By Henry Bloget, Business Insider
October 11, 2011
People with high incomes receive income from multiple sources, particularly investments which are taxed at a much lower rate than earned income from labor. There is nothing fundamentally wrong with capital gains/investment income, a.k.a. unearned income; the issue, however, comes in its distribution and recognizing that investment income is not representative of value that is created by the recipient; rather, it represents value that was created by other people. Millions, and ultimately billions, of people creating value, significant percentages of which are funneled to a few thousand people, is what makes the wealth of the world's richest people possible.
The vast majority of the income of the wealthiest individuals comes from investment income since this is the only way that such high incomes can be generated. High incomes are generated through investments not due to the contributions of the individual investor, but because investment income is a product of collective wealth generation, whereby value created by millions of people is transferred to single individuals. Everything comes back to capital ownership and control. So all of the highest incomes in America (and generally around the world) are products of massive systems of collective production, in which significant portions of collectively-produced value is funneled to a relatively small number of people.
When we look at a breakdown of income type by income group, it's clear that the wealthiest Americans receive a significantly higher portion of their income from capital than the vast majority of other Americans. When we look at the distribution of income vs. tax receipts by type, however, we see that despite the fact that capital income is by far the primary form of income for the wealthiest Americans, the tax burden falls disproportionately on income from labor. The form of income that is most heavily concentrated among the wealthy was taxed the least, while the form of income that was dominant among working class Americans is taxed the most. This has actually been the case ever since the so-called Reagan Revolution. The tax burden on capital was significantly reduced during Reagan's presidency and has been reduced further since his presidency in following with the trends established during the Reagan Revolution.
More Americans today own some kind of investment, but far fewer stocks are owned directly by individuals, and average individuals who do directly own stocks own such small amount that their voting rights are meaningless. The amount of stock (including mutual funds) owned by most American stock holders is very small, less than $10,000, while the wealthiest Americans own billions of dollars worth of stocks each. The majority of stocks owned by Americans in the bottom 80% of the income population are owned inside of retirement plans like 401(k)s and IRAs.
While about half of Americans own stocks, the majority of those Americans are taxed at the higher wage rates on their investment income because most American's investment income comes only from their retirement plans. Likewise, with the growth of individual retirement accounts since the 1980s, it means that more of the capital that individuals do own is locked up in retirement accounts, and is thus not a source of income for most Americans until after age 65.
What many Americans don't realize is that income from these retirement plans is taxed as though it were wage income; it is not taxed at the lower capital gains tax rates. The idea that around half of Americans "own stocks" is used to support the low capital gains tax rates, when in fact the only people paying those rates are individuals who generate income from investment outside of retirement plans, which is almost exclusively wealthy Americans.
Despite rapid growth in the number of Americans owning stock over the past 30 years, the reality is that there is continued and growing disparity in capital ownership and investment income. Yes, more Americans own at least some form of stock today than ever before, but this hasn't translated into more equal distribution of capital ownership overall or of investment income. In fact, the wealthiest Americans receive a larger share of investment income today than any time in American history, aside from just prior to the market crash of 1929.
The so-called democratization of stock ownership has not lead to democratization of capital control, because despite the fact that more Americans own stocks today than ever before, the vast majority of that stock ownership is through mutual funds which are controlled by institutional investors, who in the end gain greater control and influence via the use of other people's money.
The only people with meaningful investment income prior to retirement are wealthy Americans.
November 24, 2009
Over the past decade, some 3,000 U.S. companies have been bought by private-equity firms. Their M.O.? Suck up companies with borrowed money, make them more efficient and then resell, turning a profit in the process.
These days, nearly 1 in 10 nongovernmental employees works for a private equity–owned company, and that, says longtime industry reporter Josh Kosman, is a big problem. In his new book, The Buyout of America: How Private Equity Will Cause the Next Great Credit Crisis, Kosman argues that private-equity firms not only pillage the companies they buy, but also put the broader economy at risk by making those companies take on copious amounts of debt.
