Tim Geithner: The Forrest Gump of World Finance
One almost feels sorry for Treasury Secretary Tim Geithner.
He’s a punchline in his own country because he oversees the IRS even though he conveniently forgot to declare $80,000 of income (and managed to get away with punishment that wouldn’t even qualify as a slap on the wrist).
Now he’s becoming a a bit of a joke in Europe. Earlier this month, a wide range of European policy makers basically told the Treasury Secretary to take a long walk off a short pier when he tried to offer advice on Europe’s fiscal crisis.
And the latest development is that the German Finance Minister basically said Geithner was “stupid” for a new bailout scheme. Here’s an excerpt from the UK-based Daily Telegraph.
Germany and America were on a collision course on Tuesday night over the handling of Europe’s debt crisis after Berlin savaged plans to boost the EU rescue fund as a “stupid idea” and told the White House to sort out its own mess before giving gratuitous advice to others.German finance minister Wolfgang Schauble said it would be a folly to boost the EU’s bail-out machinery (EFSF) beyond its €440bn lending limit by deploying leverage to up to €2 trillion, perhaps by raising funds from the European Central Bank.”I don’t understand how anyone in the European Commission can have such a stupid idea. The result would be to endanger the AAA sovereign debt ratings of other member states. It makes no sense,” he said.
All that’s missing in the story is Geithner channeling his inner Forrest Gump and responding that “Stupid is as stupid does.”
...at birth?
Separated...
This little spat reminds me of the old saying that there is no honor among thieves. Geithner wants to do the wrong thing. The German government wants to do the wrong thing. And every other European government wants to do the wrong thing. They’re merely squabbling over the best way of picking German pockets to subsidize the collapsing welfare states of Southern Europe.
But that’s actually not accurate. German politicians don’t really want to give money to the Greeks and Portuguese.
The real story of the bailouts is that politicians from rich nations are trying to indirectly protect their banks, which – as shown in this chart – are in financial trouble because they foolishly thought lending money to reckless welfare states was a risk-free exercise.
Europe’s political class claims that bailouts are necessary to prevent a repeat of the 2008 financial crisis, but this is nonsense – much as American politicians were lying (or bamboozled) when they supported TARP.
It is a relatively simple matter for a government to put a bank in receivership, hold all depositors harmless, and then sell off the assets. Or to subsidize the takeover of an insolvent institution. This is what America did during the savings & loan bailouts 20 years ago. Heck, it’s also what happened with IndyMac and WaMu during the recent financial crisis. And it’s what the Swedish government basically did in the early 1990s when that nation had a financial crisis.
But politicians don’t like this “FDIC-resolution” approach because it means wiping out shareholders, bondholders, and senior management of institutions that made bad economic choices. And that would mean reducing moral hazard rather than increasing it. And it would mean stiff-arming campaign contributors and protecting the interests of taxpayers.
Heaven forbid those things happen. After all, as Bastiat told us, “Government is the great fiction, through which everybody endeavors to live at the expense of everybody else.”
Hoenig for FDIC
On July 8th, Sheila Bair will step down as Chair of the Federal Deposit Insurance Corporation (FDIC). While I believe she’s gotten a lot wrong (such as not preparing the fund for the coming crisis), she has been about the only voice among senior bank regulators for actually ending too-big-to-fail. With her departure, we might lose that one voice. Later this year, Kansas City Fed President Tom Hoenig is also scheduled to leave his current position.
Hoenig has actually gone beyond Bair in trying to address too-big-to-fail, having called for the largest banks to be broken up. While I don’t believe that should be our first approach, having an advocate for both the taxpayer and the overall economy at the helm of the FDIC could make a significant difference.
Given that Section 2 of the Federal Deposit Insurance Act requires the FDIC to have a bipartisan board, President Obama is faced with the choice of either appointing a non-Democrat or asking Vice-Chair Marty Gruenberg to leave. While I have no idea as to Hoenig’s politics, he’d likely be able to pass that test.
Hoenig has also been willing to publicly challenge Bernanke on a number of issues. Given the narrow group-think among regulators that contributed to the crisis, having a loud, credible, independent voice among bank regulators is solely needed. Hoenig again fits that bill. His appointment would also offer Obama a chance to show that he is not completely beholden to the Geithner “never seen a bailout I didn’t like” worldview.
