Thursday, July 05, 2007

Risk-Aversion Therapy on Wall St.

Published: July 1, 2007

THE bloom came off the Blackstone Group’s rose last week as the share price of this celebrated private equity firm fell below its June 21 offering price of $31. Investors have some nerve to dump Blackstone’s shares — don’t they know who Steve Schwarzman is?

The mighty deal maker atop Blackstone, Mr. Schwarzman is. The man of the moment in le tout New York, whose already sizable fortune was augmented by his $7.7 billion stake in newly public Blackstone shares.

Blackstone declined to comment about its faltering stock — it closed on Friday at $29.27 — and it may still rally, of course. But its downward drift seems part of a shift in investor sentiment — away from risk — that looks anything but temporary.

This mood change was visible across Wall Street last week. In the corporate bond market, investors’ risk aversion was evident when at least eight companies decided to postpone or pull their planned sales of securities.

One example was Kia Motors, the South Korean carmaker, which canceled a $500 million bond sale. Another was U.S. Foodservice, a unit of Royal Ahold, the Dutch supermarket company. It postponed a planned sale of $650 million of senior notes on Wednesday; the securities were intended to finance a proposed buyout of the company by two other private equity titans, Kohlberg Kravis Roberts and Clayton Dubilier & Rice.

Risk aversion is also showing up in the derivatives market, where the issuance of collateralized debt obligations is slowing. Last year, issuance of collateralized debt obligations — which include commercial and residential mortgages, corporate loans and small-business loans — approached $500 billion, up from $235 billion in 2005, according to Thomson Financial. But that flood is subsiding: global issuance of these pools of debt securities came in at around $46 billion in June, well down from the $62 billion issued in March.

The mortgage market, meanwhile, continues to reel. Last week, the Carlyle Group, a big private equity firm, reduced by 25 percent the size of a fund backed by mortgage securities that it plans to offer to investors. The firm also cut the offering’s projected price.

A retrenchment on risk is not surprising, given that the anything-goes mentality among investors has lasted for the past three years. The mortgage market’s woes were the first to tip the balance, but corporate bonds, stocks and private equity will also feel the effects of a pullback in risk-taking.

“Until now we were in a period where risk was underpriced,” said Nouriel Roubini, a professor of economics at New York University’s Stern School of Business and chairman of Roubini Global Economics. “Debt was so cheap that anybody could take a semiprofitable company private and leverage it. Now the price of this is going to be more expensive.

“There are some $200 billion of L.B.O.’s in the pipeline,” he added. “I think some of them might not be done or they will be done at a higher cost.”

There is — as there always is — a historical parallel here. Go back to the late 1980s and you will see another easy-money era when a real estate bubble and takeover mania was fueled by the issuance of risky securities, in that case junk bonds. Back then, the firm at the center of the profits — and later, the plunge — was Drexel Burnham Lambert. Michael R. Milken, its brilliant bond impresario, figured out how to raise money for companies that investors had previously shunned (the corporate version of subprime mortgages).

Savings and loan institutions, using insured deposits, were the manic lenders 20 years ago. Commercial real estate development and multifamily housing projects were the favored investments. When that party ended, the United States taxpayer had to foot the bailout bill. It cost $140 billion.

Back then, as now, the public watched with dismay as big players in the takeover game pocketed enormous sums. (Remember Mr. Milken’s $500 million payday? It was in 1987.) The takeover titans’ gains were especially distasteful when viewed against mass firings at companies that had been taken over in leveraged buyouts financed by junk bonds.

TODAY we have subprime mortgages being financed by hedge funds, pension funds, insurance companies and other institutional investors. But these same investors have also been lax in their lending to corporations issuing debt, often at the behest of private equity managers who hope to take those companies private.

“In both the L.B.O. market and collateralized loan markets there are practices that are the equivalent of the reckless lending in subprime mortgages,” Mr. Roubini said. “Subprime people will say it was a niche problem. That’s nonsense.” And the correction of those freewheeling ways has only just begun.

Mr. Milken’s successors on the big money front are hedge fund managers and private equity guys, and their ostentatious displays of wealth have started to attract unwanted attention from lawmakers in Washington — concerned about such mundane things as taxes.

But what may be most unseemly about all this is that many of the lucrative fees being generated by these managers — the money that finances their lavish lifestyles — are coming out of the pockets of pensioners. Police officers, firefighters, teachers, sanitation workers — hard-working people who just want to be able to retire comfortably someday — are the pension fund investors paying enormous fees to get into hedge funds and private equity deals.

There will always be haves and have-nots. But that doesn’t make the ever starker contrast between the two any more desirable.