Geithner

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Geithner’s Poor Legacy

It’s my turn to comment on Tim Geithner’s unfortunate legacy at the Treasury Department.

I think that, by and large, that legacy has to be seen through the lens of Wall Street. He was an ally of Wall Street, he bent over backwards to help Wall Street, and will forever be associated with an overly cordial relationship with Wall Street bankers and sympathy for their self-inflicted plight.

The record is unequivocal: Geithner, whenever called upon to choose, chose to back Wall Street’s interests over those of the public at large. In this he simply follows in the footsteps of other Treasury Secretaries – Rubin and Paulson come to mind – who made the tragic mistake of conflating Wall Street and Main Street as if the two shared common cause.

Geithner is a limited person who, having been brought up in the Reagan era, sees nothing wrong with the stranglehold big finance has on the economy. Big gigantic banks betting on both sides of the street, propped up by taxpayer subsidies, and with ineffective, duplicative, and outdated oversight are, in his eyes, perfectly fine.  They represent no threat to our economy. They simply need a periodic tweak, a tad more capital, and a little nudge now and again and they will steer their rivers of cash towards socially beneficial ends.

In all this Geithner is the living epitome of the group thinks that grips our elite whenever it tries to confront the perpetual problems that our big banks create. The first order of the day in this group think is always to save the banks. The hope being that by so doing we will stop them destroying the economy. But, banking being the unstable art it is, banks will forever cause us difficulties. The trick is to mitigate those difficulties and to limit the banks in every way possible. Unfortunately during the Reagan/Clinton/Bush era public policy threw caution to the wind and let the banks do whatever they wanted. The culmination of this was, of course, the epic crisis of 2007/2008 from which we mere non-bankers are still struggling to recover.

The banks?

They recovered.

They recovered and then some.

In our panic over their panic we made several key errors the consequences of which still rumble around. We suspended all judgement over the massive mergers rushed through ostensibly to ‘save’ Wall Street. We didn’t address the key issue of bank size. We still subsidize them. And we lent them massive amounts of short term cash at ridiculous rates to prop them up. Yes we got all that money back, but it was hardly a profitable exercise. The only thing we didn’t get returned to us was the enormous silk bow tied around the wads of cash as it was trucked over to Wall Street.

Now, it’s one thing to criticize, it’s another to offer an alternative.

So I want to remind you of what I was arguing at the time.

Here are the key steps to bear in mind:

  • Banking is a volatile sport. It deals with the fundamental uncertainty of the economy. It isn’t just about risk, it is about uncertainty. Those two are very different things as we have all known for a long time.
  • Banks create and destroy money. They do this every time they lend and are repaid.
  • Our banking system is very highly concentrated with a few behemoths accounting for the lion’s share of loans, deposits, and the operation of our payment system.
  • That latter part – the payment system – is a public good, not a private asset.
  • Bank’s rely on judgements about their profits and about the value of their assets. This is more art than science and is subject to fads or waves of emotion.
  • These waves drive banks herd-like to tighten or loosen credit at the wrong times for the economy. They loosen when the economy is good and can self-finance; they tighten when the economy is bad and needs credit.
  • So banks make our economic highs higher, and our economic lows lower.
  • This is why they need to be restrained and monitored closely.
  • But our banks were let off the hook. First by Reagan; then by Clinton. The restrictions were removed and we relied on so-called market forces to act as a brake on bank activity.
  • But those market forces do not work as advertised; are weak at best; and reinforce rather than counteract banking trends.
  • Further, modern business management is often at odds with business shareholder interests – there is a disconnect in the agency relationship that market theory likes to see as the source of enforcement.
  • This disconnect comes in the form of management’s ability to control both the amount and source of incentives – aka bonuses – which often drive performance away from shareholder interests.
  • Add in the fact that modern shareholders tend to be institutions – e.g retirement funds – reluctant to enforce action on bank management, and market forces break down completely.

The financial crisis erupted after we gave up the regulations that restricted banking in the wake of the Great Depression. Those regulations worked well and limited, but did not eradicate, banking problems which will recur because of the factors I listed above.

Where does Geithner fit in all this?

