Barney Frank recalls Kravis’s lesson on markets

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Sometime in 2006 or 2007, Barney Frank, the former chairman of the House Financial Services Committee, got an education from Kohlberg Kravis Roberts co-founder Henry Kravis on what was wrong with the markets.

KKR was chasing a big deal, and was looking for banks to finance the transaction. The firm gave notice to various banks about the deal on a Friday, and by Sunday the financing was oversubscribed, Frank said Wednesday at the the International Finance Corp’s 16th Annual Global Private Equity Conference (in association with the Emerging Markets Private Equity Association), recalling the conversation with Kravis.

The bankers got comfortable so quickly with the transaction because the important factor in taking the deal was whether the bank could find buyers for the debt, he said.

“The bank didn’t feel the need to examine the deal. They didn’t have to look at whether the borrower could repay; the only question was whether other investors would buy it,” said Frank, the Massachusetts Democrat who retired in 2013.

Frank related the conversation as a way to describe the philosophy behind the Dodd-Frank Wall Street Reform and Consumer Protection Act, which became law in 2010. Since the 1980s, he said, the markets had become infused with risk-taking without responsibility, especially when it came to lending.

Banks no longer cared about the quality of the borrower, because as long as they could syndicate debt off their books, defaults were no longer their concern.

“This gave people the view that they had managed to find a way to take risk while minimizing their responsibility when that risk went bad,” Frank said. “That’s what happened in America, from the 1980s on, that culminated in our crash.”

While Frank spent much of his speech talking about the need to regulate bank behavior, he told the audience the only effect the Dodd-Frank Act was intended to have on private equity and hedge funds was, through registration with the U.S. Securities and Exchange Commission, to give regulators more information into the industries. Registration was not intended to lead to the creation of more legislation governing the private equity industry, he said.

“We did not, at the time, regard equity in any form as a serious contributor to the problem,” Frank said. “Very little of our legislation was intended to affect equity.”

Curiously, Frank did not have much to say about the recent findings by the SEC of “violations of law and material weaknesses in controls” involving fees and expenses in more than half of the 150 private equity examinations completed so far. It was Frank’s and co-author Christopher Dodd’s law, Dodd-Frank, that forced most private equity firms to register with the SEC and be subject to periodic examinations.

“After the crash, most financial regulators have all decided they were too lax. Post-crash, the regulators are more diligent,” Frank said on the sidelines of the conference after his speech.

Although private equity executives often complain about government regulation, the crowd offered Frank a round of applause and no pointed questions.

Additional reporting by Steve Gelsi

Photo Credit: Chris Witkowsky

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