TIME's Barbara Kiviat spoke with Kosman about where he thinks the industry is headed.
You predict that private equity will go through a shakeout similar to what we've seen in the housing market. How does that analogy work?
Private-equity firms used the same cheap credit to buy companies that caused the housing bubble.
There are about 100 of these firms — KKR, Blackstone and Carlyle are some of the bigger ones — and they buy a company the same way we would buy a house. Put down about 20% and borrow about 80%. The big difference is, the company they're buying borrows the 80%, so they're the ones responsible for repayment. These loans were structured the same way and sold to the same people as mortgages. And the same kind of crazy prices were paid, so unfortunately we probably are going to see a private-equity meltdown just like what we saw in the housing market.
How bad do you think it will get?
The opinions on this shift, but the Boston Consulting Group in late 2008 predicted that about 50% of the companies bought in leveraged buyouts would default on their debt. If half default, and they fire about half of their workers — not the most aggressive estimate — then you're talking about 1.9 million unemployed.
Why haven't we seen more evidence of this yet?
I think the media hasn't put it together, but it actually is starting. The default rate for the past 12 months is roughly 12% — that's very high. Half of those companies that have defaulted, according to Standard & Poor's, had some type of private-equity involvement in their corporate life. A lot of those are PE-owned companies, ranging from Chrysler to the Tribune Company to Simmons Bedding. We've already seen the tip of the iceberg.
More broadly, what sorts of companies should we be worried about?
Unfortunately, private-equity firms infiltrated almost every industry — industrials, consumer goods, retail, hospitals, utilities — so a leveraged-buyout bust will be very widespread. TXU, which is now called Energy Future Holdings, one of the largest utilities in Texas, faces huge problems. They probably won't default on their debt until 2013, but at this point, and this is according to ratings agencies, it looks like they have very little chance of paying their debt. The range is from a huge utility like that to HCA, the largest hospital chain in the country.
And you think the private-equity industry will be the next one to line up for bailout money?
Yes. It's already happened with GMAC. You know, private-equity firms are very well connected. Four of the last eight Treasury secretaries currently work for private-equity firms.
Is there anything we could do now to prevent this wave from coming?
Probably not much. One of the main points of the book is to show how private equity and leveraged buyouts don't work, and even if the credit crisis I'm predicting doesn't happen — even if the economy recovers and some of the companies can refinance and push their debt off — the core practice is still destructive.
Many of these companies will fall apart anyway. In the 1980s, when Michael Milken was funding buyouts, 52% of the biggest 25 companies acquired ended up going bankrupt. I did a study of the 1990s, ideal economic times, and with 6 of the 10 biggest buyouts, the companies clearly were worse off 10 years later. In three cases the results were mixed, and in one case the private-equity firm improved the business.
This decade, 6 of the 10 biggest buyouts are already considered distressed, according to Moody's. The core practice does not work and rips apart our economy.
September 3, 2009
The Illuminists are desperate. They are appealing the Bloomberg directive to reveal who received funding from the Federal Reserve to keep from going bankrupt.
In addition, HR 1207 (Federal Reserve Transparency Act) will pass in the House this month. The question is in what form. No matter what happens, the Illuminati know we are hot on their trail. They have to do everything possible to end the depression, or go for broke.
Thus far there has been little recovery even with an official $23.7 trillion committed by the Treasury and the Fed. This number alone shows you how serious this situation is.
The banking sector is still broke and is using TARP funds to buy out failing smaller banks. The residential TARP funds returned will go toward helping bail out the collapsing commercial real estate industry. Quantitative easing has not worked, nor has TARP and the endless stream of money from TALF.
We are anxious to see if the FASB sticks to its guns and demands mark-to-market accounting. That will pull the cover off of the fraud known as mark-to-model, which really is mark to whatever you want it to be.
As you can now see this is a much deeper problem than a subprime problem - that just triggered events. As we pointed out before, we are still facing a new wave of subprime loans written over the past year by FHA, Ginnie Mae, Fannie Mae and Freddie Mac, plus ALT-A, Option ARMS Pick-and-Pay Loans, and the failure of prime loans that will stretch to 2013.
