Listening To The Secretary

Secretary Geithner spoke with NPR’s Adam Davidson today and the result, on the Planet Money podcast, is a helpful guide to official thinking.

The Secretary’s best line, at around the 18 minute mark is, “If you underestimate the problem; if you do too little, too late; if you don’t move aggressively enough; if you are not open and honest in trying to assess the true cost of this; then you will face a deeper long (sic) lasting crisis.” 

The contrast he draws is with those who favor a more gradual approach to banking system problems that would “stretch it out.”  After about 17 minutes (and again around 20 minutes), Secretary Geithner contrasts what he is doing with “letting the market sort it out by itself”.  

He does not even hint at the possbility that there is a government-led strategy that could faster than what he has in mind.  So could it be that he really has in mind something that will actually be bold and move fast?

I don’t think so.  He says we will “make capital available where it is necessary”.  But he also stresses, in response to Adam’s last question (after around 25 minutes), “[Nationalization] is not the right strategy for the country.”  And Secretary Geithner says clearly “that broad strategy” would do more damage than his policies.

The bottom line is that the government will support the credit system a great deal and in many innovative ways, but Treasury will try really hard to avoid FDIC-type takeovers/reprivatizations of large banks.  This is quite striking, and presumably the hope is that a big “no nationalization” rally in the price of banks’ common equity will turn the tide more generally.

But the government’s stress scenario is quite optimistic, the real economy continues to weaken, and global problems mount.  How much government capital can you put into the banking system until the lack of taxpayer upside becomes quite awkward?  And if that taxpayer upside takes the form of common stock, how do you prevent the state from effectively acquiring a controlling stake in large troubled banks?  Numerous smart people are at work on this problem, but it is probably intractable.

The underlying question is in any case much simpler.  How long can you say, “we are being bold” when in fact you are not?

37 thoughts on “Listening To The Secretary

  1. The terms of the Capital Assistance Program are interesting (and disappointing). We taxpayers get preferred stock with a 9% dividend plus warrants — good for 10 years — to purchase 20% of our investment in common shares. So if things go well, we do get quite a bit of upside.

    Unfortunately, the bank has the option to convert the preferred into common at any time. So if things go badly, we will lose our entire investment before the bondholders or other preferred shareholders lose a penny. (We do get significant voting rights in this case.)

    Our Treasury and Fed seem to be engaged in some kind of bizarre Martingale strategy: As long as you are losing, keep doubling down. Works fine if you have infinite resources, I guess…

    Apparently, the plan to fix the problem is to keep throwing money at the people and institutions who created the problem. I almost hope this is an example of regulatory capture or simple corruption, because the alternative is that this really is the best course of action, and that is truly terrifying.

  2. I have a few worries:
    1) What will the public reaction be if we end up losing hundreds of billions of dollars in order to keep these banks going? Or this plan fails? I can’t imagine anything but real government control of banks if the taxpayers are going to have to invest huge sums of money to guarantee the continuation of these banks.
    2) Do we really plan to allow these behemoths to exist? What’s the long term plan given that we’ve now explicitly acknowledged that we will support these banks if they ever become insolvent?
    3) What if the government loses credibility if this plan fails, and it becomes next to impossible to unload the assets of the banks without giving buyers a huge subsidy or selling them for nothing? Right now, no one wants to buy anything from these banks because they’re not trusted, unless they can get a great deal. What if that lack of trust gets transferred to the government?
    4) By fiddling with all the rules to make these banks appear solvent, doesn’t that make a mockery of our desire to get tough with banks going forward?
    5) What do you tell small banks you’re seizing? Tough luck? You simply weren’t big enough to cause a systemic crisis and be saved?
    6) What if the government starts easing the terms, as with AIG? Won’t that be perceived as a bait and switch?
    7) What’s the down side for these bankers if these geniuses keep losing money ? After all, they now know that can’t fail.
    8) If the government is effectively running the banks through strict supervision, what’s the great advantage conferred by private ownership? Either the government knows what its doing or it doesn’t. Having puppet managers is hardly a ringing endorsement of private management.
    9) If this plan scares the markets, what’s Plan B?

  3. If the administration was committed to putting all the insolvent banks into receivership as soon as possible, how would they go about it? Would they need to spend a few months stalling while they staffed up the auditors and inspectors? Do they need to shut down the markets for two weeks while they do it?

