The buyout frenzy came to a peak in 1988 with the $25-billion acquisition of RJR Nabisco, the foods company, by private equity firm KKR. This deal, immortalised in the book Barbarians at the Gate, held the record for the largest buy out until last year.

The architects of the late-1980s dealmaking were riding high socially and financially. Michael Milken, self-styled junk bond king, was earning $500 million a year at the end of the 1980s, before going to jail for securities fraud. Ivan Boesky, the mergers and acquisitions trader on whom Gordon Gekko was based — he gave a speech to the University of California in 1986 about how greed was healthy — was convicted of insider trading and served two years. Many of the companies taken on by the buyout kings struggled with their debt loads in the harsh recession of the early 1990s. Some were forced to refinance and spent years juggling their banking arrangements, others collapsed under the weight of debt. The U.K. housing market crashed. Sound familiar?

KKR has just bought its first top 100 UK company, Alliance Boots, for £11 billion, £7 billion of which is debt. Sainsbury’s was also briefly a private equity target. As private equity buyers stalk the world’s stock markets looking for underperforming targets, there seem to be few companies out of reach. Buyouts of listed companies have reached a record this year. Unions complain about cost-cutting and job losses at the companies taken private. The partners pocket multimillion-pound pay packages and are fighting a rearguard action to protect their low tax rates. Private equity has made £1.2 billion in cash over three years from its investment in Saga and the AA, which announced they would merge this week. The founders of one of Europe’s largest hedge funds, GLG Partners, will gain around £1 billion when it is floated on the stock exchange later this year. City bonuses are at record highs and there is a housing bonanza.

Borrowing has been cheap for so long that the world is awash with cash — personal debt has reached a record and private equity buyers are loading up their target companies with debt. Banks are now even offering so-called covenant-lite loans which give fewer protections in a downturn. In a speech at the Mansion House last week, Mervyn King, Governor of the Bank of England, recounted a banker recently telling him: “I can’t recall a time when credit was more easily available.”

So could this boom turn into a 1980s-style crash? Financial markets have changed a lot in the past 20 years. Credit markets are much wider, which means there is a broader range of lenders offering different types of debt. The introduction of credit derivatives in the 1990s has acted as a form of insurance against a company defaulting on its debts. That market has become very sophisticated, with debt and insurance being packaged into bite-sized chunks and sold off to all sorts of buyers.

As Mr. King said in his speech: “Risks are no longer concentrated in a small number of regulated institutions, but spread across the financial system.” It is this recent repackaging of risks to the extremities of the financial system that worries me — a lot of these products are ending up in our pension schemes, bought by people who have little understanding of them. What’s more, these new products have never been tested in a real market downturn. New financial instruments create different risks. Some of these are impossible to quantify and the past gives little guide to what might happen in future. Innovative products may work in a rising market but often do not behave as expected when prices become disorderly.

In the 1987 stock market crash, stock index futures which were designed to protect portfolios from a decline exacerbated the sales pressure on Black Monday, pushing share prices down more quickly.

Interest rates around the world are now edging up, which will make it more difficult to make the finances work in takeovers involving large amounts of debt. So far the world economy shows few signs of weakness, but there are warning signs. Soaring prices for almost all assets, including houses, are showing signs of peaking. High personal debt has caused record insolvencies.

Mr. King warns: “Excessive leverage is the common theme of many financial crises in the past. Are we really so much cleverer than the financiers of the past?” History has a habit of repeating itself, in unexpected ways. It is astonishing how many financiers appear to forget that higher returns come at the expense of higher risk. —

Guardian Newspapers Limited 2007

(Deborah Hargreaves is The Guardian’s business editor.)

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