http://www.nypost.com/p/news/business/the_next_bubble_xgWBulf5HcOUkkpsZz0WoN The next bubble Book: Spike in PE-owned firm defaults ahead By JOSH KOSMAN Last Updated: 5:17 AM, November 15, 2009 It is late 2011, months before President Barack Obama will run for re-election. The US economy is gradually recovering from four years of hovering on the brink of disaster. Banks are lending money again, at least to strong companies, and employment is stabilizing. President Obama has finally begun to breathe a bit more easily, when the Secretary of the Treasury walks into his office one day. "You better sit down," the secretary says. "I've got bad news. First Data, the largest merchant credit card processor, has defaulted on $22 billion in loans. Clear Channel Communications, which owns more than twelve hundred radio stations, is on the brink. The other credit tsunami that we knew was out there has begun." The Treasury Secretary is talking about private equity. It's not the private equity firms themselves but the companies they own that are defaulting. During the boom years of 2001-07, private investors bought thousands of US companies. They did it by having the acquired companies take on enormous loans using the same cheap credit that fueled the housing boom. That debt is now starting to come due. "Considering what we have already been through, how bad can it be?" Obama asks. "Well," says the Treasury Secretary, "PE firms own companies that employ 7.5 million Americans. Half of those companies, with 3.75 million workers, will collapse, between 2012 and 2015. Assuming that those businesses file for bankruptcy and fire only 50 percent of their workers, that leaves 1.875 million out of jobs. "To put that in perspective, Mr. President, NAFTA caused the displacement of fewer than 1 million workers, and only a slightly higher 2.6 million people lost jobs in 2008 when the recession took hold. "A spike in unemployment will mean more people will lose their homes in foreclosure, and the resulting nosedive in consumer spending will threaten other businesses. The bankruptcies will also hit the banks that have financed LBOs and the hedge funds, pensions and insurers who have bought many of those loans from them." "Is this bigger than the sub-prime crisis?" "It is similar in size to the sub-prime meltdown. In 2007, there were $1.3 trillion of outstanding sub-prime mortgages. As a result of leveraged buyouts, US companies owe about $1 trillion. "Sir, we are on the verge of the Next Great Credit Crisis." Obama is no longer smiling. The picture painted by the Treasury Secretary in this imaginary scene, as dire as it is, is not total fantasy, nor is it a worst-case scenario. Some knowledgeable observers say the carnage will start sooner. In December 2008, the Boston Consulting Group, which advises PE firms, predicted that almost 50 percent of PE-owned companies would probably default on their debt by the end of 2011. It also believed there would be significant restructuring at these companies, leading to massive cost cuts and difficult layoffs. A rain of defaults is already starting. From January 1 through October 31, 2009, 175 American companies defaulted on their debt. That is almost double the number for all of 2008. Half of those companies have been involved in transactions with PE firms at some point in their corporate life, according to the Standard & Poor's rating agency. The tsunami of credit defaults described by the imaginary Treasury Secretary is not inevitable. If the US economy manages to recover from the credit crisis that began in the mortgage markets in 2007 before the big PE debts come due, more of the PE-owned companies will be able to refinance their debt. In that case, we won't see a full 50 percent of them go under. Although if history is any guide, many of them will collapse anyhow, regardless of any easing in the credit markets, thanks to the greed and grossly shortsighted management policies of their PE owners.