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Banking on a banker
Does the Treasury secretary's past career matter?
SO THE new Treasury Secretary, it seems, will be Timothy Geithner, currently president of the Federal Reserve Bank of New York. As the top economic official in Barack Obama’s administration at a time of economic crisis, he must be up to the task at hand, and his expected appointment has been widely welcomed. But does his previous career, mostly as a government bureaucrat in the central bank, really equip him for the job?
The first Treasury Secretary, Alexander Hamilton, was a politician, economist, lawyer, businessman and banker. His successors have typically been at least one of those—though they have disproportionately come from Wall Street.
But the tenure of the current Treasury Secretary, Hank Paulson, proves, if nothing else, that having a Wall Streeter in the Treasury is no guarantee of success. Mr Paulson may have been more familiar with the complexities of the financial system than his two predecessors, John Snow and Paul O’Neill, but that did not stop him making some catastrophically bad decisions—notably failing to rescue Lehman Brothers and, last week, reviving uncertainties about Citigroup by saying that the Treasury would not buy the toxic assets from banks it had earlier pledged to purchase.
In an effort to demonstrate that the “real” economy, not finance, drove policy, President George Bush’s first two Treasury secretaries were selected for their big business background. Mr O’Neill headed Alcoa, an aluminium giant, while Mr Snow led CSX, a rail-transport company.
Apart from being businessmen, however, they had little in common. Mr O’Neill was outspoken and often publicly at odds with his president. Mr Snow concentrated on being boring, which was probably why the president wanted him in the job.
Before them was Larry Summers, an economist, whom Mr Obama reportedly passed over this time, opting instead to make him head of the National Economic Council (NEC). One of the main tasks of the Treasury Secretary is to reassure the markets and the public. Economists, by contrast, are at their best—and there are few better than Mr Summers—when they are thinking the unthinkable, challenging conventional wisdom and doing other things that are anything but reassuring.
Public statements by Mr Summers occasionally flustered the markets when he was Treasury Secretary, and that was during unusually upbeat economic times. Mr Obama was surely wise to leave provocative economic thoughts to the NEC.
The most reassuring Treasury Secretary in recent memory was Robert Rubin, who preceded Mr Summers. He oozed credibility, not least during the Asian financial crisis and collapse of a hedge fund, Long Term Capital Management, which helped bring about a rapid recovery of confidence in the markets. The precise source of Mr Rubin’s credibility—which he retains to this day, despite having spent the past few years at the top of Citigroup—remains unclear, though it was thought to stem from his understanding of Wall Street, having formerly headed Goldman Sachs.
Mr Paulson, another former boss of Goldman Sachs, was supposed to bring a similar ability to reassure. Perhaps this hope reflected too simplistic an understanding of what Messrs Rubin and Paulson did at Goldman. Mr Rubin rose to the top through risk arbitrage. As a trader, he knew that the important thing was to understand the big picture, and get big calls right. He knew to keep his mouth shut: talking about your ideas might let someone else steal your profits. This may be the perfect skill set for a Treasury Secretary, which is why the trader currently running Goldman, Lloyd Blankfein, might one day make a good one.
Mr Paulson, by contrast, rose to the top of the firm through investment banking, which is largely about dealmaking. The caricature of a dealmaker is someone who only wants to get the deal done, and cares not one fig for the consequences. Indeed, a lot of investment-banking deals involve undoing mergers put together by previous dealmakers.
The meltdown in the financial markets was arguably due in large part to dealmaking while ignoring the bigger picture. And Mr Paulson has stumbled from one crisis to the next, often fixing one in a way inconsistent with his approach to the next, with little indication of having a bigger strategy.
Mr Paulson’s poor showing is perhaps also evidence of the risks of putting a very rich man in charge of the Treasury. Like Andrew Mellon on the eve of the Great Depression, Mr Paulson has struggled to communicate with, or understand the needs of, the common man. Perhaps Warren Buffett, once tipped for the job, would have done better, though Mr Obama was probably wise to pass him over.
So instead it is the turn of a central banker. Mr Geithner is well liked and respected. His ability to keep his mouth shut and avoid controversy certainly gave him an edge over Mr Summers. Yet it is not clear whether the skills of a central banker are those needed by a Treasury Secretary.
