I finished watching Secretary Geithner’s press conference on the bank rescue package. Much of the information can or will be found on www.financialstability.gov. My initial reaction was to write a post on the private equity portion of the bank rescue, that is the Treasury’s plan to use government guaranty funds to mobilize private capital. That post will take some time to write as I want to explain the history of the concept, the pluses, the minuses and a proposed structure. What I did realize over the past hour was that this administration has a Herculean task ahead of it, setting up such a fund (and this is only one part of the plan) will not be easy, nor will it be assured of success. Here is my initial take:
Who is private equity?
To show just how far behind Secretary Geithner is in planning this phase of the rescue, he did not define what private equity is. The largest definition is that it is investment in any instrument that is not traded publically, though many private equity funds may have mixed portfolios of public shares and private investments. The definition is important because different PE players have different skill sets, a hedge fund is different from an LBO shop, which is different from venture capital which is different from a fund of funds. So what are these bank assets and who buys them?
(The when, what, why, how and some existing US Government private equity programs after the jump . . . )
When will the structure, deal and terms be announced?
Established PE deals (venture, buyout, hedge, …) can be set up in a matter of days or weeks, but more complex deals and funds, such as those involving the government, usually take many months. The Obama administration may have been working on this plan since last summer, even so, final terms will take a long time to put in place. I think the market’s negative reaction was in part due to the realization that any distressed asset fund will not be in place for a while. However, where information is key, a timeline would be helpful.
What will this really cost?
The information sheet put out by Treasury stated a fund size of $500-$1,000 billion (that’s up to one trillion). But is that figure total fund size or simply government contribution.? Is the government contribution in the form of investment guarantees, direct loans or equity? To really be a government accounting nerd, is the government size the whole government commitment or is it simply the amount of government subsidy (in other words, the commitment is much larger)? Does the government actually expect this to be profitable?
Any good fund plan needs to have a business plan with targets, goals and benchmarks. There should be a transparent manager selection process and clear asset valuation process. We should wait for the plan to roll out, but again, absent this information, it is impossible to judge.
Why is PE the best alternative?
The original TARP was supposed to be able to purchase bad assets, until it wasn’t (it was supposed to recapitalize the banks). We heard a great deal about the good bank-bad bank plan that would accomplish removal of impaired assets. Of course, there is the simple solution of just writing these assets down and closing/restructuring the banks that are insolvent die to write-downs. Why are those options worse than trying to raise a PE fund?
How will this be executed?
What is the guarantee that PE money will buy in to these funds and assets. A number of PE groups will not participate in government funds because of government disclosure and other contractual requirements. Will the government waive those requirements or are those pools of capital off the table? Do the funds have to be majority US owned (can Dubai buy up everything)?
If the government has to use a high amount of leverage to attract capital (in other words, Treasury has to guaranty a large portion of investment), isn’t this just shifting our current problem from the private sector on to the taxpayer while giving PE funds a shot at making a profit? If PE can’t get high leverage, will they come? Just because you build it . . .
Conclusion
I was impressed that the Obama administration and Secretary Geithner would be this innovative. The positive is that they are using new, big, bold solutions to fix the financial crisis. What worries me is that these plans are not developed or thought out. Having managed 35+ such public-private funds myself, I can say from experience that it is not as easy as it looks and there are no guarantees. Anyway, there are some US Government examples where this has been done and I hope President Obama and Secretary Geithner are busy seconding employees from these programs to Treasury this afternoon.
SBA’s SBIC Program (the first public-private private equity program in the US)
OPIC’s Investment Funds Program
CIA’s In-Q-Tel venture capital program
. . . And that’s how it goes
