Naked Capitalism picked up on this three years ago. I guess Alan Greenspan didn’t read it.
Go to the link for Prince’s words. I’m more taken with the Naked Capitalist’s own insight – remember, this was written in the summer of ’07:
From everything I have seen, most market participants, and I mean that in the broad sense, hedge funds, private equity firms, money managers, and the lenders and advisors to them, are going to keep going full bore as long as they can, until conditions become untenable.
In one sense, this isn’t crazy. It’s extremely difficult to call a market top. And in this competitive world with hyperactive deal and investment activity, someone who pulls back early looks like a moron. They will lose their place in the league tables and if they manage money, will suffer in performance rankings. It leads to a syndrome one manager called “the fully invested bear”.
As a result, you have a lot of players who are moving forward in what they know to be a deteriorating environment. Take Prince. He has to talk the market up because Citigroup has become the biggest M&A player by virtue of its funding ability. Now you know that Citi doesn’t keep much (if any) of the loans it originates on its books, so it has to talk up the market to make sure it has buyers for the loans it sells down (whether via syndication or securitization).
The irony is that Prince was brought in to clean up Citi after a series of scandals. Yet Citi is originating more LBO loans than any other firm, which means they have helped enable the erosion of traditional protections to lenders. Some of my friends in private equity have noted that the extremely favorable terms for borrowers have lead PE firms to be casual about due diligence, since if a deal goes bad, the bank can’t force a workout. The PE firms can halt interest payments with no consequences and wait for the economy or the company to straighten itself out.
Even if Citigroup has only limited exposure to LBO paper by virtue of keeping little on its books, I guarantee you that when the credit tightens further and the economy weakens, enough of these deals will come a cropper that there will be a hue and cry to find who was responsible. At a minimum, Citi will have a lot of explaining to do.
And in general, too many people like Prince have faith in markets. Peter Lynch, who achieved average annual returns of 29% for the 13 years that he ran the Magellan fund, once remarked that markets are most risky when people have the most confidence in them. Like Prince, they assume they can keep dancing as long as the music is playing. Yet Prince has in essence said he knows that when the music stops, it won’t be one chair that will be removed, but several, perhaps most. He seems supremely confident in his ability to know when to exit, but with everyone planning to stay as late as they can, he is likely to be underestimating how quickly conditions can change.