Obama Calls the Question on GeithnerRobert Kuttner - Co-founder and co-editor of The American Prospect
Posted: October 10, 2010 08:07 PM
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By pocket-vetoing the bill that sailed through Congress to expedite mortgage foreclosures, President Obama may have begun a chain reaction that will blow up Treasury Secretary Tim Geithner's confidence game with the banks. Let me explain. In early 2009, Obama and his top economic aides faced a fateful choice: either do an honest accounting of the nation's big insolvent banks, like Citigroup; or keep propping them up and collude with the banks in camouflaging just how bad things were -- and still are.
They opted for camouflage. Geithner and the Federal Reserve devised a "stress test" exercise that avoided an honest accounting of the junk on the banks' balance sheets; instead they used economic models based on very rosy assumptions about how bad the recession would be. Citi and the others were pronounced basically healthy. This move avoided the kind of reckoning that would break up (and clean up) the big banks. Instead, the camouflage policy allowed the big banks to very slowly rebuild their balance sheets with speculative profit centers, relying first on TARP money and then on zero interest rate advances from the Federal Reserve.
But there was a huge downside for the economy. The banks reverted to the same kind of speculative plays that crashed the system; they also continued gouging consumers. And thanks to the Federal Reserve, the banks could make very easy money borrowing from the Fed at almost zero interest rates and investing the money in government guaranteed Treasury securities. By 2010, the banks were again making large profits and paying huge bonuses -- as if the financial collapse had never occurred. What they did not, however, do was make very many loans to small and medium sized businesses or hard pressed consumers. Meanwhile, regional and community banks, which do make loans to business, have been hard hit by the collapse in commercial real estate prices, and have tightened terms for ordinary business borrowers. So all but the largest businesses, which can access the bond market directly, are starved for credit.
Thanks to Geithner's permissive accounting standards, the big banks have also been allowed to carry on their books at full value securities based on underwater mortgage loans -- securities that are really worth between 30 and 70 cents on the dollar. If the banks had to honestly account for their depressed market value, the banks' balance sheets would look even worse. This is an exact repetition of what befell Japan in the 1990s -- a lost decade of economic growth caused by a financial collapse and the collusion of the government with the banks to pretend that all was rosy. Indeed, the US economy today is in far worse shape than Japan was, because all during that period Japan continued to be a major export power while the US today runs a huge trade deficit.
But Obama's veto of the foreclosure-streamlining bill calls the question on Geithner. We are now learning that a lot of the securities were not properly documented, which makes them worth even less. If the foreclosure machinery is suddenly gummed up because the President has ruled out a quick fix that favors bankers, the banks may be forced to recognize what the junk on their balance sheets is really worth (not much). And the whole game of pretending that all is fine with the banks is in jeopardy.
The fact is that a vast number of mortgages that we turned into mortgage backed securities are legally flawed. This calls into further question the value of massive portfolios held by banks -- and forces some kind of reckoning...
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