There is no such thing as a free paddle

PLATFORM:The current financial meltdown happened because rules were ignored or forgotten

WHEN YOU'RE up the creek and there aren't any paddles in the boat, the temptation to reach out and grab anything that looks remotely paddle-shaped is very strong - as is the temptation to yell for help even though you don't know whether the natives are friendly or not.

In a tricky situation, survival is the key. You worry about the consequences later.

The financial creek is still littered with paddle-less boats and they're full of people shrieking to be helped. Standing on the banks are the financial authorities and the politicians, most of whom initially waved those boats away from shore, trusting that those in them were fully equipped.

As we continue to float with the stench of failure in our noses, though, the desire to remedy the situation becomes more urgent.

The latest paddles being waved in the direction of US boats are held by natives whose friendliness is questionable.

Reports from the States indicate that private equity firms are prepared to invest substantial sums in the almost underwater banking industry.

Private equity firms have a reputation for investing in companies whose share prices have been decimated, which means that struggling banks are a prime target - but there is no such thing as a free paddle.

If a firm invests enough to have a controlling stake in a bank, it then falls under the Fed's normal capital requirement and other regulations.

The private equity firms don't want to have to deal with the restrictions that accompany the kind of investments they want to make. As a result, the firms are trying to convince the Fed to ease up on their bank ownership regulations and give them a greater degree of management control and flexibility.

Their justification is that their investments will likely be short- term (just long enough for the financial market to get its act together again) and that the issues that worry the regulations are less likely to occur during a short-term deal.

I can't believe that the Fed might be seriously considering an offer which is basically saying "forget the rules, we'll give the cash, don't worry about what might happen because it probably won't".

The current financial meltdown happened precisely because rules were ignored or forgotten and because people who should have known better were chasing profit at the expense of properly managed and regulated institutions.

The private equity firms are circling the boats like sharks in the water. They know that cash is king right now and that the Fed would dearly love to free up the log-jam of credit. The purchase of a large stake in a bank by a private equity firm would help it to repair the damage to its balance sheet and begin lending again.

There is no doubt that lightly regulated companies can be far more nimble in closing deals. A recent Ernst Young report painted a rosy picture for private equity firms in 2007 (although it wasn't until later in the year that the credit-crunch hit some of their preferred financial instruments so that fund-raising in their quarter was at its lowest level for two years).

Harris Williams Co estimates that they have more than $757 billion in buying power and other analysts agree that private equity groups have large sums of capital to be put to work.

Given that the banks are looking for money (estimates on total losses still hover around the $1 trillion level), the lure of cash from the private equity companies is very tempting.

If we have learned anything though - and it's a big if because I truly doubt that the financial services industry ever learns from its mistakes, it just repackages them and sells them on all over again - it's that poor regulation or lack of regulation allows profit- hungry institutions to wreak havoc.

Private equity companies work their assets hard and they will want a quick return on their investments. There is, of course, no reason to suppose that their actions would be detrimental to the banks themselves or that in a conflict-of-interest situation it would be the bank - and by extension its customers - that loses out.

However, the regulations are there for a reason and the reason is to protect the people who, so far in the current cycle, have not been protected.

The truth of the matter is that it is time for the financial regulators to be stronger than they've been in the past - to see past the promises of people who want to make as much money as they possibly can in as short a time as possible while believing that the rules shouldn't apply to them.

Because that's the kind of thinking that got us in boats without the paddles in the first place.

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