He left Wall Street untouched, and therefore he left us vulnerable to another major crisis. This is his legacy. He failed to deploy more draconian measures – he opposed nationalization of failing banks on ideological rather than practical grounds. He failed to advocate smaller banks. He was not innovative. He obstructed policies that might hinder bank profit making. And he remains steeped in the Wall Street – Treasury nexus that has dogged us for decades.

One last point: I used the hated “n” word back there.

Nationalization is a perfectly legitimate tactic to enforce government policy on lazy shareholders and self-interested and incompetent managers. If shareholders and creditors won’t evict rotten managers then taxpayers have the right to. After all taxpayer subsidies lower the cost of funds for our major banks and allows them to fatten their profits. This constant giveaway entitles us to clean house every so often whenever those banks spill their stupidity onto us all. Nationalization need not be permanent, but merely long enough to clean out the toxic cause of our problems and then to send a then healthy bank back into private hands.

The key to keep in your memory is that our banks are not very well run, and banking is always – always – unstable. So problems will recur every so often. That means we have a right to intervene to protect ourselves. That intervention ought to cause the banks major discomfort, and ought to end the careers and bonus gravy train for bank managers. Geithner didn’t grasp this. Indeed, he disagreed with it. By protecting the banks he protected both lazy shareholders and rotten management teams.

His legacy is thus mediocre at best.

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Fact Based Thoughts

For all you worriers out there, and I know there’s quite a few, calm down. It helps to keep the facts in front of you and push those more vivid opinions to one side.

Take, for example, our debt. If you listen only to the opinions, you’d think we lived in a version of the Weimar Republic replete with wheelbarrows needed to move around the useless hyper-inflated currency that we all now own. Or, as Speaker John Boehner in Washington, and Governor Walker of Wisconsin put it: “we are broke”. Really? I wonder why the rates on US bonds are going down? Could it be that those hard headed folks out there who buy and sell our debt, and who stand to lose their shirts if they are wrong, don’t see something that Boehner and Walker do?

No it isn’t possible.

The fact is that the cost of US debt is going down at the moment because world uncertainty is driving investors towards US bonds. The rise in demand for our paper is driving down rates. No one, except for some rabid Republicans with an axe to grind, thinks we face an imminent debt crisis. No one.

Our debt problem is strictly a medium term issue and is caused by the deliberate reduction in government revenues resulting from the infamous Bush tax cuts that are now so hard to undo, and from our awful health care system that is on a trajectory to destroy us whether it is publicly or privately financed. The current crisis is cyclical and so any addition to our debt stemming from it will be contained as we start to grow again. Which is why getting people back to work, and thus paying taxes again, is so important. There is no advantage in getting corporate profits pumped up: big business avoids taxes like the plague. We need honest tax paying citizens back at work. Then our deficit will start to drop.

Muddling the two problems, short term and medium term, will inevitably mean we screw up the former and forget the latter. Unfortunately that’s where our opinion leaders are headed.

Likewise the banks. The fact is that they are not fixed. We are headed back into bubble land. The opinion leaders mostly voted against any hard-nosed fixes for the banks. Now they are all for debt reduction and austerity. Yet the need for austerity is a result of the bank’s foolhardy attempt to destroy themselves by engaging in anti-social and juvenile activities they didn’t understand. The facts tell us that we should never again allow Jamie Dimon and his confreres to play with matches. They are likely to blow us all up. The poor dears cannot help themselves. The taxpayer bail out of the banks may not end up costing us a lot directly, and the opinion makers like Tim Geithner keep harping on that as evidence we should all be pleased. But the facts say something else: the crisis and its enormous social cost is an indirect result of banker lunacy, greed, and regulatory capture. So the fact that we did not fix the banking system is the result of wrong opinions holding sway.

Similarly inflation. The more dramatic of our opinion leaders are almost apoplectic about an imminent burst of inflation. This, they say, is the inevitable result of the Fed’s easy money policy. But look at the facts. Core inflation, which is our best guide for the trend in inflation, is moving down, not up. Short term factors have masked that. Some problems are no doubt out there as worldwide demand rises rapidly to squeeze raw material and commodity prices. But nowhere is that a result of US monetary policy. And, besides, food prices are being driven by shortages due to weather. That’s not a medium term policy issue. It is a short term meteorological issue. But our opinion leaders want us to think we need to tighten and possibly risk our recovery, based on their opinion. No thank you. The facts support continued easy money until we get the economy beyond its current jobless phase. When wages start to jump, that’s when we tighten.

