Keep Private Equity Away From Our Banks
By ANDY STERN July 7, 2008
The recent efforts by Congress and the Federal Reserve to facilitate capital injections by private-equity firms into banks may seem like a welcome development. But a closer look reveals that all that glitters isn't gold.
A growing number of ailing banks and thrifts need cash fast – and private-equity funds are anxious to deliver. With built-in cash cows in the form of mortgages, credit cards and accounts subject to an endless array of fees and interest-rate hikes, banks are a ripe target for private-equity firms seeking returns of 20%-30% or higher over relatively short periods.
But short-term capital infusions from private-equity funds will only make the banking crisis worse, by encouraging risky behavior and abusive banking practices.
It's hard to imagine private-equity funds resisting the urge to double down on the tactics banks have used to drive profits in recent years – unfair lending practices, higher fees, and exorbitant interest rates on credit cards and other consumer products. Are America's working families prepared to absorb that kind of risk?
Private-equity firms have made a lavish living on making big bets when no one is looking. Unlike banks and thrifts – which are regulated, transparent and generally publicly owned enterprises – private-equity firms operate in secret, virtually free from regulation. They use tax loopholes around carried interest – and deduct interest payments on the debt they use for buyouts – to extract huge profits from the companies they buy. Private-equity profits are built on big risks, and taking advantage of lax regulation – the very problems that led to the subprime and credit crises.
Shareholders are also paying the price for private-equity investments in banks. Texas Pacific Group's (TPG) recent investment in Washington Mutual (WaMu) massively diluted shareholder stakes by handing 50.2% of the company to TPG and its partners. While the deal – crafted in secret without shareholder input or approval – has already put $50 million in transaction fees in the pocket of TPG, WaMu shareholders have seen their stock value fall to $5.38 a share, the lowest level in 16 years (a nearly 90% drop in the last year alone).
The thrift's shareholders, including the SEIU Master Trust, showed their disapproval by stripping CEO Kerry Killinger of his title as chairman of the board. Mr. Killinger's pick of TPG over a merger with JPMorgan Chase may have saved his job, along with those of other failed executives. But the shareholder-led revolt sends a clear message that the match between private equity and banks is likely to be rocky.
The trend toward private-equity investments and the new risks it introduces to the system could also significantly increase taxpayer costs. TPG chief David Bonderman cherry-picked the good part of American Savings – eventually selling the thrift to Washington Mutual for a fourfold profit – and saddled taxpayers with its bad debts. Rest assured that if taxpayers wind up bailing out troubled banks, private-equity firms will be first in line for the biggest share.
Private-equity firms are now hatching a plan to provide a backdoor entry for sovereign wealth funds to U.S. retail banks. David Rubenstein, chief of the Carlyle Group, argued in an April speech that troubled U.S. banks are tempting investment targets because "sovereign wealth funds can't do certain things because of their foreign status . . . private-equity groups can join forces with the funds to facilitate transactions." No one's arguing that the U.S. should be closed to investments from sovereign wealth funds. But offering pieces of our financial infrastructure to foreign governments poses a threat to national security.
The Service Employees International Union is asking Congress to hold hearings reviewing the TPG-led, $7 billion investment in WaMu, and the $7 billion private equity-led investment in National City Corp. Lawmakers must look closely at these capital injections into the heart of the nation's financial infrastructure from unregulated, secretive sources.
In the short run, banks have other, more public options for raising badly needed capital – including from existing shareholders or by merging with a stronger bank. Already, banks such as Wachovia and RBS have raised capital by issuing new stock. Troubled banks should also look to banks with stronger capital ratios for merger and buyout opportunities. This would deliver new stock and cash, while giving the failed management of the existing bank a one-way ticket out of the boardroom.
Ultimately, private-equity funds have no place in the country's retail banking system – and lifting regulation and oversight is the last thing policy makers should be considering. We need regulation and policy changes that provide more safety, soundness and transparency in our banking system.
Regulators, shareholders and taxpayers must think about how to solve the crisis in a real way – not through stopgap measures that enrich private-equity firms while our nation's banks go belly up.
Mr. Stern is international president of the Service Employees International Union.