Obama's Banking Plan Could Batter Private Equity, Weigh on Markets

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Flush with easy loans to fuel buyouts, American private equity funds were famously compared to locusts by foreign workers and government officials as they marched overseas during the credit bubble.

Now, as the private equity industry attempts to pick itself up in the wake of the credit crisis, it will face another major obstacle. Under President Obama's new proposals, banks may be forbidden from investing in private equity funds. The plan would cut off a major source of funding for the already battered private equity industry while doing little to make banks safer.While widely reviled -- private equity funds are known mainly for taking over and dismembering struggling business, usually firing masses of workers in the process -- the private equity industry actually has a valuable role to play in the nascent economic recovery taking shape. Even vultures, after all, play an important role in their ecosystem.

While only a trickle of their vast overall portfolios, at $115 billion bank investments nevertheless amount to 12% of overall funding for the private equity industry, according to the Private Equity Council of New York. And banks are especially important given the nosedive that overall funding has taken.

In 2009, private equity fund raising of $246 billion came in at the lowest level in five years, tumbling from the record $646 billion raised in 2007, according to research firm Prequin. The paltry $34 billion raised in the fourth quarter was the lowest since 2003, indicating that things aren't improving much yet.

Productive Uses for Private Equity

Despite the loathsome industry image, though, private equity's flexible pool of capital has been put to some good use lately. And much like the crackdown on hedge funds a few months ago, when officials scrambled to deal with the public outrage amid huge bank bonuses, the current attempt to tap populist anger at banks may ultimately prove to be counterproductive.

Homebuilders have recently turned to private equity firms for funding to complete unfinished construction as banks shied away from the sector, for example. As acquisitions pick up steam again and help prop up a turbulent market, private equity firms are seen as potential buyers and thus help bolster stock valuations. And the process of creating and selling securities, which ground to a halt during the crisis, could again be aided by private equity firms, which could help banks clear their books and extend new loans.

With the stock market having gained ground and the IPO window opening again, some high-profile private equity investors were hoping that a change in the industry's fortunes was finally underway. "Generally I think we're coming back. We're now investing again. Our companies are in good shape," David Rubenstien, cofounder of private equity giant Carlyle Group, told Bloomberg in October.

But any comeback would be that much harder if even more funding was to dry up. And while banks -- with only a meager allotment of their overall assets in private equity -- would not be much safer because of the proposal, most other investors would suffer if private equity firms were again removed from the equation.
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