Throwing down the gauntlet
Institutional Risk Analytics managing director and financial commentator Christopher Whalen has challenged Timothy Geithner to a public debate, in which Barack Obama's nominee for Treasury Secretary could put forward his qualifications for the job and explain how he proposes run the office. Whalen talks to Business Spectator's Isabelle Oderberg about his fears that an opportunity for change in the way his country's economy and financial markets are managed has been lost and explains:
Isabelle Oderberg: You've publicly challenged Timothy Geithner to a debate about the US bailout and economy going forward. Do you want to tell me a little bit about why you’ve done this?
Christopher Whalen: Well, I’ve been having a go at him in The New York Times and some of the other media for the last couple of months and I felt bad because the man’s a human being and I feel he deserves an opportunity to take a shot at me, so since he’s been put forward as the nominee for Treasury Secretary, I think this is a good time to illustrate some of the issues that the next secretarial face, so that’s why I called him out.
IO: Are you questioning his ability to actually do the job? Do you think he’s got the mettle?
CW: Well, I think we could use someone with different talents. Let’s put it that way. I’ve got three basic beefs with Mr Geithner.
First and foremost is just experience. He doesn’t have any real financial markets or business side experience. He’s a political operative, a prodigy of Henry Kissinger, someone everyone knows. He has great political talents and qualifications but unfortunately Reserve Bank presidents in the Fed system tend to be patronage appointees and even back in the ‘20s before the Great Depression we had the same pattern, but we need people right now with very different skills. We need people who actually know how to take a company apart and understand financial markets and all that, because we’re going to be faced, in the next couple, of years with a lot of problems that have nothing to do with politics and in good times Geithner would be a perfectly fine Treasury Secretary flying around and going to summit meetings and stuff like this, but I don’t think he has the background really to deal with the issues that are pressing. So that’s kind of the first point.
The second issue is more serious which is just his performance to date, since really you could say the New Century Financial collapse which was at the beginning of 2007. The Fed and the other regulators have been pretty much on notice that the bloom was coming off the rose and the real estate market in the US, right, and you even had other indicators. One of the most interesting ones was Washington Mutual had actually been shrinking their bank since 2005. Rather remarkable, don’t you think? So the point was that Geithner, Ben Bernanke, the Board of Governors, the whole slew of other officials at the Fed, the other regulators didn’t get it and we lost almost a year between the collapse of New Century and finally with Bear Stearns’ collapse in the late spring of this year. So the problem was, with Bear they didn’t let it go bankrupt. They saved it and in fact they gave the equity holders $10 a share, which today looks rather extraordinary, doesn’t it? So by doing this, he gave the wrong signal to the market. He said to the market place 'it’s OK, no matter how excessive, how silly are the things you’ve been doing for the last few years, in terms of leverage and derivatives, we’re going to bail you out and indeed we’re going to bail out the equity holders, so the bond holders got a free ride, the equity holders got $10 a share'. That’s amazing. So you wind the clock forward through the summer and come September we have the failure of Lehman Brothers and everybody of course looking at the Bear Stearns example assume that the fed would also prop up Lehman Brothers and when they did not, they not only surprised everyone which is the definition of a systemic event by the way, but they terrified everyone because of their inconsistency.
So just these two events and then the subsequent bailout of AIG, which is essentially a prop for the credit default swap market, you have this pattern of inconsistency and I think also very troubling partisan and almost favouritism by a Fed official towards a couple of firms on Wall Street and this is really my third point with Mr Geithner and that is the nexus he has formed over the last 18 months or so with the Goldman Sachs crowd, with Hank Paulson, let us not forget was the head of Goldman Sachs, and with this whole group of officials around this bank and Morgan Stanley.
It would be one thing if you could complain and say Geithner represents Wall Street, but I think he only represents a small piece of Wall Street because much of the rest of the financial community’s been left to the wolves. But I think my big concern is that by having our new president-elect select Tim Geithner, there is no change. There’s continuity unfortunately between the people who’ve been running this bailout, very badly I think, and Mr Geithner now coming into treasury to continue those policies. I really worry because I didn’t vote for Barack Obama, but I think we have a shared interest in his success as President. We really need to see him address the economic and financial issues in a very direct way and so, you know, having the right person in treasury is absolutely essential.
IO: OK. You’ve raised a whole lot of really interesting issues, so let's just go back and examine a few. In terms of the inconsistency of who’s getting propped up and bailouts and who’s not, to what degree would Timothy Geithner have been involved in those decisions?