Judging by recent history, another awkward fact, that may be never.

Of course this all just my opinion.

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Geithner’s Foot in Mouth Problem

Tim, did you just say what I thought you said?

Did you just say that the government stands by to step in when banks get into the trouble in the future?

If so, then what of that great reform last year? The Frank-Dodd reform. The one that was sold to the public as the solution to the banking problem.

If Frank-Dodd solved the problem, then there will be no future crises. More to the point: there is no need for the government to stand by the banks. They’re on safe ground now. Right?

Maybe not.

Or is it simply that Frank-Dood was an enormous – literally, the legalese made the law into an epic pile of paper – fudge?

I have said from the beginning that the only way to solve the great “too-big-to-fail” conundrum is to cut the banks down in size. All else leaves them to blunder on trampling all of us as before. Gutless bureaucrats didn’t want to do that. Nor did politicians beholden to the flow of cash from the banking industry. Yes, Frank-Dodd was a fudge. It didn’t attack the disease at it roots. It dealt with symptoms. It didn’t cure. It wasn’t meant to. The system, we were told, was too fragile. It only needed tweaking. Leave it to the big people who knew banking. They would fix it for us. The taxpayers could rest assured that the banks would never again be in a position to destroy the economy and the lives of millions of people around the world.

Except now we are told that the government stands ready to plunge right back in if needed.

The question, Tim, occurs to me. Exactly why, in view of all that reform, is future government help needed?

Don’t bother to answer. I already know why.

You caved in. The moment I realized that Obama had no intention of fighting the big banks was the moment I realized he was not a true reformer. Instead he, and his people like you Tim, are simply bureaucrats incapable of formulating an alternative world and then fighting to put it in place. You are the ultimate tweaker. Lost in the details and the finer points you have spent years mastering you are incapable of seeing that radical change is needed. Indeed you despise the word radical.

As a result we have binary banking system. The small banks struggle to keep a foothold, while the government tilts the playing field in favor of the behemoths who have managed to make themselves indispensable. The big players have co-opted policy making to the extent that only what they approve ever gets done. Meanwhile their income statements are fattened by the ongoing subsidy. Your statement that the government is standing by lowers the risk profile and thus the cost of funds for the behemoths. They then can be less smart because you have widened their degrees of freedom of action. They don’t need to be clever to survive. Just big. So they blunder on.

Maybe you’re just cynical. Maybe it’s because you decided that bankers are irreparably stupid that you see the need to keep them on life support. Or maybe you just don’t understand the system you are supposed to nurture.

In either case you sold the taxpayers out. And those banker bonuses will flow once more, safely protected from harm by the largesse of the public still digging out from the storm unleashed by those self same bankers.

The only ethical thing in all this mess is your simplicity Tim. At least you are upfront about the extent of the capture. At least you can tell us, with a straight face, that the problem is not solved.

And before you tell me that I am making this up: why is it that Standard and Poors, an accomplice in the last heist, incorporates an element in its analysis of bak risk to take into account the extent of government support? They figured you out Tim. So have I.

Thanks for nothing.

Now take your foot out of your mouth.

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Details, Details

All we are hearing seeing at the moment are snippets of news rather than headline grabbing insights into the big numbers we all care about. But there are sometimes tell tale signs of what’s in store for us in those details, so here’s a few of them:

Import prices: the price of imports into the US jumped 1.1% in December. That’s quite a movement for one month. The biggest increase came in fuel costs where prices were up 4.1%. Non fuel imports saw an increase of only 0.3%. This continues a trend that could have more wide reaching impact as the newt year or two unfolds. Commodity prices are rising more rapidly than finished goods prices. This is the result of worldwide demand and the continued emergence of countries like China whose economy is sucking in commodities at a prodigious rate. There is nothing nefarious or odd about this. It is the natural progression of development. The simple fact is that the Chinese economy will soon be far larger than that of the US and so we all had better get used to the notion that activity in China, not activity in the US, will set global trends. This, I suspect goes for global standards too: how long will it be before the Chinese market is the one where new products are unveiled? This implies that Chinese standards will intrude into the marketing plans of everyone worldwide. It also implies an ever growing Chinese presence in investment, banking, and economic policy setting. Get used to it.

