Brooks v. Krugman

David Brooks comes out in defense of embattled Treasury Secretary Tim Geithner; former Enron advisor and current populist Paul Krugman argues that Geithner was a key player in the Wall Street bailouts that squandered the public trust. 

Krugman's focus is the controversial decision by the Fed to buy out AIG's credit default swaps at 100 cents on the dollar.  And that is a sensible place for an Earnest Lib to put the focus - although Obama appointee Geithner ends up under the bus those were Bush-era decisions.

But if the public trust has been squandered, was it really because of some obscure credit default swaps?  What about the failure of Geithner, Daschle and Rangel to vex themselves by paying their taxes?

What about the crony stimulus bill that was more of a Congressional Democrat wish-list than a serious attempt to stimulate the economy?  Rick Santelli's epic Tea Party rant focused on the absence of tax cuts, the unfairness of expecting people to pay off their over-extended neighbor's mortgage, and the implausibility of the economic multipliers that said we could spend our way out of a recession.  I am sure the Tea Partiers don't love the Wall Street bailouts but they highlight other issues at this website.

What about the unpopular Chrysler and General Motors takeovers that looked like crony capitalist bailouts of Big Labor - did that undermine public confidence in Team Obama specifically and Washington generally?

What about the ongoing "jobs created or saved" clown show?

I understand the short-term benefit to the Dems of pretending that the credibility problem of Washington and Obama began and ended with the AIG bail out, but a serious attempt to regain the public trust ought to begin with a serious attempt to understand why that trust was lost.

ERRATA:  Paul Krugman recycles some myths about AIG; I follow with tedious facts:

About the A.I.G. affair: During the bubble years, many financial companies created the illusion of financial soundness by buying credit-default swaps from A.I.G. — basically, insurance policies in which A.I.G. promised to make up the difference if borrowers defaulted on their debts. It was an illusion because the insurer didn’t have remotely enough money to make good on its promises if things went bad. And sure enough, things went bad.

As to whether AIG had the resources to make good on its promises - AIG had roughly $100 billion in shareholders equity in the halcyon days of 2007; they lost about $32 billion on the credit default swaps in question.

Now on the one hand a firm with a $100 billion net worth ought to be able to pay off $32 billion in claims.

On the other hand, one might well have wondered how the rest of AIG's many businesses and investments might fare in the grim sort of economic environment that would actually lead to losses on the mortgage bonds they were insuring.

And the ex post answer is, not so well.  AIG managed to realize capital losses of about $55 billion in 2008 (2008 10-k, p. 36) by purchasing (and repoing) mortgage bonds for their conventional insurance portfolios.  These transactions eventually required $44 billion of Fed support, which exceeded the amount paid out on the credit default swaps.  Ooops!

Those Fed payments in support of securities lending were modestly controversial at the time, since there was strong overlap between the securities lending counterparties and the credit swap counterparties (e.g., Goldman Sachs appeared on both lists).

On the other hand, collateralized securities lending is a foundation of our capital markets, so although AIG lost a lot of money in a hurry it was not "evil" in the same way that their credit derivatives activity was.  Or something.  Whatever the reason, there is not much hue and cry saying the Fed should have risked chaos and confusion in the securities lending market by promoting the proposition that the government was demanding haircuts on contracts they had assumed.

No, Krugman et all apparently think Geithner should have risked chaos and confusion by disavowing some contracts but not others.  As to which contracts were "evil" and too politically hot for the Fed too handle, well, who knows?  We now know (because Krugman has told us) that Credit Default Swaps=Bad.  What about conventional interest rare and currency swaps, also booked out of AIG-FP?  Who knows!  Municipal GICs booked at AIG?  Maybe!  Stable value wraps, a new product peddled by AIG in the 401-k market?  Let's find out together!

As the Special Inspector General's report makes clear, AIG was involved in all sorts of esoteric contacts all over the world.  If the Fed had allowed the perception to take hold that a deal was not a deal and all contracts would be subject to random renegotiation then they could have precipitated the scramble for assets and the mad dash from AIG that they were trying to avoid.