CW: Well, very much. I mean the Bear Stearns thing was thrown right in their lap and they indeed agreed to loss sharing between the fed in New York and JPMorgan Chase in order to incentivise JPMorgan to buy Bear. There is this vehicle called Maiden Lane, which is the assets of Bear Stearns that the Fed took away from this insolvent dealer and then the rest of it was sold pretty much as is to JPMorgan. That’s kind of almost a description of a bank resolution process or what we call open bank assistance. But I think it was a mistake. Bear belonged in bankruptcy. The Fed should have stuck to its guns or stuck to our national tradition of letting insolvency resolve problems with broker dealers because we have a whole structure of law, we have SIPC [Securities Investor Protection Corporation], we have all of the other mechanisms for dealing with broker dealer insolvencies and that’s where this one belonged - in bankruptcy court in New York.
IO: Now, you also mentioned Geithner's links to Hank Paulson and to some of the investment community, though not all. Who would have been a more bipartisan candidate? Would it be difficult to find someone who didn’t have links to certain parts of the…
CW: Oh, no, no, no. Look, look. You’ve got to understand America has been held hostage by a criminal gang from Wall Street who have bought their way into politics and have been directing our financial services policy in this country for many years. Their end is near because the harsh drop in aggregate demand and economic activity in the US this next 12 or 18 months is going to be so nasty that it’s going to consume many of these people in terms of their careers. But you’ve got to realise it’s a…look at Paul O’Neill. Everybody laughed that Paul O’Neill came from industry, very plain sort of guy, but the best Treasury Secretary we’ve had in a long, long time; wasn’t corrupted by Wall Street, wasn’t like a Rubin or a Summers [both former Treasury Secretaries] who were both basically creatures of Wall Street and really quite incompetent too. I mean, imagine having Robert Rubin as the overarching demigod of the Obama economic team. The man has overseen an absolute catastrophe at Citigroup. He was the lead director of that bank. He’s still there. He hasn’t even had the common sense to resign and that bank is going to end up probably under the control of our government banks here. So, the same crowd is here that we had 12 years ago and my question is: why?
I’ll give you an example. Two great candidates we could reach out to; Roger Ferguson, a former vice chairman of the fed, chairman / CEO of TIAA-CREF [Teachers Insurance and Annuity Association - College Retirement Equities Fund], one of the smartest humans on the planet, very capable guy, has run banks, run companies, worked for McKinsey, so you know, hands on sort of guy and there’re other people around the community we could reach out to. There’s the chairman of Wells Fargo. I think we can tolerate asking somebody to come directly out of industry at a time like this. But I’d love to have somebody who’s actually done deals, who’s gotten their hands dirty in either financing or bankruptcy because that’s really the competency we need. And go back to Paul O’Neill; he was a decent, honest man who understood business and Wall Street hated him because he wasn’t aligned with their agenda and they drove him out of the administration and then we end up with Hank Paulson. You know, Hank Paulson’s a politician too. Remember Paulson worked for Haldeman and Ehrlichman in the Nixon Administration. Don’t ever forget that.
IO: Everyone that I spoke to in the US before the election, all the economists, yourself, Bert Ely, said that Obama just simply didn’t have the economic or financial credentials to have the Presidency, except for Stiglitz. Stiglitz was the only one who said that he was very much in favour of an Obama presidency. My question is: has Obama failed his first task? Does his appointment of Timothy Geithner in this position give you real fear for his economic and financial decision making going forward?
CW: Well, it does in that I’m just disappointed. I was hoping to see more diversity in terms of the people at the table...Paul Volcker’s great. He’s an old family friend. I know the chairman. In fact, I saw him recently. This isn’t his battle. He is very credible, he’s got great wisdom but he doesn’t understand the details of this mess sufficient to really wade in there and deal with it and we need to go back and look at the people in the ‘30s like Jesse Jones, like the others at Treasury and the FDIC [Federal Deposit Insurance Corporation] because those were technicians. They were not political at all and they were there to do a task which was the remediation of an economy that had 50 per cent foreclosure rates. We’re not there yet but we are going to be next year. I think next year will really surprise people as to the depths of the trough, if you will, in terms of the bank industry and real estate and we’re going to need people who know how to roll up their sleeves and do the right thing which is bankruptcy. You can’t paper over this stuff. We can’t paper over AIG. The AIG belongs in a bankruptcy and that’s how we’re going to cut to the chase and get this economy back on its feet quickly.
So my fear is that Obama doesn’t get advice like this. He’s getting advice from a bunch of essentially academic economists who think that they can play around with the levers of policy and print some money and re-inflate this economy and what I’m telling you is that it may not be that easy, because we’ve destroyed so much of our market infrastructure in the US. There’s not much left for the Fed to manipulate. They don’t have banks that they can use to leverage and create credit and the only banks that are viable are the smaller and medium-sized institutions and I think that’s where we’re going to have to draw the line. You’re going to end up nationalising Citi. You’re probably going to end up nationalising JPMorgan with a big government stake in Bank America and Wells Fargo even and so the rest of the industry’s going to have to be rebuilt around our US Bancorp and M&I Bank, people like that, that aren’t really household names nationally, but they have the skills to make loans. See the big guys don’t and the big guys… like I say, we’re going to end up having to liquidate these banks. Imagine the politics of that. So, Obama needs more people on his economic team, trust me, but I think events are going to dictate that. He’s going to be forced to go back and look for more qualified people to get involved in this just by the sheer press of issues that need to be addressed.
