On “The Bailout”, Part 7: The George Soros Plan (Hint: I like it)

Here’s a link to the George Soros plan in the Financial Times (I miss daily delivery of this paper, but it cost too much for me).

I read his plan yesterday during lunch and found it interesting. My strawberry yogurt was delicious as well.

His criticism of the USGOV/Congress plans are two-fold.

First,

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

This is because we can’t value those assets with any reasonable certainty and any plan that involves passing/selling/buying those assets is massively flawed.

Second,

It does very little to enable house owners to meet their mortgage obligations and it does not address the foreclosure problem.

I don’t care about this part. Housing prices should fall since there is a glut. Bad Actors who took on to much debt whether from ignorance or from purposeful risky investing deserve to fail and loose their homes. I know that sounds harsh.

Soros also noted an inflation/currency component to the plans I had not thought of:

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.

Soros sees recapitalization (not buying the bad assets) as the key to the key to the problem:

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.

The key points of the Soros Plan are:

– Use Bank Examiners to determine what the correct capitalization should be for a bank (the capitalization gap between what it is and what it should be)

– Banks would be required to try to close that gap on their own using private investors

– Failing in that, the government would provide capital infusion to banks through the purchase of preferred Stock (with a reasonable coupon) and Warrants. The low coupon means the dividend would not effect lending too much, and the warrants mean that eventually the bank ownership would be diluted (presumably USGOV wouldn’t purchase the shares but sell the warrants on the market to others who would purchase the shares). This should also server as a an incentive for the bank to seek private investors on more favorable terms.

– “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.”

– He explcitly addresses handling insolvent banks (determined I assume by bank examiners)

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.

Some of this sounds a bit like what actually just happened at GE (for GE Capital) Warren Buffet (playing the role of USGOV in this analogy) bought newly issued preferred stock (at a discount and with a 10% coupon) and warrants purchase additional common stock directly from GE in a private offering to shore up the bottom line. GE is now planning an additional common stock offering.

[Disclaimer: I am Berkshire-Hathaway shareholder so I have a direct interest in Buffet’s moves working out]

I like the Soros plan. I would vote for his plan if I was in congress:

-Using bank examiners to determine the correct the level of capitalization is brilliant because they are neutral and all parties can agree to this as a standard. Keep this away from politicians and executive branch bureaucrats who have different agendas!

-The leverage idea sounds like the Kling idea of reducing the capital requirements for lending a bit. This enables funds for lending without cost to taxpayers. I like this a lot (and cribbed it for my own plan from Kling). The Soros plan is different in that the recapitalization occurs first and then as a reward, the deposit ratio is lowered (aka the leverage limit is raised). The advantage of this is the overall soundness of the bank is increased first. The downside is that it takes more time.

-I like that his plan is not a scheme to relieve Banks from the complex securities that cannot be valued by putting the burden on US taxpayers.

-I like that the capital infusion comes from things like preferred stock and warrants so the new investors have some precedence over the old investors.

-I like that the insolvent banks are dealt with explicitly and timely so they don’t present a continuing menace to the economy. The goal should be to get the pain over with quick, and not to trickle it out (Machiavelli would approve of this). I wish I had thought of something like this in my plan.

The Soros plan also has stuff for homeowners:

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.

I don’t see a need for this. Homeowners who can’t meet the Mortgage should loose the homes. They made decisions (and some committed fraud). They must pay.

Overall, the Soros plan is good. I have no problems supporting it. It is vastly superior to anything Congress has tried.

Update: There is a related discussion at TDAXP.

Update: Hot Air says the vote is underway. It should fail. Congress wants US Taxpayers to a crap sandwich. Those fuckers (Congress) have caused so much damage to this country. Americans keep vote for incumbents, so maybe we are getting what we deserve. As for myself, I always vote against an incumbent unless I have a reason to vote for them.

Update: I have the correct link to the Soros plan now.

I think he may be thinking about his vast wealth.
I would smile all the time too.