PRIVATE EQUITY AND THE BANKS / THE WALL STREET JOURNAL OP EDITORIAL ( RECOMMENDED READING )

OPINION

AUGUST 4, 2009

Private Equity and the Banks

By ANDY STERN

While we’re still digging ourselves out of the greatest economic crisis since the Great Depression, private-equity firms are shoveling dirt back in the hole. Firm leaders still argue that the overleveraged, privatized and market-worshipping financial model they perfected—uninhibited by regulation and enforcement—is key to rescuing our nation’s banks.

Last month, the Federal Deposit Insurance Corporation (FDIC) released draft guidelines limiting the ability of private-equity firms to invest in failed banks. These new guidelines will ensure that the banks are well capitalized, that the details of their investments and loans, like those of any commercial banks, are made available to the FDIC, and that the FDIC and other agencies can prevent a rerun of the Savings & Loan crisis of the 1980s and ’90s.

Meanwhile, private-equity stalwarts have been arguing against those guidelines. If we are to believe these guys, any attempt to rein in private equity’s ability to invest in bank deals would stifle investment and hinder economic recovery.

They promise they’ll play by the rules this time, that we can trust them, that they’re looking out for taxpayers. But we’ve played that game before. And we learned ordinary Americans pay the price when financial markets are unregulated and overleveraged deals—which initially thrived—eventually go bust.

We lose our jobs as our employers cut back or are forced to close their doors altogether. We lose our retirements as the value of the stock market plummets, along with our investments and our pension funds. We lose our homes because we can no longer afford our mortgages after getting laid off or having our hours cut. We lose our recovery when banks cut off the credit our small businesses need to survive.

But hard-working people lose in more ways than this. As homes foreclose and businesses go bankrupt, states and cities lose tax revenue—resulting in cuts to services we depend on. That tax revenue could be used to provide health care for all, develop a new green economy, or foster a world-class education system. But instead of investing in our future, we end up bailing out a reckless financial industry.

Most Americans, like myself, believe in a pretty simple philosophy—that if you work hard and play by the rules, you should be able to get by and raise a family, send your kid to college, and retire with dignity.

That’s been the promise of America for decades—until a handful of people on Wall Street and in Washington figured out how to rig the system against us.

Nobody is trying to stop private-equity firms from making profitable investments. But we need to ensure that the decisions made by a few never again threaten our ability to provide for our families and win a better life for our children. The FDIC’s guidelines are, for two reasons, an important step toward protecting the economy from future financial recklessness.

First, banking is still a relatively new industry for private-equity investors. It’s therefore not unusual for the government to provide them with increased oversight, ensuring their new investments prove sustainable. Private equity’s recent track record suggests that it needs regulation on this front.

For example, the Texas Pacific Group’s (TPG) disastrous investment in Washington Mutual last year prevented the financial giant from raising additional capital until it was too late, resulting in its forced fire-sale to J.P. Morgan Chase. This wiped out TPG’s entire investment.

Then in May, four private-equity investors teamed up to buy BankUnited—a bank with $12.7 billion in assets and $8.3 billion in deposits—for only $900 million. The FDIC committed to share in 84% of the bank’s losses. Though taxpayers subsidized the purchase and took on most of its risk, private-equity firms stood to gain most of the profits.

Second, private equity’s entire business model is based on reworking the connection between risk and reward. In this case, they get all the rewards while the government and taxpayers take on all the risk. This is not the way to stabilize our banking system. The FDIC’s guidelines ensure that more risk is spread out among investors with less saddled onto the taxpayers.

These are the kinds of guidelines that the Service Employees International Union (SEIU) called for long before this economic crisis. SEIU wanted to ensure that private-equity firms wouldn’t continue to reap all the rewards of their investments while using workers and taxpayers as a backstop against potential losses and failures.

The FDIC’s new guidelines are a good first step, but full economic recovery will take more. We must continue to act more boldly and more broadly if we are truly serious about building a new financial model that rewards long-term sustainability over quick profits and fad investments.

—Mr. Stern is the president of the Service Employees International Union.

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