Timothy Geithner: Department of “WTF?!?!”: Friday Focus: May 9, 2014

Andrew Ross Sorkin: What Timothy Geithner Really Thinks: “What is certain, however, is…

…Geithner had a predisposition that Wall Street, even as it was, remained essential to the functioning of the U.S. economy in just about every sector:

I did not view Wall Street as a cabal of idiots or crooks. My jobs mostly exposed me to talented senior bankers, and selection bias probably gave me an impression that the U.S. financial sector was more capable and ethical than it really was.

During his first few months in the job, Geithner fought with Summers, who felt that his protégé had become overly solicitous of the banks. Geithner dismissed Summers as espousing “the hedge-fund view.” (“Hedge-fund executives tended to see the banks as dumb, lumbering giants,” Geithner writes.)

He disagreed when Summers suggested to Obama that the administration pre-emptively nationalize banks like Citigroup or Bank of America or even to try to embarrass them into changing their compensation structures. “I feared that the tougher we talked about the bonuses, the more we would own them,” Geithner writes, “fueling unrealistic expectations about our ability to eradicate extravagance in the financial industry.” Geithner’s stance often came off as aloof, or worse…

Remember: in the winter of 2008-2009, every single major New York bank–with the exception of Goldman Sachs and perhaps J.P. Morgan Chase–was insolvent if marked to market: the only value their equity and option holders had came off of the fumes from expected government bailouts that were supposed not to enrich bankers and bank shareholders but keep the economy from collapsing, and on expectations of future reflationary policies that would push asset prices up above their winter 2008-9 values.

For Geithner to after the winter of 2008-9 to talk about the major New York banks as anything other than dumb, lumbering giants that had failed to understand the consequences of their own leverage, the risks they were running, or even what the factor loadings on the securities they held in their portfolios were–that suggests a substantial disconnect from reality indeed…

They were bankrupt in the winter of 2008-9. The accepted principle for dealing with a financial crisis is the “Bagehot Rule”: (a) lend freely to solvent but illiquid institutions (b) at a penalty rate so their executives and shareholders do not profit from the moral hazard they created, and (c) shut down insolvent institutions so executives and shareholders in the future do not think they will escape the consequences of the moral hazard they created.

It appears from Geithner that Summers was just trying to follow what had been the standard playbook since the 1870s. What did Geithner think he was doing?