Perhaps with Hoenig at the helm, we can actually begin a debate about reducing the moral hazard created by the Federal Reserve. While Bair was all too willing to see both insurance coverage and regulatory powers of the FDIC expanded, Hoenig strikes me as open-minded to the very real excess bank risk-taking that is encouraged by the existence of the FDIC.
Could Technical Default Today Save America from Greek-Style Fiscal Disaster in the Future?
There’s a lot of buzz about a Wall Street Journal interview with Stanley Druckenmiller, in which he argues that a temporary delay in making payments on U.S. government debt (which technically would be a default) would be a small price to pay if it resulted in the long-term spending reforms that are needed to save America from becoming another Greece.
One of the world’s most successful money managers, the lanky, sandy-haired Mr. Druckenmiller is so concerned about the government’s ability to pay for its future obligations that he’s willing to accept a temporary delay in the interest payments he’s owed on his U.S. Treasury bonds—if the result is a Washington deal to restrain runaway entitlement costs. “I think technical default would be horrible,” he says from the 24th floor of his midtown Manhattan office, “but I don’t think it’s going to be the end of the world. It’s not going to be catastrophic. What’s going to be catastrophic is if we don’t solve the real problem,” meaning Washington’s spending addiction. …Mr. Druckenmiller’s view on the debt limit bumps up against virtually the entire Wall Street-Washington financial establishment. A recent note on behalf of giant banks on the Treasury Borrowing Advisory Committee warned of a “severe and long-lasting impact” if the debt limit is not raised immediately. …This week more than 60 trade associations, representing virtually all of American big business, forecast “a massive spike in borrowing costs.” On Thursday Federal Reserve Chairman Ben Bernanke raised the specter of a market crisis similar to the one that followed the 2008 bankruptcy of Lehman Brothers. As usual, the most aggressive predictor of doom in the absence of increased government spending has been Treasury Secretary Timothy Geithner. In a May 2 letter to House Speaker John Boehner, Mr. Geithner warned of “a catastrophic economic impact” and said, “Default would cause a financial crisis potentially more severe than the crisis from which we are only now starting to recover.”
Mr. Druckenmiller is not overly impressed by this hyperbole. The article continues with this key passage.
“Here are your two options: piece of paper number one—let’s just call it a 10-year Treasury. So I own this piece of paper. I get an income stream obviously over 10 years . . . and one of my interest payments is going to be delayed, I don’t know, six days, eight days, 15 days, but I know I’m going to get it. There’s not a doubt in my mind that it’s not going to pay, but it’s going to be delayed. But in exchange for that, let’s suppose I know I’m going to get massive cuts in entitlements and the government is going to get their house in order so my payments seven, eight, nine, 10 years out are much more assured,” he says. Then there’s “piece of paper number two,” he says, under a scenario in which the debt limit is quickly raised to avoid any possible disruption in payments. “I don’t have to wait six, eight, or 10 days for one of my many payments over 10 years. I get it on time. But we’re going to continue to pile up trillions of dollars of debt and I may have a Greek situation on my hands in six or seven years. Now as an owner, which piece of paper do I want to own? To me it’s a no-brainer. It’s piece of paper number one.” …”Russia had a real default and two or three years later they had all-time low interest rates,” says Mr. Druckenmiller. In the future, he says, “People aren’t going to wonder whether 20 years ago we delayed an interest payment for six days. They’re going to wonder whether we got our house in order.”
This is a very compelling argument, but it overlooks one major problem — the complete inability of Republicans to succeed in forcing fiscal reform using this approach.
Why Are Geithner and Bernanke Trying to Panic Financial Markets with Debt Limit Demagoguery?
By taking advantage of “must-pass” pieces of legislation, Republicans have three chances this year to restrain the burden of government. They didn’t do very well with the “CR fight” over appropriated spending for the rest of FY2011, which was their first opportunity. I was hoping for an extra-base hit off the fence, but the GOP was afraid of a government shutdown and negotiated from a position of weakness. As such, the best interpretation is that they eked out an infield single.
The next chance to impose fiscal discipline will be the debt limit. Currently, the federal government “only” has the authority to borrow $14.3 trillion (including bookkeeping entries such as the IOUs in the Social Security Trust Fund). This is a very big number, but America’s gross federal debt will hit that limit soon, perhaps May or June.
