Timothy Geithner claimed on Wednesday that the government had no choice during the financial crisis but to lend to banks and AIG using an interest rate, Libor, that everybody knew was flawed.
Call it a back-door bailout: By using an artificially low Libor, the government saved the banks and AIG millions, maybe billions -- and cost the taxpayers the same amount.
The use of Libor in the bailouts also rubber-stamped that hopelessly manipulated interest rate as a market measure, raising still more questions about just how worried Geithner and other regulators really were about it.
In a House Financial Services Committee hearing on Wednesday, Treasury Secretary Geithner was asked why Treasury and the Fed used the London Interbank Offered Rate as a basis for loans to insurance giant American International Group and to U.S. banks under the Term Asset-Backed Securities Loan Facility -- even though Geithner and other regulators had long suspected that Libor was artificially low, as Geithner testified.
"We were in the position of investors around the world," Geithner shrugged. "You have to choose a rate, and we did what everybody did -- use the best rate available at the time."
Geithner repeated his claim that he warned other U.S. and British regulators in the spring of 2008 about possible manipulation of the key interest rate and recommended changes to the way the rate was set.
But he also said that, months later, when it came time to set bailout terms for the Too Big To Fail Set, the government just had no other choice but to use Libor.
Sure, that's one way to look at it. Another, less charitable way to look at it is that the Fed was fully aware that Libor was being manipulated lower, and was fine charging an artificially low rate to lend money to banks and to AIG, in what amounted to yet another kind of bailout. Why make life harder for them, right? They had enough problems dealing with the crisis they had created. Raising red flags about Libor might have only made the crisis worse, making it harder for banks to borrow money.
But in the process, the government left untold mountains of cash on the table for U.S. taxpayers. Even if Libor was only manipulated a tiny bit lower, these small breaks add up.
In fact, if you wanted to be cynical about it, you could say this is yet another example of the Treasury Department and the Fed once again putting the needs of banks ahead of all else, including such niceties as "faith in the market" and "taxpayers."
I wrote a story for the Wall Street Journal back in 2009 estimating that banks may have saved $24 billion by borrowing at unusually low rates in another crisis-era government lending program, the Term Liquidity Guarantee Program -- loans that were frequently based on Libor.
There's still a lot of number crunching to be done in the weeks ahead, but it would not be surprising if TALF banks and AIG saved similar amounts by borrowing from the government at an artificially low Libor rate.
As Neil Barofsky, former inspector general for TARP, and others have noted, by using Libor, the Fed and Treasury rubber-stamped that rate as a lending benchmark, despite widespread doubts about its accuracy.
Despite Geithner's claim that there was just no choice but to use Libor when setting bailout terms, Treasury and the Fed easily could have used other rates -- the federal runds rate targeted by the Fed, for example, or a market-based rate such as the "eurodollar" rate, which is typically very similar to, but has in recent years been a little bit higher than, Libor.
Geithner argued on Wednesday that his quiet warnings to other regulators led to the investigations that are only now starting to bear fruit, with Barclays paying big fines and other banks bracing for fines of their own.
But those warnings were very quiet, letting banks continue to reap the benefits of low Libor -- benefits that probably far outweighed any fines they will pay.