All the cash has been sucked from Simmons’ mattresses.

Is it any wonder we don’t trust Wall Street?

I saw it back in the 80′s up close and personal, when the debt was called “junk,” but the practice goes on and on and on. When credit markets are good, investors (called “private equity firms” or “merchant bankers” or “leveraged buy out firms” or the like among their peers and minions) will sell a company’s bonds to finance their purchase of the company, take fees for issuing those bonds, issue more bonds later on to take cash out of the company for themselves (and fees for the new issuance), and then, when the debt becomes to burdensome for the company, the purchasers of the bonds are left high and dry — that is, broke or, at best, with equity in a new, reorganized, and crippled company worth a fraction of what they paid for their bonds.

The latest victim? Simmons Bedding Company, the maker of the Simmons Beauty Rest Mattress. As the New York Times reports:

Simmons says it will soon file for bankruptcy protection, as part of an agreement by its current owners to sell the company — the seventh time it has been sold in a little more than two decades — all after being owned for short periods by a parade of different investment groups, known as private equity firms, which try to buy undervalued companies, mostly with borrowed money.

For many of the company’s investors, the sale will be a disaster. Its bondholders alone stand to lose more than $575 million. The company’s downfall has also devastated employees like Noble Rogers, who worked for 22 years at Simmons, most of that time at a factory outside Atlanta. He is one of 1,000 employees — more than one-quarter of the work force — laid off last year.

But Thomas H. Lee Partners of Boston has not only escaped unscathed, it has made a profit. The investment firm, which bought Simmons in 2003, has pocketed around $77 million in profit, even as the company’s fortunes have declined. THL collected hundreds of millions of dollars from the company in the form of special dividends. It also paid itself millions more in fees, first for buying the company, then for helping run it. Last year, the firm even gave itself a small raise.

Wall Street investment banks also cashed in. They collected millions for helping to arrange the takeovers and for selling the bonds that made those deals possible. All told, the various private equity owners have made around $750 million in profits from Simmons over the years.

If it’s too good to be true, it’s too good to be true.

Yesterday i wrote about recognizing lies.  It is also fundamental to anyone who deals with contracts that they recognize that the higher a price one gets, the higher a risk one is taking.  So, if you buy “junk” bonds, you are getting a high interest rate, but along with the high interest rate comes a high risk you’ll get paid nothing at all.  That’s why they are called “junk” bonds — they’re the bonds of high-risk borrowers.  If you want to lend to those borrowers, you might get a lot back, but you might get nothing.  You can assume, therefore, that if you are told you can’t lose — that you’ll always make money, — that the risk you are taking is infinite.

These are the fundamental points Ben Stein made in this last Sunday’s New York Times when he connected the Bernie Madoff fraud, the sub-prime mortgage crisis, and the 80′s rise and fall of Drexel Burnham Lambert, the investment bank that specialized in the junk bond market:

ABOUT two years ago, a little delegation from a major investment bank arrived at my home in Beverly Hills. These nice young people were from the bank’s “wealth management division.” I told them straight away that I didn’t have anywhere near enough wealth to make their trip worth their time, but they smilingly insisted that we could help each other.

They told me that if I invested a certain sum with them, they would make sure that a large chunk of it was managed by a money manager of stupendous acumen. This genius, so they said, never lost money. He did better in up markets than in down markets, but even in down markets he did well. They said he used a strategy of buying stocks and hedging with options.

I protested that a perfect hedge would not allow making any money, because money made on the one side would be lost on the other. They assured me that this genius had found a way to spot market inefficiencies and, indeed, to make money off a perfect hedge.

I thanked them for their time and promptly looked up Bernard Madoff online. Nothing I saw was even a bit convincing that he had made a breakthrough in financial theory. . . .

My point is not that I was so smart. I am not and I was not. Mistakes are a big part of my life. My point is that, as humans, we seem unable to learn from our mistakes very well.

I have never heard of an entity that could make money in all kinds of markets consistently, year in and year out. Yet we continue to believe that there will be one.. . .

The same goes on a much larger scale for the debacle of subprime mortgages. In essence, it is a much larger version of the Drexel Burnham Lambert junk-bond debacle of the 1980s. Back then, investors were charmed by the idea that the lower-ranked the bond, the more money it would make. It seemed like a great idea: there’s this little corner of the market that the big boys turn up their noses at. But in this little corner, huge money is made. It’s almost like the myth that you get great bargains in poor parts of town.

In fact, the Drexel episode should have taught us to be wary, indeed, of poorly rated debt. But it didn’t. The new version of the myth was so alluring that it drew in not just billions of dollars from lenders and mortgage bond buyers, but much more in derivatives linked to the myth.