The End of the Private Equity Party

Under those circumstances the loss is, in effect, masked for nine months, keeping crucial information from investors about the true state of the firm.

Even with this potential landmine, hot money has poured into private equity funds for years as investors confused easy investment exits into overheated markets at amazing returns for actual alpha created by management. Current market conditions, however, have exposed this supposed magic as little more than smoke and mirrors.

Future fund raising even by the most respected private equity firms could be seriously altered. Major institutional investors may become wary of the long lock-ups (usually 10 years) and big price tags for funds that may no longer offer such exceptional returns.

Big-name firms such as Blackstone, KKR and Fortress could become far less profitable as fund sizes fall and returns fizzle due to falling share prices. Profitability is already in question, as Blackstone and Fortress posted operating margins of -631.84% and -81.53%, respectively, in the third quarter.

Eager investors have long been lining up at top private equity firms to get a slice of new funds. The best firms have been able to handpick their investors -- who in turn are more than willing to pay 2% management fees along with 20% performance fees -- similar to those on hedge funds. Such fees weren't considered unreasonable during the bull market. Private equity funds could generate returns that exceeded those of the S&P 500, even with gigantic fees.

Commitments to major funds skyrocketed in the past few years. Several funds raised more than $10 billion, based only on past performance, with single institutions making investments of more than $1 billion. The California State Teachers' Retirement System put $1.74 billion into Blackstone V.