Page 2 of 2 Perhaps a cool hand By Julian Delasantellis
administration. Supposedly, the public sector was so maladroit and inept in
everything it did that everything it did, from educating learning disabled
children to fighting wars, would be done better with the private sector's
profit placed center stage.
Is Geithner saying that the private sector can clean up the financial sector
better than the public? Is this another example of Obama's surprising policy
moderation and non-ideological bent? Probably not. It's more likely that this
is Geithner handing off the now fetid baby to someone else. It stinks so much
that nobody in government wants any part of it anymore.
The congressional hearings last week, with the presence of the
eight major banking executives whose firms received TARP infusions of public
funds to replenish bank capital, were very instructive and illuminating on the
question as to just how much more of its tax money the American public wants to
see go to the financial system; all that was missing was Madame DeFarge from
Charles Dickens' A Tale of Two Cities sitting in the front row knitting
the names of the bankers into her tapestry.
Congress went out of its way to pass the TARP for Paulson last autumn, but the
only pat on the back they got from him turned out to be the "kick me" sign he
taped to their backs when he changed his mind. Geithner must have known that
advancing a proposal to devote a trillion tax dollars or so to support the
banking system in this environment would have been like jumping into a shark
tank wearing a three-piece prime rib suit.
So is the "public-private partnership" just a way to get around that problem,
to, in effect, give the bankers the money in camera rather than out in the
open? Maybe, but, like a banana peel left on the ground that everybody slips on
because nobody thinks to pick it up, the MBS pricing issue is still out there,
ready to make a fool of Geithner the same way it did Paulson.
There seems to be three major untouched pools of capital with resources large
enough, perhaps, to make a dent in the crisis out there in the financial world
- sovereign wealth funds (SWFs) , hedge funds, and private equity. Since trying
to come to the system's rescue in late 2007, and in doing so taking massive
losses for their troubles, the SWFs have been playing their cards close to the
chest; as for hedge funds, they're suffering massive redemptions, investor
withdrawals, as their customers come to wonder if behind the smiling Dr Jekyll
countenance of their supposedly brilliant fund manager lies not a Mr Edward
Hyde but another Bernie Madoff.
That leaves private equity. During the stock boom, private equity preferred a
wildly profitable strategy of having a large pool of very wealthy investors
coming together to borrow money to buy public stock companies in order to take
them private. A few tens or hundreds or thousands of employees would be fired;
then, following some other varied fiddling with the corporate structure, the
companies would be brought back to the stock market after a few years or months
for a premium, making a huge profit for the private equity folk. (See
The highs and lows of buyouts, Asia Times Online, February 22, 2007 -
written during the Elysian days of private equity.)
Although, what with having its sources of finance cut off in the credit crunch,
private equity isn't really doing any new deals, it's still out there, sitting
on pools of capital in the hundreds of billions of dollars range. The core of
the Geithner plan seems to be to have been to buy from the banks the bad MBS,
then place them in hands more proficient and accustomed to managing risk than
the banks. During the glory years of the boom, the banks deluded themselves
into thinking that they could effectively manage risk, but, when things turned
bad, they proved themselves absolutely incompetent at this risk management,
what is generally considered to be the core proficiency of banking.
But even during the good times, when capital was plentifully sloshing all over
and around the world's financial markets, private equity was known as having
some of the sharpest elbows in the business - far be it for them to buy an
asset at fair market value; they looked to buy it for much less than the asset
was worth. The banks aren't even willing to sell their rotten MBS at current
market prices. They want far more. How will these two diametrically opposite
positions be reconciled?
That's easy to answer - they're not going to be.
When the press reports started to indicate that Geithner was moving away from
the bad "Aggregator" bank as being the core of the financial rescue plan, it
was speculated that he was going to have the government guarantee the values of
any MBS bought by private parties from out of the bank's portfolios. Once
again, the crucially important questions of at what prices the MBS would be
valued, and just how much or how expensive the insurance would be to the US
taxpayers, were ignored.
This insurance strategy, sometimes called ring-fencing, was used by the
Treasury in the autumn rescues of Wachovia and Citigroup, but it does not
appear to be part of the new plan. Instead, the plan's focus is going to be to
"providing the financing the private markets cannot now provide". The
government is going to borrow the money for private equity to buy the MBS; in
the strictest sense, Geithner will not be handing over hundreds of billions to
give to the banks as did Paulson with TARP - he'll be giving it away for
someone else to give to the banks.
But the pricing issue is still there; the banks are going to say no to anyone
who gives them a bid they don't like for the MBS - it doesn't matter if it's
from government or private equity. It was the realization that Geithner was not
addressing this critical issue that got both the chattering classes in the
blogosphere so aroused, and the markets tanking.