Republicans say they will not raise the debt limit unless such legislation is accompanied by meaningful fiscal reforms. The political strategists in the Obama White House understandably want to blunt any GOP effort, so they are claiming that any delay in passing a “clean debt limit” will have catastrophic consequences. Specifically, they are using Treasury Secretary Tim Geithner and Federal Reserve Bank Chairman Ben Bernanke to create fear and uncertainty in financial markets.
Senator Toomey’s Legislation Would Protect Financial Markets During a Debt Limit Showdown
There will be several pivotal fiscal policy battles this year and the fight over the debt limit may be the most crucial.
This is a “must-pass” piece of legislation, so it will be a rare opportunity for fiscal conservatives in the House to impose some much-needed spending restraint.
But it’s also a high-stakes game. If Obama (or Reid) refuses to accept the fiscal reforms approved by the House and there is a stalemate, the 
federal government ultimately would lose its ability to borrow from private credit markets. And while that notion has some appeal for many of us, it almost certainly would require more fiscal discipline than the political system is willing to accept (i.e., actual deep cuts rather than just restraining the growth of spending).
In a bit of reckless demagoguery, the Treasury secretary even says it would mean default — which could cause instability in financial markets.
To preclude that possibility, Senator Toomey of Pennsylvania has a proposal to protect the “full faith and credit” of the United States by requiring the federal government to make interest payments a top priority. Writing for Bloomberg, I opine about the Senator’s proposal.
…the federal government is expected to collect more than $2.1 trillion of tax revenue this year, while interest payments on the publicly held debt will only be about $200 billion. So even without an increase in the debt limit, the Treasury Department will have more than enough revenue to cover its interest obligations and avoid a default. That being said, financial markets are sometimes spooked by uncertainty. And since Treasury Secretary Timothy Geithner began making some irresponsible statements about the risks of default, there is growing interest in legislation by Senator Pat Toomey, a Republican of Pennsylvania, to alleviate the market’s fears. Quite simply, Toomey’s bill would require the federal government to fulfill obligations to bondholders before making any other disbursements. …If the Toomey legislation is adopted, fiscal reformers will have a powerful weapon at their disposal. Secure in the knowledge that default no longer is a possibility, they can be much tougher in their negotiations with the politicians who favor the status quo. This explains the attacks against the Toomey plan. Some even argue that the law requires the government to pay Chinese bondholders (gasp!) before it pays Social Security recipients. This is demagoguery. The federal government will collect more than enough revenue to finance the majority of budgeted outlays. Social Security checks will be disbursed, unless the Treasury secretary decides otherwise. In any event, the attack is rather hollow since it’s almost always made by people who say that default would be a cataclysmic event. What they really mean, it seems, is that deficits, debt and default are bad, and only higher taxes are the solution. That’s what this debate is all about. We have a fiscal crisis caused by too much spending, not too little taxes. Restraining the size and scope of government is contrary to the interests of the iron quadrangle of politicians, interest groups, lobbyists and bureaucrats who benefit from ever- expanding government.
Bill Daley and ‘Too Big To Fail’
MIT Professor Simon Johnson recently argued that Bill Daley’s appointment as Obama’s Chief of Staff signals that “too big to fail,” as it relates to our largest financial institutions, is here to stay. Personally I never thought it was in doubt. With Geithner at Treasury and Dodd-Frank further codifiying “too big to fail,” its been clear for some time that the bailout net is larger than it’s ever been, and is not being pulled back.
That said, Professor Johnson’s focus on Daley distracts from the real issue, which is changing our bank regulatory structure to end bailouts. The focus on Daley has the potential to lead us down that path of “if we just had the right people in government…” We shouldn’t be designing our regulatory structures with the “right” people in mind, but rather with the rule of law in mind. In fact, one of the benefits of the Obama administration is that it serves as a great test of the “right people” hypothesis of government. One is unlikely to see a more left-leaning White House than this one, so if this one gets captured by special interests, including Wall Street, than it’s a safe bet that any future administration will as well.
Since I believe most of us actually want to end “too big to fail,” the real question is how to do it. It strikes me that we have three options: regulate the largest institutions to death (or competitive disadvantage), break them up, or credibly impose losses on their creditors. Ultimately I think the regulation approach is bound to fail, if for no other reason than regulatory capture. (Even Elizabeth Warren seems to get this: “Regulations, over time, fail. I want to see Congress focus more on a credible system for liquidating the banks that are considered too big to fail.”) Breaking them up might sound attractive in theory, but I have a hard time seeing how it truly works in practice. After all, few in Washington viewed Bear Stearns as “too big to fail.” Accordingly, I believe the best approach would be to force creditors to take losses or be converted into equity. To make this credible, we must bind the hands of the regulators. As long as the Fed, Treasury, or the FDIC can inject money, then bailouts are always on the table.