    Is there a need for strategic ambiguity?

  4. Transparency is turning into a magic trick, no ones numbers seem to match and the net result i am afraid, is that billions of dollars are gone forever…(starting with AIG)

    …and why is it that all anyone seems to worry about is the money going for the stimulus package–at least that money wasn’t paying off the bets of the people who brought us our current economic disaster.

    I am bewilderedandindespair.

  5. Intractable.

    I like that word. Like trying to find a mathematical solution to a problem where it has been proven (Godel) that some can never be proven true or false given any set axioms.

    This issue cannot be “solved” by giving banks money or shifting academic monetary equations around. The problem space is outside the monetary policy; it is a people problem. A problem of social dynamics.

    It is like this: we have a friendly card game and the certain players (the bankers) have a losing hand and refuse to show it. There is a large pot on the table; it’s make or break time.

    But the dealer is friends with the bankers. In fact, they trade seats often. So the dealer starts coming up with new rules and delaying tactics. Perhaps the bankers get more cards or get to trade away with the dealer their bad ones. Maybe a “do-over” or reshuffle. Not your cards of course, theirs. You get the idea.

    So they stall. But we need those very same cards to get the game going again with next hand. So we sit around, waiting. Meanwhile, no business is being conducted.

    Sure, OK, the card game analogy starts breaks down a bit compared to monetary policy.

    But the confidence part does not.

    Confidence that the rules of the game will be followed, that those who fail will suffer losses, be liquidated, so the game can move on. A fair market with fairly priced assets. Simply: that there is no cheating.

    That, in fact, is why the powers that be are getting so twisted up inside. You can see it in their expressions. They know they are trying to cheat for their friends. The kind of cheating that with a strong sudden wind of political change leads to lifetime incarceration. Or worse.

    How long can it go on? Pretty soon, the players waiting will have had enough and also will go “outside the rules” to solve the problem.

  6. In the clash of civilizations, the white christians have met their fate, in terms of utterly laughable fall of their much touted capitalist system….

  7. Treasury is setting itself up for failure. By most accounts their “worse” case scenario is bad, but nor worst by any measure. So what happens to the bank that fails this weak test and can’t raise the needed capital in the private markets in 6 months. Is treasury really going to just write them a check without putting them through the FDIC recievership process?!?! When that happens you better be prepared for a taxpayer witch hunt of treasury officials.

  8. Listening to Geithner was actually painful. He went through linguistic gymnastics to avoid even saying the N-word (“nationalizaton”) and avoided answering the tough questions about

    He promised transparency but it is not clear whether Treasury will release the results of the stress tests. I suspect we will have to reverse-engineer the results by seeing which banks get further capital injections unless they try to mask the poor health of some banks by making everyone take more TARP II money.

    Maybe Simon could explain why big banks fear bankruptcy. The Big 3 automakers are explicit about this; they explain their bankruptcy-phobia by claiming that consumers won’t buy from bankrupt companies because of worries about losing warranty protection. Geithner obviously wants to avoid being blamed for a market collapse triggered by letting another investment bank filing for Chapter 11, as Paulson was blamed for letting Lehman file for bankruptcy. And Bernanke says that bankruptcy is not a good option for the “too big to fail” (really, too big for bankruptcy). Bernanke also testified this week that there is no good mechanism for “resolution” of the failure of insolvent big banks. Do we need a new Resolution Trust Corporation to provide a bankruptcy-like solution for the largest banks, those whose failure(s) are deemed to pose “systemic risk”?

  9. Somehow my first paragraph got truncated. It should read:

    Listening to Geithner was actually painful. He went through linguistic gymnastics to avoid even saying the N-word (“nationalizaton”) and avoided answering the tough questions about whether banks are currently insolvent. One gets the feeling he really wants to say that Citi, BAC etc. ought to be taken over but if we did the entire market would collapse.

  10. Robert, I’m not sure I understand, or have ever understood, exactly why allowing these failed institutions to go into receivership will “destroy the market” and why, if it will, this is bad. If there is enough speculation and artificial inflation in the market that the bubble bursting “destroys” it, isn’t that the price of the HOLY REGANESQUE UNREGULATED FREE MARKET? Is it just that Wall Street doesn’t want to have to admit that the dirty hippies were right and we need regulation? IMHO a lost decade, even a lost generation is worth the cost if it breaks our current government by bank and economy by bank system.

