investors sell to them and then buy the asset back when it comes back to the market," he said.

The UNI global union - which has 15 million members in 150 countries - used the recent Davos economic forum to condemn private equity companies for "corporate greed". Philip Jennings, UNI general secretary, said: "They are like a global vacuum cleaner hoovering up assets at any price, anywhere, any time and we want to bring them out of the shadows." The Transport & General Workers' Union warned yesterday about the potential Sainsbury's bid. Brian Revell, T&G national organiser for food and agriculture, said: "Such a takeover would be based on borrowed money followed by extracting as much wealth as possible from the company ... Private equity does not create wealth; they extract it for their shareholders." Mr Gordon has some sympathy. "Employees are a little further down the pecking order in private equity," he said.

Concerns have also been raised about the standard of corporate governance at private equity firms. Sir Derek Higgs has suggested they could comply with the corporate governance standards he devised for stock market listed companies. But the industry argues it is transparent and clear. The BVCA says investors in private equity funds provide "complete and comprehensive" information to their investors and its members also follow a code of conduct. This is a point taken up by a senior venture capitalist. "Our investors can ring us up at any time and ask how investments are going. Every half year they get official updates," the venture capitalist said. He says investors in private equity funds actually get more information than they would for stock market listed companies. Private equity firms can know personally all the investors in their funds - a few hundred, say, compared with the millions on the registers of the biggest stock market companies.

Job cuts
Some attempts by the industry to answer critics have backfired. The launch of the Private Equity Foundation, which is to make donations to children's charities, was picketed by unions upset at job cuts at venture capital-owned businesses Little Chef and Birds Eye. Others note that the increasing interest by the Financial Services Authority in the sector may also be helping to focus minds.

Hector Sants, managing director of wholesale markets at the FSA, last month met the heads of the biggest venture capital firms. The meetings came after the FSA's warning in November that it was "inevitable" that a large private equity-backed firm would default on its debt and that it was concerned there was potential for insider dealing in the industry.

By March 6, the industry and other interested parties are required to tell the FSA what they think. In the coming months, the industry will find out whether the FSA is satisfied that it has answers to the potential risks.

Going private: Debt is the key
The terms private equity and venture capital are used interchangeably in the City to describe deals that involve buying companies listed on the stock market and taking them into private hands. (In the US venture capital tends to be used to describe investment in early-stage and expanding companies.)

The deals are usually associated with high levels of borrowing - known as leverage - relative to the amount of equity in the business.

The BVCA, the British venture capital and private equity association, says most of the publicity the industry attracts is for a dozen or so of the big value deals on the stock market. Most private equity deals - those conducted by 80% of the members of the BVCA - are for £2m or less. Some do not involve stock market listed companies, as private equity-owned firms can keep changing hands in the private sector.

Even so, an obvious exit route for private equity owners is to float the business on the stock market. The BVCA says this is an important discipline in running the companies - they have to be managed well so they can be sold on.

The big difference between private equity and stock market listed companies is that the private equity firm is the only owner of the business - while investors in stock market listed companies only influence rather than control them.

Private equity investments are said to grow faster than stock market listed companies. Over the past 10 years, the best buyout funds have outperformed stock market indices. Some of this is due to the leverage and has prompted analysis by Citigroup into whether simply buying a stock and increasing the size of your investment by borrowing money can replicate private equity returns. The answer is sometimes.

    Whatever the rights and wrongs, the present controversy about buying companies using private equity has generated a rare public debate in which the protagonists are actually listening to each other. Such deals have already seen household names such as the AA and Little Chef taken over - with Sainsbury's mooted as the next target - and have naturally provoked opposition from unions fearing job losses. Instead of denying this, Michael Gordon, chief executive of Fidelity Investment, actually admitted that "employees are a little further down the pecking order in private equity". In yesterday's Financial Times two private-equity groups put their heads above the water. Permira, Europe's biggest - which owns New Look and the AA - pledged to provide more information about what it owned in response to criticism that private-equity firms were not required to make quarterly reports as publicly quoted companies are. Steven Rattner, co-founder of Quadrangle, while rigorously defending private equity as "a constructive force in making capitalism work" admitted that at the moment there was a "credit-fuelled bubble driving private-equity deals that would not happen in a normal credit market". To cap it all, Britain's biggest charity, the Wellcome Trust - also the biggest institutional owner of private-equity buyout funds in the UK - warned against changing the tax treatment of these funds, arguing that this would reduce the income the trust uses to maintain Britain as a world leader in biomedical research, thereby forcing it to redeploy more of its investments abroad. Some pension funds, also heavy investors in these funds, would agree.
    Anyone with memories of the "asset stripping" boom of the 1960s and 1970s may be unsurprised by the phenomenon. What is new is the scale of it. More money was raised through private equity in the first half of last year than through stock-market flotations. Private equity embraces everything from providing vital venture capital for new start-ups to short-term moves to strip companies of their property assets before selling these firms, laden with debt and without any of that concern for staff that has allowed some businesses, such as the John Lewis Partnership, to thrive.
    It is good that equity firms are responding to public concern. They have even produced a survey claiming that they generate jobs much faster than traditionally financed ones. That needs a lot more scrutiny before it is taken seriously. Even if it were true that they merely accelerate the destructive forces necessary to make economies more productive, it ought to be done in a more opaque and humane way. If they do not learn from the current debate and stop treating companies as if they were objects in a private game of Monopoly then they should be unsurprised if the government is forced by public opinion to curb their excesses.

Stephen Thompson started working as an AA patrolman in April 1985. It was, he says, his perfect job. On several occasions he was named patrolman of the year in his region. But 20 years to the day after joining, he left with a payout of just Â£18,000. His marriage has since broken up from the stress. Thompson, now 46, has no doubt who to blame - the private equity owners of the AA who bought the business in 2004. "I'm very angry," he says. "All they are here for is for profit making. They ripped the guts out of the AA."

If critics are to be believed many more workers will share Mr Thompson's fate if the private equity juggernaut is not checked. In the past few weeks, this burgeoning but secretive industry has been catapulted out of the shadows and into the political spotlight. Private equity has become so powerful that a handful of firms own businesses that employ one in every five workers in the private sector in Britain. The firms are largely secretive, rarely give interviews and do not disclose who invests in their funds. The industry meanwhile has made a small number of people who manage the funds immensely rich. Sir Ronald Cohen, the Labour donor and adviser to chancellor Gordon Brown who founded private equity firm Apax, is said to be worth Â£250m. Damon Buffini, who grew up on a Leicester council estate and is now a managing partner at Permira, is estimated to be worth Â£100m.

Few people outside the business world would have heard of these companies just a short time ago. But now they find themselves the latest flashpoint in a broader debate on social divisions as City financiers bank billions of pounds in bonuses while ordinary workers struggle. Within months of buying the AA for Â£1.75bn, the private equity owners Permira and CVC Capital had cut 3,400 jobs. Permira, the largest private equity group in Europe, last year bought Birds Eye from Unilever and pledged to keep workers' employment terms for at least three years. Within five months it had closed a plant in Hull at
the cost of 600 jobs.

Unions have now forced the issue on to the agenda in the battle for the Labour leadership and on to the front pages. Workers at NCP, the UK's biggest car-parking group, picketed the offices of private equity owners 3i this week complaining of a pressure-cooker environment and failure to recognise the union. They were met by John McDonnell, a Labour MP and candidate for party leader. He said it was a "national scandal that the casino capitalists from global private equity groups are allowed to treat British workers and some of our biggest companies as nothing more than pawns in a game of
get-rich-quick".

Buffini broke cover yesterday and gave interviews to Radio 4 and the Financial Times in an effort to calm the growing political storm. "People don't quite understand what we do and the benefits we do bring to the economy," he said. "There is a positive story about productivity and job creation. Those messages have not gotten through."

Private equity has been described by The Economist as a "superior model of capitalism". It can generate huge rewards for its investors in a short period of time. One City dealer described it as akin to trading companies like secondhand cars. There are two kinds of private equity deals. The first, sometimes referred to as venture capital, involves investment in small start-up businesses. The second is the more contentious; the aim is to target businesses that may be badly run, undervalued or in need of an overhaul. Private equity firms buy the companies with money from rich individuals and financial institutions such as pension funds, alongside large debts. Private equity has flourished in Britain because firms can claim tax relief on interest payments on the debt used to buy the businesses; a loophole unions want to close. The aim is to sell the business again or float it on the stock market, typically within three to five years, at a profit.

The amount spent buying public companies in Britain last year reached a record Â£26.3bn. There have been so many buyouts that the combined value of companies on the stock market is shrinking. Other household names bought by private equity last year include United Biscuits, Matalan, Travelodge, John Laing, Associated British Ports and Phones4U. The US private equity firm Apollo this week bid Â£1bn for Countrywide, the UK's biggest estate agency.

And they are getting more ambitious. It emerged this month that a consortium of four private equity firms is running the slide rule over the supermarket group Sainsbury's. If the Â£10bn takeover were to happen, it would enter the history books as the largest private equity deal ever done in Europe. "It is about extracting as much as you can as quickly as you can," says Karel Williams at Manchester Business School. "It is part of a broader series of changes in capitalism.

These intermediary groups, like private equity and hedge fund managers, are able to enrich themselves in ways thought unimaginable a few years ago. "The ultimate question is whether this behaviour becomes normalised and accepted. This is a socio-cultural change. The culture of naked self-interest among private equity managers is characteristic of the elites in third world countries."

Senior managers are also getting a share of the spoils, raising questions about their decisions to sell out companies. "In the debate on private equity, it is important to recognise the potential conflict of interest for senior management," says Michael Gordon, chief investment officer at Fidelity, one of the biggest fund managers in the world. "They become highly incentivised to sell out to new owners."

Debenhams has become the text book case. CVC, Texas Pacific and Merrill Lynch Private Equity used Â£600m to buy the business in 2003. They increased the retailer's debt from Â£100m to Â£1.9bn and paid themselves a dividend of Â£1.2bn. They sold the freehold of the stores for Â£500m and leased them back. They then floated the business and took another Â£600m. In a little over two years, they made around three and a half times their investment. Debenhams now faces huge interest payments and rent on stores it once owned. Yesterday, its shares rose 10% on speculation that the private equity
industry may try to buy it back again - in a clear illustration of the need by private houses to find homes for their cash.

Anger at NCP has been stoked by reports that 3i is preparing to sell the business to another private equity group after just 18 months for a profit of Â£245m. Francis Fordjour is a parking attendant at NCP in Enfield, north London and has joined colleagues on strike. "Working conditions at NCP are horrible," he says. "All they are interested in is how many tickets you have issued."

Patrick Dunne, a 3i director, says the image of a ruthless owner wringing the business dry is far from the truth. "No one wants to buy a business that has been starved of investment or has a reputation for mistreating its workforce. "The other social issue that isn't mentioned is that millions of people benefit from private equity because their pensions are invested in these funds. There is, he says, no intention to "flip" NCP quickly, but adds that "we have a duty to our shareholders to consider any proposals".

Permira is equally dismissive of the claims of unfair treatment by Thompson at the AA. "He left voluntarily with a generous financial package which followed a performance review in March 2005 when all patrolmen were reviewed," an AA spokesman said.

There are signs that the private equity fad might be running out of steam. Company shareholders and directors have begun to fight harder and demand higher prices for their businesses. Approaches for the likes of ITV, EMI and HMV failed. And the latest offer for Countrywide is a second attempt which may fail again.

Economists fear a downturn in the economy or higher interest rates could spell disaster. Companies that private equity firms have loaded with debt and liabilities like rent are much more vulnerable. We have been here before. Highly leveraged management buyouts became popular in the 1980s. They fell out of favour as the economy dived and a couple of high-profile companies defaulted on heavy debts.

The Financial Services Authority recently warned that the City should get ready for some "short sharp shocks". Former AA patrolman Thompson, might argue that the short, sharp shock has already been delivered.

Philip Yea runs 3i, the only private equity firm in the FTSE 100. He joined the business in July 2004 while the company was still struggling with the legacy of a clutch of poor investments during the dotcom boom. He has shifted the business away from technology, invested more in fast growing markets overseas and sharply reduced the portfolio. By last year profits were back up at £855m, from £500m in the previous year. Before private equity, Mr Yea, 51, spent most of his career in the corporate world. He was with Guinness and then its latter day incarnation Diageo for 13 years, six of them as group finance director.
Guy Hands - Chief executive, Terra Firma

Hands is one of the highest profile financiers in the City, perhaps best known for a string of deals that made his then employer, the Japanese bank Nomura, Britain's biggest (and unlikeliest) pub landlord. Hands joined Nomura in 1994 and spent billions of the bank's money on a succession of less than glamorous assets including the former British Rail leasing company Angel Trains and 57,600 Ministry of Defence-owned homes. Hands, 46, set up Terra Firma in 2002. He has pledged £65m of his own money to the firm's next fund, which is looking to raise £3.5bn. Terra Firma owns the Odeon and UCI cinema chains in Britain.

Buffini, 43, has become the poster boy for the private equity industry and Permira Europe's biggest private equity firm. The son of a black American serviceman, Buffini was brought up by his mother on a Leicester housing estate. He went to grammar school, Cambridge University and Harvard before ending up at the investment bank Schroders and engineering the management buyout that created Permira. Some of the most stinging campaigns orchestrated by the GMB union against private equity have targeted him personally. The firm already owns household names such as the AA, Little Chef and New Look. Buffini's personal fortune is estimated at at least £100m.

Arguably, Kravis is the founding father of the private equity business and the rightful owner of the sobriquet "big swinging dick". With his first cousin George Roberts and their mentor Jerome Kohlberg, he set up Kohlberg Kravis Roberts 1976. The deal for which they are best known is the record-breaking buyout of RJR Nabisco in 1989 which was immortalised in the book Barbarians at the Gate. Two decades on, KKR is still doing deals including buying toy retailer Toys "R" Us. Married three times, he has had three children including a son who died in a car crash aged 19.

A grandee of the British venture capital business, Sir Ronald set up Apax in 1971 with three friends at the age of 26. Apax invested in firms including PPL Therapeutics, which cloned Dolly the sheep, and the computing group Autonomy as well as Virgin Radio and Waterstones. He retired from the business 18 months ago and is actively involved in the Middle East, directing funds to Palestinian businesses. He is a Labour donor and well known for parties at his home in Notting Hill. Born in Egypt, Sir Ronald arrived in Britain at the age of 11 unable to speak English. Today he is worth some £250m.

Philippe Costeletos is the venture capitalist who masterminded the buyout of Debenhams three years ago. Now relisted on the stock market, it is held up as the textbook "flip it and spin it" venture capital deal. When Debenhams was relisted, the retailer was laden with debt after the venture capitalists had taken their spoils. Texas Pacific also became a household name after it prompted a staff walkout at the airline catering firm Gate Gourmet and sacked the strikers. A native of Greece, he has been with Texas Pacific since 2003, joining from Investcorp where he was involved in a number of buyouts in Switzerland, Norway, the Netherlands and the UK.

Smith joined the firm in 1982 when it was part of Citigroup, the biggest banking group in the world. He became managing director in 1986 then led a management buyout of the business to create CVC, one of Europe's leading private equity groups. The firm has made billions buying and selling companies including Kwik-Fit and Debenhams. It managed to earn four times its original £137m investment in the Halfords bike and car chain. It is now moving aggressively into the Asia Pacific region. Smith, 54, avoids publicity. He has homes in Berkshire and Monaco and is married with two children.

Moulton is still best known for a deal he never did. Villified at the time as a "ruthless asset-stripper", Moulton had attempted to buy the MG part of MG Rover in 2000. He lost out to rival bidder Pheonix Partners, who promised to save all 6,000 jobs, rather than the fraction offered by Moulton. Rover collapsed anyway and Moulton has since described feeling "an awful shame" about the affair. Moulton was one of the first private equity specialists to give interviews and defend the industry. Before Alchemy he was in charge of buyouts at Apax and was once a player at Schroder Ventures, the business that has now become Permira. His wealth is estimated at £50m.

    It is time to come to the defence of the public limited company, one of the great Enlightenment gifts to western civilisation. Increasingly capital, in the quest for higher returns to make vast personal fortunes, is going private to escape the demands of public accountability on stock markets. If uninterrupted, the long-term adverse consequences of this privatisation of capital for our economy, society and democracy will be profound.
    Even six months ago, very few outside the City or the readers of business pages had come across the idea of private equity. Today, as Sainsbury's is stalked by a club of four private equity firms allegedly plotting a £10bn bid and the GMB has ignited a campaign against job losses incurred in private equity restructurings by comically embarrassing one its leading lights - Damon Buffini, the boss of Permira - private equity is news. It is even becoming an issue in the contest for the deputy leadership of the Labour party.
    Quite right. Private equity is now the dominant element in the stock market. According to the Financial Services Authority, in the first six months of 2006 private equity firms raised £11.2bn in capital on the London Stock Exchange. Ordinary firms raised £10.4bn. So many public companies are being taken over by private equity companies, or retiring their own shares to head off the risk, that the London stock market, despite rising average share prices, shrank by nearly £50bn in the same period. More than 2.5 million people in Britain work for private equity companies.
The story, as recounted by consensus opinion from the shadow chancellor, George Osborne, to the CBI, and eagerly rehearsed by the private equity industry itself, is that the emergence of more than 700 private equity companies deploying saving and borrowing power of more than £1 trillion is crucial to wealth generation. By taking public companies out of the public arena of accountability, regular reporting and scrutiny, they can instead enjoy the benefits of engaged, committed ownership.
    Too many companies, they allege, are just not trying hard enough to maximise their profits, indulged by disinterested pension fund and insurance company shareholders. They need the managerial alchemy of private equity investors who, aiming to make "life-transforming" money for themselves, will give them the necessary managerial and strategic shock treatment.
    One truth about private equity shines out: the extravagant management fees and annual "carry" (the share in profits) certainly means life-changing fortunes. Researchers at Manchester University's ESRC Centre for Socio-Cultural Change recently got hold of the internal management accounts of one fund with up to £8bn of funds under management. After five years 30 full partners expected to make between £25m and £50m each.
    The rest of the industry's claims about creating jobs, investment and exports do not bear close scrutiny. Much of the alleged managerial alchemy is no more than old-fashioned financial engineering - that is, leveraging up returns by incurring lots of debt. One study by Citigroup showed that if pension funds and insurance firms had borrowed money themselves and invested in a basket of companies in which private equity groups invested, they would have made higher returns than even the best-performing private equity firms.
    Mortgaging the future to capture gains for personal enrichment in the present is easy - as one chief executive of a well-known public company told me recently, the task of the good manager is to resist it. Managers have to balance the interests of today's shareholders with tomorrow's shareholders. Private equity drives a coach and horses through the proposition. And as Paul Myners, the former chairman of Marks & Spencer and chairman of Guardian Media Group, has remarked: "The one party that is not rewarded is the employees, who generally speaking suffer an erosion of job security and a loss of benefits."
    The catalogue of firms thus financially engineered is endless. A consortium bought the car rental company Hertz in 2005, packaged up the car fleet in blocks of tradeable assets that could be bought and sold by banks, and sold the weakened company back to the stock market. Others have bought media outfits such as PanamSat in the US or EirCom in Ireland - not to develop a free media that holds truth to power but, as Columbia University's Eli Noam argues, to weaken that capacity while remaining unaccountable owners themselves.
    In Britain Debenhams was bought, its stores sold off to be leased back by the enfeebled company, which was then sold back to the stock market. And other public companies, including ICI, Amec and EMI, are being stalked, and adjusting their strategies accordingly. The shadow of private equity falls everywhere, making the gamut of British business hyper short-termist.
    This is not pro- but anti-wealth-creation. In this respect the attitude of private equity closely mimics that of the Chinese communist party. Both conceive of companies as networks of contracts between capital and labour that generate revenue streams to be manipulated by whoever has central control for personal or political advantage. Neither has any conception of companies as Enlightenment institutions that incorporate real-life human beings into a joint enterprise, in which being publicly scrutinised and held to account helps managers make better decisions. The foundation of a durable business, as James Collin and Jerry Porras argued in their famous book, Built to Last, requires vision, values, leadership and purpose around an organisation's "reason to be" - the antithesis of everything private equity stands for.
    So if we want such companies, shareholders have to give managers room for manoeuvre and back long-term business strategies. But British shareholders are not required by law to take their ownership responsibilities seriously (it would be a "burden on business"). Nor are British companies required to give them the range and quality of information that might help them. As a result, British shareholders are extraordinarily neglectful of their ownership responsibilities.
    Pension funds and insurance companies are myopic and short-term enough, but because takeover is so easy in Britain private equity has been able to carry short-termism to new extremes. This is said to raise productivity and performance. I would argue the opposite. The chief reason British business remains at the bottom of the international league tables for innovation, research and development, and productivity growth is because of too much takeover and too much private equity. Innovation lowers short-term profits.
    The answer is obvious. Private equity cannot be outlawed; in any case it can do a good job. Rather, the perverse incentives in Britain that favour takeover need to be removed. We need to defend the public company and create conditions in which it can prosper. But who is going to do that? Not the Conservative party, in thrall to private equity, and not, judging by its legislative record, the government. Our politicians are confused. There is more to wealth creation than constructing a plutocracy of private equity partners.

· Will Hutton is chief executive of the Work Foundation and author of The Writing on the Wall.
will.hutton@observer.co.uk

Koolio    February 23, 2007 6:06 AM
    Having railed against stock market capitalism, I find it interesting to see Will Hutton defending the companies listed on the stock market.
    It takes two to tango, in order to buy the companies, institutional investors like pension funds and insurance companies, who tend to own most of the shares, have to be willing to sell.
    Taking Sainsburys, the shares were trading at 400p before the possible buyers were flushed out, now the shares are valued at over 500p and any expected offer is likely to come in north of 550p. So if a take-private deal can prove the market - all those traders, fund managers and city analysts - wrong, and pay 25% more than the market price, let them put their money on the table. In some cases, as with Marks & Spencer and plenty of others, investors will reject offers and back the incumbent management.
    Hutton says that "if pension funds and insurance firms had borrowed money themselves and invested in a basket of companies in which private equity groups invested, they would have made higher returns than even the best-performing private equity firms." Yes, but they didn't do this. Is Will Hutton calling for pension funds companies to load themselves up with debt?
    The debate about the wealth of the partners involved is really a separate matter. There are many others in the City from traders to hedge fund partners who are making a lot more money. I suppose I can see how talk of these big salaries is useful for the Labour Party's internal politics but listing people's wages is only good for demagogy and cheap newspaper headlines.
    Finally, all this is a topical subject but it'll blow over. No one has yet to even make an indicative offer to the board of Sainsburys. Right now, money is very cheap at the moment and the stock market has been rising, two conditions ideal for private equity houses. As the credit cycle is perhaps turning now, things should look different in a year's time and those private equity might rhyme with negative equity.
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steerforth    February 23, 2007 6:28 AM
Will        Private equity has enjoyed very good returns on capital in the last 4 years for the simple reason that they
have been operating in an environment of low interest rates and rising stock markets. They have benefited in
exactly the same way as people who were lucky enough to have purchased houses utilising low mortgage rates. Any
time a private equity company buys a quoted company and tries to develope it for a profit it is engaging in a
high risk activity as it uses its own capital and a large amount of debt.
    You seem to be a little naive in your glowing description of public companies and how they came from the enlightenment
era. Public companies have never been properly accountable to their shareholders since the directors have always
been able to use proxy votes to act in their own interest which is often not aligned with the shareholders. The incentives to act for short term profitablity is just as strong for options holding directors as it is for the private equity companies.
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fortyniner    February 23, 2007 6:32 AM
    Looks like we have a new version of "selling off the family silver". Only this time, it is the private sector which is the target. In the old days, this sort of activity was called "asset stripping" and "the unacceptable face of capitalism". But in a society where money has become "god" those who makes loads of it are worshipped as "gods".
    But as the Native Americans would say "you can't eat money". We have been warned.
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TimWorstall    February 23, 2007 9:15 AM
    A quick question for Will Hutton if he's ever going to demean himself by getting down and talking to us plebs in the comments.
    Your argument is that there is something vastly better about companies being public than there is in their being private.
    Excellent, so when is The Guardian being floated?
    Of doesn't it work like that? I'm sure I saw pieces a year or two back, around the time of the changeover to the Berliner format, stating that it was in fact the paper's private ownership which enabled it to make the huge investment required, freed from the short termism of the public equity markets.
    Do as I say, not as I do perhaps, from one of the trustees of the Scott Trust, who own The Guardian?
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englandismdotcom    February 23, 2007 9:28 AM
    Go to Guardian Unlimited and peruse 'neo-liberal' McGreevy's stalwart defence of private equity houses:
"I believe that private equity houses and activist fund managers of all kinds, including hedge funds, play a much more valuable role than any government or regulator in propelling the liquidity of our capital markets, in reducing the cost of capital, in driving forward Europe's growth and in equipping European industry to survive and compete in the more challenging global markets we now face."
    And, then if you missed it, go to Radio 4 Today and listen to the interview with Damon Buffini of Permira.
    A more 'neo-liberal' champion it would be hard to find given his background and rise from the 'underclass' but still this does not prevent the TUC from launching an animal rights style campaign of personally targeted public vilification.
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GJTORY    February 23, 2007 9:32 AM
    It is worth pointing out, Mr Hutton, that in order for the these private equity partners to earn the £25m - £50m you write of, if they get a 20% share of profits as carry, they would have to generate returns of about 20% per year for those 5 years on £8bn.
    That is a pretty good return by anyone's standards. If they generate it, why should they not be paid?
    fortyniner - private equity funds plan on selling the 'family silver' back to you after 5 years - and in considerably better shape than when they bought it, for more money.
    But no one forces the buyers of those companies to buy them. They only do so if they think it is a good deal. Therefore private equity is incentivised to deliver healthy companies. Short termisim does not prevail in private equity. That is a myth peddled by unions.
    What is more, Koolio is right (IMO). Currently there are a lot of private equity funds with a lot of money to spend because it is easy to raise funds. With higher interest rates or a recession this will cease to be the case and private equity may go back to being the niche investment style that it used to be.
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eleuthera    February 23, 2007 9:46 AM
    Hutton lauds the public listed company as "a great Enlightenment gift to Western civilisation". The reason for his enthusiasm? "Being publicly scrutinised and held to account helps managers make better decisions."
    What he fails to understand is that, in relation to public companies, mechanisms of accountability have had to be developed because of the separation of ownership and control. Since ownership of the company rests with a diverse population of shareholders (often pension funds and insurance companies), whereas control rests with the board of directors, accountability mechanisms have been developed to allow the owners (shareholders) to keep an eye on what the directors are doing with their property (the company).
    Where a private equity firm purchases a company and takes it off the stock market, ownership and control are much more closely aligned. The population of shareholders is far less diverse, reduced to a population of one or two (or, in the unusual case of the Sainsbury's bid, four). This concentration of ownership means that formal accountability mechanisms (quarterly reports, regulatory announcements, etc.) become far less important; the owners are actively engaged in supervision and management of the business.
    What Hutton has overlooked is that these accountability mechanisms are not an end in themselves; they were designed as a solution to the problem of a diverse and therefore disenfranchised shareholder base. A privately owned company does not suffer this underlying problem, therefore the formal accountability Hutton desires is not relevant.
    A couple of weeks ago, Hutton wrote similar a peice in the Observer
http://www.guardian.co.uk/commentisfree/story/0,,2010611,00.html
which laughably sought to link the Sainsbury's bid with the Bernard Matthews contamination. He asserted (with absolutely no justification at all) that managers of companies owned by private equity firms would be more likely to turn a blind eye to breaches of health and safety laws.
    This analysis is at best lazy if not mendacious. It shows little understanding of the nature, purpose or function of private equity in the economy. Observer and Guardian have far better economic and business writers on their staff (Larry Elliot, William Keegan, Richard Wachman). Why do these papaers continue to publish such undistinguished thoughts from a writer who has repeatedly been found wanting? Oh yes, that seat on the Scott Trust....
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Accor February 23, 2007 9:55 AM
Notwithstanding the arguments above, Hutton is arguing that Britain is less innovative because it is tied down by short-termism and PE. If this were true, wouldn't the United States, which has a significantly more advanced PE culture, be saddled with the same problem? Under Hutton's reasoning, the US should be the least innovative and productive nation, rather than consistently one of the most. Could it be that Hutton's desire to make a political point has interfered with his analysis?
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Trilobyte February 23, 2007 10:48 AM
I'm inclined to agree that Private equity largely appears to be geared to cherry picking the profitable parts of a business for the short term benefit of a very few people, but I need convincing that public listed companies are paragons of probity and virtue just because they are accountable to the stockmarket and have to publish accounts-Enron, Parmalat, MCI, BAE anyone?
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Margin    February 23, 2007 11:01 AM
    It should also be pointed out that a factor in the rise of private equity is not the cheap debt they use to buy firms, but the fact that so many firms have failed to take up the advantage of cheap debt to improve their business.
    When debt is cheap public companies should be in a good position to take out debt to expand their business or invest in cost reducing technology. That might mean building new stores at home or abroad for a supermarket. Or it could mean installing new robotics equipment in a factory.
    The rise of private equity clearly suggests that not only are a lot of public listed firms being badly run, but that there are major opportunities for expansion out there being missed by UK firms.
    The UK’s biggest economic weakness is the low standard of managers in its firms. They lack ambition. They lack vision. And they lack the will to act.
    So if private equity is widening the influence of the very best managers in the world, that must surely help Britain?
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CityBoy2006    February 23, 2007 11:14 AM
    Some good posts debunking the frankly poor arguments put forward that somehow PE is a house of cards waiting to tumble and is somehow screwing the workers / pension funds / society etc as it does it.
    PE works by identifying underperforming companies and unlocking efficiencies that the incumbent management either lacked the vision to do, or as is more usually the case, were too constrained by governance, board inaction and lobbying by interest groups such as unions. PE often returns these companies to the market or sells them on to other PE groups (see the recently proposed NCP deal). If these companies had been gutted and were being returned to market as basket cases don’t you think that the institutional investors, PE buyers etc would realise this and not touch the stock?
    PE takes on risk (often the partners doing so personally) and speculate where others can’t. But it is a typical labour left response to a perceived problem, not if they can do it, why not other bright guys? Rather if the majority can’t do it lets stop those that can.
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Ieuan    February 23, 2007 11:28 AM
    eleuthera said: "accountability mechanisms are not an end in themselves; they were designed as a solution to the problem of a diverse and therefore disenfranchised shareholder base. A privately owned company does not suffer this underlying problem".
    Surely what Hutton is saying is that 'a diverse......shareholder base' is not a problem, in fact it is a benefit (as said also Maggie Thatcher, remember that we were 'all' going to be shareholders, owning British business as 'stakeholders'). Disenfranchisement is a problem, but needs other methods to solve it, scrapping the diverse shareholder base to get rid of the disenfranchisement really would be throwing the baby out with the bathwater.
    A couple of decades ago the behaviour of the private equity firms would have been simply called 'asset stripping' (as has been pointed out before). This was roundly condemned and steps were taken to prevent it. But, as always, those who make money out of money (rather than by doing anything productive) found a way to get round any restrictions and go on looting the work and creations of others for their own short term benefit.
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Cameron1 February 23, 2007 11:45 AM
Since when did Private Equity become responsible for the following: "The one party that is not rewarded is the employees, who generally speaking suffer an erosion of job security and a loss of benefits."? Final salary pension schemes have become hen's teeth without the so-called malign influence of private equity. I agree with eleuthera that much of your analysis is recycled horseshit. Private equity has succeeded in transforming some of the UK's worst commercial laggards: Travelodge anyone? Don't forget that for Debenham's to be re-floated, institutions clearly wanted to buy it back which they did. Why? Because it was still worth buying and it floated successfully. The underperformance of many plc's is in fact due to reticent pension funds who have themselves become too bureaucratic and obsessed with computer models to take an active interest in their holdings and reprimand poor managers. I am afraid you're just a johnny come lately in joining the already overcrowded train of private equity bashers. PS if you wish to produce convincing analysis, you have to at least skim over both sides of the story to form an argument.
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recklessinspector    February 23, 2007 11:47 AM
    Will Hutton seems to be arguing for more responsibly monitored public companies as the solution to the alleged 'problem' of private equity. However, I would tend to look at things from the other way round: isn't private equity actually an imperfect and problematic solution to the long-standing accountability problems that continue to plague our listed company sector.
    The US Enron fiasco and dotcom bubble problems showed that, despite the expertise of institutional investors and stock analysts, such parties are always at an informational disadvantage relative to managerial 'insiders'. In any event, the inherent liquidity of public capital markets means that they are naturally limited as a source of long-term, large-scale or high-risk investment capital (as Mr Hutton himself argued in his excellent work 'The State We're In'). This no doubt partly explains the current popularity of public infrastructure businesses in the eyes of private equity funds, whose more concentrated ownership and incentive structures arguably make them better placed to support extensive investment projects carrying considerable economic and/or political risk.
    Furtheremore, despite the best intentions of policy-makers, recent regulatory initiatives such as the Combined Code on Corporate Governance have only served to burden UK listed company boardrooms with American-esque independence and sub-committee structures, without any obvious benefits in terms of either improved informational flows to shareholders or more responsible share pricing practices. So, whilst private equity is undoubtedly a highly problematic institution, let's not allow it to blinker us from the more fundamental accountability and incentive problems that it is (albeit indirectly) trying to solve.
    And, as a final matter, I fear that by making the wholesale assumption that private equity investors are a bunch of short-termist asset strippers, influential commentators from the left (such as Mr Hutton) risk being excluded a voice in the debate about the future of this highly complex investment phenomenon. For instance, regardless of one's opinion on the wider merits of private equity transactions, is it wise that BAA, the operator of seven British airports including Heathrow, should be burdened with multi-billion pound debt liabilities on top of a huge government-agreed investment schedule? More worryingly, what would happen if a major private equity-funded instution like BAA or Thames Water went bankrupt due to a change in the credit environment? Would the government sit back and allow this to happen, or would we, the taxpayers, be force to step in and act as a creditor of last resort?
    However, these are specific consequences of private equity infrastructure investments that need to be investigated urgently, and I feel that by simply denouncing the institution of private equity as a whole, we are only helping to mask these extremely serious but specific risks to Britain's economy and society as a whole. So, for the sake of Britain's future, the left urgently needs a voice in the private equity debate. And, by making broad-brush negative conclusions about what is both a highly valuable but also highly risky feature of our current corporate governance landscale, I feel that we only risk discrediting the case for considered regulatory reform.
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Gumbo    February 23, 2007 12:05 PM
    The article completely glosses over the fact that when these supposedly crippled companies are sold back onto the stock market, they attract perfectly willing investors to buy them. Implicit in this is that Hutton believes that somehow the entire market is being somehow mislead and that perhaps only he has spotted that the company is a shell now.
    Or on the other hand he could be talking rubbish. Companies relisted after PE firms have been owners actually outperform the market. Those buying these companies - ie the future shareholders - get a good deal. What's more the consumer gets a great deal too, because PE firms are relentless on cutting off dead wood and improving efficiency. In some cases they do heavily gear the company, but basically any reasonably solid non-cyclical company probably ought to be heavily geared anyway. What's more, PE firms are less reliant on borrowing to achieve their aims than they are on getting the right management in place and setting up good incentives.
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PeterHCT    February 23, 2007 12:11 PM
    Will Hutton - "The answer is obvious. Private equity cannot be outlawed; in any case it can do a good job....defend the public company"
    GJTORY - "it is easy to raise funds. With higher interest rates or a recession this will cease to be the case and private equity may go back to being the niche investment style that it used to be."
    Well, we are getting higher interest rates. Need to check the source, but read since 9/11 money supply grew at perhaps twice what might have been justified by growth+inflation, if that is the correct equation. So lots of cash sloshing about to be lent, hence silly property prices [1], availablity for privateering equity, etc.
    As far as I can follow it, the maxim nowadays is that interests rates are a tool for the Bank of England to control inflation. All jolly fine as far as that goes, but interest is basically a price. Market forces eventually dictate prices.
    There are mutterings that inflation is more than not the Governments quoted rate against which the Bank's performance is measured.
    There are doubts on the extent to which PFI has obscured HMG's borrowing position.
    Oh, wars and rumours of wars. Iran?
    What if - or indeed when - this lot comes unstuck? Not neatly and gradually, as economists like to forecast, but abruptly with an 'Oh, shit' factor as tends to happen in the imperfect real world??
    Just how robust are these private equity firms' calculations on debt and interest cover? One publicised disaster, and it might all look a bit silly.
    I'd like to think I'm being over-pessimistic, but I really can't convince myself that it's anything more than healthy scepticism.
    [1]FSA "We believe that, at this point in time and reflecting current market conditions, an average reduction of 40% in property sales price forms an appropriate reference point when assessing downturn LGD for mortgage portfolios."
    http://www.fsa.gov.uk/pubs/international/mortgage_LGD.pdf
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Agog February 23, 2007 12:55 PM
More British anti-business sentiment. What is this country going to fall back on when the finance industry goes into a spin?
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North2South    February 23, 2007 1:07 PM
    Despite economists' assumption that firms maximise profits, in reality many (most?) firms could operate more efficiently - they just need a kick up the backside to do so. Often, that comes through competition from a new entrant to the industry, or from a sudden and sharp rise in one of their costs (eg energy). In this case, it comes from the fact that low interest rates and sophisticated financial markets raise the threat of leveraged buy-outs and repackaging of financial agreements. If it increases the efficiency of production, it is no bad thing. And other posters are right to say it won't last forever.
    In my view, more of a concern is when profits are made by removing rights from the workforce. If private equity firms are able to make large amounts of cash by stripping workers of security and entitlements, that is an unhealthy situation for society, and adds to the perception that British capitalism is working wholly to the advantage of the wealthy and to the disadvantage of the poor. But the minimum wage and other measures to strengthen workers' rights is the way to tackle that - not to favour some kinds of ownership over others.
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duroi    February 23, 2007 1:10 PM
    May I request the Guardian to ensure that all columnists who write about economic issues have passed an Economics 101 exam?
    Even The Sun's agony aunt columnists would blush before writing such drivel as "balance the interests of today's shareholders with tomorrow's shareholders"
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Tzimisces    February 23, 2007 1:21 PM
    Good article- not sure about some of the comments.
    First of all, the point is not about the distinction between private and public limited companies. The point is about private equity companies' behaviour. This is why Tim Worstall's comment is irrelevant. The Scott Trust are not asset- strippers, private equity companies can be.
    Secondly, constructing fantasy pictures about how firms should behave (eleuthera, GJTORY) is bad economics. Managers who own a firm are just as capable of behaving badly if they are effectively in debt to banks or investors. Their incentives are skewed away from long term investment to short- term debt repayment. THis is what is actually happening. Economics has long ago moved away from fantastical, fully informed, hyperrational profit maximisation as an assumption.
    Finally, (GJTORY and eleuthera again), Will Hutton is taking a Social Welfare viewpoint of the economy. He thinks that these companies are behaving pathologically and are harming the economy and overall social welfare. Simply assuming that profit- making is always socially enhancing or that the divide between owners and managers is the only problem is ridiculous.
    Will Hutton has taken a perfectly sound position. Is there any serious criticism out there?
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rightwinggit February 23, 2007 1:47 PM
Why Doesn't WH just come out and say that the only people who should own the means of production are the workers.
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Noah88 February 23, 2007 1:50 PM
If it's so easy, why doesn't the GMB and the TUC run their pension funds as a private equity scheme and earn these magnificent returns for their members?
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emillee    February 23, 2007 2:45 PM
    Will - If you want to have a go at private equity the place to start is those lovely PFI contracts that Brown donors like Sir Richard Cohen are mopping up. Fixed, 30 year investment terms (unheard of) plus tax-free profits.... Basically robbing taxpayer Peter to pay Labour donor Paul. If only I had a look-in, but I'm not a Labour donor so I haven't got a hope in hell.
    As for public companies being more moral and accountable, I just can't see it - if anything the profit motive is stronger because of the increased scrutiny. And there were plenty of excellent posts by other bloggers which you've obviously decided to ignore on that point.
    And the pensions disaster - I think we can partly thank Gordon for plundering the private pensions for that as well.
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chrish    February 23, 2007 2:48 PM
    The success of private equity companies in buying companies from the equity market, selling assets and increasing debt and them selling them back on to the market does raise questions, as to whether the equity market gives eenough emphasis on the quality of a company's earning and assets.
    I do accept that it is not that easy and the post above (eleuthera February 23, 2007 9:46 AM) does provide some reasons why private equity can make money, but the mispricing of companies by the equity market must play some part as well. Valuations are often to geared towards financial ratios such as PE and EV/Ebitda measures rather than more closely examining the company as a whole and hidden assets. The current trend towards sale and lease back of property and other assets is surely a case in point.
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melo February 23, 2007 2:49 PM
So when there are no British companies left and all the work has been outsourced to India and the private equity fund managers have gone to live in a more civilised country abroad (the majority of them being foreign anyway), what will the Government do then?
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mhenri February 23, 2007 3:01 PM
Interesting, and in places not unpersuasive argument. Pity then, that Mr Hutton feels compelled to 'strengthen' it by dragging an entirely irrelevant red herring - that of those wicked and wickedly stupid 'Chinese Communists' who like private equity capitalists don't understand the great benefits of the publicly-owned corporation - across our path. Was Mr Hutton afraid that a discussion of the workings of the City in London wouldn't stand on its own without the Chinese spectre ? He reminds of those politicians who find it necessary to drag the name of Hitler into every discussion of the policies of adversaries.... Henri Offensive? Unsuitable? Email us