On top of that, we have commercial real estate loans now to deal with and credit card failure. This is what the Illuminati crime syndicate has brought you in their lust for more power and riches. We must not forget as well, standing in the wings, are America’s creditors, especially the Chinese who are dumping $25 billion to $100 billion in dollar denominated assets monthly. Their goal is to be out of dollar paper in another 1 1/2 years.
Then there are the other sellers. There are few buyers, so the Fed will have to monetize trillions of dollars in dollar denominated bonds, which presently they are doing secretly. It is no wonder they are terrified of an audit, which would not only uncover their illegal activities, but also expose their leadership and participation in the outrageous suppression of gold and silver prices.
The status of foreign creditors could turn on a dime. We predict they will abandon ship one at a time, as the dollar slips lower and lower. The Fed and the Treasury have tried over and over to keep the USDX, dollar index, over 80 for weeks, and they have been totally unsuccessful. It settled this past Friday at 78.31, just ready to break to new lows. We wonder how long these countries will tolerate such arrogance and the dream of world government? One must remember these countries are suffering the fallout of the actions that have been deliberately executed by these Illuminists, and they are not happy about that. They are all suffering recession and many depression. It is only a matter of time before they too dump dollar denominated assets.
We would like to say for individuals caught up in this mess worldwide, other currencies are not the answer. Only gold and silver related assets are the answer. Remember that, for in the final analysis, all currencies will fall in value versus gold and silver, and there are no exceptions. We have been there before and seen that, so do not be deluded into going into other currencies, or shares in foreign markets denominated in other currencies; they are not the answer, only gold and silver are.
Then we hear the fairy tales of recovery in the US, Europe and Asia. If you spend enough money you can create a recovery, albeit of short duration. No one is out of the woods. Europe, particularly the eurozone, has cut issuance of money and credit to 3.7%, but they are maintaining interest rates at 1%, which is in reality ½%. The European recovery will be a parallel movement for a year, and without more cheap money or an increase in money and credit, it will die and wither away.
Then there are the ongoing real estate collapses in the US, Ireland, Spain and in the Persian Gulf. There could be a bank panic or holiday in any of these regions. If a panic occurs, the first liquid asset sold will be US Treasuries and Agencies and the US dollar. This would spread terror in Frankfurt, Paris, London and NYC. All these stock exchanges could collapse as well.
The world is about to find out that free trade and globalization has been a disaster.
The millions of jobs lost in the US and Europe, so that transnational conglomerates could prosper, is in the final stages of death. The redistribution of wealth from the rich to the poor countries is about to end in a shattering smash-up. The myth of worldwide prosperity is about to end.
Contrary to prevailing thought, the biggest losers will be world exporters, such as China, which has already seen a 40% fall in exports. All the money and credit creation we have seen in China over the past seven months, some $1.9 trillion, isn’t going to work. They still face 30 million unemployed. Those jobs are not going to return for a long time, if ever. Out of desperation, there eventually will be tariffs (legislated in the US, Europe and in other countries), and inflation will rise as a result.
In America, the safety net of the FDIC doesn’t exist. It is virtually broke, and that is why, a few months ago, unofficially the FDIC asked government for $500 billion. Putting this into perspective, about $700 billion would insure about 1% of all the qualifying deposits in the US.
Not only will the Federal Reserve Transparency Act, HR-1207, pass the House, but also it will pass the Senate, because you are going to write every Senator demanding that they pass it.
If passed, we will see our gold inventories. We’ll find out what toxic garbage the Fed has been buying from banks and what they have paid for it. We will find out every company that received funds and how they were spent. We will subpoena every piece of correspondence, fax, e-mail, and phone calls the Fed has ever made. We will get a real balance sheet; not some version the GAO approved. Wait until the public sees how the Fed and its owners have looted the people for almost 100 years.
