bloggingbuyouts

When operations like Morgan Stanley (NYSE: MS), Lehman Brothers (NYSE: LEH), and Goldman Sachs (NYSE: GS) reported earnings, it was obvious that they had been hurt by being forced to mark down assets in private equity deals. Some had losses in their hedge funds or from the subprime mortgage meltdown. But, the hope remained that global M&A markets would help drive earnings going forward.

It looks like that was a pipe dream. According to a survey by Dealogic covered in the Financial Times, M&A activity dropped 42% from Q2 to Q3 of this year. That deal activity may not come back. One Morgan banker told the paper: "If there is no recession, strategic acquirers will be active across sectors, and mid-sized private equity deals will get financed."

That's a big "if." Part of the problem is private equity. Those deals fell 68% during the third quarter. And that business is not likely to recover soon, especially if credit markets remain volatile. These deals are only a modest amount of deal flow. That means that there could also be a drop-off in normal company-to-company M&A.

What the information means to investors in the big financial firms is that there may still be more downside on these stocks, and the downside could be considerable. At $62, Lehman's shares are significantly down from their 52-week high. But the low for the same period is $49. It has been there once, and it could go back again.

Douglas A. McIntyre is a partner at 24/7 Wall St.

That loud thud you heard Thursday morning at 8:30 was Chuck Prince, CEO of Citigroup (NYSE: C), hitting the floor following the much-stronger-than-expected GDP report.

Citigroup, which has committed tens of billions of dollars to finance many of the larger private equity deals, will be stuck holding these loans on its books for much longer than it anticipated due to this report. The simple fact of the matter is the Fed will not be able to lower short-term rates with GDP growth of 4%.

Leaving short-term rates unchanged means the yield curve will not change for the better and could actually change for the worse. If rates start heading higher, this means the loans the money-center banks are holding will drop even more in value.

Yesterday's GDP report means this post-PE-bubble environment will be difficult to work through. Any easy fix of a slowing economy leading to the Fed dropping rates and a downward shift in the yield curve is not going to happen. Actually, it looks like the longer end of the bond curve was wrong in forecasting an economic slowdown, with the possibility of rates rising. This means it is too early to get back into the money-center banks.

Ben Bernanke told us in May that the impact of subprime mortgages collapsing would be contained. But The Financial Times begs to differ. FT reports that leading bankers are trying to calm the global markets even as they admit that the shockwaves from the U.S. subprime collapse could put private equity deals on hold for the next few months.

Is Ben Bernanke wrong? How could a former Princeton economist not understand that problems in one category of loans might make banks nervous about other loan categories? Or is it simply that Bernanke took his job as economic cheerleader in chief a little too seriously?

One banker thinks it could be three months before subprime's damage takes its foot off the brakes of private equity. Bob Diamond, Barclays president, predicted the consequences of the subprime collapse could take more than a year to be resolved. However, he said the leveraged loan market should recover more quickly: "We would expect at some point over the next two to three months to see that market at more normal volume levels."

Maybe Diamond is right and Bernanke is righter. But is it possible that their predictions are just wishful thinking? I don't know. What do you think?

Peter Cohan is president of Peter S. Cohan & Associates, a management consulting and venture capital firm. He also teaches management at Babson College and edits The Cohan Letter.