George Soros joins the great howling majority saying that the Paulson plan is weak. What’s more, he says, the conditions that Congress and the Senate have tacked onto the plan just make it less likely to work, because the banks will be less likely to subject themselves to it (he’s right).
What Hank Paulson should do instead with his $700 billion, Soros says, is buy bank equity, not crap assets. (This is what most other smart people are saying, too.) George notes that, because banks borrow $12 for every $1 of equity, this $700 billion would produce $8.4 trillion of lending power. It would also solve the real credit problem: a lack of capital. And…here’s the kicker…it would encourage private investors, including George Soros, to step up and take advantage of low bank-stock prices to buy even more equity.
We and hundreds of others have been shouting down a rainbarrel about this equity vs. crap assets problem, but, regrettably, no one in Washington is paying any attention to us. The answer is so simple and so obvious. Our only hope at this point is that, when/if the neutered Paulson plan doesn’t achieve the desired results, Hank will decide to start investing his bailout money in equity instead of toxic trash.
George Soros (from the FT):
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.
Don’t like Soros? Here’s another voice saying exactly the same thing in the WSJ.
See Also: Consensus: Paulson’s Plan Stinks
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