mhenri February 23, 2007 3:04 PM
Interesting, and in places not unpersuasive argument. Pity then, that Mr Hutton feels compelled to 'strengthen' it by dragging an entirely irrelevant red herring - that of those wicked and wickedly stupid 'Chinese Communists' who like private equity capitalists don't understand the great benefits of the publicly-owned corporation - across our path. Was Mr Hutton afraid that a discussion of the workings of the City in London wouldn't stand on its own without the Chinese spectre ? He reminds of those politicians who find it necessary to drag the name of Hitler into every discussion of the policies of adversaries.... Henri
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radished    February 23, 2007 3:40 PM
    "Observer and Guardian have far better economic and business writers on their staff (Larry Elliot, William Keegan, Richard Wachman)."
    Nothwithstanding the shoot the messenger criticism Hutton comes in for we should most definitely have more from Larry Eliot
    "Yet, according to Nesta, Britain still seems to be doing just fine and "has one of the strongest economies in Europe". This, says Nesta, is a paradox. If innovation is so important, how come the UK has been growing robustly? Its answer is simple: the data is misleading. "The resolution of this paradox lies in the way in which innovation has typically been measured."
    Well, that might be one explanation. Another might be that growth in Britain has been boosted by a substantial expansion of the public sector. Another might be that a colossal boom in the property market has allowed consumers to borrow against their main asset and so live beyond their means for a prolonged period.
    The lack of rigour in this analysis of Britain's recent macro-economic performance hardly inspires confidence. If the traditional measures of R&D do not really reflect the dynamism and creativity of the UK, why is that over the past 15 years Britain's trade balance has dived deeper and deeper into the red while those countries that score well on R&D and product innovation - Sweden and Finland, for example - run healthy trade surpluses? The suspicion that Nesta, a body funded by the national lottery, is scratching around for some good news only deepens when it lists examples of Britain's hidden innovation. These include creating the National Cycle Network, regulations and incentives to improve social housing, networking among NHS scientists that has resulted in new genetic tests, and "aggressive" tax planning.
    It is clear that if you adopt a liberal enough definition you can describe just about everything as innovation. Within a 10-minute walk of the Guardian there is a barber's shop where the staff -allegedly - offer their male customers extra "services". This, presumably, would be seen as product innovation in Britain's thriving service sector. Most of us would call it prostitution.
    There are some bright spots. A group of executives from Japan's equivalent of the CBI were in town recently and were impressed by London as a centre for design. Some firms, such as Nissan, have already set up design centres in the capital. But some businessmen are concerned about design becoming divorced from manufacturing.
    Writing in the recent journal for the Royal Society for Arts, Ivor Tiefenbrun, who founded Linn Products, a Glasgow-based company making sound systems, said: "What I call design is so closely coupled to manufacturing and so competitive that it cannot survive if the links are too tendentious."
    Mr Tiefenbrun takes a somewhat gloomier view of things than Nesta. "The sad truth is that nobody in Britain has built a major manufacturing company from scratch since the time of the Attlee Labour government in 1945. All our major manufacturers pre-date the second world war. And yet countries that didn't exist, were only partially literate or were engaged in endless conflict 20, 35 or 45 years ago have managed to build major manufacturing businesses from scratch"
    http://business.guardian.co.uk/story/0,,1928870,00.html
    The finance side has done a fantastic job, obviously
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blowme    February 23, 2007 4:11 PM
    Surely the best form of company is one where the owners have the most control - in which case, private trumps public.
    The private equity boom is just another example of the effects of massive amounts of liquidity/cash sloshing about in the global marketplace. In itself, it is not a particularly pernicious force.
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CityBoy2006 February 23, 2007 4:19 PM
Why is the page not updating, haven't see any of the new posts since about 9.30 this morning
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gordong156    February 23, 2007 4:47 PM
    It is interesting that so little of the wealth washing around the UK appears to have been earned through productive labour within the UK.
    Meanwhile debt, in all its forms, grows...     http://www.ablemesh.co.uk/thoughts.html#property
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tommydog    February 23, 2007 5:35 PM
    It is amusing to see the Guardian refer to public companies as a great "Enlightenment give to Western civilization" and then to go on to criticize present shareholders of not living up to their responsibilities. I was unaware there was such sympathy and respect for the management of public firms.
    Mr Hutton says that British law does not require shareholders to take their responsiblities seriously and give management chance to manoeuvre and implement their strategies - shareholders are too focussed on short term gain. I am curious as to what rules Mr. Hutton would like to see imposed.
    The management of public companies do have opportunties to sell their ideas and strategies to the investment community. That's much of what investor relations departments do and what analyst conference calls are all about.
    However, fund managers' responsiblities are to maximize the returns their funds can achieve. Many mutual funds, pension funds, and individual investors do hold their shares for a long time. As long as they feel a shareholding will help accomplish that goal they may hang on to it. Some activist investors may even endeavour to influence management.
    To argue that shareholders have a responsiblity to provide company's with room to manoeuvre is to put them in a conflict of interest position as regards to their responsiblity to achieve (or more accurately "try to achieve") the highest returns possible for their investors.
    Furthermore, sometimes a shareholder might just think that the management's strategy is a crock of bull and that the firm is run by a bunch of Bozos. In Mr. Hutton's world what would be the shareholders' responsiblity under those conditions, especially if others (such as the CEO's mother) disagree with that assessment? At the moment you can simply either sell your shares or possibly try to beat up on the management. Neither action would meet Mr. Hutton's suggestion that management be given room to manoeuvre.
    PE firms are not necessarily buying up well run, highly valued public firms that "are built to last." Such firms firms by being highly valued are, therefore, expensive to acquire and wouldn't offer the potential to make an outsized gain.
    PE often target firms that they believe are not being run particularly well and aren't "sweating" their assets enough. They can give the management a well needed boot in the tail, or even bring in new management. Often they may invest significant amounts of capital. If they succeed they may have built something to last, or at least made it an attractive enough candidate for someone else to acquire once they're done making some "quick fixes."
    Many public companies probably shouldn't be public in any event. With the passage of Sarbanes Oxley in the US the costs of regulatory reporting and compliance increased several fold. Accountants are making a fortune. One may feel that after Enron, etc. this is all well and good, but there are many relatively small firms that are publicly listed. These have seen substantial amounts of their profits gobbled up by increased regulatory burden, reducing the earnings that they might otherwise utilize to implement their grand strategies.
    As a private company they may be perfectly decent, profitable firms, possibly even good acquisition candidates for a larger public firm. But as public firms they are not all that profitable and therefore often not worth much on the public market.
    Mr Hutton and The Guardian have been beating this drum for several weeks, and it seems as though he is mainly upset that someone might make a "life changing" fortune. True enough; someone might. It's possible that someone could also write a book, a song, a software program, or invent a new gizmo that might also result in a life changing fortune. So what?
    Frankly, this dog don't hunt.
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guernica    February 23, 2007 8:11 PM
    There is an Australian Air line QANTAS, derived from Q- eensland And Northern Territory Airways. It is listed on international stock markets. The vultures (private equity) are circling to acquire the company using a technique of public bribery (offering to purchase current shares from stock holders at a premium )which caused the expected rise in the current value of each share. The offer amounts to a premium of 37% increase over the average broker price target of $4.09 / share. The offer is also accompanied by intimidation of current stock holders, by threatening a decline in the stock price if the offer is rejected. This rabid (a term derived from "rabies" a fatal disease, sometimes spread by the bite of a rabid dog) form of capitalism is accelerating homo sapiens to the inevitable abyss of extinction. Bribery, intimidation, corruption and false promises about efficiency - that's private equity. Incidentally, air travel, a major contributor to global warming/greenhouse gases is not discussed in the prospectus. Self-promoting thugs are begging the question "what is wrong with the current board, directors who are responsible for Qantas ?" I'll tell you what: they have accepted what amounts to a huge bribe.
    http://www.airlinepartnersaustralia.com.au
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emillee February 23, 2007 10:36 PM
Will - forgot to mention that other delightful private equity firm Carlyle, which this government has netted over £300m in a few years. And like Brown with Cohen, Blair is set to tidy up very nicely when he leaves office as a result. The whole Nulabour policy of giving taxpayers' money and government wealth to these firms is verging on treason.
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A string of corporate collapses is likely next year as debt-laden private equity deals begin to unravel, a leading firm of accountants said yesterday.
The complexity of the deals and the timing of debt repayments will undermine companies that under previous ownership structures might have survived, said insolvency experts from Ernst & Young.

The firm's analysis of corporate buyouts and potential losses for investors is likely to increase pressure on private equity firms under fire from unions over job cuts.

The government has called on the industry to be more transparent. The purchase of Madame Tussauds by US private equity firm Blackstone this week follows high-profile deals including Permira's buyout of breakdown recovery firm AA from Centrica and Birds Eye from Unilever
The Treasury select committee yesterday launched an inquiry into the private equity industry to review its impact on the economy and various stakeholders. The committee was responding to intense criticism by unions and senior Labour politicians following allegations of profiteering and anti-labour practices.

A report by the Financial Services Authority also prompted the review, the powerful all-party committee said.

Last week the industry said a working group chaired by former Bank of England director and Morgan Stanley banker, Sir David Walker, would examine the need for more disclosure by private equity firms and debt funds set up to buy companies.

The British Private Equity and Venture Capital Association (BVCA), which will publish the results of Sir David's inquiry, welcomed the intervention of the Treasury committee yesterday and said it would be pleased to make representations to MPs.

Private equity deals often involve buying companies with billions of pounds of bank loans and other funding through the international debt markets. Private equity firms often target stock market listed companies that they hope to revamp and re-sell in three to six years.

Unions say they are only able to manage dramatic increases in profits in a short time because they are largely based offshore and avoid corporation tax, avoid tax on much of their debt interest and use anti-labour tactics to drive down wages and other costs. Unions feared that a possible takeover of supermarket chain J Sainsbury by private equity firms would result in cuts to staff terms and conditions.

Fees paid to private equity firms have also attracted criticism. Partners in private equity firms have enjoyed bonuses that in some cases have dwarfed the sums offered by London investment banks, unions said.

Keith McGregor, an insolvency partner at Ernst & Young, said the complex nature of many private equity deals was likely to make them more prone to collapse if they suffered a downturn in sales or increase in costs.

"The quality of the debt has dropped off in the last few years. Debt with a CCC rating has a one in three chance of going bust within two years. But it is the fastest growing element of debt in private equity structures," he said.

He said the situation would worsen next year when a significant increase in costs would begin to hurt companies when they needed to fund the second tranche of their debt repayments. The first level of debt, known as senior debt, is paid back in instalments and lenders have the first call on the company's assets if it should go bust. The second and third tier of debt is typically paid back after four and six years respectively.

"Around 90% of the debt issued in the world is less than three years old. That means tranche two and three are still one and three years away from being repaid. There is no reason why the default rate will go up this year. I don't think it will hit until 2008," Mr McGregor said.

The big deals
Ten years ago a private company would only need to think about its overdraft and bank loans. Depending on the size of the company, the loan might be held by one bank or several. As Ernst & Young partner Alan Hudson describes it, one bank would act as sheriff if there was any problem making repayments. Those uncomplicated days have gone. A company subject to a takeover by a private equity firm will find itself with a layer of debtors, all with different rights and expectations. They might be hedge funds or pension funds. If the company gets into trouble it might find itself negotiating with a gang of distressed debt buyers looking for a quick profit.

When a company fires its first distress signal these creditors may be in line to get 90% of their money back and care little if the whole enterprise goes under.

Other creditors, further down the hierarchy, may want the company to keep trading to give them a chance of recouping losses. Mr Hudson says firms like his have already seen creditors fighting so hard the company is paralysed and eventually broken up.

Finance's more esoteric reaches may not lend themselves naturally to a gag , but some wits in the City are proposing a new definition of the verb "to privatise". No more should it refer to a state-run business being placed in the public stock market, they suggest. Now privatisation means whisking a firm away from the enormous exposure to the light of a public listing and into the hands of a private-equity firm.

Not the stuff of belly laughs, admittedly, but that jokes are being cracked at all is evidence of how private equity has entered the public consciousness. The practice of buying up companies on credit, making them leaner, and then selling them on at a profit has been around for decades, although it has rarely attracted public attention. All that has changed, however, with the sector's own ambitious growth. This explains why unions and thinktanks are on its case this week. Private-equity firms have already bought such names as Madame Tussauds and Birds Eye. Now they are circling over Sainsbury's and Boots. Going after such high-profile names means that private equity is also courting more scrutiny. Yet the industry has been slow to acknowledge this. Perhaps it is simply unused to the exposure. Even the humblest firm listed on the stock market has to report and justify its results at regular intervals. But there is no such requirement on private equity and the dominant attitude often seems to be: never apologise, never explain.
This may be changing. First, the outside world is trying to get a peek inside what is sometimes called "the dark box". MPs on the Treasury select committee have launched an inquiry into the sector. The Work Foundation's report on the industry yesterday shows that life for employees can get markedly worse after a private-equity takeover. Where a new management is simply imposed by the acquiring firm, the report finds, big lay-offs can result, with one in five jobs going within six years. Wages too can fall, leaving workers on average £231 a year worse off than their counterparts in the rest of the private sector.

The bete noire, for critics of the industry is what happened to the AA after it was taken over by two of the industry's giants, Permira and CVC, in the summer of 2004. More than 3,000 jobs - nearly 30% of the workforce - were axed. The GMB trade union also says that it has been derecognised by the AA's owners. GMB is finally to meet Permira this morning. It was only after a large publicity campaign (they took a camel along to one meeting) that the union secured the meeting. But the concession is a welcome one for the entire industry. The sector may be private in name, but that does not mean it should be unaccountable.

suraci    March 27, 2007 8:02 AM
    The AA was decimatd after the take over. The patrolmen are disillusioned and demotivated. I broke down, called the AA out and it took them 4 hours just to get to me, another 7 hours to get my car back to my home, 80 miles away. The attitude of the patrolmen was one of resigned apology, they were sorry for all the inefficiency but this was the neww AA, run with a skeleton patrol force that frequently runs out of driving time in the middle of recoveries and has to ditch the motorist at a service station until another recovery vehicle becomes available.
    Private equity firms are financial rapists. Their mission is to screw over succesful companies, draining out all available profit, not reinvesting it into the company, laying off half the workforce and forcing those left to renegotiate their contracts and work harder or packs their bags.
    All those big bonuses in the city, propping up the housing boom in London along with foreign dirty money, are coming from somewhere.
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kaskasi    March 27, 2007 8:58 AM
    Acquisition preceeding that of the AA by private equity fund managers amply illustrate the socially devastating consequences of their ballooning personal fortunes.
    Is it possible some of those invloved with the AA were also responsible for the 'restructuring' of UK businesses begining with Thorn EMI Kenwood in the late 80's, followed by Clarks the shoe company, and on it went, on it goes.
    The GMB and the press ought to look at the players, and ask what has been their contribution to the common wealth.
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SwissBob    March 27, 2007 12:09 PM
    "The sector may be private in name, but that does not mean it should be unaccountable."
    Accountable to whom? The management of privately owned companies is accountable to the owners, who else should they be accountable to? Neither the public nor the government has any right to know about the internal details of private companies, just like they have no right to know about your own private dealings. Its called freedom.
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firsttimer March 27, 2007 2:52 PM
@SwissBob Every private individual is accountable for their actions - it's called responsibility.
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sedan2    March 27, 2007 4:21 PM
    There's a part of it all I don't understand.
    I borrow billions of pounds to buy up a company, then I sell the company on a few years later at a handsome profit. But what of the debt I incurred to buy the company? Everything that I have read and heard about private equity says that the company is left saddled with the debt.
    How can that be right? If I borrowed to buy a company that's [paid with] my debt surely, so how can I offload the debt on to the company I just bought? Okay it may be legal, but it certainly seems wrong to me. That seems to me to be the root of the whole problem.
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LESS than a decade ago, Stephen A. Schwarzman, the chairman of the Blackstone Group, used to spend his days flying from city to city to drum up money for his private equity funds. “If I could raise $10 million, that was a good day,” he recalled recently.

How times have changed. “Now, someone who doesn’t know you will just come into our office and say, ‘I’d like to give you $200 million,’ ” Mr. Schwarzman told a conference in January.

The shift shows partly how Blackstone has grown in size and reputation. Mr. Schwarzman co-founded the firm in 1985 with $400,000; it now manages more than $78 billion and is planning to go public.

But the change also reflects the deluge of money that has washed over private equity and hedge funds in recent years. The multitrillion-dollar infusion is remaking the deal economy and corporate America, creating a buyout boom not seen since the 1980s, when Michael R. Milken helped takeover artists finance deal after deal with seemingly unlimited cash.

But where is this money storm coming from? How long will it last? Mr. Schwarzman, whose firm recently closed a $39 billion takeover of Equity Office Properties Trust, said at the conference: “You look at these numbers, and they are stunning. It’s like an out-of-body experience.”

Mr. Milken, in a rare interview, recently compared the latest buyout wave with the one he helped set off. “You have substantially more debt than you did 20 years ago,” he said. He noted, however, that debt is far cheaper and may be less risky this time around because interest rates are so much lower.

Nine of the 10 largest leveraged buyouts in history have been announced in the last year and a half. These include the proposed $45 billion buyout of the Texas energy giant TXU; the $33 billion acquisition of the hospital operator HCA; and the proposal on Monday of a $29 billion acquisition of the payment processor First Data.

Much of the capital for these transactions is flowing from institutional investors and pension funds, which have pulled money out of the stock market in search of higher returns. Just as important, though, are the banks that are willing to lend huge sums on friendly terms. These lenders have allowed buyers to leverage their investments with cheap debt to new levels. Hoping to win lucrative business from private equity firms, banks are taking extraordinary steps. Besides loans, some banks are agreeing to provide “equity bridges” — contributions toward the equity portion of a deal — akin to a mortgage lender covering part of a down payment. The banks’ appetite for risk shows little sign of fading, but if it did, the private equity deal machine would lose an important fuel source.

If there is anyone to thank — or blame — for the free-flowing credit, it is Alan Greenspan, the former chairman of the Federal Reserve, who brought interest rates to near-record lows, allowing borrowings to hit record highs. “Low risk-free, long-term rates worldwide seem to be one factor driving investors to reach for higher returns,” Mr. Greenspan said in 2005, when he was chairman. “The search for yield is particularly manifest in the massive inflows of funds to private equity firms and hedge funds.”

All that low-cost credit has allowed private equity firms to leverage their investments, amplifying their buying power to some $1.5 trillion, according to Morgan Stanley. Blue-chip companies that once seemed out of reach are now relatively easy targets for a take-private transaction.

In an odd twist, all the money going to private equity has helped buoy shares of public companies. Nearly every day seems to bring another rumor of a multibillion-dollar buyout opportunity, prompting investors to pile into shares of companies they expect to be acquired.

The speculative investing creates another potential obstacle to the private equity juggernaut because it forces buyout firms to pay even more for companies they take private, which could end up crimping their returns.

The top buyout firms appear to be producing remarkable profits. When Blackstone filed for its initial public offering two weeks ago, it disclosed a 30.8 percent annual rate of return on its private equity funds since 1987, far outpacing the Standard & Poor’s 500-stock index during the same period. (After Blackstone took its fees, the returns were 22.8 percent, much higher than the S.& P., which was about 11.1 percent.)

Some have suggested that the above-market returns enjoyed by Blackstone and other firms are mostly a result of leverage — which can supercharge returns but only by adding risk — as opposed to smart investing by fund managers.

Steven Kaplan, a professor of entrepreneurship and finance at the University of Chicago, has estimated that if similar leverage were applied to investments in the S.& P. 500 index, the returns would exceed those of private equity.

Whatever the reason for their success, these glittering returns are a major reason investors have reallocated more of their money into the industry. Consider one of the larger pension funds, the Employee Retirement System of Texas, which manages $23 billion of state workers’ retirement plans. It has put 7 percent to 8 percent of its funds into private equity investments to help balance its budget.

In some cases, there is a whiff of desperation in pension funds’ leap into private equity. Many funds have fallen behind on their future obligations to workers, so they are plowing money into higher-risk assets to try to close the gap. More than 51 of 64 state pension plans were underfinanced last year, compared with about 25 in 2000, according to a recent report by Wilshire Associates.

Less often acknowledged in the recent deal boom is the role of hedge funds, which have also been raising huge sums from institutional investors and rich individuals. In search of higher returns, these funds have been increasingly buying stakes in companies and then pressuring them to sell themselves, so they can pocket the premium when a buyer emerges.

The result is more companies on the auction block, ripe for acquisition by private equity investors. With so many investors jumping into the private equity game, some are wondering if the buyout business’s best days might be over. “It’s hard to imagine it can get better than it is,” Mr. Schwarzman said to the audience at Wharton School of the University of Pennsylvania in January. “We’re at maximum advantage in all probability right around now.”

1. April 4th, 2007 1:23 pm Brings to mind the high flying investment trusts of the Roaring 20s.
A shareholder in most of the first quality money center banks I’m not happy with risk taking like ““equity bridges” —contributions toward the equity portion of a deal — akin to a mortgage lender covering part of a down payment.” That said I remain convinced following a global bust they’ll pay dividends. Suspect yields would rise to compensate for depressed bank share prices. (Probate to probate blue chip investors sleep very soundly.)
On the hustlings these days meeting lots of ordinary Americans who are really hurting. Today’s Masters of the Universe behave like the French Court before the revolution. Think we are very close to a fundamental rupture of the public’s basic trust in our leadership elites.
— Posted by Mark Klein, M.D.

2. April 4th, 2007 2:05 pm Having been witness to some of the early period of the blackstone group i can remember mr schwarzman as being the least likely to call attention to himself compared with with mr peterson, mr altman, mr engleman, mr stockman et al who all had their gravitational pulls on all that was around them they were each very important people then but a lot has happened to each of them in the last ten years my guess is that today mr schwarzman is more humble than he was back then
— Posted by frank daddario

3. April 8th, 2007 7:52 pm One comment ends on the following:” My guess is that today Mr. Schwartzman is more humble than he was back then” Huh?
Does a humble man invite 1000 nearest and dearest to celebrate his 60th birthday?, does he buy ephemeral art pieces for $800,000.00? Does he pay hundreds of millions for fashionable art instead of donating the money for research, hospitals and schools?
Methinks Mr. Schwartzman behaves more like the Sun King with leveraged money.
As an investors I just hope all this hubris ends well.
— Posted by Freda Neuwirth

4. April 8th, 2007 9:36 pm “my guess is that today mr schwarzman is more humble than he was back then” psychology studies have shown that people become more extroverted when they gain power.
Can someone summarize the basic tenets of the advantage created by private equity investing? My understanding is that basically a private management can implement changes that one serving a board and shareholders can’t. This must translate into plans for longer term increases in profitability that compromise shorter term numbers. Yet, there is an amazing amount of flipping that goes on within private equity.
If Greenspan is responsible for the increase in funding liquidity, why didn’t the boom reach a peak closer to the low in the fed funds rate? Has the spread of activist investing as a “style” changed things? Have pension obligation shortfalls increased precipitously in recent years?
— Posted by Skeptical Investor

5. April 8th, 2007 11:25 pm A hedge-fund collapse is due to occur. 30% returns come with the risk of heavy losses, which investors have overlooked as their portfolios have grown and the downside hasn’t materialized. Amaranth’s bad bet on natural gas was a harbinger of things to come. Once the market manipulations of hedge funds are exposed, for example, the practice of naked short selling to keep stock prices down, major hedge funds will collapse and take their places in history next to the collapse of Drexel Burnham Lambert, the savings and loan crisis, the long-term capital management fund collapse, and the scandals at Enron and Worldcom.
— Posted by Yves Grant

6. April 11th, 2007 9:33 pm I agree that “humble” may not be what comes to mind to describe certain stereotyped individuals but in comparision to the other names based on what i know i do stick to my premise moreover look at what other leaders have produced in the last decade given the resources at their disposal - which were far and away greater than the blackstone group had access to ten or so years ago furthermore it was mr peterson in an interview with charlie rose who stated words to the effect he would NOT hire dubbya to run a company controlled by the blackstone group which is his position he is entitled to but considering when he gave that opinion (immediately before the second election) it could be taken as having significantly more weight additionally mr altman (redacted recusal) and mr stockman (bankruptcy) have found themselves in a mess during the last decade when one comes from ordinary origins and reaches stupendious heights yet sees others with the greater advantages of life going into the game only to crumble, yes i do believe one becomes “humble”
— Posted by frank daddario

THE transactions are big, but Wall Street’s top tier of deal making can seem like a small world. Many of the marquee mergers and buyouts of recent years have been dominated by a relatively short list of players, notably kingpins from private equity and some billionaire financiers, advised by investment bankers, lawyers and other professionals.

Their universe is one of shifting alliances and strange bedfellows, in which professionals on the same team in one deal may be on opposite sides of another fierce bidding war — in a conference room across the hall.

The links have grown as takeover targets have gotten larger, often requiring buyers to band together. Consider last year’s deal for Freescale Semiconductor, in which two consortiums — each of which included four major private equity firms and an armada of advisers — battled to acquire the chip company, which was eventually sold for $17.6 billion.

A result is a six-degrees-of-Henry-Kravis separation (or Stephen Schwarzman), in which much of the community is connected through a dozen or so high-profile deals.

GRAPHIC: Masters of the New UniverseHere is a snapshot of the current deal ecosystem: we played connect-the-dots with 100 deal makers on Wall Street.

Some caveats: Each deal includes many more advisers than are listed, and many significant deals of the last few years are not represented. As a result, many top bankers, lawyers and buyout professionals are not here.

The chart is also selective in the transactions, so that some executives who are connected to only one deal could be connected to more. Because the mergers and acquisitions game has been skewed so heavily toward private equity deals recently, executives like James B. Lee Jr. of J.P. Morgan Chase, who has advised and financed many of the biggest leveraged buyouts, is linked to eight deals; while Felix G. Rohatyn, who has acted as sage on many big mergers over his career, is linked to only one deal. As megadeals keep coming, the ecosystem will also change, creating new connections and power brokers.

1. April 5th, 2007 5:28 pm Wow, what an amazing map of relationships. I knew that the PE industry is connected, but didn’t realize that they are THAT connected!!!
— Posted by Sam Ng

2. April 5th, 2007 6:47 pm Couldn’t believe New York Times will create a specail section, lionising works of Gordon Gekkos of the world. Yeah, couldn’t agree more, you never know, if NYT is bought private one day by a bunch of Mid Age, Mid-East PE folks and dedicate a specail fortnightly supplement dedicated on them.
— Posted by amit agrawal

AS the chiefs of private equity pull off one highflying buyout after another, bankruptcy lawyers are beginning to get their safety nets and first-aid kits ready.

Many Chapter 11 casualties are expected to come from the dozens of companies that have been taken private in the last few years in debt-financed transactions. Anticipating that the long lull in corporate bankruptcies may finally be over, law firms are bulking up their bankruptcy and restructuring groups.

Harvey Miller, perhaps the nation’s pre-eminent bankruptcy lawyer, said in March that he would leave the investment bank Greenhill & Company to return to the law firm Weil Gotshal & Manges. Later, four Weil Gotshal bankruptcy partners jumped to Cadwalader, Wickersham & Taft, the counsel to Northwest Airlines in its Chapter 11 case.

Skadden Arps Slate Meagher & Flom, adviser to some of the biggest companies in bankruptcy, including Kmart, Polaroid and US Airways, is also hunting for restructuring talent. J. Gregory Milmoe, a co-head of Skadden’s corporate restructuring group, said he thought a bankruptcy surge was coming soon. “We are hiring people and training them with the expectation that it is going to be happening this year,” he said.

It has been a relatively quiet period for J. Gregory Milmoe of Skadden Arps Slate Meagher & Flom, but he doesn’t expect that to last. He suggested that the ocean of capital that has kept many companies afloat in recent years might begin to dry up. This is especially likely, he said, if investors are rattled by more hedge fund collapses, like the one last year at Amaranth Advisors.

