Loren Steffy's  Instablog

The FDIC is struggling to combat this year's wave of bank failures, and its insurance fund may be tapped out by year's end. As we saw with the failure of Austin-based Guaranty Bank last week, the agency is now more willing to consider foreign banks as bidders for failed institutions.

With its insurance fund dwindling, the FDIC has apparently decided it can't afford to be so picky about potential buyers. Yesterday, its board voted to ease requirements for private equity firms to buy failed banks. It lowered the minimum amount of capital that private-equity investors must maintain for three years after buying a bank.

But the requirement is still twice as much as the capital requirement the FDIC set for banks to be considered well capitalized. The move drew a tepid reaction from the Private Equity Council, which is sort of like a trade association for hedge funds:

The revised FDIC guidelines represent an improvement over those originally proposed in July. But we continue to question the need to impose more onerous capital requirements on private equity firms that invest on behalf of retired police officers, firefighters, teachers, and other public employees.

The council argues now is not the time to be discouraging the influx of capital into the troubled banking industry. Perhaps not, but it's the subsequent outflow that the FDIC seems worried about. Hedge funds, after all, buy distressed companies, squeeze out costs and sell them again for quick profit. It's one thing to do that with, say, manufacturing firms, but quite another to be flipping banks.

Certainly, hedge funds broaden the pool of potential investors and might enable the FDIC to get a better price.

But the council's statement is disingenuous. Hedge funds aren't buying banks on "behalf of retired police officers, firefighters, teachers, and other public employees." They're buying them for the same reason they buy everything else: potential returns.

Sure, public pension funds have loaded up on private equity investments, but that strategy hasn't worked too well for them. Ask those civil servants if they think buying failed banks is a good way to invest their retirement.

The FDIC isn't in the investor protection business, but its hard line with the hedgies may ultimately do more to help retired public servants than the banks it insures.

Disclosure: no positions

Seems like just yesterday everyone was jealous of private equity. Those outsized returns, those huge fees, the low tax rates for partners. Pension funds across the land had to get some of that, and they loaded up on private equity investments to generate the returns that mere stocks and bonds couldn't.

In the past decade, U.S. pension funds poured $1.2 trillion into pension funds. So what do they have to show for it? Not much, Bloomberg News reports.

So far, they only have dwindling paper profits and a lot less cash to show the millions of policemen, teachers and other civil servants in their retirement plans.

Few pension managers disclose details of their investments, but among those that do, it isn't pretty. Take, of example, state pensions in California, Oregon and Washington, which invested a combined $53.8 billion in private equity deals since 2000. By the end of last year, they'd recouped just $22.1 billion, according to data compiled by Bloomberg. That's a 59 percent shortfall, and the funds' haven't reaped a paper gain from those investments in seven years.

Just like with their dabbling in commodities, pensions have strayed from their true purpose:

"Pensions should be invested in fixed-incomes with the same maturities as the future beneficiaries," said Roger Lowenstein, author of While America Aged, which chronicles problems facing U.S. pensions.

By chasing the latest investment fad, funds inevitably miss them or hold onto them too long, he said. Often, they fail to understand the markets for such securities.

Too often, of course, pension managers are more concerned with boosting their own records and boasting about their returns, so they take unnecessary risks. Now, it seems they have some explaining to do to the civil servants with whose retirements they were entrusted.

What's in your retirement plan?

Disclosure: No positions

The bankruptcy court auction for Frontier Airlines began this week, and Southwest already upped the ante, raising its bid to $170 million on Monday.  As I pointed out in Sunday's column, winning will put Southwest in an unusual position when it seeks anti-trust approval from the Justice Department.

The carrier that helped redefine airline competition in the post-regulation world will have to argue that having one less carrier in Denver will increase competition.

That issue struck a nerve with the Dallas-based airline, and Ron Ricks, the executive vice president for corporate services, called me Monday afternoon to explain the carrier's position.

"We didn't do all this just so we could walk up to the DOJ and get stuffed,'" he said. "We have a plan to win."

That includes demonstrating that Southwest's plans for Denver will be pro-competitive. Southwest contends that Frontier isn't actually a low-fare carrier, that its fare are low only in markets where it competes with other low-fare airlines. In markets were it competes solely against, say, United, its fares are much higher.

When Southwest entered the Denver market in 2006, it had the same effect that it's had in other markets - fares declined, Ricks said. Based on government data, fares from Houston to Denver, for example, fell and average of 21 percent. Frontier itself lowered fares by 20 percent to compete. At the same time, passenger traffic increased by 27 percent, he said.

That isn't really the issue, though. The issue is what happens after it buys Frontier.

As it stands now, United controls about half of the Denver market, and even if it combines with Frontier, Southwest will hold less than a third, Ricks said.

"We're buying Frontier in order to become an immediate force in the marketplace," he said.

In other words, Southwest will argue that it can compete more efficiently against United if it has more market power. But that ignores the fact that the merger would also create a near duopoly in Denver.  In way, Southwest is asking the DOJ to trust it to keep fares low. If any airline could pull that argument off, Southwest could, given its track record.

But as I noted in my column, Southwest has been losing big bucks in the Denver market, probably since it entered. A big chunk of those losses can be blamed on Frontier, not United.

Ricks, though, rejects my assertion that buying Frontier is a defensive strategy. Even with the increased price of the bid, it's getting a billion-dollar airline with international routes and gates in new markets such as Atlanta for the price of about five 737s.

"It allows us to do virtually overnight what might take a decade to do and cost a lot more money," Ricks said.

That's the same case Southwest has been making to its employees. 

"We had some major issues here with our own workforce," he said. "We are in a no-growth mode right now because of the economy, and Southwest Airlines has never been in a no-growth mode. Some of our unions are very unhappy about that."

So, Ricks argues, the whole strategy is straight out of the classic Southwest playbook. It's about growth and busting United's chops, not removing a competitive threat from Frontier.

"The real story here isn't Frontier," he said. "The real story is the competitive war that's about to break out between an invigorated, a more powerful, a bigger Southwest combined with Frontier against United."

There's no question that buying Frontier offers a lot of benefits for Southwest, both in terms of growth and in bulking up against United. But given its losses in the market, and given United's own shaky financial condition, I still say its going to be a tough sell before the DOJ.

With Frontier gone, Southwest could - indeed probably should - raise fares enough to at least make Denver profitable. So it's essentially arguing that higher fares and fewer market participants improves competition.

That, as I said in my Sunday column, is an argument only a legacy airline could love.

Disclosure: no positions