GEORGE SOROS: We Can Do Better Than a 'Bad Bank'

[RedEarth]

The Obama administration should come out of the gate with a comprehensive economic program that has two pillars in addition to a fiscal stimulus package. One would prevent housing prices from overshooting on the downside by making mortgages cheaper and more available and reducing foreclosures to a minimum; the other would enable banks to resume lending by adequately recapitalizing them. It would take several months to implement the program and a further period before it impacts the economy. But in the meantime, people could see that there is a way out, and that would help mitigate the severity of the downturn.

Adequate recapitalization of the banking system now faces two seemingly insuperable obstacles. One is that former Treasury Secretary Henry Paulson has poisoned the well by the arbitrary and ill-considered way he implemented the $700 billion Troubled Asset Relief Program (TARP). As a result, the Obama administration feels it cannot ask Congress for more money at this time. The other is that the hole in the banks' balance sheets has become much bigger since TARP was introduced. The assets of the banks -- real estate, securities, and consumer and commercial loans -- have continued to deteriorate, and the market value of bank stocks has continued to decline.

It is estimated that an additional $1.5 trillion would be required to adequately recapitalize the banks. Since their total market capitalization has fallen to about $1 trillion, this raises the specter of nationalization, which remains politically and even culturally unpalatable.


...........

For these reasons it would be a mistake to take the "bad bank" route, especially when there is a way to adequately recapitalize the banks with currently available resources. The trick is not to remove the toxic assets from the banks' balance sheets but instead put them into a "side pocket," as hedge funds are doing with their illiquid assets. The appropriate amount of capital -- equity and unsecured debentures -- would be sequestered in the side pocket.

This would cleanse bank balance sheets and transform them into good banks but leave them undercapitalized. The same $1 trillion that is now destined to fund the bad bank could then be used to infuse capital into the good banks.

Although the amount needed to recapitalize the banks would be more than $1 trillion, it would be possible to mobilize a significant portion of the required total amount from the private sector. In the current environment, a good bank would enjoy exceptionally good margins. Margins would narrow as a result of competition, but by then the banking system would be revitalized and nationalization avoided.

http://online.wsj.com/article/SB123371182830346215.html

[Riverman]

1. Sorry Soros, You are Wrong! Nationalization in not "unpalatable"

it is necessary. Those running the banks and investment firms and those who profited enormously must take responsibility for their actions, take your loses and not turn to the likes of me to bail your out for your mistakes. Nationalize the banks and use the funds for investments that improve the conditions of the nation for the benefit of the vast majority of the citizenry.

[On the Road]

2. I Agree with Soros

that direct government investment in the corporations is a better option than buying only the bad loans.

These two part, however, seem at odds with each other:

1) "making mortgages cheaper and more available and reducing foreclosures to a minimum"
2) "a good bank would enjoy exceptionally good margins"

What worries me about efforts to reduce mortgage rates, expand lending, and limit foreclosures is that they all have the potential to create another banking crisis under very plausible circumstances:

--Inflation pushes up long-term interest rates, sending 30-year fixed mortgages underwater
--Expanded lending results in more loans to poor credit risks.
--Postponing foreclosures only delays the inevitable for most deliquent accounts and creates a financial black hole for the banks.

What's difficult is that it has to be a balancing act between and public and the bank. While re-regulation is needed, attempts to penalize the banks or help consumers without regard for consequences has the potential to cause another financial crisis. Legislation does not normally deal with subtleties like this very well.