Bernanke Speaks - On Banks and Private Equity

by: The Deal Economy

Federal Reserve Chairman Ben Bernanke appeared on CBS' "60 Minutes" on Sunday offering a positive outlook. Bernanke said that the U.S. recession might stabilize by the end of the year and a recovery could happen in 2010. However, the most interesting part of the interview was his suggestion of a sign of recovery: private equity firms investing in banks.

"One sign would be that a large bank would be successful in raising private equity. Right now all of the money is sitting on the sidelines saying we don't know what these banks are worth and we don't know if they are stable, and they are not willing to put their money into the banks," Bernanke said.

That's true. Even though the decline in prices of bank stocks have made financial institutions attractive for private equity firms to invest in, PE firms have not started to invest in financial institutions. However, why private equity firms are not investing is not solely due to uncertainty surrounding the stability of a financial institution. PE firms have been discouraged from making investments in financial institutions due to regulatory restrictions, and until the Federal Reserve addresses this, PE firms will remain on the sidelines.

Hunton & Williams LLP's Peter G. Weinstock did a great job of outlining the restrictions on PE in his column, "Don't bank on it" where he explains that while the Fed did relax restrictions in September on PE firms investing in bank holding companies, the restrictions keep private equity players from taking a controlling stake in a financial institution or influencing its recovery. One example is the Fed's recent redistribution of Cerberus Capital Management LP's deal with the Fed over GMAC LLC shares, after the institution converted to a bank holding company.

"For PE firms, the challenge is to be able to influence the bank's direction without becoming subject to banking restrictions," Weinstock wrote.

John Douglas, who chairs the banking and financial institutions group at Paul, Hastings, Janofsky & Walker LLP, agreed in a recent Deal Video interview that the Federal Reserve's recent action to encourage private equity investment in banks was a helpful step, but it didn't go far enough. In the interview he states that the Fed needs to set forth the basis with which PE firms can take a controlling interest in banks. Until the Fed addresses this problem, it's likely most of the money will remain on the sidelines. - Maria Woehr

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