Friday, November 21, 2008


Gary Weiss, Portfolio, June 2008 - As president of the Federal Reserve Bank of New York, Geithner, at least at this point in early April, is the man of the moment. Credit-crunched investment bankers are calling to withdraw funds from the discount window, which the Fed uses to loan money directly to banks. Nosy politicians are trolling for scapegoats. Journalists are asking what will happen next. . .

Geithner was the central figure in that drama. It was Geithner's Federal Reserve bank, not the Treasury, that came up with the $29 billion loan that made the deal possible or, more precisely, acceptable to J.P. Morgan. Geithner brought the parties together, hashed out the details, and demanded answers when things got shaky. It was a heady role for a non-economist who has, to put it kindly, only on-the-job training in the financial markets and who relies on an A-list inner circle. Officially, his advisers include the board of the New York Fed, which counts several heads of financial institutions as members. Unofficially, he has built an impressive career with the help of a number of kingmakers, including some with a financial interest in the industry he oversees.

It was in this office, right here, where the Bear deal was done. During that time and in the weeks after, Geithner was getting two hours of sleep a night, and he still looks it. You might even say that this youthful 46-year-old is starting to look his age. The sudden fame clearly unnerves Geithner, a quiet sort who is described by people who know him as shy. "He does not try to blow you away, to overwhelm you," says Henry Kissinger, Geithner's first boss. . .

"We're going to need to change a whole bunch of aspects of our financial system," Geithner says, speaking quickly and leaning forward in his chair. "We should not have a system that's this fragile, that causes this much risk to the economy."

The reform process has started creaking forward, with a wide-ranging (and swiftly dismissed) series of proposals by Treasury Secretary Hank Paulson. Meanwhile, Geithner has begun sending teams of examiners to the major investment banks to pore over their books and risk-control policies. Since the Bear blowup, he has also been urging bankers to boost their capital levels.

It has become something of a Wall Street parlor game to try to figure out why Geithner got as involved as he did in the Bear mess and whether he was had by crafty bankers. Geithner insists that the Bear deal benefited the public and not just the other big banks, who stood to gain from their competitor's going out of business. (Granted, it did help the banks, assuaging fears of an industry wipeout.) The implicit message is, Weep not for Bear but for what could have happened to the rest of us if it hadn't been saved. Geithner is impatient with-and a bit teed off by-talk that he is pushing the Street's agenda. "The Fed's actions in this financial crisis will benefit Main Street more than they benefit Wall Street," he asserts. He is certain that calamity was averted and that the people who gain most from the deal are not bankers but "the family who needs to borrow money to finance a house or send their child to college, or the individual trying to build enough savings for retirement, or the worker worried about losing her job."

That sounds like campaign rhetoric, but Geithner is an avowedly apolitical independent-contrary to the assertion of one columnist that he was an adviser to John Kerry in 2004-and has served under both Republicans and Democrats. But he's going to have a hard time remaining above the political fray, certainly in this election year, when, given the weak federal response to the subprime-mortgage crisis, the Bear Stearns bailout may anger voters.

Questions linger as to whether Geithner, who's supposed to represent the public interest, ended up with the best possible deal. He's an experienced negotiator, having wrangled with foreign powers during his days at Treasury, but some critics contend that he may have been outmatched by Jamie Dimon, J.P. Morgan's chief executive, and Alan Schwartz, Bear's C.E.O. "He doesn't really have what you would describe as a banking or financial background. He's never taken risk, never worked as a trader or in credit, or even had operational responsibility in a bank," says Chris Whalen, a vocal critic of the Fed and a managing director of Institutional Risk Analytics, a consulting firm.

After the Bear deal, the Fed wound up with $30 billion in collateral, mostly in the form of subprime-mortgage securities. Even Paul Volcker, the former Fed chairman who served on the search committee that picked Geithner and who still holds him in high regard, has expressed queasiness about the way the deal was structured. In a speech to the Economic Club of New York, Volcker said the Fed took actions that "extend to the very edge of its lawful and implied powers, transcending certain long-embedded central-banking principles and practices." Volcker later leavened this harsh assessment a bit, telling me that the Fed's intervention "was a proper action, but it was extraordinary-something that's never been done before, in terms of calling upon that emergency power. It tells you how seriously they took it."

Still, misgivings about the deal are hard to ignore, no matter how catastrophic the consequences of not intervening might have been. It doesn't help that the deal is teeming with connections that are sure to raise questions. Dimon is one of the three class-A directors of the board of the New York Fed, and its head is Stephen Friedman, a former Goldman Sachs chairman, who still sits on the investment bank's board. The New York Fed's board also includes Richard Fuld of Lehman Brothers, a firm that is another oft-rumored potential candidate for a bailout. Fuld is a class-B director, meaning that he is elected by member banks, astoundingly, to represent the public. (Friedman is also supposed to be looking out for you: He was "appointed by the board of governors to represent the public.") Thus Geithner reports to a board that is composed of people who are not only under his purview but would also benefit from any potential bailouts. The structure of the New York Fed's board bears more than a passing resemblance to that of the New York Stock Exchange in the bad old days, when member firms, regulated by the N.Y.S.E., were heavily represented on its board.

