Private Equity- Some of the illusions uncovered!

One type of investment which all the big banks are involved in is Private Equity. It is the buying of whole companies in order to sell at a later date at a profit. There are a number of problems with private equity buyouts.

1...Borrowed money: Usually 80% to 90% of full purchase price!
The majority of the money used for private equity buyouts is borrowed from banks.- Mortgaging the company obviously increases its costs until the loan is paid back. The dept could potentially put the company out of business.

2...Maintaining profits; Even with the added debt which has added to the costs?!
These companies are bought to be re-sold within a few years. For this to happen it is vital that profits are maintained if not increased. This can be a major challenge when you consider the costs have just gone up as a result of the interest and other costs of the borrowing to purchase the company. To achieve this there are customary redundancies and then an increase on the work load of the remaining staff. Also in the majority of cases there will be assets of the company sold off. The sold assets will generate cash to quickly pay off some of the debt, so helping stabilize the company, at least for the time being. A private equity management team may claim it is selling off loss making parts of a company to the media,but they will generally do this as a matter of course in order to recoup as much cash as possible shortly after the buyout. Loss making or not, there could be more job losses here if sections of a business are closed down. Often property owned by the company will be sold and rented back adding to future costs of the company.However the accounts will look more healthy though this is likely to be short term.

3...Banks only too willing to lend.- Its only too willing as long as there is a safety net!
The reason why banks are content to lend to what many people  will seem like a pointless re-mortgaging of businesses is that the private equity company will have arranged an investment fund to pay the mortgage on the company. If the company was to go out of business, the outstanding mortgage would be paid by the investment funds investors. It is actually difficult for the bank to lose out here, and this is therefore a factor which affects the amount of money which has been lent by banks to this type of business.

4...Any gains from your pension plan or other investment are lost through rising prices of goods and services.
 There are however important points which any one who pays into an investment fund should be aware of. This is because at some stage prices charged to the public for the product or service are going to increase as a result of the borrowing by private equity companies to purchase businesses. For this reason, you will notice that private equity companies will favour businesses that they know the public depend on, so there is more scope for price increases in the future. Of course, private equity will not be blamed for the increase in prices. This would be blamed on changing market conditions. If lots of companies face this same problem and inflation rises as a result, the Bank of England will have to think up some new ideas as just increasing interest rates will only make things worse for all the companies in debt resulting in more price hikes.

5...Business closures and job losses, as well as your pension reduced.
Closure of major companies are a result of private equity.This is not always because the private equity management company has made a mistake. It may be because the company has been bought in order to be closed down. A factory in Britain could be closed down by a private equity company which owns similar factories in Argentina and China, where costs are far less. It is then quite easy to run the factory in the U.K. 'out of business' as it has its prices undercut by the two over seas factories. The private equity management company can then up production at the other two factories and very probably the prices too. In the situation that the U.K. company has gone out of business, the private equity company may not even pay back the bank the borrowed money to buy the purchased U.K. company which is now in receivership. In this case the investment funds which were arranged by the private equity company to back the mortgage would foot the bill for the outstanding borrowing, leaving the private equity management company and the bank unscathed. Often a cartel of private equity management companies will work together to buy a number of similar companies, but with the same result, that one or more will be closed down.

6...The Public are held to ransom by companies supplying every day vital products and services!
Private equity companies tend to target vital products or services that we all need from day to day. It is inevitable that buyout after buyout certainly in the case of energy companies, is going to increase the costs of these services so that many people will just not be able to afford them in the future. Regulating bodies that are formed to protect the public from the rising prices of some of these companies are powerless as the criteria for restraining these companies is based on excessive profits rather than the reason for their rising prices which is their rising costs (The debt they are burdened with).

   Private equity companies and banks take advantage of our need to save and invest for the future. Private equity companies also feed on our reliance on vital products and services. Unfortunately the interest on pension plans and other investments received by most investors will never off set the damage  the banks and private equity companies do by creating unemployment and more expensive products and services as a result of borrowing and other costs associated with buying businesses. Any investment which involves the purchase of a company should have benefits to the product or service to be produced and to its customers and to the economy before any finance from a bank or investment fund should be authorised.

'Buy to Let' Property Investments- They are not economically sustainable.

There are a number of problems associated with 'Buy to Let' property investments which cause economic problems.

1...There is usually no counterbalance to counter the return which is being made on the investment. This means there is little given back to the economy which is providing the return for the investor.

   Usually, buy to let properties are existing properties, often many decades old. For this reason little or no employment is generated by this so called 'business' investment. To make an investment- i.e To put in an amount of money in purely for the purpose of getting more out, unless you are creating some sort of employment, is not sustainable within an economy. The investor is demanding more from the economy without giving anything back to the economy. This applies to any business or investment which does not create any or minimal employment. This is a very simple and very important economic fact. You can not take money out of the economy by any form of business or investment unless you are creating employment at the same time. Continuous investment in these negative businesses will damage the economy, increase living costs, create unemployment and eventually contribute to an economic crisis.

2...There are increasing costs mounting on the welfare system as a result of investments in homes by landlords.

