It’s been a big rebound year for private equity. Portfolio valuations have climbed, the IPO window has opened and mega-cap firms like Kohlberg Kravis Roberts & Co. (KKR) have begun raising new funds.

But the industry continues to be dogged by the ghost of excess past. Specifically, the fact that PE funds raised far more capital in 2007-2008 than they have been able to invest. The industry term for this phenomenon is “overhang,” and it’s not the sort of thing that funds can cure by the hair of the dog that bit them (in fact, that would exacerbate the situation).

Research firm Cambridge Associates this week reported that U.S. private equity overhang stood at $376 billion (net of fees) through the end of 2010. Around 85% of that figure is for funds larger than $1 billion, including 42% of funds that are $5 billion or larger. More than 60% is for funds raised in 2007 and 2008 — which are just 46% and 34% called, respectively.

This is a slight improvement from the $445 billion overhang at the end of 2009, but still remains far too high. The typical private equity fund only has five years to invest its cash, which means those 2007 checkbooks get voided at the end of next year. One distressing scenario is that funds rush to their deadlines, overpaying for companies because an inflated deal is better than no deal at all. Another is that these expired funds go back to their limited partners for an investment period extension — almost never does a PE firm just call it a day — in which fee concessions rarely make up for the annualized return declines.

Overhang also negatively affects new fundraising efforts, since it forces LPs to maintain an unusually large amount of dry powder.

One hope would be that the overhang will decline another 15% this year, but it’s unlikely. The 2010 dip was caused by two simultaneous factors:

1. 1. An increase in large deal activity, enabled by a promiscuous leveraged loan market.
2. 2. A relatively-stagnant fundraising environment (i.e., capital inflows), particularly for large-cap firms.

Leveraged buyout activity has been decent this year, but large deals have been on the decline. In fact, some of the market’s largest funds have been trying to rebrand as “middle market.”

Moreover, it’s virtually impossible for interest rates to get any lower and new mega-funds are finally getting raised.

“Absolutely there’s a chance the overhang could grow this year,” says Andrea Auerbach, head of U.S. private equity research at Cambridge Associates. “The biggest contributor to the decline was large-cap funds doing deals and not raising new capital. If you get a combination of low-volume large transactions and new funds greater than $5 billion, then it will just exacerbate what we already have.”