Private Equity and the Banks

A review article in WSJ claims FDIC is right to demand protection for taxpayers.I agree.

Federal regulators are meeting Wednesday to decide on rules for investing in failed U.S. banks, and they're under heavy pressure to ease up on the draft terms that the Federal Deposit Insurance Corp. laid out earlier this summer. While some flexibility may be in order, the FDIC is right to drive a hard bargain for taxpayers.

The private-equity community has in particular been lobbying hard against the draft rules, which set tough capital and cross-ownership standards. Wilbur Ross, who has made a fortune buying failed assets with the help of Uncle Sam, has hit the media circuit saying he'll never invest in a failed bank again if the FDIC's terms aren't watered down.

That's best understood as negotiating melodrama. Mr. Ross is entitled to wrangle for the best terms he can get, but he isn't entitled to an easy profit as if he's waiting to invest as a great favor for taxpayers. He and other private-equity players aren't amassing $40 billion or more to buy bad banks as philanthropy. Mr. Ross was already part of a private-equity group that bought BankUnited, a Florida thrift, on bargain terms from the FDIC.

For their part, the feds have to balance the need for private capital with the interests of taxpayers. Last Friday, the FDIC closed the 81st failed bank this year, and its deposit insurance fund had already fallen to $13 billion in March, with many more failures to come. The FDIC does have access to a $500 billion Treasury line of credit to pay off insured depositors, but FDIC Chairman Sheila Bair and the Obama Administration are reluctant to tap it for obvious political reasons. (We advised long before TARP that the FDIC was going to have to be recapitalized, and we wish that is where most of the TARP money had gone.)

By attracting private capital to buy these failed banks, the FDIC can reduce the number of liquidations and thus reduce the potential losses to taxpayers. And there seems to be no shortage of bidders. Last Friday, the FDIC rolled up Guaranty Bank of Texas—the ninth largest bank failure in U.S. history—and sold most of its operations to the U.S. division of a Spanish bank. A week earlier, it sold $20 billion in deposits and some assets of failed Colonial BancGroup to BB&T Corp. These buyers are experienced banking operations that are relatively healthy and already meet the capital and ownership standards of any bank holding company.

The big fight is over private-equity investors who want to pool together and bid on failed banks without meeting the 24.9% ownership limit that triggers bank-holding company regulation. PE investors like Carlyle and BlackRock claim, with good reason, that their far-flung holdings in commercial companies mean they can't operate as a bank-holding company. So if the FDIC wants them to bid on banks, it will have to allow them to control banks despite the 24.9% rule. And as long as they claim to be "passive" investors, the PE firms won't technically violate current banking law—the degree of passivity being a subject of some debate.

The FDIC is willing to go along with this, but it understandably wants to build in protections for taxpayers. The FDIC absorbs a big chunk of these failed bank losses, after all, while the new investors benefit from deposits that are taxpayer insured. One proposal would require a 15% Tier I capital standard, which is higher than the 8% required for a new bank. The FDIC seems prepared to budge on that 15%, and we can see the need for some flexibility depending on the investors and the condition of the failed bank. But the impulse to demand a high capital cushion as proof of ownership commitment and staying power is exactly right.

The same goes for the proposal to require a holding period of three years from the purchase of a failed bank before it can be re-sold. The still weak U.S. banking system doesn't need investors looking mainly for a quick spinoff that could leave a bank in poorer hands within a year or two—and eventually back in the arms of the FDIC for more taxpayer losses.

We keep hearing from Treasury and Congress that the U.S. needs more and tougher bank regulation, even though regulators failed miserably to detect problems at Citigroup and many others in their charge. Yet the FDIC is being roughed up—even by some in the Obama Treasury—for demanding capital and other standards from nonbank investors who won't have to meet current bank holding company rules. This is not the way to restore confidence in the banking system.