What Went Wrong for Tim Geithner

It was a good week for Barack Obama. He found his voice during a fine visit to the heartland in Elkhart, Indiana. He turned in a masterful performance at his maiden press conference, deftly explaining how he was reaching out with new civility to the Republicans, and if they were too pigheaded to accept the olive branch, well, he would have to roll over them for the greater pragmatic good of the Republic. The Senate passed his stimulus bill, as choreographed, and the House would soon undo part of the damage. There was little doubt that the bill would be on his desk by President's Day.

And then Tim Geithner stumbled again. The treasury secretary had gotten off to a rocky start when tax irregularities imperiled what should have been a smooth confirmation. He survived, passing the Senate on the grounds that he was an indispensable man in a terribly dangerous time.

Now, Geithner has unveiled a Rube Goldberg of a second bank bailout that won no plaudits anywhere on the spectrum. The idea was to reassure financial markets by resisting nationalization of failed banks. But the financial markets took one look at the plan, and the Dow fell by almost 400 points. As well it should have. This is not a plan that fixes Wall Street. It is a plan that rebuilds it using the very profit-hungry traders and exotic financial instruments that caused the crisis in the first place.

There were signs that some in the administration were uncomfortable with the proposal before it was even announced. In a strange and revealing preemptive leak, The New York Times published an anonymously sourced article on the eve of Geithner's performance in which other Obama officials took pains to distance themselves from Geithner. It was Geithner, they said, who had weakened the plan’s more punitive elements and who had struggled against strict limits on executive compensation. It was Geithner's plan, and it would be Geithner, they implied, who should be blamed if it failed.

Their desire to distance themselves was not misplaced. The plan is a convoluted mess, but here is the essence: The basic problem is that America's largest banks are insolvent. They owe more than they own. Geithner's strategy is to disguise this reality. His problem is that Congress is in no mood to legislate another nickel of bailout funds. If his latest plan were written as legislation, it could not get even a majority of Democrats. So his scheme takes $100 billion of the Treasury's remaining $350 billion in TARP money, uses the Federal Reserve's enormous funds, which are outside congressional control, to leverage that sum to $1 trillion, and then uses that money to insure private purchases.

If that sounds complicated, it is. And it’s complicated because Geithner expressly rejected the more straightforward solutions: He explicitly ruled out direct government ownership of the big banks, or even giving the government majority seats on bank boards. Rather, under his plan, regulators will subject bank balance sheets to intensified study to determine just how bad things are -- something that regulators should have been doing all along. Then, Geithner hopes to use loans from the Federal Reserve and guarantees from the remaining TARP funds "as a bridge to private capital," as Geithner delicately put it. Private capital turns out to mean private equity and hedge funds.

Geithner's premise is that banks are not engaging in a variety of lending because they are no longer able to package loans as bonds. So Geithner, using public funds, hopes to restart the engine of loan securitization. In effect, he wants to rebuild the very model that caused the crash, relying on the most unsupervised and speculative part of the system -- hedge funds and private equity. One well-placed official told me, "It's as if his goal is to help Wall Street, not to restore a functioning banking system."

Nobody has figured out how existing toxic assets would be priced; that is one of the many details to be filled in later. But if hedge funds and private-equity companies are to profit -- with government and Federal Reserve guarantees, no less -- it has to be a less efficient and more risky and costly solution than temporary government ownership, if only because it is so much more circuitous, with so many more players who need to take a cut.

By doubling down once more, Geithner is now playing roulette with America's ultimate bank, the Federal Reserve, which stands to take on at least a trillion dollars more in risk, doubling the size of the Fed's own balance sheet. People mistakenly think that the Fed "prints money" without consequences. It does not. The Fed has a balance sheet of assets and liabilities like any other bank.

For Obama, the huge political problem is not just that the Geithner plan is a stinker. It's that the controversy over the bank bailout is upstaging the stimulus debate, where Obama has had the upper hand. But in the news coverage and the public perceptions, the $800 billion stimulus -- mostly for regular Americans -- is getting all mixed by with the $1.5 trillion bailout for Wall Street.

Obama's political team, which ordinarily never sleeps, just missed this one. Geithner's plan should never have seen the light of day until the recovery bill was safely on the president's desk. Now they should take Geithner's plan back to the drawing board. Or maybe his successor will.

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