A mere 18 months ago private equity's Masters of the Universe were sweeping corporate Britain before them. Even the political furore about cleaners paying more tax than partners at Permira, the elite buyout shop, could not stop them sealing mega-buyouts.

In July last year Alliance Boots fell to KKR, the American private equity superpower, for £11 billion and in the US in April the $45 billion TXU buyout broke global records. Private equity partners claimed no company in the FTSE was safe from their attentions. And with debt still dirt cheap, they were probably right.

But when the credit crunch hit in August last year, that world changed and private equity was left asking itself whether its model is still viable without the huge leverage that got the industry where it is today.

CVC, one global player with a huge fund still to invest, is trying to find an answer to that question. It is in advanced talks to buy 51 per cent of Royal Bank of Scotland's insurance business with Swiss Re, its industry partner. Sources close to the deal say the private equity house and Swiss Re will put up about 50 per cent of the reported £3 billion purchase price in cash — a far cry from the 10 per cent equity that was injected into deals at the height of the buyout boom.

At this level of investment, CVC must either believe the business is a real bargain on which it can make money later or think it can refinance Direct Line within months, injecting more debt.

Paul Thompson, chief executive of Resolution, the insurance group, and now a partner at Pamplona, the European private equity house, admits that acquisitions are a challenge with no debt available but says there are increasing opportunities to pick up bargains.

He argues that the ability of private equity to hold investments for a long time — the industry's long-touted advantage over the public markets — will really come to the fore in a recession.

However, industry advisers are more cautious. One lawyer commented: “There are acquisitions being looked at and you will start to see funds that are so desperate they will underwrite their own debt. But the problem in the West is that there are not many sectors that are recession-proof.”

With debt currently trading well below face value, picking up cheap debt in private equity-owned companies is proving a lot more popular than new buyouts. The world's biggest private equity houses, including Blackstone and KKR, have set up funds specifically to buy that debt.

And with hedge funds being forced by redemptions to sell their investments at huge discounts, there are many bargains. Jon Moulton, founder of Alchemy Partners, said: “Some of the stuff we've been offered is AAA-rate debt, which is cheap enough for us to buy into our distressed fund.”

Private equity's big guns are also being distracted by problems in their portfolio companies. Heavily indebted companies — particularly those bought at the height of the boom in 2006 and 2007 — are facing real problems already and the situation can only deteriorate further going into a recession.

Andrew Merrett, co-head of restructuring at NM Rothschild, said: “There have probably been more than 30 private equity restructurings across Europe so far this year and that will increase significantly next year.”

But even private equity's cleaner does not think it's the end for the industry. “There are going to be losses at portfolio companies but that's not the end of private equity. The model has always been about having winners and losers in the portfolio,” he said.

However, beneath the radar of the global buyout giants, mid-market private equity has carried on virtually as before. For instance, Lyceum Capital, which was founded by Philip Buscombe, a former Goldman Sachs banker, took Carewatch, a healthcare business, private last month, buying it from the AIM-listed Nestor for just £35 million. In 2008, small is beautiful.

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