Geithner’s faulty apologia

Jan 28, 2010 00:16 UTC

Tim Geithner’s appearance in front of Congress today was another embarrassment, perhaps more for the people’s representatives than the Treasury Secretary. Still, Geithner offered a clumsy defense for paying out 100¢ on the dollar to AIG’s counterparties, which included more than Goldman Sachs.

What they lacked in knowledge and nuance, Congress made up for in volume and OUTRAGE. The worst moment I saw was the utterly bogus comparison by Rep. Stephen Lynch between AIG’s payout to Goldman (100¢ on the dollar!) and the bailout offer for Bear Stearns shareholders (only $2 per share). 100 is a bigger number than 2, you see.

Geithner was lucky to be doing battle with such an unprepared, unimpressive group.

His defense, such as it was, amounted to the following:

Had the Fed imposed haircuts on AIG counterparties, it would have led to AIG’s credit rating being downgraded and the company (and consequently the economy) would have collapsed.

But AIG had already been downgraded, that’s why the government stepped in with a bailout. At that point the firm’s liabilities were taxpayer backed, so it strains credulity to say that extinguishing certain CDS it had written would cause systemic fallout in and of itself. Essentially what was happening here was unused insurance contracts were being extinguished. (Imagine a pro-rata refund from your insurer for a homeowner’s policy it wants to cancel…)

And there was precedent for this kind of negotiation. Eric Dinallo, former Commissioner of the NYS Dept. of Insurance and current candidate for Eliot Spitzer’s old job, had previously negotiated haircuts on CDS written by the monoline bond insurers. They were never forced into a taxpayer bailout. Did anyone at the Fed pick up the phone to consult Dinallo? Why not?

At the hearing, Geithner said he took “great pride” in his judgment to pay out 100¢ on the dollar to AIG counterparties because, he claims, it saved us from economic catastrophe.

No doubt the system was on the verge of collapse. But the biggest threat was undercapitalized banks. The payout to AIG counterparties was just a backdoor bailout for them. As Dan Alpert of Westwood Capital points out:

Every dollar of [haircut] would…amount to a dollar less of capital on bank balance sheets today (actually more, because in the interim the affected banks made money with that capital). If the discount was more than a little, some of the institutions would have required “front door” bailouts, or would have failed.

That’s why everyone is still so angry about this, and Goldman’s ridiculous claims that it would have been fine even absent the $12.9 billion it received from taxpayers via AIG. Sure, they’ve paid back TARP. But here’s another $12.9 billion of your money that’s helping to fund their bonus pool.

Jim Rickards offers a good closing thought on the matter:

What was actually done [in the AIG bailout] shows a breathtaking lack of imagination and legal skill on the part of the people involved.  The Fed and Treasury do have an obligation to save the system, but they have no obligation to save each and every member of the system.  That’s a big difference.  You may need to build a firewall but it’s important to build it in the right place.  Makes sense to protect the little guy but where was the national security interest in protecting Goldman? This is why I am just speechless when I hear Geithner testify that though he was utterly surrounded by ex-Goldman people they somehow had NO IMPACT on his judgment to save Goldman.  How blind and unaware can you be?

Not so blind that you can’t be Treasury Secretary…


It’s one thing to make a boneheaded decision. It’s another to repeatedly lie about it under oath. Time for Beavis to resign.

Posted by Fielding Mellish | Report as abusive

The Ascent of Volcker

Jan 21, 2010 20:30 UTC

So, wow, the Obama administration has reacted very quickly — perhaps too quickly — post the Massachusetts Senate election. After proposing a tax on bank liabilities, Obama is taking an even tougher line, adopting recommendations from Paul Volcker that banks be limited in their size and scope.

Before getting to specifics, it’s worth noting how Geithner and Summers appear to have lost favor. In the preamble to the proposal, Obama mentions neither of them. And when he announced the plan he did so with Volcker and Bill Donaldson standing behind him…Geithner and Summers were off to the side. Could the duo be headed for the exit?

But back to the proposals themselves. Unfortunately they are very vague:

1. Limit the Scope – The President and his economic team will work with Congress to ensure that no bank or financial institution that contains a bank will own, invest in or sponsor a hedge fund or a private equity fund, or proprietary trading operations unrelated to serving customers for its own profit.

In his prepared remarks, Obama called this first proposal the “Volcker Rule,”

2. Limit the Size – The President also announced a new proposal to limit the consolidation of our financial sector. The President’s proposal will place broader limits on the excessive growth of the market share of liabilities at the largest financial firms, to supplement existing caps on the market share of deposits.

These are good ideas, but until we see the details it’s hard to offer unconditional support.

