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Thursday, January 22, 2009

The Right and Wrong Way to Bail Out the Banks

George Soros:

The right and wrong way to bail out the banks, by George Soros, Commentary, Financial Times: According to reports..., 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 worth of bad assets. ...

[T]his approach harks back to the approach originally taken – but eventually abandoned – by Hank Paulson... The proposal suffers from the same shortcomings... These measures ... would ... support ... banks at considerable expense to the taxpayer, but would not put the banks in a position to resume lending at competitive rates. ...

In my view, an equity injection scheme based on realistic valuations, followed by a cut in minimum capital requirements..., would be much more effective in restarting the economy. The downside is that it would require significantly more than $1,000bn of new capital. ...

The hard choice facing the Obama administration is between partially nationalising the banks, or leaving them in private hands but nationalising their toxic assets. 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.

The latter course would avoid recognising and coming to terms with the painful economic realities... The public interest would dictate that the banks should resume lending on attractive terms. However, this lending would have to be enforced by government ... because ... banks would ... focus on preserving and rebuilding their own equity.

Political realities are pushing the Obama administration towards the latter course. 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... That is what is leading the Obama administration to contemplate reserving up to $100bn ... for the “aggregator bank” solution. ...

The choice between the two courses is momentous; once made, it will become irreversible. ... 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.

    Posted by on Thursday, January 22, 2009 at 03:33 PM in Economics, Financial System | Permalink  TrackBack (0)  Comments (28)

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