Chase's Private Equity Deals

This morning's Wall Street Journal contained a small piece highlighting Chase's private equity group bidding $6/share for the outfit that produces American Idol.

The article was attempting to be wry in its scepticism over the price and proposed deal. The quasi-analysis focused on the production company's contract with Fox to air a few more seasons of the program, and Simon Cowell's recent departure from the firm.

Bottom line, concluded the piece, is that Chase may be overpaying for the small firm's current assets and management.

That's not what struck me about the article, though.

No, what I saw was yet another case of a federally-, meaning taxpayer-insured financial institution playing roulette with our money.

First, why on earth should taxpayers even allow a federally-insured bank to have a private equity unit? Private equity is all about risk. About bidding on existing firms, typically with more debt than is in the current structure. That's the easiest way for a private equity firm to bid over current market valuations, i.e., put in less equity, borrow more money and toss it to current owners.

Fine if you're, say, TPG. Or Cerberus.

Ooops! Not Cerberus, actually, after the GMAC and Chrysler fiascoes.

And that's my point.

Dress it up any way you like, Chase's private equity group is essentially taking on obligations, by way of borrowed money, used to pay off the current owners of CKX. If the deal doesn't work as envisioned, shareholder equity is the first call for repayment of the debt.

But, ultimately, the last resort is you and me, via the FDIC and Treasury.

This is why the Volcker Rule makes so much sense. And causes such outraged opposition in the banking sector.

Jamie Dimon obviously would love to keep this sweet, one-way risk spreading deal.

You and I should not want that.

And don't be fooled by the implication that Chase is so large that it can absorb the risk. If their private equity group is too small for the risk to matter, it's too small to really affect earnings or valuations.

If it's not, it's too risky for a taxpayer-guaranteed bank.

Period.

At a minimum Chase should be forced to separately organize and incorporate the private equity group, with equity capital that is off-limits for use against the bank's other activities. Further, the private equity unit shouldn't be allowed any leverage whatsoever. Of course, in today's private equity world, that would make it extremely disadvantaged. It would, could be little more than an investor in the deals of others, because it would never be able to offer competitive bids for companies based on all-equity funding. But to allow such an entity to borrow is to basically recreate the flawed Citigroup SIVs of several years ago.

In effect, this little thought experiment demonstrates why allowing a federally insured bank to gamble with businesses like private equity or proprietary trading is nothing more than playing with taxpayer funds. Heads, Chase wins. Tails, taxpayers lose.

How is it, two years after Bear Stearns' collapse, we still allow taxpayer-backed financial institutions to take large leveraged investment bets?

Have we, and, most importantly, our pompous, pontificating Congressional members and federal regulators, learned nothing?

Evidently not.