Meanwhile rising commodity prices ought to be a warning to all industrialized nations that they had better take conservation, waste management, and recycling seriously. It is a long term trend not a short term cycle. More to the point we all need to pay attention to the efficiency of aggregate economies: how much resource does it take to generate a dollar [euro etc] of wealth? Last I looked the US lagged way behind the Europeans in this regard due to its cheap energy heritage. US industry and homes are extremely wasteful and it takes a far greater amount on input to create a similar output. I haven’t looked at the detailed numbers for a while now, but my hunch is that the efficiency advantage still lies with Europe – especially Germany.

Municipal Bonds: We don’t hear much about local fiscal crises, but they are one of the great threats to the overall US economy. The well known basket cases like California are simply the tip of a very large iceberg. Just yesterday legislators in the state of Illinois were forced to vote for a 66% tax increase in order to rescue their state’s decrepit finances. We are all accustomed to looking at bond spreads in order to detect what the markets think about local finances. The media is full of Greek, Irish, or Portuguese bond prices versus those of Germany or other more secure nations. We can do the same thing here in the US for state issued debt. When we do, we find that Illinois tops the risky list with spreads of about 215 basis points over a AAA bond. California weighs in at 125 basis points, while rust belt stricken Michigan is at 80 basis points. For reference New York City is at 56, and Florida at 40. While I do not expect a rash of defaults on local debt, there is no doubt that the same process of separating good economies from bad economies is going on within the US municipal debt market. It will become harder for some states to issue debt, and the interest cost will start to impinge on local tax rates and opportunities. The last two or three decades has seen reckless budgeting at various local levels here, and there are serious doubts about whether all states and cities can survive without draconian cuts in services. Here in New York the incoming governor is trying to cap property taxes which is a sure sign of future service quality declines. The reason California is in such a mess is that it voted for a similar cap, subsequent to which it was forced to defund all sorts of services, not least its once vaunted public education system which now languishes in disrepair.

I have reported here before, but it bears repeating, that the impact of local government efforts to balance their budgets will be to slow economic growth. Whether this braking effect is sufficient to pull the US as a whole down I doubt. But it will dampen activity, possibly seriously, over the next year or two. This is one reason why I advocated a larger Federal stimulus – but that’s a lost cause!

Portugal, and the Baltics: We read everywhere of the peripheral European countries and their issues. Today the bond market is breathing a little more easily because the Portuguese managed to float a bond issue and thus avoid immediate cash flow problems. But take a look at the price of those bonds. The poor taxpayers of Portugal will be paying through the nose for that debt. For what purpose? So that their creditors don’t take a hit on the old debt. This story is getting repeated time and again. In fact it is getting dull. The banks, via their ridiculous activities threw the world into recession. They were bailed out. That cost an arm and a leg, and sent some smaller countries into recessions so deep that the constitute depression status. And now those countries are being forced to issue debt to cover the cost of the recessions caused by the banks, while earnest bankers opine on the imminence and terrors of possible sovereign defaults. Apparently we must go through hell in order that the banks continue to issue credit so we can pay for the bailouts for the … banks. Am I the only person who finds this circularity both demeaning and insulting?

And please, no more headlines about how well Latvia is doing. Yes its economy is now growing. And, no, it is not a poster child for the benefits of austerity. It’s GDP dropped like a stone. It’s unemployment shot through the roof. It is an unequivocal disaster – witness the mass out migration of its population. Latvia is a poster child for why we do not think austerity is the answer. Not that you could figure that out from the glowing headlines in the Wall Street Journal and Financial Times. It is a success only if you don;’t worry about the people who live there. Which I do.

