Lifting the Tarp: Will President Obama's Economic Team Lead Him Off a Cliff?

In the past two weeks, political support for the Tim Geithner/Larry Summers approach to solving the banking crisis has been unraveling in Congress, with blistering criticism from legislators of both parties.

The financial danger is that the Treasury will burn through the money approved by Congress without fixing the system. The political danger is that Republicans will posture as the populists, expressing faux-indignation that so much taxpayer money has gone to Wall Street. The overarching risk to Obama's presidency is that the plan won't work, and his political capital will evaporate along with the financial capital.

There is a whole other path to repairing the banking system, and a whole other set of experts, equally brilliant and better in touch with financial realities. But their unfiltered views are not reaching the president. This loyal opposition, of which more shortly, is not limited to lefties; it spans the ideological spectrum.

Though the details are numbingly technical (and deliberately mystified both by the investment bankers and their allies at the Treasury), the basics of what's wrong with the banking system and how to fix it are, at bottom, very simple.

After all, what do banks do? They take in deposits and they put out loans and make other investments.

In the past decade, far too many of the banks' investments were far too speculative. They lost vast sums, which now exceed the value of their capital. In plain English, they are insolvent.

In a situation like this, a busted banking system can push the whole economy into prolonged depression. We are right on the edge of that condition, and there is little time to lose.

As the president of the Federal Reserve Bank of Kansas City, Thomas Hoenig, explained March 6 in a brilliant speech (PDF) that is being widely circulated on Capitol Hill, "Too Big Has Failed," to save the banking system we need a public corporation like the Reconstruction Finance Corporation of the 1930s, which at one point held about one-third of all U.S. bank stock, and by the time it wrapped up its affairs it did not cost taxpayers a penny.

A modern RFC would be given the technical competence and manpower to audit just how bad things are. It needs to determine how far underwater is each of the large banks. (The top four hold about 55 percent of all deposits; fix them and you fix the system.)

The public corporation, according to Hoenig, would need to decide which banks to take into receivership, which ones have competent management teams, and which managers need to go.

Once the size of the hole in bank capital is determined -- and it will be on the scale of two trillion dollars -- the government needs to decide who eats the loss. How much do the taxpayers put in, and how much do the bondholders have to sacrifice?

Owners of bank stocks are not really relevant. They have already lost upwards of 95 percent of their investments. When a bank is taken into receivership, they will lose the rest. But it's no big deal for the system. Trying to use public money to pump up the value of bank stocks -- Geithner's approach -- has it backwards.

Finally, when the banks are restored to solvency, they need to be returned to private ownership.

Hoenig is not exactly a Bolshevik, but he is embracing Roosevelt and the President's men are not. A well-staffed government corporation, which would take insolvent banks into receivership, is the most effective approach because it gets the job done swiftly and transparently, and with the least unnecessary government subsidy of market middlemen.

Last week, at a hearing of the Joint Economic Committee, Alex Pollock of the conservative American Enterprise Institute commended this strategy, and the Committee's ranking Republican, Sen. Sam Brownback of Kansas embraced it. For a quick tutorial, the video of the hearing is must-watching.

But the Geithner/Summers strategy is the complete opposite. Geithner hopes to enlist hedge funds and private equity companies to purchase bonds from banks, using loans and loan guarantees from the Treasury and the Federal Reserve, and thereby restart the very system that failed.

This approach gives far too much power and taxpayer subsidy to the least transparent and least regulated parts of the financial system. On Saturday, the Wall Street Journal reported that the announcement of the details of the plan had to be delayed yet again, because two of the biggest firms wanted even sweeter terms before they came to the table.

This latest Geithner scheme to restart the doomsday machine of securitization for newly issued bonds is the fifth do-over since Paulson embarked on this path last October. Geithner's scheme sidesteps the core problem that stymied Paulson -- what about the pre-existing bonds that are clogging bank balance sheets? This huge hole in bank assets is a far bigger challenge than re-starting the engine of new lending, which never entirely quit.

