TheCenterLane.com

February 16, 2009

On Tuesday, February 10, our newly-appointed Treasury Secretary, “Turbo” Tim Geithner, rolled out a vague description of his new “Financial Stability Plan”.  Most commentators were shocked at the lack of information Geithner provided about this proposal.

This was in stark contrast with President Obama’s description of what we would hear from Geithner, as the President explained during his February 9 press conference.  In response to a question by Jennifer Loven of the Associated Press, concerning his earlier statements about the worsening recession, Obama stated:

And so tomorrow my Treasury Secretary, Tim Geithner, will be announcing some very clear and specific plans for how we are going to start loosening up credit once again.

Later in the conference, Julianna Goldman of Bloomberg News asked the President how he could expect the remaining $350 billion in available in TARP funds to solve the problems with the financial system when individuals, such as economist Nouriel Roubini, have explained that the price tag for such a fix could exceed a trillion dollars.  Again, the President explained:

We also have to deal with the housing issue in a clear and consistent way.  I don’t want to preempt my Secretary of the Treasury; he’s going to be laying out these principles in great detail tomorrow.

Yet again, in response to a question from Helene Cooper of The New York Times as to whether financial institutions receiving federal bailout money would be required to resume lending again, the President responded:

Again, Helene — and I’m trying to avoid preempting my Secretary of the Treasury, I want all of you to show up at his press conference as well; he’s going to be terrific.

Despite this hype, the following day’s presentation by Tim Geithner offered neither “clear and specific plans” nor “great detail” about the principles involved.  Nearly all of the editorials dealing with this strange event voiced a negative appraisal of Geithner’s discourse, particularly due to the complete absence of any discussion of specific measures to be employed by the Department of the Treasury.  Did something change between Monday night and Tuesday’s event?  Recent developments suggest that disagreements over the details of this plan, particularly those related to the possible “nationalization” of insolvent banks, forced the entire project into a state of flux.

Prior to last Tuesday’s fiasco, Geithner admitted to David Brooks of The New York Times that he was averse to the idea of nationalizing insolvent banks, even on a temporary basis:

Therefore, Geithner argues, the government doesn’t need to go in and nationalize the banks.  “It’s very important that we don’t look like there’s any intent of taking over or managing banks.  Governments are terrible managers of bad assets.  There’s no good history of governments doing that well.”

Geithner’s throwaway argument was disputed by Joe Nocera in the February 13 New York Times:

But that’s a canard.  The government did a terrific job managing banks during the savings and loan crisis of the 1980s.  It took over banks — “we called them bridge banks,” recalled William Seidman, the former chairman of the Federal Deposit Insurance Corporation, with a chuckle — replaced their top managers and directors, stripped out bad assets that the government then managed brilliantly, and sold the newly healthy banks to private buyers.  It turned out not to be all that hard to find actual bankers who could run these S.& L.’s for the federal government.

Geithner’s resistance to nationalization of insolvent banks represents a stark departure from the recommendations of many economists.  While attending the World Economic Forum in Davos, Switzerland last month, Dr. Nouriel Roubini explained (during an interview on CNBC) that the cost of purchasing the toxic assets from banks will never be recouped by selling them in the open market:

At which price do you buy the assets?  If you buy them at a high price, you are having a huge fiscal cost.  If you buy them at the right market price, the banks are insolvent and you have to take them over.   So I think it’s a bad idea.   It’s another form of moral hazard and putting on the taxpayers, the cost of the bailout of the financial system.

Dr. Roubini’s solution is to face up to the reality that the banks are insolvent and “do what Sweden did”:  take over the banks, clean them up by selling off the bad assets and sell them back to the private sector.  On February 15, Dr. Roubini repeated this theme in a Washington Post article he co-wrote with fellow New York University economics professor, Matthew Richardson.

Even after Geithner’s disastrous press conference, President Obama voiced a negative reaction to the Swedish approach during an interview with Terry Moran of ABC News:

Sweden, on the other hand, had a problem like this.  They took over the banks, nationalized them, got rid of the bad assets, resold the banks and, a couple years later, they were going again.  So you’d think looking at it, Sweden looks like a good model.  Here’s the problem; Sweden had like five banks.  [LAUGHS] We’ve got thousands of banks.  You know, the scale of the U.S. economy and the capital markets are so vast and the problems in terms of managing and overseeing anything of that scale,  I think, would — our assessment was that it wouldn’t make sense.  And we also have different traditions in this country.

Obviously, Sweden has a different set of cultures in terms of how the government relates to markets and America’s different.  And we want to retain a strong sense of that private capital fulfilling the core — core investment needs of this country.

Obama’s strident resistance to the Swedish approach could force him into an embarrassing situation, in the event that he changes his view of that strategy.  This may happen once Geithner begins applying his “stress tests” this week, to measure the solvency of individual banks.  On the ABC News program “This Week”, Republican Senator Lindsey Graham of South Carolina expressed his opinion that the option of nationalizing these unhealthy banks should remain open:

GRAHAM:  Yes, this idea of nationalizing banks is not comfortable, but I think we have gotten so many toxic assets spread throughout the banking and financial community throughout the world that we’re going to have to do something that no one ever envisioned a year ago, no one likes, but, to me, banking and housing are the root cause of this problem.  And I’m very much afraid that any program to salvage the bank is going to require the government…

STEPHANOPOULOS:  So what would you do now?

GRAHAM:  I — I would not take off the idea of nationalizing the banks.

President Obama and Turbo Tim need to keep similarly open minds about the nationalization option.  They wouldn’t want to be on the wrong side of the “moral hazard” argument, forcing taxpayers to eat the losses risked by investors — especially with a prominent Republican wagging his finger at them.  This situation calls for only one response by the new administration:  Blink.