Securities and Exchange Commission Chairman John Shad warned yesterday that the recent wave of leveraged buyouts on Wall Street could result in a surge of corporate bankruptcies in the event of an economic downturn.
"The more leveraged buyouts today, the more bankruptcies tomorrow," said Shad, responding to questions from a National Press Club audience. "If we have a significant recession in the next few years, there will be a piper to pay by some of these leveraged companies."
Leveraged buyouts have become a growing trend in corporate takeover battles and are frequently used by company managers to thwart a hostile outside raider. In a typical buyout, a small group of executives and financiers borrow heavily to buy up the publicly owned stock of a company. The debt is then paid back with cash from the acquired company or by selling some of its assets.
But Shad warned that the debt burden being imposed on leveraged companies is too great, comparing it to "standing pyramids on their head." He also said that the proliferation of so-called "junk bonds" -- high-yield, low-rated securities that are often used to finance leveraged buyouts and hostile takeovers -- has reached the point "where it's worth [the SEC] taking another look at."
But he also said that junk bonds have historically performed "extremely well," adding, "I'd rather have my savings and loan in junk bonds than illiquid real estate."
The Federal Reserve Board last week announced a new regulation designed to curb some junk-bond financing, but Shad said, "I don't think this is going to have a big impact on contested takeovers."
On another matter, Shad criticized the tax reform bill recently passed by the House Ways and Means Committee. The bill, which would eliminate the 10 percent business investment tax credit and require companies to write off their assets over a longer period of time, would "roll back" incentives for investment and have an "adverse effect" on capital formation.
Shad also said that the SEC will give banks more time to apply for exemptions from a new regulation that banks with discount brokerages register with the agency.