Wednesday, May 13, 2009

The Coming New Financial Regulations

A friend writes that it now appears as if the legislation to revamp financial regulation will contain three main elements:

1) A systemic regulator to provide overall protection against another global financial crisis.

2) New resolution authority - similar to the power the FDIC now holds over banks - giving the government, or some entity, tools to rescue troubled institutions
outside the banking sector.

3) A shuffling of power among existing agencies to streamline the way various parts of the financial system are regulated.

One group with extensive political power may escape most of the heavy hand of regulation.

Neither the Obama Administration nor the leadership of the House and Senate committees are focused on Private Equity (PE) as a major target of the systemic reform effort. Thus, Carlyle Group, and the like, are likely to receive close to a free pass as it relates to the the new regulation. However, it is not realistic to believe that PE will completely escape any oversight.

Treasury Secretary Geithner's four-part "Framework for Regulatory Reform" would require that PE funds, along with hedge funds and other private pools of capital with assets exceeding an as yet undetermined threshold, register with and provide financial information to the SEC.

Expect PE to vigorously oppose any effort to require PE to register under the Investment Company Act (ICA), if that is proposed.

The PE stance is that ICA was enacted largely to govern the activities of mutual funds that market investments to the general public. Moreover, the ICA has strict rules regarding independent board membership; prohibits many transactions among affiliated companies; and strictly limits leverage. PE on a regular basis operates in a manner that would be significantly restricted if these rules were to apply to them.

PE is waving around a new research paper by the well connected economist Robert Shapiro (Advisor to Bill Clinton, Tony Blair, Hillary Clinton, Barack Obama, Al Gore, Google and NASADQ. Degrees from Harvard, Univ of Chicago and the London School of Economics) to justify only light regulation of PE. According to data gathered by Shapiro and compiled in the paper, "The Role of the Private Equity Sector in Promoting Economic Recovery," during the past five periods of negative economic growth in the U.S., private equity investment increased by 94 percent during the initial year of recovery, even as total business investments continued to decline.

Additionally, the number of PE acquisitions grew by an average of 55.1 percent in each of the five years following an annual decline in GDP. The increased number of private equity acquisitions suggests, according to PE, that private equity retains access to capital during economic downturns and initial recoveries and that more companies actively seek private equity funding during tough times.

Bottom line, while most of the financial industry will be shackled to the regulatory wall, the politically connected PE sector will be allowed to run wild. It's as if prostitution was banned for all women except Carlyle Group secretaries. David Rubenstein would surely become the ultimate Mac Daddy. I'm talking, the man with all the bling, the Pimp of the Year.

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