I've personally seen this script played out a couple times in my career similar to what you describe. But the piece I don't understand is the banks. The loans usually end up worthless since the future earnings evaporate, so why do bankers go along with it?
The banks know this is likely to happen, but believe (usually correctly) that they can sell the debt to someone else before it becomes worthless.
I.e. the deal for the bank is not "we're going to issue this loan and collect payments for it over the next 20 years", it's "we're going to issue $20M loans and simultaneously sell $21M of bonds backed by that loan. We skim the $1M difference for ourselves at basically no risk, and if the bonds default, they default. Not our problem."
Why do people buy the bonds?
- they think they can do the same thing - repackage the bonds as CDOs (collateralized debt obligations), skim a percentage and dump the risk on someone else. This possibly includes hiding the risk by combining multiple different kinds of debt, and then issuing different 'tranches' with different risk/reward levels. (this is what happened to a lot of mortgages in the 2008 financial crisis)
- they only plan to hold the bonds for a short time (the company will probably make the first few loan, and hence bond payments) and sell them to someone who's further removed from the original sale (who may have not done their due diligence) before things go badly
- they believe the private equity propaganda (propaganda works! at least sometimes) and actually think the bonds will be paid off.
The bank doesn't keep the loan, they sell it off to someone else. This happens all the time with mortgages. The banks are constantly adjusting their portfolios to ensure a desired level of risk and leverage. If nothing else, they've collected the origination fee already, so even if they don't get much in the way of payments they still come out ahead.