  11. Hummmm—If Geithner has to do a stress test to assess a bank’s condition, evidently, he does not have enough data to take them over or take control of much of anything.

    What kind of data do we need to do some sort of nationalization and how long would it take to get all of that?

    If we do not have the appropriate evidence, then we are stuck.

    So, what can anyone do while they are collecting the data?

    Also, I get a vague feeling that Geithner and his friends are wise enough not to telegraph what options they plan to use.

    This just seems like a long process and we need an interim plan.

    Bob Spencer

  12. So Geithner isn’t going to nationalize the banks, so…we’re doomed.
    That is, the probability of an L-shaped stag-defaltion Depression as bad or worse than Japan’s in the 1990s is now a near certainty.
    Maybe I’m wrong about this, I hope so. Would anyone on this site care to re-estimate the chances of Depression?

    Ed Beaugard

  13. I suppose an argument can be made that we are suffering “irrational loss of exuberance”. Perhaps springtime will bring a new mood, and equity holders will refinance in order to invest in research, improvements, equipment replacement, etc. Trends don’t seem to indicate it, however. Interest rates and prices need to be even lower in order to be really attractive. Who has enough confidence to invest in their own ideas right now? Furthermore, can confident borrowers find confident lenders? Instead of debt, we may just have to work our way out of this.

  14. So what would happen to “the markets” if Treasury came out on Sunday (any Sunday) and said, Citi and BofA are going to be nationalized? What, exactly, is everybody afraid of? I think we, the taxpayers, are getting hosed if there’s going to be no nationalization / reprivatization strategy. But I have a 401(K) – that’s quickly diminishing – and I wonder how much I’d be hurt by whatever it is everyone seems to be afraid would happen if Treasury would nationalize one or more of the big banks. Thanks for any comments.

  15. Geithner is starting to remind me of Paul Bremer, former Viceroy of Iraq. Bremer’s idea was to hose money out the windows without making any fundamental changes, and hope for the best.

  16. AIG is the boondoggle that should guide our future policy. The taxpayer has lost a substantial, if not the entirety of the $150 billion bailout.

    Still debt is senior to taxpayer funds. Assuming AIG is bankrupt, we have just given $150B to debt. WHY? Debt must come to the table for TARP funds just like the auto bailout.

    Oh, even with an 80% equity stake, AIG management is still making the decisions. Separating the company into parts does not address the fundamental issue, but might make one division very profitable and allow management to survive this mess.

    NATIONALIZE AND LIQUIDATE AIG NOW! We are all big boys and girls, stop playing grab-ass.

  17. Geithner also did an interview on McNeil/Lehrer, and when he expressed his disappointment with bank management failures and said they have an obligation to do everything they can to restore confidence, I couldn’t help saying to the TV, “Where’d your buddy Robert Rubin go?” These folks may be too close to the industry to see the problem objectively.

    And folks in favor of nationalization may overestimate the government’s ability to manage such a big task in an orderly fashion without risking even more disruption of the system. An FDIC takeover of First Tallahassee Savings is a much easier matter. (And remember the FDIC arranged a buy-out of WaMu — it didn’t do a seizure.)

    Or are they just worried that the ideological inanities in Washington would make life too difficult for them? They have a big agenda and the stimulus fight was hard (and ridiculous) enough. Have any Republicans voiced any strong opinions on what should be done with the big banks?

  18. Our federal government continues to pour vast amounts of cash into a drain, rather than plugging the frickin’ drain.

    1.7 trillion now – counting only Tarp, AIG, and this new pledge – in direct subsidies to the financial system.

    Remember the bloody cry of murder over the 25 billion for the auto industry? Over the 15 billion for green energy jobs?

    Nationalization or not – it doesn’t really matter. Either way we absorb the losses. The only difference is that if we nationalize, we get to take out our anger on the bank leadership and perhaps alter the banking structure (I am very skeptical about this long term). But honestly, who cares?

