Out of One Pocket….

The WSJ highlights  the skepticism with which the GSEs are being viewed by the private equity community.  And why not:  there’s a lot to be skeptical about.  As the AP points out, their balance sheets are devilishly complicated, what with Fannie Mae’s 17 classes of preferred and Freddie’s 24.  It eludes me how a group of private equity guys comes swooping in and says, “we’re comfortable with sitting between classes 5 and 6 but not in between 8 and 10.” Certainly not in a time frame that would solve the situation.  (Update:  the NYT reported the following day that at least KKR, Blackstone, and Carlyle had come to precisely this conclusion).   The only solution would be some sort of government guarantee, which is what Paulson is trying to avoid in the first place.  And besides, it’s far from clear–unless Paulson has received almost certainly unsought assurances that he’d be retained by both candidates–what appetite a lame-duck Secretary has for guaranteeing anybody anything.

Additionally, there’s the oft-overlooked fact that when the press talks about “private equity,” for the most part an accurate substitute would be “public pension funds.”   Private equity firms are compensated with a fee and 20% of profits for managing pools for vast institutional investors, the likes of CALPERs.  They put up next to none of their own money.  Sure, some sovereign wealth funds, university endowments, and insurance companies invest in private equity.  But as the industry has grown so astronomically, it has been the public pension funds who have shown the greatest willingness and ability to scale their commitments. 

In fact, it’s pretty easy to make the argument that a taxpayer bailout is more fair than one which relies primarily on pension funds.  Tax revenues are far more equally distributed across the populace; none of us is really counting on those funds to do anything except in the most abstract way, i.e. help government do its job.  Oh, and the money is no long in our personal possession.  And to get really technical, a Treasury bailout of the GSEs would only cost you and me the extra interest on the additional government securities the U.S. would sell to foot the cost of the rescue.  (Of course, your grandkids might have something to say about this, but most of them aren’t born yet).

Pension funds, on the other hand, are still owned by the pensioners themselves, who are very much counting on those funds in their retirment.  A private equity bailout  therefore concentrates the risks among a relatively few citizens, forcing them to double down on the GSEs at the sole discretion of the private equity managers their pension fund administrators have chosen. 

To a great extent, this is only an extreme example of the way the system has always worked.  CALPERs invests plenty of its pensioners’ money in distressed debt, venture capital, and all kinds of other risky assets.  Most managers of defined benefit pension plans gave up long ago that they could hit their return requirements with a portfolio split in the classic fashion of 60% equity and 40% bonds.  But it’s important that everyone understands that when we talk about a “private equity bailout,” the stakes for such a rescue aren’t being ponied up by the masters of the universe who prowl the mahogany-lined hallways of private equity firms.   But if you have a corporate or government pension, you are almost certainly coming up with part of the dough.


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