SNL Nails "Stress" Tests

When it comes to the stress tests, I think SNL's Tim Geithner might have been a tougher negotiator than the real Tim Geithner.

Geithner Is Wall Street's Guy

Should we bring back the Geithner Death Watch? This New York Times profile in regulatory capture certainly sets up the it-was-Geithner's-fault narrative if the economy dramatically worsens. Some of the highlights from the article, with between the lines translations:

Last June, with a financial hurricane gathering force, Treasury Secretary Henry M. Paulson Jr. convened the nation’s economic stewards for a brainstorming session. What emergency powers might the government want at its disposal to confront the crisis? he asked.

Timothy F. Geithner, who as president of the New York Federal Reserve Bank oversaw many of the nation’s most powerful financial institutions, stunned the group with the audacity of his answer. He proposed asking Congress to give the president broad power to guarantee all the debt in the banking system, according to two participants, including Michele Davis, then an assistant Treasury secretary.

The proposal quickly died amid protests that it was politically untenable because it could put taxpayers on the hook for trillions of dollars.
“People thought, ‘Wow, that’s kind of out there,’ ” said John C. Dugan, the comptroller of the currency, who heard about the idea afterward.

Translation: Geithner wanted to put taxpayers on the hook for all the mistakes bankers, their counterparties, and their bondholders made, with no real upside for the public. Is a more bank-friendly proposal possible? Back to the piece:

Mr. Geithner was particularly close to executives of Citigroup, the largest bank under his supervision. Robert E. Rubin, a senior Citi executive and a former Treasury secretary, was Mr. Geithner’s mentor from his years in the Clinton administration, and the two kept in close touch in New York.

Mr. Geithner met frequently with Sanford I. Weill, one of Citi’s largest individual shareholders and its former chairman, serving on the board of a charity Mr. Weill led. As the bank was entering a financial tailspin, Mr. Weill approached Mr. Geithner about taking over as Citi’s chief executive.
But for all his ties to Citi, Mr. Geithner repeatedly missed or overlooked signs that the bank — along with the rest of the financial system — was falling apart. When he did spot trouble, analysts say, his responses were too measured, or too late.

Translation: Despite being so close to Citi officials that they wanted him as CEO, he was clueless as to how much trouble there were in. This is a nice double whammy: show that Geithner was close - too close - to the bankers he was supposed to be supervising, and then that he was ineffective at supervising them. Was he unaware because his closeness compromised his judgment, or simply because he was not good at his job? Back to the article:

To Joseph E. Stiglitz, a Nobel-winning economist at Columbia and a critic of the bailout, Mr. Geithner’s actions suggest that he came to share Wall Street’s regulatory philosophy and world view.
“I don’t think that Tim Geithner was motivated by anything other than concern to get the financial system working again,” Mr. Stiglitz said. “But I think that mindsets can be shaped by people you associate with, and you come to think that what’s good for Wall Street is good for America.”

Translation: Geithner is a textbook example of regulatory capture. Back to the article:

In a May 15, 2007, speech to the Federal Reserve Bank of Atlanta, Mr. Geithner praised the strength of the nation’s top financial institutions, saying that innovations like derivatives had “improved the capacity to measure and manage risk” and declaring that “the larger global financial institutions are generally stronger in terms of capital relative to risk.”

Two days later, interviews and records show, he lobbied behind the scenes for a plan that a government study said could lead banks to reduce the amount of capital they kept on hand.

While waiting for a breakfast meeting with Mr. Weill at the Four Seasons Hotel in Manhattan, Mr. Geithner phoned Mr. Dugan, the comptroller of the currency, according to both men’s calendars. Both Citigroup and JPMorgan Chase were pushing for the new standards, which they said would make them more competitive. Records show that earlier that week, Mr. Geithner had discussed the issue with JPMorgan’s chief, Mr. Dimon.

At the Federal Deposit Insurance Corporation, which insures bank deposits, the chairwoman, Sheila C. Bair, argued that the new standards were tantamount to letting the banks set their own capital levels. Taxpayers, she warned, could be left “holding the bag” in a downturn. But Mr. Geithner believed that the standards would make the banks more sensitive to risk, Mr. Dugan recalled. The standards were adopted but have yet to go into effect.