Mr. Milmoe, who led the Skadden team that advised Refco, the commodities broker that collapsed into bankruptcy in October 2005, was asked recently about the next wave of bankruptcies. Following are excerpts from the discussion.

Q. Why has corporate bankruptcy activity been so slow?
A. It’s part of a normal cycle. Over 35 years, give or take, we see high levels of activity every five to seven years with some regularity. The deals most easily charted are the ones that are a function of economic policies: easy money versus tight money. At the moment, we are experiencing a massive amount of available cash, and that cash for investment has been available for two and a half to three years. What we’re predicting is that companies who were bailed out of a difficult situation two or three years ago are now coming up on a situation where they will have gotten in trouble again. Some percentage of those companies will continue to be rescued by available capital. But with others, people will say, “This was a bad investment, and we’re not going to throw more good money after bad.”

Q. When you look at the recent boom in leveraged buyouts, do you think of it as bankruptcy work in the making?
A. During the last cycle there was — or there used to be — a stigma associated with private equity firms’ having their portfolio companies go into bankruptcy. But if you look back at the period from 1999 to about 2002, enough portfolio companies went in that a flippant kind of remark gained some currency: “If at least one of your companies doesn’t go into bankruptcy, you’re not trying hard enough.” The analogy is: “You’re not going to hit home runs unless you strike out.” Of course, I’m a lawyer, and I bill by the 10th of an hour. There are multibillionaires out there who got to be multibillionaires by taking risks, identifying companies that had the wherewithal to load up on leverage and still make wonderful equity returns. Still, you hate to see decisions being made that are not wise.

Q. How has the proliferation of hedge funds affected the bankruptcy business?
A. I think that it’s likely there will be a few more situations like Amaranth. There are so many hedge funds that as those situations come to light, the pools of capital will become a bit more cautious about investing in risky situations. Which would mean that the portfolio companies that were being bailed out at these extremely high-leverage ratios will not be able to be bailed out at those extremely high ratios anymore. Some of them will have to go into bankruptcy and undergo a very painful right-sizing of their business and their capital structure.

Q. How has the new bankruptcy code changed the Chapter 11 process?
A. One of the much-talked-about provisions was a prohibition, except under very strict conditions, of KERPs — key employee retention programs, what we used to call golden parachutes. Reasonable people can debate this as a matter of social policy and business sense, but it is not an easy job to run a troubled or bankrupt company. So to the extent a company has an opportunity to prepare for bankruptcy, what you need to do is plan to have the appropriate people assured, or reassured, that they should stay there and help rather than doing what’s best for their families by getting out while the getting is good. That’s significantly more difficult now under the new program.

Q. What will you do until the bankruptcy wave hits?
A. I personally am enjoying a much more relaxed schedule. I’m speaking at symposia and catching up on scholarship, which I just did not have time to do in the last 14 to 16 months. On a firmwide basis, our group is underutilized and, perhaps counterintuitively, we are actively seeking to expand. Skadden has the luxury of being able to plan and to invest, so we are trying to get terrific lawyers on board and get them trained. We’re running internal seminars on things to think about from a restructuring and bankruptcy perspective. This is really a good thing — because when the onslaught comes, there’s not a lot of time to think.

1.April 12th, 2007 9:41 am Continuing on Greg’s comment re: “not a lot of time to think” it may be important now for fund investors, public company directors, institutional equity and debt holders and other potentially affected parties to re-educated themselves on the laws, processes, tactics/strategies, pitfalls, “lessons learned”, etc. and to think about where their exposures might be on multiple fronts. Not false firedrills but thoughtful, focused reflection/attention. Having been through two rounds of this cycle myself there is some level of updating, familiarity and advanced preparation that can be taken. And there are some do’s/don’ts that should be provided by counsel. Especially: call us first. It may be time to sit down with firms such as Skadden, S&C, DP&W and others who have the talent and experience. And there will be substantial opportunity for those investors who understand (and act on) the Rothschild adage: “buy on bad news and sell on good”.
— Posted by Hank Devine

The International Monetary Fund has issued an unprecedented warning to the private equity industry, saying that a large-scale collapse in the sector is increasingly possible and that many of the major deals currently being mulled could prove a disappointment.

It said that potential problems with the buy-out industry were among the biggest risks facing the global economy in its latest survey of the financial system. The warning comes at a time when the appetite for private equity deals is at an all-time high.

The IMF, which hosts its spring meetings alongside the G7 summit of finance ministers at the end of the week, also warned that the risks to the economy from defaults in the US sub-prime mortgage market had increased. It said that because of these two issues, the chances of a worldwide financial crisis rose over the past six months - though it is not a likely outcome.

However, it is the IMF's warning on private equity that will strike a particular chord in the City, where the industry has become a formidable part of the financial landscape.

In the Global Financial Stability Report, the fund said: "Financial market investors may be giving insufficient weight to downside risks [to private equity deals], assuming that low-risk premia and low volatility are a more permanent feature of the financial market landscape. The situation bears careful attention, especially if a large high-profile deal runs into difficulty, as this could trigger a wider reappraisal of the risks involved."

The size of the industry has increased rapidly in recent years, and it is expected to raise $500bn (£253bn) this year, compared with $430bn in 2006.

But the IMF warned that this is largely because conditions are particularly kind at the moment, with money cheap and the economy strong. If these circumstances deteriorated, it added, "deals that looked promising in a benign environment could suddenly appear much less attractive. It is therefore likely that some private equity deals will fail to live up to expectations."

The private equity phenomenon is not a new one, and it bears some resemblance to the leveraged buy-out craze in the 1980s. But the IMF said: "The recent wave of M&A is exhibiting some worrying symptoms of the past, and has introduced some new risks." These risks are, it said:

• While low interest rates are reducing debt servicing costs, this is encouraging firms to increase their debt burden. "Higher debt levels potentially increase the vulnerability of acquired firms to economic shocks."

• Rising corporate debt levels make it more likely that there will be an increase in defaults.

• The banks financing the deals face the risk that changes in the market after they have committed the money could make the deal unattractive and lose them money. • Private equity firms are providing less of the money themselves, so more is coming from outside investors.

• Anecdotal evidence suggests that the due diligence being performed by some investors may be weakening as the demand for deals takes hold.

Private-equity and hedge-fund executives have found a way to get windfalls before their companies even go public, potentially cushioning their losses if the value of their ownership stakes eventually falls on the open market.

Here is how it works: Wall Street's investment banks loan these private firms significant sums of cash as the companies consider initial public offerings of shares. The loan money then is used to pay fat dividends to top stakeholders, typically
senior executives in the companies, and can be paid down later with IPO proceeds or management fees and the like.

Executives at Apollo Management, which is moving toward a $1.5 billion private sale of 10% of the private-equity firm and considering a public offering later this year, are among those looking to get a dividend, according to people familiar with the
matter. Bankers at J.P. Morgan Chase & Co., which is representing Apollo, have spent recent weeks trying to persuade other Wall Street firms to help provide Apollo with a $1 billion loan, these people say. The loan would be used to fund a pre-offering dividend to Apollo's top executives, including founder Leon Black, who owns about half the company. A spokesman for Apollo declined to comment.

Last year, Fortress Investment Group, the New York money manager that recently became the first U.S. hedge fund to sell shares in an IPO, borrowed $750 million from a consortium of lenders, freeing up $250 million that it put toward a dividend
to five key executives in the process.

Blackstone Group, which announced plans late last month to undertake a roughly $4 billion IPO by selling a 10% stake of the company, is also contemplating a similar dividend, according to people familiar with the matter.

Banks' willingness to lend money for such dividends, even before a company's offering is a sure thing, is a testament to the growing clout of private money managers on Wall Street, where hedge funds and private-equity firms contribute ever-larger portions of firms' investment-banking fees. Securities firms are keen to loan the money, as they hope it will help them
win lucrative underwriting business down the road.

The dividends can have a downside. Investors considering buying the stock of these newly public companies may become leery about the additional debt, say investment bankers, and that could end up lowering the initial price of the shares. If the offering doesn't come together as planned, the money manager may have to pay down the debt with revenue from other sources. A
shelved IPO could also be bad news for the lenders, which may have to wait years to get their money back. And some people say the move by some of Wall Street's shrewdest players to lock in their profits quickly is also a sign these firms may not be a good buy.

"Smart people sell when they think they're overvalued," says Steve Kaplan, a finance professor at the University of Chicago's graduate school of business who teaches private equity. "Here, they can borrow in order to pay themselves a dividend because I'm sure they have management fees locked in for a while, so they're able to pay off the loan. But why they want to do it so quickly and lock it in, suggests that they're overvalued."

Not everyone agrees. While "some investors may balk at the large distributions the principals have given themselves, we note that each of the 5 principals [at Fortress] created this firm from 'scratch' and continue to own a majority of it," Bank of America Corp. research analyst Michael Hecht wrote in a recent research note. He has a "buy" rating on the firm.

These early dividends -- which some money managers consider to be part of the normal cash distributions to their principal players -- are ripped from the traditional private-equity playbook. Companies taken private by firms such as Apollo often
borrow money to pay dividends to their owners before going public again, a way of returning cash immediately to the private-equity firms. On Wall Street, these are sometimes known as a "midnight dividend" because the dividend is often paid out just before the IPO.

Fortress, whose successful offering of approximately $600 million in early February is regarded as a bellwether deal in the money-management industry, paid out hundreds of millions in dividends before its offering. Last June, Fortress borrowed
$750 million from a group of banks that included a number of the underwriters of its eventual IPO, according to people familiar with the matter.

According to regulatory filings, $250 million of the June loan was used to pay out a cash "distribution" that same year to Fortress's five principal shareholders, including Chairman and Chief Executive Wesley Edens. In total, they received about
$600 million more before the offering from other sources. They then paid down $250 million of the June bank loan by using proceeds from the IPO.

Private equity firms are reshaping the American economy to the detriment of workers and local communities, one of the largest trade unions in the US said yesterday after publishing a report into the industry's growing influence.
The almost two million-strong Service Employees International Union said the booming private equity buyout industry had turned back the clock on community involvement and workers' rights. In a dossier documenting private equity deals in the US over recent years, the union highlighted buyouts that it argued left companies "hollowed out" or even bankrupt. Others saw gains that were paid exclusively to the new private equity owners.

Claims that the private equity industry created jobs and boosted the economy were unfounded, said the union, pointing out that there was little quantitative research in the US to support the view. It said the only detailed study was carried out in Britain and while it showed that buyouts increased the number of jobs in 60% of cases after six years, almost all workers suffered cuts in pay. The union, has launched a website, BehindtheBuyouts.org, to act as a forum for information on the private equity industry.
Private equity deals could work in the interests of all parties, its report said, pointing to one example of a buyout where workers were consulted and included in profit sharing. This example had rarely been repeated, the union said.

The report gave the example of the £150m buyout of KB Toys in 2000 by Bain Capital, which had loaded the company with "a second mortgage" and debt repayments of such magnitude that it dragged it into insolvency four years later. Meanwhile, Bain, which put £9m of its own funds into the deal, benefited from a £60m debt refinancing in 2002 that was used "to pay Bain and several KB Toys executives a special dividend", the report said.

BANKERS who sit on the supervisory boards of non-financial firms in Germany benefit their bank but not necessarily the company—or so concludes a recent study* for the European Corporate Governance Institute, a [industry-supported] think-tank. The three authors examined the record of 137 German companies and 11 banks between 1994 and 2005, and found that the mere presence of bankers in the boardroom appears to increase a company's debt and diminish its overall performance. But the board-member's bank tends to win merger-and-acquisition business from the firm. It also tends to increase its loans to the firm's competitors—perhaps thanks to the expertise in the industry the banker gained while serving on the board.

That last finding is perhaps the most surprising. German banks must report all loans over €1.5m ($2.3m) to the Bundesbank, Germany's central bank. When the researchers examined this data, which is normally secret, they discovered that a bank represented on a board in one year tended to lend more to other companies in the same industry the next.

German companies, especially big ones, tend to have at least one banker on their supervisory board. Of the non-financial companies in the DAX 30 stock index only four do not. Of the companies examined in the study, 46% had a banker on the board, compared with 32% for equivalent firms in America.

Why is this practice so widespread? To some extent it is a hangover from the days when banks owned stakes in many German firms. As recently as 1994 they owned an average of 4% of all non-financial firms. But after 2002, when the government exempted the sale of these stakes from capital-gains tax, the banks sold out. By 2005 they held a mere 0.4%. That may have skewed the interests of bankers on boards away from improving the firm's profits and towards peddling their services—to rivals if need be.

In more than a decade of buying into down-and-out companies across three continents, Cerberus Capital Management has applied a similar strategy to most of its targets: cut, cut and cut some more.

Now Chrysler is set to join a list of acquisitions that includes long-haul trucker Fruehauf, Air Canada and lingerie maker Frederick's of Hollywood. Many of those companies have experienced turnarounds under Cerberus's slashing ways, but not without pain.

New York's Cerberus bought more than 600 struggling Albertsons supermarkets last year and laid off nearly 1,000 workers within months. Last fall, the firm bought the on-the-brink Blue Bird school bus manufacturer; earlier this month, Cerberus closed its Canadian bus plant and let go 130 workers. Cerberus bought a North Carolina textile company out of bankruptcy in 2004 and closed two mills within the year. It bought the Alamo and National car rental chains out of bankruptcy in 2004 and moved them from high-rent South Florida to more-affordable Tulsa.

Cerberus's sharp-toothed ways may be inspired by its namesake: Cerberus was the three-headed canine guardian of the gates of Hades in Greek mythology.

Cerberus the company maintains an even lower profile than its rivals, such as Providence Equity Partners, Blackstone Group and Washington's Carlyle Group. Cerberus has $25 billion under management and in funds and accounts. With just 200 of its own employees, Cerberus owns or has pieces of about 50 companies with more than 175,000 employees and a combined annual revenue of $60 billion, the company says.

The firm is run by financier Stephen Feinberg, who was a trader at Drexel Burnham Lambert in the 1980s, when the firm popularized the use of "junk bonds" for corporate takeovers. Former Treasury secretary John W. Snow was named chairman of Cerberus in October. Former vice president Dan Quayle is on the board.

Cerberus distinguishes itself from other private-equity firms by maintaining a staff of in-house operations executives. Meaning: When it takes over a company, it often doesn't have to recruit a new chief executive; it puts one of its own in place.

"This is a bit of an unusual transaction for them in that it does now make them very, very public," said Boston University law professor Charles Whitehead, who studies equity firms. "It's like the Japanese buying Pebble Beach -- if you want to get attention, this is the way to do it."

These are flush times for Cerberus and all of private equity. Moneyed investors seeking big payoffs have created an equity pool estimated at $500 billion, up from $8 billion at the beginning of the 1990s, according to the Columbia Business School.

Nearly $400 billion in private-equity transactions have taken place so far this year, nearly doubling the dollar amount by this point last year, Thomson Financial reported.

Investors are attracted to the high returns generated by equity funds. Among Cerberus's investors is the California State Teachers' Retirement System.

Generally, equity money seeks struggling industries where cuts can be made and profits quickly increased. Some firms seek to flip their companies soon after paring them to the bone. Others have a longer-term view, taking their annual guaranteed profit and helping turn around ailing companies.

Cerberus would not comment yesterday on its strategy but appears to be in an automotive buying cycle. Previously, the company passed through a fashion and retail stage by acquiring textile mills, Mervyns discount department store and Frederick's.

Cerberus bought 51 percent of GMAC, General Motors' financing unit, last year, and it owns auto parts maker Peguform Group in Germany and is trying to buy into troubled parts maker Delphi. Now, the buyout firm is set to add an entire automaker to its portfolio.

A look at Cerberus's track record with its previous acquisitions may indicate how it will treat Chrysler and raise the question: Under a Cerberus ownership, will one of Detroit's Big Three remain so, or will it become a substantially smaller automaker, more analogous in size to Mitsubishi than Ford?

Albertsons was a supermarket chain based in Boise, Idaho, that spread throughout the West. Hurt like all supermarket chains by Wal-Mart, the company's sales went flat and profits dropped. Cerberus joined supermarket chain SuperValu to buy 655 Albertsons stores in January 2006 in a $17.4 billion deal.

Cerberus went to work fast. In June 2006, nearly 200 Albertsons warehouse workers were laid off in Northern California. The next month, a number of Albertsons stores ended their costly online grocery-shopping services. In November, Cerberus sold 132 Albertsons in California and Nevada. A year later, Cerberus-owned Albertsons closed nine Colorado stores, laying off 750.

Shoppers have noticed improvements at Cerberus-owned Albertsons in Florida, the St. Petersburg Times reported last month, and the chain has installed efficient new registers, raised some prices and instituted systematic employee training for the first time.

In 2004, Cerberus targeted Mervyns, an underperforming chain owned by Target and squeezed by rivals such as Wal-Mart and Kmart.

Cerberus paid $1.7 billion for 257 Mervyns stores and started cutting. In September 2005, the company said it had decided to concentrate on California, exiting poorer markets in Michigan and Oklahoma. As a result, the company closed 62 stores and laid off 4,800 full- and part-time workers. Four months later, Mervyns pulled out of Washington state, closing 20 stores and letting go 880 full- and part-time workers, and closing stores in Oregon, as well.

Now, Mervyns is trimmed down to 189 stores, including four new stores opened in October in California, Texas and Arizona, the first since the Cerberus acquisition. Cerberus's Vanessa Castagna is chairman of Mervyns' board and said at the time that the company will continue to "expand in our core markets."

It is tempting to look at the dissolution of the ill-starred union of Daimler-Benz and Chrysler and chalk it up to an irreconcilable clash of cultures and question the very tenability of trans-Atlantic mergers. But that would be the wrong lesson.

Not only can such a linkage work, Daimler has succeeded with one before. In 1981 the German concern bought Freightliner — which builds heavy-duty commercial vehicles — and today Daimler, with the help of Freightliner, is the world’s largest truck manufacturer. Automobile mergers can also transcend the divide between luxury vehicles and more functional ones. BMW has been successful with Mini, while Volkswagen has done well with Lamborghini and Bentley.

Daimler spent $36 billion to buy Chrysler and sunk tens of billions more into its North American subsidiary in less than a decade. Yet the private equity firm Cerberus Capital Management had to shell out only $7.4 billion to take it off Daimler’s hands.

An overreliance on large gas guzzlers certainly hurt. And the Mercedes-Benz elites never embraced the mass-market Chrysler sufficiently to truly integrate it. Still, those problems might have been solved. What seemed intractable was the tremendous drag of Chrysler’s legacy costs. The pension and health-care commitments for employees and retirees come to a whopping $18 billion.

This is a role reversal: it is the American free-market system that is supposed to be maneuverable like a snazzy little sports car and the German social welfare state that is supposed to groan under the weight of high costs.

Cerberus will try to lower those costs at the negotiating table with the United Automobile Workers. But policy makers in the United States will also have to confront the increasingly obvious fact that the American health-care morass does not just leave close to 50 million people without insurance, it is a drag on our most important industries.

DaimlerChrysler agreed yesterday to a costly deal with Cerberus Capital Management to undo Daimler's merger with Chrysler, ending a partnership hailed nearly 10 years ago as a model of global cooperation and underscoring the shaky financial state of Detroit auto companies.

The breakup of the Daimler-Chrysler marriage poses fresh uncertainty for Chrysler's 80,000 employees. More than most buyout firms, New York-based Cerberus is noted for targeting underperforming companies or ones in bankruptcy protection -- such as Air Canada and Alamo car rental -- and making quick, deep cuts to workforces and overhead. Cerberus would assume control of 80 percent of the carmaker, and Daimler would retain the remaining 20 percent.

In taking the American icon, Cerberus would lift private-equity investment into the highest ranks yet of the struggling auto industry. The firm agreed to contribute $6.05 billion to Chrysler and pay Daimler $1.35 billion. But through a complicated set of transactions and other considerations, Daimler would be about $1.5 billion, including a $400 million loan to Chrysler, to relieve itself of the American automaker. Daimler paid $36 billion for the company in 1998.

As part of the deal, Daimler also would no longer have the massive $19 billion burden of Chrysler's pension and health liabilities, which were an increasing aggravation to investors.

Despite the uncertainties, United Auto Workers President Ron Gettelfinger endorsed the deal. In a Detroit radio interview, Gettelfinger said he and another senior UAW official made a "last-ditch" appeal to Chrysler Chairman Dieter Zetsche on Saturday to keep Chrysler under the Daimler umbrella. He said Zetsche made it "absolutely clear" that Daimler holding on to Chrysler "was not an option."

Gettelfinger said Zetsche spent an hour and a half with him, going over every consideration that went into the choice of Cerberus and noting the firm's financial commitments to Chrysler. He said the UAW is scheduled to meet with Cerberus on Tuesday to confirm its promises. "I want to make sure the commitments made to us along the way will be kept," Gettelfinger said on "The Paul W. Smith Show" on WJR radio.

He went out of his way to express optimism about the arrangement: "It's time for us to get all of this behind us and move forward to make this company successful for our membership and for the shareholders. . . . In fact, our goal now will be to prove that Daimler made a mistake because we're going to make this thing successful."

John W. Snow, former U.S. Treasury secretary and chairman of Cerberus, also took to the Detroit radio waves yesterday to promote the Chrysler deal.

"We want to be part of restoring Chrysler to the front ranks of the auto industry, where it belongs," Snow said. He promised to maintain good labor relations and to shield Chrysler managers from the scrutiny of Wall Street, giving the automaker room to make a new start. "The great name of Chrysler is coming home," Snow said on Smith's show.

But the question raised throughout the industry yesterday is what a new Chrysler might look like. Aaron Devers, a 46-year-old repairman at Chrysler's Sterling Heights assembly plant, near Detroit, said worker morale was low yesterday. He said plant workers expect more job cuts.

"We already know we are under the hatchet," Devers said. "This particular company has a reputation for that."

Salespeople at a Chrysler-Jeep dealership in Gaithersburg were confused about the deal, according to sales manager Greg Lewis. Late in the day, Chrysler's corporate office sent over a six-page explainer document with 34 questions. Among them: "Why is Cerberus purchasing Chrysler? What does Chrysler have to gain? Who is Cerberus Capital Management?"

Private equity's entrance into the U.S. auto industry is part of the historic changes forced on the automakers by increasingly hard times, said David Cole, chairman of the Center for Automotive Research.

"You just can't escape the fact that we're in a transformational period," Cole said. "The old way is not survivable. Investors, managers and labor all have accepted that big things have to be done."

Among the many factors that led to this milestone was the diminishing clout of organized labor in the auto industry. Labor historian Nelson Lichtenstein of the University of California at Santa Barbara said Gettelfinger -- who once vocally opposed the entrance of private equity into the U.S. auto industry -- had little choice but to go along with the Cerberus purchase because of the UAW's inability to organize foreign automakers in the United States.

"When you can't organize Toyota and other [foreign carmakers], then you're wedded to trying to save Chrysler. It's a bad marriage, and you're stuck with it," he said. "This is only the latest shoe to drop. What we're witnessing, slowly, over many years, is the death of unionism in the American auto industry."

For DaimlerChrysler, the big reward of the deal was getting Cerberus to assume the $19 billion in health-care and retirement costs for Chrysler retirees and their families. Cerberus is expected to ask the union to share those costs when the UAW contract expires in September, if not before.

Officials of both Ford and General Motors have expressed interest in a model adopted last year by Goodyear Tire and Rubber and the United Steelworkers, in which Goodyear agreed to pay the union a lump sum, which the union will invest and use to pay for future health-care costs. The result is that the union, rather than the company, has to cover the cost of inflation.

Chrysler's legacy costs are much larger than Goodyear's, but industry officials said Cerberus, with its deep pockets, would have an easier time dealing with the union than would Chrysler.

Harley Shaiken, a labor economist at the University of California at Berkeley who knows Gettelfinger well, said the UAW may have accepted the Cerberus buyout as inevitable, "but if Cerberus has in mind a strategy of slash and burn, they'll be on a collision course. The UAW and Cerberus have a common interest in a more competitive Chrysler. The key issue is how Chrysler becomes competitive."

The private equity bug that is sweeping through the ranks of British companies shows no sign of abating. Companies previously thought immune are becoming targets and it has claimed its biggest scalp so far with the imminent departure of Alliance Boots from the first FTSE100. In mainland Europe the big names are also being lined up. Carrefour, the number two global retailer, saw its shares climb 2.6% in Paris yesterday on talk of a renewed takeover attempt.

In Germany, the technology giant Siemens may be worth around €80bn (£54.5bn) but it lost its chairman and chief executive in six days last month and there is speculation that it could be prey to a takeover bid from private equity.
But there is one problem - families. Putting aside the enormous premium that any successful bid would have to command, the family of Werner von Siemens, the firm's founder more than 150 years ago, is the biggest single shareholder with 6% of the equity. Peter von Siemens, a great-grandson of the founder, sits on the supervisory board. His control over more than 4% of the voting rights might not prove enough to fend off the rampant corporate raiders in the way the Sainsbury family's 18% holding recently deterred a £9.6bn bid, but it represents a formidable obstacle.

Carrefour has been the subject of bid talk for some time since Colony Capital joined forces with billionaire Bernard Arnault to buy a 9.1% stake through their Blue Capital vehicle. But the Halley family, which owns 13% of the equity and 20% of the voting rights, says it has no plans to sell. The model is repeated throughout Europe where family-owned or family-controlled firms - ranging from Germany's BMW and Haniel to Italy's Benetton - have built up ownership structures that are deterrents against attacks from the "locusts" as the private equity and hedge funds are known in Germany. It is in sharp contrast to the Anglo-Saxon business world, where the Sainsbury family's ability to fight off the raiders is the exception and not the rule.

Listed family firms, in which founders or their relatives retain at least a quarter of the ownership, are outperforming their publicly owned counterparts. In Germany, where three-quarters of firms are in family hands - many of them the famous Mittelstand or medium-sized companies that still employ 70% of the workforce. The Gex-index of such companies, set up by Deutsche Börse in July 2004, has risen more than 20%. "We can look calmly into the future," says Siegfried Dais, deputy chief executive of Bosch, which is 8% owned by the founding family and 92% by a foundation - with voting rights exercised by a trust. The group's ownership structure, he says, enables it to plan for the long term without worrying about short-termist reaction to each quarterly set of results.

Lack of capital or difficulty in obtaining access to capital markets is one reason family-owned or family-controlled firms have turned to listings or even private equity firms to help their growth. This was one of the main reasons behind the 1,000-plus leveraged buyouts in Europe worth an estimated €125.3bn in 2005 - with 57 family-owned firms in France, 37 in Italy, 23 in Spain and 22 in Germany among those sold off.

Another is the tendency, especially strong after the third generation, for family members to fall out over the spoils or to show no interest in the business (or even to spend the family fortune on drugs). In France the 38 members of the Taittinger dynasty, owners of the champagne business, disagreed over how to sell their shares but, in the end, sold out to Starwood Capital for €2.6bn two years ago. In the late 1990s a clan dispute in the Bahlsen cake empire in Germany led to the break-up of the company.

The problems of finding a successor to run the business, according to consultants PwC in Germany, affect 70,000 family firms in Germany each year, with 30,000 forced to close. But others in Europe succeed in handing over the baton from one generation to the next over decades and even centuries, with the Michelin family controlling the 120-year-old tyre-maker even though up to a half of its stock is held by overseas investors, while the Peugeot family owns 45% of the voting rights of the car firm.

In France, where about a quarter of the CAC-40 top firms are family-controlled, even a 12% share in Pernod Ricard can give the founding Ricard family control and, in the case of Danone two years ago, the 0.1% held by chief executive Franck Riboud, son of the founder, was enough to fend off a potentially hostile bid (from Pepsi) only because the "political class" saw this as an assault on a French national citadel.

The barbarians have tended to target smaller fry among family firms and there are some companies which appear impregnable. German carmaker BMW, which is around 46% owned by the Quandt family, has become a byword for cautious long-term planning and strong profitability and is always compared favourably with DaimlerChrysler, owner of arch-competitor Mercedes.

BMW's rival Porsche, which has made Volkswagen immune from hostile takeover by acquiring a 31% stake, is owned by the Porsche and Piech families on a roughly 50/50 split. "They watch each other's every move like hawks. So you can be sure the locusts won't get a look in," says one insider. But Siemens may be the barbarians' biggest coup yet.

Porsche Ferdinand Piech, 70, grandson of Ferdinand Porsche, who designed the Beetle for Hitler. Mr Piech expanded Porsche VW holding.

Carrefour Born 1934, Paul-Louis Halley merged French grocer Promodes with biggest rival, Carrefour, to create world's second largest retailer.

Benetton Luciano Benetton and sister Giuliana launched jumpers' range in 1956. Brothers Gilberto and Carlo joined. Siblings' net worth is $10bn.

     «IF you've been in the [poker] game for 30 minutes and you don't know who the patsy is," said Warren Buffett, "you're the patsy". As the world watches hedge-fund and private-equity managers build up billion dollar fortunes, many people are wondering where all this money is coming from. In short, who is the patsy?
    To a left-wing politician, the answer is obvious: the ordinary worker. Financial speculators and corporate raiders force companies into short-term decisions, which increase share prices by holding down wages, sacking workers or skimping on capital expenditure.
    To a free-market enthusiast, the question might seem misguided. There need be no patsy, because the economy is not a zero-sum game. Private-equity and hedge-fund managers improve economic welfare by allocating capital more efficiently.
But even if such people create wealth, they may create losers too. After all, even though the growth of trade is a blessing all things considered, some people might suffer as it happens. In fact, economic progress hardly ever succeeds in malung some people better off, without also making someone eise worse off.
    Take Peter Wood, the British entrepre-neur who created the Direct Line insur-ance group in the 19805. Telephone-based insurance was undoubtedly more efficient. And British drivers, who saw their premiums slashed, probably did not be-grudge sharing their gains with Mr Wood, who became fabulously wealthy. But the innovation also created losers: the insurance salesmen who used to operate from offices all around the country.
    Private-equity funds profit by arbitraging between private and public markets, exploiting their different attitudes towards debt for example. In 1989, Michael Jensen of the Harvard Business School argued that the owners and managers of quoted companies were doomed to squabble over cashflow. "The pressure on management to waste cash flow through organisational slack or Investment in unsound projects is often irresistible."
    By gearing up companies, private-equity groups withdraw managers' freedom to decide what to do with cashflow. In theory, this maximises the value of the firm. The losers are the shareholders of public companies who miss out on these gains by selling too early. Shareholders are suspicious of too much debt on the balance sheet, perhaps because heavily geared firms have more volatile profits.
    Indeed, shareholders such as pension funds and insurance companies may be the patsies in another way. They are re-allocating assets from public markets to "alternative assets", including private equity. So they end up owning stakes in the same underlying businesses, but paying higher fees for doing so.
    Hedge funds are equally controversial. Arguably, they improve economies in two big ways. They provide liquidity to mar-kets, thanks to their high trading volumes.
     Other things being equal, the more liquid a market, the lower the cost of capital. Second, they act as financial-risk insurers. Just as entrepreneurs are happier to set up businesses if they know they can protect themselves against fire and theft, so they are more willing to establish companies if they can protect themselves against inter-est-rate and currency moves.
    Credit derivatives, for example, allow investors to separate the risk of default from other risks, such as interest-rate movements. Among the beneficiaries are companies that issue investment-grade debt. These firms have traditionally faced interest rates that seem unjustifiably high given their low risk of default. The advent of credit derivatives seems to have forced down these premiums.
    In this case, the patsies are other financial institutions. The big banks have lost out now that companies no longer depend on them to offer hedges on interest-rate and currency movements. The banks can easily cope with the loss, since hedge funds are such huge money-spinners for their prime broking arms.
    The hotshots who run hedge funds also have some skill to offer, academic research suggests. But thanks to performance fees, they keep most of the benefits of their abilities. So the patsies are those investors who pick the below-average managers. The same is probably true in the world of private equity, except that it is easier to spot the best-performing managers in advance. Even so, investors who are desperate to diversify may end up giving money to the poorer performers in the hope they will improve.
    When they contemplate their portfolios in a few years' time, such investors may regret their decisions. But at least they can bask in the knowledge that the global economy is the better for their folly

Nicht immer agieren hochrangige Exponenten einer Branche als klassische Interessenvertreter. Zuweilen durchbricht jemand die sonst geschlossene Front und vertritt als «Freigeist» Ansichten, die nicht im unmittelbaren Eigeninteresse liegen. In diesem Sinne hat der Verwaltungsratspräsident der britischen Private-Equity-Gruppe SVG Capital die tiefen Steuern von Private-Equity-Managern kritisiert. Die Steuersätze seien niedriger als diejenigen einer Putzfrau, hatte er in einem Interview erklärt. Dies sei nicht richtig und er habe noch von niemandem eine klare Rechtfertigung dafür bekommen, sagte Ferguson weiter. Der Private-Equity-Manager bezog sich mit seiner Kritik auf die in Grossbritannien besonders günstige Besteuerung von «carried interest», den Kapitalgewinnen, die die Manager bei ihren Investitionen erwirtschaften. Diese werden nicht zum maximalen Einkommenssteuersatz von 40% versteuert, sondern nur zu 10%. Finanzprofis aus der Private-Equity-Szene oder Hedge-Funds-Manager profitieren von dieser Regelung besonders, da sie in der Regel mit eigenem Kapital hoch in ihren eigenen Vehikeln investiert sind und keinen «normalen» Lohn beziehen bzw. dieser nur einen kleinen Teil ihres Verdienstes ausmacht. Da die Private-Equity-Deals immer grösser werden, steigt auch der Gewinn für die führenden Partner.
Die Kritik von Ferguson, der allerdings auch betonte, das Kind nicht mit dem Bade ausschütten zu wollen, kommt in einer für die Private-Equity-Branche heiklen Zeit. Lange bewegte sich die Branche mehr oder weniger ausserhalb des Radarschirms von Politik und Öffentlichkeit.
Wegen des «privaten» Charakters der Investitio-nen abseits einer Börsenkotierung mit Aktien-gewinnen oder -Verlusten für eine Vielzahl von Anlegern blieb das Interesse gemässigt. Die Übernahmen bzw. die Übernahmeversuche von Grossunternehmen mit mehreren zehntausend Angestellten wie Boots und Sainsbury haben dies jedoch geändert. Angesichts der neuen Grössen-ordnungen wird von den Private-Equity-lnvesto-ren mehr Rechenschaft gefordert. Sich der Öf-fentlichkeit einfach über den Rückzug in die «Pri-vatsphäre» zu entziehen, entspreche nicht mehr der gesellschaftlichen Bedeutung, die die Investo-rengruppe mittlerweile erlangt habe.
Die Rolle, die Private Equity in Grossbritannien einnimnit, wird damit zunehmend zum Gegenstand der Politik. Der parlamentarische Wirtschaftsausschuss hat für Ende Juni eine Anhörung mit hochrangigen Private-Equity-Vertretern anberaumt. Aufgeboten sind Dämon Buffini, Managing Partner von Permira, und Dominic Murphy von Kohlberg Kravis Roberts, dem Private-Equity-Haus, das unlängst für 10 Mrd. £ die Apotheken- und Drogeriekette Boots gekauft hat. Geladen sind ferner Philip Yea, CEO von 3i, David Blitzer von Blackstone und Robert Easton von Carlyle. Höchstwahrscheinlich stehen das Steuerregime, das regulatorische Umfeld und die Risiken durch die hohe Fremdfinanzierung der Gebote hoch auf der Agenda der Parlamentarier. Die Gewerkschaften haben unlängst kritisiert, dass im britischen Steuerregime Fremdkapital gegenüber Eigenkapital begünstigt wird. Das ist zwar kern spezielles Privileg für Private-Equity-Gesellschaften, sondern gilt für alle Unternehmen. Allerdings profitieren die Finanzinvestoren von dieser Regelung de facto besonders, da sie mit hohen Fremdkapitalanteilen arbeiten.

