Wednesday, 29 October 2008

So farewell, leveraged buy out loans

It wasn't just the housing market where banks were injecting silly amounts of money without fully understanding the risks. The leveraged buyout business was another favourite for reckless bankers.

The idea of a leveraged buyout is straightforward. A speculator raises huge money, either by issuing junk bonds or taking out loans, and then uses the money to take over a controlling interest in a target company. The speculator doesn't actually put up much of her own money -hence the title leveraged. Therefore, the speculator needs a ready source of credit. Until the credit crunch rolled into town, banks have been all too ready to provide money for these highly risky projects.

The leveraged buyout business has a long and grim history of financial failures. Towards the end of the 1980s, many buyouts proved to be highly unprofitable, leading to a number of horrific bankruptcies.

The chart above illustrates the explosive growth of leveraged buyout loans. In order to make the years comparable, the half yearly amounts have been inflation adjusted. The business peaked during the first half of 2007, and it has been sliding ever since. The stock of new loans during the first half of 2008 has fallen back to the level of 2004. It is likely that the market will have totally evaporated by the end of this year.

Leveraged buyout loans raises an old issue - bank supervision. Why did regulators allow banks to get involved in such a dangerous business?


vodka drinker said...

Another win for the FSA and its light touch regulation.

Anonymous said...

Like the Foxtons buy-out best. £390 million, of which £260 million bank loans

Anonymous said...

Hi Alice - Thanks again.

Something bothered me today. We were told in the media for several days that the most recent downward movements in the stock markets had to do with hedge funds who were being forced to sell at any price by withdrawals. Then we here that hedge funds have lost $18 billion by shorting Volkswagen while Porsche were buying up all the cheap VW stock they could.

That looks like a comprehensive manipulation of the markets and media by some clever hedge funds to me - a media-accepted and promulgated story of hedge fund catastrophe, lapped up universally, while hedge funds were using the rumour to short stocks and make yet more killings at the expense of serious stockholders and gamblers alike.

What do you think?


B. in C.

Anonymous said...

Sitting on all that depositors' money + economic rents from big deals thanks to big bank oligopolies + too big to fail + the discovery by US banks that there are dumb hicks with cash in other countries too.

Alice Cook said...

B. in C.

I'm a very poor judge of this kind of thing. I get all my "market information" from the web.


seema said...

Another bubble explodes....

Nick von Mises said...

B in C - I haven't read up much on the VW trade but wasn't it the hedgies who got taken by Porsche, not the other way around?

Alice - Didn't you get the memo? "leveraged buy out" is such a vulgar term. We use "private equity" now. It sounds much nicer.

Anonymous said...

NIck, Yes, of course. My point is that the hedgies may have been shorting stock as a general strategy, seeking to push down the whole market, not realising that a single buyer was taking many VW trades because of a 'takeover' strategy. The hedge-funds got taken by their own trap through lack of intelligence (pun intended). B. in C.