If PE firms are so bad, and you outlaw them, then would this bakery have just gone into Chapter 7 (liquidation)?

I thought the PE firms (bad as they seem to be) only existed because there were distressed businesses that were going to fail totally.

Granted maybe the way of the future is for the Government to take over all businesses that are failing like GM and Chrysler, but I thought that was the exception since they were so big.

When I used to work in commercial construction, for example, one company I worked for had at least two legal personae at any given time. One was a development/management company that took out loans to build shopping centers and office parks on land it owned in areas that already had too many of both. The other was a general contracting and construction management firm that got the contracts to build the buildings for the development firm.

The development firm would take out a monster construction loan from a bank and hire the general contracting firm. It would pay out the loan money to the general contracting firm as the buildings were built, in a series of draws.

When all the money was drawn and the buildings were finished, the general contractor’s connection to the project was over. It had fulfilled its obligations and been paid for its work in accordance with contracts approved by the bank.

The development/managment firm was now supposed to lease the space or sell the buildings in order to retire the debt and make a profit of its own. But sadly, there were, as I said, already too many commercial buildings lying vacant. The development company invariably defaulted on the loan without ever renting a unit and went bankrupt.

This was called “selling a project to the bank,” and it was this particular firm’s only business at the time I worked for them. Bizarrely enough, the bank as often as not hired the general contracting firm–which was, of course, the real company–to maintain the vacant property while the bank/s sought tenants or buyers. They did this again and again until one of their lendors–a notorious saving and loan–got seized by the feds. Some other, more ovbviously illegal irregularities came to light and that was that.

Think of these guys as pimps; money is the whore they pimp out.
But once credit derivatives and huge leverage came along, simply pimping out companies wasn’t good enough for them anymore; now, they leverage at odds as high as 30:1, knowing that if they lose we’ll cover their sorry asses.

There was a time when hedge funds probably served some very sound economic purposes in the process of wealth creation; however, with the emergence of tools like credit derivatives as a tool for hedging, they’ve gone completely out of control.

When leverage ratios became unstable (as high as 30:1) their activities turned radically predatory and destructive. No economic system can afford to pay out the equivilent of $29 on a $1 bet and remain functional for very long. But that’s the leverage ratio these guys were using, and that’s the ratio that our TARP funds were expected to cover in terms of ‘lost bets’.

Once derivatives came into the picture, their role of hedge funds in wealth creation was severely undermined by what can only be called their phenomenal, enormous ability to radically destabilize economic systems. Any system that costs you 29 to 1 is going to be catastrophic in a very rapid period; we’ve seen how destabilizing this has become in the complete absence of any form of regulatory oversight.

George Soros has recommended that government regulate CREDIT as well as MONEY SUPPLY. If that occurred, then hedge funds might be useful again.

At the moment, they’re become a threat to economic stability.
The wackier the leverage ratios, the more destabilizing they are to the larger economic system.

Just because these guys are socially well connected doesn’t mean they’re not assholes.

Hedge funds were not always evil, but after the late 1990s changes (that Sen Phil Gramm, R-Tx shepherded through the Senate) which Clinton signed off on, and which accelerated under BushCheney, the hedgies had access to global money, with no oversight, insane leverage, and new tools like CDOs. Basically, Congress designed economic vampires under the guise of ‘banking reform’.

Oh, BTW: in the Bronze Age, when a slave died, the chains were sent back to the forge to be remelted. The chains were sold at a higher value than the slave.

Not too much has changed in 3,000 years.

hey are also highly leveraged and have gotten hammered as the value of their holdings has plummeted along with everything else in the economy. In fact, if you could look at their books, they are, like so many other players in the financial system, insolvent.

This is also my understanding. And IMVHO, it bears plenty of repetition so the basic concept sinks in: they’ve borrowed money to buy things, gambling that we will bail them out. What part of this does Congress seem unable to comprehend…?

Take for example a time not so long ago – the 2000s – when the financial sector was go go go and ordinary manufacturing was passe. A PE firm does a LBO of a manufacturing concern, does it’s thing and sells off a skeleton. In the end they make money because they’ve gotten rid of a skeleton and produced lots of cash capital which can be invested in CDOs and maybe firms invested overseas — more profitable places.

The value of capital varies over time.

LBO: Buy a company with borrowed money.
Take everything of value (and give it to the LBOer), sell off parts, etc.
Then let the company go bankrupt…taking it’s debts to the grave.

How does the company’s owner not owe the debt?

THAT looks like something which would need to be illegal. It actually sounds a lot like the off-the-books financial entities created by Enron. They pushed debts off the books, so the company looked more valuable. That made it’s stock price soar and that enriched the top officers who had stock options.

I don’t condone vulture/destructive capitalism, but good uses of capital are something we need just now.

In an LBO situation the new owner generally strips the company of expenses, perhaps sells off less profitable parts and then tries to sell what remains back into the market as somehow a better company.

In a CDO situation a bunch of junk is packaged with good stuff and rated as AAA when in fact it isn’t. Then they sell the CDO to someone unawares of it’s true value.

In both cases they sell something as valuable when in fact it’s something else. The reasons these techniques work are somewhat different from one another.

A long time ago firms stopped offering dividends to keep capital for investment. Stock holders assumed the resulting company was worth more and the share price went up. The question was always whether the use of that capital was really going to be useful at that time in those market conditions. In the computer industry it usually did. In utilities or transportation it might not have been.

A CDO was simply based on a lie and the buyers were either blind or looked the other way. They thought they could sell it to another ‘greater fool’. After the housing crash it became apparent to everyone looking on that the toxic assets weren’t worth so much (perhaps 10%-50% of their face value) and that made the company’s worth much less. Naturally the stock value dropped.

One speculation/investment and the other a lie/speculation.