    Nicholas Ferguson, l'une des sommités du private equity européen, a brisé le tabou au sujet de la fiscalité des gérants alternatifs dans une interview au Financial Times.
    Le président de SVG Capital et fondateur de Permira, un fonds qui pèse 11 milliards d'euros, a estimé «injuste» que les cadres du private equity, grassement payés, «paient moins d'impôt qu'une femme de ménage ou d'autres travailleurs à bas salaires. Je n'ai pas encore en-tendu une explication claire qui justifie cet état de fait», a-t-il déclaré.
    Cet aveu intervient au moment où la Grande-Bretagne s'apprête à modifier les règles fiscales les plus attrayantes au monde pour les gérants alternatifs. Le régime d'exemption britannique permet aux associés de firmes de private equity et de hedge funds enregistrés offshore et conseillés depuis l'Angleterre d'être taxés à seulement 10% de leurs gains. Des syndicats britanniques mènent campagne contre cet avantage fiscal.
    Aux Etats-Unis aussi, où les gérants sont taxés à 15%, des syndicats font pression sur le Congrès pour corriger cette situation. Des membres du Congrès parlent de normaliser leur taxation à 35%. Max Baucus, chef du comité financier du Sénat, envisage depuis début mai une législation modifiant le régime fiscal pour les gérants de private equity et de hedge funds.

    Explaining away nasty stains on the carpet after an office Christmas party is one thing. But Britain's private equity chiefs are going to struggle to tell their cleaners why they pay tax on the "carried interest" in their investment partnerships at a lower rate than those who tidy up after them do on their wages. Private equity, however, is simply adapting to the tax System as it stands and part of the problem with that System is tax reliefs introduced by Cordon Brown, chancellor.
    Nicholas Ferguson, the chairman of SVG Capital and a leading figure in Britain's private equity industry, told the Financial Times "... that a highly paid private equity executive paying less tax than a cleaning lady or other low-paid workers ... can't be right". Few would disagree.
    There are two reasons for such low tax rates: first, Britain taxes the carried interest on a private equity fond as a capital gain and second, capital gains on business assets attract generous tax relief.
    In two separate agreements with thé industry body, in 1987 and again in 2003, Britain's tax authorities agreed that carried interest should be taxed as a capital gain and not as income. This is because thé général partners of a fund usually put up 20 per cent of the capital, though this may only cost a few thousand pounds, even if the fund's value
runs into billions, because limited partners can provide almost ail of their money in the form of loans.
    There is no doubt that, technically speaking, these profits are capital gains. They arise from a capital investment. But because that investment is so small and because private equity partners only get to make it by virtue of their jobs, the question is whether such gains are actually not employment income. It is a question that the Treasury's current inquiry into private equity taxation should revisit.
    The distinction only matters, however, because of generous tax reliefs that can eut capital gains tax on shareholdings by three-quarters. The resuit, for a private equity partner who would normally pay tax at 40 per cent, is an effective rate of just 10 per cent.
    These tax reliefs were supposed to encourage small businesspeople to risk their savings in start-ups. But fiddling with thé tax System ahnost always produces unintended consequences and unintended beneficiar-ies. This taper relief cost £6.3bn in revenue foregone during the last tax year and there is no.w a strong case for limiting its scope.
    Private equity is playing by the rules but those mies are very generous. For now, at the least, buy-out firm partners had better buy their cleaners a nice bunch of flowers.

    ON BOTH sides of the Atlantic private-equity firms have faced all sorts of populist barracking recently for profiting at the expense of workers. The financiers have sidestepped most of these charges with pin-striped aplomb - and rightly so.
The debate has been more about class war than economics. Most of the accusations against the locusts and barbarians
have been false; virtually all the remedies would do more harm than good to an industry that has been remarkably useful, not least when it comes to creating jobs.
    Tax has always been part of this assault. Critics initially focused on the fact that interest payments are tax deductible, but dividends are not. This attack seemed unconvincing: interest deductibility does help highly leveraged firms more than most, but borrowing money is hardly an Option just limited to private-equity ones. Now a new tax-related criticism has emerged - to do with the low taxes that private-equity partners pay on their income. Once again, it comes suspiciously larded in the language of envy (shadowy moneymen are dodging taxes that decent workers pay). But this time the critics have apoint. The rules should be changed.
    The argument centres on one long-established discrepancy - the gentler tax treatment of capital gains than annual income. In America this dates back to the 1920s, and was originally intended to reward small-business owners and entrepreneurs for "sweat equity" - the hard work they put in to building a business from scratch. Now it is benefiting people in private-equity firms (and to a lesser extent hedge funds), who receive a large part of their pay in the form of "carried interest" - usually 20% of investment gains. In America these are taxed at the 15% capital-gains rate, rather than 35% income tax. In Britain the benefits are even more generous. Those who hold an investment for two years can pay 10% on the gains, compared with a 40% rate of income tax.
    In theory, an efficient tax system would tax both income and capital gains at the same rate - and allow people to make their decisions on merit alone. But even if you think capital gains and income should be taxed differently, carried interest looks like income, not equity, and should be treated as such. It is much closer to a performance fee than an equity stake (managers can only gain from the carried interest, which cannot be negative). The obvious analogy is with the share options awarded to company managers, which are taxed as income.
    One worry about closing this loophole is that venture-capital companies and other limited partnerships that focus on start-ups might well find their managers caught in the fallout. On closer inspection, this seems unlikely. Venture capitalism has done much better in America than Britain, although the incentive from carried interest is bigger in the latter. The industry's success clearly depends on other things than tax.
    A bigger danger is that in seeking to fix one relatively small thing politicians will get carried away. Gordon Brown, courting the unions this week on his coronation march to Britain's highest office, talked about ensuring "justice and integrity" in the tax treatment of private equity; one union boss was quick to crow that "the fat cats are losing the argument on tax". London's tabloids are also hunting for tubby felines: a British private-equity investor, Nicholas Ferguson, won approving head-lines on June 4th when he protested that private-equity executives were charged less tax than office cleaners.
    In America the issue is being dealt with more cautiously, partly because of intense lobbying by the venture capitalists who have a much better standing in Congress than private-equity firms do. Even so, two prominent members of the Senate Finance Committee, Max Baucus and Chuck Grassley, met industry executives and academics last month to explore the tax treatment of private-equity fees. Increasingly, American unions are returning to the language of redistributive justice.

Concentrate on the good part of the story
The private-equity industry would do well to heed this populism. It has, on the whole, a good story to teil. As a force for efficiency, the industry is more often a source of investment and new Jobs than a rapacious asset stripper. To work its magic, private equity does not need an unfair tax break, designed for another age and another set of entrepreneurs.
There are lessons too for politicians. When authorities tinker with the tax System to favour some forms of capital over another, the distortions they create usually come at a cost. If you think the tax system is unfair, blame the people who create d it, not the financiers who took advantage of it.

Time is running out on the incredible tax privileges enjoyed by wealthy private equity partners. Thanks to concessions from Gordon Brown, they pay a lower rate than a nurse or a cleaning lady - a state of affairs we have criticised on these pages for months.

The situation is so absurd that City figures including Nicholas Ferguson of SVG Capital and Paul Myners, chairman of Guardian Media Group (the owner of this paper), have spoken out in public. Even the beneficiaries admit they have no defence. As one leading player put it this week, there is a 'valid debate' over tax. Translation: 'We can't quite believe we've got away with this for so long.'

Brown, having inadvertently opened this door, has been reluctant to close it; similarly, he has done nothing about the concessions for wealthy non-domiciles living here. His benign attitude to the rich contrasts with his stinginess over helping people who have lost their pensions - often when their firms have been taken over by private equity, as we report on pages 4-5.

But the pressure on Brown to act is becoming irresistible. Tax is one of the issues that will be aired at a series of select committee hearings into private equity starting this week, at which the industry will go head to head with its trade union critics. Damon Buffini of Permira and his peers, who are appearing next week, can expect a mauling.

Their rock-bottom rates of personal tax come courtesy of Brown's brainchild, 'taper relief', which cuts the amount payable on business gains to just 10 per cent on assets held for at least two years. His aim was to encourage entrepreneurs, but it has been the private equity princelings who have gained the most.

The argument in favour of tax leniency is that private equity boosts the economy and that taxing partners more heavily would drive them away. But in any sane world, this tax advantage must be seen for what it is - an unjustifiable perk. It is debatable whether fairer taxation would lead to an exodus. The UK has plenty of other advantages, including open, non-protectionist markets and a hub of world-class expertise in the City - and, despite the squeals from the industry, there is far less hostility to private equity here than in other European countries.

Reduced tax rates for private equity moguls undermine the whole principle of progressive taxation. There is also an argument that their profits are being incorrectly classed as capital gains, since partners invest relatively small stakes. If their returns were reclassified as income, they would be taxed at 40 per cent - the top rate paid by doctors, senior teachers and other professionals.

There is a separate issue around private equity's use of debt to minimise corporate tax bills. All companies are entitled to offset the interest they pay on loans against their tax bills, but private equity reaps the biggest benefit because its deals are structured around heavy borrowing. This strikes many as unjust, but in practice it is hard to tackle. The Treasury could look at limiting the amount of debt eligible for relief, but that would also hit public companies and possibly inhibit their investment plans.

Drawing attention to the tax arcana surrounding private equity is not a question of resenting the wealthy. Either billions in foregone tax have to be recouped from the rest of us, or there will be less available for public spending.

Two Treasury reviews are under way, one into the personal tax rules and one into private equity debt, which may be published with the pre-Budget report later in the year. Brown has promised the unions he will ensure fairness in the tax system. While he is at it, he might get a move on with his review into the taxation of non-domiciles, which three civil servants have been working on for the past five years.

Powerful, super-rich and flamboyant, they are revered as the new kings of Wall Street. A rare glimpse at the top ranks of executives in the private equity industry reveals a world of private jets, personal helicopters and take-home earnings running into hundreds of millions of dollars.
One of the most powerful names in private equity, the Blackstone Group, was obliged yesterday to reveal a breakdown of its finances as part of its preparations for a stock market flotation. Though little known to the public, Blackstone has snapped up businesses ranging from Madame Tussauds to Center Parcs holiday camps, Cafe Rouge restaurants and America's biggest office landlord, Equity Office Properties.

Its prospectus reveals that its chief executive, Stephen Schwarzman, enjoyed personal earnings of $398m last year. When Blackstone goes public, he will receive a windfall of at least $449m and he will retain a stake in the business worth $7.7bn.
A colourful figure known in New York for his star-studded parties, Mr Schwarzman, 60, founded Blackstone in 1985 with an investment banking colleague, Peter Peterson, who served as US commerce secretary in the Nixon administration.

Mr Peterson, who is still working at 81, took home $212m last year and will get $1.88bn by selling shares on Blackstone's flotation. A third senior executive, Hamilton James, enjoyed annual income of a $97m and stands to receive $147m.

Blackstone started with $400,000 and now manages funds of $88bn. These funds are used to buy companies, take them away from the glare of the stock market and restructure them. The firms are often returned to the public markets by being sold several years later.

The sheer scale of the wealth amassed by private equity has angered unions. The TUC's general secretary, Brendan Barber, last month warned that the rise of a super-rich class in the industry threatened to "fundamentally change" the nature of British and European capitalism.

In the US, the Service Employees' International Union has hit out at the "extraordinary riches" for a handful of individuals at the top of the industry. It says the money should be shared with workers in businesses acquired by private equity who contribute to the industry's huge returns.

Blackstone in which the Chinese government has a 10% stake, said the money paid to its top people was simply a reflection of the funds they personally staked at the firm's inception: "One of our fundamental philosophies as a privately-owned firm has been to align the interests of our senior managing directors and other key personnel with those of our investors."

A former contemporary of President Bush at Yale university, Mr Schwarzman once remarked that his working schedule never allows him to eat lunch. Blackstone's disclosures reveal that he co-owns a helicopter with Mr Peterson - and that they billed the company $158,500 for its use last year. For longer journeys, they have a part-share in a private jet.

Colin Blaydon, director of the centre for private equity at Dartmouth College, New Hampshire, said Blackstone's success meant that investors - including public employee pension funds and university endowment funds - were sharing the benefit.

"You've got to look at the way these partnerships are structured," he said. "They can only make this kind of money if their investors, who make 80% of the capital gains, are also doing extremely well."

Among the businesses targeted by private equity have been Boots and Sainsbury's in Britain, the casino owner Harrah's in America and the Australian national airline, Qantas.

Experts say the low cost of debt and the strength of corporate cashflow are among the factors helping private equity firms to snap up public companies. Ageing demographics in the US and Europe mean pension funds are increasingly searching for greater long-term returns than those traditionally provided on the stockmarket.

Blackstone and its US rival, Kohlberg Kravis Roberts, are vying for the title of the world's biggest private equity firm. Mr Schwarzman has emerged as the industry's most prominent figure.

He lives in a 35-room Manhattan apartment with his wife Christine, and his 60th birthday party in February featured private performances by Rod Stewart and Pattie LaBelle, an a capella group serenading him with "happy birthday" and a troupe of cadets from New York's Knickerbocker Greys to lead guests - including tycoon Donald Trump and city mayor Michael Bloomberg - to their seats.

Further down the ranks, Blackstone's success has paid off for its management. Vice-chairman Tomlinson Hill got $45m last year and chief financial officer Michael Puglisi received $17m. Seven more executives will have shares worth a combined $380m on flotation.

In political circles, pressure is mounting for greater transparency and taxation of private equity. The Labour-dominated Treasury select committee is due to hold hearings on the issue today.

Eli Talmor, a private equity expert at the London Business School, said the industry's rewards still pale in comparison with the billions earned by top hedge fund managers. "This money isn't really pay for their labour or for their daily involvement," he said. "They're more equivalent to shareholder returns - these partners needed to buy their positions."

He said individuals such as Mr Schwarzman could justifiably claim to offer special skills, although he asked: "Are they 500 times more special than someone who makes a million dollars? Probably not. Is there an element of luck here? Probably. But this is equivalent to establishing a start-up and taking it to stardom."

The backlash against the tremendous wealth being created by managers of hedge funds and private equity funds may be gaining strength. Yesterday, Robert E. Rubin, a former Treasury secretary in President Bill Clinton’s administration, made the case for why private equity and hedge fund managers should pay more than double the low rate in taxes they now enjoy.

Mr. Rubin, now the chairman of the executive committee at Citigroup, was responding to a question posed to him about whether the 20 percent fee on profits that most private equity firms charge should continue to be taxed at the lower capital gains rate of 15 percent or changed to the top ordinary income tax rate of 35 percent. Mr. Rubin, who said he was expressing his own views and not that of his employer, was a panelist at a tax reform conference run by the Hamilton Project, a policy group initiated mostly by moderate Democrats from business and academia that is housed at the Brookings Institution.

“It seems to me what is happening is people are performing a service, managing peoples’ money in a private equity form, and fees for that service would ordinarily be thought of as ordinary income,” Mr. Rubin said. He made clear that he was not a tax expert but said the issue should be looked at “with great seriousness” by the appropriate tax committees in Congress.

The compensation of private equity and hedge fund managers has become a hot button issue as their pay has skyrocketed. James Simons, chairman of Renaissance Technologies, earned $1.7 billion last year while the average compensation of the top 25 managers was $570 million, according to Institutional Investor’s Alpha magazine.

Stephen A. Schwarzman, the co-founder of the Blackstone Group, which is in the process of going public, made $400 million last year. He plans to cash out up to $677.2 million after the initial public offering and will own a stake worth $7.5 billion if the offering is priced in the range the company’s underwriters have planned.

Congress, searching for alternate sources of revenue, has taken notice. A few months ago, staff members of the Senate Finance Committee started to examine taxes on the 20 percent fee on profits, which private equity firms call “carry” and hedge funds call performance fees, as well as other tax issues involving hedge funds and private equity.

Another area of interest to the committee is the ability of hedge fund managers and private equity managers to defer large portions of their income offshore, where it can increase tax free (they pay taxes when they bring it back into the United States). The chairman of the Senate Finance Committee, Max Baucus, Democrat of Montana, recently said the committee was not close to doing anything.

Private equity firms and hedge funds are generally structured as partnerships, which means they have “flow-through” accounting: every owner receives his or her share of the profits and pays taxes on it. No corporate entity is taxed.

Most private equity funds and hedge funds receive two kinds of fees: a 2 percent management fee (2 percent of the assets they manage), and a 20 percent incentive fee, or a 20 percent cut of the profits.

There are crucial differences though. Many hedge funds trade in and out of liquid securities, like stocks, very rapidly, so their gains are taxed as ordinary income (because they do not hold them for more than a year). Private equity funds, by contrast, borrow money to buy companies, strive to improve the company’s operations in the private market and take it public or sell it, generally in five to seven years (though that time has recently been shrinking).

The dispute does not center on whether the income generated by the transaction should be treated as a long-term capital gain, but whether private equity managers, who are not risking significant amounts of their own money, but managing money for others, should get the lower capital gains tax treatment.

Jason Furman, director of the Hamilton Project, framed the issue this way: “Is it an employee doing a service and getting a fee, or is it more like a business owner selling their business at a profit?” (The Hamilton Project is not an advocacy organization and does not have a view).

While the tax treatment of so-called carried interest focuses more directly on private equity managers, many hedge funds are getting more involved in buying and selling more illiquid assets, including companies, which would bring the issue closer to home for them. At the same time, private equity funds and hedge funds are increasingly getting into each other’s business.

So much for the argument often made by managers of hedge funds and mavens of private equity that higher taxes would cripple their business.

The prospect of higher taxes did not dent, in the least, the initial public offering on Friday of the Blackstone Group, the giant private equity firm. The week before, a bill was introduced in the Senate to raise taxes on private equity firms that go public. On the day of the offering, a House bill was introduced that would raise their taxes, whether they’re publicly traded or not.

And yet, Blackstone had a debut that was one of Wall Street’s biggest, its thunder muted only by the announcement by its longtime rival, Kohlberg Kravis Roberts, that it, too, planned to go public.

The bills in Congress take aim at a provision of the tax law that has allowed private equity and hedge fund operators to pay a lower capital-gains tax rate of 15 percent, instead of the ordinary top income-tax rate of 35 percent, on the performance fees that make up the bulk of their huge paychecks.

With income inequality surging along with the need for tax revenue, the bills’ supporters rightly conclude that it is untenable for the most highly paid Americans to enjoy tax rates that are lower than those of all but the lowest-income workers.

Fairness is not the only reason to change the rules. The private equity industry is on shaky ground when it claims that current practice is a correct application of the law.

Many of the firms’ partners are not investing their own money in the various funds and ventures, and so have no direct risk of loss, the general test for claiming capital-gains treatment on one’s earnings. Moreover, the tax rules in question were developed decades ago for enterprises that had passive investors to whom gains were passed along. Hedge fund managers and private equity partners are not passive. They’re actively managing assets, and should be taxed accordingly as managers earning compensation.

The challenge now is to develop a single bill that can withstand the formidable lobbying efforts of the private equity industry to water it down.

To do so, the final bill should clearly apply to other firms where partners may also receive most of their pay as capital gains, such as oil and gas partnerships. It will also be necessary to narrow the bill, where appropriate. For instance, it could include a mechanism to allow some compensation to be taken in a form similar to incentive stock options.

Congress will achieve a significant victory, for fairness and for fiscal responsibility, if it ends the breaks that are skewing the tax code in favor of the most advantaged Americans.

Private Equity» Mit der Übernahme der Hilton-Hotels ist dem US-Finanzinvestor Blackstone gestern eine milliardenschwere Überraschung gelungen. Wer steckt hinte den Private-Equity-Fonds. wiwo.de veröffentlicht die Portraits der Deutschland-Chefs (alle Illustrationen: Bernd Schifferdecker)

Doch ist es nicht das erste Mal, dass eine Private-Equity-Firma Interesse an der Touristik zeigt. Finanzinvestoren und Investmentbanken halten schon seit einiger Zeit Einzug in eine Branche, um die sie lange Zeit einen großen Bogen gemacht haben.

Auch Blackstone ist im Freizeit- und Hotelsektor längst präsent und hat dort offensichtlich positive Erfahrungen etwa mit Hotels von „La Quinta Inns and Suites“ und der Luxusmarke LXR gesammelt. Vor allem in Nordamerika haben Investoren die Hotelbranche entdeckt. Die Investmentbank Morgan Stanley kaufte zu Jahresbeginn für knapp sieben Milliarden Dollar den Immobilienfonds CNL Hotels & Resorts.

Vor wenigen Wochen kündigte der Immobilienfonds Whitehall der Investmentbank Goldman Sachs den Kauf der Hotelkette Equity Inns an. Der kanadische Hotel-Investmentfonds Legacy gilt ebenfalls als attraktives Übernahmeziel für Investoren und hat nach eigenen Angaben bereits mehrere Angebote erhalten. Einen Gruppe um Microsoft-Gründer Bill Gates stieg im Februar beim Luxus-Hotelbetreiber Four Seasons ein.

Gesellschaft: Die britische Gesellschaft ist der älteste Finanzinvestor der Welt. Sie entstand 1945 aus zwei Mittelstandsförderbanken. Der Name steht für „Investors in Industries“. Seit 1984 ist 3i in Deutschland, seit 1994 an der Londoner Börse notiert. 3i engagiert sich in allen Segmenten des Private-Equity-Geschäfts: Venture Capital, Wachstumsfinanzierungen, Buyouts und Infrastruktur.

Person: Stephan Krümmer übernahm das Deutschland-Geschäft Anfang 2005. Vorher führte der Opernliebhaber das deutsche Investmentbanking von Rothschild und arbeitete elf Jahre bei Bertelsmann. Krümmers erste Ehefrau Renate leitet heute das Deutschland-Geschäft des US-Finanzinvestors J.C. Flowers. Der 3i-Chef ist ein exzellenter Skifahrer. Als gebürtiger Hamburger hat er eine Schwäche für den Norden behalten und verbringt seine freie Zeit am liebsten in Hamburg oder auf Sylt. Allianz Capital Partners (ACP) Thomas Pütter

Fondsgröße: ACP ist kein Fonds, sondern eine 100-prozentige Tochter der Allianz und investiert konzerneigene Mittel

Gesellschaft: ACP ist der größte deutsche Investor in Private Equity und profitiert von den Kontakten der Konzernmutter. Die Allianz-Tochter kann aus eigener Kraft Übernahmen bis zu zwei Milliarden Euro stemmen und so als einziger Deutscher im Spiel der Großen mitmengen. Schiffbruch erlitt Pütter mit der Übernahme des Flugzeugbauers Fairchild Dornier und der Bundesdruckerei.

Person: Pütter verbrachte den größten Teil seines Lebens in Großbritannien und ist mit einer Engländerin verheiratet. Erst mit 40 kehrte er für die ACP-Gründung zurück nach Deutschland. Pütter und Cinven-Partner Peter Gangsted sind enge Freunde aus Kindertagen. Ihre Väter arbeiteten für Coca-Cola. Gangsted war bei ACP früher ein Kollege von Pütter. Auch mit dem Gründer des Ven-ture-Fonds Wellington, Rolf Dienst, verbindet den ACP-Chef ein enger Kontakt aus gemeinsamen Zeiten bei der Matuschka-Gruppe, der Mutter aller deutschen Private-Equity-Gesellschaften. Jüngst übernahm Dienst von Pütter den Vorstand beim deutschen Private-Equity-Verband. Pütter hat drei Kinder – und zwei Labrador-Hunde. In seiner Freizeit spielt der frühere Leistungsschwimmer „gerne, aber schlecht Golf“. Außerdem sammelt er gute Weine. Apax Michael Phillips

Fondsgröße: 4,3 Milliarden Euro, der neue 11-Millliarden-Euro-Fonds steht kurz vor dem Abschluss

Firma: Apax gehört zusammen mit Permira zu den Private-Equity-Gesellschaften, die am längsten in Deutschland aktiv sind. Früher engagierte sich Apax bei Startups, heute hat sich die Gesellschaft auf große Buyouts konzentriert. Größte Schlappe für Apax in Deutschland war der gescheiterte Kauf der Bundesdruckerei.

Person: Der gebürtige Kanadier Phillips lebt seit 1989 in Deutschland. Er ist ein großer Eishockeyfan und spielt selber auch in einem Hobbyverein. Er hat vier Kinder, mit denen er von München aus gern zum Skifahren fährt. Bain Capital Ulrich Biffar

Investments: Bavaria Yachtbau, früher Brenntag, ProSieben Sat.1, Treofan, Jack Wolfskin

Gesellschaft: Bain Capital gehört zu den erfolgreichsten Private-Equity-Firmen der Welt. Biffar sagte einmal: „Uns ist nicht bekannt, dass irgendeine andere Beteiligungsgesellschaft auf Dauer höhere Renditen geliefert hätte.“ Nach Informationen der WirtschaftsWoche lagen sie historisch bei über 90 Prozent (WirtschaftsWoche 10/2006). In Deutschland machte Bain jüngst von sich reden, als Biffar mit seinen Münchner Büro-Nachbarn von General Capital die Übernahme des Reifenherstellers Continental plante. Die Aktion scheiterte, weil sich jemand verplapperte – und der Kurs stieg.

Person: Biffar war früher mit der Olympia-Dressur-Reiterin Nadine Capellmann aus der Aachener Reiter-Dynastie verheiratet. Sein Ex-Schwiegervater Kurt Capellmann war nicht nur Reitstall-Besitzer und Chef des Chio-Turniers, sondern auch Inhaber der Aachener Waggonfabrik Talbot. Biffar übernahm Anfang der Neunzigerjahre die Geschäftsführung des Familienunternehmens in fünfter Generation, um den Betrieb 1995 an Bombardier zu verkaufen. Danach ging Biffar zunächst zum britischen Finanzinvestor BC Partners, bevor ihn Bain als Deutschland-Chef holte. Vergangene Woche kaufte Freizeit-Segler Biffar für den Finanzinvestor den Yachtbauer Bavaria. BC Partners Jens Reidel

Gesellschaft: Die Herren von BC Partners sind die Nice Guys im Haifischbecken der Finanzinvestoren. Über das Team um Reidel und seine fünf Partner in Hamburg hört man kaum ein böses Wort. BC Partners gilt als fair, umgänglich und partnerschaftlich, dabei professionell. Einzig der Verkauf des Armaturenherstellers Grohe an die Kollegen von Texas Pacific kratzte am Ruf. Die Gesellschaft überlegt derzeit, in New York das erste Büro außerhalb Europas zu eröffnen.

Person: Reidel ist begeisterter Golf-Spieler (Handicap 21), kommt allerdings nur zu selten dazu. Früher hat er Handball gespielt. Der gebürtige Frankfurter sammelt Kunst der klassischen Moderne – und ist Eintracht-Frankfurt-Fan. Er hat sieben Kinder, die ihn in seiner Freizeit beschäftigen. Damit ist er unter den generell kinderreichen Private-Equity-Managern absolute Spitze. Sein ältester Sohn macht gerade ein Praktikum bei einer Investmentbank, könnte also vielleicht in Vaters Fußstapfen treten. Reidel: „Als ich mit meinem Sohn nach seinem Abitur sechs Tage verreiste, war er sauer auf mich, weil ich so oft telefonieren musste. Aber im Moment arbeitet er mehr als ich.“ Blackstone Thorsten Langheim

Gesellschaft: Blackstone ist der größte börsennotierte Finanzinvestor der Welt. In Deutschland machte Blackstone vor allem mit seiner untypischen 4,5-Prozent-Beteiligung an der Deutschen Telekom von sich reden. Das macht nur Sinn, weil sich der Bund als Großaktionär und Sparringspartner „wie ein Private-Equity-Investor verhält“, sagt ein Insider. Bundesfinanzminister Peer Steinbrück will die Beteiligung nämlich auch innerhalb der nächsten Jahre verkaufen. Als Duo können die beiden viel bewegen: Der Bund hat die Stimmen, Blackstone das Know-how und den Kampfgeist.

Person: Thorsten Langheim ist als Managing Director zwar noch nicht in den erlauchten Partnerkreis von Blackstone aufgenommen worden. Doch als ranghöchster Deutscher koordiniert er die hiesigen Aktivitäten, auch wenn im Telekom-Aufsichtsrat Blackstone-Partner Lawrence Guffey sitzt. Langheim war bei allen Transaktionen in Deutschland mit von der Partie. Er kam 2004 von JP Morgan zu Blackstone und lebt mit seiner Familie in London. Carlyle Gregor Böhm

Gesellschaft: Carlyle gehört in den USA zu den traditionellen Schwergewichten der Branche. In Deutschland kam das Geschäft nur schwer in Gang und liegt von der Größenordnung der Investments unter dem internationalen Niveau der Gesellschaft. Bisher hat Carlyle in Deutschland zwar kein einziges Verlustgeschäft gemacht. Allerdings sind die Erträge durch Restrukturierungen wie bei den Automobilzulieferern Honsel und Edscha hart erarbeitet. Carlyle sucht einen weiteren Managing Director für Deutschland, ist dabei seit dem Abgang von Heiner Rutt Anfang 2006 jedoch nicht erfolgreich.

Person: Seitdem leitet Gregor Böhm als einziger deutscher Partner das Münchner Büro der Carlyle Group. So bleibt es dem eher zurückhaltenden Wirtschaftswissenschaftler nicht erspart, sich gelegentlich auch der Öffentlichkeit zu stellen. Böhm wohnt mit Ehefrau Sabine, einer promovierten Patentanwältin, und seinen drei Töchtern im Münchner Süden. In seiner Freizeit joggt er und fährt als Wahl-Münchner natürlich Ski. Außerdem sammelt er moderne Kunst und interessiert sich für Literatur. Cerberus David Knower

Fondsgröße: nicht bekannt, insgesamt 16,9 Mrd. Euro (22 Mrd. Dollar) verwaltetes Vermögen

Gesellschaft: Im Gegensatz zu vielen anderen Finanzinvestoren schreckt Cerberus vor schwierigen Fällen und Restrukturierungen nicht zurück. Gerade in den vergangenen Monaten machte Cerberus durch die Übernahme des Autobauers Chrysler von sich reden. Auch in Deutschland hat Cerberus noch große Pläne und hat ein Gebot von acht Milliarden Euro für den Ruhrkohlekonzern RAG abgegeben. Cerberus hat es in Deutschland mit einem so Furcht einflößenden Namen nicht leicht und steuert gegen – etwa mit der Förderung von 600 Lehrstellen mit sechs Millionen Euro.

Person: David Knower baut seit Februar 2003 das Frankfurter Büro von Cerberus auf. Vor seiner Zeit bei den Höllenhunden arbeitete er lange bei Procter & Gamble und als Personalberater. Der gebürtige Bostoner lebt schon seit über 20 Jahren in der Nähe von Frankfurt, seit Neuestem Mitten in der Stadt im Westend. Knower war bereits das erste Mal 1978 als Austausch-Schüler in Deutschland, damals in Neustadt an der Weinstraße. Später verbrachte er als Student ein Jahr in Freiburg. Knower hat zwei Kinder und spielt in seiner Freizeit gerne Golf und Fußball. Cinven Peter Gangsted

Investments: Springer Science + Business Media, früher Klöckner Pentaplast, CBR

Gesellschaft: Cinven gehört zu den großen Finanzinvestoren in Europa, ist in Deutschland allerdings relativ zurückhaltend mit Investitionen. Aktuell ist der Fonds lediglich noch zusammen mit Candover an Springer Science + Business Media beteiligt.

Person: Der gebürtige Däne Peter Gangsted gehört mit seiner ruhigen Art zu den Sympathieträgern der Branche und den wenigen mit langjähriger Industrie-Erfahrung. Gangsted war früher 15 Jahre bei Unilever, unter anderem als Deutschland-Chef. Von dort lockte ihn sein Jugendfreund Thomas Pütter zu Allianz Capital Partners (siehe Porträt Pütter). Dort wiederum warb ihn Cinven ab, um das Deutschland-Geschäft aufzubauen. Gangsted ist komplett unprätentiös. Bis vor Kurzem fuhr er entweder mit seinem alten Mercedes oder dem Mountain-Bike durch Bad Homburg. Ende vergangenen Jahres verließ er den Taunusvorort allerdings mit seiner Familie und ging zurück nach London. Das Deutschland-Geschäft übernehmen seitdem offiziell fünf jüngere Geschäftsführer in Frankfurt. CVC Steve Koltes

Gesellschaft: CVC wurde 1981 als Citicorp Venture Capital gegründet. 1993 kauften sich die Partner frei. Der Fonds gehört seitdem kontinuierlich zusammen mit Permira, Apax und BC Partners zu den größten in Europa. CVC genießt einen Top–Ruf, weil es dem britischen Finanzinvestor stets gelang, die Wachstumsversprechen zu erfüllen. Nur ein Börsengang fehlt CVC in Deutschland noch zur Glückseligkeit. Den sollte eigentlich der Energiedienstleister Ista liefern. Doch angesichts des üppigen Gebots des britischen Finanzinvestors Charterhouse wurden die begraben. Dafür trägt sich CVC angesichts des erfolgreichen Blackstone-Börsengangs selber mit Parkett-Plänen.

Person: Deutschland-Chef Steven Koltes ist für das öffentliche Image von CVC in Deutschland ein Glücksfall. Der sympathische Amerikaner spricht fließend deutsch und wickelt mit seiner lockeren Art nicht nur die Öffentlichkeit, sondern auch noch die Gewerkschaften um den Finger. Der sportliche Co-Gründer von CVC lebt mit seiner Frau und den beiden Kindern in der Schweiz – offiziell wegen der Lebensqualität, tatsächlich wohl aber eher wegen der Steuersätze. In seiner Freizeit ist Koltes so oft wie möglich in Bewegung: beim Wandern, Fahrradfahren, Schwimmen, Golfen oder Skifahren. Aber immer mit Telefon am Mann. EQT Marcus Brennecke

Gesellschaft:: Der schwedische Finanzinvestor EQT hat seine Präsenz in Deutschland in den vergangenen Jahren enorm ausgebaut. Zweitgrößter Geldgeber von EQT sind nach der schwedischen Familie Wallenberg die Duisburger Haniels. EQT arbeitet stärker als andere Fonds mit industriellen Ratgebern und macht grundsätzlich keine Club-Deals mit anderen Finanzinvestoren. Mit seinem wachstumsgetriebenen Ansatz hat sich EQT in den vergangenen Jahren einen hervorragenden Ruf in Deutschland erarbeitet.