If Geithner fails to square the MBS pricing circle and the plan thus dies
stillborn, it still can be said that the plan had a useful function. It's
showing that the only real, remaining way out of the problem is the so called
"Swedish solution", full nationalization of the banks.
Nationalization solves the MBS pricing problem in the simplest possible
fashion: the banks will get a price of absolutely zero for the securities, and,
for that matter most everything else in their portfolio. The idea gets lots of
play in the blogs, but the Obama administration is wary to go anywhere near the
concept. It probably fears, with good reason, the Republicans countering any
nationalization talk with TV spots featuring a Treasury apparatchik in a Soviet
army uniform driving a tank over a wide-eyed little girl's lemonade stand.
But if the Geithner plan is not massively improved, and if no other contender
arises to challenge it, the alternatives then be will either nationalization,
or, like in 18th-century medicine, using the faltering MBS as leeches to bleed
slowly the poison out of the financial system.
No matter that, in many or most of the cases they were used, leeches just bled
the patient to death.
But among all the gnashing of teeth and rending of garments that followed the
release of, as Willem Buiter put it, the "Geithnerbharata", there was one
component of the plan that makes me wonder whether Geithner is not being
massively underestimated in all of this. He may be like the proverbial
country-bumpkin-looking fellow who sits down to play poker with a bunch of Las
Vegas sharpies, and winds up running the table.
Amid all the confusion and consternation surrounding the public-private
partnership, less noticed was Geithner's proposal for vigorous government
audits, to be called "stress tests", of the major banks.
"We're going to require banking institutions to go through a carefully designed
comprehensive stress test, to use the medical term. We want their balance
sheets cleaner, and stronger. And we are going to help this process by
providing a new program of capital support for those institutions which need
it. To do this, we are going to bring together the government agencies with
authority over our nation's major banks and initiate a more consistent,
realistic, and forward-looking assessment about the risk on balance sheets, and
we're going to introduce new measures to improve disclosure."
Can this basically be translated as "'Come into my parlor', said the spider
[Geithner] to the fly [the banks]?"
There is one huge, rarely talked about anomaly to the entire effort to get the
MBS away from the banks. The banks say that they don't want to sell the MBS on
the cheap, for that will require them to mark down, to "mark to market" all the
MBS in their portfolios, using the reduced sale prices as a valuation guide.
That implies that the banks are carrying a whole lot of MBS at values nowhere
near what they would fetch in the market. They haven't marked them down
according to what few transactions of MBS have occurred, such as the $30
billion in MBS Merrill Lynch sold away at 22 cents on the dollar last summer.
They're not supposed to do that; according to the Basel II bank accounting
regime, if the banks have market prices for securities similar to what is in
their portfolios, they have to mark down, to "mark to market" their securities
using the market prices as guidelines. (See
Of termites and index mania, Asia Times Online, July 3, 2007, for a
comparison of mark-to-market and the much preferred banking system accounting
alternative, "marked to model".)
"So," Geithner could tell the banks if they continue to play hard-to-get
regarding the MBS sales prices. "Why don't we set you up for one of our 'stress
tests?' You won't have any trouble recognizing our auditor - he'll be the
really thin guy in the long black cape and hood going through your books with
his scythe. Or would you maybe rather think of a new number at which you'd be
willing to sell your MBS to the public-private partnership?"
It's true that there was nothing in the Geithner package that implied that the
Treasury secretary was thinking of using the stress tests in this manner; then
again, Harvard University economist Jeremy Stein, an advocate of bank audits so
vigorous that they border on bondage, just took a job on the staff of Lawrence
Summers' National Economic Council. Monday's Financial Times reports that Wall
Street is already "nervous" about the stress tests, even though not one has yet
Maybe the real question about the success or failure of the Geithner package
is, indeed, the Geithner package. Geithner spent large parts of his childhood
in Zimbabwe, India and Thailand before heading off to Dartmouth and Johns
Hopkins; hopefully, in all those travels, he might have picked up a set of
cohones sufficient to face down the banks.
It's not like it's hard. At last week's congressional hearings with the banking
chief executives, it was revealed that Goldman Sachs is desperately trying to
round up the money to pay the government back for the capital injections it
took from the TARP last October. It's not like Goldman doesn't need it; it's
just that the Obama administration's restrictions on executive pay and bonuses
for those taking TARP funds, restrictions strengthened in the recently passed
stimulus bill, are driving them nuts. If necessary, they'll have the partners
tipping over couch cushions looking for change and doing weekend car washes
outside fast-food joints so they can get their bonuses back.
Geithner, don't fight the banks - they fight back. The bankers, on the other
hand, they fold up like cheap card tables.
Julian Delasantellis is a management consultant, private investor and
educator in international business in the US state of Washington. He can be
reached at email@example.com.