The Next Credit Crisis Will Involve Private Equity, Says Author Josh Kosman

As the nation struggles to endure the financial crisis -- with rising foreclosures and increased unemployment threatening to prolong the devastation -- another meltdown looms around the corner.

The next credit crisis may be caused by private equity companies, which bought over 3,000 companies this decade by forcing them to take on enormous amounts of debt, argues financial reporter Josh Kosman, the author of "The Buyout of America: How Private Equity Will Cause the Next Great Credit Crisis."

Almost one in 10 nongovernment employees works for a company owned by a private equity firm, and many of them could find their jobs in jeopardy if their employers can't pay back the loans.

"Private equity firms bought thousands of companies this decade using the same cheap credit that fueled the subprime mortgage crisis and that debt is coming due in the next few years," Kosman tells HuffPost in an extended interview, citing Chrysler and Simmons Mattress as two recent examples.

Though private equity leaders like Stephen Schwarzman of Blackstone insist that "the worst is behind the industry," six of the ten companies acquired by PE firms in the biggest buyouts of the last decade are already considered distressed by Moody's. Looking ahead, between 2011 and 2014, almost half a trillion dollars in leverage buyout debt will mature.

Those numbers are fiercely disputed by the industry trade group, the Private Equity Council, which says that half of the defaults described by Moody's are not traditional defaults, but rather opportunistic transactions to deleverage companies.

The potential dangers of private equity acquisitions are due to the risky methods they use, says Kosman:

"They're playing with other people's money -- putting 20% down, and company they buy is borrowing 80% -- in that sense, there's already little risk [for the private equity firm]. Apollo doubled its money in two years while driving Linens N' Things into bankruptcy. Most of the risk comes from other investors like state pension funds, some of which are really exposed to private equity investments - Oregon has 22% exposed, California is 14%."

The biggest leveraged buyout in history -- when PE firms Kohlberg Kravis Roberts and TPG took control of power generator TXU (now called Energy Future Holdings Corp) in 2007 -- is close to the brink due partly to a collapse in natural gas prices. "Their cash flow is negative, they owe $30+ billion," says Kosman. "They won't go bankrupt in next year or two but there is no prayer of that company being able to pay that debt."

Kosman explains that PE firm execs often do well when their companies collapse because most of them earn enough from management fees they charge their investors and the companies to more than cover their losses. Typically, private equity managers rake in 'two and twenty' fees -- two percent of the total amount assets under their management, regardless of performance, and twenty percent of any profits their fund earns.

He also warns that PE firms are trying to profit from the current crisis by buying up distressed assets like banks, mortgage and corporate loans at deep discounts and the US government is seeking them out to help rescue failing banks.

And Kosman takes a tough looks at Bain Capital, the PE firm owned for 11 years by potential 2012 presidential candidate Mitt Romney. He claims that three companies -- Ampad, Dade Behring and GS Industries -- failed after being bought by Bain Capital. In the case of Dade, a lab testing equipment maker, Romney pushed for big cutbacks in the employee pension plan, which saved the company $40 million. The next month, he used that as a basis to borrow $420 million.

A company executive told Krosman that he confronted the CEO about the move, telling him "Well, that'd be like me going out and borrowing the amount of money I make in a year and then trying to pay it off and pay for my house and feed myself and everything else. That doesn't make sense." The CEO responded: "Companies do that all the time." Within two years, the company collapsed.

Kosman is skeptical about Romney's claims that he wasn't aware of some of these events: "That either indicates he doesn't know what's going on at a company which he [owned] 100% of, which is incompetent, or he's lying, which is worse."

In a call to arms at the end of his introduction, Kosman urges lawmakers to close tax loopholes exploited by PE firms: "I believe the record shows that PE firms hurt their businesses competitively, limit their growth, cut jobs without reinvesting the savings, do not even generate good returns for their investors, and are about to cause the Next Great Credit Crisis."

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