Page 1 of 2 Geithner's folly By Hossein Askari and Noureddine Krichene
The latest US jobs report announced on March 6 does not make good reading. Job
losses over the past three months are put at nearly 2 million and at 4.4
million since the beginning of this recession in December 2007. The losses over
the last four months are the worst in the post-World War II era and total
losses in this recession are comparable to those in the worst post-World War II
recession of the early 1980s, when unemployment peaked at 10.8% in 1982.
There are now 12.5 million Americans unemployed. We have long said that
unemployment may peak in the double-digit figures and, with this latest jobs
report, you can bet the family farm on it.
With the unfolding unemployment picture, the Barack Obama
administration and the US Federal Reserve have swung into high gear. The Obama
Administration started with a big bang. Although highly populist, raising
expectations, and with various merits, the stimulus will push fiscal deficits
and US debt to uncharted levels. As such, it could seriously destabilize the US
economy by depleting further savings and private investment, widening external
deficits, depreciating the US dollar, and in view of its gigantic size, running
the risk of triggering highest inflation in recent US history.
The Republicans in both houses of Congress rebuffed the administration's US$789
billion stimulus program, labeled by some lawmakers as "theft" and by Senator
John McCain as a "generation theft". All this will, in time, spill over onto
the rest of the world.
In defending his program before Congress, Obama indicated that his program was
not his idea; Harvard professors, who cannot be wrong (we have heard that
before!), developed it and therefore its well-reasoned size and recovery power
should not be questioned. My bottom line, he said, is to make sure that we are
saving or creating four million jobs, we are making sure that the financial
system is working again, that homeowners are getting some relief.
Obama maintained that without his gigantic stimulus program the country will
face a catastrophe. Such was indeed the similar threat leveled by Federal
Reserve chairman Ben Bernanke and former Treasury Secretary Henry Paulson in
their push for money for their Troubled Assets Relief Program. While the
meaning of catastrophe is not clear, wrong policies could also increase
economic and social pains for millions of vulnerable people. One thing is
clear; Obama's program is not immune from this risk, and if it fails it will
stress the world to no end.
Endorsing essentially the same unfocused policies as the George W Bush
administration, Obama sees no limit to bailouts, in spite of their confiscatory
and pure wealth-redistribution effects in favor of bankers and speculators and
at the expense of taxpayers, the homeless, workers and fixed income earners. A
recent CNN survey in fact showed that bailouts have already totaled $11.5
trillion, or 70% of GDP.
As a matter of fact, the Fed's policy under Bernanke's predecessor Alan
Greenspan has made millions of homeowners happy owning expensive houses, brand
new cars, furniture, and borrowing on their home equity (estimated in 2007 at
$9 trillion) to finance a very lavish lifestyle thanks to rapidly rising home
prices without any income or savings.
Whose savings were being used? The collapsing stock market index and banks hold
the answer. It is the hard-working people and retirees who are seeing their
savings being handed over gratuitously by the Fed to borrowers who will enjoy
huge wealth freely without paying for it. Those who saved during a lifetime
will retire poor. That's justice for you.
All the while, the Obama administration seems to be pressuring the dependent
"independent" Federal Reserve to unleash further money supply and to force
loans back into the subprime markets in spite of highest default rates in these
markets. Bernanke, locked up in his sheltered world, does not seem to be aware
of the cascading job losses, with much more to come. Although admitting that
interest rates were at zero bound, he said that the Fed faced no limit to
expand its balance sheet as a way to push liquidity in the economy; he informed
Congress that he intended to do so.
Maurice Allais, the renowned French economist, condemned money creation out of
nothing as counterfeiting. He wrote: in essence, the present creation of money,
out of nothing by the banking system, is similar: "I do not hesitate to say it
in order to make people clearly realize what is at stake here - to the creation
of money by counterfeiters, so rightly condemned by law."
While the ongoing US recession and financial crisis were brought about by the
very same policies that Obama is now championing, he will make economic
stabilization more difficult for his successors, who will be forced to rein in
fiscal deficits and monetary expansion, not willingly, but under forced
His Treasury Secretary Timothy Geithner announced a four-point plan on February
10 for rescuing banks and stepping up credit to business and consumers. First,
the Treasury will "stress-test" the biggest banks - with more than $100 billion
in assets - and provide capital to those that need it. Second, the Treasury
will provide $100 billion in seed money to expand the Federal Reserve's Term
Asset-Backed Securities Loan Facility (TALF) from $200 billion to $1 trillion,
injecting money for consumers and small business loans in sub prime markets,
and in which investors in bonds backed by credit card and other consumer loans
can swap those bonds for Treasury Securities.
The TALF aims at reviving securitization of credit cards, auto and small
business loans. Assets rediscounted under the TALF are non-recourse loans,
which means that the Fed will bear all risks associated with these assets.
Third, the Treasury will create a private-public partnership to take toxic
assets off banks' balance sheets with an initial capital of $500 with the
prospect to expand it to $1 trillion. Fourth, the Fed and Treasury will commit
$50 billion to reduce mortgage payments and establish loan modification
Before outlining his financial stability plan, Geithner said "I want to explain
how we got here. The causes of the crisis are many and complex ... Governments
and central banks around the world pursued policies that, with the benefit of
hindsight, caused a huge global boom in credit, pushing up housing prices and
financial markets to levels that defied gravity. Investors and banks took risks
they did not understand. Individuals, businesses, and governments borrowed
beyond their means. There were systematic failures in the checks and balances
in the system, by Boards of Directors, by credit rating agencies, and by
"These failures helped lay the foundation for the worst economic crisis in
generations. Our challenge is much greater today because the American people
have lost faith in the leaders of our financial institutions, and are skeptical
that their government has - to this point - used taxpayers' money in ways that
will benefit them. This has to change.
"We believe that access to public support is a privilege, not a right. When our
government provides support to banks, it is not for the benefit of banks, it is
for the businesses and families who depend on bank and for the benefit of the
country ... This program will require a substantial and sustained commitment of
public resources. Congress has already authorized substantial resources for
this effort ... But I want to be candid: this strategy will cost money, involve
risk, and take time. As costly as this effort may be, we know that the cost of
a complete collapse of our financial system would be incalculable for families,
for businesses and for our nation".
Let us hope that by governments and central banks around the world Geithner was
not referring to Zimbabwe which was running an astronomical inflation rate. Why
did he not refer directly to the US fiscal deficits and US Fed as the main
contributors to the present crisis?
Certainly, Geithner as a voting member in the Board of Governors of the Federal
Reserve was a staunch supporter of the same policy that pushed housing prices
to levels that defied gravity. By still advocating the same policy, he was all
along supporting as a policymaker in the George W Bush administration, the
economy will still remain "here".
While Geithner's explanation fits well the Fed's views, which have always
ignored the role of interest rate cuts and their powerful inflationary effect
in causing economic recession, a more complete elaboration was advanced by
Professor John Taylor in the Wall Street Journal on February 9:
third policy response was the very sharp reduction in the target federal-funds
rate to 2% in April 2008 from 5.25% in August 2007 ... The most noticeable
effect of this rate cut was a sharp depreciation of the dollar and a large
increase in oil prices. After the start of the crisis, oil prices doubled to
over $140 in July 2008, before plummeting back down as expectations of world
economic growth declined. But by then the damage of the high oil prices had
been done. After a year of such mistaken prescriptions, the crisis suddenly
worsened in September and October 2008. We experienced a serious credit crunch,
seriously weakening an economy already suffering from the lingering impact of
the oil price hike and housing bust".