Person: Wer Marcus Brennecke googelt, könnte meinen, der Mann sitzt kaum im Büro, sondern ständig nur in seinem Segelboot. Brennecke ist mehrfacher deutscher Meister in der Drachen-Klasse. Außerdem soll er eine Schwäche für blonde Frauen haben. Vor zehn Jahren heiratete er die Milliardärstochter Alexandra Flick, mit der er einen Sohn hat. Das Paar lebt seit Jahren getrennt. Inzwischen erwartet Brennecke von seiner neuen Partnerin sein drittes Kind. Der gebürtige Hamburger gehört seit 20 Jahren zusammen mit Emanuel Prinz zu Salm-Salm und Hans Graf zu Rantzau zu den Organisatoren der „Hamburger Nächte“, einer der exklusivsten Partyreihen der feinen Hamburger Gesellschaft. Goldman Sachs Alexander Dibelius

Alter: 46 Jahre (ungefähr, Dibelius macht zu seinem genauen Alter keine Angaben)

Fondsgröße: 6,5 Mrd. Euro, der Nachfolgefonds mit 15 Mrd. Euro (20 Mrd. Dollar) wird derzeit eingesammelt.

Gesellschaft: Goldman Sachs ist nicht nur eine der erfolgreichsten Investmentbanken der Welt, sondern auch einer der größten Investoren im Bereich Private Equity. Beliebt bei den Bankern ist das sogenannte Triple-Play, das dreifache Verdienen an einer Transaktion: Goldman berät Finanzinvestoren bei Übernahmen, finanziert die Deals und beteiligt sich als Co-Investor gerne noch mit eigenem Geld am Unternehmen. Das gelang Deutschland-Chef Alexander Dibelius zum Beispiel bei der Übernahme des Chemieunternehmens Cognis. KKR Johannes Huth

Investments: Kion, ProSieben Sat.1, DSD, früher Zumtobel, MTU Aero Engines, Demag Holding, Wincor Nixdorf

Gesellschaft: KKR ist eine der größten und wohl die bekannteste Private-Equity-Gesellschaft der Welt. In den vergangenen 18 Monaten hat KKR das Tempo seiner Investitionen extrem beschleunigt und kommt in 2007 bisher auf einen Marktanteil von 44 Prozent aller Private-Equity-Deals. Europachef Johannes Huth belegt eindrucksvoll, dass ein US-Fonds auch aus London Geschäfte in Deutschland machen kann.

Person: Johannes Huth lebt mit seiner Frau, einer Iranerin, in London und hat fünf Kinder. Der gebürtige Heidelberger spricht fünf Sprachen; Russisch lernt er gerade – die sechste. Huth ist Harley-Davidson-Fan, fährt gerne Ski und Rennrad. Sein Bruder Martin führt den Finanzinvestor Triton in Frankfurt, einen Investor in mittelgroße Unternehmen. Huth kam 1999 als Quereinsteiger von Investcorp zu KKR. Vorher war er bei Salomon Brothers. Er studierte an der Pariser Sorbonne, der London School of Economics und machte seinen MBA an der Universität von Chicago. Odewald & Cie. Jens Odewald

Gesellschaft: Odewald & Compagnie gehört wie Quadriga Capital zu den größten deutschen Fonds. Gegründet 1997 vom ehemaligen Kaufhof-Chef Jens Odewald hat sich der Fonds zu einem wichtigen Spieler im deutschen Mid-Market entwickelt. Neben Odewald sind der frühere Dresdner-Bank-Vorstand Ernst-Moritz Lipp und der frühere Bertelsmann-Manager Klaus Eierhoff Partner des Fonds.

Person: Odewald hat die Attitüde eines Vorstandschefs noch immer nicht so ganz abgelegt. Die früheren Funktionen als Kaufhof-Vorstand und Verwaltungsratschefs der Treuhandanstalt bleiben wahrscheinlich kaum einem Gesprächspartner verborgen. Odewald übernahm als Kaufhof-Chef den Wettbewerber Horten und kaufte für die Metro die erfolgreichen Saturn-Märkte. Das macht auch bei Mittelständlern Eindruck. Odewald setzt mit seinem Team sehr stark auf Industrieerfahrung und hat sich angesichts der Erfolge die Anerkennung der Branche erarbeitet. Er hat vier Kinder und lebt in Köln. Permira Thomas Krenz

Investments: ProSieben Sat.1, Debitel/Talkline, Cognis, Takko, früher Kiekert, Premiere, Sirona Dental, Rodenstock

Gesellschaft: Permira war eine der ersten Private-Equity-Gesellschaften, die mit Thomas Krenz in Deutschland im großen Stil aktiv war. Die Gesellschaft hat früher spektakulär erfolgreiche Übernahmen in Deutschland gesteuert. Der Ruf hat in den vergangenen Jahren etwas gelitten, unter anderem wegen der Krise beim Automobilzulieferer Kiekert, wo Permira von den Gläubigern aus dem Eigenkapital gedrängt wurde. Auch bei der Einzelhandelskette Takko musste restrukturiert werden. Trotzdem gehören die Permira-Fonds weltweit stets zu den Fonds mit der besten Rendite.

Person: Krenz sagt, sein Hobby sind seine beiden Kinder. Abgesehen davon geht er manchmal Joggen. Da dürfte er angesichts seines Zigarillo-Konsums gelegentlich aber mal kräftig hustend Pause machen müssen. Für mehr bleibt neben seinem Job keine Zeit, sagt der Permira-Chef. Krenz ist berüchtigt für mitternächtliche E-Mails an Mitarbeiter und Dienstleister. Er bezeichnet sich selbst als Adrenalin-Junkie. Quadriga Capital Max Römer

Gesellschaft: Quadriga Capital gehört zusammen mit Odewald & Cie. zu den größten deutsch-stämmigen Fonds. Die Gesellschaft investiert erfolgreich in Mittelständler, Familienunternehmen und kleine Konzern-Spin-offs. Quadriga gelang es auch, einen erfolgreichen Russland-Fonds mit derzeit 140 Millionen Euro aufzulegen.

Person: Römer gehört zu den Urgesteinen der deutschen Private-Equity-Szene. Sein Handwerkszeug lernte er bei CVC. 1995 gründete er mit Partnern Quadriga Capital. Der erste Fonds hatte 100 Millionen Euro, der jüngste 525 Millionen Euro. Quadriga hat in der Vergangenheit rund zur Hälfte Unternehmen aus Familienbesitz gekauft. Das gelingt sicher auch, weil die Quadriga-Herren so bodenständig und vertrauenerweckend auftreten. Römer, ein gebürtiger Westfale, hat zwei Kinder. In seiner Freizeit malt er und schreibt Gedichte, die er auch gemeinsam mit seiner Schwester veröffentlicht. Er hat allerdings auch schon langweiligere Artikel zum Thema Management-Buyouts geschrieben. Terra Firma Guy Hands

Gesellschaft: Terra Firma investiert am liebsten in infrastruktur-nahe Unternehmen, die einen steten Zufluss an Geld versprechen. Mit der Deutschen Annington ist der britische Finanzinvestor der größte Wohnungsbesitzer in Deutschland. Die Autobahnraststätten-Kette Tank & Rast gehört Terra Firma seit 2004, gerade wurde die Hälfte davon wieder verkauft. Hands machte sich unter anderem einen Namen mit innovativen Finanzierungsinstrumenten wie der Verbriefung von Krediten.

Person: Hands liegt das Unternehmertum im Blut. Schon als Kind verkauft er Spielzeug, als Oxford-Student gründete der Hobby-Fotograf eine Galerie. In dieser Zeit lernte der Legastheniker auch seine Frau Julia kennen, die in Cambridge studierte, und zwar bei ihrem gemeinsamen Engagement für die konservative Partei. Trauzeuge der Hands ist der frühere Parteivorsitzende der britischen Konservativen, William Hague. Hands ist einer der wenigen Private-Equity-Pioniere, die auch eine erfolgreiche Frau haben. Julia Hands ist Inhaberin und Geschäftsführerin der Hand Picked Hotels, einer Kette von 14 Edel-Country-Hotels in Großbritannien. Dafür wurde sie 2005 als eine von Englands Top-Unternehmerinnen ausgezeichnet. Das Paar hat vier Kinder und steht mit einem geschätzten Vermögen von 200 Millionen Pfund (rund 300 Millionen Euro) laut „Sunday Times“ auf Platz 351 der reichsten Briten. Texas Pacific Group (TPG) Matthias Calice

Gesellschaft: TPG hat sich den Ruf in Deutschland durch das ruppige und ungeschickte Vorgehen bei Grohe vermasselt. Dabei gehört TPG in den USA zu den erfolgreichsten und angesehensten Private-Equity-Fonds. TPG hat spektakuläre Sanierungen hinbekommen. Unter anderem von der Fluglinie Continental. In Europa hatte TPG-Gründer David Bonderman zum Beispiel früh auf die Billig-Fluglinie Ryanair gesetzt.

Person: Calice lebt mit seiner italienischen Frau und seinen zwei Kindern in London. An Office-Tagen bringt er seine ältere Tochter selber in die Vorschule, und versucht, vor 19.30 Uhr wieder zu Hause zu sein, um die Kinder noch zu sehen. Als gebürtiger Österreicher fährt Calice natürlich leidenschaftlich gerne Ski. In London geht er ersatzweise mit seinem Bruder – einem Investmentbanker – joggen. Außerdem interessiert sich Calice für Kunst.
[05.07.2007] brigitte.haacke@wiwo.de (Frankfurt)
Aus der WirtschaftsWoche 27/2007.
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«Unheimliches Geschäft»
    Doch das ist noch nicht alles: Die Subprime-Hypotheken wurden vielfach mit anderen Schuldscheinen tranchenweise zu Bündeln gepackt und am Markt weiter verkauft. Diese strukturierten Kredite sind nun durch die Subprime-Krise kontaminiert.
    Keiner weiss mit Sicherheit, ob sich das Glimmen nicht zum Brand ausweitet. Die Verunsicherung ist greifbar. So haben die Riskoprämien auf Schuldbriefen in den USA deutlich zugenommen - die Schuldner müssen also mehr dafür bezahlen, dass sie noch jemand finanziert. Diese Bewegung hat mittlerweile sogar Firmenanlei-hen erfasst. Gleichzeitig ziehen immer mehr Anleger Qualität einem hohen Zins vor - ungünstig für die risikoreichen Tranchen in strukturierten Krediten, denn mit schwindender Nachfrage fällt ihr Preis. Kein geringerer als US-Notenbank-Chef Ben Bernanke zeigt sich inzwischen besorgt über ein Übergreifen der Subprime-Turbulenzen auf andere Kreditinstrumente.
    Ivo Felder, Head of Funds-of-Hedge-Funds bei der auf alternative Investments spezialisierten Horizon21,sieht bis jetzt noch keinen «Flächenbrand». Er gibt aber zu bedenken: «Die Möglichkeit besteht, dass das Debakel bei Bear Stearns weitere Kreise zieht.»
    Wie gross diese Kreise sein könnten, steht noch aus. «Das unheimliche am Geschäft mit den strukturierten Krediten ist, dass sie so breit unter die Investoren gestreut sind. Das macht es schwierig, eine Reaktion vorauszusagen», sagt Christophe Grünig, CIO der zur Vontobel-Gruppe gehörenden Hedge-Investorin Harcourt. Tatsächlich sind nicht nur Hedge-Fonds, sondern auch Banken, Versicherer und Pensionskassen in strukturierte Kredite investiert. «In der Schweiz waren viele institutionelle Investoren an dem Marktsegment interessiert», sagt Grünig.

«Respekt vor der Situation»
    Von den grossen Schweizer Hedge-Anbietern will die Mehrheit nicht oder nur zu kleinen Teilen in strukturierte Kredite angelegt haben. Grösser sind dagegen die Hoffnungen. «Der Subprime-Markt ist ein relativ kleines Segment. Daher rechne ich nicht mit einer grösseren Krise, auch nicht für die Hedge-Branche», sagt Steffen Meister, CEO der an der SWX kotierten Partners Group, die alternative Anlagen anbietet.
    Viel hängt jetzt von den Investoren ab. «Für die betroffenen Hedge-Fonds hätte eine Krise bei den strukturierten Krediten im besten Fall Buch- oder Bewertungsverluste zur Folge», sagt Felder von Horizon 21. Schwieriger werde es, wenn die Investoren ihr Geld zurückhaben wollen - denn dies könne einen gefährlichen Domino-Effekt auslösen. «Vor der heutigen Situation sollte man nicht Angst, aber Respekt haben», sagt Felder.
    Damit die Domino-Steine nicht zu fallen beginnen, gehen hiesige Hedge-Anbieter nun aktiv auf ihre Kundschaft zu (siehe Kasten).

FRAGEN STATT FURCHT
Worauf Hegde-Anleger jetzt achten müssen
Information     Anleger sollten jetzt nicht in Panik ihr Geld abziehen, sondern bei ihrem jeweiligen Anbieter nachfragen, wo das anvertraute Vermögen genau investiert sei, sagt Ivo Felder von Horizon 21.
Indizien     Einen möglichen Hinweis auf strukturierte Kredite liefert das Etikett «Fixed Income» innerhalb von Hegde-Investitionen. Solche Produkte sind oftmals in den risikoreicheren Segmenten des Kreditmarkts angelegt. Einzelne dieser Fonds haben aber offenbar von der Subprime-Krise profitiert und in den letzten zwei Monaten bis zu 30% zugelegt. Ebenfalls zu untersuchen sind «Event-Driven»-Strategien. Diese wetten unter anderem auf Kursbewegungen bei Firmenübernahmen, wo heutzutage jeder dritte Deal von Private-Equity-Investoren getätigt wird. Weil Letztere nun Mühe bekunden, am Kreditmarkt ihr Risikokapital zu finden, lässt sich nicht mehr jeder Kauf durchziehen.
Performance     Nach einer Rendite von 8 bis 10% bei Dachfonds seit Januar wird fürs restliche 2007 eine leichte Verlangsamung erwartet.

    Private equity funds have few admirers outside their own circles. Their seemingly ruthless actions in restructuring companies and their oversized profits give them the image of cold-hearted, greedy profiteers. The Left defames them as parasites which, for short-term profit, suck out whatever juice is left in the companies they invest in. For example, when he was chairman of the Social Democratic Party, current German Vice Chancellor Franz Müntefering repeatedly vilified them as swarms of locusts and used them as the prime example in his critique of Anglo-Saxon-style business methods. Tlie ugly face of capitalism, he said, is not a museum piece but very much alive today. That's why we supposedly need the state to intervene in the economy to preserve our welfare.
    In stark contrast to this ideologically distorted view, the track record shows that private equity does much for the public good. Private Equity has raised our wealth in four major ways.
    First, private equity funds are not charities. They buy companies, or at least a significant stake, with the aim of reselling after between five to seven years at a considerably higher price. Their job is to make money for their Investors. Their short time frame puts them under pressure to raise a company's valuation, or net worth, fast. They are, therefore, not passive investors. Instead, private equity funds attempt to exert influence on strategie decisions that will raise the valuation of a company in the short to medium term.
    While their take-no-prisoners attitude in restructuring has not endeared private equity funds to labor unions and politicians, layoffs are usually outweighed by later employment growth. The public view has been distorted since the short term pain of restructuring receives much press, while the ensuing recovery and long-term job gains get short shrift.
    Of course, not all actions taken by private equity funds have turned out to be right. Easy credit has tempted some to
overdo their financial engineering, sail too close to the wind and saddle their portfolio companies with too much debt. Some of these companies have failed, but these are few compared with those that succeeded.
    In a 2006 survey, the consultancy A.T. Kearney found that private equity firms contribute to sustained net job gains and revenue growth in Europe. This is good news for society. The profits earned by the funds when they exit are a reflecüon of
the value they have added. The gain to the overall economy comes in the form of more competitive companies with solid
prospects for growth and jobs.
    Second, private equity offers an alternative new form of corporate finance. Financial innovatiön has allowed private equity funds to earn a high return where conventional finance could not. They have, on more than one occasion, taken over companies that were on the brink of disaster and that nobody eise wanted to touch. When DaimlerChrysler sold off its flailing U.S. unit earlier this year for example, the only interested buyers were a combination of industrial and private equity funds.
Likewise, private equity has elevated many sound companies to new heights. With access to investors' funds and cheap credit, private equity firms can see opportunities which family-owned, closely held companies cannot.
    In Germany, many closely held small and medium-sized companies are short of equity and struggle to finance their growth. Globalization requires taking leaps in investment, not small steps, in order to build new production facilities in other countries, enter new markets, develop new products, or acquire other companies. Since family-owned companies often cannot finance this on their own or through traditional lending channels, private equity funds can provide the fresh money needed for a quantum move. The gain to the economy is obvious.
    Third, private equity recharges entrepreneurship. "Family-owned" also means that the family are the prime source for managerial talent. But there is no guarantee that a great founder's entrepreneurial genes are passed on to subsequent generations; they may have the desire to be boss but not the DNA of a leader. In many private equity takeovers, fresh entrepreneurial spirit has been injected by putting second-tier, non-family managers in charge and giving them an equity stake in the venture as an incentive to perform.
    Finally, private equity transactions have created a wider and more competitive market for buying and selling closely held companies. Before private equity firms came in, a Company that was for sale usually attracted only few potential buyers, typically competitors from the same industry or large companies seeking to expand. With private equity funds, both the number of potential buyers and their purchasing power have increased. Potential buyers and sellers of companies can now find out more and better price information from comparable sales. Valuations are now also much higher than in the past.
    Higher and more transparent valuations benefit all companies. not only those that are under the auspices of private equity. By the same token, a higher valuation imposes higher expectations and discipline on all companies to earn a commensurate return. The economy is elevated to a higher level of efficiency.
    Think about how patents and technological innovation increase the efficiency and growth prospects of the economy. In short, they improve the supply side by allowing companies to offer better products at a lower price and, thus, increase social welfare. Financial innovation such as private equity does the same. If an inventor's patent makes him rich, we applaud. Likewise, we should not resent a financial innovator because of his profit.
    At the end of 1999, the previous German government of Chancellor Gerhard Schröder announced a corporate tax reform that abolished tlie capital gains tax on the sale of corporate subsidiaries äs of 2001. The imintended consequence was to help restructure German corporations and dismantle many corporate cross-holdings. What once was called Deutschland AG, or Germany, Inc., is now history. German industry owes much of its regained competitiveness to this and other supply side moves.
    Private equity has a similar supply side effect. What the capital gains tax reform was for restructuring corporate Germany, private equity may do for closely held companies. As a capitalist tool of our time, it is proof that capitalism does not just enrich investors but improves social welfare as well.

Mr. Prewo is chief executive ofthe Han-nover Chamber of Commerce and is affili-ated with the Center for the New Europe.

Rupert Murdock's successful bid for the Crown jewel of economic and political journalism may change the reputation of private equity deals somewhat - the jury is now out on that one. But even the impressive arguments laid out by Wilfried Prewo in "Private Equity and Public Good" (WSJE, July 26, 2007) may not really stand the test of time if the lead decisions in this and other mergers and acquisitions will not indeed remain inspired and driven by that commanding, yet elusive and thus most often ignored entity called Public Good. To wit:
As a long-time student of Friedrich List, Max Weber and Edgar Salin, I should be less bewildered
than I am by what is happening, both nationally and globally, in the wake of the fall of the Berlin Wall.
I.e. where the unwittingly weakened nation-state - formerly a bulwark against plain-levelling & globalization -
no longer tempers the social, economic and other pitfalls foreseen by Karl Marx, Antonio Gramsci, etc.
Where - as the Laffer & Rider Curves illustrate in the tax & the social fields - excessive poor/rich gradients
are upsetting the delicate social fabric, thus washing away fertility factors with uncontrolled erosive powers.
Where indeed, as Patrick Martin pointed out, monopolistic capitalism and the associated reckless greed
are no longer kept in check by Adam Smith' invisible hand, i.e. by the balance of contradictory interests.
And where the capacity for self-correction is increasingly inhibited by loss of freedom, mooring & orientation
which led to market frenzies & false alpha birds feeding on hype & bubbles, reminiscent of the Roaring 20s.
IMF & FATF estimate black funds (drugs, tax evasion etc) to be 2-5% of world's GDP (2006: $960-2400bn).
An IMF Report indicates these funds to be increasingly chased under anti-terrorism & ever flimsier pretexts.
Helped by the US Secret Service, the world economy has indeed been made hostage of ill-considered rules
which impede more legitimate business than crime. For big time money laundering, the US Treasury set the
standard in 2001 with its 31% confiscatory backup withholding tax on unidentified investors in US securities,
turning foreign bankers from trustees of clients into IRS agents (qualified intermediaries) subject to US laws.
Private equity & hedge funds thus found a government-sponsored access to black funds, while the latters'
entry into subprime markets was also eased by the Internet. Results: predatory lending & systemic risks.
Society's organization needs re-thinking with Plato, Gottlieb Duttweiler, José María Arizmendiarrieta etc.
For man's evolution may only be stressed by technological leaps but not accelerated beyond natural limits.
Also: return on investment rates above productivity gains & organic growth are predatory & not sustainable.
If driven by managers, lawyers & funds on the back of other stakeholders, M&As are thus Ponzi schemes
where shareholder value adepts can maraud with stacked Monopoly cards, helped by micro-economic laws.
Like compulsory social insurance systems whose doom is delayed or obscured only by inflation, war, etc.
And where the cunniest operators are state-supported by myopic magistrates hood-winked into fiscal deals.
Gary J. Aguirre's US Senate testimony details fraud & market mechanics which were at work before 1929,
e.g. Ponzi structures, unregulated pools of money, siphoningfrom unsuspecting mutual fund investors, and
abuse-prone market dominance: hedge funds' $1.5 trillion drive half of the $28 trillion NYSE's daily trading.
Tongue-in-cheek, Warren Buffet famously opined: "derivatives are financial weapons of mass destruction";
yet, under increasing performance & compliance pressures, some bankers still see a future in fee hunting.
Society wised up against churning of accounts by undelicate trustees, but not yet against macro-parasitism
which feasts on ignorance, sucks & devours a firm's life-preserving substance, & weakens society's pillars.
Which turns economic rat races into societal tailspins with early burn-outs & senior citizens being wasted,
& instills values causing youth to be educated out of sync, resulting in drug, violence & €1000 generations.
With profit-driven quarterly thinking & cost-cuttings also eroding due infrastructure maintenance & renewal,
& democracy's promises ridiculed by Fatf, EU & UN bureaucratic lawmaking as if Berlin Wall fell eastward.
So why not thinking things over & “Revisiting Das Kapital while some dance on the Titanic”?. Iconoclast

Dazu schreibt die finnische Zeitung HUFVUDSTADSBLADET:
"Früher führten solche Krisen zu langen Schlangen vor den Banken, wo Kunden in Panik ihre Konten leerten. Heute gibt es Institutionen, die einen finanziellen Kollaps abwenden können. Am Donnerstag leitete die Europäische Zentralbank 95 Milliarden Euro in einen nervösen Geldmarkt, um die Lage zu normalisieren, der größte Betrag dieser Art, der jemals eingesetzt wurde. Die amerikanische und japanische Zentralbank folgten mit etwas kleineren Summen nach. Gestern hat die EZB erneut 61 Milliarden Euro aufgewendet, enorme Summen also. Durch so schwere Geschütze haben die Zentralbanken die Zinsen in einem erträglichen Rahmen und das Bankenwesen am Laufen gehalten. Der Rest besteht nun aus Psychologie. Geht alles gut, herrscht bald wieder Ruhe, denn in Europa besteht kein Anlass zur Panik. Aber der Einsatz derart schwerer Abwehrgeschosse könnte auch das Misstrauen stärken",
gibt das HUFVUDSTADSBLADET aus Helsinki zu bedenken.

Die tschechische Zeitung LIDOVE NOVINY hält es für wichtig,
"dass dass die Lage nicht außer Kontrolle gerät. Bislang scheint das den Zentralbanken zu gelingen. Die tschechische Krone profitiert indes als einzige Währung von der Krise. Sie gilt momentan als eine Art mitteleuropäische Insel der Sicherheit und wird in den nächsten Tagen offenkundig noch weiter anziehen. Aber auch der amerikanische Bankenmarkt ist trotz der jüngsten Erschütterungen letztlich stabil und die Investoren werden sich spätestens in ein paar Wochen wieder beruhigt haben",
ist sich LIDOVE NOVINY aus Prag sicher.

Die spanische Zeitung DIARIO SUR hält fest:
"Die Maßnahmen haben weltweit für Panik gesorgt, nicht zuletzt in Spanien, wo der Kreditmarkt für Immobilien ähnliche Schwächen hat wie in den USA. Der rasche und konzertierte Einsatz der Zentralbanken hat Vorbilder, wenn es um die Bewahrung der Wechselkursstabilität ging. Aber die Ursache war diesmal die Warnung vor einem Kollaps der Kreditmärkte. Die Zentralbanken haben reagiert, aber die Frage ist, wie Gefahren dieser Art künftig reduziert werden können",
kommentiert DIARIO SUR aus Málaga.

Für den britischen INDEPENDENT waren die Turbulenzen absehbar:
"Eine Riesenmenge billigen Geldes schwappte in den vergangenen Jahren dank historisch niedriger Zinsen durch die Märkte. Kreditnehmer wie Kreditgeber waren durch die Fülle von Angeboten in einer Welt, in der Renditen für immer zu steigen schienen, in ihrer Urteilskraft beschränkt. Das Risiko war schlecht eingeschätzt. Zu viele Schulden wurden aufgenommen. Um es kurz zu machen: Die Leute wurden gierig. Die Experten sprachen von einem neuen Paradigma der niedrigen Inflation, des billigen Geldes und des niemals endenden Wachstums. Wenn man solch eine Anmaßung hört, ist es eigentlich an der Zeit, sich Sorgen zu machen",
findet THE INDEPENDENT aus London.

Die ebenfalls in der englischen Haupstadt erscheinende TIMES fordert:
"Die Nutzer des Finanzmarkts müssen ihre Lehren aus dem Geschehen ziehen. Hedge Fonds und andere ähnlich aggressive Investoren haben viel zu den Turbulenzen beigetragen, weil sie sich zu sehr spezialisiert haben, weil sie voller Gier Megagewinne in doppelter Geschwindigkeit erreichen wollten und weil sie sich törichte Summen geliehen haben. Mr. Smith aus Sheffield sollte sich genauso wie der im Steuerparadies beheimatete Hedge Fond daran erinnern, dass nachhaltige Finanzierung mit Risikostreuung, Geduld und dem vernünftigen Umgang mit Schulden einhergeht",
mahnt die TIMES aus Großbritannien.

Die polnische Zeitung RZECZPOSPOLITA hält fest:
"Heute ist schwer vorherzusagen, wie lange sich die Phase der Kursstürze auf den internationalen Finanzmärkten hinziehen wird. Vielleicht haben wir in einigen Wochen schon alles wieder vergessen, vielleicht steht uns aber auch ein längerer Zeitraum der Stagnation bevor. Möglicherweise werden andere Wirtschaftssegmente in den Strudel hineingezogen. Wichtig ist vor allem eines: Wir werden wieder einmal daran erinnert, dass das Risiko ein untrennbares Element des freien Marktes ist",
notiert die RZECZPOSPOLITA aus Warschau.

Nach Auffassung der französischen Zeitung LE MONDE - Zitat:
"ist es das wichtigste Ziel für die EZB und die anderen Zentralbanken, zu verhindern, dass die Finanzkrise sich auf die gesamte Wirtschaft ausweitet. Bis vor kurzem schien die Globalisierung der Finanzmärkte, durch die sich die Risiken auf mehrere Akteure verteilten, als die beste Garantie gegen eine größere Krise. Die kommenden Wochen werden zeigen, ob die Akteure mit dem Feuer gespielt haben oder nicht".
Das war LE MONDE aus Paris.

Der schweizerische TAGES-ANZEIGER führt aus:
"Bislang versuchten uns Experten mit dem Hinweis zu beruhigen, dass die Banken mit Hilfe neuer, ausgefeilter Finanzprodukte wie Derivate in der Lage seien, ihre Kreditrisiken zu portionieren und dann bei Investoren im weiten Universum des Finanzmarktes zu platzieren. Die Kernschmelze in Amerikas Hypo-Markt und dessen Ausläufern rund um den Globus fördern nun die Kehrseite zu Tage: Die ach so praktische 'Feinverteilung' der Risiken ließ die Finanzinstitute bei der Bewertung dieser Risiken zusehends sorgloser werden. Und kaum jemand hat noch einen verlässlichen Überblick, wer die Kreditrisiken letztlich zu tragen hat. Die Finanzmarktaufseher – wie auch die Anleger – stehen vor strapaziösen Zeiten",
prophezeit der TAGES-ANZEIGER aus Zürich.

Die portugiesische Zeitung DIARIO DE NOTICIAS beleuchtet einen anderen Aspekt:
"Einige Analysten weisen auch auf die Notwendigkeit hin, dass die EU, die USA und Japan künftigt verstärkt mit den Finanzbehörden aufstrebender Wirtschaftsmächte wie Brasilien, Russland, Indien oder China zusammenarbeiten. Denn diese haben heute ein deutlich größeres Gewicht als noch vor zehn Jahren".
Das war DIARIO DE NOTICIAS aus Lissabon.

The severe turmoil in the credit markets last week has raised serious questions about the future of the buyout craze that gave rise to the biggest deals in U.S. corporate history.

For the past few years, a group of elite Wall Street players have been buying up major American icons and taking them private. These massive acquisitions have depended on access to cheap credit, which is supplied by a complex relationship between investment banks and hedge funds.

But with credit markets tightening, the pace of these deals, at least in the short run, is expected to dramatically slow. Already-announced multibillion-dollar buyouts, like Tribune Co., Sallie Mae and Hilton Hotels, are likely to be far more complicated to close, analysts said.

If one or two of these big deals were to collapse, it might not send the economy into a downturn. But it would profoundly shake investors' confidence in a financial system already under siege from billions of dollars in losses from home mortgage defaults. That could make it even more difficult for companies and home buyers to get loans.

Private-equity firms, which use big pools of private money to buy companies, generally describe the tightening credit as a temporary setback. But some market watchers are predicting the end of the buyout boom. Either way, both sides say, the private-equity movement is at a crossroads.

"There is a crisis of confidence in the credit markets that is . . . letting a little helium out of the buyout balloon," said Colin Blaydon, director of the Center for Private Equity and Entrepreneurship.

Buyouts are credited with bringing efficiency to industries such as steel and airline parts. But they are also criticized for forcing employees to take on more risk for the success of their companies, as in the case of Tribune. The deals created a new class of powerbrokers, like Stephen A. Schwarzman, who made $400 million last year and holds about a $6.4 billion stake in his company Blackstone Group. But they also enriched universities and pension funds that have been increasingly investing in private-equity funds and helped propel the stock market to new highs.

Fueled by easy-to-get money from the credit markets, buyout shops gained the ability to acquire all but the largest corporations in the past few years. Many companies began to see the benefits of going private -- they could get funding from buyout firms and did not have to deal with the scrutiny that comes from being public.

This year, buyout shops announced $600 billion worth of acquisitions and were on track to set a record, according to Thomson Financial. But in July, the number of deals dropped considerably. And many companies that had agreed to be bought out by private-equity firms are now seeing their shares slump before the deals have been consummated, a Wall Street bet that these agreements will be renegotiated or fall apart.

The stock of Tribune Co. closed Friday 22 percent below the price real estate mogul Samuel Zell agreed to pay in April. Zell is acquiring the media company for $13.2 billion. Shares of Hilton Hotels recently have traded 12 percent below what private-equity giant Blackstone consented to spend in July. It agreed to buy the hotel chain for $26 billion.

One deal that analysts say is particularly vulnerable is the $25 billion acquisition of Sallie Mae. Its stock closed 20 percent below its deal price Friday.

In April, the student loan giant announced that it had agreed to be acquired by buyout firm J.C. Flowers for $25 billion. The deal was hailed as a breakthrough for private equity which had never before been able to acquire a major financial firm. Other financial stocks, such as Bank of America and Student Loan Corp., rose on the news as traders speculated the Sallie acquisition would lead to a frenzy of new buyouts in the financial sector.

Now four months later, the Sallie Mae acquisition is facing difficulties and none of the other deals have happened. On Thursday and Friday, as the market scrambled to cope with the global credit crunch problems, Sallie's share price fell about 3 percent.

One problem with the deal is that it is being funded with $16.5 billion in debt. Borrowing that amount of money was cheaper earlier in the year. But it is far more expensive now because the credit markets are more sensitive to risk and are less willing to issue loans with generous terms and low rates, noted Richard Hofmann, analyst at CreditSights, who has followed the Sallie Mae situation closely.

"We believe [J.C. Flowers] wants to walk away because of what's happening in the credit markets," Hofmann said.

A person who spoke on the condition of anonymity because he is not authorized to speak publicly about the deal said that J.C. Flowers is fighting to back out of the deal or at least lower its price. A J.C. Flowers official declined to comment Friday, while a spokesman for Sallie Mae said the firm expects the buyout to close in October.

As deals stall, the two most powerful players on Wall Street that rode the buyout wave to riches -- investment banks and private-equity firms -- are suddenly locked in a contentious battle over who is going to pay for the mess.

"It's kind of a game of chicken right now," said Greg Peters, chief credit strategist at Morgan Stanley. "There is not a lot of give and take going on, and ultimately that's what you are going to need."

The problem is that large investment banks, including Lehman Brothers, Goldman Sachs, J.P. Morgan and Morgan Stanley, have committed to provide money for private-equity firms to make these deals. They were willing to do this because in the past they could slice and dice these loans into pieces and sell them to hedge funds and other investors around the world, including major financial institutions in Japan, France and Germany.

It was the willingness of these investors to take on these pieces of debt that fueled the era of easy money over the past few years. The risk of lending could be spread across many players. Now, spooked by several big hedge fund collapses and a widening crisis in the mortgage industry, these investors are saying no.

"The whole system is choked up," said a hedge fund manager, who spoke on the condition of anonymity because he did want to endanger deals he has in the works. "The buyers, like us, are saying -- 'Not a chance.' . . . We are getting calls today from banks that have this inventory they want to get rid of. They want to get rid of everything they can, even if they have to take a hit on it."

