More Tsuris from Soros

By George Soros
Published: January 22 2009 20:06
Financial Times

According to reports in Washington, the Obama administration may be close to devoting as much as $100bn of the second tranche of the troubled asset relief programme funds to creating an “aggregator bank” that would remove toxic securities from the balance sheets of banks. The plan would be to leverage this amount up 10-fold, using the Federal Reserve’s balance sheet, so that the banking system could be relieved of up to $1,000bn (€770bn, £726bn) worth of bad assets. (Sounds like a good plan. - AM)

Although the details have not yet been decided, this approach harks back to the approach originally taken – but eventually abandoned – by Hank Paulson, the former US Treasury secretary. The proposal suffers from the same shortcomings: the toxic securities are, by definition, hard to value. The introduction of a significant buyer will result, not in price discovery, but in price distortion.(Hard to value is ridiculous pablum. There is something called price discovery George. It involves a buyer and a seller, it is reciprocal and it works. Hard to value means hard to accept the true value. You coined the term reciprocity friend didn't you? - AM)

Moreover, the securities are not homogeneous, which means that even an auction process would leave the aggregator bank with inferior assets through adverse selection. Even with artificially inflated prices, most banks could not afford to mark their remaining portfolios to market so they would have to be given some additional relief. The most likely solution is to “ring-fence” their portfolios, with the Federal Reserve absorbing losses that extend beyond certain limits.(Balancing the interests of investors with the interest of taxpayers you utilize the acid test of price discovery to liquidate the capital structure of insolvent institutions until fair value is reached. Plenty of pirates and vultures that will take a punt on this if the price is right. - AM)

These measures – if enacted – would provide artificial life support for the banks at considerable expense to the taxpayer, but would not put the banks in a position to resume lending at competitive rates. The banks would need fat margins and steep yield curves for a long time to rebuild their equity. (Yield curves are fat but margins will not be, the golden age has come to an end.- AM)

In my view, an equity injection scheme (Ah but whose equity? answer: a private/public partnership - AM) based on realistic valuations, followed by a cut in minimum capital requirements for banks, would be much more effective in restarting the economy.(Agreed sir! - AM) The downside is that it would require significantly more than $1,000bn of new capital. It would involve a good bank/bad bank solution, where appropriate. That would heavily dilute existing shareholders and risk putting the majority of bank equity into government hands.(Quoting Faber : if folks don't like the downside of capitalism they should become socialists.- AM)

The hard choice facing the Obama administration is between partially nationalising the banks, or leaving them in private hands but nationalising their toxic assets.(A false choice ... a private/public partnership can determine the clearing price of cancer. It's called the free markets, surely we haven't collectively forgotten that there is such a thing?- AM) Choosing the first course would inflict great pain on a broad segment of the population – not only on bank shareholders but also on the beneficiaries of pension funds. However, it would clear the air and restart the economy.(George is a bit wishy washy on his approach here but he's got a grasp on the solution. - AM)

The latter course would avoid recognising and coming to terms with the painful economic realities, but it would put the banking system into the same quandary that proved the undoing of the government sponsored enterprises (GSEs) – Fannie Mae and Freddie Mac. The public interest would dictate that the banks should resume lending on attractive terms. However, this lending would have to be enforced by government diktat because the self-interest of the banks would lead them to focus on preserving and rebuilding their own equity.

Political realities are pushing the Obama administration towards the latter course.(Let's hope not - AM)It cannot go to Congress and ask for the authorisation to spend an additional $1,000bn on recapitalising the banks because Mr Paulson has poisoned the well in the way he demanded and then spent the money for Tarp.(He can if he has the pirates and vultures in tow. - AM) Even the second tranche of Tarp – the remaining $350bn – could only be pried loose by a congressional manoeuvre. That is what is leading the Obama administration to contemplate reserving up to $100bn of that tranche for the “aggregator bank” solution. (Remember what Bair said, they could'only' get 37 cents (it was probably less but hey there's always a narrative) on the dollar for Indy Mac ... see Virginia there is a price that will be paid by private monies that is more than zero and less than fantasy. - AM)

The stock market is pressing for an early decision by putting pressure on financial stocks. (No need to rush Barry. As the Stones sang' time is on your side.' The longer you wait the more the market will beat down the banksters. The more punishing the free market discount before the 'data S.W.A.T. team' shows up the easier that you can clear the decks of the toxicity. You need to go full monty when you make the presentation and show the true 'endgame' on this. Here's hoping you wait 'em out. - AM) But the new team should avoid repeating the mistakes of the previous one and announcing a programme before it has been thoroughly thought out. The choice between the two courses is momentous; once made, it will become irreversible. It should be based on a careful evaluation of the alternatives.

President Barack Obama can fulfil his promise of a bold new approach only by establishing a discontinuity with the previous team. Congress and the public are right in feeling that too much has been done for the banks and not enough for beleaguered householders. The government ought to take the GSEs out of limbo and use them more actively to stabilise the housing market. Having done so, it could go back to Congress for authorisation to recapitalise the banking system the right way.