On February 13, 2007, defining the peak of the private-equity bubble, Blackstone’s CEO Steve Schwartzman decided to celebrate himself … by hosting a multimillion-dollar birthday party, complete with entertainment by Rod Stewart and Patti LaBelle. The event, which followed by just a few days Blackstone’s $39 billion takeover of Equity Office Properties – the largest leveraged buyout ever — was so extraordinary as to attract the attention of the media. Soon thereafter Blackstone decided to sell itself to the public, in the process releasing a fair amount of financial information that perhaps was better left private. Among other things, several members of Congress began to agitate for a change in the absurdly favorable tax treatment of private-equity firms, whose management fees are taxed at capital gains rates, defying logic.

Though an initial attempt to end the favoritism was defeated, most players that I spoke to at the time agreed that some modification was inevitable. They were none too pleased with the glare produced by Schwartzman’s birthday candles.

In the past 18 months, as the credit crunch gathered steam and investors’ appetite for new stock issues waned, private-equity firms slumped. The wizards behind the curtain turned out to have fewer tools at their disposal than investors expected. Unlike hedge funds that usually allow investors to get their money out every quarter, private-equity firms typically lock up your funds for several years. Often, investors pay in only a chunk of their total commitment up front, and then get “capital calls” for the balance as it is needed. Today, many investors are seeing returns plummet, but are nonetheless having to pony up more cash. They are not too happy.

Because of outstanding results earlier this decade, private-equity companies attracted too many investors and too many imitators in the past several years, driving returns down. There is now a shakeup underway, and ultimately the firms that really do add value will be those that survive. Will Cerberus be one of them? Stay tuned.