Geithner’s New ‘Reform’ Plan: Keep Backing Risky Investments

Worse, Geithner’s new rescue plan is likely to have even less government oversight than the original TARP program, a notorious boondoggle for financial institutions.

On top of all that, Geithner and Fed Chairman Ben Bernanke continue to serve as enablers for a little-known Federal Reserve initiative that’s placed a stranglehold on widespread lending.

That lending disincentive is a provision inserted into the 2008 Emergency Economic Stabilization Act that also included the $700 billion TARP program. As noted by a handful of financial experts and the investigative author of It Takes a Pillage, former Goldman Sachs managing director Nomi Prins, this provision has actually spurred the Fed to pay interest to financial institutions to park its excess reserves with the Fed — rather than use those funds to lend to businesses or even smaller banks.

The excess reserves have ballooned from $2 billion in August 2008 to about $765 billion in August 2009. As she bluntly headlined in her book the real-world impact of this measure, ​“They Encouraged Banks to Sit On Their Money.”

But most critics have zeroed in on his financial rescue plan that aims to help prop up or unwind major institutions when they’re failing. How? By getting money from their $10 billion-or-more competitors to pay for saving them or breaking them up. And the decision-making power on who should be helped — and how — would be held by the still-secretive Federal Reserve.

The proposed Financial Stability Stability Improvement Act is Geithner’s new vehicle to dun large financial companies for the billions – if not trillions – needed to bail out a failing firm. It’s been dubbed by such critics as Rep. Brad Sherman (D-CA) as ​“TARP on steroids.” 

To Time Magazine, though, Geithner is the savvy pragmatist navigating between the blinkered ideologues of the right and left, while talking tough to Wall Street (no mention here of his regular phone chats with his investment banking CEO pals). Time’s panegyric begins:

Last spring when he had just started as Treasury Secretary, Tim Geithner came across as timid, uncertain and a little small in front of the TV cameras and on Capitol Hill. Flash forward to his appearance Thursday morning before the House Financial Services Committee and Geithner was hardly recognizable: he interrupted the members, rolled his eyes, shot questions back, spoke over them and even ignored the chairman himself as he pounded the gavel.

What’s got into Geithner? The short answer: a deadline. With their energy bill stalled, health care dragging out and other initiatives pushed aside, financial reform is a high priority for an Administration in search of wins. Geithner’s bosses at the White House are pushing to get a bill to the President for his signature by the end of the year, and Geithner is the point man in making that happen…

As he promotes his Wall Street-friendly version of reform, neither Time nor Meet the Press host David Gregory thought it worth asking the brainy Geithner about the devastating findings of the special inspector general for TARP — even as the Treasury Secretary pursues a new bailout plan modeled to a certain degree on the old one.

And, critics say, it could be worse, because they say it lacks any meaningful controls or spending limits. And too much of the power to resolve a huge firm’s pending failure would reside with a notoriously secretive agency, the Federal Reserve, that faces little now in the way of fundamental reforms that would open it up to the public.

“The current bill fails to address the close ties between the Federal Reserve and the Big Banks that are at the heart of the problem,” said Heather Booth, the director of Americans for Financial Reform, the leading citizens’ coalition.

But what Geithner’s proposing, despite all the hype, isn’t real reform — but an illusion of reform that could promote risky actions and, potentially, another meltdown. Rep. Sherman made the case at the hearing late last month (hat tip to Firedoglake and the Washington Independent):

Rep. Brad Sherman (D-Calif.), a former accountant and member of the House Financial Services Committee, says the proposed new bailout authority would create a kind-of mutant extension of the Wall Street bailout – the differences being, he maintains, that the $700 billion Troubled Asset Relief Program at least had a cap on spending, an expiration date, congressional approval, independent oversight and some executive pay limits for the banks on the receiving end of the taxpayers’ largesse. The California Democrat is calling the bailout authority requested by the White House, which lacks most of those safeguards, ​“TARP on steroids.”

AFL-CIO leader Richard Trumka is one of the wide array of progressives who are condemning the new plan for not doing nearly enough to protect the public, and allowing the Fed under the new plan to keep its cozy relationships with banks it supposedly ​“regulates.” Trumka declared recently:

The discussion draft appears to take the most problematic and unpopular aspects of the TARP and makes them the model for permanent legislation […] The discussion draft would appear to give power to the Federal Reserve to preempt a wide range of rules regulating the capital markets - power which could be used to gut investor and consumer protections….

He added, ​“Giving the Federal Reserve with its current governance control over which financial institutions are bailed out in a crisis is effectively giving the banks the ability to raid the Treasury for their own benefit.”

Other critics have condemned Geither and like-minded Obama advisers for ignoring solid proposals by experts like former Fed Chairman Paul Volcker to break up ​“too big to fail” financial institutions into separate firms offering safer commercial lending and riskier investments. In short, a return to the protections of the Depression-era Glass-Steagall Act that were stripped away during the Bush era.

As former investment banker Prins says of Geithner’s new ​“systemic risk” plan: ​“All these [Adminisration] ideas start when that institution that is too big to fail is failing, and everything is catch-up. At the very least we should prevent institutions from becoming too big to fail or too risky.”

