24/7 Wall St.

Henry Paulson’s newest idea for his $700 billion bailout fund is to get private equity firms to invest side-by-side with him in the next series of financial firms that will get money. This will not apply to those banks which have already gotten their hand outs.

Paulson’ argument may be that even $700 billion is a finite amount and to stretch it new applicants should go out and get extra money from the private sector. Why should the US government take all of the risk?

According to The Wall Street Journal, "Treasury is considering attaching such conditions to any of its future capital investments." No money to invest from the US government would mean no money at all for many modest-sized banks and insurance companies. By that formula, even the Big Three would have to get billions from investors who have already rejected putting capital into the auto firms.

Seeking private capital has huge drawbacks. The first is that these funds have gone into their shells as the liquidity crisis has spread and the stock market has crashed. They are having enough trouble protecting their investments from their 2006 and 2007 LBOs. Taking on more risk, even with Treasury involved, is not likely to happen. As a matter of fact, it is a long shot.

In addition, private equity firms are known for cutting tough deals. The terms on which the Treasury is willing to bailout a bank may not be usurious enough to draw the likes of Blackstone (BX) or KKR. The US government cannot afford the optics of an LBO house getting a much better deal than it does. Debating over terms could take months, time that struggling financial institutions do not have.

Perhaps, Treasury should just put its capital into private equity and let them beat the banks into submission if they want capital to stay afloat. They are better predators than Paulson’s people.

Douglas A. McIntyre