George Soros is Right About the 'Bad Bank'

To say that I'm not a fan of George Soros would be an understatement. My animus is not solely because of his support, overt and covert, of the Left and the Democrats, but also at his way of doing business. With the formation of the Quantum Group of Funds in the 1970s, he literally created the modern day hedge fund business -- a business whose transparency issues rival those of official Washington.

But when he comes out of the shadows with straightforward financial advice he is often brilliant (albeit self-serving), and it would be foolish to not admit when he is right. And he is very right in a 2/4/09 op-ed in the Wall Street Journal, We Can Do Better Than a 'Bad Bank'.

The financial fiasco that the world finds itself in today started with problems within the housing sector of our economy. Those problems, specifically with the housing markets, were created by the federal government and Democrats in Washington, in particular Barney Frank in the House and Chris Dodd in the Senate. In their infinite wisdom well over a dozen years ago, they decreed that home ownership was a human right, and mandated by law that anyone, regardless of their credit worthiness or ability to pay, be allowed to purchase a home. Hence the creation of the sub-prime market.

Over the past decade plus, that resulted in hyper-inflated housing prices and the collapse of affordable rentals. When the predictable occurred, and people who had no ability to repay a loan defaulted on their mortgages in huge numbers, the secondary mortgage security markets and derivatives associated with it collapsed. Then followed the freeze-up of the overall worldwide credit market, and the collapse of housing prices.

While Soros doesn't explain it that way (he really doesn't explain it at all), he does recognize that the results of the above -- the stagnation of the housing and credit markets and the trillions of dollars in illiquid assets -- needs to be addressed immediately for us to get out of this mess, and that no real plan so far has been put forth to do so.

The GOP has been pushing for the federal government, via their now wholly owned GSEs Fannie Mae and Freddie Mac, to revitalize the housing market by purchasing home mortgages in the secondary market -- loans that would be originated at between 4% and 4.5%. George Soros agrees:

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.

As such a push from the GSEs would affect both home buyers and people who choose to refinance their existing mortgages, the Republicans' plan would jump start the housing market and immediately stimulate the economy more so than anything the Obama Administration or the Democrats have proposed so far. Hopefully the Democrats are smart enough to allow this to be included in their stimulus plan. That leaves the second issue: what to do with the toxic assets currently held by financial institutions. The idea d'jour that has been floated around is the creation of a "bad bank" that would own all of the bad mortgages and securities. But that's not necessary. There have always been mechanisms within easy reach, via either the temporary suspension of certain regulations or very simple Congressional legislation, which could take care of both the existing bad assets and the recapitalization of banks -- relying not on the federal government, but on the private sector. From Soros:

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.

This seems to be an intelligent way to solve the fundamental problems currently freezing the credit and housing markets. It is also comprised of programs that the Democrats have not promoted or included in their 'stimulus' bill, which places Soros in opposition to the Democrats - an odd place for him to be.

Instead, Democrats like Harry Reid, Chris Dodd, Nancy Pelosi, and Barney Frank - with assistance from Obama Administration members Timothy Geitner at Treasury and Sheila Bair at FDIC - seem intent an nationalizing both the housing sector and the banking system.

Let's hope that Soros and the Republicans can convince them otherwise.
To say that I'm not a fan of George Soros would be an understatement. My animus is not solely because of his support, overt and covert, of the Left and the Democrats, but also at his way of doing business. With the formation of the Quantum Group of Funds in the 1970s, he literally created the modern day hedge fund business -- a business whose transparency issues rival those of official Washington.

But when he comes out of the shadows with straightforward financial advice he is often brilliant (albeit self-serving), and it would be foolish to not admit when he is right. And he is very right in a 2/4/09 op-ed in the Wall Street Journal, We Can Do Better Than a 'Bad Bank'.

The financial fiasco that the world finds itself in today started with problems within the housing sector of our economy. Those problems, specifically with the housing markets, were created by the federal government and Democrats in Washington, in particular Barney Frank in the House and Chris Dodd in the Senate. In their infinite wisdom well over a dozen years ago, they decreed that home ownership was a human right, and mandated by law that anyone, regardless of their credit worthiness or ability to pay, be allowed to purchase a home. Hence the creation of the sub-prime market.

Over the past decade plus, that resulted in hyper-inflated housing prices and the collapse of affordable rentals. When the predictable occurred, and people who had no ability to repay a loan defaulted on their mortgages in huge numbers, the secondary mortgage security markets and derivatives associated with it collapsed. Then followed the freeze-up of the overall worldwide credit market, and the collapse of housing prices.

While Soros doesn't explain it that way (he really doesn't explain it at all), he does recognize that the results of the above -- the stagnation of the housing and credit markets and the trillions of dollars in illiquid assets -- needs to be addressed immediately for us to get out of this mess, and that no real plan so far has been put forth to do so.

The GOP has been pushing for the federal government, via their now wholly owned GSEs Fannie Mae and Freddie Mac, to revitalize the housing market by purchasing home mortgages in the secondary market -- loans that would be originated at between 4% and 4.5%. George Soros agrees:

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.

As such a push from the GSEs would affect both home buyers and people who choose to refinance their existing mortgages, the Republicans' plan would jump start the housing market and immediately stimulate the economy more so than anything the Obama Administration or the Democrats have proposed so far. Hopefully the Democrats are smart enough to allow this to be included in their stimulus plan. That leaves the second issue: what to do with the toxic assets currently held by financial institutions. The idea d'jour that has been floated around is the creation of a "bad bank" that would own all of the bad mortgages and securities. But that's not necessary. There have always been mechanisms within easy reach, via either the temporary suspension of certain regulations or very simple Congressional legislation, which could take care of both the existing bad assets and the recapitalization of banks -- relying not on the federal government, but on the private sector. From Soros:

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.

This seems to be an intelligent way to solve the fundamental problems currently freezing the credit and housing markets. It is also comprised of programs that the Democrats have not promoted or included in their 'stimulus' bill, which places Soros in opposition to the Democrats - an odd place for him to be.

Instead, Democrats like Harry Reid, Chris Dodd, Nancy Pelosi, and Barney Frank - with assistance from Obama Administration members Timothy Geitner at Treasury and Sheila Bair at FDIC - seem intent an nationalizing both the housing sector and the banking system.

Let's hope that Soros and the Republicans can convince them otherwise.