IO: Timothy Geithner was not elected. He was appointed. Do you think he really should have to get up in a public forum and defend himself?
CW: Well, I do and in a very collegial way. If you want to be the chief fiscal officer of the United States at a time like this, I think you damn well better be able to get up in front of a crowd and defend yourself and defend your position because you are in fact going to become the chief salesman of the United States and it may not be that easy for the US to sell that as we go forward. This is one of the other infantile assumptions that you see in Washington still is that they just assume that the markets will buy endless amounts of treasury debt at rates that are comfortable and that’s not the case. Right now everybody wants treasury bonds, but that will not always be the case and you’re going to see yields in the US climb, I think, after we get passed this bailout phase.
IO: Not sure China’s going to be lining up again?
CW: Well, they don’t have a lot of choice. I mean this whole notion of decoupling is really quite silly, isn’t it? I think we’ve addressed that for now.
IO: I wanted to ask you how you feel about a possible automotive industry bailout. I’m not an American citizen, but I would be pretty concerned if I was a tax-payer and my tax dollars were going into propping up publically-listed companies that hadn’t done a very good job of managing themselves and are flying around on corporate jets to attend meetings to ask for money. What’s your feeling about the car bailout?
CW: Well, I think you’re right. I mean GM and the rest of it should all probably go through a restructuring. The politics of this are somewhat difficult, but you know the argument is made that the auto makers were making progress and this financial crisis has essentially left them high and dry. I don’t know that with the Democrats in charge in Washington now, you’re going to avoid some kind of a SOP [Standard Operating Procedure] being thrown to them, but long term I think Chrysler’s going to be gone. Ford, you know there’s no point in putting Ford in bankruptcy because they’ve already leveraged all their assets to the banks, so it’s already done and they’ve made progress, probably more progress than GM. But in GM is a mess. They have to rationalise their relationship with the unions and they have to do a lot of things that are probably best done in a bankruptcy. So, I agree with you.
IO: When you say that Chrysler’s gone, how’s it going to 'get gone’?
CW: Well, there’s not much left of it. It’s already pretty much controlled by the vendors, but in any event, I think Cerberus made a mistake buying Chrysler from Daimler. I think the thing should have just been restructured at that point and I’m pretty sure that’s what’s going to happen because to me there’s no point in propping up Chrysler. I think you have too much capacity in North America. You’re going to have too much capacity for years if we’re going to be struggling to do 10 or 12 million units this next calendar year, so obviously we have one too many car companies and one of them needs to go. So, I agree with you.
IO: So, I just want to understand this. You said that GM’s a mess and needs restructure and needs to re-establish its union relationships. You said Ford has made the most progress out of any of the companies.
CW: And they’ve already refinanced. I mean if you filed for bankruptcy tomorrow with Ford, there wouldn’t be anything left because all the creditors have already got it.
IO: So that leaves GM for a possible cash injection. Would you be injecting cash…?
CW: Oh no, I think they’ll all try and take the cash if it’s offered. I agree with you. I don’t think there’s any point. I think you should let them be.
IO: Let what will happen, happen, que sera sera?
CW: Yes.
IO: Yesterday the Dow Jones ended up 4.6 per cent I noticed. Is this anything to get excited about or is it just another sort of volatile up or down motion?
CW: It’s volatility. I mean most equities right now are in a situation where… well, most large cap equities have triple digit volatilities right now, so they going to move around a lot.
IO: I think every time we Aussies come to work in the morning and the Dow Jones is up more than three per cent or so, everyone goes ‘Oh, could this be it? Could this be turning the corner? Could people finally start putting money back in instead of taking it out?’
CW: Well, yeah, there are analysts out there saying that US banks are cheap and I think that’s crazy. I think that we’re in a period now of still people not ready for capitulation. They still think that there’s going to be a bounce or that whatever means are being thrown at the financials are going to help provide the economy, but we’ve taken so much financing out of this economy over the last 12 months, it’s going to take a long time to replace that. I mean it’s trillions of dollars worth of available financing, so it’s got to bring activity down. There’s just no other way for it to go and you see what the fed’s doing. They’re buying assets directly. They’re offering cut rate financing to people who have GSE Paper for example which is trading almost two points over treasury’s now. So there’s still a lot of dysfunction in the markets and that’s not going to change any time soon, so I definitely wouldn’t be buying bank stocks to hold right now because I think a lot of them could go to zero. The people who will really benefit from this are the ones who have cash and who will be ready to buy these assets on the other side of a resolution, a receivership. That’s where you’re going to see people making a killing.
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