There is a worrying precedent. In 1979, George Miller, then the chairman of the Federal Reserve, was appointed Treasury Secretary by Jimmy Carter (after he had informed the president of some unsavoury personal details about the previous Treasury Secretary). Mr Miller had done a lousy job fighting inflation at the Fed, where he was replaced by Paul Volcker.
He also became embroiled in controversy surrounding the government bail-out of Chrysler. Mr Geithner is likely to preside over a similar rescue, albeit also of General Motors and Ford. Let’s hope that will be the only way in which history repeats itself—and that Mr Geither will prove that a central banker can be an effective Treasury Secretary.
Commentary by David Pauly
Nov. 25 (Bloomberg) -- Sandy Weill never dreamed Citigroup Inc. would end up as a ward of the government.
When he merged Citicorp and Travelers Group Inc. in 1998, Weill envisioned the ultimate financial-services empire -- peddling checking accounts, stock brokerage, investment banking and commercial loans around the world.
Today, five years into his retirement as chief executive officer, Citigroup has collapsed under the weight of massive bad market bets.
After the company’s stock closed Nov. 21 at $3.77, down 87 percent for the year, the U.S. government threw more aid at the giant to prevent a run on the bank by customers.
The Feds agreed to back up $306 billion in Citigroup bad debt, covering 90 percent of losses after the bank absorbed the first $29 billion. The government also infused $20 billion into the bank with a purchase of preferred stock. That was in addition to the $25 billion of Citigroup preferred shares it bought last month as part of a plan to recapitalize U.S. banks.
Citigroup’s failure undercuts the strategy of many U.S. businesses. Bigger is better, CEOs argue. Only the big survive in a cutthroat world. What they don’t say is, I get paid more if my company gets larger. In the years 2000 through 2005, Sanford I. Weill took $83 million in bonuses for his work at Citigroup.
Weill and his successor, Charles Prince, might argue that they had bad luck. No one predicted the collapse of the credit markets that followed the excesses of the U.S. mortgage business. Still, wasn’t the Citigroup financial powerhouse built to survive any crisis?
Sorry History
Better that they should acknowledge the colossus was a bad idea, and their own poor management. Citigroup’s $66 billion in write-offs for bad loans proves a reckless approach to investments. On Weill’s watch, Citigroup issued fraudulent reports on stocks and paid billions of dollars to settle charges it misled bond buyers.
The government may have let current Citigroup CEO Vikram Pandit remain at the helm because he has been in charge only since December -- leaving most of the blame to Weill and Prince.
Citigroup shares yesterday rallied along with the rest of the stock market after the company’s second bailout, climbing to $5.95. The Standard & Poor’s 500 Index rose 6.5 percent.
U.S. taxpayers can only hope this latest government move is the answer to the credit-market woes. If banks start trusting each other again, losses on the bad-loan deal with Citigroup might be minimal.
Happy Returns?
There’s also a chance the government will earn a little money for its efforts. For the new $20 billion in cash, it gets $27 billion in Citigroup preferred stock, paying an 8 percent dividend. The Feds also get an option to buy a 4.5 percent stake in Citigroup common stock.
As part of the earlier deal, the government owns $25 billion of Citigroup preferred, paying 5 percent the first five years and 9 percent after, plus warrants to buy common shares equal to 15 percent of that preferred investment.
Weill’s Citigroup stock prospered for a time after his merger, topping $50 on occasion. But the shares began falling steadily in the spring of 2007. Citigroup’s best strategy now may be to undo what Weill wrought and Prince tried to manage.
“We should be thinking about breaking this company up and redistributing the assets into stronger hands,” says Christopher Whalen of Institutional Risk Analytics, a research firm in Torrance, California.
Let’s hope Bank of America Corp. CEO Kenneth Lewis is paying attention. Lewis bought Countrywide Financial Corp. to beef up in mortgages, and is buying Merrill Lynch & Co. to add stock-brokerage and investment-banking assets. Does he really want to mimic Citigroup?
Commentary by Caroline Baum
Nov. 25 (Bloomberg) -- It’s not every day that college students get to play policy maker. Nor would most of them want to, even in the best of times. The arcana of monetary policy is something that more typically appeals to Ph.D. economists.