Translation: Geithner is a fool - perhaps what Rubin would call a useful idiot - who shilled for the bankers. While Geithner was hardly alone in believing that derivatives helped manage risk by spreading it to those most able to bear it, pointing out that he still trumpeted their virtures in 2007 makes him look rather clueless. And if Geithner really believed that lowering bank capital levels would make them more cautious and sensitive to risk, rather than simply more vulnerable to any downturn, then I have a Nigerian friend for him who can help him score big if he'll just send a check. Back to the piece:

In making the Bear deal, the New York Fed agreed to accept Bear’s own calculation of the value of assets acquired with taxpayer money, even though those values were almost certain to decline as the economy deteriorated. Although Fed officials argue that they can hold onto those assets until they increase in value, to date taxpayers have lost $3.4 billion. Even these losses are probably understated, given how the Federal Reserve priced the holdings, said Janet Tavakoli, president of Tavakoli Structured Finance, a consulting firm in Chicago. “You can assume that it has used magical thinking in valuing these assets,” she said.

Translation: This paragraph doesn't even require any between the lines reading; it explicitly says that Geithner accepted Bear Stearns' fake values for assets, with the taxpayers making up the difference. Back to the article:

Over Columbus Day weekend last fall, with the market gripped by fear and banks refusing to lend to one another, a somber group gathered in an ornate conference room across from Mr. Paulson’s office at the Treasury.

Mr. Paulson, Mr. Bernanke, Ms. Bair and others listened as Mr. Geithner made his pitch, according to four participants. Mr. Geithner, in the words of one participant, was “hell bent” on a plan to use the Federal Deposit Insurance Corporation to guarantee debt issued by bank holding companies.
It was a variation on Mr. Geithner’s once-unthinkable plan to have the government guarantee all bank debt.

The idea of putting the government behind debt issued by banking and investment companies was a momentous shift, an assistant Treasury secretary, David G. Nason, argued. Mr. Geithner wanted to give the banks the guarantee free, saying in a recent interview that he felt that charging them would be “counterproductive.” But Ms. Bair worried that her agency — and ultimately taxpayers — would be left vulnerable in the event of a default.

Mr. Geithner’s program was enacted and to date has guaranteed $340 billion in loans to banks. But Ms. Bair prevailed on taking fees for the guarantees, and the government so far has collected $7 billion.

Translation: The vast guarantees of bank debts were Geithner's brainchild. Time and again, the article poses Sheila Bair and the FDIC as unsuccessfully trying to thwart Geithner's plans, worrying that they put the taxpayers at too much risk. It's certainly not good for his image that Geithner is repeatedly depicted as standing up for the banks' interests, while other government officials, usually from the FDIC, stand up for the taxpayers (although this does seem to be a fairly accurate description). Might the unnamed "others" in the room have been FDIC officials with an axe to grind, hoping to make their boss Bair look better? Back to the article:

Mr. Geithner has also faced scrutiny over how well taxpayers were served by his handling of another aspect of the bailout: three no-bid contracts the New York Fed awarded to BlackRock, a money management firm, to oversee troubled assets acquired by the bank.

BlackRock was well known to the Fed. Mr. Geithner socialized with Ralph L. Schlosstein, who founded the company and remains a large shareholder, and has dined at his Manhattan home. Peter R. Fisher, who was a senior official at the New York Fed until 2001, is a managing director at BlackRock....

For months, New York Fed officials declined to make public details of the contract, which has become a flash point with some lawmakers who say the Fed’s handling of the bailout is too secretive. New York Fed officials initially said in interviews that they could not disclose the fees because they had agreed with BlackRock to keep them confidential in exchange for a discount.

The contract terms they subsequently disclosed to The New York Times show that the contract is worth at least $71.3 million over three years. While that rate is largely in keeping with comparable fees for such services, analysts say it is hardly discounted.

