To Risk Or Not To Risk: Fed Ponders Private Equity Dilemma

Private equity firms are dying to get in on the action of turning around failing banks, if only the Federal Reserve would let them. They may soon get the chance.

A group of private-equity firms, including Carlyle Group and Blackstone Group, have submitted a bid to buy troubled Florida lender BankUnited Financial, according to Marketwatch, which cites an anonymous source close to the action. Meanwhile, buyout firm MaitlinPatterson Global Advisers has been the given a thumbs up by the Office of Thrift Supervision to buy failing Michigan-based Flagstar Bancorp.

Although the Federal Reserve isn’t opposed to private equity firms taking minority stakes in banks, it’s officially anti any more involvement by the cloak-and-dagger dealmakers. That’s because the Fed doesn’t want to set the stage for another financial implosion by getting ultra-high risk private equity firms involved in the running of what are meant to be steady businesses this time round.  

It’s looking more and more like the Fed is running out of options if to wants to turn around the beleaguered banking sector, however. Crucially, private equity firms have around $1 trillion in investable cash right now — certainly enough to shore up a sizeable chunk of the big banks’ capital requirements. More worryingly, U.S. policy looks like it’s starting to threaten the solvency of many regional firms, which are having a hard time raising required funds from selling stakes in themselves.

The conundrum the Fed faces now is essentially the core problem with risk: once you get started, it’s a vicious circle.

The whole reason firms such as Carlyle and Blackstone want to buy majority — as opposed to passive — stakes in banks is, of course, in order to run them themselves and turn a tidy profit. But in order to do that, the private equity firms will of course have to add big risk components back to the banks’ operations, and most likely apply lots of leverage.

Now the Fed is up against a really challenging situation. Either it can act in the interest of the long-term stability of the banking sector and let a few of the players file for bankruptcy — and hence induce another round of job losses — or it can give in to the pressures of the present problems and let the risk arbiters back through the gates.

Given that markets are just showing signs of stabilizing, but that more Americans than forecast are filing for unemployment benefits again, the Obama Administration is unlikely to allow the Fed to fully opt for the latter. In what was increasingly beginning to resemble a freshly de-risked financial landscape, get ready for another round of re-risking.

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