The idea behind the first proposal is that since government insures bank liabilities, it must control bank assets. Bank liabilities are insured explicitly via deposit insurance and implicitly, for the biggest banks, via a general too-big-to-fail guarantee. Deposit insurance is the only one of those two that is defensible and its purpose is to protect the integrity of the payments system. Currently banks use this insurance to obtain cheap funding that supports risky side businesses, like proprietary trading.

But how will prop trading be defined? Will banks actually have to split up? Will they merely have to tweak their corporate structure?

As for the proposal regarding bank size, it doesn’t appear that there will be much to it. Banks won’t have to get smaller or even stop growing. Instead the new rules will just prevent bigger banks from making (any?) acquisitions. They’ll be able to continue growing organically. This probably isn’t enough to reduce systemic risk, unless other reforms can successfully reduce risk-taking. (Personally I think we should break up the banks into baby banks the way we busted AT&T into baby bells….so that none is so large as to be impossible to resolve in a crisis.)

It looks a little clumsy, putting out a plan this short on detail. That said, it seems to mark a clean break with the ridiculous policy that somehow protecting the banks protects America.

The real test for Obama’s leadership, by the way, will probably come if a substantive plan like this passes. Forcing banks to make big changes to their balance sheets will surely crimp the economy in the short-run as it makes it more difficult for banks to extend credit.

That’s not a bad thing. Either we do it proactively in order to contain risk, or we let the system blow itself up again. The latter course will lead to more credit destruction of course. But asking people to voluntarily subject to economic pain will be tough. Hopefully Obama sticks to his guns.


The markets resposne is a good sign…it says that this is going to change the way banks make their profit.

The present system stinks. Investment banks getting bank status to get a credit line from the fed then hyper-leveraging their free money to make big bucks. Not a lot of skill to that!

Soros and Volcker are right. You need the right regulation that takes out the moral hazard. Investment banks should get their money from the Private sector and Commercial banks should get their money from the Fed(public). This way the Commercial Banks serve as a firewall between riskless funds and Investment bank speculation. And it forces IBs to speculate carefully because they have to invest a lot of capital and energy to convince investors in their magic. What could be wrong with that? This could be the first good policy from Obama.

As Winkler notes, the sacred cow theory of the financial markets is a lot of bull. A false belief. Because the financial system is not a free market, it is structured by government policy and regulation. That regulation needs to be changed. Adjust leverage margins to reasonable levels and pull the Fed’s capital subsidies from IBs.

This crisis was created by overleverage and the inversion of risk. So, put a cap on leverage and get the IBs back in the business of managing real risk. Simple, eh?

Posted by DrSavage | Report as abusive

Morning Links 1-7

Jan 7, 2010 14:48 UTC

Tim Geithner covered up AIG’s payments to counterparties (DealBook) Timmy G. knew it looked bad for AIG to pay out 100¢ on the dollar to counterparties like Goldman. So he told AIG to shut up.

Obama buget will raise “carried interest” tax (Comstock, Business Insider) Awesome proposal from the Prez. Recall that hedge-funders and PE guys can treat their partnership income as capital gains. As a result they’re only taxed at 15% instead of normal income tax rates of 35%. Last time this came up, Chuck Schumer killed it. This time it’s likely to happen.

Obama OKs taxing high-end health plans (Werner, AP) Another good move. It’s Republicans who’ve argued that such health plans should be taxed so this will get bipartisan support if Dems get on board. Unions oppose it so this demonstrates some backbone from Obama.

New Japanese finance minister calls for more stimulus, weaker yen (Kajomoto/White, Reuters) Debt surpassing 200% of GDP doesn’t faze the new guy…

Redrado fight roils Argentina’s markets (Cowley, WSJ) Argentina’s president wants to fire the central bank chief for refusing to release reserves to pay down debt. He says he won’t go. He has the backing of Congress too. RBS says it’s an opportunity to buy Argie debt.

Banks favorite Dem set to replace Dodd (Grim, HuffPo) Tim Johnson is from SD, the home of credit card processors. He’s the only Dem who voted against credit card reform. He also opposes cramdowns and is a supporter of pay-day lenders…

Fed conflicted on MBS purchase program (Aversa, AP) The Fed has promised to stop printing money to buy mortgage-backed securities this March, after buying $1.25 trillion total. There are many who think the Fed is trapped and can’t step away. Not only will they never sell what they bought (effectively monetizing mortgage debt) but they’ll continue buying to support the housing market. Minutes from the latest Fed meeting suggest that some officials indeed think the program will have to keep going…

Schwarzenegger seeks U.S. funds (Woo/Carlton, WSJ) He says the nation’s taxpayers owe California money…

H&M says it will no longer destroy unworn garments (Dwyer, NYT) Jim put a good article in yesterday’s Times criticizing H&M for this practice. They responded quickly.

