Kass: Private Equity Is the Next Shoe to Drop

This blog post originally appeared on RealMoney Silver on Oct. 30 at 8:10 a.m. EDT.

"I've been in a hurry all my life. I've been in a hurry to succeed, and in a hurry to prove myself."

-- Henry Kravis

The casualty count in the world of finance is about to expand in scope.

At the epicenter of the leveraged binge of the last decade were the private equity shops' "deals." These firms funded their "products" to individuals, endowments, hedge funds and to other institutions around the world with the promise of turning waste into gold.

There were few secrets to their alchemy, which was borne out of highly leveraged transactions of often rather unattractive corporate takeovers in mundane and cyclical industries (contained for all to see right in their pitch books).

The structure of the compensation of the private equity firms favored their managers over their investors in their deals. This is not unlike the avaricious compensation schemes that were made available to those wonderful folks on Wall Street who gave the world a new generation of dirty bombs -- namely, derivative and securitized products. Those financial weapons of mass destruction have seized our credit markets in 2008, irreparably poisoning our financial institutions and leading to large investor losses.

For a while, things went smoothly. Investors in the leading private equity firms -- Blackstone (BX Quote), Cerberus, Fortress (FIG Quote), etc. -- poured unlimited money into their coffers as steady returns buoyed investors' appetites and produced much-needed non-correlated alpha (excess returns). Indeed, Stephen Schwarzman, Henry Kravis, Stephen Feinberg and their ilk became the new masters of the universe.

Soon thereafter, others got into the act, and, in the fullness of time, many large hedge funds got into the hunt, serving to raise target prices to unrealistic valuations. As the private equity bubble inflated, deal valuations got as carried away as non-documented mortgage lending, perhaps even more so.