There’s a rabbinic saying that I’ve mentioned here before: when a woman comes from a far country and tells you she’s divorced, believe her. In legal terms that’s called a “statement against interest” or “party admission” and is given weight in legal proceedings. In the Financial Times this morning George Soros proposes a somewhat different strategy for dealing with the ongoing financial crisis than has been suggested by Treasury Secretary Henry Paulson:
Since Tarp [ed. Troubled Asset Relief Programme, the Paulson-Bernanke plan] was ill-conceived, it is liable to arouse a negative response from America’s creditors. They would see it as an attempt to inflate away the debt. The dollar is liable to come under renewed pressure and the government will have to pay more for its debt, especially at the long end. These adverse consequences could be mitigated by using taxpayers’ funds more effectively.
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 rights would be tradeable and the secretary of the Treasury would be instructed to set the terms so that the rights would have a positive value.
So, here’s my question. Mr. Soros is a currency trader and currency traders prosper under conditions of uncertainty. Is he giving advice that run with his own interests or counter to them?
Mr Soros has prospered in the past by accurately identifying weakness in currencies and then betting big against them. He thrives on the uncertainty of others and on the compulsions of politicians and governments. So if Mr Soros says TARP will lead to a weakening of the dollar, rest assured Mr Soros has already shorted the dollar heavily.
His plan for capital infusion will seriously dilute shareholder equity. Shareholders who have taken serious haircuts over the past year. A dilution of equity mandated by the government might severely dent investor confidence (which is already pretty low), causing a flight of capital. That would surely weaken the dollar and would work in Mr Soros’ favour.