TechWeek: Pop Goes the Equity Bubble

The mortgage bubble is bad enough. The specter of thousands of homeowners and their lenders going belly-up after an orgy of subprime lending has Wall Streeters reaching for the Xanax.

Even worse, though, could be a private-equity bubble, warns Eric Gebaide, managing director of Innovation Advisers, a technology-oriented investment bank.

Mortgage brokering and investment banking are very different businesses, of course, but there is a scary parallel. The downfall of many homeowners has been the ability to borrow large amounts of money for very little cash down, with the expectation that rising equity will make the transaction work. But when interest rates rise and selling prices fall, the math gets ugly.

Similarly, some private-equity firms have engaged in their own version of that high-wire act, says Gebaide. Leverage by the purchaser of four or five times EBITA is reasonable. But when that ratio climbs as high or seven or eight times, it gets risky, because the debt has to be serviced while the owners are trying to increase the value of the company.

That may work in good times, but a string of bad quarters, whether caused by an economic hiccup or a company-specific issue, can erase the equity the firm has built up.