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The Banks, Private Equity, and the Fate of Consumers

posted by Adam Levitin

The New York Times has an interesting op-ed about private equity investment in banks. Long story short: banks need money now, and private equity is one of the last remaining sources of capital available. PE investment strategy is to buy a control stake, maximize efficiencies, and resell the company in 5-7 years. Because current bank regulations require that an entity holding beyond a certain threshold of a bank's stock either register as a bank holding company (which subjects it to various regulation, including disclosure requirements) or forgo involvement in the bank's management, PE firms are reluctant to invest in banks. Private equity is about control and lack of transparency. PE smells a great buy in banks, however, so PE shops are pushing federal banking regulators to relax the regulations. Their argument: without us, the banks will fail and/or credit will contract, and this will be on your heads, banking regulators, so beggars can't be choosers.

The Times rightly notes that PE shops shouldn't get special treatment and if banks fail, well let that be a lesson to their investors and creditors to monitor lending practices better in the future. Depositors are largely protected by FDIC insurance.

But there's another worrisome angle left unmentioned in the Times editorial. Because PE shops are simply trying to maximize efficiencies in the short-term in order maximize their return on exit, they aren't concerned about the long-term safety-and-soundness of banks. If the company blows up after the sale, the PE shop doesn't really care. This could spell bad news for consumers. If a PE shop buys a bank and sets out to maximize revenue/cut costs, it will likely start milking the consumer cow much more vigorously. And this means PE shops might be tempted to push all sorts of abusive, but very profitable lending practices. This is quite concerning, and if federal bank regulators do loosen the investment requirements for PE, it should be with very explicit commitments to maintaining best practices vis-a-vis consumers. Of course, once the camel's nose is under the tent, these commitments could start to look a lot like the ones on human rights that China made the International Olympic Committee.

Comments

The banks are basically broke. All their reserves (Fed member banks) are borrowed (has never happened since the FED started keeping stats end of the 1950s), Google BOGNONBR. There exists a $1 QUADRILLION derivatives bubble (a giant casino), that is collapsing. This dwarfs the housing bubble, which was nothing but part of the larger bubble. We need to start fresh:

www.TakeBackTheFed.com
www.xFed.mobi (mobile)

Superficial and uninformed analysis. The post speaks as if raising the 9.9% threshold a modest amount would gives the PE firm total control over the institution. Obviously unlikely that the rest of the shareholders would surrender control to a minority investor. Further, it ignores the whole consortium phenomenon in which a host of sovereign wealth funds, hedge funds and PE firms have ALREADY taken substantial equity stakes and acquired board representation at major bank holding companies. Finally, the premise that PE firms have a shorter horizon than existing board and management is silly as to a public company - it was the myopic focus of publicly owned banks' board, management and stock holders on generating short-term earnings that led to the overinvestment in subprime loans, etc.

I'm not really sure who MarkT is taking a shot at--I didn't address what, if anything, would be a proper ownership threshold for imposing regulatory requirements on an investor in a bank. For what it's worth though, owning 10% of a publicly traded company might generally be sufficient to control the company, if the other shareholders are dispersed.

I'm willing to accept the claim that PE investors' investment horizon may not be as short as some others, say hedge fund managers, or CEOs who are looking to retire in a couple of years. And consortium investing also raises problems as the regulations are based on form, not substance. But neither truism undermines the point about PE firms investing in banks having potentially negative consequences for consumers. Just because there are problems elsewhere doesn't mean we should graciously accept another pig at the trough.

I think the better argument would be that PE firms' horizon is actually much longer than other interests involved and therefore a good thing. But that only means that PE firms will want products that explode in 6-8 years, not 2-3 years. I guess that buys consumers some time.

Oooff- let'em have it. The predation that these firms embody just accelerates the destruction of value.

Soon enough, consumers get sick of it and pull their funds and the whole thing collapses that much quicker.

I don't want to see our banking complex fall apart, but, if we go ahead and let them have their "hindmost", they will ultimately serve a decent use.

Why fight a pre-ordained outcome?

If you wanna despise someone, invest your client's funds in a PE fund and watch your equity disappear in 3 years when there isn't any re-fi money available and your money disappears in a Chapter 7/11 while the managers are toasting your stupidity in Bermuda.

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