    Either way, we are absorbing bank debt while killing homeowners and 401k holders. As more of them fall victim, we need to pour more money down the drain to make sure that the people who bought the bonds (backed by mortgages) get paid off for the bad loans they made. And we seem to be prepared to pour an infinite amount of money in.

    So this is the message we are sending: Those smart capitalists who bought the mortgage backed and insured bonds… Well, _they_ deserve to be covered. But those dumb homeowners who bought homes they couldn’t afford while Bush was touting homeownership as the surest way to the American dream? Well, they deserve what they get.

    Actions speak louder than words. 75 billion to bail out homeowners (if they can even get the banks to cooperate) and 1.7 trillion to bail out big banks and bondholders.

    This is sooo unbelievably backwards that it boggles the mind. I am stunned.

    Alternatively, you could take that same 750 billion and just hand it out to the states (in proportion to the amount of income tax generated by the states to avoid over-subsidizing low cost states), and demand they spend it in 2009 or commit it to specific projects on infrastructure, education, and renewable energy.

    Consumers see themselves being wiped out, hoard money like they could lose their jobs any day (which they might), and there’s no end in sight.

    Last September, Paulson pointed the government in a direction, and Obama is blindly marching in that same direction.

    On any less respectable blog, I would be cussing up a storm.

  19. I am not versed in market dynamics or even understand well the various tools used on Wall Street and by extension the Treasury and the FED. When Geithner’s name was mentioned as a possible Obama pick, many seemed to be of the mind that he is bright and a rare suitor for the problems facing this economy. Yet, every time I have listened to him I don’t get the sense that I can really trust his judgement. Robert, I watched him on News Hour the other night and that too was painful to watch. Secretary Geithner appeared almost to be flailing. The only time he appears certain is when asked about Nationalization. He spent nearly the whole interview saying ‘well we’re still trying to ascertain the severity’ and things akin to ‘well we still don’t know or won’t know until……’. How can you be clear on not understanding the full extent of the problem but have already taken an option off the table? When asked about possible restrictions he was unclear and didn’t seem to be really committed when pressed on protecting the country’s stake in these troubled banks. I can understand that he doesn’t want to speak without knowing some things or revealing certain aspects before the unveiling, but each time I see him I feel as though he doesn’t really know what he is doing.

    Some of it is just that he sounds too much like the rest of Wall Street. Can government really be that bad at running businesses after the businessmen have run the country into the ground. The image of Bankers asking for money from the Government while telling the Government it’s not suited to the running of banks is laughable and Secretary Geithner spouting the same pseudo wisdom is not comforting. To his credit he did tell Wall Street that they needed to help Lehman Brothers, though interestingly Lehman Brothers didn’t get any help. These are the facts as I understand them anyway. My point is, if Lehman Brothers is the litmus test for Wall Street eating its own dog food, then apparently when they’re asked to put capital up to save one of their own, failure is the preferred option. Maybe the unforeseeable requires the ability to entertain the unthinkable at least a little bit and I don’t get that from Geithner. He is clearly trying to stay in his comfort zone and that is dangerous for the country.

    Can someone tell me why “Conflict of Interest” doesn’t come up in the appointment of guys like Paulson and Geithner. Maybe they are too close to the people and companies they used to work with and for. Why is this? I know they say they want experience and so forth. Fine, there must have been some guys on Wall Street or even some of Alan Greenspan’s most vocal critics that warned of this. Maybe someone bold enough to have seen this coming and sounded the alarms has the true vision to see us through this.

  20. I think the whole “nationalization” question is imprecise. What we want to know is “Will the FDIC force and insolvent a bank with over a trillion dollars of assets into receivership?” The government’s denials about “nationalization” don’t answer that question. We already know that the Treasury has no problem with owning common stock in banks based on the so called “convertible preferred” injections proposed by Secretary Geithner and the negotiations with Citigroup.

    Adam Davidson had a good question about which group loses. Either the banks shareholders, bondholders, or taxpayers have to absorb the write downs in an insolvent bank’s assets. Secretary Geithner said he was acting in the taxpayers’ interests, but he did not make a convincing case for how he would prevent taxpayers from absorbing all the losses instead of insolvent bank’s shareholders or unsecured creditors.

  21. I think I got an answer to my question (see above)over at RGE monitor in Matthew Richardson’s “Case for and Against Bank Nationalization”. He mentions systemic risk in the context of Lehman Brothers. I sort of get what he’s saying…if anyone here would like to bring it down to layperson’s language, though, I’d appreciate it.