The Geithner/Summers approach is complex, slow, ad hoc, non-transparent, and far too Wall Street oriented. Only now is Geithner getting around to initiating proper audit of the zombie banks he is aiding, under the euphemism, "stress tests."

As an indication of just how closely Geithner and company are acting on Wall Street's behalf, consider this tidbit, whose significance the media largely missed: Friday's Washington Post reported that a man named H. Rodgin Cohen, under consideration for Deputy Treasury Secretary, had become the latest proposed senior appointee to withdraw from consideration. The Post treated the story as part of the continuing saga of unfilled sub-cabinet jobs.

But who is "Rodge" Cohen? Astoundingly, he is a senior lawyer from the firm of Sullivan and Cromwell, and the man who has been negotiating with Geithner on behalf of the large Wall Street banks!

What the hell, if you're going to act mainly in the interests of the banks, why not bring just their people right into government? The story didn't give details, but only mentioned that "an issue" had emerged during the vetting process. We can only imagine what kinds of conflict of interest problems the vetting team unearthed.

If you ask the question, how can we get America's banking system restored to health, the Geithner/Summers approach makes absolutely no sense. But if you ask a different question, it makes perfect sense: how can we pump up the share price of outfits like Citi and Goldman, while we pump in taxpayer and Federal Reserve money and hope for a miracle.

Unfortunately, a miracle is just what it would take for this approach to work.

Unlike Roosevelt's RFC, the Treasury lacks any institutional capability to do the job properly. As a consequence, it shovels out money first, does audits later, oscillates wildly between being hands off and micro-managing, and tries to wring out purely symbolic sacrifices like making Citi give back its proposed new $43 million executive jet.

On Sunday morning, the talk shows were dominated by the revelation that AIG -- on the hook to taxpayers for $175 billion -- was paying out bonuses to the very unit in London that caused the catastrophe. The newspaper stories suggested that news of this latest outrage originated with a preemptive leak from the administration.

Larry Summers solemnly declared on the Sunday talk shows that these bonuses were appalling, but that America is a nation of laws where "a contract is a contract." That's malarkey. The UAW has been forced to renegotiate contracts as part of the auto bailout.

Summers credited Secretary Geithner for reducing the original proposed bonuses, but if Geithner has the leverage to achieve that reduction, he has the leverage to reduce the bonuses to zero. The government owns 80 percent of AIG.

But the outrage over the AIG bonuses is a sideshow. The larger problem, both financially and politically, is the entire strategy for rescuing the banks.

It would be hard to imagine two administrations seemingly more opposite than the Bush and the Obama presidencies. Yet Geithner's approach is essentially a continuation of the failed strategy of Bush Treasury Secretary Henry Paulson, Geithner's former close colleague in Geithner's prior role as president of the New York Fed.

In defending the AIG bonuses, CEO Edward Liddy actually said that you had to pay bonuses to attract and keep "the best and brightest talent," in this case the very people who are costing America's taxpayers $175 billion and counting. Far from receiving bonuses, these people deserve to share a cell with Bernie Madoff.

By the same token, Larry Summers and Tim Geithner are not the only smart people about finance. If President Obama wants a second opinion, he could begin with Paul Volcker, nominally chairman of Obama's own "Economic Recovery Advisory Board," which so far is mainly window-dressing. According to my sources, Summers and Geithner seldom talk to Volcker because they don't like Volcker's criticisms of their plan.

The president could also consult with several people in the Federal Reserve System who have a different view, and also the FDIC leadership, and the Congressional Oversight Panel that was created by Congress as the precondition for appropriating the TARP money. The panel has the statutory right to get documents from the Treasury. But under Geithner as under Paulson before him, Treasury has been stonewalling. Legislators of both parties are increasingly viewing Geithner as part of the problem.

As the administration continues its coziness with Wall Street and the approach fails to bring zombie banks back to life, populist anger passes to both the Republicans and to media tribunes such as Lou Dobbs. This brand of populism is one part anti-Wall Street, but two parts anti-government and anti-immigrant. It has no strategic coherence as a recovery plan.