Corporate Taxes: It didn’t take long before the Obama administration jumped back onto my black list. Today we are hearing rumors that it wants to reduce corporate tax rates. This in an era of all time profit making. I suppose someone in Washington has bought into the old supply side argument and wants to ‘stimulate’ the economy by making business cheaper to do. No doubt we will be told that lower corporate costs will generate jobs. I hear that there is some give and take on the issue and that the lower tax rates may come along with a reduction in the loopholes and give-aways that debilitate the current set up. The US has one of the highest corporate tax rates in the world, but that ignores all those loopholes. The actual rate paid is much smaller. While I understand that corporate tax rates are simply passed along to consumers as higher prices, I find it politically inept to be talking about cutting government revenues – potentially – in the face of a rampant and anti-government Republican House of Representatives. Ny guess is that we are headed for another one of those pyrrhic victories Obama loves to win. So look for a fine bi-partisan hand out to business followed by a zero boost to jobs.

The simple fact is that business is flush with cash. If it wanted to employ it would. It doesn’t need more hand outs. Putting tax cuts on the agenda, even if loopholes are also discussed, is a dangerous ploy. The tax rate will be cut and the Republicans will block the closing of loopholes. The deficit will rise, and unemployment will fester. I think we’ve seen this act before.

And I am not re-assured to learn that Tim Geithner is going to discuss this all over dinner with “leading business leaders”. When was the last time he had dinner with “regular people”? My guess? Never.

The Beige Book: This is the dossier put together by the Fed as it gathers local and anecdotal information from around the country. It forms a vital part of the background for policy makers because it fills local detail into the overall context. The latest version was made public today, and was fairly encouraging. This is especially true for employment where local reports suggest that businesses are, at last, hiring not just to replace workers previously fired, but to expand as well. In other words the long drought may be over. Bear in mind this “data” is often more opinion than fact. Still, experience shows that it usually contains germs of truth. If that holds, then the jobs market will improve this year. Whether that improvement is enough to bring unemployment down quickly I doubt. Look at it as a first step. In the meantime the Fed reports that real estate and tight credit are still the biggest drags on growth. There’s nothing new there.

So, as you can see there are number of details we can find useful as we try to understand where we are headed. One or two, like the municipal debt problem, and the Beige book data are worth following. They could turn out to be very important indicators down the road.

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Don’t Ask, Don’t Act

The military may be having an issue with its notorious”don’t ask, don’t tell” policy, but the economy is having an even bigger problem of its own. Policy makers and media don’t ask how big the problem is. Then, if they discover what’s going on by accident, they don’t act proportionately. Don’t ask, don’t act is not the basis for success in today’s crisis. It is the basis for a goodly dose of Japanese disease, which is something we should all want to avoid like the proverbial plague.

The New York Times, belatedly, has an article describing the ills that have befallen Japan in the decade or so since its economy went through a massive bubble, and then began what appears to be a long term swoon into mediocrity. Long gone are the heady days of “Japan Inc.”. Instead the subtle erosion of deflation has sapped all the vibrancy from the economy and made it entirely dependent on exports for growth. That strategy is now souring as the Chinese continue their assault on world trade. Before long the Japanese look destined for second class status and much diminished lifestyles. If they are not there now.

The story in the NYT is truly saddening. The people interviewed respond with a combination of resignation and confusion. They mourn the lost vitality and the yawning gap between the new prospect and the opportunity, now gone, in the old. A whole generation of Japanese people are growing up in diminished and straitened times.

So what’s new?

Nothing.

Nothing at all.

In fact the problem I have, and it is very disheartening, is that it has taken this long for the media to take Japanese style sclerosis as a serious enough threat to the US that they assign time and energy to reporting it. Up until now the typical American response has been one of arrogant “it can’t happen here” avoidance. Even the NYT falls into that trap by quoting, with obvious approval, several analysts who make the point that the US economy is somehow more flexible and energetic. This will, they suggest, ensure we do not fall into the same hole.

But we already have.

The issue is not the basic flexibility of the economy. Yes the US is structurally more adept that Japan. It is less tied to old fashioned ways. But that is looking more and more like the days of yore and less like the real US we now live in.

Why?

Politics and a deficient elite.