With hedge funds and other investors refusing to buy such debt, investment banks have to sell them at a severe discount to investors or hold on to them. Keeping the debt can be painful for investment banks because they would have to absorb the losses if the borrowers default. A large inventory of unsold loans also means less revenue for banks. Wall Street banks are currently holding $289 billion in unwanted debt, according to research firm Dealogic.

Alarmed bankers are pushing private-equity firms to scuttle deals or renegotiate prices, which most private-equity firms do not want to do. Such disputes are putting the relationship between these powerful players in jeopardy. Their partnership has been at the heart of the buyout boom and the source of enormous wealth for Wall Street.

No activity has been more profitable to investment banks than private-equity buyouts, which typically provide more than $1 billion in fees every year.

Wall Street insiders acknowledged that the buyout run is being tested. "The process is slowing down because everybody is more cautious," said Donald Marron, chairman and founder of private-equity firm Lightyear Capital. "Everybody wants to think about things a little more."

The buyout boom that saw a handful of investment firms snap up ever larger public companies seems to be fizzling as the debt market used to fuel these takeovers seizes up.

Carlyle Group's David Rubenstein says private equity is no longer too 'private.' David Rubenstein, who co-founded Carlyle Group in 1987, has seen his share of deal cycles. With deals harder to finance, private-equity firms will have to live with their companies for longer now. In an interview with The Wall Street Journal, Mr. Rubenstein struck an optimistic tone despite the challenges facing the industry.

WSJ: How serious a setback for private equity is the turmoil in the debt markets?
Mr. Rubenstein: Cheap debt fooled people. Because financing was so cheap relatively in the past few years, many people think all we do is buy companies with cheap debt, wait a short while and then sell them. But most private-equity firms are about hard work, not just financial engineering.
In the near future, we won't see buyout deals of the size we saw 60 days ago due to the debt-market uncertainty. And available debt will be more expensive. The sellers will have to adjust to lower prices. This is not a calamity. What we have now is just a temporary imbalance of credit. When the debt market returns to equilibrium, a lot of companies will be available and there will be clear bargains. Private-equity firms will continue to buy companies with a bit more expensive debt but also a bit more pricing discipline.

WSJ: But isn't it true that in recent years, financial engineering was a big part of what drove deals? Your partner Bill Conway himself described cheap debt as the "rocket fuel" of this cycle.
Mr. Rubenstein: We got labeled with the financial engineering label because in the early days, the deals were done with only 5% to 7% equity and the companies were highly levered. Today, the average equity is between 32% and 35%. Deals aren't as heavily engineered or have as levered structures.

WSJ: How dramatic is the change in the debt market today?
Mr. Rubenstein: The banks found that providing financing to private-equity firms was very attractive and profitable, so the banks made it easier and easier to accept their financing. They offered us relatively low interest loans. They later said they didn't need "mac" clauses (which give the banks an out if circumstances change). Then they offered us covenant-lite loans and pik toggles (which give borrowers much more flexibility). And then they offered to bridge some of our equity. How could buyers resist taking those terms, knowing the result would be better returns for their investors.
And because of this favorable financing, we could pay a bit more for companies. For the last five years, there was almost no penalty for overpaying by 5-10%, for we were emboldened by these attractive loan features. Now these things are probably a relic of the past, or at least for the next few years. We won't see many covenant-lite or pik toggles. That will no doubt mean more discipline in assessing deals. But private equity can do quite well in this changed environment, as it has in previous times of retrenchment. Prices will return to more normal levels. And that will be quite helpful to the industry.

WSJ: Can you describe the dialogue between the banks and the private-equity firms now?
Mr. Rubenstein: Now there is a Kabuki dance going on among the buyer, the seller and the lenders. Everyone is assessing what to do. Some deals announced in the past 60 days will close as negotiated and some will be renegotiated and some will never close.
Our attitude has been we live with the banks every day. They help us get our deals done. We are not in the business of saying we win and you lose. You create more animosity and you don't live to play the next day. Our attitude is we want everyone to make a profit and we are willing to have discussions to get deals done on sensible terms. You make more friends when you help when there are problems.

WSJ: Are there other sources of capital to tap?
Mr. Rubenstein: Five years ago, a lot of buyers, including [managers of collateralized loan obligations] and hedge funds realized the debt financing buyouts is a good investment. They liked the higher fees and the higher interest rates on [leveraged-buyout] debt. As a result, a great deal of debt money came into the market so there were many sources of capital for debt deals. But at some point, you will see pension funds and sovereign wealth funds, especially those with fixed-income investment departments, come in as sources of debt. It won't happen overnight or dramatically but it will happen.

WSJ: How will private-equity firms evolve in coming years?
Mr. Rubenstein: Private equity is in the process of becoming bifurcated. There are eight to 10 brand names and thousands of other private-equity firms. Most make investments in small firms and do so profitably, but they don't get publicity and they should still be able to raise money. However, the better known private-equity firms will benefit from a flight to quality, for many investors will want to invest in brand-name firms, assuming their returns stay consistent.
You will also see more mergers and acquisitions, especially after some of the private equity go public and have currencies in the form of stock. When investment banks went public, they bought niche firms. Large private-equity firms might do the same, especially when expanding abroad.

WSJ: How is Carlyle itself changing?
Mr. Rubenstein: We are a deeper, more global organization today. We have 425 investment professionals, operating in all continents and in many different investment disciplines. We can clearly add more value than we did in our early years. We also have dozens of individuals who have been CEOs and CFOs at other companies, and they can now add real value through their experience to our portfolio companies. Twenty years ago, we couldn't say that. If the economy slows, our companies and all companies will feel the effects. It will delay returns and slow down exits. We are not magicians. But we are not as vulnerable to downturns as in earlier years.

WSJ: How do you feel about the limelight into which private-equity firms have been thrust?
Mr. Rubenstein: In the current environment, private equity is not so private. We need to deal with Congress, regulators, environmental groups, trade unions, the media and community organizations. It is a complicated shift. Now we recognize that we must explain to other constituencies -- and to the public -- how we add value and why we are productive forces in the national economy and contributors to local communities.

WSJ: Was Blackstone Group's going public a mistake in that it brought attention to the industry and its big profits? What are Carlyle's plans to go public?
Mr. Rubenstein: The private-equity industry was attracting attention for its considerable success and growth in size long before that offering. If we feel it is necessary to be public to be competitive and to maintain our track record, we would look at it. But we are comfortable now with our posture of the last 20 years -- privately owned.

WSJ: What's your prognosis on the Grassley-Baucus bid to raise taxes on private-equity firms?
Mr. Rubenstein: Treating private equity differently will likely bring back the Law of Unintended Consequences -- the same law which gave us the [alternative minimum tax], an earlier effort to produce a tax "fix" on a few. It now covers 50 million Americans.

Wall Street may be facing its worst financial storm in years, but billionaire buyout king Henry Kravis is forging ahead with the biggest deals in U.S. history. Kravis's firm, Kohlberg Kravis Roberts, has made deals for $123 billion in acquisitions this year, more than its three chief rivals combined.

Much as KKR's acquisition of RJR Nabisco came to symbolize the buyout boom of the 1980s, the firm's record $45 billion purchase of Texas utility giant TXU, approved by shareholders last week, exemplifies the freewheeling borrowing that defined the golden age of private equity in the past few years.

Now debt markets are closely watching the latest drama involving KKR -- the attempt to push its massive, debt-laden purchases through the financial system. Wall Street banks need to find investors and hedge funds to back the $36 billion to close the TXU deal, and success is far from certain. If they fail, several analysts said, it could well mark the end of the private-equity frenzy that has transformed the financial world.

"This is probably the high-water mark of the buyout boom of 2007," said Peter Fitzgerald, a former U.S. senator from Illinois whose family has been in the banking industry for decades. "KKR is stretched. The banks that have been backing KKR may be the ones left holding the bag because they have given commitments to fund those buyouts and they have to live up to those commitments."

From his firm's flashy, big-ticket acquisitions to his philanthropy and his status in New York social circles, Kravis, 63, has long played a larger-than-life role on Wall Street.

He practically invented a new sector of Wall Street when he formed his private-equity firm with his cousin George Roberts in 1976. (The other founding partner, Jerome Kohlberg Jr., left KKR in 1987.) He pioneered ways to use massive pools of money to take companies off the stock markets, put them under the control of investors who operate beyond the public eye and sell them later at a profit.

In 1988, KKR stunned the financial world when it agreed to buy RJR Nabisco for a whopping $31.4 billion, even though the junk-bond market, which helped fund buyout deals, was collapsing. The size of the takeover was so extraordinary -- and the burden of the debt KKR took on so immense -- that it became the subject of a best-selling book, "Barbarians at the Gate," which detailed the corporate egos surrounding the deal.

In recent years, KKR has had some notable successes, including a foray into the power business. In 2003, the firm bought privately held ITC Holdings, a power company in Michigan; when it took the company public two years later, KKR made a 500 percent return on its investment.

KKR had required ITC's chief executive, Joe Welch, to put his own money into the company. Welch said he ended up betting his entire life savings. Now he is a millionaire several times over and a believer in KKR. "Of all the people I've ever done business with," Welch said, "the folks at KKR, starting with Henry Kravis, are the most honorable, stick-by-your-word people that I've ever met."

In recent years, KKR has paid more fees to Wall Street banks than any other firm -- about $2 billion since 2000, according to several bankers. Those lucrative fees made bankers eager to help KKR as it reached for ever more expensive and riskier deals.

Now KKR's bankers face their biggest challenge ever -- finding investors for the TXU deal as the credit markets are unraveling.

The Texas utility provides electricity for 2.4 million customers in Texas and has a network of generating stations, including two nuclear-powered and nine coal-fired plants that have been the target of environmentalists.

The private-equity buyers, known more for pursuit of profits than for environmental sensitivity, agreed to several concessions to help sell the deal to the Texas public and regulators. KKR and its partners, Texas Pacific Group and Goldman Sachs, agreed to cancel construction of eight of 11 coal-fired plants that TXU planned to build in Texas, as well as others slated to go up in Pennsylvania and Virginia. The buyout firms also agreed to back federal legislation that would require reductions in carbon dioxide emissions and to spend $80 million a year promoting energy efficiency.

Some experts question whether KKR has overreached with TXU. "KKR has a history of doing courageous deals with large amounts of debt," said James Angel, associate professor of finance at Georgetown University. "But often, investors who have been successful in one investment become overconfident on the next one. Could this be the bridge too far for KKR?"

Others say the deal could work out for everyone involved, though the banks that need to sell the debt to investors are at greater risk.

"I don't think the fundamentals have changed materially on a long-term basis from when KKR struck this deal," said Douglas A. Fischer, an analyst with A.G. Edwards. Fischer said that the shareholders received an appropriate price and that KKR would probably do well in the long run, but added, "It probably is less of a good deal for the banks."

Even the nation's biggest labor unions have a stake in the deal. The AFL-CIO said its pension funds, which serve 55 unions across the country, own TXU stock and invest in KKR funds. The same is true of the California Public Employees' Retirement System, which runs nearly $250 billion in investments. A CalPERS spokesman said the pension fund also will probably buy portions of the debt instruments from the deal.

"It wouldn't be unusual if we had an interest on both sides of this equation," said Clark McKinley, a spokesman for CalPERS. "Because of the size of the fund, with something approaching $250 billion, we are all over the market in every asset class, public equity and private equity." Meanwhile, KKR is moving ahead with its own initial public offering. The firm, which rarely speaks publicly about its own business, declined to comment for this article because of the quiet period that federal regulators impose in the run-up to an IPO.

But according to filings with the Securities and Exchange Commission, a key KKR subsidiary, KKR Financial, is under siege from its investors after making bad bets on securities backed by subprime mortgages. And KKR said in SEC filings that it had received a request for documents from the Justice Department, which is investigating possible anti-competitive behavior among private-equity firms, which frequently team up for acquisitions.

KKR has been locked in contentious negotiations with its banks over how to fund its $26 billion acquisition of First Data, which processes credit card transactions. KKR is trying to raise $14 billion in buyout debt, plus another $8 billion in junk bonds, to fund the transaction. It is the first big test of the markets' appetite for a KKR mega-deal since the credit crunch began, and according to published reports this week, KKR has already made a concession that will make the loans easier for banks to sell to their investors.

The firm also faces other challenges. Congress is considering legislation that would significantly increase the taxes paid by private-equity firms, while the credit crunch is threatening to eat into private-equity profits.

None of this seems to have dampened KKR's appetite for risk. It is raising $2.5 billion in new financing for one of its hedge funds. The fund is promising an "unprecedented opportunity to invest in current corporate credit 'meltdown' and earn estimated gross returns in excess of 20 percent," according to an investor who received one of its brochures.

The fund will seek to buy at a discount the debt that was generated by KKR's own deals -- the same loans that other investors consider too risky to buy.

On Wall Street, buyout professionals are seen as the smart money. But their new shareholders are starting to look like the dumb money.

The gilded realm of private equity — in which moguls use private money to buy stockholder-owned companies — has turned into dross for everyday investors this year. And hedge funds, those secretive investment pools for the rich and, increasingly, the not-so-rich, have been losers for the investing public as well.

The Blackstone Group, the private equity powerhouse lead by Stephen A. Schwarzman, has lost a quarter of its value since it went public in June. Fortress Investment Group, a diversified alternative asset management company, and Och-Ziff Capital Management, a hedge fund run by Daniel Och, a former Goldman Sachs trader, have also stumbled after initial public offerings.

As the financial markets brace for another wave of large losses at Wall Street banks, the outlook for these newly public firms and their as-yet-private brethren has darkened starkly. The tightening credit squeeze has sent the buyout industry into a funk and left some hedge funds with steep losses.

Kohlberg Kravis Roberts & Company, which invented the modern buyout industry, is now struggling to get its own I.P.O. off the ground. AQR Capital Management, a $38 billion hedge fund, has suspended its plans for an offering. Citigroup, which helped take Och-Ziff public in November, recently warned that Och-Ziff is likely to face headwinds for the foreseeable future.

Mr. Schwarzman, by contrast, cashed out in June, a few weeks after he said that public markets were “overrated.” He and his partner, Peter Peterson, sold while business was still booming.

“These are sophisticated investors, and they certainly know how to time their own exits,” said Adam Zoia, managing partner and founder of Glocap, an executive search firm focusing on the alternative asset industry.

Blackstone’s shareholders — among them Fidelity Investments, the mutual fund giant, and the Ohio Public Employees Retirement System — have not been so fortunate. They would have made more money this year investing in an old-fashioned index fund that tracks the S.& P. 500-stock index, which is up 4.24 percent.

For now, Henry Kravis, a founder of K.K.R., is pressing ahead with plans to take it public. But selling stock may not be easy given the turmoil in the financial markets. Deals, and the cheap money that private equity firms have come to depend on to pay for them, have grown increasingly scarce.

After the credit markets became unhinged at midyear, United States merger activity fell 46 percent during the second half, according to Thomson Financial, the research firm. Merger volume in 2007 still hit a record $1.57 trillion in the United States, thanks to all the deal-making early in the year.

Life may not get easier for the buyout crowd any time soon. Weakened by mounting losses on mortgage-related investments, big banks are reluctant to risk capital on leveraged buyouts. Many are still struggling to sell the loans and bonds used to finance previous deals.

According to a recent report by PricewaterhouseCoopers, banks are sitting on about $245 billion of buyout-related debt, a backlog that could take months to clear. The likelihood that rising financing costs will pinch private equity returns, coupled with the possibility that Congress may eliminate a tax loophole enjoyed by buyout funds, adds to the gloom hanging over the industry.

Blackstone’s sinking stock price will not help other alternative investment firms looking to tap stock market investors, said John E. Fitzgibbon, the publisher of IPOScoop.com, an online newsletter. “When the leader of the group goes public and hits the wall, the rest don’t go out the door,” he said.

While many on Wall Street have focused on Blackstone’s slump, several large hedge funds have also disappointed new shareholders. Brevan Howard Asset Management, a British investment firm, raised only $1 billion in an initial public offering in March, half as much as it had hoped. New shares of GLG Partners, one of Europe’s biggest hedge fund managers, and of Third Point Offshore, a public offshoot of the New York hedge fund run by Daniel Loeb, have fallen too.

Despite all the gloom, more private equity and hedge fund firms are likely to go public once the markets stabilize, said Mr. Zoia of Glocap. But these latecomers may have to accept lower valuations, he said. “This is the tip of the iceberg,” he said.

Wall Street, after all, adheres to theory that you can always make money trading in securities, whether they are overvalued or not, because there will always be someone willing to pay more for them than you did. As Mr. Fitzgibbon put it: “What Wall Street is about is smart guys thinking about ways to make money from dumb ones.”

When I sat down for my annual review of what I've written over the past year, something jumped out at me. Usually, I write about widely diversified subjects. But in 2007, I devoted an inordinate number of columns to the shenanigans of leveraged buyout firms and the attempts by the world's central banks to rescue financial markets.

That's an accurate reflection, I think, of how business news played out in 2007. For the first half of the year, the leveraged buyout industry -- which has renamed itself "private equity" -- seemed poised to take over the world, which I knew wouldn't happen. In the second half of the year, problems in the debt markets made it look as if the world was ending, which I knew wasn't happening, either.

The credit market meltdown wasn't exactly a shock to anyone who can count and has a sense of business history. In fact, I devoted most of my 2006 year-end column to predicting the end of the buyout boom. Making that call was like shooting fish in a barrel -- the boom was fueled by ridiculously cheap and abundant credit, which I knew would eventually dry up because it always does. But the boom took longer to end than I thought it would, and the credit crunch is proving nastier and more widespread than I expected.

I wrote four columns that focused on Blackstone Group, the big LBO -- excuse me, private-equity -- house, including three in a row about its initial public offering. (The Washington Post March 20, March 27, and April 3.) It's the first time I've gone the three-peat route since I became a columnist in 1989. But who could resist? The Blackstone deal was so complex and so much fun to dissect, and the firm was being treated with such undeserved reverence. Besides, a giant private-equity firm going public screamed "top-of-the-market" -- which, in fact, it was.

Then, piling pig on pork, as they say on Wall Street, my first column after joining Fortune this summer was the way Blackstone's partners (perfectly legally) got public investors to pick up most of their capital gains tax tab for selling some of their Blackstone stake in the offering. Nice work if you can get it -- which with luck, may not be for long.

Congressional loophole closers have zeroed in on Blackstone's game and on two other games I wrote about -- Sam Zell's tax-dodging on his purchase of Tribune Co. and tax deferrals involving exchange-traded notes. The IRS, to its credit, also is pursuing the ETN loophole and seems likely to try to close it before it becomes too popular.

Alas, the Senate, in a display of total cowardice, wouldn't touch the most offensive loophole of all -- the way that private-equity players and hedge fund operators pay only 15 percent federal income tax on their piece of their investors' long-term gains, which is really fee income, while mere mortals pay up to 35 percent on their fees and salaries. Having buyout billionaires pay just 15 percent tax on their fees is ludicrous.

I spent a lot of time in 2007 trying to understand how the subprime meltdown happened and why it spread so wide. In the process, I came upon a particularly wretched 2006 issue of mortgage securities underwritten by Goldman Sachs in which two-thirds of the value of second-mortgage loans that individually were toxic waste was rated AAA (if only briefly) by Moody's and Standard & Poor's. Goldman, being Goldman, figured out early in the game that these markets were heading south and made a fortune betting against them. However, also being Goldman, the firm didn't pass on that insight on to buyers of the securities it underwrote.

Shortly after I joined Fortune, the debt market meltdown began in earnest. (No, I don't think it was cause and effect.) In recent months, I've focused -- some would say obsessively -- on the fact that the too-big-to-be-allowed-to-fail firms that enabled financial excesses are getting bailed out at the expense of those of us who have behaved properly. It's obvious that this is going on, but not too many people are saying it, at least not in public.

Let me hasten to add, however, that the cards that Federal Reserve Chairman Ben Bernanke and Treasury Secretary Hank Paulson have to play are much weaker than most people realize. One reason is that their predecessors allowed enablers of previous excesses to escape, reducing their credibility and clout in the markets. A second reason: the Fed and Treasury now need cooperation from foreigners, on whom the United States has become financially dependent.

So what's ahead? Amid all the gloom and doom, I see at least one encouraging thing: Some financial firms are being forced to raise new capital on terms that dilute the stakes of existing shareholders by selling new stock at below-market prices. But if I ran the world, I'd go one step further. I'd force these firms to eliminate their cash dividends and do huge, horribly dilutive offerings as a condition of getting help. The point? Even though we can't allow these firms to fail, lest the world financial system implode, we ought to teach them -- and their shareholders -- the penalty for engaging in excesses. That painful memory might inhibit excess in the next upcycle.

Finally, a contrarian and optimistic thought: The same kind of thinking that foresaw endless leveraged buyouts a year ago now foresees a worldwide financial meltdown that will go on indefinitely. Maybe this is really a signal that things will stop getting worse sometime in 2008. I'm not predicting that, but I'd sure welcome it.

Allan Sloan is Fortune magazine's senior editor at large. His e-mail address is asloan@fortunemail.com.

    Banks have recently been acknowledging enormous losses, yet those losses are barely reflected in employee compensation. For example, Morgan Stanley announced a $9.4bn (€6.4bn) charge-off in the fourth quarter and at the same time increased its bonus pool by 18 per cent. The justification was that many employees had a banner year and their compensation should not be held hostage to mistakes that were made in the subprime market. John Mack, chief executive, however, assumed some responsibility and agreed to take no bonus for 2007 - although he got a $40m payout for 2006. Even so, most readers would suspect something is not right here. Indeed, compensation practices in the financial sector are deeply flawed and probably contributed to the ongoing crisis.
    The typical manager of financial assets generates returns based on the systematic risk he takes - the so-called beta risk - and the value his abilities contribute to the investment process - his so-called alpha. Shareholders in asset management firms, such as commercial banks, investment banks and private equity or insurance companies are unlikely to pay the manager much for returns from beta risk. For example, if the shareholder wants exposure to large traded US stocks she can get the returns associated with that risk simply by investing in the Vanguard S&P 500 index fund, for which she pays a fraction of a per cent in fees. What the shareholder will really pay for is if the manager beats the S&P 500 index regularly, that is, generates excess returns while not taking more risks. Hence they will pay for alpha.
    In reality, there are only a few sources of alpha for investment managers. One of them comes from having truly special abilities in identifying undervalued financial assets. Warren Buffett, the US billionaire Investor, certainly has it, yet this special ability is, by definition, rare.
    A second source of alpha is from what one might call activism. This means using financial resources to create, or obtain control over, real assets and to use that control to change the payout obtained on the financial investment. A venture capitalist who transforms an inventor, a garage and an idea into a fully fledged, profitable and professionally managed corporation creates alpha.
    A third source of alpha is financial eutrepreneurship or engineering - creating securities or cash flow streams that appeal to particular investors or tastes. As long as the investment manager does not create securities that exploit investor weaknesses or ignorance (and there is unfortunately too much of that), this sort of alpha is also beneficial, but it requires constant innovation.
    Alpha is quite hard to generate since most ways of doing so depend on the investment manager possessing unique abilities - to pick stocks, identify weaknesses in management and remedy them, or undertake fmancial innovation. Such abilities are rare. How then can untalented investment managers justify their pay? Unfortunately, all too often it is by creating fake alpha - appearing to create excess returns but in fact taking on hidden tail risks, which produce a steady positive return most of the time as compensation for a rare, very negative, return.
    For example, an investment manager who bought AAA-rated tranches of collateralised debt obligations (CDO) in the past generated a return of 50 to 60 basis points higher than a similar AAA-rated corporate bond. That "excess" return was in fact compensation for the "tail" risk that the CDO would default, a risk that was no doubt perceived as small when the housing market was rollicking along, but which was not zero. If all the manager had disclosed was the high rating of his investment portfolio he would have looked like a genius, making money without additional risk, even more so if he multiplied his "excess" retum by leverage. Similarly, the management of Northern Rock followed the old strategy of taking on tail risk, borrowing short and lending long and praying that the unlikely event of a liquidity shortage never materialised. All these strategies essentially earn the manager a premium in normal times for taking on beta risk that materialises only infrequently. These premiums are not alpha, since they are wiped out when the risk materialises.
    True alpha can be measured only in the long run and with the benefit of hindsight - in the same way as the acumen of someone writing earthquake insurance can be measured only over a period long enough for earthquakes to have occurred. Compensation structures that reward managers annually for profits, but do not claw these rewards back when losses materialise, encourage the creation of fake alpha. Significant portions of compensation should be held in escrow to be paid only long after the activities that generated that compensation occur.
    The managers who blew a big hole in Morgan Stanley's balance sheet probably earned enormous bonuses in the past - Mr Mack certainly did. If Morgan Stanley managed its compensation correctly those bonuses should be clawed back and should be enough to pay those who did well this year without increasing the bonus pool. At the very least, shareholders deserve better explanations. More generally, unless we fix incentives in the financial system we will get more risk than we bargain for. Unless bankers offer these better explanations, their enormous pay, which has been thought of as just reward for performance, will deservedly come under scrutiny.

The writer is a professor of finance at the Graduate School of Business at the University of Chicago and former chief economist at the International Monetary Fund

Wall Street's five biggest firms together paid a record $39 billion in bonuses, even though three of them suffered the worst quarterly losses in their history and shareholders lost more than $80 billion.

Goldman Sachs Group, Morgan Stanley, Merrill Lynch, Lehman Brothers Holdings and Bear Stearns together paid $65.6 billion in compensation and benefits last year to their 186,000 employees. Year-end bonuses usually account for 60 percent of the total, meaning bonuses exceeded the $36 billion distributed in 2006 when the industry reported all-time high profits.

The bonuses are larger than the gross domestic products of Sri Lanka, Lebanon or Bulgaria.

"To many people, it will be shocking and questionable," said Jeanne Branthover, managing director of Boyden Global Executive Search. "People in New York in the world of investment banking will understand it. It's critical that pay is still there or you're going to lose really good people."

The five firms' combined profit for the full year was $11.5 billion, the lowest since 2002. The firms, based in New York, have said they would eliminate at least 4,900 jobs as losses mount from the collapse of the subprime mortgage market.

Shareholders in the securities industry had their worst year since 2002, as Merrill Lynch and Bear Stearns slumped more than 40 percent in New York trading, costing the chief executives their jobs. Morgan Stanley fell 21 percent and Lehman dropped 16 percent. Only Goldman rose, gaining 7.9 percent.

Bonuses paid for 2007 probably will mark a high point as revenue declines stretch into this year, said Charles Geisst, a finance professor at Manhattan College in Riverdale, N.Y.

"The gilded age just ended," he said. "Ferrari dealers are going to be selling Tata cars. I think this is going to be the worst year we've had in a very long time."

Management teams at Morgan Stanley, Merrill and Bear Stearns, which each recorded their worst quarters in history, rewarded employees who made money in the first half of the year, and who work in fastest-growing businesses, by lifting the percentage of revenue they pay in salaries, bonuses and benefits. At Morgan Stanley and Bear Stearns, the chief executives did not accept bonuses.

UNDER the stewardship of Dow Kim and Thomas G. Maheras, Merrill Lynch and Citigroup built positions in subprime-related securities that led to $34 billion in write-downs last year. The debacle cost chief executives their jobs and brought two of the world’s premier financial institutions to their knees.

In any other industry, Mr. Kim and Mr. Maheras would be pariahs. But in the looking-glass world of Wall Street, they — and others like them — are hot properties. The two executives are well on their way to reviving their careers, even as global markets shudder at the prospect that Merrill and Citigroup may report further subprime losses in the coming months.

Mr. Maheras, who left his job as co-president of Citigroup’s investment bank this fall after being demoted, has had serious discussions with several investment banks, including Bear Stearns, about taking on a top management position, people who have been briefed on the situation said. And he has also been approached by investment firms willing to back him to the tune of $1 billion or more if he decides to start his own hedge fund, these people said.

Mr. Kim, who until this spring was a co-president at Merrill Lynch with oversight of the firm’s trading and market operations, has been crisscrossing the globe in recent months raising money for his new hedge fund, Diamond Lake Capital.

The ease with which Mr. Maheras and Mr. Kim have put themselves back in play is a reminder that for many top Wall Street executives, humiliation and defeat need not result in a professional exile. And they aren’t the only ones. Zoe Cruz, the Morgan Stanley co-president who was forced to leave her job after $10.8 billion in subprime losses, has been approached by investment banks, hedge funds and private equity funds about a senior management role, people briefed on those discussions say.

“It is always an assumption on Wall Street that it is not the individuals that lose money; it’s the system,” said Charles R. Geisst, a Wall Street historian and a finance professor at Manhattan College. “You can fail big time, but you can also succeed big time.

“They think it’s bad luck,” he said, so the attitude is “let’s give them another chance.”

The quick comebacks of these executives stand in stark contrast to the plight of the hundreds of investment bankers who have received pink slips in the last two weeks. They also illuminate a peculiar aspect of Wall Street’s own version of a class divide. Senior movers and shakers often land on their feet, no matter how egregious the losses tied to them. The industry rank and file, however, from mergers-and-acquisitions bankers at Bank of America to sales executives in Citigroup’s hedge-fund servicing business, see their jobs eliminated despite being far removed from the subprime crisis.

Perhaps the most notorious example of failure leading to prosperity is John Meriwether. Ousted from Salomon Brothers in 1991 for his role in a bond trading scandal, he became a co-founder of Long Term Capital Management, the hedge fund that nearly collapsed in 1998, rattling markets worldwide. He has since founded a second fund, JWM Partners, with assets of around $3 billion.

More recently, Brian Hunter, the energy trader at Amaranth Advisors whose disastrous bets led to the disintegration of that $9 billion hedge fund, is now advising a private equity fund called Peak Ridge on starting a hedge fund. Howard A. Rubin, a trader at Merrill Lynch, who lost $377 million in 1987, quickly landed a job at Bear Stearns, where he had a successful career.

But last week, as markets worldwide gyrated, lower-level bankers braced themselves for bad news. Bank of America, whose profit fell 95 percent last year from mortgage-related exposure, has said it would pare down its trading and investment banking operations and cut more than 1,000 positions. Citigroup has also laid off investment bankers in recent weeks and has said it would cut 4,200 jobs, with more expected to follow. Morgan Stanley said Thursday that it would cut 1,000 operational jobs, and Merrill Lynch was expected to reduce its staff.

With a recession looming, the deal-making and underwriting environment is looking stagnant. Banks are cutting costs and taking a hard look at their head counts. All these developments do not bode well for bankers’ chances of landing another job anytime soon.

MR. KIM and Mr. Maheras, both 45, took different routes to the top at their respective banks. Born in South Korea, Mr. Kim received an elite education in the United States, attending the prep school Phillips Academy in Andover, Mass., and earning undergraduate and graduate degrees from the Wharton School of the University of Pennsylvania.

In 2001, Merrill’s new leader at the time, E. Stanley O’Neal, plucked him from his job as a bond derivatives expert and put him in charge of the firm’s bond business. A promotion followed just two years later, and he became president of Merrill’s overall markets and trading operations. In taking the job, he was given a mandate by Mr. O’Neal to enhance Merrill’s risk profile, and in the ensuing years, Mr. Kim’s business became a prime generator of profits. One area Mr. Kim leaped into with the encouragement of Mr. O’Neal was the market for collateralized debt obligations, complex pools of securities tied to assets like subprime mortgages. Under his watch, Merrill’s exposure to these securities climbed to $52 billion in 2006 from $1 billion in 2002, making the firm the top underwriter of C.D.O.’s on Wall Street.

Always interested in running his own fund, Mr. Kim left Merrill in May 2007, just a few months before his big C.D.O. position collapsed, causing the largest losses in Merrill’s history and pushing it into the arms of foreign investors.

In a statement, Mr. Kim said that in late 2006 he and his team put in place a program to reduce Merrill’s mortgage-related securities exposure. He said that after his departure in May, he had no authority over Merrill’s risk management, trading or other operations and was not consulted on those issues.

As recently as a month ago, Mr. Kim was telling investors he planned to raise about $2.5 billion, and he highlighted his abilities as a business builder and risk manager, people briefed on his plans said. But the turbulent markets over the last month have forced Mr. Kim to scale back his ambitions, and he is no longer discussing such a sum, said people who have spoken with him.

He has established headquarters in Midtown Manhattan but has not hired any portfolio managers, a person who had knowledge of his plans said.

While respected for his intelligence, Mr. Kim has never been a money manager, and hedge fund experts say that his experience at Merrill could be an impediment to raising money. “He has no track record, and the business he built wrote down billions in losses,” said Tim Cook, the president of Kailas Capital, an investor in hedge funds. “He has some questions to answer.”

Mr. Maheras, the son of a Greek immigrant, is a Notre Dame graduate who got his first taste of markets as a runner on the Chicago Mercantile Exchange. He started out at Salomon Brothers in 1984 and by the early 1990s had become one of Wall Street’s top traders of junk bonds. By 1996, he was running Salomon’s bond trading business, and after the 1997 merger of Travelers and Salomon, became a favorite of Sanford I. Weill, rising to co-president in 2007 with oversight of Citigroup’s trading and bond operations.

As the head of its large capital markets division, Mr. Maheras had broad oversight for all aspects of trading and investment.

IN 2004 and 2005, senior executives at the bank, including Robert E. Rubin, Citi’s influential director, urged it to become more actively involved with in-vogue areas like structured credit, pools of securities backed by different assets, and commodities. The buildup in C.D.O.’s began at this time, several reporting layers beneath Mr. Maheras. By 2006, Citigroup had become the second-leading underwriter of C.D.O.’s.

Mr. Maheras declined to comment for this article, but a person who worked closely with him said that Mr. Maheras had been aware of the broad exposure, but that he, along with others, had been caught by surprise when some of the most highly rated securities imploded so quickly.

As the size of the write-downs grew, so did pressure on Charles O. Prince III, then the chief executive, to hold someone accountable. In October, he demoted Mr. Maheras, who then chose to leave the only firm where he had ever worked. It was a move that still irks James Dimon, the chief executive of JPMorgan Chase, who worked closely with Mr. Maheras while they were at Citigroup and who has counseled him in recent months.

“The great shame is that people are often never as good or as bad as they are held up to be,” Mr. Dimon said. “Tom is a class act personally and professionally.”

Mr. Maheras has told friends that he feels horrible about the recent events. A direct, ingenuous man who lacks the guile and gloss of most bankers who have reached such a high position, he has told colleagues how upset he is that he did not discover the scale of the losses sooner, though he has not pointed fingers.

“I wish I could turn back the clock,” he has told peers. “But it happened on my watch.”

