Advanced Personal Finance

It’s not news that private equity firms have been doing buyouts like crazy recently. Money is cheap, and these groups are taking advantage of the situation. In the process, valuations are getting crazy high. Just for a frame of reference, until very recently, buyout firms typically funded their deals with about $4 of debt for every dollar of the target company’s cash flow. Today that number is more like $6 or $8.

Who cares, you say? Well, besides the direct effects to those of us who invest in an index fund, there is the very real possibility that private equity is the next bubble and when it pops, it will affect you and me directly.

Again, who cares? You and I aren’t in private equity. What do we care if a private equity bubble pops? We should care because those firms are getting their money from someone else. Of course, it’s purely speculation on my part which firms get money from which sources. However, it’s no secret that pension funds, especially state and municipal ones, are increasingly seeking increased returns. That’s because in the Pension Protection Act of 2006 (the one that made the Roth 401(k) law), it became mandatory for state and municipal governments to fully disclose their future obligations to retirees, which are huge. I believe endowments, public and private pension funds are lending many of the billions of dollars being used by private equity firms to fund these deals.

In the event of a meltdown in the private equity market, ultimately it will be the providers of funding that will get killed. And guess what? If those lenders are your state’s pension fund, you’re going to pay for it in two ways. Directly, you’ll be paying higher taxes to fund those pension loses. Just as importantly, though, when a municipality goes to fund a bond issue, it will face sharply higher borrowing costs. Costs that will be passed on to you in the form of service cuts, yet higher taxes, or both.

Still think the private equity bubble won’t affect you and me?

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