GP is repeating the PE as corporate raiders story, but leaving out that these are often struggling, mismanaged companies, and that those loans have a sophisticated counterparty. The lenders might eat the losses, but after a few rounds, they'll demand higher interest rates once they see PE's turnaround track record. This is actually an example of where markets work; it's just ugly to see a beloved band go out like this.
I'm aware that some private equity actually does plan to make money by applying good management to a fundamentally sound company which is currently struggling (or "cheap") because of fixable mismanagement. Warren Buffet got rich by doing this repeatedly.
But that's not what happened to Toys'R'Us.
"Raider" PE doesn't care about the high interest rates because they don't intend to pay them for long enough to matter, and - as mentioned in other replies - usually the sophisticated counterparty to the loans has identified a less-sophisticated other counterparty to sell the loans to and sees this as a risk-free deal that nets them origination fees. Suckers exist. Banks make it their job to find them.
> Warren Buffet got rich by doing this repeatedly.
Warren Buffet would insist that he's not in private equity because Berkshire's stock is publicly traded and there's no lockup. He has publicly stated that he thinks being a PE LP is financial malpractice.
Warren Buffet is interested only in solid businesses, not in buying distressed assets in a fire-sale. One of his maxims: "is better to buy a wonderful business at a fair price, then to buy a fair business at a wonderful price"
Commonly, the bank that undewrites the loans will essentially do the same thing - they collect a commission but sell the underlying debt to someone else as (high-yield, because they are high-risk) bonds.
If you've heard of "Junk Bonds", this is (one source) of where they come from.
It's like a financial game of "hot potato" - you can make money as long as you're not the last person to hold the debt. So the answer to "who lends the money?" is "anyone who thinks they can sell the debt to someone else before it explodes".
In the end, a lot of it goes to "unsophisticated" individual investors, who will buy it based on "Sears (or whoever) is a great company, why wouldn't I buy their bonds" without realizing the full extend of what's happening.
> In the end, a lot of it goes to "unsophisticated" individual investors, who will buy it based on "Sears (or whoever) is a great company, why wouldn't I buy their bonds" without realizing the full extend of what's happening.
Unfortunately, a lot of these and similar financial schemes end with the phrase "...eventually retail investors end up holding the bag and taking the losses." LBOs, collateralized mortgages, crypto, every equity that gets pumped and dumped. When every layer in the banking industry has skimmed its profit and did their own renaming/reselling/repackaging of these "products" finally there's some individual investor chump who takes the loss, making the numbers add up.
Banks want to keep working with PE because banks have a lot of M&A business, and PE firms are the high-dealflow clients of their M&A arm. If Elliot (to pick a vulture at random) hires you to do mergers they're going to expect you to also help with the financing.
The banks don't end up being the bag-holders in any case, because they securitize the loans.
PE firms mostly make money on the management fees they charge the company, and by stripping assets, so they're often OK if they lose money on the ownership stake. In any case, the PE principals make money from their LPs with fat fees on assets under management so even if the entire investment goes south, it's the LPs who ultimately take the hit (5-10 years later) and not the principals.
TLDR: you know how people will by crypto that has absolutely no backing of anything? Well these bonds at least back to the company. There's always another sucker there to unload your debt to after you make a profit in fees and interest.
Ultimately it falls on the taxpayer. The existence of the FDIC not only incentivizes but almost forces banks to be risky with their investments. It doesn’t matter if their lending fails because the government has to come in and clean it all up and those expenses are passed on to the public.
Banks aren't defaulting because they held bad PE loans. The recent memorable case was SVB, but it held quality paper, just with a duration risk. Banks aren't investing depositor funds in loans to Toys R Us.
Fractional reserve banking means the bank only has a small percentage of the money its customers deposit on hand (currently 0% since 2020). What do they do with the rest of that money? They invest it. They take on risky investments because it will either pay off or they will be bailed out by the taxpayer through FDIC. There is zero risk on the banks part.
Once you get as far as FDIC insurance being involved, the bank generally ceases to exist (ideally via a fire sale to another, more stable bank) and the shareholders generally get (all but) wiped out, at best.
Competent risk management so that doesn't (generally) happen is a core competency for a bank, and if regulators think you're doing it wrong they will come down on the bank's leadership like a ton of bricks.
If anybody reading this comment would like to learn more from people who understand the area far better than I do, I would recommend patio11's 'Bits About Money' and Matt Levine's 'Money Stuff.'
FDIC has as much to do with what you're talking about as the gravity that holds you down. Yes its technically correct that they're covered by both, but you're miles away from any kind of rational point.