Yet here they were, at ground zero in the war to contain the financial meltdown. Teams from seven colleges descended on the Federal Reserve Bank of New York last Friday to compete in the semifinal round of the Fed Challenge, a learn-by-doing program that’s the brainchild of Lloyd Bromberg, director of school programs at the bank.
The New York Fed is one of four district banks participating in the program, which began as a high school competition in 1995 with 14 schools participating. The college competition started in 2000 and had 125 entrants this year.
Dressed in suits, accompanied by faculty advisers and armed with elaborate PowerPoint presentations, teams of three to five undergraduate students present their analysis of current economic conditions, forecast for the economy, assessment of risks and recommendation for policy.
In other words, it’s just like a Fed meeting, without the refreshments and the headaches policy makers endure in their effort to stay no more than two steps behind the crisis.
Team members address one another as “Chairman Amin” and “Governor Cohen.” One team has a token hawk who argues against lowering the benchmark interest rate from its current 1 percent.
The students compose a statement to be released to the public at the conclusion of the meeting. One Fed chairman has taken it upon himself to draft the statement in advance, a Greenspan touch that was not lost on this observer.
Judge Judy
I am one of three judges evaluating three of the seven semi- finalists. (The teams’ affiliations aren’t known to the judges.) I have been pre-schooled in my judicial responsibilities and have studied the material Bromberg sent me.
Even so, I am not prepared for what I see and hear. I’m blown away by the students’ poise, presentation skills and wide- ranging knowledge as they deliver their 20-minute presentations and submit to 15 minutes of questioning from the judges.
We grade the teams on knowledge of the Fed, presentation skills, quality of research and analysis, and teamwork.
There are no slackers among them. The teams are well- prepared and well-versed, not just in the format of Fed meetings and the latest economic and financial developments but in Fed research and speeches from years ago.
One team, responding to a question on what the Fed can do (in addition to lowering the funds rate) to stimulate the economy, cited a 2004 paper by then-Fed Governor Ben Bernanke and then-Fed Director of Monetary Affairs Vincent Reinhart on conducting monetary policy when the overnight rate is close to zero. In it, the economists recommend quantitative easing, buying long-term bonds and influencing expectations about future short- term rates. Bernanke could dust off that paper and recycle it today.
Channeling Operation Twist
One student critiqued the recommendations, invoking the Treasury’s failed experiment in reshaping the yield curve in the 1960s, known as “Operation Twist.”
This isn’t the stuff one learns about in Econ 101 or from the chapter on the money multiplier in an Intro to Macro text. These kids live and breathe this stuff. Some past winners have gone on to internships and careers at the Fed. Participation in the Fed Challenge has become a “recognizable credential” on a student’s resume, Bromberg says.
The Chicago Fed, another participating bank, had a Fed Challenge summer camp. One high school held a pep rally to support the team it was sending into competition, with 500 students showing up.
Learning by Doing
At Friday’s Fed Challenge, the students demonstrate they have mastered the art of Fedspeak, tossing out well-worn phrases such as “uncertainty” in the outlook, the risks of a “negative feedback loop,” the importance of “anchoring inflation expectations,” and other staples. They are equally adept at discussing how monetary policy works.
When Bromberg came to the New York Fed in 1994 from the New York City school system, “the challenge was, what can we do to teach the kids about the Fed,” he told me over lunch last Friday. “What way do the students learn best? It doesn’t always work well with someone telling you about it. You have to do it.”
The Fed Challenge is doing in the extreme. The only thing missing is the outcome of policy decisions and the onus of living with them.
As the finals get under way Friday afternoon with the four teams that have made the cut, Bromberg emphasizes that it’s not about competing or winning. All the students are winners, he says, even if they don’t qualify for the monetary awards established by the Moody’s Foundation.
Pretend Meets Reality
The students don’t see it that way. They have worked long and hard and want to be selected to compete in the “nationals” at the Federal Reserve Board in Washington on Dec. 3. There, the winner of the New York Fed Challenge -- New York University’s Stern School -- will meet winners from the Boston, Chicago and Richmond Fed Districts.
At that time, the pretend policy makers will be judged by the real ones, who may just learn a thing or two in the process.
Nov. 25 (Bloomberg) -- The U.S. Treasury and Federal Reserve will unveil as soon as today a lending program to shore up the consumer-finance market, using money from the government’s $700 billion rescue, two people familiar with the effort said.
