Geithner's Folly

President Obama deserves immense credit for being willing to spend serious money to prevent recession from becoming depression. He has resisted pressures from fiscal conservatives to put budget balance first, or to make social insurance bear the brunt of spending cuts down the road. And he has used his gifts as a teacher to enlist the broad support of the American people for a far-reaching strategy of public investment.

However, all of this good work will be for naught if his team doesn't get the banking system functioning again. And so far the grand design of Treasury Secretary Tim Geithner is entirely on the wrong track.

On Friday, the Treasury made its latest deal with Citigroup to infuse even more public money into the essentially insolvent zombie bank. The terms were appalling. Basically, the government gets more preferred stock with little voting power. It can be converted to common stock, but if Citi goes deeper into the red, the government takes the loss. If by some miracle, Citi recovers, its shareholders get the gain. Once again, Treasury has declined to convert its de facto ownership into effective management control, preferring to bargain with Citi's executives at arm's length.

Geithner has also come up with the idea of subjecting the largest banks to "stress tests" to determine just how badly damaged their balance sheets are. This has been advertised as government examiners crawling all over bank records, but much of this belated effort will rely on the banks' own risk models--the same risk models that got the banks into this mess.

Come to think of it, where have the examiners been all along? Why wasn't there serious investigation of bank balance sheets all along? Why should stress tests be performed only after disaster has struck (shades of Hurricane Katrina)?

The worst culprit among the feeble regulators is the Federal Reserve Bank of New York, whose examiners are responsible for assessing the safety and soundness of the holding companies of Wall Street's largest banks. It was high risk speculative activities by holding company affiliates that put the big banks under water.

Who dropped the ball? You may recall that Secretary Geithner, before he assumed his present post, was president of the New York Fed Bank. According to a withering feature piece from Bloomberg, he was asleep at the switch, and far too cozy with the banks. Heckuva job, Timmy.

The stress tests are likely to find what everyone already knows. Surprise, the big banks are bust. To put the best possible face on what Geithner is up to, it's possible that he is just playing for time. While the stress tests are going forward, the public and the financial markets can be prepared for the eventuality of nationalization. But there is no good evidence that Geithner is there yet. The greater likelihood is that he is just improvising, as he has done for months. In this latest banking rescue, as in the effort to stem mortgage foreclosures, the man's slogan might as well be: "Details to follow."

President Obama has just taken a huge political risk in his budget by proposing to put another $750 billion at Geithner's disposal to save the banks. Before the banking system is returned to health, we will need this much money and more. But if that money is dripped out in modest increments, as has been the pattern to date, the banks will only continue their slow bleed.

Eventually, the administration will get around to nationalizing the big banks, because it has no choice. Officials can prettify this reality by calling it a receivership or a conservatorship. But the exercise, done properly, will entail shutting down Citi in its present form, getting the bad assets off the bank's books, sharing the loss with Citi's creditors, breaking up Citi, and getting a sound bank functioning again.

The government may well need to do this with one or more other large banks, including Bank of America. And it can't achieve this by proxy using existing management. Civil servants accountable to the public need to run the operation. The Treasury has no such mission and no such staff. Only the Federal Deposit Insurance Corporation has hands-on experience taking over, cleaning out, and running failed banks. The mission will need to be entrusted either to the FDIC or to a new agency created for the purpose. If the government needs to hire more people, plenty of Wall Street veterans are looking for work. With different masters and different motives, their technical competence is more than adequate.

The government can either act quickly, the way the Swedes did when they faced a similar financial collapse; or the government can belatedly take banks over after delaying and trying half-measures, the way the Japanese did it. The Swedish economy got back on track and the banking system was returned to private ownership in fairly short order. The Japanese economy bled for a decade.

Why is Geithner dithering? Because he is asking the wrong question. The question he is posing is: how can the government save Citigroup? The right question is: how can the government rebuild the banking system?

