June 1 (Bloomberg) -- Investment banking is a wonderful business.

First, persuasive bankers in New York and London promote takeovers, earning millions of dollars for their advice.

To complete the deals, investment firms load the companies with debt, taking more fees for selling the junk bonds or making the interim loans necessary.

Finally, when companies collapse under the debt burden, the bankers profit again. They advise corporations on how to avoid or get out of bankruptcy and they trade the companies' distressed bonds and loans.

Today, even as they continue to bask in the latest takeover boom -- $2.3 trillion in global deals have been announced so far this year -- investment firms are cynically preparing for the bust they know must come.

New York-based firms Goldman Sachs Group Inc. and Morgan Stanley have beefed up their distressed-debt groups recently. So has Amsterdam's ABN Amro Holding NV, which is the target of two takeover bids.

Blackstone Group LP, which manages $33 billion in funds that buy companies largely with borrowed money, is starting a corporate salvaging group in London. Does Blackstone have any of the companies it bought in mind?

While hard evidence of corporate distress is scarce at the moment, the rapid pace of debt accumulation can only mean trouble. Leveraged buyouts totaling $446 billion have been proposed so far this year following a record $702 billion for all of 2006.

What Risk?

Investors have a great appetite for high-yield, high-risk U.S. corporate bonds, many of which are sold to finance takeovers. The yield on junk bonds is just 2.42 percentage points higher on average than the yield on U.S. Treasury bonds, according to a Merrill Lynch & Co. index that tracks this spread. The difference over the past five years has been about 5 percentage points.

Junk bonds do well because stocks are doing well, analysts say. A strong economy that buoys share prices also helps companies pay their debts. U.S. stocks have advanced in each of the past four years and the bellwether Dow Jones Industrial Average has gained 9.3 percent so far in 2007.

There may be a self-perpetuating cycle here. Takeovers -- which virtually always give a premium to shareholders of target companies -- boost stock prices. Higher stock prices then boost demand for junk bonds used to pay the premiums that boost stock prices.

Something may give soon. Warren Buffett, whose Berkshire Hathaway Inc. investments regularly beat the market, says there are few bargain stocks today.

No Restraint

The merger pace won't abate as long as money can be borrowed at relatively low interest rates and on easy terms.

Kohlberg Kravis Roberts & Co., another LBO firm, has negotiated $16 billion in loans from lenders led by Credit Suisse Group to help finance its $26 billion buyout of First Data Corp., which processes credit-card transactions.

There will be no need for the borrower to comply with such onerous terms as having to limit debt relative to cash flow. Loans like this are called covenant-lite -- an unfortunate combination of jargon and advertising agency spelling -- but one that conveys the trend.

Though no one knows exactly when the credit bubble will burst, investment firms on Wall Street and in the City of London will be ready. They are paying as much as $3 million a year for bankruptcy specialists and distressed-debt traders, according to Heidrick & Struggles International Inc., a recruiting company.

That gives you an idea of how much the investment bankers figure they will make by rescuing the companies they once advised to go astray.

(David Pauly is a columnist for Bloomberg News. Opinions expressed are his.)

To contact the writer of this column: David Pauly in Normandy Beach, New Jersey dpauly@bloomberg.net

Last Updated: June 1, 2007 00:14 EDT