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Global situation: Private equity borrowing no problem, regulators back off

By Paul Wallis     Jul 25, 2007 in Business
Australian regulators have been faced with the same problem as the rest of the world. Private equity is moving in. It’s buying up big, and it doesn’t work like the corporates, and isn’t regulated.
That’s having an impact as leveraged buyouts sniff around some of Australia’s larger corporations. Australia’s regulators, like most of the world’s, have taken the softer option of not doing very much. The Sydney Morning Herald has come up with some interesting figures, but there’s a bit more to it than a feeling of general benevolence to private equity investors.
This is an interesting example of regulators ducking an issue they know they can't handle. As the article says, private equity, when borrowing for acquisitions, is subject to official scrutiny, but the sort of scrutiny which is really no more than a watch on viability. Their creditors, naturally, watch the figures. Basic business practice, and that’s seen to be enough.
Further to this situation, private equity is taking up where the hedge funds left off. Private capital is now bigger than ever, and doesn’t have to play by the same rules as corporate takeovers, or even the hedge funds. According to the article, leveraged buyouts totaled $800 billion US globally last year. That’s seen as a small percentage of the global market.
It’s also a lot more than it was a couple of years ago. $800 billion relative to some lenders is a lot of cash, and it’s supposed to translate into viable assets as collateral. If it doesn’t, there could be more than a little wistful smile among some of the lenders.
Relative to the Australian economy, it’s about a year’s GDP. We’re as exposed to the global lending market as anyone, perhaps slightly more so because our financial institutions have to go offshore to access the big capital. In the US, lending is currently a messy issue, thanks to the housing bubble.
Point being that the amount of actual borrowing is very high. Add private equity borrowings to the fact of a global economy living on a credit card, and the picture gets a little less enchanting. In some ways this is a bit like the 80s approach to borrowing, and that was a real mess. In the 80s the idea was that you bought something and then just wrote up the asset value.
It didn’t work, but it’s still the preferred way of making a profit on assets, and the same sort of methodology that drives runaway housing prices. In the corporate sphere, rewriting assets relative to debts, and borrowing relative to those assets was partly what killed Enron. Looked good on paper, no basis in fact. Private equity, with a bit of similar stupidity, could do the same thing.
There’s one thing that makes private equity a bit different, though. The money is private. Where 401k funds might be blasé about their investments, and just trust the indices to keep them making a profit, private money is a lot tougher. They couldn’t be said to be passive investors. Ironically, stock values matter a lot to them, being the real value of their investments and the collateral for their loans in some cases. In that sense they can create a check on some of the less adorable corporate malfeasances.
Nobody can pass a law saying people can’t borrow and invest. That part of the decision not to regulate does make sense. However, if lenders get lumbered with $800 billion a year of new debt, something’s going to happen to interest rates if the loans don’t perform.
If you watch the markets, watch this, and see if you can keep count of the number of regulators who don’t want anything to do with private equity.
More about Private equity, Regulation, Global lending