Saturday, June 28, 2008

Watching The Power Elite As They Grab Some Power and Money

Earlier this year, April 6, to be exact, I attended a luncheon meeting of the Washington D.C. National Economists Club. The guest speaker was Randal Quarels.

Quarles was former Under Secretary of the Treasury who led the Treasury Department’s effort in the coordination of the President’s Working Group on Financial Markets (aka, The Plunge Protection Team) and he is currently a Managing Director at Carlyle Group.

Plunge Protection Team coordinator? Managing Director at Carlyle Group? Folks, this is what is known as a major league insider.

At the time, I posted on the luncheon meeting and wrote in part:

In his talk, Quarles said that estimates go into the hundreds of billions in terms of capital that will be required by the financial industry because of losses sustained as a result of the current crisis. He said there will be more financial institutions that will go under in coming months.

He said that public markets will not supply the necessary funds because they don’t have the capabilities to study in detail the risks and potential rewards of the complex financials of financial institutions. He said private equity firms have the capabilities to do so and to supply the necessary funds. (N.B. Carlyle Group is a private equity firm).

Quarles stated that some changes in the structure of regulations that Paulson proposed were necessary but would take time to develop. He specifically stated that one regulation that needed to be changed is the limitation on the size of positions that non-banks can take in banks. (Note: Limitations in the size of non-banks positions in banks now limits Carlyle Group from taking large positions in banks).

It sounded to me like a power grab was being set up, and I titled my post:

Carlyle Group's Plan to Takeover the Banking Industry

Lo and behold, three months later Bloomberg is reporting that the Carlyle Group, and other private equity firms, have been meeting with the Federal Reserve to discuss removing limitations on the size of positions equity funds can take in banks.

Writes Craig Torres at Bloomberg:

Federal Reserve officials are reviewing regulations that limit investment firms' stakes in banks in an effort to channel more capital into the U.S. banking system....Fed officials have met with the Washington-based buyout fund Carlyle Group, spokeswoman Ellen Gonda confirmed. ``There is an ongoing dialogue,'' she said. ``It's not unusual for regulators to seek private sector input on policy.''

There's a few lessons to be learned here about how the power elite operate.

First, they always take advantage of crisis to make a grab. Notice how Quarles in his talk at the luncheon mentions Treasury Secretary Paulson's call for reform in financial regulation and structures.

Of course, Paulson made his comments about financial reform under the guise of changing things because of the current mortgage crisis. Nowhere did Paulson specifically state, "As part of this reform we are going to allow private equity funds, such as Carlyle Group, to buy bigger stakes in banks."

Quarles at the luncheon also mentioned that he picked the topic of financial reform way back in January. So we now have something of a timeline. Quarles had financial reform on his mind in January. Thus, one can assume, with a large degree of confidence, that the plotting was certainly going on at Carlyle back then. Paulson doesn't come out with a speech about the need for financial reform until late March. And, viola, here we are in late June and meetings between the Fed and the Carlyle Group are leaked to the press.

Which brings us to point two, of how the elite operate. They always make things complicated. Just what exactly are the Fed and Carlyle Group meeting about? It's "an ongoing dialogue" says the Carlyle Group.

If the Fed simply wanted to increase the amount of capital that banks could take from any one investor or investor group, the problem is fairly simple and could be solved with a Fed statement as follows:

Restrictions are hereby removed that prevent investors from increasing their stake in a financial institution above a specified level.


Restrictions on what individual investors or investor groups can invest in a financial institution have been increased to X.

Anytime a regulation is more than one sentence long, special interests are carving up little slivers for themselves and putting up barriers to entry that make it difficult or impossible for others to play the game.

The barriers to entry come in the form of complex regulations that require teams of lawyers to understand. Unless, of course, you are "in dialogue" with the regulators and help design the regulations so you know where the loopholes are, and in fact probably suggested some of them.

Taking advantage of crisis and making things complex is how the elite play. The current crisis is the mortgage crisis. They are taking advantage of the crisis to sweep up and buy into banks on the cheap, and they are sitting in a conference room with the Fed to create regulations so onerous that only the elite will be able to play.

When do you as an individual investor come in? Three to five years down the road when the banks stocks are prettied up and sold to the public at a price somewhere between 5 to 20 times what the elite paid for them.

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