Fed to Ease Restrictions on Private Equity Investments in Banks? It's About Time

The Wall Street Journal reports that the Federal Reserve is considering relaxing rules that have effectively prevented private equity investors from making major investments in the banking industry. Good for the Fed—it’s about time! This is a move we’ve been agitating for months . The Fed needs to make changes, and sooner rather than later.

The rules as they now stand are ridiculous. According to current regulations, a U.S. investor that takes more than a 9.9% in a commercial bank is deemed to have a “control position,” which in turn means it has to register as a bank holding company. That’s an enormous straitjacket: BHCs cannot invest in non-bank activities, and operate under a myriad of other regulatory restrictions, as well. Worse, once the investor does become a bank holding company, it must agree to be an open-ended “source of strength” to the bank should it encounter financial problems. Which is to say, the investor takes on an unlimited contingent liability.

That’s crazy. No private investor can operate under such restrictions. These rules might have made sense back when all banks did was take in deposits, lend them out, and hold the loans on their balance sheets. Now, though, the credit-creation industry is a global network of banks, nonbanks, and semi-banks that operate under various regulatory regimes. The Fed’s restrictions are archaic and unfair to U.S. investors.

Which is precisely the argument we first put forth here in March. Back then, during a prior round of fundraising by the industry, sovereign investment funds were able to supply new capital since they aren’t bound by the Fed’s rules. (How is that fair, by the way?) In the months since, private investors have been allowed to make major investments, but only selectively--and with egregious restrictions. A group led by Corsair Capital provided a huge infusion to National City in April, for instance. It now controls 70% of the bank—but gets all of one seat on the board. And TPG was able to invest $7 billion Washington Mutual—but only because WaMu is regulated by the OTS and thus not subject to the Fed’s rules.

The writeoffs at the big banks don’t seem to be about to end anytime soon, and new credit problems are emerging at the regionals. Bottom line: the industry still needs to raise a massive amount of new capital. It won’t come via a bunch of one-off deals like Corsair-NatCity. Nor are the SIVs a dependable source of new investment anymore.

Besides, it’s better, in my view, for sophisticated domestic investors to be the ones to take the lead in shoring up the banking industry. I believe that many private equity investors will be able to offer not just substantial financial support, but operating expertise, as well.

So here’s what the Fed should do. Find a way to eliminate the requirement that a 9.9% stake in a commercial bank constitutes a controlling interest. Bring it up to 24.9%, at a minimum. And find a way, too, to eliminate the “source of strength” requirement of bank investors.

And when you make the changes, don’t drape them with so many new restrictions, provisos, and ifs, ands, or buts, that have the effect of making the new rules just as restrictive as the old rules are. The industry needs to capital. The Fed ought to find a way for large domestic investors to be able to supply it.

Private equity investors are smart and shrewd, and many are eager to invest in the banking industry in its current state. The Fed should get rid of its bureaucratic mindet and enable them to do that.

Comments

[bbzz24]

great argument! keep owners' liability limited and add implicit guarantee from the fed and voila! or wait: the bank can guarantee the debt that the private equity company will use to buy it's own share in the bank! that would be a masterpiece: sort of you pay present shareholders 10 cents for every buck of shares and tell them off.

[Chris White]

Are these regulations? Or are the Fedsters moving beyond the legal frame of their charter to encroach on the Congress's monopoly of obligating tax payers only through the discussion and passage of legislation? If the latter what legal guarantee do private investors have that Bernanke and the Fed Board will prevail? Their word? Is it really such a good idea, just because someone says its a good idea? Moral hazard isn't only incurred cleaning up messes, it is also incurred in the decisions made, and the process by which they are made, before the messes need to be cleaned up.

[sivere]

It is time to get the Fed out of the picture. Our entire financial system is collapsing- with Fed support and encoutragement to get this point, and you are dwaadling on about Fed actions. We need to TakeBackThe Fed.com