News Intelligence Analysis
October 2, 2008
Soros: On How to Fix the Banking
Crisis
By George Soros,
The emergency legislation initially presented to Congress was
ill-conceived – or more accurately, not conceived at all.
As Congress tried to improve what Treasury originally requested,
an amalgam plan emerged that consists of Treasury’s original
Troubled Asset Relief Programme (Tarp) and a quite different
capital infusion programme in which the government invests and
stabilises weakened banks and profits from the economy’s
eventual improvement. The capital infusion approach will cost
tax payers less in future years, and may even make money for
them.
Two weeks ago the Treasury did not have a plan ready – that is why it had to ask for total discretion in spending the money. But the general idea was to bring relief to the banking system by relieving banks of their toxic securities and parking them in a government-owned fund so that they would not be dumped on the market at distressed prices. With the value of their investments stabilised, banks would then be able to raise equity capital.
The idea was fraught with difficulties. The toxic securities in question are not homogenous and in any auction process the sellers are liable to dump the dregs on to the government fund. Moreover, the scheme addresses only one half of the underlying problem – the lack of credit availability. It does very little to enable house owners to meet their mortgage obligations and it does not address the foreclosure problem. With house prices not yet at the bottom, if the government bids up the price of mortgage backed securities, the taxpayers are liable to loose; but if the government does not pay up, the banking system does not experience much relief and cannot attract equity capital from the private sector.
A scheme so heavily favouring Wall Street over Main Street
was politically unacceptable. It was tweaked by the Democrats,
who hold the upper hand, so that it penalises the financial institutions
that seek to take advantage of it. The Republicans did not want
to be left behind and imposed a requirement that the tendered
securities should be insured against loss at the expense of the
tendering institution. The rescue package as it is now constituted
is an amalgam of multiple approaches. There is now a real danger
that the asset purchase programme will not be fully utilised
because of the onerous conditions attached to it.
Nevertheless, a rescue package was desperately needed and, in
spite of its shortcomings, it would change the course of events.
As late as last Monday, September 22, Treasury secretary Hank
Paulson hoped to avoid using taxpayers’ money; that is why
he allowed Lehman Brothers to fail. Tarp establishes the principle
that public funds are needed and if the present programme does
not work, other programmes will be instituted. We will have crossed
the Rubicon.
Since Tarp was ill-conceived, it is liable to arouse a negative response from America’s creditors. They would see it as an attempt to inflate away the debt. The dollar is liable to come under renewed pressure and the government will have to pay more for its debt, especially at the long end. These adverse consequences could be mitigated by using taxpayers’ funds more effectively.
Instead of just purchasing troubled assets the bulk of the funds ought to be used to recapitalise the banking system. Funds injected at the equity level are more high-powered than funds used at the balance sheet level by a minimal factor of twelve - effectively giving the government $8,400bn to re-ignite the flow of credit. In practice, the effect would be even greater because the injection of government funds would also attract private capital. The result would be more economic recovery and the chance for taxpayers to profit from the recovery.
This is how it would work. The Treasury secretary would rely on bank examiners rather than delegate implementation of Tarp to Wall Street firms. The bank examiners would establish how much additional equity capital each bank needs in order to be properly capitalised according to existing capital requirements. If managements could not raise equity from the private sector they could turn to Tarp.
Tarp would invest in preference shares with warrants attached. The preference shares would carry a low coupon (say 5 per cent) so that banks would find it profitable to continue lending, but shareholders would pay a heavy price because they would be diluted by the warrants; they would be given the right, however, to subscribe on Tarp’s terms. The rights would be tradeable and the secretary of the Treasury would be instructed to set the terms so that the rights would have a positive value.
Private investors, including me, are likely to jump at the opportunity. The recapitalised banks would be allowed to increase their leverage, so they would resume lending. Limits on bank leverage could be imposed later, after the economy has recovered. If the funds were used in this way, the recapitalisation of the banking system could be achieved with less than $500bn of public funds.
A revised emergency legislation could also provide more help to homeowners. It could require the Treasury to provide cheap financing for mortgage securities whose terms have been renegotiated, based on the Treasury’s cost of borrowing. Mortgage service companies could be prohibited from charging fees on foreclosures, but they could expect the owners of the securities to provide incentives for renegotiation as Fannie Mae and Freddie Mac are already doing.
Banks deemed to be insolvent would not be eligible for recapitalization by the capital infusion programme, but would be taken over by the Federal Deposit Insurance Corporation. The FDIC would be recapitalised by $200bn as a temporary measure. FDIC, in turn could remove the $100,000 limit on insured deposits. A revision of the emergency legislation along these lines would be more equitable, have a better chance of success, and cost taxpayers less in the long run.
George Soros is chairman of Soros Fund Management
© 2008 The Financial Times All rights reserved.
Read the Introduction to George Soros' latest book: The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means.
Send
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to the editor
about
this article
The Financial Crisis: An Interview with George Soros
By George Soros, interviewed by Judy Woodruff on April 4, 2008
Judy Woodruff: You write in your
new book, The New Paradigm for
Financial Markets,[1] that "we are in the midst of a
financial crisis
the likes of which we haven't seen since the Great Depression."
Was this crisis avoidable?
George Soros:
I think it was, but it would have required recognition
that the system, as it currently operates, is built on false
premises.
Unfortunately, we have an idea of market fundamentalism, which
is
now the dominant ideology, holding that markets are self-correcting;
and this is false because it's generally the intervention of
the authorities
that saves the markets when they get into trouble. Since 1980,
we
have had about five or six crises: the international banking
crisis in
1982, the bankruptcy of Continental Illinois in 1984, and the
failure of
Long-Term Capital
Management in 1998, to name only three.
Strategies, Communication and Propanda Techniques
The Sarah Palin Strategy:
Upon learning the news, Matthew
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the choice, "Absolutely brilliant. . . ."The excitement
was palpable among conservative leaders when they
heard that Gov. Palin was Sen. McCain's choice for
Vice President. There is a high level of optimism among
conservative leaders that the McCain-Palin combination
is a ticket that will
connect with values voters."
See these directories also:
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