The alternative to Lou Dobbs' brand of populism is of course Franklin Roosevelt's. But something is really off when Sen. Sam Brownback, the AEI, and the Kansas City Federal Reserve Bank start sounding more like Roosevelt than Barack Obama's treasury secretary does.

Obama needs to get a second opinion, firsthand.

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

[amacd]

Even the future Republican President, Gen. Eisenhower, when he was the Supreme Allied Commander fighting the Nazi EMPIRE did not so foolishly believe in a Republican 'big tent' as to invite Nazis into negotiations about how the political economy of Europe should be arranged.

Obama is letting his concern about bipartisanship convince him to open his 'big tent' to the inexorable, implacable, ineluctable, obdurate, obstinate, remorseless, resolute, rigid, unappeasable, unbending, uncompromising, unmovable, unrelenting, and unyielding fascists sworn in blood to protect the ruling-elite 'corporate financial Empire' which controls our country behind the facade of its two-party, 'Vichy' sham of democracy.

Obama has apparently not yet learned the seminal lesson --- when you are fighting Empire for your very life, you do not compromise and let they and their dogs of war into your Commander's tent!!!

Or as Raul Julia explained to Robert Redford in the film "Havana" about why the rebels had to actually FIGHT Batista's fascist pawn regime, fronting for the US corporate and gambling EMPIRE; --- "But, they will not leave by asking NICELY".

[pathwhisperer]

Absolutely, Obama and the Dems are in danger of throwing it all away. Obama is taking ownership of this ongoing economic trainwreck. This is just insane. The barn doors of this sociopaths gone wild economy must be closed.

[research]

Off a cliff? Yes.

AIG sold risky investment insurance with ZERO RESERVE.

Econo 101 tells you that is:

Fraud.

More info on my profile.

[sandyboy]

Everyone keeps wondering why President Obama chose Geithner. I hope that stating what I think is an obvious fact does not label me anti-semitic. The majority of those in charge of our financial market are Jewish. Why? It is because they are the most intelligent? I find it hard to fathom why 2 per cent of the population control our finances. Surely there are many others who are equally intelligent. I believe they control congress as well. Is this a conspiracy theory or is this true? By the way, I saw "The Paulson Fund" run across the Bloombery screen last night. Is this Henry Paulson's new venture?

If the crew we have in charge of finance now are the "best and the brightest" most people think we are truly in trouble. Personally I do think they ARE the smartest. They have pulled off the largest scam in US history and it seems there is to be on consequences at the top(only one the poor working stiffs at the bottom.)

[Diana]

Very well said. I agree, and am completely horrified by the thought that the republicans are now--CAN now--present themselves as populists merely by opposing TARP abuses.

Obama doesn't have much time. If he fails to provide serious, sincere support to main street while holding wall street essentially accountable, the republicans and their massive propaganda machine will seize this moment for the corporations and fascism will be unavoidable.

[Mildmannered]

I agree

[paixa3]

Robert; I read your headline. You are kidding right? Bush and Obama have both been led over the cliff. It is much too late now to protect citizens taxation with representation. Your country is TOAST.

[RossalGondamer]

Strategic coherence in a truly free market is never guaranteed.

Only populism (i.e democracy) can validate such false assurance.

[Litchfield]

I gagged when I heard that Summers was going to play a pivotal role in Obama's economic planning. It was the beginning of the end of any O-shaped stars in my eyes. These two, Summers and Geithner, will sink the Obama presidency and he should get rid of them pronto. This is being stated out loud on more and more blogs and surely the "mainstream' will start picking up the picture. I never liked the looks of Geithner, but just recently I have been noticing his ears.. . . . Lucky for him this isn't still the middle ages!! LItchfield

[Cheez]

Personally I don't think you can blame lack of quality as the entire problem of Obama's treasury cabinet. The problem is quantity. Geithner and Summers are out there trying to solve this mess practically by themselves and they're simply not one man wrecking machines. If Obama is ever going to implement any of his ideas to restore solvency to the banks(I.e. Oversight of TARP money and revamping of financial sector) he's going to need a much larger staff for his treasury department (which isn't saying much considering that the only senior member of the treasury department is Geithner).