Sadly, what the Daley appointment reminds us is that any attempt to end “too big to fail” will likely have to wait until the next administration. Not only is this one wed to bailouts, the President would likely veto any bill that really tied the hands of the Fed.
The White House Has Declared Class War on the Rich, but the Poor and Middle Class Will Suffer Collateral Damage
The 2001 and 2003 tax cuts are scheduled to expire at the end of this year, which means a big tax increase in 2011. Tax rates for all brackets will increase, the double tax on dividends will skyrocket from 15 percent to 39.6 percent, the child credit will shrink, the death tax will be reinstated (at 55 percent!), the marriage penalty will get worse, and the capital gains tax rate will jump to 20 percent. All of these provisions will be unwelcome news for taxpayers, but it’s important to look at direct and indirect costs. A smaller paycheck is an example of direct costs, but in some cases the indirect costs — such as slower economic growth — are even more important. This is why higher tax rates on entrepreneurs and investors are so misguided. For every dollar the government collects from policies targeting these people (such as higher capital gains and dividend taxes, a renewed death tax, and increases in the top tax rates), it’s likely that there will be significant collateral economic damage.
Unfortunately, the Obama Administration’s approach is to look at tax policy only through the prism of class warfare. This means that some tax cuts can be extended, but only if there is no direct benefit to anybody making more than $200,000 or $250,000 per year. The folks at the White House apparently don’t understand, however, that higher direct costs on the “rich” will translate into higher indirect costs on the rest of us. Higher tax rates on work, saving, investment, and entrepreneurship will slow economic growth. And, because of compounding, even small changes in the long-run growth rate can have a significant impact on living standards within one or two decades. This is one of the reasons why high-tax European welfare states have lost ground in recent decades compared to the United States.
When the economy slows down, that’s not good news for upper-income taxpayers. But it’s also bad news for the rest of us — and it can create genuine hardship for those on the lower rungs of the economic ladder. The White House may be playing smart politics. As this blurb from the Washington Post indicates, the President seems to think that he can get away with blaming the recession on tax cuts that took place five years before the downturn began. But for those of us who care about prosperity more than politics, what really matters is that the economy is soon going to be hit with higher tax rates on productive behavior. It’s unclear whether that’s good for the President’s poll numbers, but it’s definitely bad for America.
Treasury Secretary Timothy F. Geithner took the lead Sunday in continuing the Obama administration’s push for extending middle-class tax cuts while allowing similar cuts for the nation’s wealthiest individuals to expire in January. …The tax cuts, put in place between 2001 and 2003, have become an intensely political topic ahead of the congressional elections this fall. Republicans have argued that extending the full spectrum of tax cuts is essential to strengthening the sluggish economic recovery. Geithner rejected that notion, telling ABC’s “This Week” that letting tax cuts for the wealthiest expire would not hurt growth. …On Saturday, the president used part of his weekly address to chide House Minority Leader John A. Boehner (Ohio) and other Republicans who oppose the administration’s approach, saying the GOP was pushing “the same policies that led us into this recession.”
Lehman’s Failure Taught Us Nothing
Several commentators have reacted to Senator McConnell’s floor statement regarding the Dodd bill as a defense of “doing nothing”. And accordingly argue that such a position would be, in the words of Simon Johnson, both dangerous and irresponsible. This familiar canard is based upon the oft repeated assertion that the failure of Lehman proved that we cannot simply let large financial companies enter bankruptcy.
The simple, but important, fact is that we have no idea what would have happened had we let AIG and Bear go into bankruptcy proceedings. Nor do we know what would have happened if Lehman had been saved. Macroeconomics does not have the luxury of running natural experiments to determine the impact of a corporate failure. Scholars have an obligation to accurately reflect the uncertainties in the debate. Those that assert Lehman proved anything, are being at best disingenuous, and at worst, dishonest.
Let us, however, put forth a few things we do know:
- We know none of Lehman’s counterparties failed as a result of Lehman’s failures. Just as we know none of AIG”s counterparties would have failed if they did not get 100 cents on the dollar from their CDS positions. So where exactly is the proof of contagion?