  22. Michael,

    Conflict of interest!

    The only way to show that a conflict of interest was acted upon is if someone somehow accomplishes one of two things:

    1) Gettting the list (which is not avail. now) of who got every penny of the 185Billion that went in the front door and out the back of AIG. Surely, whoever accomplishes this needs to be aware that affiliations need to be carefully considered. If money went to Goldman or Morgan or both, then this looks like a conflict of interest.

    2) the other way to do it is to demand a retroactive accounting for all banks and now bank holding comppanies as of Sept. 14, 2008 so that it could be clear who benefited from Lehman failing and the subsequent payment of bets through AIG via we the people.

    Morgan and Goldman became bank holding companies shortly after Lehman went down just in time for TARAP 1. America has been brainwashed into being members of the American GROUPTHINKTHINKTANK that requires all members to believe that the there was no way to save Lehman , but the world would come to an end if we didnt immediately give AIG 85 Billion dollars (now up to 185B, and yesterday AIG needs another 60 BILLION). Still the GROUPTHINKTHINKTANK mantra somehow is requiring all of us to believe we don’t need to worry about it because if we hadn’t done that the world would have ended already.

    There aren’t any investigative reporters even pushing the point. Only press releases that only 5 million net was spent on settling lehman CDS’s. But, whether it is Lehman or other CDS’s shouldn’t the public know which companies directly survived as a result of the free government money that flowed through AIG?

    Shoulds and oughts as far as this subject is concerned, seem to be fantasy land.

  23. Did anyone see the article, “CIA Adds Economy to Threat Update” here is the link:

    With all the BILLIONS of dollars that seem to have gone to pay off the PLAYERS in the game that have given us this CRISIS, it seems to me that this is a threat to our national security…why doesn’t anyone but the folks making comments on this blog seem to understand this. Who can put the puzzle together to JOG the public out of the complacency that the stimulus spending is NOT the critical issue, it is that the US government has already been robbed and the doors to the US coffers are still open for the robbers to take all they want?

  24. A quick question regarding nationalization. Presumably, shareholders (other banks, potentially) loose everything. Perhaps not a huge problem given the small market cap. The question pertains to bond holders; they stand to loose something between a haircut and being wiped out. But is it unfair to presume that there are outstanding CDS covering the bond holders that were issued by other banks? Would nationalization of a few cascade into the insolvency of potentially many others?

    Any opinions most welcome.

  25. Why not use the threat of RICO?

    Officials of the adminsitration pursuing the erroneous policy should be reminded of RICO.

    Summers, Geithner, Geithner’s chief assistant (from Goldman-Sachs) and other advisers of Obama are simultaneously judges, jury, instigators, and perpetrators of the present crisis. It is a nightmare.
    The Racketeer Influenced and Corrupt Organizations Act covers several of the activities that seem in plain sight. People can be convicted under RICO, not for specific acts, but for a pattern of behavior. There are 35 of those patterns. One of them is bankruptcy. Another is securities fraud. Others are obstruction of justice, money laundering, theft, fraud…

    Patrice Ayme

  26. Thought experiment:

    Suppose the administration *did* have a bold plan.

    Suppose it planned to nationalize insolvent banks, wipe out the equity, haircut unsecured creditors, remove toxic assets, and re-privatize.

    Do you think they would say it just yet? Consider what would happen.

    If they announced this plan *without* identifying the offending institutions, credit and equity markets would freak out, wholesale funding from all banks would get yanked, and general chaos would ensue.

    So, if you’re Geithner, you need to do it in one fell swoop. So, first and foremost, you need to identify who’s on the “kill” list. Until you’ve done this, you have to keep a poker face. You have to just be vague and make reassuring noises to the markets.

    Then, when you finish the stress test and have your kill list, you let the axe fall on all of them at once. You can stop the head fakes. They’re wiped out.

    Shareholders and creditors of institutions not on the kill list are actually reassured: they got the implicit seal of approval!

    What you can’t have is a period of uncertainty and panic.

    All I’m saying is that if the Administration were planning bold action, we shouldn’t expect to know. In fact, we should expect them to be doing just about exactly what they’re doing.