Two Republican lawmakers, Darrell Issa, (R-CA) and Rep. Spencer Bachus, (R-OK), House Financial Services ranking members, are seeking an audit of the trust that manages the government’s controlling stake in AIG.
Three more U.S. banks failed on Friday, bringing the total to 84 so far this year, as the industry continues to grapple with deteriorating loans on their books. Regulators shuttered Affinity Bank of Ventura, California, Bradford Bank in Baltimore, and Mainstreet Bank of Forest Lake, Minnesota, which in total are expected to cost the government’s deposit insurance fund about $446 million.
The Federal Deposit Insurance Corp. on Thursday reported that the insurance fund’s balance stood at $10.4 billion at the end of the second quarter. But the agency also noted that the figure was adjusted to account for $32 billion set aside for expected failures over the next year. FDIC Chairman Sheila Bair said this week that bank failures will remain elevated as banks go through the painful process of recognizing loan losses and cleaning up balance sheets. The total of 84 failures this year marks a sharp rise over the 25 last year, and the three failures in all of 2007.
We stated long ago the somewhere between 3,400 and 4,200 banks would go under, and the FDIC would spend trillions of dollars to cover the loses. A loss of 3,400 banks would lead to losses of over $33 trillion.
The FDIC now has foreign banks and private equity groups about to engorge themselves on failing US banks. Worse yet, rather than cash, the FDIC is allowing these financial firms to use equity, which is unprecedented. The use of non-cash collateral assets is being used because the purchasing banks are broke; and without TARP, not only could they not buy anything, but they’d probably be out of business.
What Ms. Bair has done has been to expedite the takeover of banks by bigger banks and involved the use of foreign banks as well as private equity partnerships.
As far as we are concerned, as a foreigner, you have to be deranged to buy dollar denominated assets with the massive monetization of agency securities, collateralized debt obligations, and treasuries going on, never mind the underhanded secret deals the Fed is involved in to fund their markets. If we can understand what the Fed is up too, so can these foreigners. That is what a more than $600 billion swap facility is all about, including suppression of foreign currencies in order to bolster the strength of the dollar.
This month, September, a great confusion will begin. The occupation of Iraq will continue, more troops will be sent to Afghanistan, and Pakistan will become another major battleground. Terrorism will be used to continue to propagandize the American public, along with Cap & Trade and medical reform and the Swine Flu fiasco. These are all distractions to keep the publics’ eye off the continued failure of our financial system.
Deflation continues to eat away at assets, except for gold and silver, and the Fed creates money and credit to offset deflation’s savages.
The torrent of money and credit has pulled some nations, at least temporarily, out of the negative decline on GDP. Japan, France and Germany are examples. The question is when will their economies run out of stream? Probably when they attempt to raise interest rates. In the case of the eurozone, the expansion of money and credit has already fallen 3.7%.
The global economic crisis, now more than two years old, has allowed governments to run banking and financial systems in a usurpation of power over the individual and private property. What we are facing is perpetual crisis and intended government control. There will not be a return to normality. Next will come food shortages and rationing, and one epidemic or pandemic after another.
We wonder what will happen when the public finds out that all these problems were preplanned by the Illuminati. Then comes the control of all labor. Government is now spending 185% of tax receipts. The budget deficit will be between $1.6 and $2.00 trillion for fiscal 2009, ending on 9/30/09.
For those who hadn’t noticed, yoy commercial real estate values fell 27% and are off 36% from their October 2007 peak. We'll see a total drop of 70% to 75% from the highs, when all is said and done. Refinancing has to be found for $165 billion in properties by the end of the year, which is impossible, even with leftover TARP funds.
Deflation has prices somewhere between minus 2% to plus 5% worldwide as imports and exports have fallen over 30%. As an example, in Los Angeles, the busiest port in the US, imports have fallen 16.9% yoy. It is the exporters who are getting hit the hardest and some have cut prices in the process.
The only thing that keeps a veneer of equilibrium is the massive creation of money and credit pumped out by central banks worldwide. We said we had entered depression this past February; and just as when we called the beginning of recession two years before, no one shared our opinion. If we are not in depression, than what is the significance of 20.8% unemployment, a factory utilization level of 65%, and continued massive foreclosures?
