Fed Should Not Buckle To Investor Lobby

HELP WANTED: The Obama administration is seeking private investors to infuse billions of dollars into struggling banks.

SERVICES OFFERED: Dozens of equity capitalists are standing by to invest billions in these banks.

Problem solved? Not exactly. Here's the catch:

Investors want controlling interest in the banks they salvage. The Federal Reserve says no they can't buy controlling interest.

Folks, what we have here is a game of chicken.

It will start playing out Thursday when Treasury announces the results of its stress tests on banks. Those deemed unworthy of surviving the troubled economy will need more capital equity.

Here's where politics enters the equation. Congress and the vast majority of the public have cast bankers as villains and they will be damned if banks receive another nickle in taxpayer money. Such a perception may be unfair. But the counter-argument of failure lingers if the behemoths such as CitiGroup and Bank of America launch a domino-effect collapse of the entire industry.

Which returns us to the fed's tough stance on the guys with wads of cash to invest.

The Federal Reserve wants to make sure that it does not set the stage for the next financial implosion by turning banks over to private equity firms, some of the riskiest players in the business world.

And they are implementing their vast reserves to lobby Treasury Secretary Timothy Geithner into submission.

These investor groups are hovering over the banks as vultures for they envision easy money to be plucked.

They see banks as the recession’s biggest prize: potential money machines that could one day generate fabulous returns, particularly after the federal government eats the losses of failed banks, then heavily subsidizes their sale. Some of them would prefer to take over the banks completely, replace their managements and take all the profit.

The fed has excellent reason to stick to its policy: Too many equity capital takeover of banks have failed, whether it be in the United States, Japan or the Euro nations.

Current law prohibits mixing banking and commerce, based on a fear that if industrialists own banks, they will dominate — and try to manipulate — the economy, as they did during the early-20th-century.

The government also wants the ability to stabilize a teetering bank by drawing on the funds of its parent company. That is hard to do with private equity firms, which have numerous businesses owned by funds, each of which is walled off to protect investors.

For these reasons, banks generally cannot be owned by nonfinancial companies.

The equity firms counter that banking desperately needs cash if the economy is going to recover, and that they are the only big sources of money around. An executive at the Carlyle Group said the industry had an estimated $400 billion in “dry powder,” or ready-to-invest reserves.

Wall Street billionaire J. Christopher Flowers is one of a handful of equity managers at the vanguard of buying banks and hopefully gaining total control with the help of the feds.

He is profiled in a fascinating reader in Wednesday's New York Times. It is recommended reading before anyone draws conclusions about the evils of saving banks.

My conclusion is moderate and pragmatic: Encourage the private investments into banks by covering toxic asset losses but keep the fed rules of controlling interest in tact.