He has said that he expects to take 6 to 12 months to weigh his next move. However, he has been courted by Wall Street firms, which may push him to take a new post sooner than he might have thought. Since leaving Citigroup, he has had conversations with chief executives at most of the large banks, people who have been briefed on his plans say. At Bear Stearns, the talks have centered on his heading the firm’s trading operations, a job formerly held by the co-president, Warren Spector, who was pushed out last summer.

What explains such an interest? To some extent, it is personal: Mr. Kim and Mr. Maheras have a web of relationships with Wall Street’s top executives. And many seasoned investors think that surviving such a crucible gives a person a degree of savoir faire and understanding of risk.

“People develop relationships that transcend the professional role so that they can rationalize away performance,” said Clayton S. Rose, a former senior executive at JPMorgan who now teaches a course on corporate leadership at Harvard Business School. “There is also a view that they have learned from their mistakes and have now figured it out.”

RIGHTLY or wrongly, there is not likely to be such a generosity of spirit for Jean Larkin, who until recently was a sales executive in Citi’s prime brokerage division. Mr. Larkin was a 17-year veteran of the firm and was coming off a profitable year for the unit, during which it increased its market share. Last week, just days before getting news of his bonus, he was laid off. Mr. Larkin, who is 43 and lives in New York, would not comment on his departure, but people who have spoken to him say he had no idea that his job was at risk. People who know him say he does not hold out high hopes of finding another job anytime soon.

More recently, Stefan Gerhard, a mergers-and-acquisitions banker for Bank of America, was told Wednesday that his San Francisco job was being eliminated. Mr. Gerhard, 35, also declined comment on his departure, but a person who knows him said the news came as a shock — he had been promoted from principal to managing director in December after a successful year in which he worked on several major technology deals.

He received the news just two days before getting notice of his bonus and, people who have spoken with him said, he was offered a severance package of just 10 percent of the amount that he had been expecting to receive as his bonus. His career outlook, these people say, is gloomy, and he does not expect to make any serious effort to find work given the current industry conditions.

“Wall Street firms are downsizing considerably,” said Leah Peskin, a recruiter at Cromwell Partners. “It will be a hard year for many of those who get downsized."

Finally, a deal! The chairman of Lightyear Capital, Donald Marron, told me that we would know we have hit bottom when deals start to flow again. Yesterday’s announcement that Novartis will acquire Nestle’s holding in eye-care company Alcon for about $11 billion could be a harbinger of the tap opening, ever so gingerly.

Deals have been off the table (and falling off the table) for months as the financial system “deleverages.” The question of late has been: Can we deleverage the economy without killing it?

One of New York’s top fund-of-funds recently held a phone-in session with investors to bring them up to date on the financial situation. If it was meant to be calming, it should have been conducted in a foreign language. The message was: The economy is still so gummed up with bad credit that hedge funds are setting the price of, well, practically everything.

Here’s how it works. The banks and investment banks (except for Goldman Sachs) are trying to reduce the debt on their balance sheets by selling loans and other securities. All the normal opportunities to offload such loans by bundling them and selling them through structured investment vehicles are dead. (For instance, new collateralized debt obligation issues this past quarter totaled $6.4 billion, versus $103.6 billion a year ago.) Banks would like to dump their shakiest assets, but there are no buyers. So they have to sell high-grade assets instead.

The “next marginal buyers” for such assets are, mostly, hedge funds. However, hedge fund managers are also reducing the debt on their balance sheets, some through their own volition, and others due to margin calls from the banks that have put several funds out of business this year. Overall, the hedge fund industry has “deleveraged” in two of the past three months, paying off trillions, it is said, in debt.

Here’s the messy part. To entice hedge funds to buy, the triple-A rated securities being sold by banks have to be priced to yield something between 8% and 12% — or in other words, a yield that would satisfy an aggressive hedge fund without adding any leverage.

This trend has played out in some startling transactions. About three weeks ago, a large bank sold an $18 billion portfolio of “money good triple-A rated paper” to yield 9%, the effects of which apparently “rippled across the market.” I bet it did.

Translated, that means that the perfectly sound top-grade debt of leading corporations and banks that was selling to yield perhaps 6% took a 33% haircut, granting the buyer a 9% yield. Welcome to the other side of the credit mountain.

On the deal side, little money has been available to finance takeovers, for essentially the same reason. As the banks reduce their debt, they have become exceedingly picky about making new loans. Loan provisions have tightened up (covenant lite has become covenant tight), and they are not willing to finance takeovers using historically high leverage. As a result, one private equity player says, deals that used to get done easily with eight times leverage are now being priced using borrowings of six or six-and-a-half times equity. That sets the bar a lot higher; fewer transactions can still make sense.

Consequently, it was likely that strategic buyers would emerge as the next round of bidders for corporate assets. These would-be purchasers were left behind in the great overleveraged takeover boom, outbid by private equity firms able to borrow gobs of money to finance otherwise unappealing deals. Today, though, they are the ones who still have money, and a rationale for getting transactions done.

That said, there is no lack of money available. Leveraged buyout firms reportedly raised $50 billion in new funds in the fall, and the hedge funds that are still healthy are said to be sitting on large amounts of cash as well. One major prime broker reported to clients that its equity hedge fund clients have average net exposure of only 28%, a level not seen since 2002. That compares with an average net exposure of 55% to 60% this time last year. Cash balances for many representative funds are up 100% so far this year.

There is money to invest, but at the moment, no reason to invest it. “Wait and see” has become “wait and prosper” as prices for nearly every kind of asset have declined and continue to fall. Hedge funds and others perceive an opportunity cost to investing today; they want to stay liquid.

How does this turn? It will be, partly, a matter of perception. Eventually a desirable asset will become the target of a bidding war, and the price will move up. Buyers who hesitate will eventually be penalized for doing so. Or assets will be sold for prices that are simply too tempting to resist.

In the leveraged loan market, for example, the pricing today suggests default rates way above what is actually taking place, or is likely to take place. This anomaly may be explained in part by a shortage of liquidity in the marketplace. Dealers are not committing capital to the sector, as they are part of the deleveraging scenario, too.

Also, investors in hedge and private equity funds will eventually demand action. They will not be pleased to be paying fees to have their money invested in money market funds.

Sovereign wealth funds, the massive investment pools run by foreign governments, are now among the biggest speculators in the trading of oil and other vital goods like corn and cotton in the United States, according to interviews with brokers who handle their investments at leading Wall Street banks, veteran traders and congressional investigators.

Some lawmakers say the unregulated activity of sovereign wealth funds and other speculators such as hedge funds has contributed to the dramatic swing in oil prices in recent months.

The agency regulating the market said it had not picked up on this activity by sovereign wealth funds. In a June letter, the Commodity Futures Trading Commission told lawmakers that its monitoring showed that these funds were not a significant factor in commodity trading.

But the CFTC is not detecting the growing influence of foreign funds because they invest through Wall Street brokers known as "swap dealers" who often operate on unregulated markets, sources familiar with the transactions said.

Several Democrats said the Republican-led CFTC won't use its authority to clamp down on such unregulated activity because it doesn't want to hurt the influential Wall Street firms it favors.

"It took prodding from Congress to persuade the CFTC to finally request information from swap dealers about the participation of sovereign wealth funds in the commodity markets," said Rep. John D. Dingell (D-Mich.), chairman of the Committee on Energy and Commerce. "The regulatory body in charge of policing our futures markets has been remarkably incurious about the role sovereign wealth funds play in commodity markets."

CFTC officials say their data show that fundamental factors of supply and demand, not financial actors, are the best explanation for the run-up in oil prices and their precipitous fall.

The officials have ordered swap dealers to open their books and reveal to the agency more information about the unregulated activities of sovereign wealth funds and other financial actors, CFTC spokeswoman Ianthe Zabel said. The findings will be published in a report in mid-September, she said.

Like most speculators, sovereign wealth funds have moved into U.S. commodity exchanges for profit, not to accumulate goods. In general, they make these investments through index funds, a kind of mutual fund composed of commodity futures contracts, which bet on the price the goods will fetch at a future date.

The index allows investors to enjoy the returns of a commodity investment without actually buying futures contracts on an exchange. For this reason, the extent of their activities may be known only to the swap dealers at investment banks such as Goldman Sachs, Lehman Brothers and Morgan Stanley, which handle such transactions.

The foreign funds involved in commodity trading are not those from oil-producing nations from the Middle East, according to a large swap dealer. Instead they are mainly from countries, such as those in Asia, that do not already make money from producing oil.

While it is difficult to quantify how large foreign funds have become, they now represent 12 percent or more of the overall commodity business for some of the largest investment banks, said an industry veteran who spoke on condition of anonymity because he had proprietary data about those firms.

Other sources familiar with the activities of sovereign wealth funds spoke on condition of anonymity because their firms did not give them permission to speak publicly.

After spiking to a record high of $147.27 a barrel on July 11, crude oil settled at $114.45 yesterday, a plummet of 22 percent in a few weeks.

Although some analysts have attributed the recent reversal in oil prices to a stronger dollar and a sluggish U.S. economy, other experts in commodity trading have suggested that the price shifts have been accentuated by unregulated, speculative activity.

Over the past year, sovereign wealth funds have become increasingly active in the broader U.S. markets, investing more than $40 billion in Wall Street's biggest names, including UBS, Morgan Stanley and Bear Stearns. China put $3 billion of its $200 billion fund into private-equity giant Blackstone. Abu Dhabi, part of the United Arab Emirates, invested $1.35 billion of its estimated $875 billion fund into District private-equity giant Carlyle Group.

About two dozen countries have established or are in the process of forming large funds, including Iran, Norway, Singapore, Kuwait, Australia, Russia and Libya. While precise data about each of the funds can be difficult to obtain, Wall Street analysts say their collective value has exceeded $2 trillion and will probably grow at least fivefold by 2012.

In a June 20 letter to the House Committee on Energy and Commerce, CFTC acting chairman Walter Lukken wrote, "The growth of sovereign wealth funds and their collective investment in U.S. markets is of interest to a number of U.S. regulators."

He said the agency was aware of only one sovereign wealth fund with large holdings trading on regulated U.S. exchanges. He added that his staff had "not observed any positions of sovereign wealth funds in the data received to date" from a London exchange that shares information with the CFTC. Trading activity anywhere else would not be regulated or captured by CFTC surveillance reports, agency officials said.

Some Democrats greeted Lukken's responses with skepticism. Sen. Maria Cantwell (D-Wash.), for one, has put a hold on Lukken's nomination in the Senate, preventing him from becoming the permanent chairman of the CFTC on the grounds that he has not kept speculation under control.

Speculators, she said, "are causing a colossal impact on the markets, and we don't have the right team to oversee and analyze whether the consumer is being protected."

The CFTC, she added, is "banking on this being too complicated for anyone to understand."

That is the score in the game of chicken played between the band of short sellers intent on pushing another Investment Bank over the brink and the regulators - in particular the SEC - who fiddle while Rome burns.

Last July the SEC imposed a ban on 'naked' short selling of bank shares which in our opinion was much too weak a measure given the pervasiveness of short selling and the fire power that the raiders have at their disposal. Naked short selling was illegal in any case, so to finally enforce it was just a pathetic gesture.

Financial Institutions are critically dependent on public trust as ALL banks would be bankrupt in a second if all depositors and creditors would demand repayment at any point in time. There was a time when short selling was limited to a small group of sophisticated investors and to market professionals such as NYSE specialists. Now this cottage industry has morphed into a monster that threatens the stability of whatever target the 'shorties' decide to take aim at.

Recent trading volumes in the shares of Lehman Brothers are so enormous that they cannot be simply the result of long-term shareholders deciding to sell. Activity in the shares is more akin to the frenetic buzz normally limited to betting shops. The SEC so far has failed to call an end to this and we fear that the taxpayer will have to pick up the bill when the music stops.

This shall not be construed to be a defense of the actions of Lehman management. That huge bets were made on property-related holdings is testimony to a serious lack of discipline on the part of top management.

Heinz Geyer
Temple Associates Consulting and Recruitment Ltd.
Banking | Fund Management | Securities | Corporate Finance
T +(44) 20 8343 7785
www.ta-consult.com
www.ta-consult.com/Geyer.htm

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James Grant, whose cluttered office at Two Wall Street overlooks Trinity Church, has been warning about financial disaster of one form or another for nearly 25 years. Two years ago, for example, when the now-beleaguered Morgan Stanley was trumpeting a 61 percent jump in profits, Grant wrote a pessimistic analysis titled "over the cliff with Morgan Stanley."

Now much of the financial industry has gone over the cliff. And as one of the most incorrigible bears on the street, the editor and author of the gloomy Grant's Interest Rate Observer should be doing a victory lap and saying "I told you so."

When reached by phone yesterday, Grant tried not to gloat. "What are the costliest words in finance?" he said. "One is 'it's different this time' and the other is 'I told you so.' It brings down the wrath of the gods."

The gods have sent down plenty of wrath already, so much that even Grant admits he has been surprised by the "ferocity and violence" of events that have shaken the financial world over the past two weeks.

"Nobody has been bearish enough," Grant said. "I, looking back on it, was not nearly enough of a calamity hollerer. What you did not read in Grant's was that the socialization of credit risk, a long-run trend, would yield in a few weeks an outright nationalization of our financial system. That sentence we did not write. So many things have happened in so dramatic and so violent a way that one is thunderstruck."

Kenneth Rogoff, an economics professor at Harvard University and former chief economist of the International Monetary Fund, also has reason to point to his foresight. At a conference a year ago, he predicted that a major bank would fail. In July he doubted Treasury Secretary Henry M. Paulson Jr.'s assertion that Fannie Mae and Freddie Mac could remain in the same form. They were "toast," Rogoff said.

And then a month ago, after many analysts thought the worst of financial instability had passed with the rescue of Bear Stearns, Rogoff told another group that more failures were on the way among the financial institutions that had been reporting awe-inspiring profits and annual bonus payments in the tens or even hundreds of millions of dollars.

"We on the outside have been saying: 'How is it possible to manufacture money like that? How can Goldman give out those bonuses? How could financial services be a third of the economy?' " Rogoff said. "And the answer was that it was taking much bigger risks than it should have."

Profiting from that sort of wisdom is no easy thing, however. Charles D. Zender, co-portfolio manager of the Grizzly Short Fund at Leuthold Weeden Capital Management in Minneapolis, says that his fund has been betting largely on a decline in financial stocks for the past two years. Recently it has been betting against some consumer discretionary shares. It has about 75 equally weighted positions.

But Zender cautions that the fund is one of the smallest at Leuthold Weeden, where other funds search for stocks that will rise. "Our philosophy has always been that there have been up markets and down markets," he said. "They go up about 70 percent of the time and down about a third of the time. This is one of those ugly times."

That's made the Grizzly fund look like a beautiful creature -- at least for now. It was up 40 percent from Jan. 1 through the close of business Wednesday. It was down 5 percent or so Thursday. It isn't meant to be a buy and hold fund, he says; over the past five years, its returns are slightly negative.

When it comes to tomorrow, the long-term pessimists are still, well, pessimistic. "I think the central banks are going to next wear the goat horns," said Grant, saying that the Fed and other central banks would lose credibility as they wade deeper into managing banks and insurance companies.

Referring to former Federal Reserve chairman Alan Greenspan and current chairman Ben S. Bernanke, Grant said that "in the old days, when the maestro ran the Fed, people attributed to him qualities of clairvoyance. Then the next guy came and, though mere mortal, was given the benefit of doubt. He turns out not to have been much of a prophet."

Rogoff says, "I think the government will ultimately be pressed to take more radical measures." He predicts an expansion of federal deposit insurance, a new institution similar to the Resolution Trust Corporation, which bailed out savings and loan institutions two decades ago, and the need for the Treasury and Fed to shell out $1 trillion to restore stability.

Among the gloomiest -- and most prescient -- of economic prognosticators has been Nouriel Roubini, an economic professor at New York University and founder of RGE Monitor, an economic consulting and commentary firm.

In the past two weeks, Roubini has been lashing out at the Bush administration on his blog. He calls the president, Treasury secretary and Fed chairman "comrades Bush, Paulson and Bernanke" and brands them as "laissez faire voodoo-economics zealots." He says the United States has turned into the "United Socialist State Republic of America," bringing "socialism for the rich, the well-connected and Wall Street" and making sure "profits are privatized and losses are socialized."

Grant, for one, has a bit more humility. One reason may be that in March, he recommended that people buy American International Group, the insurance giant that the federal government just seized control of to prevent the cash-short firm from causing even greater market turmoil. He points out, however, that he reversed his opinion in May, at which point, he notes, "the stock still had two digits attached to it." After the federal takeover, AIG now sells for $2.69 a share.

ON the subway, a stranger in a suit knowingly eyed my Lehman Brothers ID badge in its Bear Stearns holster. With a look of detached curiosity, he expressed his condolences. This is not the way I thought my Wall Street career would begin.

During college, I was an intern at Bear Stearns. There, I toiled at the lowest levels of Wall Street, fetching coffee, moving boxes, filing papers.

In my final summer at Bear, I was promoted to intern in the marketing department of the asset management division. There, I worked on some hedge funds that invested in stuff called “mortgage-backed securities.”

Several months later, the hedge funds went down the tubes, dragging Bear Stearns behind them.

After I graduated from college, Lehman Brothers hired me to help settle trades in complex derivatives, the very derivatives that led to the company’s demise. I helped resolve trading issues involving tens — hundreds — of millions of dollars.

And now? Now from my desk here in the trenches, my colleagues and I watch CNBC reports on the collapse of Wall Street. Over the months, we have watched our stock price plummet 99.8 percent, from $65 per share to 15 cents.

The news provides grist for the rumor mill. I trade notes with my colleagues here. Though some more senior people have lost their entire life savings, the steady stream of bad news and uncertainty are also difficult for those of us at the bottom of the Wall Street food chain. It is dizzying.

Most of the time, in the office and out, I feel like I am on display, an object of pity or fascination. Friends and family send frequent expressions of concern and empathy by phone, e-mail and text message.

Even though I had little — nothing, actually — to do with the real estate losses that led to Lehman’s problems, or the hedge funds that precipitated Bear’s demise, the only conclusion I can draw is that I’m a jinx. Prospective employers will take one look at my résumé and call security to escort me out the door lest my mere presence infect their otherwise healthy businesses [*].

Meanwhile, I sit at my desk. “Your password will expire in nine days,” my computer informs me. “Would you like to change it?” Each time, I click “No.”

[*] [Would somebody please tell this hapless fellow that he still might have a chance in Switzerland, where some leaders of various trade groups, like the Swiss Bankers Association and Geneva Place Financière, have successfully leaned on the federal and the cantonal tax authorities in order to attract - rather than keep away - these financial apprentice-sourcerers by way of special tax rates and immigration facilities]

Traders who have sought to profit from the financial crisis by betting against bank stocks were attacked on two continents on Thursday.

The Securities and Exchange Commission is considering a temporary ban on short sales of some or all shares and an announcement could be made as early as Friday morning. Earlier Thursday, the S.E.C. scrambled to put together an emergency rule to force major investors to disclose their short sales daily.

Short selling — a bet that a stock price will decline — is the practice of selling stock without owning it, hoping to buy it later at a lower price, and thus make a profit. It has often been blamed for forcing prices down in times of market stress, but the level of anger has intensified as the American government has been forced to bail out major financial institutions and the leaders of some investment banks have asked for action to protect their shares.

Both the S.E.C. and the New York State attorney general promised to intensify investigations into short selling abuses. “They are like looters after a hurricane,” said Andrew M. Cuomo, the attorney general. “If you pass a rumor in a normal marketplace, people are calm, they check it out, they do their due diligence. When you get the market in this frenzied state and they are on pins and needles, any false information is much more impactful.”

Short sellers say that the criticism directed at them, and any restrictions on their activity, are wrong-headed, because they were among the first to raise the alarm about the risky mortgage lending practices that led to the current financial crisis.

Senator John McCain, the Republican presidential candidate, said the S.E.C. had “kept in place trading rules that let speculators and hedge funds turn our markets into a casino” and said that the S.E.C.’s chairman, Christopher Cox, had “betrayed the public’s trust.”

Speaking at a rally in Cedar Rapids, Iowa, Mr. McCain said, “If I were president today, I would fire him.”

The White House immediately said it supported Mr. Cox, who has said he will resign at the end of the Bush administration. Mr. Cox said he had moved against short sellers and was doing all he could to stem the financial crisis.

“Now is not the time for those of us in the trenches to be distracted by the ebb and flow of the current election campaign,” Mr. Cox said in a statement released by the commission. “It is precisely the wrong moment for a change in leadership that inevitably would disrupt the work of the S.E.C. at just the wrong time.”

Mr. Cox is a former White House aide to President Ronald Reagan and a former Republican congressman from California. Some conservative columnists and commentators, including Robert Novak, supported him as a running mate for Mr. McCain. Writing in the American Spectator earlier this year, Quin Hillyer said that conservatives would rally to a Cox selection and called him “the best choice, bar none.”

In recent weeks, Mr. Cox has also stepped up his criticism of short sellers, particularly those who engage in “naked” short selling. While short sellers are supposed to borrow shares before selling them, naked shorts do not borrow. That saves the cost of borrowing, though the trader is still vulnerable to losses if the share price rises.

Opponents of short selling believe that it can force share prices down and destroy confidence in a company that might otherwise survive. Regulators have long thought that the practice was crucial for efficient markets to function, but earlier this year the S.E.C. imposed temporary limits on short selling of some financial stocks. Financial share prices rallied when those limits were announced but fell during the period in which the rule was in effect.

Share prices for many financial companies shot up Thursday afternoon after plunging the day before in the wake of the government decision to take control of the American International Group, a large insurance company, to prevent it from collapsing. Financial shares were especially hard hit Wednesday, with Morgan Stanley plunging 24 percent, to $21.75, and its chief executive, John J. Mack, blaming false rumors spread by short sellers. On Thursday, Morgan Stanley regained part of that loss, rising 3.7 percent to close at $22.55.

The latest moves against short sellers began Wednesday. In the morning, Mr. Cox announced new rules to prevent brokerage firms from selling a stock short if they previously had sold the stock short without having borrowed it. That night, he said that he would propose more rules, to force large short sellers to disclose their positions.

The rules were needed, he said, “to ensure that hidden manipulation, illegal naked short selling or illegitimate trading tactics do not drive market behavior and undermine confidence.”

Details of the possible new disclosure rule were not released, and it is not clear how much authority the S.E.C. has over hedge funds, which have successfully sued to prevent the commission from forcing them to even register with it. Institutional investors, including some hedge funds, provide details of stocks they own every three months but do not disclose short positions. Mr. Cox said he wanted daily disclosure of short positions, which he said would be made public, though he did not say how quickly.

By late Thursday, the S.E.C. was considering a temporary ban of some or all short selling. Mr. Cox told reporters in Washington late Thursday that he had discussed the ban with other senior administration officials but no decision had been made yet.

Richard Baker, the president of the Managed Funds Association, a hedge fund trade group, said the funds would comply with any rules but said that disclosure of their trading positions should not be made so quickly that it would harm them in the market.

Mr. Cox also said the S.E.C. would intensify its investigations of short selling by hedge funds and would demand their records on trading in certain securities.

In Britain, the Financial Services Authority said that beginning Friday it would bar traders from taking new short positions in listed stocks of financial companies, and that starting next week, investors would have to disclose their short positions if they were at least 0.25 percent of a company’s outstanding shares.

This week, the British bank Lloyds TSB took over HBOS, a mortgage lender, after HBOS’s stock tumbled. That fall was widely blamed on short sellers, and Prime Minister Gordon Brown vowed to clean up the financial system.

To obtain shares to sell short, traders often borrow them from institutional investors, who receive small fees for the loans. But public pension funds in New York and California said Thursday that they would stop lending shares of some financial companies.

New York State’s comptroller said the state’s Common Retirement Fund would temporarily stop lending the shares of 19 banks and brokerage firms to short sellers. “This speculative selling has put downward pressure on the entire stock market and threatens to drive our national economy deeper into decline,” Thomas P. DiNapoli, the comptroller, said in a statement.

The suspension removes 105 million shares from the fund’s securities lending program. It will last until market conditions stabilize, a spokesman said.

New York City’s comptroller announced the same move, as did officials in California.

“We’re pulling them back because of the unfortunate predators that are out there right now, trying to be greedy,” said Patricia K. Macht, an official of the California Public Employees’ Retirement System.

With the nation’s financial system teetering on a cliff, the compensation arrangements for executives of the big banks and other financial firms are coming under new scrutiny.

Bankers’ excessive risk-taking is a significant cause of this financial crisis and has contributed to others in the past. In this case, it was fueled by low interest rates and kept going by a false sense of security created a debt-fueled bubble in the economy.

Mortgage lenders blithely lent enormous sums to those who could not afford to pay them back, dicing the loans and selling them off to the next financial institution along the chain, which took advantage of the same high-tech securitization to load on more risky mortgage-based assets.

Financial regulation will have to catch up with the most irresponsible practices that led banks down this road, in hopes of averting the next crisis, which is likely to involve different financial techniques and different sorts of assets. But it is worth examining the root problem of compensation schemes that are tied to short-term profits and revenue, and thus encourages bankers to take irresponsible levels of risk.

The banks recognize that pay is a problem. “Some firms” used “compensation incentives that exacerbated the weaknesses and contributed to the market turmoil,” admitted the Institute of International Finance, a lobby group for big banks.

One direct way to address this problem is for bankers to have more of their own money at risk in the bets they are making.

The regulator of Fannie Mae and Freddie Mac set an example when the government took over the mortgage finance companies last week — barring them from paying their former chief executives severance packages worth millions that were stipulated in their contracts. It is proper for the federal government to intervene in executive compensation or exit pay when it takes over a bank. When the federal government assumed a huge ownership stake in the American International Group, it fired the chief executive.

But that was a drastic measure. Banks’ boards of directors, encouraged by their shareholders, must look hard at reforming the pay of top bankers. The core problem is this: bankers get stellar rewards in the good times and don’t have to give money back when their strategy sinks the bank a few years down the road. They might miss a bonus, or even get fired — and float down to earth on the “golden parachute” negotiated in the flush years.

One way to change this would be for banks to hold a big chunk of bankers’ pay in escrow, to be doled out over several years. A bigger share of a bankers’ pay could be made in restricted stock that can only be sold over a fairly long period of time. Golden parachutes could depend on good performance through the executive’s tenure.

Deleveraging is a very painful process, and will run longer and deeper than anybody can imagine. I've been fearful of this.

So far, what we're seeing is the pain in the financial system. Later on, we'll see the echo effect of the pain in the real economy. I can't understand economists talking about no recession or mild recession. This is the worst financial crisis since the 1930s. It's different than the '30s, but is the worst since then, and the consequences will be very, very painful for virtually everybody in our economies.

So it's a global downturn?
That's right. It started out in the U.S., but it is a global event, led by the [excessive lending practices that grew up in the] housing boom in the U.S. But we also had housing booms in some of the European countries, and in some of the emerging countries. People are already talking about a glut of unsold homes in China.

How will these countries fight this severe downturn?
Governments, particularly those in the industrialized economies, will use fiscal stimuli to prop up the system and prevent them from collapsing. Usually, those stimuli are a little too small to really have a lasting impact, which is usually spent after two to three quarters. So we could have a pop in the market in '09 and the economy into 2010, and then it disappears again; then there is the next fiscal program, and so on. That can go on for a long time.

By issuing more debt, all of these governments are trying to stimulate deteriorating economies. But what do you see as some of the other consequences of all that additional debt?
Government debt is going to rise dramatically over the next five to 10 years. Government debt is at 300% of [gross domestic product] in most industrialized countries, if you calculate correctly. That can increase to 400% and 500%, but at some point the government-bond market will not take this without any consequences. That will lead to rising long-term interest rates. But because the economy is not on solid footing yet, short-term rates will stay low for a long time. So you will have a very steep yield curve for many, many years, and this is bearish for bonds since their prices keep falling.

What's your take on the inflation outlook?
Most governments and central bankers are still concerned about the inflation rate. I think for cyclical reasons that inflation will probably drop sharply into '09, partly due to lower commodity prices. But what's more important thereafter is that there will be a secular rise of the inflation rate, because governments and central bankers will be forced to reflate these economies in a big, big way, and this will be bad for nominal assets, whose value decreases because of less purchasing power. But it will be good for real assets at some point of time in the future. For example, companies can adjust by raising their prices and growing their incomes.

What does all of this deleveraging, in which firms try to get various forms of debt off their balance sheet, mean for those involved?
When the deleveraging starts due to declining asset prices, there is no one there to reverse it. I cannot see the private sector stopping this and turning it around. It has to be the government, together with the central banks, and they are starting to do that.

What's your assessment of the steps Federal Reserve Chairman Ben Bernanke and U.S. Treasury Secretary Henry Paulson have taken to stem these problems?
It's a challenging job. Bernanke and his team and Treasury are doing the utmost, but doing the utmost means they're always one step behind. So far, it seems that the Fed is constrained by not being able to expand its balance sheet. It has replaced a lot of Treasury paper with other paper of lower quality, and the level of Treasury paper on the Fed's balance sheet has now reached such a low point that it cannot expand more without really monetizing debt.

You can't stop this [downturn] or turn it around without going to monetization, a step the central bank hesitates to take. But eventually the developments will force the Fed to do it.

What's your reaction to Friday's announcement that Paulson is crafting a plan for the federal government to buy illiquid assets from various financial firms?
Treasury, together with the Fed, is taking a big step forward to keep the system from melting down. It will work, but it has to be at least $1 trillion in size and the Fed has to help by cutting rates. The idea is good; now the Treasury has to make it solid and the Fed has to lend its support. This is probably the beginning of a medium-term bottom. Usually a good bottom, even medium term, doesn't stand on one leg. In the coming three or four weeks, the low will be tested, but from there we have a chance for a good medium-term rally.

Could you elaborate?
What the Fed has to do is buy paper in the asset market, including Treasuries and corporate bonds, and create new money in the financial system -- because the deflationary process created by the deleveraging is at work. Deflationary power is growing dramatically, and the Fed has to replace the dollars that have disappeared into a black hole. The private credit system cannot do that anymore. The Fed and government are really the lenders of last resort.

From your vantage point, what do you see happening to the Eurozone's economy?
Short term, it will probably get a little bit worse in Europe, because we have a different policy mix than in the U.S. Your central bank has cut rates. They've been aware of the problem. The fiscal situation is expansive already, whereas in Europe we have tightening fiscal policy, and we have still a restrictive central bank that's looking at holding the value of the euro. So Europe could get hurt a little more than the U.S. in the short term, but I think it will do better over the medium term.

Why is that?
First of all, Europe can finance itself, meaning it's not dependent on outside money. It runs a slight current-account surplus and, net-net, it is not indebted to the rest of the world. The U.S. is indebted to the rest of the world; that's a major difference. Also, Eurozone households [collectively] run a financial surplus, while U.S. households have deficits. So when you look at the large European economies such as those in Germany or France, the consumer is in much better shape and the banks are probably in a little bit better shape than in the U.S., although some internationally active banks and investment banks are like their U.S. competitors.

What about emerging-market economies?
Even emerging economies are getting hurt. We have seen how real-estate prices in some emerging economies, from the Baltic States to some Asian countries, are coming down. But these countries have a better situation from a very, very long-term point of view because of demographics. They are much younger nations. They are much lower in their standard of living, they are going up the ladder, and they are competitive.

Another thing to consider is that current-account and trade deficits will shrink. So what used to be a big stimulus for emerging economies will be curtailed and it will hurt those economies in the short run much more than the markets assume.

What do you see ahead for the U.S. economy and elsewhere?
The U.S. economy goes flat for several years, and from time to time there probably will be major fiscal programs, each one bigger than the previous one, to help the economy. Europe will be similar; its potential growth is relatively low, with a stagnating population.

The emerging economies have much higher potential growth rates. They are going through a down-cycle, but they will come up again in the next cycle and have higher growth rates. But it is going to be a very tough 2009, a global recession. Whoever gets elected president in November will come through with a fiscal program. Monetary policy is really ineffective in this situation. When you have a balance-sheet recession and everybody is deleveraging, monetary policy cannot do the trick. It doesn't work because there is no one willing to leverage up their own balance sheet.

Around these parts there has been a lot of focus on Merrill, Lehman and AIG, not to mention Fannie Mae and Freddie Mac, which the U.S. government bailed out recently. What does the future hold for financial firms globally?
Bankers have to learn that banking is an industry like any other industry. The financial sector has grown dramatically over recent decades, and I think it has grown to a level that is too big in proportion to total GDP.

Global financial-sector debt has gone up fivefold in the last 25 years relative to GDP. So what you now see is a reversal back to the mean. That means that the financial sector as a profit generator, as an employer and as a provider of services will shrink over many years -- back to a level that is more normal than in recent years. The financial-services industry has been treated extremely well for a long time and people made a lot of money and created careers, etc. But it is going to be much, much tougher in the next 10 years globally.

Do you see any industries that look promising at the macro level?
First, we go through a down-cycle, and it will affect virtually every industry. After that down-cycle is over, particularly in the emerging economies that have higher growth potential, it will turn up again. It could again be infrastructure-related assets or commodity-related assets that will perform very well. If I'm right in this scenario, what will happen is we will create a stimulus to grow in the future. And those who grow the best in a world of stimuli will be those that have the highest growth potential, namely the emerging economies. And then we will see rising bond yields. They will go in cycles, of course, and they will not shoot up straight. But they will go up.

What investments look interesting to you?
In this environment, those who do not lose win. For the average guy, I'd say go into the most defensive position. I'm not really interested in any longs in equities. I'm holding a lot of government bonds on the long side. I suggest that American investors stick to shorter-term Treasuries with maturities of up to two years.

Any other suggestions for equity holdings?
If you have extra money left and want to be more aggressive, you can play the markets short-term. There are going to be a lot of runs up and down in a declining market.

This is all sounds very bleak, Felix.
I'm not interested in any longs in equities. If you are an optimist by nature and if you want to be long, the one area that you should look at is daily necessities, notably consumer staples. Companies like Procter & Gamble [ticker: PG], General Mills [GIS] and maybe Johnson & Johnson [JNJ]. Those are the defensive names. But I have absolutely no interest in investing on the long side in anything that is cyclical in nature, because this cycle could last longer on the downside and go deeper than most investors assume.

WASHINGTON - U.S. Republican presidential candidate John McCain on Sunday called for broad oversight of the Bush administration's $700 billion plan for rescuing Wall Street.

In an interview on financial cable TV channel CNBC, McCain said responsibility for the bailout should be spread beyond Treasury Henry Paulson.

"I think we need to appoint an oversight board of the most respected people in America, such as maybe Warren Buffett, who's an Obama supporter, Mitt Romney, Mike Bloomberg, so that there can be some kind of oversight of, instead of just putting all this responsibility on a person who may be gone in four months," McCain said.

The Arizona senator also said the bailout should set limits on compensation for chief executives of financial institutions that would be rescued by the federal government.

