A moment of equipose: 2005

Peering down from the gloomy heights, 2005 shimmers, a haven of prosperity and moderation. The seeds of our current woes may have been planted then: the housing bubble, the torrents of liquidity, the overleveraging. But 2005 still feels like a moment of equipoise, a ball frozen at the height of its toss, between the tech bust early in the decade and the recession near the end.

Closer up, it looks messier. The stock market flopped around, with the Dow just over 10,000. M&A surged, after a slow second half of 2004. In a cover in March ("The phantom wave," March 20), we examined whether an M&A wave was dangerously cresting. We decided it wasn't -- at least not yet -- and used the occasion to analyze the complexities of the M&A cycle, and how success or failure changes as the cycle unfolds. Clearly, share prices played a determinant role. The market had trodden water for much of 2004, then lunged at year's end; M&A followed -- hence the "wave" talk. We also noted the changing face of M&A, with private equity ascendant, fueled by ample financing. "It's really less an issue of interest rates than the availability of financing, and there's no shortage of cash," said Alliance Capital Management LP's Brad Hintz at the time. "Everyone has lots of cash."

This could be the epitaph of that era. In March, buyouts already accounted for 13% of U.S. M&A and 25% of European. This was remarkable -- and about to grow. Buyout firms, some wielding megafunds, began to test limits, migrating from mature, cash-flow-heavy companies to larger, riskier targets. The breakthrough deal, announced in August, was the buyout of SunGard Data Systems Inc., the largest tech LBO at the time, for $11.4 billion. Some seven blue-chip buyout firms led by Silver Lake collaborated to pull off the so-called club deal, which was quickly followed in September by a club deal for Hertz Corp. at $15 billion, then for Albertson's Inc. at $16 billion.

In October, we stepped back to take a hard look at the club phenomenon ("Members only," Oct. 3). The advantages were obvious: More firms meant bigger targets, and diversification of risk. But clubs raised questions about power sharing, governance, communication. Venture capitalists had been clubbing together for years, but buyouts were different. VCs expect deals to crap out; PE shops do not, potentially igniting conflicts in the event of problems. And there were regulatory uncertainties, particularly after the Justice Department sent out letters inquiring about the practice. (Nothing came of it.)

Club deals faded in years to come, as funds grew wary of regulators, LPs reacted against club regulars getting "free" rides and financing became so cheap and ample that firms could buy major assets alone.

Still, this represented a fundamental shift. Private equity, increasingly "private capital" as the line between buyouts and hedge funds blurred, grew into a serious rival for long-dominant public-market capital. More and more assets were "privatized" beyond the reach of investors and regulators. The private option had advantages, mostly from a governance perspective. The classic governance issues of public corporations -- the fragmentation of shareholdership and the agency problem -- continued to bedevil public companies as hedge funds proliferated and became more active. Buyout shops had a simpler governance equation, despite the club deals, and did not have to worry about pay or Sarbanes-Oxley. And they could tap the kind of cheap financing that hadn't been seen since Michael Milken.

Not everyone was happy. The first explosion came from Europe in the spring, when a German politician branded PE firms "locusts." Much handwringing ensued. We took a look at the episode a month or so later ("Days of the locusts," July 25), providing deeper context: lackluster growth in Europe, a backlash against the European Union constitution and a reaction against foreign investment and "outside" funds.

Indeed, there were many reminders that the world remained risky as a roadside bomb. In May we posited what a General Motors Corp. bankruptcy might look like ("Crash test," May 23), and in August we revisited battered auto parts deals ("Auto parts: It seemed like a good idea at the time," Aug. 15). Meanwhile, Iraq imploded, the dollar fell, New Orleans was flattened by Katrina, an avian virus broke out in Asia and the Fed grew mildly freaked out by credit derivatives. On Dec. 5 we published an interview with Deutsche Bank AG's head of global banking, Michael Cohrs, headlined "The world is flat (except for a few bumps here and there)." Still, all that liquidity made the bumps seem somehow, in that Bushian way, less real.

Everything's relative.