- We know we had a nasty housing bubble. We were going to lose millions of jobs in construction and real estate regardless of what we did. We knew financial institutions heavily invested in housing would suffer. How exactly would saving Lehman have prevented any of that?
The debate over ending bailouts and too-big-to-fail will not progress, we will not learn a thing, if we let simple, empty assertion pass as fact. Much of the public remains angry at Washington because those responsible, such as Bernanke and Geithner, have never laid out a believable or plausible narrative for the bailouts. It always comes back to “panic.” If we are ever to hope to return to being a country governed by the rule of law, rather than the whims of men, then we need a lot more of an explanation than “panic.”
Thursday Links
- The back story behind the Citizens United free speech case. (Or if you don’t have time to read about it, this short video clip explains it all.)
- RomneyCare: Obama’s OTHER Massachusetts problem.
- Tim Geithner’s lifelong love of bailouts.
- How substantial and meaningful change can be brought to Haiti.
- Podcast: “Supreme Court Affirms First Amendment” featuring John Samples.
Last Minute Christmas Shopping?
This is the last week to buy presents, so for those of you who can’t find zhu zhu pets, here are a couple of options sure to bring a smile. The first option is a long-sleeved t-shirt honoring the Secretary of the Treasury.
If t-shirts are not high on the list for your friends and family, here’s something everyone can use. There are more than 70,000 pages of tax law and IRS regulation, and although there are not that many squares in this roll, all taxpayers will enjoy creating their own “performance art” with this gift (sadly, does not include a grant from the NEA).
Geithner Ignores Bailout History
Perhaps the biggest problem with the Obama plan to “reform” our financial system is the impact it would have on the market perception surrounding “too big to fail” institutions. In identifying some companies as “too big to fail” holders of debt in those companies would assume that they would be made whole if those companies failed. After all, that is what we did for the debt-holders in Fannie, Freddie, AIG, and Bear. Both former Secretary Paulson and Geithner appear under the impression that moral hazard only applies to equity, despite debt constituting more than 90% of the capital structure of the typical financial firm.
Geithner believes he’s found a way to solve this problem – he’ll just tell everyone that there isn’t an implicit subsidy, and there won’t be a list of “too big to fail” companies. Great, why didn’t I think of that. After all, the constant refrain in Washington over the years that Fannie and Freddie weren’t getting an implicit subsidy really prepared the markets for their demise.
Even more bizarre is Geithner’s assertion that the government can force these institutions to hold higher capital, maintain more liquidity and be subjected to greater supervision, all without anyone knowing who exactly these companies are. Does the Secretary truly believe that these companies’ securities disclosures won’t include the amount of capital they are holding? Whether there is an official list or not is besides the question, market participants will be able to infer that list from publicly available information and the actions of regulators.
One has to wonder whether Geithner spent any of his time at the NY Fed actually watching how markets work. Before we continue down the path of financial reform, maybe it would be useful for our Treasury Secretary to take a few weeks off to study what got us into this mess. We’ve already been down this road of denying implicit subsidies and then providing them after the fact. Maybe it’s time to try something different.
Robbing Peter to Pay Paul
The FDIC’s insurance fund, which it uses to pay off despositors in failed banks, is getting low. One way it can bolster its reserves is to draw on a $100 billion line of credit from the Treasury. Instead, however,
Senior regulators say they are seriously considering a plan to have the nation’s healthy banks lend billions of dollars to rescue the insurance fund that protects bank depositors. That would enable the fund, which is rapidly running out of money because of a wave of bank failures, to continue to rescue the sickest banks.
A brilliant scheme to avoid another taxpayer bailout? Not really.
The banks are willing to lend because the FDIC will pay them a good interest rate. Repayment is virtually guaranteed because the FDIC can always draw on its line of credit. Thus the banks are getting a better deal than they would in the marketplace (that’s why they are doing this), so the scheme is a backdoor way of further bailing out the banks.
Why go through this charade? Apparently, using the Treasury credit line
is said to be unpalatable to Sheila C. Bair, the agency chairwoman whose relations with the Treasury secretary, Timothy F. Geithner, have been strained.
“Sheila Bair would take bamboo shoots under her nails before going to Tim Geithner and the Treasury for help,” said Camden R. Fine, president of the Independent Community Bankers. “She’d do just about anything before going there.”
Instead, the FDIC will con the taxpayers. The FDIC has no choice under existing policy, of course, but to pay off depositors of failing banks. They should just be honest about how who is paying for it.
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