But Geithner’s latest plan, and the entire range of federal rescue efforts so far have done precisely the opposite, she contends. ​“We’re subsidizing risk with an additional capital cushion,” she says, although some financial guarantees – with sensible safeguards and strings attached – could well be justified. Her analogy: ​“It’s like a tight-rope walker with a big fluffy capture net underneath; you’re probably going to take more risks than if you knew there was no cushion beneath you.”

While most progressives have focused their ire on Geithner’s latest systemic risk plan, the disincentive to major bank lending buried like a suicide bomb in the 2008 bail-out legislation keeps doing its damage. Even Ben Bernanke has admitted that this seemingly misguided policy is encouraging banks’ hoarding and crushing much potential lending.

Apparently, few reformers outside of Prins, the I.F. Stone of financial journalists, bothered to read an article in the January 13, 2009 Financial Week, in which Bernanke admitted, ​“A huge increase in banks’ excess reserves is currently stifling the Fed’s monetary policy moves and, in turn, its efforts to revive private sector lending.”

So, under Geithner’s and Bernanke’s steady direction, they’ve kept this wonderful policy going.

The apparent aim of this Congressionally-approved approach was to give the Fed more flexibility to aid troubled institutions and to serve as a brake on potential inflation. But since it’s backfired, the Fed, according to Prins, has the emergency powers to suspend these credit-destroying interest payments. The ​“excess” reserves go beyond what the banks are required to give the Fed as financial guarantees of soundness and a backstop for a crisis.

As the Wall Street Journal blandly explained in October, 2008, back when it seemed like a good idea: ​“The change will encourage banks to leave more money on deposit at the Fed, and that’ll give the Fed more maneuvering room to lubricate the financial system and lend to troubled institutions without increasing the total supply of credit in the economy [emphasis added] and pushing down the federal funds interest rate [for inter-bank lending], the Fed’s key interest rate tool.”

Sure, that’s exactly what the economy has needed since the fall of 2008: no increase in the total supply of credit. How’s that worked out for us? Yet, presumably, that somehow became the policy of the members of Congress who signed off on the economic stabilization legislation and the great financial minds who have led our federal economic policy.

Meanwhile, federal officials, including the President, are forced to launch even newer initiatives to loosen credit, such as proposed expanded loan programs to community banks and small businesses, while expressing frustration at the ongoing tight credit market for small businesses and homeowners.

President Obama announced on Oct. 21 why he was launching this new effort to loosen credit, as Bloomberg News reported: ​“There is still too little credit flowing to our small businesses,” Obama said. The steps being taken by the administration ​“will lead to more jobs, more growth, and a stronger economic recovery,” he said.

But he and his Wall Street alumni officials are not doing anything to impose new lending requirements on the five top commercial banks that now control 40 percent of all deposits, after federally-approved ​“shotgun” mergers, and trillions in loans and gurantees, have boosted their size and power.

And since few people involved in financial reform advocacy seem to have heard of the perverse federal incentive to hoard banks’ funds, let alone speak up about it, there’s no public pressure at all to fix the disincentives to lending. ​“It doesn’t help that there’s no incentive to lend money,” Prins observes.

Time nonetheless still portrayed Geithner as the noble champion of reform. Yet this is the same Tim Geithner who allowed Lehman Brothers to fail while chairing the New York Fed, helped push a no-strings-attached $17.5 trillion in bailout and guarantees to save Wall Street, and, of course, proposed last week that new blank-check program to salvage ​“too big to fail” institutions after they start to implode.

On Meet the Press, while Gregory asked some politely tough questions about continuing high rates of unemployment, he allowed Geithner to spin him, and the public, about the impact of the financial rescue operations implemented so far:

Right now what’s happening in the financial system is for the first time in almost 18 months the credit markets are opening up, companies are, are able to raise capital again. And the big risk we face now is not that banks are taking too much risk, the big risk we’re face right now is banks are going to take too little risk after having gotten it wrong in run-up to the crisis. And that’s why you see across small businesses, other parts of the country today, the kind of financial headwinds, the classic credit crunch risk that could slow recovery. The big risk we face now is that banks are going to overcorrect and not take enough risk. We need them to take a chance again on the American economy. That’s going to be important to recovery.

This Panglossian optimism supporting more risks – as opposed to sensible steps to spur lending in the real economy – in part leads Prins to conclude, ” The implicit idea in Geithner’s head and with Bernanke is that we’ve gone through the worst and it won’t happen again.” She contends that has led them to avoid stronger measures that could prevent ​“too big to fail” institutions from wrecking the economy again.

As economic analyst and author Jeff Madrick wrote this week in the Daily Beast:

The too-big-to-fail approach of Washington and the widespread advocacy of something along the lines now proposed in the House are simply naive, politically oriented reactions to crisis. A regulator is subject to the influence of the times and of those being regulated. It is called regulatory capture. Leaving decisions to the ad hoc judgment of such regulators only opens the door to future errors. The Fed already has plenty of such ad hoc authority over monetary policy. Let’s not give it more. Until we hear Washington speak about regulatory capture, we won’t really minimize the prospects of another credit crash

An effective federal back-up mechanism to salvage institutions that pose system-wide risk could be a sound idea if the legislation is improved, reformers say, but not without doing far more to prevent that risk in the first place.

But without sweeping, comprehensive reform, though, we’re just reduced to hoping that the financial institutions we depend on don’t try any double somersault-style investments on the financial tightrope being held up with taxpayers’ money.