    This would also explain a few of the puzzling developments: the weirdly half-baked Capital Assistance Program (it’s not the real plan!); Citi’s odd desire to convert preferred to TCE (maybe they caught wind of what’s coming and hope to make themselves solvent on a TCE basis); and above all, the stress tests.

    I’m just saying. Maybe we should give the Administration more credit. Maybe they’re doing the right thing.

  27. One major issue on bank balance sheets is not being discussed, and may be why we may be avoiding the “N” word….the word is derivatives. Citicorp, as an example, has merely $36 trillion of notional exposure (Sep 30, 08 10-Q, page 43). While much of this exposure is interest rate, $1.8T is equity and $3.6T is credit.


  28. Simon:

    Is is possible that what is really overlooked about Geithner is his long, long time with the Federal Reserve? I mean, it’s obvious that the Federal Reserve and those who plan with the Federal Reserve have an agenda which isn’t in sync with the priorities of the American people. Perhaps someone should do a follow up to this post that explores the collaborations between Federal Reserve heads and their European counterparts and how the American banking system is being made more to look like what has been put in place by the EU in most European countries over the past 12 years.

  29. Sophie:

    Thanks. I was speaking of Conflict of Interest in the sense that typically judges and politicians used to have to reveal personal associations and recuse themselves in dealing with things involving those associations. A few years ago I think 2 Supreme Court Justices recused themselves from hearing a case involving the death penalty because they knew the father of the victim many years previous. My curiosity is why COI doesn’t come up when Haliburton was getting no bid contracts and Cheney was a former employee and more to point in yesterdays post; we have all these ex Wall Streeters as part of the administration and so forth. Ordinarily COI might not be as strong a consideration, but when the discussion turns to bailing out companies that these people used to work for and with, shouldn’t we NEED to consider the possibility at least. Paulson for instance came from Goldman Sachs having lobbied strongly against the “Net Capital Rule” and voluntary regulation in addition to any efforts to assess future risk to Wall Street investment houses. Should we really have been surprised when this guy hands Wall Street money with virtually no strings attached in the form of the initial bailout. Where finance is concerned there is clearly the academic/political track and then there is Wall Street but they share the same schools and golf courses. It is a small world and as much as Nationalization should be a part of the discussion potential Conflicts of Interest should also be on the table.

  30. I have a question which I wish someone would address. It is clear what ought to be done. It is also clear the Geitner and Obama are not going to do it. So, why not? I would like to know if it is possible that the big banks, BOA, Citi, Chase which hold the bulk of credit card debt are essentially threatening to shut credit cards down, limit credit that already out there, no more added in. Debt is 915 billion now, but cutting credit usage would have a rapid and serious defltionary effect. Is this one possible reason for the continued policies?

  31. “Do they need to shut down the markets for two weeks while they do it?”

    Now, there’s a thought. And one with a precedent. That just might not be the wrong thing to do. It bears some consideration. It wouldn’t be the worst way to go about it, while they stress test and do what they have to do, before re-opening the solvent ones.

    But if wimpiness is the order of the day, will it make a difference?

  32. Mr. Geithner’s tight rope is pretty simple: back the depositors or back the shareholders. The shareholders, myself one, have already bought bank stocks in companies we thought were run by banking people but turned out to have been run by bankers who had gone temporarily insane and turned into gamblers. That money is long gone. The people who made deposits into these gamblers’ banks need to be protected. I invested in bank stocks and I lost. Period. But Geithner needs to stop pussyfooting around, tell it like it is, send the gamblers home, and back the depositors. When given a choice, I try to come down on the side of reality.

  33. A better analogy would be the following. Let’s say you own a house and you are renting and earning a 6% return from your renter. Now let’s say that housing prices drop 10% in your area and there are some foreclosures, some distressed sales,etc on your street. You have a mortgage on the property and it’s being paid off by your renter and you are making a profit. Because a house down the street sold for 20% less due to a desperate seller the bank comes to you and says…hey, your house is worth 20% less. You need to come up with an extra 20% equity or we will take your house.

    This issue is similar to what the banks are facing with mark to market. If the loan is current (the renter is paying the rent in our above example) why should you have to write down the value of the asset. The loss should only be taken the momemnt the loan goes into default.

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