Translation: Geithner gave lucrative contracts to close acquaintances. Even if this is not a case of clear cut corruption, there is an appearance of impropriety.

The obvious question this article raises is why publish it now? The populist fervor over the AIG bonuses has died down, and the market rebound over the last six weeks has quieted other (read: CNBC and their ilk) critics. Several possibilities jump out:

• FDIC officials are wary of being implicated in the PPIP scheme, and want to separate themselves from Geithner.
• Officials are worried not enough banks are willing to participate in the PPIP since the prices the leverage the government will provide will not be enough to prevent banks from taking large losses, so they want to lay the groundwork for blaming Geithner.
• Administration officials are jockeying for Geithner's job (yes, that means you Larry), and are setting him up as the fall guy once it becomes clear the green shoots are just a blip on our downward trajectory.
• The politicos like Rahm and Axelrod - who already distanced themselves from Geithner when he rolled out the PPIP - are positioning themselves to take a much tougher line on the banks, and need to scapegoat Geithner first (though is it really scapegoating if the blame is justified?). The fact that the article quotes several liberal critics of the bailouts - Stiglitz, Buiter, and Roubini - suggests that their ideas are gaining currency with whoever pushed this story. This would be a very positive development.
  

We can only hope that Geithner is feeling the heat within the administration and that Obama will reconsider whether he wants to tie himself to these unpopular bailouts Geithner has championed. Now if we could just someone besides Summer or Rattner to become Treasury Secretary, we might avoid a lost decade. Would Roubini give up his hard partying ways to take the job?

Rattner Probe

Is anyone in the administration working on the bailouts clean? The latest revelation that car czar Steve Rattner is being investigated for his potential role in a kickback scheme with the New York state pension fund does little to contradict the perception that political and financial insiders play by a different set of rules, and have gamed the system at the public's expense. From the WSJ:

A Securities and Exchange Commission complaint says a "senior executive" of Mr. Rattner's investment firm met in 2004 with a politically connected consultant about a finder's fee. Later, the complaint says, the firm received an investment from the state pension fund and paid $1.1 million in fees.

The "senior executive," not named in the complaint, is Mr. Rattner, according to the person familiar with the matter. He is co-founder of the investment firm, Quadrangle Group, which he left to join the Treasury Department to oversee the auto task force earlier this year....

In the long-running pay-to-play case, authorities allege that about 20 investment firms made payments in exchange for investments from the $122 billion New York State Common Retirement Fund....

The main legal issue for the investment firms turns on whether they knew, or should have known, that fees they paid to certain entities for access to the New York fund were legitimate or were improper kickbacks, and whether they were properly disclosed, according to people familiar with the matter.

Even if there was no wrongdoing, this appearance of impropriety and insider dealing is horrible press. Nothing galvanizes populist rage like financial and political elites playing the system for themselves. I guess this will take Rattner out of the running as potential Treasury Secretary-in-waiting, should Geithner ultimately "decide to spend more time with his family."

Relaxation Tests

About those "stress" tests...turns out they're not so stressful. From the New York Times:

Regulators say all 19 banks undergoing the exams will pass them. Indeed, they say this is a test that a bank simply will not fail: if the examiners determine that a bank needs “exceptional assistance,” the government, that is, taxpayers, will provide it.

This is beyond farcical. If banks cannot fail the stress test by definition, then it is not a stress test. The notion that banks can both require "exceptional assistance" and "pass" their stress test is so absurd that it boggles the mind that anyone will fall for this. But, of course, some investors and talking heads (read: CNBC) will go bonkers when they see the headlines that the banks all passed, and they will pour into financials. Eventually, once writedowns continue to exceed puffed up earnings, even the slowest investors will realize that the banks are a bad bet. At that point, it will become apparent what an enormous waste of time this entire stress test exercise has been.

The saddest part is that the stress tests could have been the first step in a viable banking rescue. If Geithner had honestly assessed the banks' books and put hopelessly insolvent banks into receivership, there would be justified public confidence in the remaining banks. This is what FDR's banking holiday accomplished during the Great Depression. Unfortunately, Geithner seems to think that the minimal appearance of transparency and accountability is a good substitute for actual transparency and accountability. He is badly mistaken.