As we have said over and over again, the Fed, Treasury, Wall Street and banking are in a box and they cannot get out. They deliberately created this horrible situation, and there is no going back. It is impossible to reverse the process. We are in an economic and financial depression. The palliative supposedly is bigger budget deficits and credit expansion into infinity. We are going to see a replay of the 1970s. Inflation will catch up and overtake deflation one more time, but in the end deflation will prevail.
Fiscal spending is running wild, and our president predicts a budget deficit of $9 trillion dollars over the next ten years. The Congressional Budget Office (CBO) says spending has to be cut 8% permanently over the next several years. In July alone, federal spending rose 26%, as revenues fell 6%. Corporate tax receipts fell 58%, as individual revenues fell 21%.
The official economic contraction is the worst since the great depression. Can you imagine what it really is? 9.4% unemployment is front-page news, but you didn’t hear about the 4.7% loss in salaries and wages of 4.7% for the 12 months ended in June. There are more government employees now than all those employed in manufacturing and construction.
How is it that state employees now make 40% more than the average income in non-governmental jobs? What a perversion of government. It is no wonder that the US poverty rate is higher than in Mexico and Turkey.
August 27, 2009
U.S. regulators backed down from the tough stance they took a month ago on rules for auctions of troubled banks, clearing the way for more private equity bidders to come back into the game.
A capital requirement for private equity investments in banks was lowered to a Tier 1 common equity ratio of 10 percent, from the 15 percent Tier 1 leverage ratio previously proposed.
The regulators also dropped a requirement that investors serve as a "source of strength" for the bank they buy, which critics said could have put them on the hook for more capital if the institution struggled.
A cross-guarantee proposal — meaning if an investor owns more than one bank , the FDIC can use the assets of the healthier bank to cut losses from the one that has faltered — was modified to only include investors that had an 80 percent common ownership of the two banks...
"On the whole, it's favorable to private equity. It's positive in terms of attracting private equity money," said Brett Barragate, a partner with the Jones Day law firm...The FDIC also said it would seek comment about whether to phase in the impact on banks' capital requirements of an accounting change that requires institutions to bring off-balance sheet assets back on their books.
August 11, 2009
...One new abuse that should be stopped before it spreads: big private equity companies, which are largely unregulated, are hungry to take over failed banks. Their argument is that the banks need new capital, and the private equity firms have it. But this is a profoundly bad idea.
Today, the FDIC is sitting on an inventory of failed banks that it needs to unload, and an insurance fund that it needs to replenish. Enter shadowy and unregulated private equity outfits like the Carlyle Group and Blackstone Capital, who are circling like vultures. The FDIC has done the hard part — at taxpayer expense: it has eaten the losses and cleaned up the failed banks’ balance sheets, making them appetizing targets...
In earlier deals, the FDIC has bent its own rules somewhat: it doesn’t permit any single private firm to own a bank, but in the $32 billion collapse of Indy Mac last year, the agency permitted a consortium of private equity firms to be the buyer.
Last month, the FDIC proposed to toughen its policy. It put out a draft policy statement for comment, signaling that it would prefer to merge failed banks with other banks, or to find investors other than private equity conglomerates. It proposed to prohibit self-dealing by firms acquiring failed banks, and to exclude firms based in offshore tax-havens. And if a private equity firm acquired a bank, it would be required to have higher ratios of capital because of its inherently riskier business strategies.
The private-equity companies have mounted a fierce lobbying campaign to soften the terms, arguing that the banking industry needs the capital. But the FDIC, the rare agency in this whole crisis that has put the public interest first, should hold the line.
In financial crises, conflicts of interests by insiders tend to mutate. We got into this mess, after all, because federally guaranteed banks were behaving like compulsive gamblers. Let’s not repeat these abuses in new forms.
