Floyd Norris has a good piece for people like me who were wondering how so many public companies could suddenly become hugely profitable when they are taken private. The answer is debt. The private equity funds borrow to the hilt against the companies' assets and then pay out huge "dividends" to themselves. This gives the private equity funds a quick payback, it allows the company to deduct the interest on the debt, and leaves ill-informed bondholders with the risk that the company won't make enough to pay back the bonds. It has been widely reported in the business press that spreads between safe bonds (e.g. government debt) and highly risky bonds have collapsed. This creates a great opportunity for private equity managers to make a fortune. The trouble will be for the holders of the bonds, who apparently don't recognize the risk they are taking. (Unfortunately, the ill-informed investors are often people who get paid a lot to manage other people's money, for example pension fund managers.) The workers who may lose their jobs as heavily leveraged companies lack the money to invest and remain competitive are also potential losers in this story, as is the economy as a whole, with massive amount of resources being devoted to financial arbitrage rather than productive investment. After the collapse, we will not doubt read many good analyses of the situation from the "who could have known" school of economics.
--Dean Baker
