Sunday, January 13, 2013

Why Wall Street thanks Tim Geithner for his service

In a must read Guardian column, Dean Baker credits Treasury Secretary Tim Geithner with the choice to pursue policies that were good only for banks and banker bonuses at the expense of the real economy, society and the social contract.

Regular readers know what Mr. Geithner pursued was the Japanese Model for handling a bank solvency led financial crisis.  Under this model, bank book capital levels and banker bonuses are protected at all costs.

This results in a series of polices like bailouts, zero interest rates, quantitative easing, austerity and failure to enforce securities laws that are bad for the real economy and society.

For example, the burden of servicing the excess debt is place on the real economy.  This diverts capital that is needed for reinvestment and growth to debt service.  This diversion triggers a negative self-reinforcing spiral for the real economy:  less capital leads to less demand which leads to even less capital...

As the real economy shrinks, so too does tax revenue.  As tax revenue drops, the call for austerity policies and changing the social contract to limit money spent on social programs which have acted as automatic stabilizers to the real economy grow.  As these policies are implemented and spending on social programs declines, this further harms the real economy and society.

From the perspective of the real economy, society and the social contract, the Japanese Model has never worked positively.  But this is not surprising as the goal of the Japanese Model is not positive for the real economy, society and the social contract.  The goal of the Japanese Model is to protect the banks and the bankers' ability to loot society.

Regular readers also know that there is an alternative to the Japanese Model that Tim Geithner had to lead a rejection of every day.  The alternative is the Swedish Model.  Under the Swedish Model, banks are required to recognize today all the losses on the excess debt in the financial system.

This protects the real economy as capital is not diverted to service the excess debt.  This protects society and the social contract as tax revenue can be used not to bailout the banks and pay for the debt incurred in bailing out the banks, but instead can be used to maintain and expand the social programs.

Finally, regular readers know that the global banking system is designed to support implementation of the Swedish Model.  Because of the combination of deposit insurance and access to central bank funding, banks can operate with low or negative book capital levels.

Deposit insurance effectively makes the taxpayers the banks' silent equity partner while they have low or negative book capital levels.  So the banks have time to rebuild their book capital levels after recognizing the losses.

Rebuilding the capital levels requires the banks to retain 100% of pre-banker bonus earnings until such time as the banks have achieved the book capital levels required by both financial regulators and market participants.

To keep the banks from gambling on redemption as they rebuild their book capital levels, the banks have to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.  With this information, market participants can assess the risk each bank is taking and adjust both the amount and price of their exposure so that the bank's cost of funds reflects this risk.
Treasury Secretary Timothy Geithner's departure from the Obama administration invites comparisons with Klemens von Metternich. Metternich was the foreign minister of the Austrian empire who engineered the restoration of the old order and the suppression of democracy across Europe after the defeat of Napoleon. 
This was an impressive diplomatic feat – given the widespread popular contempt for Europe's monarchical regimes. In the same vein, protecting Wall Street from the financial and economic havoc they brought upon themselves and the country was an enormous accomplishment. 
During his tenure as head of the New York Fed and then as treasury secretary, most, if not all, of the major Wall Street banks would have collapsed if the government had not intervened to save them.... Had it not been for Geithner and his sidekicks, therefore, we would have been permanently rid of an incredibly bloated financial sector that haunts the economy like a horrible albatross. 
Along with the salvation of the Wall Street banks, Geithner also managed to restore their agenda of deficit reduction. 
Even though the economy is still down more than 9 million jobs from its full employment level, none of the important people in Washington is talking about measures that would hasten job creation. 
Instead, the focus is exclusively on deficit reduction, a process that is already slowing growth and putting even more people out of work. While lives are being ruined today by the weak economy, Geithner helped create a policy agenda where the focus of debate is the budget projections for 2022.... 
Nonetheless, the path laid out by Geithner's team virtually ensures that these distant budget targets will serve as a distraction from doing anything to help the economy now. 
There are two important points that should be quashed quickly in order to destroy any possible defense of Timothy Geithner. 
It is often asserted that we were lucky to escape a second Great Depression. This is nonsense. 
The first Great Depression was not simply the result of bad decisions made in the initial financial crisis. It was the result of ten years of failed policy. There is zero, nothing, nada that would have prevented the sort of massive stimulus that was eventually provided by the second world war from occurring in 1931, instead of 1941. We know how to recover from a financial collapse: the issue of whether we do so simply boils down to political will.... 
Correct, implementing the Swedish Model requires political will.  At the start of the current financial crisis, Iceland found the political will because it simply did not have the resources to adopt the Swedish Model.

Interestingly, even an imperfect adoption of the Swedish Model has left Iceland's economy far ahead of the EU, UK and US that adopted the Japanese Model in recovering from the bank solvency led financial crisis.
Finally, the claim that we made money on the bailouts is equally absurd. We lent money at interest rates that were far below what the market would have demanded.
Walter Bagehot, the father of modern central banking, said that the central banks should lend freely against good collateral at penalty rates of interest.  Clearly, the interest rates charged were not punitive.
Most of this money, plus interest, was paid back. But claiming that we thus made a profit would be like saying the government could make a profit by issuing 30-year mortgages at 1% interest. Sure, most of the loans would be repaid, with interest, but everyone would understand that this was an enormous subsidy to homeowners. 
The claim we made money on the bailouts is actually a distraction from the real issue that modern banks do not need to be bailed out in the first place.  Deposit insurance means the taxpayers are already the banks' silent equity partner.  A bailout is only in the interest of the bankers protecting their bonuses and continuing to loot society.
In short, the Geithner agenda was to allow the Wall Street banks to feed at the public trough until they were returned to their prior strength. Like Metternich, he largely succeeded. 
Please re-read the highlighted text as Mr. Baker nicely summarizes the Geithner agenda although he misses the crucial fact that letting Wall Street banks feed at the public trough until they return to their prior strength is effectively letting the bankers feed at the public trough through their bonuses.
Of course, democracy did eventually triumph in Europe. Let's hope that it doesn't take quite as long for that to happen here. 

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