The Soros Plan

You knew it was coming. We concede, definitely better than the modified Paulson plan that got defeated:

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 first big hang-up we have about this is it preserves the low fixing of interest rates -- which is one of the core problems that got us into this mess in the first place. Then:

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.

No, no, no, no, no!! We cannot allow more gearing up at this point. That is the other big thing that got us into this mess. The only entities that have any business gearing up at this point are those that have been completely nationalized, like Fannie and Freddie.

So that part would be a big step in the wrong direction, and would be unlikely to be unwound until the next crisis, if we even get that far.

With high leverage and low interest rates under the Soros plan, global capital could very well go on strike from the US, given low return and continued high risk.

Let us state this clearly and categorically: any proposal which increases leverage will either make the problems worse right now, or make them worse in the (very) near future. This is the spirit of virtually every intervention so far in the past year (except direct asset swaps on the Fed's balance sheet), and what do you know, the problems have gotten worse. That's because once leverage is identified as the problem, more of it isn't going to comfort the market. Therefore, the market itself cannot recover if we go this route.

The cynic in me says: Soros just thinks his plan would produce a nice "pump and dump" for financials warrants, which he could get a piece of. Just like Buffett, maybe.

The proposal to subsidize loan mods is decent. We would also like to see more rental conversions, because that would really help address the supply problem.

We also agree that the FDIC will probably need to be "recapitalized".

As per our proposal, we would like to see what troubled banks need to pay for fresh capital on the free market, with some basic (and meaningful) assurance against deposit runs.

— Aaron Krowne, for the Implode-o-Meter.