The problems Japan created for itself were sourced in its inability to meet a huge crisis with an equally huge response. Instead it meandered through years of half measures, politically compromised and watered down policies, and weak steps taken but then retracted. It was an epic example of lack of willpower combined with a bureaucratic complacency. The lack of willpower resided in the political leadership – what there was of it – and its unwillingness to describe the situation properly to the voters. The consequence was that the voters had less tolerance for the necessary scale of policy response. This then fed into the bureaucratic malaise which was typified by constant mistaken advice, fear of error, fear of mockery if mistaken, and fear of over reaction. There was always just sufficient evidence to support weaker measures. That evidence was pounced upon with glee by politicians and bureaucrats wanting to avoid strong policy stands. And even when strong policies were introduced, they were withdrawn at the very first sign, however tentative, of an improvement.

The result has been a dithering and deliberate slippage into perpetual deflation and contraction. The people of Japan have been betrayed by the weakness of their leaders.

That anyone can look at this and not see the obvious and exact parallel now being acted out here is beyond me. I see it very differently: we are already well down the same path, and yet we are in denial of the future we are choosing. We have decided to be mediocre.

Why?

Because fighting our way out is both risky and expensive.

It is risky because leaders actually have to bet their reputations, which is not something one does in a corrupt and weak political system like ours. And it is expensive because the banks did a number on us that we have not seen for seven decades. We seem not to grasp how toxic that combination can be.

And that is our central problem. Far too many commentators evaluate the US ability to avoid the Japanese trap through a rosy prism of self reference and self congratulation. They look at the US circa 1960 and think we are still operating with that level of bold decision and skill. We are not. The evidence is the past two years. We dithered in precisely the same way as the Japanese did. Our policies were riddled through with compromise that undermined their efficacy. The prescriptions were calibrated to be the least we could get away with, rather than strong enough for a certain cure. We have constantly misdiagnosed the depths of the problem, and then under prescribed against that misdiagnosis. And our political system is slow, unwieldy, and corrupt. It is time we took off those rose colored glasses and looked reality in the face.

We are no different. In fact we may be worse given our self absorption.

Even Bernanke, who made a reputation lashing into the Japanese government for its constant addiction to half measures, finds himself having to issue watered down statements and commit to weak policies because of the political atmosphere and the willful misinterpretation of our position.

And then there is the economic team. Ugh. Summers, Geithner and the others are petrified of doing anything that might upset the “system”, by which they mean the banks and the credit markets. It is the public’s interest that counts here, not the banks. The notion that we might be handing on to the next generation a much diminished economy, with weaker prospects and stagnant standards of living, should motivate our leaders to face down and eliminate the opposition of the banks. After all, the potential loss of wealth for society as a whole is vastly greater from stagnation than it is from any short term hissy fit the markets might throw.

Which is why I view the so-called financial reform as such a failure. It was a strategic error not to take on Wall Street and cripple its political influence. Not only would such action have been a popular vote winner, it would have been sound economic policy too: for financial instability remains the premier and most often quoted reason to support weak policy. “We mustn’t rock the financial boat”. That would not be on our minds if we had sunk that particular boat – or rather boarded and taken it over -when the time was opportune.

So, looking back over the last two years, I see a constant stream of decisions and policies that mimic the Japanese situation exactly. Of course the two countries are very different, but so far their reactions have been similar. That does not bode well for the US. More to the point: the fact that we have such recent experience as the Japanese malaise to see and educate us, and that we have ignored that possible education, speaks volumes about our own shortcomings. We have spent two years worrying about a surge in inflation that is nowhere to be seen. We have worried endlessly about budget gaps that need to be closed, but yet. We focus on structural problems that have no meaning without the crisis being dealt with first. We quiver at the sound of a bank CEO talking about the foreclosure problems that the banks themselves created. We dither over tax cuts even though we know the impact they will or will not have. We obsess over ratios that are meaningless in our current context. We underestimate the crisis. We overestimate the impact of our tepid response. We run away from the banking industry even though it was the root cause of our problems. We focus on endless political campaigning rather than government. We capitulate to the power of cash in our electioneering. In short: we have become unable to lead or be led.

And, given the malaise we are slipping into, that worries me a whole lot. Because the end of that road is a very poor legacy to hand into the future. Very poor indeed.

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