Pretending insolvent banks are healthy, pouring endless subsidies into them to prop zombie institutions up - it's all so Japanese. Weren't we supposed to have learned from their lost decade? And with each dollar siphoned off to Wall Street, Obama is throwing his presidency away...Maybe Obama and his political advisers will wake up and realize that flirting with economic stagnation is not a path to electoral success. We can only hope that they finally admit what an unmitigated disaster Geithner has been, and undo this mistake.

Half of US Banks Bust?

Count Andy Beal among those skeptical about Geithner's PPIP. According to Beal

He says Treasury Secretary Timothy Geithner's new plan to guarantee loans to buyers of toxic assets won't lead to many sales because the problem isn't liquidity but price. They are not low enough. Half the country's banks--4,000 in all--would be bust, he says, if they marked their loans to what the loans would fetch in an auction. He says banks are fooling themselves by refusing to mark busted assets down.

"Banks are on a prayer mission that somehow prices will come back and they won't have to face reality," Beal says. And that reality, according to Beal, is going to get a lot worse. "Unemployment is going over 10%, commercial real estate hasn't even begun collapsing and corporate credit defaults are just getting started," he says. His prediction: depression, without bread lines this time, thanks to the government safety net, but with equal cost to society.

Whose judgment do you trust on whether this is a crisis of solvency or liquidity: a banker who noticed all the bad loans being made as this crisis developed, or a regulator who failed to diagnose the problem?

A Modest Proposal: Jim Baker to Treasury

If Paul Volcker can serve as an economic advisor at the ripe old age of 81, then Jim Baker should be more than spry enough to reprise his role as Treasury Secretary for a year. At this point, it only seems like a matter of time before Tim Geithner gets canned/decides to spend more time with his family. Geithner's stunning inability or unwillingness to use the government's leverage over AIG to prevent them from paying out absurd bonuses is the final straw. The larger issue is his failure to come up with a bank rescue plan that doesn't amount to a giveaway to the bankers. Apparently, nationalization is too unthinkable or scary (picking on Geithner is like hitting a ball off a tee, but Harold Meyerson hits one out of the park with his latest column).

To his credit, Baker recognizes that we face a crisis of solvency, not of liquidity. He has called for FDIC-style receivership of insolvent banks, so that they can be closed and sold back to private investors. This would admitedly be a difficult process, fraught with risk, but it is much, much better than the alternative of creating zombie banks. If anyone can pull this off well, it is Baker; throughout his career he has demonstrated a knack for simply getting things done. He is a doer. Most appealingly, he is a Republican - and one with close ties to Reagan to boot. If he were to be in charge of temporarily nationalizing the banks, it would insulate Obama from any political heat Republicans might gin up about him being a "socialist" for taking over the banks. This would be a political and policy coup. What are the odds of it actually happening?

Buffet Hints at Geithner's Plan

During a marathon interview on CNBC this morning, Warren Buffet had a surprisingly upbeat take on the banks.

Buffet claimed that banking has never been more lucrative than it is now do to historically low interest rates and wide bond spreads. While he admitted some of the worst capitalized banks will likely not make it through this crisis, Buffet did say he expected most banks to earn their way out of the holes they are in.

And this is essentially the Geithner plan: give banks enough capital to keep them alive, and hope that they can earn their way back to health. Of course as a major shareholder in Wells Fargo, Buffet favors letting the, according to its own fair-value accounting, insolvent bank try to rebound. But why is Geithner apparently so willing to just cross his fingers and hope for the best? The politics would certainly be easier if the banks did not require massive injections of capital, but instead just needed enough to tide them over till they returned to profitability. But what about banks' increasingly toxic balance sheets makes this likely? Even if banks return to robust earnings, a whole host of mortgages, commercial real estate loans, auto loans, student loans, and credit card loans made at the peak of the bubble that have yet to go bust threaten to overwhelm any new revenue streams, and send banks further into insolvency. This seems like a repeat of Japan.