Ever since the financial crisis began in 2007, there has been a tension between recovery and reform. It seems to make sense to get the economy back on track now and worry about reforms later.
But a severe crisis, when Wall Street needs big time government help, is the rare moment when government has the leverage to demand fundamental change. Otherwise, the moment is lost and the cycle of risky practices and taxpayer bailouts continues.
Despite the infusion of massive taxpayer funds, it's back to business as usual on Wall Street -- huge executive bonuses even at firms like Citigroup that lost fortunes on bad strategies and had to be rescued out by government; electronic trading gimmicks that make billions for outfits like Goldman Sachs at the expense of ordinary small investors; disgraced bankers spending fortunes to head off Obama's proposed Consumer Financial Protection Agency; and the same speculators bottom-fishing in troubled waters.
Here's one new abuse that should be stopped before it spreads: Big private equity companies, which are largely unregulated, are hungry to take over failed banks. Their argument is that the banks need new capital, and the private equity firms have it. But this is a profoundly bad idea.
A fundamental economic doctrine holds that banks should be strictly separated from ordinary commerce. Banks exist, with government help, to finance the rest of the economy. But if a regular business also owns a bank, it can get access to capital on preferential terms and disadvantage its competitors.
A private equity company, which typically seeks returns of at least 15 to 20 percent a year, takes big risks. It's fine to do that with your own money, but not with bank deposits guaranteed by the government.
The crash caused a cascade of bank failures. So far this year, 68 federally insured banks have failed, compared with 25 all of last year and just three in 2007. When an insured bank fails, the Federal Deposit Insurance Corporation takes it over, protects the depositors, sells off the bad assets for whatever it can get, and tries to find a buyer to get the bank back in normal operation.
Today, the FDIC is sitting on an inventory of failed banks that it needs to unload, and an insurance fund that it needs to replenish. Enter shadowy and very lightly regulated private equity outfits like the Carlyle Group and Blackstone Capital, who are circling like vultures. The FDIC has done the hard part -- at taxpayer expense. It has eaten the losses and cleaned up the failed banks' balance sheets, making them appetizing targets.
"The private equity companies hope to buy the banks cheap and sell them for a big profit in a few years," says an FDIC source, "or use them as funding vehicles to finance their other business activities. That business model is incompatible with the responsibilities of a bank."
In earlier deals the FDIC has bent its own rules somewhat. It doesn't permit any single private equity firm to own a bank, but in the $32 billion collapse of Indy Mac last year, the agency permitted a consortium of private equity firms to be the buyer.
Last month, the FDIC proposed to toughen its policy. It put out a draft policy statement for comment, signaling that it would prefer to merge failed banks with other banks, or to find investors other than private equity conglomerates. It proposed to prohibit self-dealing by firms acquiring failed banks, and to exclude firms based in offshore tax-havens. And, if a private equity firm acquired a bank, it would be required to have higher ratios of capital because of its inherently riskier business strategies.
The private equity companies have mounted a fierce lobbying campaign to soften the terms, arguing that the banking industry needs the capital. But the FDIC, the rare agency in this whole crisis that has put the public interest first, should hold the line.
Private equity firms are the most lightly regulated large pools of capital in the economy. Unlike banks, they are not subject to government supervision and examination. Unlike publicly-traded corporations, they do not make comprehensive and publicly available disclosures to the SEC.
In financial crises, conflicts of interests by insiders tend to mutate. We got into this mess, after all, because federally guaranteed banks were behaving like compulsive gamblers. Let's not repeat these abuses in new forms.
A version of this column originally appeared in The Boston Globe.