The Treasury and the Fed will help fund new loans packaged into securities for sale to investors, the people said. Treasury Secretary Henry Paulson, who scheduled a press conference for 10 a.m. New York time, said two weeks ago that he wants to spur lending for automobile purchases and college education while also reducing the cost of credit-card debt.
Paulson and Fed Chairman Ben S. Bernanke are widening the scope of their rescue efforts after agreeing two days ago to guarantee $306 billion of Citigroup Inc.’s toxic assets. Paulson has spent most of the first half of the government’s Troubled Asset Relief Program aiding Wall Street banks, and pressure is growing in Congress to help average Americans.
“Paulson needs to be seen taking a leadership position,” said Axel Merk, president of Merk Investments LLC in Palo Alto, California. “The markets are desperately looking for guidance on the way forward.”
Senator Charles Schumer, a New York Democrat, urged the Treasury and Fed yesterday to use the $700 billion fund to make it easier for automakers’ finance units to lend.
Credit for Autos
“It is vital that this facility be established immediately and in sufficient size to allow consumers reasonable access to credit for auto purchases,” Schumer said in a letter to Bernanke, Paulson and Neel Kashkari, the official in charge of the bailout program.
Paulson previewed the new program in a Nov. 12 speech, when he said the Treasury and Fed were “exploring the development of a potential liquidity facility for highly rated AAA asset-backed securities.” The government could use some of the bailout fund to encourage private investors to re-enter the market, he said.
“Addressing the needs of the securitization sector will help get lending going again, helping consumers and supporting the U.S. economy,” Paulson said.
Fed spokeswoman Michelle Smith declined to comment.
This will be the second Fed lending program involving funding from the Treasury. The central bank’s Commercial Paper Funding Facility, begun last month, took $50 billion in seed money from the Treasury and purchased $272 billion of the short- term debt from U.S. companies as of Nov. 19.
The Fed’s other emergency-lending programs begun over the past year provide auctioned loans to commercial banks, cash loans and Treasury securities to Wall Street bond dealers and aid to money-market mutual funds experiencing redemptions.
Nov. 25 (Bloomberg) -- U.S. Treasury Secretary Henry Paulson said a Federal Reserve lending program announced today will enable banks to extend more credit to consumers and businesses.
“I and my regulatory colleagues are committed to using all the tools at our disposal to preserve the strength of our financial institutions and stabilize our financial markets, to minimize the spillover into the rest of the economy,” Paulson said in a statement at a press conference in Washington.
The Treasury committed $20 billion of its Troubled Asset Relief Program as part of a new $200 billion plan to support consumer and small-business loans. The Fed separately said it will buy as much as $600 billion in debt issued or backed by government-chartered housing finance companies such as Fannie Mae and Freddie Mac.
The program “underscores our support for the housing market,” Paulson said. “Nothing is more important to getting through this housing correction than the availability of mortgage finance.”
The efforts by Paulson and Fed Chairman Ben S. Bernanke are the latest attempt to alleviate the credit crunch. Paulson has committed all except $20 billion of the first half of the $700 billion TARP program with less than two months before the end of the Bush administration.
“It will take time to work through the difficulties in our markets and our economy, and new challenges will continue to arise,” Paulson said.
Under the new Term Asset-Backed Securities Loan Facility, the Fed will lend as much as $200 billion on a non-recourse basis to holders of AAA rated asset-backed securities backed by “newly and recently originated” loans, such as for education, credit cards, automobiles and loans guaranteed by the Small Business Administration.
Paulson has committed $270 billion to inject capital into banks, including $20 billion as part of a rescue of Citigroup Inc. two days ago, and brokered a deal providing $40 billion to insurer American International Group Inc.
Nov. 25 (Bloomberg) -- The Federal Reserve took two new steps to unfreeze credit for homebuyers, consumers and small businesses, committing up to $800 billion.
The central bank will purchase as much as $600 billion in debt issued or backed by government-chartered housing-finance companies. It will also set up a program of $200 billion to support consumer and small-business loans, the Fed said in statements today in Washington.