Some in the administration may be wishing that they hadn't called in so many chits with senators to save Geithner from the consequences of his failure to comply with the tax laws. On the ability of Geithner (or his successor) to get this job done properly hangs the fate of the banking system, the capacity of the economy to avert a depression, and the political fortunes of the Obama administration.

Robert Kuttner is co-editor of The American Prospect and a senior fellow at Demos. His latest book is "Obama's Challenge: America's Economic Crisis and the Power of a Transformative Presidency."

Comments

[Wildscribbler]

What concerns me most about Geithner is that he has shown so little leadership at a time when we need Treasury to step up to the plate. His first press conference was a disaster and showed that he was not ready for prime time. And half of the Treasury posts remain open. Part of Geithner's job is to staff his department, and he simply is not doing it. That shortcoming has resulted in those who are at Treasury being overworked.

In these challenging times, we need a bold, decisive Treasury Secy, and Geithner does not appear to have the chops.

[zrants]

The argument over whether or not to take over the banks is not the argument we need to engage in. Whether or not the government owns or regulates them, the solution is in the direction the government gives the money lenders. In my opinion Congress needs to put a cap on interest rates now. These caps should include all credit products, credit cards, credit lines, mortgage rates, etc.

Regardless of who is to blame, or how we got into this mess, the banks need to be reigned in now. Capping interest rates and linking them to the prime rate, would be a good start.

[OSKAR T GROUCH]

"He has resisted pressures from fiscal conservatives to put budget balance first..." These idiots lost credibility two or more years ago depending on your politics.

[Jer1957]

While I was not a 2008 campaign trail fan of this president, I can appreciate what he is up against, if he reveres Lincoln and FDR as much as it seems.

Lincoln went to war with Confederate economics--and FDR put the speculators of his day into either Chapter 11 Bankruptcy Reorganization--or jail.

Pres. Obama needs to take the same approach--or risk irrelevance.

[joebhed]

It is not necessary for the taxpayers and the government to step in and "share the loss" of TRILLIONS of dollars with Citicorps' partners and lenders.
This is not an FDIC-type bailout. The FDIC has no "takeover" bank to whom the assets of Citibank can go.
I say don't touch that poison with a ten-foot pole.
Let Citicorp and its creditors work out their own asset writedown.

Today Bernanke told Congress that it needs to come up with a legal framework to make this "nationalization" thing happen.
Mr. Kuttner’s American Financial Rescue Workout Corporation is the body needed to carry out the 'nationalization" route.

Rather than get into all this new debt, we need to consider making a structural change in the monetary system of this country.
The basic structural change needed is the separation of the deposit-banking function of the money system from the credit-creation function of the system.
Deposit banking remains a completely private business.
Money creation reverts to the government.
We don’t borrow from anyone.

[joebhed]

It is not necessary for the taxpayers and the government to step in and "share the loss" of TRILLIONS of dollars with Citicorps' partners and lenders.
This is not an FDIC-type bailout. The FDIC has no "takeover" bank to whom the assets of Citibank can go.
Mr. Kuttner’s American Financial Rescue Workout Corporation is the body needed to carry out the 'nationalization" route.
I say don't touch that poison with a ten-foot pole.
Let Citicorp and its creditors work out their own asset writedown.

Today Bernanke told Congress that it needs to come up with a legal framework to make this "nationalization" thing happen.

This is the point at which consideration needs to be given to making a structural change in the monetary system of this country.
The basic structural change to be considered is the separation of the banking function of the money system from the credit-creation function of the system.
Deposit banking is private business.
Money creation reverts to the government.
We don’t borrow from anyone.

[joebhed]

sometimes....
when it says there are zero (0) comments pending.....
it's not true.

sorry.

[JDPinLA]

I read the Bloomberg piece. I hardly think it deserves being called "withering". It's more like: the jury's out on this guy, some plusses, some minuses. But i guess that just comes from the analytical skills i learned in journalism school, in part from one my earliest professors.
His name? Robert Kuttner.
I usually agree with you, "Professor", but I don't think our new Treasury Secretary is the embodiement of all that's Evil on Wall Street. C'mon.

