Outside the Beltway

George Soros on the Bank Run

Dave Schuler · Monday, October 13, 2008 · 2 comments

This morning in the Financial Times George Soros has an op-ed in which he proposes a recapitalization plan for U. S. banks that resembles nothing so much as how George Bailey handled the run on the old savings and loan in Bedford Falls in It’s a Wonderful Life:

This is how Tarp ought to work. The Treasury secretary should begin by asking the banking supervisors to produce an estimate for each bank, how much additional capital they would need to meet the statutory requirement of 8 per cent. The supervisors are familiar with the banks and are aggressively examining and gathering information. They would be able to come up with an estimate in short order provided they are given clear instructions on what assumptions to use. The estimates would be reasonably reliable for the smaller, simpler institutions, but the likes of Citibank and Goldman Sachs would require some guesswork.

Managements of solvent banks would then have the option of raising additional capital themselves or turning to Tarp, which would state the terms on which it is willing to underwrite a new issue of convertible preferred shares. (Convertibles are better than warrants because the banks should not need additional capital infusions later.) The preferred shares would carry a low coupon, say 5 per cent, so as not to impair banks’ profitability. The new issues would dilute existing shareholders but they would be given preferential rights to subscribe on the same terms as Tarp and if they were willing and able to put up additional capital they would not be diluted. The rights would be transferable and if the terms were set right, other investors would take them up.

Using this approach, $700bn should be more than sufficient to recapitalise the entire banking system and funds would be available to buy and hold to maturity mortgage related securities. Since insolvent banks would not be eligible for recapitalisation, the Federal Deposit Insurance Corporation would certainly require topping up.

with Henry Paulson in the Jimmy Stewart role and banks as the citizens of Bedford Falls. How much do you need to tide you over? Are you sure? The plan would work for the same reason that George Bailey’s plan would, he knows and trusts the citizens of Bedford Falls, only if Mr. Paulson can make the same claims.

There is an important difference: Mr. Paulson would be using the taxpayers’ money rather than his own honeymoon fund. Will he safeguard it as closely?

BTW by “taxpayer” I mean people who actually pay taxes rather than just people who happen to live here. There seems to be some confusion on that point these days.

I don’t mean to demean or diminish Mr. Soros’s proposal in this analogy. I just found the analogy striking and something of the sort does seem to be the plan that central banks are lurching towards in the hope of staving off total calamity.