August 22, 2009
With private equity firms publicly calling for radical change to banking regulations that would ease their investment into the nation's struggling banks, the Service Employees International Union (SEIU) today proposed new rules to protect consumers and working families against the buyout firms' riskiest practices, strengthen long-standing consumer protections, and support stronger banks.
The new principles called for by SEIU — the fastest-growing labor union in the Americas and a leading advocate for better private equity and banking practices — directly address recent moves by a number of leading private equity firms to win special treatment by the Federal Reserve allowing them to take over commercial banks but avoid the current transparency and oversight rules by which other investors must abide.
Allowing private equity to purchase controlling stakes in large banks would undermine long-standing banking regulations and consumer protections by permitting buyout firms to access subsidized funding in the form of FDIC-insured deposits. Special rules could allow buyout firms to sell themselves their own debt at a discounted rate from the banks they want to control.
Under the terms called for by the private equity industry, buyout firms would remain exempt from oversight and transparency rules governing bank holding companies. This kind of special treatment from the Federal Reserve could open the door for private equity firms to assume little responsibility if a bank fails, adding unacceptable risk to taxpayer bailouts of banks deemed "too big to fail" by federal regulators.
May 22, 2009
After a disastrous foray into banking early last year, private equity is making a cautious comeback with deals such as the BankUnited takeover, and their return will likely change how the industry looks.
Regulators appear to be working with private equity firms looking to buy banks, and in the next year or two several U.S. regional lenders could end up in the hands of buyout funds, banking analysts said.
"I can't picture a 5,000-branch bank coming out of this. But could I see 300-, 400-, 500-branch networks stitched together? I think so," said Seamus McMahon, chief executive of bank consulting firm McMahon Advisory LLC.As real estate markets continue to crater, many of the 8,300 U.S. banks will suffer, and some will fail. Private equity funds, meanwhile, have roughly $1 trillion of untapped funds at their disposal.
"Private equity firms are going to have a lot of influence."
Some buyout funds are dipping their toes in the water now.
Firms including Wilbur Ross's WL Ross & Co, Carlyle Group, Blackstone Group, and Centerbridge Partners teamed up to take over Florida-based BankUnited in a government-assisted deal announced on Thursday. The funds put in $900 million of their capital, and are receiving support in the deal from the government.
Earlier this year, private equity firm J.C. Flowers & Co. got together with other investors to take over assets of failed mortgage lender IndyMac. In December, MatlinPatterson Global Advisers LLC agreed to invest in Flagstar Bancorp Inc.
After winning the auction for BankUnited, the group led by former North Fork Bank head John Kanas intends to continue growing through further acquisitions that could be rolled into the new bank once it is fixed. One of the targets could be BankAtlantic Bancorp Inc. a person familiar with the consortium said. The source is anonymous because the plans are not public...
Private equity firms have to structure their deals carefully to stay below thresholds that would subject their entire firms to onerous banking regulations. So as many as eight investors pitched in to buy BankUnited. The largest stake holders are Ross, Carlyle and Blackstone, each holding between 20 percent and 24.9 percent, below the level they are deemed to be in control, the source said...
January 5, 2009
...This weekend, a group of seven private equity firms led by Dune Capital bought the carcass of failed Pasadena, Calif., mortgage lender IndyMac. The private-equity firms plan to rebuild it and use it as a platform to acquire other financial institutions, while overhauling IndyMac’s business model to steer clear of risky subprime mortgage loans. Because each of the firms are pitching in some money, no one firm owns more than 10% of IndyMac, thus appeasing federal regulators.
Similarly, in August, private-equity investor J. Christopher Flowers, a veteran of Goldman Sachs Group’s financial-institutions group, bought a little bank in Missouri called First Cainsville Bank. The bank, with $14 million in assets and just two branches, probably wouldn’t normally be considered worthy of the attention of a financial sophisticate like Flowers, who kicked the tires at such massive potential M&A targets as Bear Stearns, American International Group and Washington Mutual and advised on Bank of America’s acquisition of Merrill Lynch. But Flowers saw the Cainsville acquisition as a way to get a foothold into the banking business and make it easier to buy other banks. And instead of buying the bank as part of his private-equity firm, J.C. Flowers, he bought it under his own name, overhauled the board of directors and informed the Office of the Comptroller of the Currency of his plan to make more acquisitions.