[californiadreamer]

There is more and more evidence that more will be revealed but that the powers that be don't want it to be revealed. What could it be? What do Obama's advisors know that enables them to get him to act in what does not seem to be his best interests: appearing to be more cozy with Wall Street than with Main Street. Seems to me it would have to be something very big, such as an uncontrollable collapse to the global economic system if the banks aren't allowed to clean up their mess their way which means taxpayers and homeowners take the fall, not the fat cats. So it is somehow a system based on economic blackmail that is at work here. We are supposed to allow those who wound everything up into a tight little ball to be trusted with the job of unwinding it since they wound it up in the first place and pay them bonuses as well. I hope enough people keep pushing on the door to finally force it open. I hope Obama's political advisors see how damaging it is for Obama to appear to be on the side of the rich and not on the side of the people.

[peterg76]

Obama - assuming he isn't part of the scam (and it's not obvious) - seems not have realized that it is not a private sector vs. government situation, but a combine public and private financial oligarchy against citizens. Far too many of these people really believe that helping the economy means helping only the rich and undeserving.

[conniedogs]

"(and it's not obvious)"

: )

[LuckyLeif]

AIG bonuses? Citi malfeasance? I suspect if this story gets legs, it won't matter what Obama's staff does or doesn't do. For the American public to realize tax dollars are going to fund terrorism through these bailouts is for Americans to discover they've been screwed every which way to Sunday.

http://allanerickson.wordpress.com/2009/03/10/i-didnt-know-i-was-funding-terrorism/

[consultant55]

Since the first time I heard him speak, I've been saying "get rid of Geithner"!!

I tell you, this man is Dr. Strangelove. Why on earth Obama picked him is a mystery.

Here's the deal. If by this time next year we are still floundering economically, after having spent hundreds of billions of additional dollars, Obama is finished as President. If they pump up our zombie banks (with taxpayer dollars) who take off another round of stupid, ill fated investments, Obama is finished. If they don't start indicting many of the criminals who caused this epic economic collapse, Obama is finished. Of course, if that happens, the country is finished too.

Obama-drop Geithner (Dr. Strangelove) and Larry (women can't do science) Summers. They are bad investments!

[doesnotsufferfools]

I second the motion...

[fresita]

A good chunk of the country is beginning to agree with you. Finally. Geithner has to go.

[racetoinfinity]

Three essential things that must be done, and aren't being proposed by the Administration or Congress (or anyone outside of the progressive blogs):

1) Reinstate the Glass-Steagall Act.

2) Stop the exemption for over-the-counter derivatives.

3) Rescind the Bankruptcy Bill of 2005.

[racetoinfinity]

I want to add one more:

4) Temporary "nationalization" (or call it another word) of the "too-big-to-fail" zombie banking houses.

[tdh]

While we're talking about things to do -- I want usury laws reinstated. I want it to be illegal for banks and credit card companies -- anybody -- to charge exorbitant interest rates.

[skymuffin]

I agree with you and consultant55. I don't know why Obama insisted on Geitner. Why in the world would we want someone in charge who is continuing the failed policies of Henry Paulsen?

Obama's choice of Summers is also a bad one. Good gawd, we have so many other good choices. Why is he choosing someone who is responsible for the deregulation of the financial sector?

What a great scam. These guys make money getting us into this mess and get paid to get us out of this mess. Sound familiar? It's the same modus operandi of the Bush Administration. I was hoping for better from Obama.

[QuietAmerican]

Food for thought.

I've never understood why Pres. Obama has so much confidence in Geithner.

He has frankly been underwhelming at every turn.

[Puzlfxr]

"Lifting the Tarp: Will President Obama's Economic Team Lead Him Off a Cliff?"

President Obama picked this team, it is his own cliff to - jump off of.
Don't try to blame the "team" for his failures.