   The rising costs of home rent become the responsibility of the tax payer when the tenant is unable to work. This could be for various reasons such as illness, injury or disability, but most likely due to lack of available suitable employment. The conditions for unemployment can be created by a rise in living costs which has been contributed to by landlords demanding the highest possible rent for their property. Living costs are also a cost for businesses as it is businesses which pay most of our living costs in the form of wages. If landlords raise the rent to a level which is close to the tenants maximum affordability level, added to other increasing living costs (some of these related to other types of investment), the tenants may find themselves in a situation where they would be no worse off not working at all.

3...Pensioners get left stranded.

   Another problem arises when the tenant reaches retirement age. Where a person does not own their own home, it is likely that the state will be paying the rent on the home from then on. If the landlords base their monthly rent on an employed persons income, it is inevitable that the tenant will not be able to afford the same level of payments after retirement. In years to come this will have a devastating affect on the economy. If landlords in the future are treated with preference above home buyers who want to buy some where to live (which is the situation today-2011- see elsewhere in Anti-Crisis Economics on how landlords have been dominating the housing market for some years),then they will be able to buy a growing proportion of homes in the future. The working population would become slaves, paying rent on their own property as well as future tax increases to cover the cost of a growing number of elderly people living in rented properties. The knock on effect will ripple through the economy. For people working now, but on a relatively low income, with other rising costs also added, with other rising costs also added, it is likely that many people will not be able to afford to work and cover the cost of their rented home in the future. It is also likely these people could be labelled lazy layabouts by politicians of the future.With the current government policies and banking practises, it is difficult to see how employers are going to be able to afford staff who are going to have to bare such a financial burden.  

Historic Banking "Grandfather rights", Is History influencing current banking policy?

   The banking crisis and resulting economic crisis has left people wondering how the banks could have created such a mess that we are all now paying the consequences for. We have found that the regulations within the banking system (atleast as far as the U.K. is concerned) appear to be vague, very few in number, and un-enforcable by a regulatory authority. Many of these 'rules' are many decades old, but where up-dated regulations would seem very necessary, changes have not been made.  It would seem therefore that there may be evidence that our current bankers are taking advantage of decisions made by bankers from the past, in the name of profit. There is clearly room for improvement, but for reasons only known to themselves  necessary updates to the banking sysem have not taken place, even in the crisis aftermath!

-Under "Bankers Rights" from the Banking Act 1979 the following statement can be found;

"Bankers may use funds deposited as it thinks fit."

Yes, this really is quoted as in the '79 Banking Act. Although this sentence wouldn't even appear to be very good English, the possiblities which are left open to bankers by this clause are prettty worrying for all of us and would go some way to explaining why we have the current financial crisis.

A more suitable replacement clause to the one in question could go something like this;

"Bankers may use funds deposited in any way which benefits both the investor, the business to be invested in and the economy."

If bankers used this as the model to build the banking system around, we could be looking at a completely different finance system today. The reason for this is that a lot of business that banks are involved in would not fit into the criteria of the 'new' clause. Explaining in detail this business is one of the aims of Anti-Crisis Economics, details of which you can see elsewhere on the site.

   Going back to the 'Rights and Duties', also stated in the Banking Act 1979 is that Banks can give financial advice or investment management services and facilities for arranging the purchase and sale of securities. However, there is no detail on the actual advice that should be given to customers. Without specific details on the advice, it looks like the banks are given the right to advise customers to buy their own 'investment products'. There is a major problem here because one of the problems we believe has caused the banking crisis and other major problems with invested savings over recent decades is that the public do not really understand what is happening to their invested money. If they did they would probably invest it some other way or buy a safe to keep it in where it could dono one any harm. (Please read elsewhere in Anti-Crisis Economics on Private Equity, Hedge Funds, Stock Markets and Property Tycoons).

This next statement is also from the Banking Act 1979;

"The banker customer relationship has been largely left to implied contract, the terms of which have been developed by judicial decisions over the years (i.e. by case law). The term implied contract means there is no written agreement between the bank and its customer, and their relationship is simply based on what has happened between the bank and its customer in the past, and the decisions that the courts have made when the banks have been sued for failure to fulfil their implied obligations."

-This particular statement appears to protect the banks from almost anything. It would appear that the bank would be unlikely to ever go to court and you would only win if somebody had previously been successful in challenging a similar breach.
The Banking Act 1979 goes on to say the following;

"The banks responsibilities towards their customers have largely been dictated by case law, as have their rights, and it is therefore necssary to look at individual cases when considering these rights and duties."

-This statement suggests that case law may dictate what their rights and duties are but it doesn't specifically say it would be enforced by the past decisions, but will treat each case individually. In other words even if customers have one cases in the past, it doesn't necessarily mean an individual will win a similar case in the future.
   The point to notice about even the "implied" bankers rights and duties is what seems to be a lack of duty to invest favourably from an economic point of view. In fact, reading between the lines, the banks seem to have given themselves the right to invest customers money "as they see fit" even at the expense of the economy as long as it is profitable for the bank.

The Banking Act 1979, although thirty two years old would appear to be setting the standard for todays U.K. banks. However, to make things a whole lot worse, the U.K. banking system is the one that many of the countrys of the world have used as a standard to set there own banks by.
Just one final point;
'The Bank of England has statutory immunity against negligence claims.'