Federal regulators have been amenable to such solutions thus far. Perhaps that has something to do with the fact that roughly 25 banks have already failed, and more are expected.
The benefit to the private-equity firms of participating in federal auctions for failed banks is the chance to own cheap assets and gain a toehold in the rapidly consolidating banking industry, which they know well. Private-equity firms plowed $23 billion of capital into financial-services deals in 2008, and that is down 69% decrease from the $74 billion of 2007, according to data from Freeman & Co.
Meantime, the federal government gets a known quantity: private-equity firms that are experienced players in financial services. This is something of an echo of the late 1980s and early 1990s, when some private-equity firms snapped up assets from the government’s Resolution Trust Corp. amid the savings & loan crisis. They are also willing buyers, which is no small comfort to the government. Federal regulators looked for a buyer for IndyMac for five months before finally handing it over to a private-equity consortium.
Still, in taking over banks, private-equity firms are entering somewhat complicated contracts to accept federal bank regulators as highly involved overlords, something not all PE firms have been willing to do. Blackstone Group abandoned its proposed $6 billion acquisition of Alliance Data Systems–which owned a bank — arguing that it wouldn’t be able to meeting the changing requirements of federal regulators. In addition, some banks are allowed to choose their regulator, which creates a confusing drama of regulatory competition. IndyMac, for instance, chose the Office of Thrift Supervision, which ended up looking the other way at the lender’s financial troubles...
May 7, 2009
Very interesting piece from yesterday's New York Times ("As Investors Circle Ailing Banks, Fed Sets Limits"). Private equity manager J. Christopher Flowers buys a tiny bank in Missouri in the hopes of using its national charter to snap up ailing banks across the country. The last two paragraphs are among the juiciest: Flowers "has estimated his banking empire will one day earn at least a 35 percent return on banks it has bought in the United States. 'I find it to be an extraordinary time to invest,' he said. He was even more blunt when he spoke to an industry group in New York earlier this year. 'Lowlife grave dancers like me will make a fortune,' he predicted."
May 6, 2009
Cainsville, Mo. — No one seems to want to own a business in this dusty, windswept corner of rural America, population 370, with its crumbling sidewalks and boarded-up storefronts. Except, that is, for J. Christopher Flowers, a media-shy New York billionaire who last year bought the First National Bank of Cainesville, one of the United States’ smallest national banks.
Mr. Flowers, a private equity manager, has no particular love for rural Missouri; in fact, he has never set foot in Cainsville. Rather, he wants to use the national bank charter he picked up in this farm town to go on a nationwide buying spree.
With that charter in hand, Mr. Flowers plans to take over a handful of large struggling banks, casualties of the economic crisis. In some cases, he hopes, the federal government will help...
For all the talk of the banking crisis, Mr. Flowers and other giant private equity players are circling distressed banks around the country, competing to buy into the industry. Bidding wars are now breaking out among private equity firms, including the Carlyle Group, which is going up against Mr. Flowers’s firm for a stake in BankUnited of Florida.
They and other investors see banks as the recession’s biggest prize: potential money machines that could one day generate fabulous returns, particularly after the federal government eats the losses of failed banks, then heavily subsidizes their sale. But like Mr. Flowers, some of them would prefer to take over the banks completely, replace their managements and take all the profit.
“I don’t think the Republic is going to be brought to its knees if private equity owns banks, personally,” Mr. Flowers said from his Midtown Manhattan office with its expansive views of Central Park. “We invest around the world — Japan, Germany, England, no problem.”The Fed is resisting this pitch, for several reasons. Current law prohibits mixing banking and commerce, based on a fear that if industrialists own banks, they will dominate — and try to manipulate — the economy, as they did during the early-20th-century heyday of John Pierpont Morgan.
