December 5, 2023

Reuters Breakingviews: A Rule Gives as It Takes Away

That is hardly what Paul Volcker envisioned when the White House trotted him out amid a frenzy of anti-Wall Street sentiment in January 2010. Mr. Volcker, a former Federal Reserve chairman, said the rule would make banks safer by curtailing high-risk behavior, including investing in leveraged buyouts.

The Dodd-Frank law stipulates that a bank’s own money cannot comprise more than 3 percent of a private equity fund it manages, and that aggregated fund holdings cannot total more than 3 percent of its Tier 1 capital. For most banks, that is no big deal. Many got out of the buyout business altogether to avoid conflicts with clients like TPG Capital and Kohlberg Kravis Roberts.

Not Goldman. It raised a $20 billion fund, its sixth, at the height of the precrisis boom. Moreover, the firm and its partners accounted for around a third of the fund’s money. Part of the allure for state pension funds, sovereign wealth funds and others is investing alongside Goldman and its people.

That model is threatened by the Volcker Rule. But while the rule limits how much of their own money banks can sink into a fund, it does not on its face place the same restriction on investments made directly from their balance sheets.

In theory, that means Goldman or another bank could make a direct investment and bring other investors along for the ride through a single purpose mini-fund managed by the bank — a bit like the merchant banks of yore.

In a traditional buyout fund, losing bets offset winning ones in calculating the manager’s performance fees. Not so if the deals are done one by one: the manager would collect on the winners, but there would be no offset for the losers. That potentially works to the fund manager’s advantage.

True, the rules potentially limit this kind of investment in other ways, for example, through higher capital charges. And investors might push back, too, by demanding lower fees or higher performance hurdles. But however it turns out, it is something Mr. Volcker surely did not intend.

Greek Bailout Blues

Euro zone governments and the European Central Bank keep insisting that a restructuring of Greece’s sovereign debt is neither desirable nor necessary. But their confidence in the country’s creditworthiness seems to be shaky at best. As they consider an add-on to the bailout package they agreed upon barely a year ago, they are now contemplating asking Greece to pledge collateral against future borrowing.

Greece’s 2010 bailout covered its financing needs only for two years, assuming it could raise 27 billion euros from investors in 2012. This now looks near impossible, making a second bailout unavoidable. But that looks hard too. Taxpayers are rebelling in lender countries like Germany and Finland, and euro zone politicians would struggle to justify lending more money to Greece when it is already barely complying with current bailout conditions in the first place.

Collateralizing the loans would make a second bailout easier. That could mean pledging assets like real estate, or specific revenue streams like tax receipts. Vague assets, like expected privatization receipts, will not be enough.

But there are drawbacks. The first is that it could run into fierce opposition in Greece, if seen as a humiliation. There is also a question about whether collateralization would cause a payout on Greece’s $5.4 billion of credit-default swaps, as holders could argue that Greece’s other debt had been subordinated. It probably would not instigate the swaps, but some short-sellers might disagree.

Finally, collateralized lending would send the implicit message to bond markets that euro zone lenders do not think much about Greece’s creditworthiness. That will make it harder to keep up the pretense that restructuring is not necessary, and that European banks do not need to recapitalize to brace for a sovereign default.

Lending with collateral is better than having more of the same, but it falls short of achieving what a proper restructuring would do.

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