Posted in Hedge Funds. Investing

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The pickings are slim when youre fighting over the carcass of a wounded economy.

Does Wall Street hate America? Clearly some people imagine that financiers want to impoverish the country so they can buy everything up on the cheap. Yes, thats paranoid, but sometimes Wall Street does give those folks ammunition.

A story from Bloombergs Devin Banerjee last week  quoted Tony James, Steve Schwarzmans no. 2 at Blackstone Group LP, saying that the turmoil from higher interest rates would give private equity firms opportunities to buy assets at low prices. This is a theme that James has touched on before. On Blackstones July investor conference call. James said:

I think if we had a sharp increase in rates and we got a lot of volatility and we had some panic, some distress, some turmoil and a lot of unhappy people, that would be great for Tac Ops. They feast on that.

That last reference is to Blackstones Tactical Opportunities Fund. a $1.5 billion fund designed to invest in under-priced, illiquid assets. Perhaps its true that a few funds can take advantage of that scenario. By and large, though, its just not true that private equity as a whole benefits from major market shocks.

Actually, its the opposite. Interest rate shocks are invariably accompanied by a flight to safe, highly liquid investments, and that means the harder-to-sell, more exotic investments plummet in value. There have always been funds that try to take advantage of this. Usually, as this post from Houlihan Lokey. an investment advisory firm, notes, those have been specialists in areas as varied as insurance settlements, patent portfolios, aircraft leases, and exotic derivatives.

Before anyone gets too excited about investing in these kinds of assets in a time of market chaos, a reminder: they are available at fire-sale prices after economic shocks because someone else is desperately trying to cut his losses by getting rid of them. Yes, in theory its possible for a fund like Tac Ops to take advantage of a panic. In practice most funds will find that the benefits of being able to buy some assets on the cheap are outweighed by the risk that a market downturn will slash the book value of the assets youre already holding.

It seems likely that when James says that turmoil can be good for private equity, he has only a narrow slice of it in mind. Indeed, its clear from other parts of the James interview that are online that he emphatically does not think economic cataclysm is good for Blackstone. You can watch about seven minutes into this video to get his take on the dangers of a government shutdown or even a very temporary default. The most salient part:

A lot of investors are saying its a good buying opportunity if that happens, were a strong country, well get through it, and Ill make some money. But boy, its got a lot of unpredictable long-term consequences.

In talking about the prospect economic catastrophe, hedge fund and buyout fund managers are in a delicate position. Theyre always expected to say that if theres a disaster theyll be well positioned to take advantage of it. Anticipating bad news is part of what theyre paid for. But they also know that very few folks actually manage to catch a falling knife and profit from market turmoil.

There may be a few people out there dreaming of another economic meltdown so they can ride in, pick up the spoils and be the next Howard Marks. Perhaps one will be; a lot of others will lose their shirts. The prospect of a government shutdown of some type tomorrow is making some folks wonder if theres any reliable way to capitalize on any market gyrations that might ensue. The good news is that most serious investors already know that there isnt.

PS: What kind of short term effects will a government shutdown have on the markets? Frankly, TMN has no idea. In the December 1995 to January 1996 shutdown, the S&P 500 index fell a meager one and a half percent the night of the shutdown, then recovered and ended the 21 day shutdown virtually unchangeda notably untroubled reaction to Washington going haywire.

An earlier version of this post appeared in the Market Now daily email. Click here to register and subscribe .