Lucky climbers (YouTube) Watch all 29 seconds…

Puppy glasses…



It’s not securities fraud, quite. It’s just very bad politics.

Posted by Justin | Report as abusive

Treasury is right to go long

Oct 27, 2009 15:27 UTC

Timothy Geithner wants to lock in low rates for the government while he can, extending the maturity of Treasury debt to 72 months from 49, a 26-year low.

It’s a smart move — if he can pull it off.

To do so, he’ll have to increase longer-term issuance by 40 percent, to $600 billion, according to FTN Financial estimates cited by Bloomberg. That could put pressure on interest rates, nipping the recovery in the bud.

It’s a risk he should take. The bigger risk is that the government continues to fund itself at the short end of the curve, requiring Treasury to roll over its obligations more frequently.

With short-term rates near zero, Treasury has drastically reduced interest costs by selling so much short-term debt. At a certain point it may have to do so in a less receptive market.

This week, Treasury plans a record $123 billion worth of issuance. A big buyer, meanwhile, is leaving the market: The Federal Reserve will exhaust its $300 billion purchase program for Treasuries once it buys another $2 billion.

Still, demand remains healthy. Monday’s 5-year, $7 billion auction of TIPS was well received. And at 3.52 percent, the current yield for the 10-year remains near historic lows.

Yet demand won’t be this strong forever.

For one, there’s demographics. As boomers age, more Treasury securities will be sold to finance retirements. The Social Security trust fund, the largest holder of U.S. government debt, will exhaust its surplus by 2016.

At that point, the fund will cash in its IOUs, forcing Treasury to borrow more. That sounds like a long way off, but those estimates assume an optimistic increase in employment and payroll taxes.

At the same time, recent Treasury data point to slowing demand for U.S. debt among foreigners (although a report from Barclays analyst Anshul Pradhan last week suggested that the data understate Chinese holdings by as much as $100 billion).

Retail investors, hedge funds and banks have stepped in to absorb much of the supply this year. But as tolerance for risky assets returns, even they might lose their appetite.

Staying at the short end of the curve also makes Ben Bernanke’s job more difficult. If inflation picks up or if an asset bubble arises, he may want to raise rates or sell securities to shrink the Fed’s balance sheet. Will he hesitate if Treasury is still flooding the market with paper?

So Geithner is right to seek balance sheet flexibility, and he should move quickly on his plan to extend the maturity of debt.

In the long run, however, what matters is getting spending under control. Confidence in the dollar will evaporate if we continue borrowing 5 to 10 percent of GDP every year.


Sheila Bair not cowed by Geithner tantrum, criticizes Obama

Aug 4, 2009 16:30 UTC

Last week Tim Geithner dropped multiple F-bombs in a meeting with regulators unenthusiastic about his plan to concentrate oversight of the financial system at the Fed.  Sheila Bair was one of his targets, but today she held her ground.  In testimony before the Senate Banking Committee this morning, she had this to say about concentrating regulatory power at the Fed:

we do not see merit or wisdom in consolidating federal supervision of national and state banking charters into a single regulator for the simple reason that the ability to choose between federal and state regulatory regimes played no significant role in the current crisis.

One of the important causes of the current financial difficulties was the exploitation of the regulatory gaps that existed between banks and the non-bank shadow financial system, and the virtual non-existence of regulation of over-the-counter (OTC) derivative contracts. These gaps permitted lightly regulated or, in some cases, unregulated financial firms to engage in highly risky practices and offer toxic derivatives and other products that eventually infected the financial system…

She hits back at the administration pretty hard:

In light of these significant [regulatory] failings, it is difficult to see why so much effort should be expended to create a single regulator when political capital could be better spent on more important and fundamental issues which brought about the current crisis and the economic harm it has done.

She makes great points throughout.

But we can’t let Sheila and FDIC off too easy, though.  They’ve been undercharging for deposit insurance for years, which meant they didn’t have the resources necessary to resolve too-big-to-fail financials when they collapsed last fall.  Instead FDIC was forced to delay the reckoning, offering big banks a federal guarantee for their debts.

But at least Bair recognizes the terrible precedent that has been set, and wants to move decisively to reverse it.

John Dugan over at OCC also questions the wisdom of concentrating too much power at the Fed, though he and Sheila clearly have their disagreements when it comes to the proposed Consumer Financial Protection Agency.  She’s a big fan of existing proposals.  He’s got qualms with it.

Incidentally, I agree with my colleague Matt Goldstein that it’s good to see Tim Geithner get mad for a change.  A little anger is certainly appropriate.  I also agree with him that Geithner’s anger seems misdirected.


Bottom-up, baby. Micro-intelligence. That’s where regulators needs to spring from.