Bombed-out buy-out

Back in late September, when David Bonderman lost $7bn on an investment in Washington Mutual bank made by a private equity consortium headed by his firm TPG, a senior executive at a rival house sent him a sympathetic note. Both the industry and the world needed a reminder that private equity was not infallible, he argued. Before that time, "we made it look too easy", this executive added.

Today, nobody could say that private equity needs any further reminders of how vulnerable both their investments and their own fortunes have become. The public vehicles set up by a few of the larger houses most clearly depict the carnage. The value of investments in the Amsterdam listed unit of Kohlberg Kravis Roberts dropped 47.5 per cent last year, while the private equity investments of Blackstone were worth 30 per cent less.

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Indeed, as bank debt has dried up and lenders have become partly state-owned, private equity deals have dwindled. So far this year, there have been 147 buy-outs together worth $18.2bn, down two-thirds from the 470 deals worth $43.6bn in the same period last year, according to Dealogic.

The industry has two main cushions on which it can rely. First, the barriers to exit are high. When private equity groups raise money from investors, it is in the form of cast-iron commitments, lasting at least 10 years, allowing them to hold companies through tough times and wait until conditions are right for a sale. Second, of its $2,500bn of assets under management, about $1,000bn is "dry powder", or uncalled commitments from investors, according to Prequin, a research group.

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Two years ago, firms had the upper hand in dealing with their investors. No longer. Instead, at conference calls Steve Schwarzman at Blackstone and Mr Rubenstein of Carlyle are begging their investors not to default on commitments - and are informally making a market for investors to opt out.

Since the credit crunch began, groups have been diversifying away from buy-outs into distressed debt, minority stakes, infrastructure and bank bail-outs. Now, many are shrinking. Some including TPG, Candover and Permira are giving back some of the money they had raised. Many are cutting staff and closing offices. "Smaller funds will mean lower fees and smaller profits and that can only mean fewer people employed in private equity and lower pay for those who remain," says Mr Hands at Terra Firma.