[ by Larry Goldfarb ]

In the late 1990s, the larger banks, including Wells Fargo, were participating in private equity transactions.  At that time, the lure of these units was based on the significant rise in small technology companies that rode the NASDAQ Index to its all-time high.  Banks made large investments in these private company securities.  But when the bubble burst, firms not only lost their gains, many also lost their initial investments. 

Following the NASDAQ meltdown, many firms fled private equity. That’s what so surprising about the latest pronouncement from Wells Fargo;  it is ramping up its private equity business.  Richard Kovacevich, grew the business at Wells Fargo in the late 90s, as its CEO from 1998 – 2009, only to watch it wither following the dot com bubble is in favor of the direction the current management of the banking is taking.

The lure of private equity to companies like Wells Fargo is not only profitable investment returns, but also new business for other parts of the bank. The funds work with small- and mid-sized companies that often also need loans, treasury management, and other financing and services, former CEO Kovacevich said.

In January 2012, for example, Norwest Equity Partners bought rifle maker Savage Sports, teaming up with the company's management. Wells Fargo also arranged senior debt financing for the purchase, which according to Crain's Detroit Business cost the buyers more than $100 million.

Business can go the other way, too - companies that borrow from Wells Fargo can get equity from Norwest Equity Partners. "It's good for the bank, and it's good for the economy," Kovacevich said. "If you do something well for 50 years why would you not continue doing it?" The funds were founded in 1961.

While the Volker rule blocked banks from making big bets with their capital, including sizable investments in private equity funds, fearing taxpayers would be left on the hook when wagers soured, it has said little about banks using largely on its own, with capital only from Wells Fargo itself and some employees. By avoiding equity from outside investors, the bank is considered to be engaging in "merchant banking," an activity that is likely to be exempt under the Volcker Rule, lawyers and people familiar with the matter said.

Well’s decisions may run counter to rulemakers' efforts to make the financial system safer. The merchant banking that Wells Fargo is embracing is riskier than investing in private equity funds with outside investors, where a bank shares any losses with others. Some critics warn that the Volcker Rule is banning the safer of the two activities, and allowing the one that could lead to bigger losses for a bank.

"Is that really what you want institutions that have safety net support doing? Is that an appropriate use for a government backstop?" said Shelia Bair, the former Head of the FDIC and on record as being against this type of business model.

Kovacevich said Wells Fargo's private equity business has had a solid track record, but the bank should be careful. "I would never want it to be big," he said. "I don't consider it something you must be in if you are a commercial bank or should be in if you don't know what you're doing. It's got risk to it.

For more information, please read [Reuters, 2/21/13].