Even more intriguing is Geithner's informal brain trust, loaded with Wall Street luminaries. Since coming to the Fed in November 2003-recruited by then-New York Fed chairman Pete Peterson, co-founder of the Blackstone Group-Geithner has learned the ways of the financial industry at the feet of some of its biggest legends. He was almost immediately taken under the wing of Gerald Corrigan, a gregarious former New York Fed chief who is now a managing director of Goldman Sachs. Corrigan describes his relationship with Geithner as close, and it has flourished since Geithner's first days at the Fed. Another frequent adviser-"you don't want those things to get too formal," Corrigan notes-is also a preeminent banker, Merrill Lynch C.E.O. John Thain, a Goldman alumnus and former head of the N.Y.S.E. Over the years, Thain has often talked to Geithner-"sometimes I talk to him multiple times a day," Thain says. Geith­ner's network also includes former Fed chairman Alan Greenspan, an old acquaintance, as well as the heads of the European central banks, hedge fund managers, academics, and his immediate predecessor, William McDonough, architect of the 1998 Long-Term Capital Management bailout and now a vice chairman of Merrill.

Geithner's link to Corrigan will be especially crucial in the months ahead. Corrigan was recently asked by a presidential policy group to form a panel charged with finding ways to protect the financial system. The group is expected to release its findings by the end of July-a rapid but necessary pace if the Street is to have an effective voice in whatever may be done to tamp down risk. . .

Corrigan says that they "talk about everything under the sun," except for monetary policy. "He brings in groups of people. That includes, at times, some of his old Treasury buddies," like former secretaries Larry Summers and Robert Rubin. "As I said, he has really worked at this networking thing I keep talking about."

Of course, these aren't exactly chitchats among people who meet casually at some South Street Seaport bar after work. This is networking between a central banker and the heads of the capital-hungry investment firms over which he holds sway. You might argue that Geithner's relationship to his charges is even closer than the typical regulator's. No other regulatory agency is in a position to loan crucial billions to the entities it monitors. . .

Naked Capitalism, April 2008 - Steve Waldman, who took the trouble to read and parse an attachment to Timothy Geithner's presentation that set forth the terms and conditions for the operation of the LLC that will [manage Bear Stearns assets]., focuses on the disclosure that some of these assets included related hedges, which are derivatives. More important, Waldman concludes that the Fed isn't on the hook for just $29 billion but could wind up stumping up more:

"It's official. The LLC that the Fed and J.P. Morgan recently formed to manage $30B Bear Stearns assets has taken over a portfolio of derivative positions along with those assets. Those positions involve both rights to receive and obligations to pay whose value may depend upon both circumstance and counterparty quality. Of course, if liabilities associated with those positions ever exceed the value of the LLCs assets, the limited liability company could declare bankruptcy, so in theory, the Fed's maximum exposure is $29B. But, if, out of reputational concern or to promote systemic stability, the Fed would inject capital rather than let the LLC default, then the Fed has indeed become a counterparty of last resort."

Looking simply at the behavior of the main actors, Michael Shedlock concludes these instruments can't be all that hot. From Shedlock:

"This is galling. Everyone is praising the quality of the assets offered to the Fed as collateral, but JPMorgan would not take them outright. Why not? And while the Fed is on the hook for fallout from those assets, what about the other assets JPMorgan picked up for next to nothing? What are those worth? Was JPMorgan acting like a 'responsible corporate citizen' or a vulture financing corporation?"

. Geithner is generally very well regarded, yet I have come to the view that as head of the New York Fed, he was in a position to have seen what was going awry, yet remained blind alternative courses of action.

He gave a very long speech, parts of which seemed designed to run out the clock so as to reduce the time available for questions (does the panel really need a discussion of the history of the Fed?). Read this section, which came at the beginning:

"This was a period of rapid financial innovation-particularly in credit risk transfer instruments such as credit derivatives and securitized and structured products. There was considerable growth in leverage, greater reliance on ratings on structured credit products and a marked deterioration in underwriting standards.

"The innovation in financial products was accompanied by a dramatic increase in the amount of financial intermediation occurring outside the core banking system. The importance of securities broker-dealers, hedge funds, and mutual funds in the financial system rose steadily. Off-balance-sheet vehicles of various forms proliferated, and increased concentrations of longer-dated assets were held in funding vehicles with substantial liquidity risk."

In a speech he gave a bit more than a year ago, Geithner covered much the same ground (without the road kill details we now have) framed more positively, and pointed out that only 15% of the non-farm credit extension was via banks. We noted at the time:

"Geithner has no objective foundation for his rosy view. He has essentially admitted the Fed and other regulators lack a complete, or even good, picture of what is happening. We've had money supply growth well in excess of GDP growth, and loose monetary conditions can obscure underlying weaknesses. His argument boils down to, 'Our current structure and distribution of risks is outside the bounds of anything in financial history. We can muster some arguments as to why this should be OK, and so far, it has been OK.' I don't find that terribly convincing."

And in that speech, he in effect said it was OK for regulators to supervise only in the most minimal way: We cannot turn back the clock on innovation or reverse the increase in complexity around risk management. We do not have the capacity to monitor or control concentrations of leverage or risk outside the banking system. We cannot identify the likely sources of future stress to the system, and act preemptively to diffuse them. . .

How can you "encourage" behavior changes among parties you don't regulate? Where you don't have enough of a view of what they are doing to even suggest where they might need to trim their sails? Yet today, the Fed's and Treasury's message to Congress was: we withstood this test, the system works, butt out. They should consider the warning of General Phyrrus: "One more such victory, and we are lost."


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