"No CEO of any corporation or business that is bailed out by us, that is rescued by American tax dollars, should receive any more than the highest paid person in the federal government," McCain said.

Treasury Department staff is working through the weekend with members of Congress and their aides to craft a plan that would absorb bad mortgages and related assets from banks and other institutions to keep the U.S. financial system from collapsing.

Sept. 24 (Bloomberg) -- The $62 trillion market for credit- default swaps, created to protect banks from loan losses, helped fuel a near-meltdown in the financial system and now may be regulated for the first time.

The derivatives precipitated plunges in the shares and debt of Wall Street firms, accelerating the collapse of Lehman Brothers Holdings Inc. and the U.S. takeover of American International Group Inc., the biggest U.S. insurer. Now, regulators want to bring oversight to a part of the credit market that may be more susceptible to manipulation than selling stocks short, according to U.S. Securities and Exchange Commission Chairman Christopher Cox.

Banks ``are suffering the consequences of their own actions,'' said Thomas Priore, chief executive officer of Institutional Credit Partners, LLC, a New York-based hedge fund with $13 billion in assets. ``They created a mechanism through default swaps to reflect a view on credit that has taken on a life of its own.''

The swaps became one-way bets on the demise of financial institutions as traders hedged the risk that their partners might implode, said Gary Kelly, a strategist at broker Tradition Asiel Securities Inc. in New York. The wagers sent distorted signals about credit risk, he said.

The resulting run on shares of financial companies prompted Cox yesterday to seek enforcement powers over the market. New York State will also start regulating some sales of the derivatives, according to Governor David Paterson.

Loan Protection
``The absence of regulatory oversight is the principal cause of the Wall Street meltdown we are currently witnessing,'' Paterson said in a statement Sept. 22.

Banks started buying and selling credit derivatives in the mid-1990s to protect loan portfolios, Andy Brindle, the former head of JPMorgan Chase & Co.'s credit-derivatives group, said in 2003. The International Swaps and Derivatives Association started reporting credit-derivative volumes in 2001, when volume stood at $919 billion.

The contracts trade in over-the-counter deals, leaving each side exposed to the risk their partner will default. There's no exchange or clearinghouse for the swaps and no system for publicly reporting trades.

Credit-default swaps aren't issued or repaid by the companies referred to in contracts. The instruments pay the holder the face value of the amount protected in exchange for the underlying securities if a borrower fails to adhere to debt agreements.

Death Spiral
The market helped set off a death spiral for Lehman and AIG as a jump in the cost of protecting debt, or credit spreads, pushed down their shares. That eroded capital and prompted credit-rating companies to threaten downgrades. Bear Stearns Cos. met a similar fate in March before JPMorgan took the bank over in a rescue orchestrated by the Federal Reserve and Treasury.

Credit spreads were exaggerated as banks and investors hedging the risk of their trading partners defaulting rushed to buy swaps. That sent the price of protection soaring.

``The risk concerns became massively overblown,'' said Tradition's Kelly, who for the past three years made recommendations on stocks based on signals from credit-default swaps. ``Now, the time that the equity market starts heavily focusing on the CDS market, it's probably a period where its reliability is the most questionable.''

`Nonsense' Trades
The difference between the cost at which dealers sell and buy protection on Merrill Lynch & Co., AIG, Morgan Stanley, Goldman Sachs Group Inc. and Wachovia Corp. widened last week to an average of about 63 basis points, compared with 10 basis points the previous week, according to quotes from London-based CMA Datavision. A basis point is 0.01 percentage point.

Trading in the derivatives became ``nonsense,'' Morgan Stanley Chief Financial Officer Colm Kelleher, 51, told investors after reporting third-quarter earnings Sept. 16.

The New York-based securities firm had net income of $1.43 billion in the quarter and reported $175 billion of cash and available equivalents, up from an average of $135 billion the prior quarter. Credit swaps showed a higher risk of default for the broker than homebuilder Lennar Corp., which reported losses in each of the last six quarters.

Credit-default sellers on Sept. 17 demanded as much as $2.1 million upfront and $500,000 a year to protect $10 million in Morgan Stanley bonds from default for five years. The price implied a 65 percent chance the company would go bust within five years, based on a valuation model created by JPMorgan. The cost today was $790,000 a year, implying it has a 50 percent chance of failing.

`No Rational Basis'
The price moves had ``no rational basis,'' and helped touch off a 66 percent slump in his firm's stock last week, said CEO John Mack, 63.

``Why should CDS spreads be having such a big impact on the stocks?'' Glenn Schorr, a UBS AG analyst in New York, wrote in a Sept. 17 report. ``Isn't this a bit disconcerting that the illiquid CDS market, or the rating agencies, can have so much influence on the fate of these companies and alter the landscape of the brokerage industry?''

Merrill Lynch, seeking to prevent itself from being the market's next target, agreed to be bought by Bank of America Corp. last week after credit-default swaps implied a one-in-three chance of default in five years and the shares plunged 31 percent in four days.

`Default Risks'
Morgan Stanley and Goldman Sachs, the last of the five big U.S. investment banks, sought approval to become bank holding companies, allowing them to build deposit bases and move away from a business model that investors had deemed too dependent on borrowed money, or leverage.

Credit-default swap traders shouldn't be blamed for pushing Lehman into its grave, said Tim Backshall, chief strategist at Credit Derivatives Research LLC in Walnut Creek, California.

``A company that relies on short-term funding and high leverage is destined to face higher default risks,'' he said.

Credit-default swap buyers and sellers don't need to own bonds or other debt of the company referred to in a contract. This leads to ``outsized incentives'' for investors to bet on an issuer defaulting, Cox said in Congressional testimony yesterday.

``We are looking at the effects of short-selling'' of shares, he said. ``Greater opportunities for manipulation exist in the CDS market.''

`Ill-Fitting' Regulation
Short sellers borrow shares and attempt to profit by repurchasing the securities later at a lower price and returning them to the holder.

``Proposals which would seek to treat privately negotiated contracts as securities, or otherwise apply ill-fitting regulatory regimes to these agreements, are likely to deter healthy economic activity,'' Robert Pickel, ISDA's CEO, said in a statement yesterday.

Banks face pressure from regulators to create a clearinghouse by the year-end that would back trades between dealers and absorb the failure of a market-maker. New York State also plans to regulate some credit-default swaps as insurance policies after AIG sold protection on more than $400 billion of debt that led to $18 billion of losses in three quarters. New York said its new rules will take effect in January.

``I hope that by then there is maybe even a more holistic solution that we can discuss,'' New York Insurance Superintendent Eric Dinallo said in a Bloomberg Television interview today.

Collateral Demand
The surge in AIG's credit spreads and slump in the shares prompted Moody's Investors Service and Standard & Poor's to cut the insurer's ratings on Sept. 15. That allowed counterparties to demand more than $13 billion in collateral on swap trades and forced the company to cede control to the government in exchange for an $85 billion loan.

``A major part of AIG's problems were created when credit- default swaps were issued by a non-insurance unit that did not hold sufficient reserves,'' the statement from Paterson's office said.

Goldman Sachs, which reported $4.9 billion of writedowns and credit losses the past year, saw credit-default swaps widen to a record 685 basis points on Sept. 17 from 148 at the end of August, suggesting a 45 percent chance of default in five years. The contracts were trading at 390 basis points today after billionaire Warren Buffett said yesterday his Berkshire Hathaway Inc. is buying a $5 billion stake in the company.

Goldman shares fell to as low as $85.88 on Sept. 18 in New York Stock Exchange composite trading, and have since risen back to $133. They're down 38 percent this year. Spokesman Michael DuVally declined to comment.

Taking Cues
Stock investors began taking cues from the derivatives in 2005, when the contracts moved before leveraged buyouts and other transactions were announced, said Tradition's Kelly. When a surge in Bear Stearns's credit swaps preceded its collapse, investors began looking to the market for early signs of stress in other financial companies.

``It's become suddenly a huge focus of the market,'' Tradition's Kelly said. ``Credit issues have really begun to start driving the equity market.''

Lost Trust
Frank Glaser, 75, a retired Hughes Aircraft executive in Los Angeles dumped Wachovia preferred shares he bought in December after asking his broker at UBS where credit-default swaps on the Charlotte, North Carolina, based-company were trading. The derivatives implied a 47 percent chance of default in five years on Sept. 17, the day Glaser sold the shares at a loss, based on the JPMorgan valuation model.

Wachovia is managing through the pressure in the credit markets and is financially sound, spokeswoman Christy Phillips- Brown said. The shares fell to as low as $8.50 last week and closed at $13.80 today.

``We don't trust the rating agencies,'' Glaser said last week. ``Lehman was A2 the day before it went bust, so what have I got to go on? I listen to the president of Wachovia. He sounded like he really knew what he was doing, and I'm reasonably sure he's going to come out of it. But the market doesn't believe him because the credit-default swaps are huge.''

After 7 1/2 years of drift, President Bush has finally returned to his compassionate conservative roots with a heartfelt plea to Congress to help a needy and deserving group: those Wall Street CEOs who, for all their hard work, have been unable to lift themselves up by their wingtips.

Treasury Secretary Hank Paulson (R-Goldman Sachs) made the rounds of the talk shows on Sunday, pleading for financial executives to be allowed to keep their multimillion-dollar compensation packages even if their companies need to be rescued by the $700 billion federal bailout.

"If we design it so it's punitive and so institutions aren't going to participate, this won't work the way we need it to work," Paulson, whose net worth is said to be north of $600 million, told Chris Wallace on "Fox News Sunday." "To have this program work, we don't want to make it punitive and make it difficult," Paulson advised George Stephanopoulos on ABC's "This Week."

It was a message of mercy and humanity -- who, after all, would be so cruel to deny executives their eight-figure bonuses merely because they drove their companies into insolvency? -- and administration officials and Republican lawmakers joined the cause of the unappreciated CEOs.

"While it is very appealing to think about executive compensation as being a part of this, one of the drawbacks to that is perhaps that we would have fewer entities participate in what is essentially a voluntary act," Sen. Mel Martinez (Fla.) said on CNBC yesterday morning. "It should be up to the board of directors of a private corporation to set the compensation of an executive; it shouldn't be Congress's role," Sen. Richard Shelby (Ala.) proclaimed on CBS News.

Bush issued a statement yesterday warning lawmakers not to "insist on provisions that would undermine the effectiveness of the plan," and White House press secretary Dana Perino, asked about Democrats' plans to limit executive compensation, advised them to pass the legislation as Paulson proposed it, "the cleaner the better, and the quicker the better."

Mitch McConnell (R-Ky.), the Senate minority leader, went to the floor to decry those who would make the bailout legislation "flypaper for partisan add-ons."

As it happens, the U.S. Mint held a ceremony at the Lincoln Memorial yesterday morning to unveil designs for a new penny in time for Abraham Lincoln's 200th birthday next year. But at the other end of the Mall, Lincoln's successors in the Republican Party were battling the impression that they were building a government of the plutocrats, by the kleptocrats, for the oligarchs.

Barney Frank (D-Mass.), chairman of the House banking committee, made his way into the House media gallery to face 75 reporters yesterday afternoon. The hard-hearted chairman hitched up his trousers, took his seat, and showed no remorse toward the CEOs who stood to lose so much. "The Endangered Species Act apparently does not apply to financial institutions," he joked, cruelly. He vowed, callously, that there will be "no golden parachutes while we are the owners" of Wall Street firms' bad debts.

"It's inconceivable that people would say the taxpayer should put some money at risk because of bad decisions made by people who would then continue to be rewarded without any restriction and, in fact, would be rewarded for their mistakes," the merciless chairman argued.

He then cynically turned Paulson's defense of the Wall Street executives upside down. "Let me defend CEOs against Hank Paulson's attack on them," Frank said with feigned sincerity. "Here is this absolutely essential program that's needed to keep the economy going, but there are CEOs who won't participate in it if a few of their many millions are going to get nicked? That's really what he's saying, that some CEOs put their ability to get unrestricted excessive compensation, including rewards for failure, over and above trying to cooperate and help the economy. If that's true, we're in worse shape than we think."

It was a brazen attempt to exploit the suffering of the CEOs, but it was irresistible to Frank's fellow Democrats.

"If you're taking a federal dollar to bail yourself out, you ought to get a federal salary," Sen. Jim Webb (Va.) said on the Senate floor. "It is wrong to have executives who have created all kinds of problems and cost the taxpayer millions, if not billions, then walk away with golden parachutes," Sen. Chuck Schumer (N.Y.) told MSNBC.

Confronted with such demagoguery, the Republicans by day's end were beginning to falter in their compassion for the struggling CEOs. After Republican presidential nominee John McCain came out against golden parachutes for bailed-out executives, Rep. Louie Gohmert (Tex.), talking with fellow opponents of the rescue plan, told The Post's Paul Kane that golden parachutes are "repugnant."

After a meeting with the Senate banking committee chairman, Chris Dodd (D-Conn.), Sen. Bob Corker (R-Tenn.) was ready to sacrifice the needy CEOs on the altar of expediency. "There are things sometimes one has to accept to reach a solution," he told The Post's Lori Montgomery.

Even Martinez, who only hours earlier was on television defending the CEO pay provisions, was now of the opinion that "there needs to be some language involving executive compensation."

The uber-capitalists of Wall Street are all socialists now. Free- market ideology, it turns out, doesn't pay the mortgage. That appears to be a job for, ahem, Big Government.

Let's be clear about why we're facing a crisis that could pull down the global financial system. The irresponsibility of individuals who bought houses they couldn't quite afford pales in comparison with the irresponsibility of the financial wizards who built on those shaky mortgages a towering edifice of irrational faith. Someone in the government should have looked at all those trillions of dollars' worth of mortgage-backed securities and collateralized debt obligations and credit default swaps and demanded that Wall Street prove that all, or even most, of this purported money was real. But we're in the eighth year of the Bush administration; adult supervision left the building long ago.

Now that the whole highly leveraged structure is threatening to fall, some kind of government bailout is necessary and inevitable. But Congress shouldn't approve Treasury Secretary Henry Paulson's $700 billion rescue plan without insisting on some measure of equity and accountability.

See, neglecting such details as equity -- in both senses of the word -- and accountability is what got us here in the first place.

Congress should have learned by now what happens when this administration is given a blank check. Unlike the run-up to the Iraq war, at least this time there's a genuine emergency -- we came within a whisker of a financial meltdown last week, and we're still way deep in the woods. No one thinks that delay is an option.

Not Barack Obama, who introduced legislation in 2006 to address lax mortgage lending and in March proposed a new regulatory framework for the financial markets. Not John McCain, who has been all over the map. Within one week, McCain has gone from saying the "fundamentals of the economy are strong" to declaring that "we are in the most serious crisis since World War II."

But first we need to be convinced that Paulson's proposal -- have the government purchase the bad debt -- is the best thing to do. Not all economists believe it is, although it's true that if you put six economists in a room, they'll come up with seven sharply differing, strongly held points of view about the time of day. Assuming that Paulson's plan is deemed workable, the "details" yet to be worked out involve staggering amounts of money. Hedge funds apparently don't qualify for relief, but what about insurance companies that branched out into exotic mortgage-backed investments? What about foreign banks with big U.S. operations?

Clearly there has to be some definition of just who is covered, and there has to be some oversight. And now that the government has nationalized Fannie Mae and Freddie Mac, who's going to run those still-vital institutions? Who's going to run the giant insurance company AIG, which was effectively nationalized last week?

Maybe Congress can insert a provision that broadly insists on the principle of oversight and leaves the particulars to be worked out later. But it would be unconscionable for Congress to absolve a bunch of wealthy financiers of the consequences of their bad decisions and not do the same for homeowners who showed similarly poor judgment. Paulson has indicated his awareness that this is, indeed, an election year -- and that members of Congress are not eager to go home to their districts and explain why Wall Street's pooh-bahs get to keep their mansions and their yachts while working-class families lose their modest homes.

The more contentious issue is the idea, supported thus far mostly by Democrats on Capitol Hill, that there should be salary caps for executives of companies that take advantage of the government bailout. Paulson complains that this will provide a disincentive for companies to participate in the program -- whatever the program turns out to be -- but it seems to me to be a reasonable idea, and a winner politically.

Why shouldn't the executives who put their companies at risk by making unwise investments pay a price for their lack of prudence?

We can't just let the system collapse -- nobody wins in that event. But I thought one of the fundamental tenets of capitalism was a direct relationship between risk and reward. The Masters of the Universe who created this mess ought to share the pain of cleaning it up.

The dollar took its steepest one-day drop in years as the financial crisis eroded the nation's basic measure of value, helping to drive U.S. stocks sharply lower and the dollar-based prices of oil and gold sharply higher.

The convergence of negative sentiment came as investors focused on the uncertainties in the Bush administration's emergency plan for a massive bailout of the financial system, outlined this weekend. Indications yesterday that the administration would need more time to iron out a compromise with Congress raised questions about what the plan will ultimately look like, even as investors tried to assess how and whether it would work.

New concerns also emerged over the toll the crisis will take on the U.S. economy, with many analysts saying the slowdown could worsen, perhaps costing more jobs and hurting consumers.

The government's plan to spend up to $700 billion to take troubled assets off the books of ailing firms and billions more to guarantee money-market mutual funds will force the Treasury to add to the already massive national debt. It may have to raise that money by selling more Treasury bills and perhaps even printing more dollars. That, economists said, could trigger higher inflation and drag down the economy further.

The dollar yesterday plunged 2.2 percent against the euro -- its biggest one-day fall since January 2001. Some analysts predicted that if the dollar continues its dramatic tumble, the Bush administration would seek the assistance of foreign central banks to prop it up.

The steep drop was partly behind Monday's surge in the price of oil -- denominated in the U.S. currency -- its biggest one-day jump ever in dollar terms. The price of the benchmark crude oil catapulted to $120.92 a barrel on the New York Mercantile Exchange, a $16.37 increase. At one point, the price was up $25.55.

"This is a revaluation of the U.S.," said C. Fred Bergsten, director of the Peterson Institute for International Economics and a top Treasury Department official during the Carter administration. "Growth is going to be slower, the budget deficit higher, but mostly, the whole U.S. financial system has been thrown into question. People around the world are looking at this and saying, 'Holy Toledo.' "

The realization that the United States may find itself in worsening financial straits with or without a bailout sparked a sell-off on Wall Street. The Dow Jones industrial average fell 372.75 points, or 3.27 percent, to close at 11,016. That wiped away Friday's nearly 400-point rally that accompanied the initial unveiling of the Bush administration plan. The technology-heavy Nasdaq composite index fell 94.92, or 4.2 percent, to close at 2179. The Standard and Poor's 500-stock index was down 47.99, or 3.8 percent, to close at 1207.

The size of the bailout, analysts said, has focused attention on just how much debt the United States can handle without being forced to raise taxes or make sharp cutbacks in government spending. Peter Schiff, president of Euro Pacific Capital, said the fear of inflation provoked by the $700 billion plan -- without figuring out a way to pay for it -- was behind the market's dramatic movement.

"Where's the tax increase to fund this bailout? Where is the cut in programs? The government's not doing either -- they're just going to print money," he said. "And if you think inflation is the answer, take a trip to Zimbabwe and see how it's working for them."

He added that the new rules imposed on short selling, short-term bets that a stock's price will go down, caused a flow of money into commodities besides oil, including gold. "You can't short stocks anymore, right? So if you want to bet against the market, you need to buy commodities: gold, oil," he said.

As the market gyrations left many investors wondering what would happen next, major credit-rating agencies issued statements rejecting the notion that the AAA rating of the U.S. government might be immediate danger. Yet analysts acknowledged it was a valid question.

"This is arguably a critical question given that the U.S. Treasury's Aaa rating acts as the cornerstone of risk pricing in the global financial system," said Pierre Cailleteau, managing director of the sovereign risk unit at Moody's Investors Service and author of a report issued yesterday on the U.S. credit rating.

A loss of that status would probably mean that the United States would have to pay more to those investors, including foreign governments, that hold U.S. bonds. But the report said, "Moody's continues to view the foundations of the U.S. government rating as unshaken."

Similarly, John Chambers, a managing director at Standard and Poor's, said he viewed the United States as stable. Although some have drawn parallels between the current financial woes and those in Japan, which lost its AAA credit rating in 2001, Chambers said the United States has far greater ability to meet its obligations.

He noted that before Japan lost its AAA rating, its general government debt was more than 100 percent of its gross domestic product. By contrast, even figuring in "every last nickel" of the proposed U.S. bailouts, general government debt in the United States falls below 60 percent of gross domestic product, he said.

One key question for investors and multilateral lenders is how the U.S. bailout plan will treat foreign investors in troubled mortgage-backed securities. "A substantial amount of these securities are held by non-U.S investors," said John Lipsky, first deputy managing director of the International Monetary Fund. "Obviously, the disposition of the U.S. [toward these investors] will be important to determining future attitudes about investing in the U.S. versus elsewhere."

Foreign governments and multilateral lenders have been offering advice to the U.S. government as it moved in recent weeks to take over some financial institutions while allowing others to fail. The IMF has been subtly calling on the United States to take a broader approach to the financial crisis, and officials there applauded the administration's efforts in recent days to launch a more comprehensive plan to address core issues.

"Obviously, these events have been striking and potentially very troublesome, but the remedial actions being taken, if done right, will help to restore any confidence that might have been lost," Lipsky said.

As investors await final details of the financial rescue plan, some analysts noted that it will not address some of the economy's fundamental weaknesses, including poor housing prices and growing unemployment figures.

"With talk of the government buying assets at steep discounts and of an emphasis on taxpayer protection, the benefits to bank and thrift capital levels may be less than the market anticipates," Paul J. Miller Jr., an analyst with Friedman, Billings, Ramsey, said in a research note yesterday. "At this point, we just do not know. While the plan will most likely help, banks and thrifts still need to raise capital."

It is also unclear whether the $700 billion will be enough. Will banks be forced to open their books to their public, and how will their bad debt be evaluated? "It's not clear who is going to be allowed to participate," said Joseph Brusuelas, chief U.S. economist at Merk Investments. "How much will each individual bank be allowed to dump on the public?"

LAST THURSDAY, the top economic policymakers in the United States told congressional leaders that the financial system was only days away from a catastrophic failure -- and that the only hope was an immediate, massive government bailout. Congress agreed in principle, buoying financial markets. But five days later, the specifics of the rescue legislation remain undecided. Two of yesterday's market events -- a 372-point drop in the Dow Jones industrial average and a $16-per-barrel jump in the price of oil -- show just how rapidly the clock is ticking.

Congress and the Bush administration generally agree that the government should buy up the toxic mortgage-backed securities that are spreading losses and destroying the confidence essential for debtors and creditors to function. This taxpayer-funded bailout is not necessarily the only conceivable approach or even the most efficient one. Quite possibly, it would have been wiser instead to inject government capital directly into banks so they would be better able to work out problem assets on their own. But for better or worse, that option is off the table, and the question is how Uncle Sam can most effectively take on as much as $700 billion worth of bad debt. The basic tradeoff here is between speed and flexibility on one hand and oversight and accountability on the other.

Treasury Secretary Henry M. Paulson Jr. clearly believes that the way to get the maximum number of financial institutions to unload as much distressed paper as possible, as quickly as possible, is to keep it simple: announce that the U.S. Treasury is open for business and let the fire sale begin. That is essentially what he advocated when he asked Congress for the power to purchase troubled mortgage-backed assets from financial institutions at whatever price he and hired experts saw fit, with only minimal congressional supervision and complete immunity from lawsuits.

The problem, of course, is that this raises the risk that the government will get fleeced by the debt-sellers, raising the ultimate cost to taxpayers. It was also politically unrealistic, in that members of Congress were quite properly concerned that financial institutions accept limits on executive compensation in return for their federal lifeline. There was no provision in Mr. Paulson's proposal for taxpayers to enjoy any of the profits that financial institutions may enjoy once they have been restored to health. A new proposal by Senate Democrats seeks to correct this by requiring would-be asset-dumpers to give the government equity if Uncle Sam winds up having to sell the paper at a loss. Of course, at the margin, the proposal could deter some firms from ridding themselves of the bad loans in the first place. And that would slow the process. Democrats are also insisting on various forms of mortgage relief for the homeowners who are about to find themselves in debt to Uncle Sam. Mortgage relief might help stabilize home prices, but since the government would now own so many mortgages, taxpayers (most of whose mortgages are not in trouble) would have to foot the bill once again.

A little delay was both inevitable and desirable. Congress cannot write a $700 billion check with no questions asked. But speed and focus are still of the essence, and leaders in both parties must not use this crisis as an opportunity to refight all the political battles of the past year. They should treat it as what it is: a chance, possibly the last chance, to keep the U.S. financial system from collapsing.

As economists puzzle over the proposed details of what may be the biggest financial bailout in American history, the initial skepticism that greeted its unveiling has only deepened.

Some are horrified at the prospect of putting $700 billion in public money on the line. Others are outraged that Wall Street, home of the eight-figure salary, may get rescued from the consequences of its real estate bender, even as working families give up their houses to foreclosure.

Most economists accept that the nation’s financial crisis — the worst since the Great Depression — has reached such perilous proportions that an expensive intervention is required. But considerable disagreement centers on how to go about it. The Treasury’s proposal for a bailout, now being negotiated with Congress, is being challenged as fundamentally deficient.

“At first it was, ‘thank goodness the cavalry is coming,’ but what exactly is the cavalry going to do?” asked Douglas W. Elmendorf, a former Treasury and Federal Reserve Board economist, and now a fellow at the Brookings Institution in Washington. “What I worry about is that the Treasury has acted very quickly, without having the time to solicit enough opinions.”

The common denominator to many reactions is a visceral discomfort with giving Treasury Secretary Henry Paulson Jr. — himself a product of Wall Street — carte blanche to relieve major financial institutions of bad loans choking their balance sheets, all on the taxpayer’s bill.

There are substantive reasons for this discomfort, not least concerns that Mr. Paulson will pay too much, thus subsidizing giant financial institutions. Many economists argue that taxpayers ought to get more than avoidance of the apocalypse for their dollars: they ought to get an ownership stake in the companies on the receiving end.

But an underlying source of doubt about the bailout stems from who is asking for it. The rescue is being sold as a must-have emergency measure by an administration with a controversial record when it comes to asking Congress for special authority in time of duress.

“This administration is asking for a $700 billion blank check to be put in the hands of Henry Paulson, a guy who totally missed this, and has been wrong about almost everything,” said Dean Baker, co-director of the liberal Center for Economic and Policy Research in Washington. “It’s almost amazing they can do this with a straight face. There is clearly skepticism and anger at the idea that we’d give this money to these guys, no questions asked.”

Mr. Paulson has argued that the powers he seeks are necessary to chase away the wolf howling at the door: a potentially swift shredding of the American financial system. That would be catastrophic for everyone, he argues, not only banks, but also ordinary Americans who depend on their finances to buy homes and cars, and to pay for college.

Some are suspicious of Mr. Paulson’s characterizations, finding in his warnings and demands for extraordinary powers a parallel with the way the Bush administration gained authority for the war in Iraq. Then, the White House suggested that mushroom clouds could accompany Congress’s failure to act. This time, it is financial Armageddon supposedly on the doorstep.

“This is scare tactics to try to do something that’s in the private but not the public interest,” said Allan Meltzer, a former economic adviser to President Reagan, and an expert on monetary policy at the Carnegie Mellon Tepper School of Business. “It’s terrible.”

In part, Mr. Paulson’s credibility has been dented by his pronouncements in previous weeks that the crisis was already contained. Some suggest this was a well-intentioned effort to stem panic. But the aftermath complicates his quest for the bailout.

“If you view your public statements as an instrument of policy, people don’t believe you anymore,” said Vincent R. Reinhart, a former Federal Reserve economist and now a scholar at the conservative American Enterprise Institute.

The biggest point of contention is over whether and how taxpayers would benefit if the bailout succeeded in righting the financial system, sending banking stocks upward.

In Mr. Paulson’s plan, the Treasury would have the right to buy as much as $700 billion worth of troubled investments, with the taxpayer recouping the proceeds when those investments were sold over coming years. But many economists — Mr. Elmendorf among them — argue that taxpayers should get more out of the deal, securing stock in the banks that make use of the bailout. The government could then sell off that stock at a profit when conditions improve. A similar approach was used successfully in Sweden in the early 1990s when its financial system melted down.

Others argue that any bailout must pinch the people who have run the companies now needing rescue, along with their shareholders, addressing the unseemly reality that executives have amassed beach houses and fat bank accounts while taxpayers are now stuck with the bill for their reckless ways.

“It absolutely has to be punitive,” Mr. Baker said. “If they sell us the junk, then we own the company. This isn’t a way to make these companies and their executives rich. This should be about keeping them in business so the financial system doesn’t collapse.”

Other questions center on how to value what the Treasury aims to purchase — an issue that goes to the heart of the crisis itself.

The financial system got to its dangerous perch by betting extravagantly on real estate. When housing prices began plummeting and borrowers stopped making payments, financial institutions found themselves with huge inventories of bad loans. Not simple loans, but complex investments created by pooling millions of mortgages together and then slicing them into pieces. These were the investments that Wall Street bought, sold and borrowed against in cooking up the money it poured into housing.

The trouble is that these investments are so intertwined and complex that no one seems able to figure out what they are worth. So no one has been willing to buy them. This is why banks have been in lockdown mode: with mystery enshrouding both the value of their assets and their future losses, banks have held tight to their remaining dollars, depriving the economy of capital.

Now, the Treasury aims to clear the fog by buying up these investments. But their value is as mysterious as ever.

“There’s a tendency for people to think these are stocks and bonds and you know what the price is,” said Bruce Bartlett, a former White House economist under President Reagan. “The problem is people are operating in a world in which nobody knows what the hell is going on. There’s some naïve assumptions about how this would function.”

If Mr. Paulson pays the market rate — whatever that is — that presumably would not be enough to persuade banks to sell. Otherwise, they would have sold already. For the plan to work, Treasury has to pay a premium.

“It’s a straight subsidy to financial institutions,” said Martin Baily, a former chairman of the Council of Economic Advisers in the Clinton administration, and now a senior fellow at the Brookings Institution. “You’re essentially giving them money.”

Mr. Baily favors the basics of the Paulson plan, albeit with some mechanism that would give the government a slice of any resulting profits. And yet he remains troubled by the dearth of information combined with the abundance of zeroes in the bailout request.

“I’d like a clearer statement of what we were afraid was going to happen that requires $700 billion,” Mr. Baily said. “Maybe they don’t want to talk about it because it would scare everybody, but it’s a bit much to ask.”

Big City firms which encourage traders to take too many risks to win their annual multimillion pound bonuses could face stiff penalties from the Financial Services Authority.

The City regulator could demand financial firms put aside a bigger capital cushion if their pay schemes incentivise traders to take short-term risks that could backfire in the longer term.

Bonuses are paid annually, sometimes before it is clear whether traders' bets have paid off or proved disastrous. Trading losses have contributed to the demise of leading firms such as Lehman Brothers, mired in controversy as its Wall Street staff seem likely to receive their bonuses after being taking over by Barclays.

Chancellor Alistair Darling yesterday put the onus on the FSA to tackle "the culture of huge bonuses" in the City.

"It's essential that bonuses don't result in people being encouraged to take on more and more risk without understanding the damage that might be done, not just to their bank but to the rest of us in the wider economy," Darling told the Labour conference.

The authority has begun scrutinising bonus policies during its regulatory visits. But the unions yesterday called on the chancellor to take direct action through taxation. Derek Simpson, leader of Unite, spoke of a "powerful mega elite with no connection to ordinary people, an amoral class without a care for how their reckless behaviour is now wrecking lives. If you can't regulate the bonus culture, then tax it out of existence."

The FSA does not intend to regulate individual bonuses, but pay deals will be analysed as part of the risk assessments of firms it regulates. A spokeswomen said: "What might happen if we don't like [what we find]? If we believe the pay deal creates additional risks, we could make a requirement to put more capital aside."

Hector Sants, the FSA's chief executive, has been warning City firms since the spring that the regulator is playing close attention to the way they pay their staff.

But Peter Hahn, banking specialist at the Cass business school, warned against scrutiny of the bonus pool, and instead urged the FSA to focus on senior executives. "If the top five people are paid the right way, so will the rest of the organisation. If the chief executive isn't incentivised for traders to take risk, the traders won't take risks," said Hahn.

In the US, the debate is also raging. John McCain has unexpectedly backed calls by Democrats for a cap on executive pay at struggling banks. Citing large salaries at Lehman as an example of unacceptable conduct, he suggested institutions benefiting from a bail-out by taxpayers should have their salaries capped at $400,000.

"No CEO of any corporation or business that is bailed out by us, that is rescued by American tax dollars, should receive any more than the highest-paid person in the federal government," the Republican presidential candidate told CNBC. The highest paid individual in the US government is George Bush, who earns $400,000.

The Democrats are fighting to insert a pay cap in legislation for the treasury's $700bn fund to buy up banks' distressed securities. They argue that huge pay linked to profits created perverse incentives for bankers to take bigger short-term risks.

But treasury secretary Hank Paulson is resisting these efforts, seeing them as a sideshow which could delay the bill.

"There have been excesses. I agree with the American people - pay should be for performance, not for failure," said Paulson; but the bail-out urgently needed to be passed in simple form and remuneration reforms should come "afterwards".

AIG boss forgoes payoff
Robert Willumstad, the outgoing head of the stricken insurance company AIG, has voluntarily forfeited a $22m (£12m) severance package after being in effect sacked from his job as part of a bail-out by the US treasury. AIG's board decided that he was entitled to the money under his contract, which was drafted in generous terms just three months ago. But in an email to his successor, Edward Liddy, he wrote: "I prefer not to receive severance while shareholders and employees have lost considerable value in their AIG shares." AIG was kept afloat last week through an $85bn US treasury loan; the government will take an 80% stake in AIG in return.

The stratospheric pay packages of Wall Street executives have become a lightning rod issue as Congress shapes a $700 billion bailout for financial firms. Proposals circulating on Capitol Hill vary, but they all would impose some limits or approval authority on salaries of executives whose firms seek help.

The moves in Washington mirror the popular outcry — in constituent e-mail messages and postings in the blogosphere — over the prospect of Wall Street’s tarnished titans walking away with tens of millions of dollars a year while taxpayers pick up the bill.

But Wall Street, its lobbyists and trade groups are waging a feverish lobbying campaign to try to fight compensation curbs. Pay restrictions, they say, would sap incentives to hard work and innovation, and hurt the financial sector and the American economy.

“We support the bill, but we are opposed to provisions on executive pay,” said Scott Talbott, senior vice president for government affairs at the Financial Services Roundtable, a trade group. “It is not appropriate for government to be setting the salaries of executives.”

Yet some formal restraint on executive pay seems unavoidable, even sensible, some finance experts and economists said.