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The theory is wrong. Perhaps you can do it for pension funds, although most pensions are government backed anyway. But investors are taking a known risk. Thes
by ikeboy 7y ago
The theory is wrong.
Perhaps you can do it for pension funds, although most pensions are government backed anyway.
But investors are taking a known risk. These are all sophisticated adults. If a bank wants to sign a contract that they will lose money if the company goes under, who is Warren to say they shouldn't? They're getting well paid for that risk, they know it's a risk.
If you ban debt-funded PE, you'll just have banks in-house the PE firms or any number of other structures that have the same result - people buying companies with other people's money and only sharing in the upside. Because that's a structure that benefits both sides (the banks and the PE companies) and they both want it to work.
- gridlockd 7y agoNice theory, but in practice many banks do not actually carry risk, because they are “too big to fail”. LBOs fall in the same category as credit default swaps - useful in theory, huge moral hazard in our version of a “free market”.
- ikeboy 7y agoIf you think the risk of debt is too high, then require banks to be capitalized higher against that kind of debt. Don't ban them from funding certain kinds of debt. There are no banks that failed due to defaults from LBOs. Besides, the plan goes well beyond banks. If a private investor wants to lend money for an LBO, this still prevents it.
- gridlockd 7y agoI am not arguing for a ban, nor am I saying that LBOs cannot work. I am saying your bank risk argument in favor only works in theory and therefore we will have for more LBOs that cannot work. Of course LBOs are not significant enough to single-handedly cause a bank to fail. However, they can still cause companies to go bankrupt that would have otherwise survived. In any event, in a system where banks are not allowed to fail, I cannot see how they should be allowed to finance LBOs.
- ikeboy 7y ago>However, they can still cause companies to go bankrupt that would have otherwise survived. If a company's operations aren't profitable, it wouldn't have "otherwise survived". If it is profitable, then bankruptcy will wipe out debt and permit it to continue operations, hence it will continue to survive. It's the difference between Chapter 7 and Chapter 11. >In any event, in a system where banks are not allowed to fail, I cannot see how they should be allowed to finance LBOs. What work is LBO doing in this sentence? Financing LBOs carry some risk of loss, as does everything except Treasuries. Why would LBOs be special as something banks shouldn't be allowed to finance? Why are banks uniquely bad at risk analysis of LBO debt as opposed to, say, regular corporate debt, or junk bonds, etc?
- gridlockd 7y ago> If a company's operations aren't profitable, it wouldn't have "otherwise survived". If it is profitable, then bankruptcy will wipe out debt and permit it to continue operations, hence it will continue to survive. It's the difference between Chapter 7 and Chapter 11. Debt is wiped out after liquidation. Most companies do not survive this. Debt service can make the difference between profitability or unprofitability. Remember, this is debt that was forced on the company externally. > Why are banks uniquely bad at risk analysis of LBO debt as opposed to, say, regular corporate debt, or junk bonds, etc? I never said they are bad at risk analysis, I am saying they do not truly carry the risk in the first place. The difference is in the outcome. An LBO that should never have happened is worse than a corporate loan that should not exist.
- ikeboy 7y ago>Debt is wiped out after liquidation. Nope. I get the feeling you don't know the difference between chapter 7 and chapter 11? >An LBO that should never have happened is worse than a corporate loan that should not exist. Why?
- gridlockd 7y ago> I get the feeling you don't know the difference between chapter 7 and chapter 11? Same here. Chapter 11 doesn't "wipe out debt", that's what Chapter 7 does. Chapter 7 implies liquidation. Chapter 11 may reduce debt obligations, entail partial liquidation, and so on. It doesn't just wipe out the debt. > Why? Because of the moral hazard. If I can just get a loan for an LBO to buy a company and squeeze it out like lemon, that's highly destructive. Unlike when issuing a junk bond, I have no real interest in the companies long-term survival. I guess you can make an argument that debt-financed stock buybacks have similar issues, but that's a topic for another day. In the short term, even a bad LBO looks good for both the bank and the PE firm. Meanwhile, the company has a debt burden that paid for nothing but the privilege of having been bought out, likely requiring them to charge higher prices, which is a strong competitive disadvantage. This leads the whole argument of "restructuring companies to be more efficient" ad absurdum.