Back in the 1980s, private equity maestro Ted Forstmann railed against the use of Mike Milken's junk bonds. He thought they were too risky and that the markets would eventually implode. He even wrote op-ed pieces in the Wall Street Journal (subscription only) about this. And, yes, he was eventually proved right.Interesting enough, there's a piece in this week's WSJ that provides some warning bells for the current state of private equity. The author is Steven Rattner, who is the managing principal of Quadrangle Group LLC.
Like Forstmann, Rattner is very concerned about the high degree of leverage in Wall Street's dealmaking.
He points to the small yield spreads on junk bonds, the subprime meltdown, and easy terms (known as "covenant light" loans).
What's more, keep in mind that it's fairly common for private equity firms to pay out huge dividends so as to magnify returns. Of course, this means more and more debt.
Basically, the credit markets are not pricing risk properly. So, when things start to go sidewise, it could be a big shock to the financial system.
Tom Taulli is the author of various books, including the Complete M&A Handbook and the EDGAR-Online Guide to Decoding Financial Statements.
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