With today’s announcement, the central bank is starting to use some of the unorthodox policy tools that Chairman Ben S. Bernanke outlined as a Fed governor six years ago. Policy makers are aiming to prevent a financial collapse and stamp out the threat of deflation.
“They’re trying to put funds into the system, trying to unfreeze these markets,” said William Poole, the former St. Louis Fed president, in an interview with Bloomberg Television. “Clearly, the Fed and the Treasury are beginning to take a large amount of credit risk.”
The Fed will purchase up to $100 billion in direct debt of Fannie Mae, Freddie Mac and the Federal Home Loan Banks and up to $500 billion of mortgage-backed securities backed by Fannie, Freddie and Ginnie Mae, the statement said. Treasury Secretary Henry Paulson said at a press conference that $200 billion is just the “starting point” for the asset-backed securities program.
“The economy is turning down pretty dramatically,” he said. “It’s very important that lending continue to be available.”
Help for Housing
“This action is being taken to reduce the cost and increase the availability of credit for the purchase of houses, which in turn should support housing markets and foster improved conditions in financial markets more generally,” the Fed said.
Fannie and Freddie bonds rallied. The yield premium on Fannie Mae’s five-year debt over similar-maturity Treasuries tumbled 21.5 basis points to 114.7 basis points as of 8:35 a.m. in New York, according to data compiled by Bloomberg. A basis point is 0.01 percentage point.
“The cheaper that they could issue their debt, the more aggressively they should be able to buy mortgages in the secondary market,” said Alan Bosworth, director of agency trading at Vining Sparks in Memphis, Tennessee.
The Fed may hold the Fannie and Freddie debt and securities until they mature or sell them, with plans to be determined, government officials said on a conference call with reporters.
Low Rates
The U.S. officials, speaking on condition of anonymity, said they don’t see the Fed purchases of mortgage bonds as a way of “quantitative easing,” or using central bank policy to add reserves to the banking system when interest rates are very low, even though the purchases will have that effect.
Separately, under the new Term Asset-Backed Securities Loan Facility, the Fed will lend up to $200 billion on a non-recourse basis to holders of AAA rated asset-backed securities backed by “newly and recently originated” loans, such as for education, automobiles, credit cards and loans guaranteed by the Small Business Administration, the Fed said.
The Fed hopes to have the TALF running by February. Traditional investors in the asset-backed securities include securities lenders and bank-affiliated conduits, the government officials said.
The asset-backed securities program is similar to the Fed’s effort to bring down the cost of financing for commercial paper, the short-term debt companies issue to finance payrolls and other expenses, because it goes beyond banks.
‘What Works’
“What the Fed has been trying to do is get a sense of what works and what doesn’t work,” said Derrick Wulf, who helps manage $70 billion in mostly fixed-income assets at Dwight Asset Management Co. in Burlington, Vermont. “One of the things that has worked is the commercial paper facility.”
Wulf added that “it can certainly improve credit conditions for consumers.”
The Treasury will provide $20 billion of “credit protection” to the Fed in the lending program, using funds from the $700 billion financial-rescue package. The Treasury said in a statement that the facility may expand over time and cover other assets, such as commercial and private residential mortgage- backed debt.
Treasury staffers are in regular communication with President-elect Barack Obama’s team, officials said. New York Fed President Timothy Geithner, Obama’s pick to be Treasury secretary, was involved in today’s plans, though not in a capacity with the new administration, officials said.
Weakening Economy
With the asset-backed securities program, the Fed is trying to avoid having “continued disruption of these markets” that would limit lending and “thereby contribute to further weakening of U.S. economic activity,” the central bank said.
Under the new lending program, known as the TALF, the New York Fed will auction a fixed amount of loans each month for a one-year term. Assets will be held in a special-purpose vehicle to be created by the Fed. The program will stop making new loans on Dec. 31, 2009, unless the Fed Board of Governors extends it.
Lenders providing credit under the TALF “must have agreed to comply with, or already be subject to,” executive- compensation restrictions in the October bailout law, the statement said.
The Fed will start buying the direct debt of government- sponsored enterprises -- Fannie, Freddie and a dozen federal home loan banks -- through primary dealers in government debt from next week. The purchases of mortgage-backed securities will be done through asset managers, and officials aim to begin the effort by year-end.
Purchases of both types of debt “are expected to take place over several quarters,” the Fed said.
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