Portrait of the Artist as a Fed Governor

May 30, 2008

Saving the financial system is probably more art than science. One gets that impression, anyway, when reading today’s Page One profile of New York Fed Governor Timothy Geithner. There are a few very juicy tidbits that suggest TG is driving the Fed’s response to the credit crisis, perhaps more-so than Fed Chairman Ben Bernanke. For instance:

…more than any other government action, it is the Fed’s unprecedented move to save Bear Stearns from bankruptcy, by lending $29 billion to aid its takeover by J.P. Morgan, that bears Mr. Geithner’s personal stamp. Final judgments about that move could make or break his reputation.

More than just the Bear Stearns rescue, it appears Geithner has been a proponent of aggressive Fed action to protect the financial sector:

At first, Mr. Bernanke looked for ways to restore confidence other than simply cutting interest rates, such as expanding loans made to banks through the Fed’s “discount window.” Mr. Geithner cautioned that such moves might not be enough to solve the problem — but could sow fear among investors about the stability of the financial system….

As the crisis worsened, the differences between the two men narrowed. Mr. Bernanke began to cut interest rates sharply, with Mr. Geithner’s firm backing. The New York Fed became instrumental in designing new lending programs for banks. Investment banks, which weren’t entitled to such loans and aren’t regulated by the Fed, began asking Mr. Geithner to persuade Mr. Bernanke to open the discount window to them as well.

So it appears Geithner is perhaps most responsible for, as Volcker has put it, pushing the Fed to “the very edge of its lawful and implied powers, transcending certain long embedded central banking principles and practices.”

The article notes that Davos attendees criticized the 75 bps rate cut of Jan 22nd as “clumsy.” Geithner “forcefully defended it.”

According to people who were in the room, he said that the Fed had to “buy a significant amount of insurance” against a “rising probability of a really bad macroeconomic outcome.” He didn’t deny that steep rate cuts risked fueling inflation. “The choice,” he said, “is between which mistake is easier to correct: underdoing it or overdoing it.”

To attendees, the message was clear: The Fed would do whatever it took to avert a financial meltdown. Inflation would be dealt with later.

Is all this aggressive Fed action saving Wall Street banks at the expense of, well, anyone that holds dollar-denominated assets? Geithner would argue no:

“An abrupt and disorderly unwinding of Bear Stearns [and presumably a failure to enact aggressive rate cuts and creative lending facilities] would have added to the risk that Americans would face lower incomes, lower home values, higher borrowing costs for housing, education, other living expenses, lower retirement savings and rising unemployment.”

Though the credit crisis seems to have ebbed for the moment, plenty of smart folks think we’re only in the eye of the hurricane. More bank failures, a possible bailout of the GSEs, mounting financial sector dislocation, all of that is on the horizon.

How much are taxpayers going to have to fork over in actual cash and lost purchasing power to rescue Wall Street?

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