[a68deville]

Geithner . Yeah,right . . . Next !

[outnow]

Monetary reform is necessary. The Fed is unconstitutional. Bailing out banks may mitigate the crisis now but is the road to serfdom and hyperinflation. Read the Constitution about Congresses power to control the money and you will understand that the real coup occurred in1913 after centuries of fighting the European central banking interests. Remeber the Revolutionary war? Even Woodrow Wilson realized that he had "ruined (his) country." That was after he signed the law.

The Boston Tea party was not about tea - it was about taking away the right to coin money and issue currency.

We need a Wall Street Tea party or your children will be serfs to big corporations and the financial industry. Whyt did they outsource our manufactoring and agriculture? Cheap labor is the reAson. Without jobs how are you going to be a consumer?

[mrsbee]

FIRE EVERYONE AND NATIONALIZE THE BANKS...FIX THE SYSTEM AND START OVER...I'M CONVINCED THAT 'S WHAT WILL HAPPEN.

[LewisCharles]

“President Obama deserves immense credit….” That I agree, we ‘will get around to nationalizing the big banks”, WHY NOT, WE CAN’T TRUST THE MONEY SYSTEM IT THE HANDS OF this/them, (meaning the banks are less than).
There are some real bad things going on in Los Angeles CA.
TAKE A LOOK AND LOOK AROUND!
http://www.youtube. com/watch? v=cWnHjhrPPX0
http://www.youtube. com/watch? v=QR4v2HMc4Gc
http://www.youtube. com/watch? v=4YByuoZswJU

[checkisinthemail]

Don't bail out the banks, fix the banking system.

[Charlie M]

I to believe Geithner Is to cozy with the banks ; The problem is President Obama has appointed persons that are bankers in the past and they think there is only one way to make the economy work and that is to shore up banks . Any banks no matter what . Our government should let the really bad banks go ,let them fall and then start new Banks under government supervision . I mean fire all those that caused our problems . Do that and this country will sort itself out quickly.

[robjh1]

Does Geithner have a clue? President Obama was so stedfast on getting this guy. Now what?

[SimonLeigh]

Nobody has a clue. And nobody's asking serious big questions, such as "Why do we need banks?" What's wrong with credit unions, or borrowing from family members or trusted friends? How did the world survive before banks began charging usurious interest (i.e.more than !3%)? How does the Islamic world get by without charging interest on loans? How can a company be a success if it has to borrow money to meet the payroll? Why shouldn't people save till they have enough money to buy a house? Why doesn't anyone live happily in the house they were born in? Do we really have to live alone and isolated in a big house to be happy?

Or do we want things just as they were?

[hollybork]

Very thoughtful post, Simon. Thank you.

[SurrealPumpkin]

Obama's entire economic team is looking lame right now. I keep hoping that they'll come up with an awesome plan that will address the real issue. Lack of regulation. We need to put a brake on the practices of the last 10 years or so. What's the point of pouring money into the banks if it flows out just as fast to no benefit to the taxpayer. Does anyone really think that the Banks have stopped questionable practices. Not just the bonuses, but the nitty gritty decision making process?

Part of the problem is that the Republican Party has managed to define the problem as Housing. It isn't. What went wrong was how the banks handled the debt. That is what is causing the banking crisis. We can fix all the failing mortgages in the country and it still won't solve our economic woes. When banks don't know how much they are worth nothing we do will stabilize the situation. It's time to bite the bullet, and set an arbitrary, low, value on the CDOs etc. The banks will take a hit, but at least any help we give after that has a hope of achieving some thing other then pretty bathrooms, fun weekends and richer bankers.

We need to downsize the banks. We should return to the days of fiscal purity. Consumer banks, savings banks, investment banks, and commercial banks which are separate from each other. At least then a hit to one won't wipe out all of them.

[Lefty08]

Totally agree SurrealPumpikin.