Private equity meltdown?

Nassim Nicholas Taleb has long been a favourite of ours at, well before the current crisis had materialized.  And since he has been proven remarkably right about the current crisis and how it is unfolding, its worth paying attention to him when he speaks.

Private-equity firms may follow banks into failure should U.S. stocks extend their worst rout since the Great Depression, said Nassim Nicholas Taleb, author of the best- selling finance book “The Black Swan.”…

The Standard & Poor’s 500 Index has dropped 4.7 percent this year following a 38 percent plunge in 2008 that was the worst in 71 years. Blackstone Group LP, manager of the world’s largest buyout fund, fell 78 percent since the end of 2007.

“Banks are being bailed out, and private-equity firms are going to go next,” Taleb said in an interview with Bloomberg Radio. “These people in a bull market look like geniuses. And now they don’t look that intelligent, and it’s going to get a lot worse for them. If the S&P goes down 20 percent from here, what will happen to private equity firms? They’re all under water.”

Layman’s terms.  You know all those venture capitalist companies with tons of money to throw at possibly profitable projects?  These are those guys.  And private equity was a boom market in the early 2000s, which is why, as Taleb says, these guys looked like geniuses.  Unfortunately, much of this boom was created by loose lending standards.  Now, why does that sound familiar…?

Private equity funds are raised by people with money to put them in the specific funds.  And, as we’ve noticed, the banks are not lending right now.  So unless you have the money to hand, cash for these firms and their managed funds is not immediately apparent.

The upshot of this is that there is going to be another round of bailouts, probably every bit as expensive as the banks.  Possibly slightly more helpful, in that such venture capital firms actually do invest and thus help create jobs.  But so long as the banks refuse to lend, this is a temporary solution at best.