By Allan Sloan
Tuesday, January 1, 2008
When I sat down for my annual review of what I've written over the past year, something jumped out at me. Usually, I write about widely diversified subjects. But in 2007, I devoted an inordinate number of columns to the shenanigans of leveraged buyout firms and the attempts by the world's central banks to rescue financial markets.
That's an accurate reflection, I think, of how business news played out in 2007. For the first half of the year, the leveraged buyout industry -- which has renamed itself "private equity" -- seemed poised to take over the world, which I knew wouldn't happen. In the second half of the year, problems in the debt markets made it look as if the world was ending, which I knew wasn't happening, either.
The credit market meltdown wasn't exactly a shock to anyone who can count and has a sense of business history. In fact, I devoted most of my 2006 year-end column to predicting the end of the buyout boom. Making that call was like shooting fish in a barrel -- the boom was fueled by ridiculously cheap and abundant credit, which I knew would eventually dry up because it always does. But the boom took longer to end than I thought it would, and the credit crunch is proving nastier and more widespread than I expected.
I wrote four columns that focused on Blackstone Group, the big LBO -- excuse me, private-equity -- house, including three in a row about its initial public offering. (The Washington Post March 20, March 27, and April 3.) It's the first time I've gone the three-peat route since I became a columnist in 1989. But who could resist? The Blackstone deal was so complex and so much fun to dissect, and the firm was being treated with such undeserved reverence. Besides, a giant private-equity firm going public screamed "top-of-the-market" -- which, in fact, it was.
Then, piling pig on pork, as they say on Wall Street, my first column after joining Fortune this summer was the way Blackstone's partners (perfectly legally) got public investors to pick up most of their capital gains tax tab for selling some of their Blackstone stake in the offering. Nice work if you can get it -- which with luck, may not be for long.
Congressional loophole closers have zeroed in on Blackstone's game and on two other games I wrote about -- Sam Zell's tax-dodging on his purchase of Tribune Co. and tax deferrals involving exchange-traded notes. The IRS, to its credit, also is pursuing the ETN loophole and seems likely to try to close it before it becomes too popular.
Alas, the Senate, in a display of total cowardice, wouldn't touch the most offensive loophole of all -- the way that private-equity players and hedge fund operators pay only 15 percent federal income tax on their piece of their investors' long-term gains, which is really fee income, while mere mortals pay up to 35 percent on their fees and salaries. Having buyout billionaires pay just 15 percent tax on their fees is ludicrous.
I spent a lot of time in 2007 trying to understand how the subprime meltdown happened and why it spread so wide. In the process, I came upon a particularly wretched 2006 issue of mortgage securities underwritten by Goldman Sachs in which two-thirds of the value of second-mortgage loans that individually were toxic waste was rated AAA (if only briefly) by Moody's and Standard & Poor's. Goldman, being Goldman, figured out early in the game that these markets were heading south and made a fortune betting against them. However, also being Goldman, the firm didn't pass on that insight on to buyers of the securities it underwrote.
Shortly after I joined Fortune, the debt market meltdown began in earnest. (No, I don't think it was cause and effect.) In recent months, I've focused -- some would say obsessively -- on the fact that the too-big-to-be-allowed-to-fail firms that enabled financial excesses are getting bailed out at the expense of those of us who have behaved properly. It's obvious that this is going on, but not too many people are saying it, at least not in public.
Let me hasten to add, however, that the cards that Federal Reserve Chairman Ben Bernanke and Treasury Secretary Hank Paulson have to play are much weaker than most people realize. One reason is that their predecessors allowed enablers of previous excesses to escape, reducing their credibility and clout in the markets. A second reason: the Fed and Treasury now need cooperation from foreigners, on whom the United States has become financially dependent.
So what's ahead? Amid all the gloom and doom, I see at least one encouraging thing: Some financial firms are being forced to raise new capital on terms that dilute the stakes of existing shareholders by selling new stock at below-market prices. But if I ran the world, I'd go one step further. I'd force these firms to eliminate their cash dividends and do huge, horribly dilutive offerings as a condition of getting help. The point? Even though we can't allow these firms to fail, lest the world financial system implode, we ought to teach them -- and their shareholders -- the penalty for engaging in excesses. That painful memory might inhibit excess in the next upcycle.
Finally, a contrarian and optimistic thought: The same kind of thinking that foresaw endless leveraged buyouts a year ago now foresees a worldwide financial meltdown that will go on indefinitely. Maybe this is really a signal that things will stop getting worse sometime in 2008. I'm not predicting that, but I'd sure welcome it.
And on that note, a successful, happy and prosperous New Year to you and yours.
Allan Sloan is Fortune magazine's senior editor at large. His e-mail address isasloan@ fortunemail.com.