Wednesday, 23 July 2014
Last updated 3 hours ago
Jan 22 2013 | 12:55pm ET
As the Federal Reserve six years ago discussed growing fears of an economic crisis—taking them perhaps less seriously than it should have—the U.S. central bank was also looking at a private equity bubble potentially as serious as the mortgage bubble proved.
At least two members of the Fed's Board of Governors expressed concern about the flood of money and credit flowing to private equity firms, which they used to finance some of their largest deals ever. In March 2007, Janet Yellen, then president of the Federal Reserve Bank of San Francisco, told her fellow governors, to laughter, that "I recently talked with the principals of several major private equity funds, who were not just amazed but also appalled about the amount of money their industry has attracted. One partner said that he would have no difficulty immediately raising $1 billion. Indeed, one of his biggest problems is would-be investors who get angry at him because he is unwilling to take their money."
That, Yellen continued, was the good news.
"My contacts suggest that some private equity firms with similar assessments of the shortage of profit opportunities are less restrained and do take additional money, partly because of the large upfront fees that are generated by these deals," she said. "So just as we have seen in mortgage markets, the bubble in private equity, as my sources characterize it, and the overabundance of liquidity more generally raise the risk of a sharp retrenchment in credit and higher risk spreads with associated risks to economic growth and, conceivably, even financial stability."
Those prescient words were echoed two months later by Randall Kroszner, former head of the Fed's Committee on Supervision and Regulation of Banking Institutions. He told his fellow governors that banks were only too happy to lend private equity firms billions, and indeed that banks were making questionable choices to win p.e. business.
"In particular, there are concerns about banks chasing private equity deals going covenant-free," he said. "In many of my discussions with private equity folks, instead of saying, well, bring us on more capital, those contacts are the ones saying that the banks are pushing them to take greater leverage than they otherwise would want. Now, if that isn’t the fox guarding the henhouse, I do not know what is. You want the banks to be the disciplinary force, and that they would potentially be taking on very large risks is a real concern."
Jul 8 2014 | 10:48am ET
The surge in derivatives regulation is among the most complex challenges facing the financial services industry today. Northern Trust’s Joshua Satten recently spoke with FINalternatives to share insights into the challenges presented by new regulation and explore how the industry is responding. Read more…