Tim Geithner dismisses the idea that he is manipulated by Wall Street. And indeed the Treasury secretary, a career Washington technocrat, has never worked on the Street. But that doesn't mean the kings of finance aren't influencing Geithner now. In fact, the public-private partnership plan that Geithner laid out with great fanfare last week to address the "legacy" assets issue was first conceived by Warren Buffett.
Buffett proposed the idea in a letter to Hank Paulson early last October, according to Phillip Swagel, who was assistant Treasury secretary for economic policy under Paulson. (A current Treasury spokesman confirms that Buffett "had some interesting ideas that are consistent with the concept" of what has become known as the Public-Private Investment Program, or PPIP.) In his letter from last fall, Buffett mentioned that he had been discussing the issue of how to deal with the toxic assets with Bill Gross of PIMCO, the giant bond fund, and Lloyd Blankfein, the CEO of Goldman Sachs. They all agreed that the private sector could help restart the frozen mortgage market. Paulson rejected the idea at the time, in part because the financial markets had deteriorated so quickly that he and Fed Chairman Ben Bernanke decided they had to move more quickly with direct capital injections into banks. "We had to put the fire out first," Paulson's former spokeswoman, Michele Davis, told me, adding that there was also a question of how the participation of major private investors would be received by the public at that early juncture. And by the time Geithner went with his plan, it had evolved somewhat from Buffett's original concept in several respects, including the idea of setting up five funds to compete for the assets.
My point in raising this episode, which has not been reported until now, is not to fault Buffett, Gross or Blankfein—or even Geithner. Indeed, it appears that Buffett, the Berkshire Hathaway chairman (who, full disclosure, is a director of The Washington Post Co., which owns NEWSWEEK), was genuinely trying to help Paulson find a way out of the bank collapse. But the genesis of the PPIP plan does resurrect questions about who's really running the show here, and how incestuous the relationship between Washington and Wall Street has become. Indeed, it goes to the heart of the deep philosophical divide over the Obama administration's financial rescue plans.
On one side are those who want to fix the financial house we have; on the other are those who think we should knock it down so we can build a brand-new one—a new Wall Street, in other words. The keep-the-house-intact crowd includes Geithner and Bernanke, as well as Obama-appointed regulators like Mary Schapiro of the SEC. They want serious fixes to the Wall Street system—new rules and regulations to repair the old house and ensure that it doesn't burn down again in the future—but they don't much want to change its structure. Having giants like Citigroup and Bank of America dominating the landscape is OK with them, as long as those giants follow the new rules. On the other side of the debate are critics such as Paul Krugman and possibly Paul Volcker and Sheila Bair, chairwoman of the Federal Deposit Insurance Corp., who think the old house is structurally unsound. They believe that not only can't we solve the present crisis by merely tinkering with the old house, but that we'll assuredly find ourselves in another crisis down the line if we don't dismantle it entirely.
It's a debate that encompasses all the back-and-forth over Geithner's and Bernanke's careful, intricate plan to fix the big Wall Street banks instead of nationalizing and dismantling them, as well as the cautious regulatory scheme they laid out last week. And it's a debate that must be settled now.
Once the big banks and firms come back to health, it's likely that Geithner and his team will have missed any opportunity to fundamentally remake America's financial system. None other than Hank Greenberg, the financial wizard who made AIG what it is today, inadvertently waded into the debate on Thursday when he told a congressional panel that the government's $170 billion bailout of the insurance giant wasn't working. Greenberg said he disagreed with Geithner's and Bernanke's assessment that letting AIG simply go bankrupt would have been a financial catastrophe. "I don't think it would have been disastrous," Greenberg said. One might question Greenberg's motivations for making these comments—he's in the middle of a bitter legal dispute with the company he once ran—but the question resonates. Why not, in fact, just get rid of this giant succubus? And create rules to ensure such a drain on our economy can never rise again?