The government also wants the ability to stabilize a teetering bank by drawing on the funds of its parent company. That is hard to do with private equity firms, which have numerous businesses owned by funds, each of which is walled off to protect investors.
For these reasons, banks generally cannot be owned by nonfinancial companies like the Carlyle Group, whose assets are as varied as an interest in Dunkin’ Donuts and United Defense Industries, a maker of combat vehicles and missile launchers.
The equity firms counter that banking desperately needs cash if the economy is going to recover, and that they are the only big sources of money around. An executive at the Carlyle Group said the industry had an estimated $400 billion in “dry powder,” or ready-to-invest reserves.
To push their case at the White House, the Treasury and the Fed, Mr. Flowers and others in his industry have enlisted an all-star cast of advisers, lobbyists and lawyers. They include H. Rodgin Cohen, chairman of the Sullivan & Cromwell law firm and Wall Street éminence grise, and Randal K. Quarles, a managing director of the Carlyle Group and a Treasury under secretary in the administration of President George W. Bush...
While they press their case, the firms have found some ways around the rules.They have formed so-called club deals, in which teams of private equity firms and other investors each buy up to the legal limit of a bank — about a quarter or a third, depending on the type of bank — with their individual pieces adding up to 100 percent control. IndyMac, the failed California bank, was sold by the Federal Deposit Insurance Corporation last fall to one such club, which includes funds controlled by Mr. Flowers; the hedge fund billionaires George Soros and John Paulson; and Michael S. Dell, founder of the Dell computer company. The investors are barred from acting in concert to, in effect, take control of the bank — an unwieldy arrangement but one that regulators insist they can enforce.
As part of the IndyMac deal, the FDIC agreed to take most of the risk from future losses on loans acquired by the partnership — leading Mr. Flowers to quip at one investor forum in New York in January that “the government has all the downside and we have all the upside.”
Mr. Flowers has come up with another way around the restrictions. There is no limit on an individual’s taking over a bank, so he purchased all of the First National Bank of Cainesville in his own name and with his own funds. But that deprives him of the billions his equity firm has set aside to buy banks, so his new bank sits in this tiny town, waiting for a change in the rules.
First National — whose second story is boarded up and whose $17 million in assets are worth about a third of what Mr. Flowers paid for an Upper East Side town house in 2006 — seems an unlikely launching pad for a new American banking empire. It is so tradition-minded that it refused to change the spelling of its name, even after the town did so back in 1925 to honor its founder, Peter Cain. Suddenly, in February, the First National Bank name was dropped and “Flowers Bank” was painted on the window. New bank executives showed up, passing out packs of promotional sunflower seeds with the bank’s new logo, urging the mostly elderly town residents to get ready to “Grow with Us.”
“Everyone wonders, who is this Flowers guy?” said Lefty McLain, as he finished up the ham, mashed potatoes and butter beans lunch special at the Little Store, an all-in-one restaurant, deli, pool hall and gossip post here in the one-block downtown.Mr. Flowers, while still in his 20s, founded Goldman Sachs’s financial services merger business, helping line up the $62 billion merger of NationsBank and BankAmerica (now Bank of America) and the $34 billion takeover of Wells Fargo by Norwest...
Mr. Flowers and other executives have lobbied hard; their efforts have included a recent meeting with William C. Dudley, chairman of the New York Fed. At the meeting, Mr. Flowers and his colleagues bragged about how they could raise as much as $10 billion in 48 hours to help with a bank takeover if they were given the chance, according to one executive in attendance.
Mr. Flowers, in an interview, said he was confident he would prevail. Even if he cannot make the Fed reverse its policy, he will consider it a victory if the Fed approves an individual deal. He has estimated his banking empire will one day earn at least a 35 percent return on banks it has bought in the United States. “I find it to be an extraordinary time to invest,” he said. He was even more blunt when he spoke to an industry group in New York earlier this year.
“Lowlife grave dancers like me will make a fortune,” he predicted.The Carlyle Group & The Carlyle Group Bailout, March 2008
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