The penny drops, the real reason for the “crisis”

Private Equity

Saturday morning, Buenos Aires: while the city sleeps off a hangover dreaming of a delicious breakfast or nightmare public hospitals full of A H1N1 patients, I read the Financial Times. I do it so you don’t have to!

So I come across this short, and, dare I say it, boring piece by Ms. Henny Sender. Henny is a dead-pan, middle aged, US east-coast financial commentator who spends a lot of time with Private Capital. She says it like it is.

So what is Private Capital? Remember “Mergers and Acquisitions” in the 1980’s? Same thing! They got a bad name for unemployment in the UK so they changed their name. Private Capital buy and sell companies. Henny’s article is about them buying and selling banks.

Sounds boring? Stick with me! I promise to get right to the point.

Private Capital are just that! They leverage secret multi-billion dollar investments from the very-VERY-rich by using their executive-level connections with investment banks. This gives them an inflated bag of cash which they use to buy collapsing companies. Once bought. they are dissected, the bad bits thrown to their friends in the government to be “rescued”, then they sell off the juicy bits for a profit. The profit is used to pay off the private clients (making them even richer), to pay back the investment bankers, and the salaries of the overpaid executives of private capital.

Henny’s short article was the penny dropping! It clearly states that “rescued” banks take taxpayers cheap loans and invest them at speculative higher rates for a profit. Meanwhile they resist making productive loans due to the uncertainty of the “recovery”.

No loans! No recovery! More zombie companies for private capital to buy. Casino capitalism is left on life support in the public wards of the nations of the world like our swine flu patients, while the rich buy another yacht in Barbados.

Recap? Governments advised by rich investment bankers, fatten up failed banks, (now too big to fail!) on a drip of free money. Private capital, eats, digests, and spits out a profit for those same rich investment bankers.

Capital is consolidated in the upper echelons, guaranteed by tax rises on the remaining jobs in the middle classes probably leading to financial collapse.
Is this really the point I ask myself?

Why don’t you take a read and ask yourself?

On Wall Street: Banks no longer so lucrative
By Henny Sender
Published: July 3 2009
The planned merger of two Japanese banks is the latest unhappy chapter in the 10-year saga of foreign private equity capital’s adventure in Tokyo finance.

The two banks, Shinsei and Aozora fell into the hands of Ripplewood and Chris Flowers and Cerberus Capital Management respectively at what appeared to be close to the end of the country’s lost decade. The two purchases came after the Ministry of Finance was unable to find any domestic buyers for the two ailing institutions. Ten years on, the two are still not healthy. Both got into trouble like many of their US peers by straying into investments that promised high yields with seemingly low risk, whether junk bonds that proved worthless for Shinsei or a piece of GMAC in the case of Aozora. It has been easy for both banks to stray from the banking business in Japan in recent years because they lacked a broad base of cheap funding from deposits and they never became the go-to source of loans for corporate Japan.

Now private equity is an eager if frustrated buyer of troubled banks in the US and one of the few sources of fresh equity for a sector that desperately needs capital. US authorities are as paranoid as their Japanese peers of these would be owners’ intentions and intend to impose onerous requirements, (which may or may not prove very burdensome) on private equity. At the same time, regulators also intend to impose all sorts of constraint on the banks and limit the degree of leverage all banks are allowed, which will likely lead to lower profitability.

Given all the new shackles, why would anybody want to own a bank these days?

Partly because, in spite of the new constraints, banking ought to be the most simple, guaranteed profitable business under the sun. Moreover, during hard times, the Fed tries to help banks support the economy by providing cheap funds that the owners then turn round and lend at a guaranteed spread over what they paid for the funds. Owners essentially get to control the profit level by deciding how much money to tuck away for a rainy day in the form of loan loss reserves.

Also, for private equity, these days owning a bank is particularly attractive because there isn’t much else to buy, for the simple reason that there isn’t much debt around. Banks are innately leveraged, making it possible to make decent returns even if the private equity firms have to put down a lot of their own money.

The desire to buy banks assumes a normal environment. But these days aren’t exactly normal economic times and there isn’t much new net lending. The authorities have been leaning on the banks to turn on the credit tap, but they are resisting. Why make a loan today when any signs of recovery are still fragile and a good loan today can turn bad tomorrow? And even if they wished to lend, there is little demand.

That is what happened in Japan. Merging Aozora ad Shinsei will allow the two banks to cut some costs. Aozora’s strong capital base will help support Shinsei. But the combination will do little to address the underlying problems. That’s why rating agency Moodys issued a sceptical report on the prospects of the latest incarnation of the two banks. “Moody’s notes that in light of each entitie’s weak franchise and management, as well as their relatively weak financial fundamentals, there is a low probability of a prompt improvement in the merged bank’s competitive position and franchise,” the report stated.

In the last cycle in the US, 20 years ago, private capital made massive profits from the savings and loans crisis partly because the government took on the losses and partly because the buyers were able to ride the powerful upward momentum of a recovering economy. But this time, the recovery is likely to be far less robust. Demand can no longer be built on the sand of over-borrowing. Consumers, 70 per cent of the US economy, will have to finance purchases with their own money, not their bankers’. Private equity in the US, as in Tokyo, may end up with far less lucrative investments than they anticipate in any banks that they do succeed in acquiring.