The Fed Considering Making It Easier For Private Equity To Provide Bank Capital

As reported a few days ago at the Financial Times, the Federal Reserve is reviewing whether or not to consider changing or loosen existing restrictions for non-bank holding companies, allowing them to take larger stakes in the banks without getting regulators involved. Some private equity firms have been interested in taking larger stakes, and providing the banks with much needed capital, but have stayed away due to existing limitations. Currently, companies that are not holding companies are prevented from owning more than 25% of a bank, and even less if they hold a board seat. Holders of large positions are also required to make what are called "source of strength" commitments, in essence agreeing to put up additional funds if necessary. While private equity funds are willing to take initial positions, many are reluctant to keep funding a decreasing asset.

The review by the Fed is in response to the need from banks to raise additional capital. Sovereign wealth funds provided some initial capital, but many have been shying away from U.S. financial companies, even at their current cheaper levels. To date banks have raised as much as $400 billion, but may need closer to $1,300 billion. To close the gap, the Fed may be forced to loosen restrictions in order to provide new ways to get the necessary capital to the struggling financial companies. The fact that the Fed is even considering such actions gives you an idea of how worried they are that another failure could develop. Even today there is an article in Vanity Fair discussing how rumor may have been the main contributer for initiating the run on Bear Stearns. The last thing the Fed, or the U.S. economy needs right now is for worries of capital concerns to cause another financial company to go under. Given the recent price action in LEH, C, JPM, MER, MS, and GS, the market certainly seems to be hinting at this possibility. Given that the Fed has its hands tied with regard to interest rates, unconventional approaches, such as making it easier for private equity to invest, or continuing to work through the discount window, may be its only current options.