At the core of the issue is the "too-big-to-fail" problem. What got us into this trouble wasn't just a lack of regulation and oversight of mortgage securitization or derivatives trading. It was a permissive approach that allowed Wall Street institutions to grow into global monsters that did as they pleased and then, when they failed, were too gargantuan to be permitted to disappear from the scene—which is supposed to be what happens in capitalism. Geithner and Bernanke are both acutely concerned about this problem, but neither has gone as far as, say, former Fed Chairman Volcker in calling for new rules that would prevent systemically dangerous monstrosities like Citigroup and AIG from rising again. Volcker, whom President Obama named to head his Economic Recovery Board but whose influence in Washington has been hard to detect, recently proposed a "two-tier" financial system somewhat in the spirit of Glass-Steagall. He didn't suggest that commercial banks and investment banks be separated into two worlds again, but he did propose that underwriting (as of mortgage-backed securities) be separated by law from "very heavy proprietary trading."
The regulatory framework that Geithner presented to Congress last week, while impressive in its scope, does not do this. He wants a lot of useful things: higher capital requirements for bigger firms (effectively a tax on bigness); a powerful systemic risk regulator; and new oversight authorities over mutual funds and hedge funds. What he didn't ask for is structural changes to the firms that will be subject to all this new regulation, à la Volcker. Neither has Bernanke. The bet is that these new rules, and an overarching systemic risk regulator, can keep that old Wall Street monster house from raging out of control again. But I wonder. Geithner did not even propose a serious reining in of the wild-west "over-the-counter" trading that occurs off exchanges world-wide. Instead, he offered up a rather mild alternative: OTC trading for derivative contracts will have to go through a central clearinghouse that presumably will be industry-run. Geithner added, almost as an afterthought: "We will also encourage greater use of exchange-traded instruments."
This don't-change-the-structure approach is of a philosophical piece with the approach that Geithner and Bernanke have taken to the immediate crisis. Both men believe that the financial sector as presently constituted—Wall Street, in other words—is too large and complex to be taken over and re-created by the federal government. Geithner, in an interview with NEWSWEEK last week, approvingly cited a recent Wall Street Journal op-ed by William Isaac, the former head of the FDIC. Isaac argues, like the Treasury secretary, that taking over the worst big banks (nationalizing them) is just too gargantuan and risky a task. "Unlike the talking heads, I have actually nationalized a large bank," Isaac wrote. This was the Continental Illinois Bank, the nation's seventh-largest, which fell into trouble during the banking crisis of the 1980s. The 1984 nationalization—or takeover—worked. But it took seven years for the government to sell it off, and that was in an up-market. Why wouldn't this work today? Isaac asks. "Let's begin with the fact that today our 10 largest banking companies hold some two-thirds of the nation's banking assets, and some are enormously complex. Continental had less than 2 percent of the nation's banking assets," he writes. Further, "who will run these companies when we dismiss the existing senior managers and board members? We had significant difficulties attracting quality people to Continental even without today's limits on compensation. … What's more, we won't be able to stop at nationalizing one or two banks. If we start down that path, the short sellers and other speculators … will target for destruction one after another of our largest banks." Finally, the FDIC's plan for Continental Illinois required it to shrink to half its size within three years. To do that now to Wall Street, in the middle of a severe recession "where deflation is a realistic concern," runs against the government's expansionary policy.
These are all good points. And Geithner is a deliberate, highly capable fellow. But he is effectively rolling the dice in the greatest gamble of his life right now—and most of ours as well. He wants us to emerge from the current catastrophe and remain safe from future catastrophes while working in an essentially unchanged financial house. I understand his concerns. The government is already strained to the limit of its financial resources and political will in what it can do to remake Wall Street. Congress would fight the kind of money needed for nationalization, and let's remember that, until it collapsed of its own size and hubris, Wall Street was a great engine of growth for the U.S. and global economy. So I hope Geithner is right. But I also fear that he may be wrong, and that even if all these new capital infusions and regulatory restraints are imposed, the old house as it stands may not be fixable. And it will, inevitably, get out of hand once again.