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Fed Move Would Ease Investing in Banks

By Neil Irwin
Washington Post Staff Writer
Friday, June 27, 2008; D01

The Federal Reserve is considering making it easier for private-equity firms to invest in banks, which would smooth the way for huge new capital infusions to the troubled financial sector.

Financial companies, reeling from losses, have raised more than $300 billion in the past year as they have tried to rebuild their capital, and they may need to raise billions more. Top officials, including Fed Chairman Ben S. Bernanke and Treasury Secretary Henry M. Paulson Jr., have strongly encouraged banks to raise more money.

But now the previous sources of those funds, buyers of public offerings of stock and foreign investors, have lost money and become wary . Private-equity firms, which assemble vast pools of money and invest them, are eager to invest in banks but have been largely absent from those deals.

One major reason: Regulations make it difficult for private-equity funds to take significant stakes in banks without exposing themselves to new government oversight and strict limits on what other kinds of businesses they invest in.

The Fed is not contemplating an overhaul of those rules, according to sources familiar with the plans. Rather, its lawyers are working on documents that would formalize how their fine points are interpreted, which would make it easier for private-equity firms to know what is and isn't possible as they consider bank investments.

There is no clear time horizon for the effort, which began more than two years ago. The problems in the banking sector -- underscored by an analyst's downgrade of Citigroup yesterday -- have added urgency to the project and could tip the balance toward a more liberal interpretation. The many subtleties of how the rules apply have been assessed only in private letters and other communications, not in a publicly available document.

The Fed is likely to clarify some of the less-settled questions of how the rules apply, the sources said yesterday. They spoke on condition of anonymity because they weren't authorized to comment publicly on the ongoing matter. For example, an investment fund cannot buy more than 9.9 percent of the stock in a bank and seek to influence its operations without being classified as a bank holding company subject to extensive oversight. Less clear is what happens if several funds get together and each put less than 9.9 percent into a single consortium.

Under a long-standing set of laws that try to separate banks from ordinary commercial companies, funds that own more than a quarter of a bank cannot own any ordinary commercial business.

Private-equity firms, meanwhile, which spent 2006 and the first half of 2007 buying businesses with borrowed money, have had fewer investment options now that lenders are being more careful. Thus, for many of these firms, the financial-services sector poses a rich opportunity -- an established sector that desperately needs their cash to make up for huge losses on mortgages and other loans.

The private-equity industry has been pushing the Fed to loosen its rules to make those investments more possible.

"Banks have a tremendous need for capital right now," said Randal Quarles, a managing director of the D.C. private equity firm Carlyle Group, "and it's in everyone's interest for the Fed to help facilitate the flow of capital into the industry, including from private equity."

The Wall Street Journal reported the Fed's possible action on its Web site yesterday afternoon.

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