Even Krugman recognizes this:

So officials could have called on bankers to offer a better deal, for their own sake, and simultaneously threatened to name and shame those who balked. It was their choice not to do that, just as it was their choice not to push for more control over bailed-out banks in early 2009.

And, as I said, these seemingly safe choices have now placed the economy in grave danger.

So it was a "seemingly safe" choice at the time.  Seriously, has the euphoria of Obama's election clouded his mind as to the memory of November 2008?  "Seemingly safe" was a very good thing back then.  Experimenting with random renegotiation strategies in that environment looked crazy at the time and still does. 

And the idea that the Fed was going to "name and shame" firms that were desperate for an extra billion is absurd.  Is Krugman absolutely, crystal clear that such a refusal would not have been taken as a sign of weakness of the firm in question?  Can he imagine the whispers - my goodness, Shamed Firm can't even throw the Fed a billion to get off their shit list - how desperate are they?  Would he want to be the one advising Geither that those whispers would not snowball into something more?

As I said, I get the politics of blaming Geithner, Goldman and Bush for all the credibility problems of a Democrat controlled White House and Congress, but that sort of finger-pointing won't point to a solution.

SINCE YOU ASK:  I blame everything (Everything!) on Greenspan's bail-out of Long Term Capital Management in 1998, which enshrined moral hazard.  If a "never heard of 'em" hedge fund can't be allowed to fail during a good economic recovery, when will firms be allowed to fail? 

Greenspan combined a laissez-faire regulatory attitude with a solid "everyone's too big to fail, even firms we haven't heard of" mindset.  We have to work our way back to reality, but November of 2008 was not the time to do so.

WHICH REMINDS ME:  The WSJ editors point out that understanding the real reasons for the support of AIG would guide the debate as to what regulatory reforms are necessary.  I was saying last spring (does that seem like ten years ago to anyone else?) that there was a huge political constituency for blaming AIG's problems on unregulated credit derivatives rather than pondering their other huge problems:

Why the misdirected coverage?  My guess is that we are seeing an unholy alliance of insurance regulators who would rather point the finger at unregulated credit derivatives, people who always favor more regulation as the answer to everything, and public officials who don't want people to wonder whether other staid, boring insurance companies that don't do credit derivatives might still have huge problems in their core portfolios.  Since securities lending lacks the glamour of M&A or international "Master of the Universe" trading, the media is easily distracted.

Krugman is still part of the distraction.

Comments

[Charlie (Colorado)]

"chrystal"?

I'm doing too much editing....

[Neo]

Save this quote for your Lefty friends ...

BURGESS: Glass-Steagall has come up this morning. If I recall, Glass- Steagall was repealed -- that bill was signed by Bill Clinton...

GEITHNER: You're right about that.

BURGESS: ... not George Bush.

GEITHNER: You're absolutely...

BURGESS: And I frankly don't understand. If that's such a good protection, this president's been in office for 10 months. Where's the signed legislation reinstating Glass-Steagall? What...

GEITHNER: Actually, I would not support reinstating Glass-Steagall. And I don't actually believe that the end of Glass-Steagall played a significant role in the cause of this crisis.

[Michael]

What about the crony stimulus bill that was more of a Congressional Democrat wish-list than a serious attempt to stimulate the economy?

When the Congress is of the the president's party, it seems in this millennium the animating spirit is 'Kindergarteners we have to use up these finger paints by tomorrow.'

[matt]

it's the esoteric financial instruments, stupid!

[Carol]

"esoteric contacts all over the world"

You mean contracts, right?

[narciso]

This is like Iran and Iraq, can't they both lose, or Dumb and Dumber

[NK]

Who is David Brooks? who --or what-- is a Paul Krugman, what is the New York Times?

[matt]

whether it was AIG or the whole magillah, it's a corrupt, insider game these days and that's what needs to be fixed. LUN

[glasater]

Actually if one thinks about it--Elliott Spitzer is the one who got the ball rolling going after Greenberg in the first place. So it's all his fault.

[Pops]

That's right I am going to say it.

Whenever I hear Obama and his white house staffers talking about those horrible bankers, I always get the feeling they dropped the word 'Jewish' from banker for public comments.

Obama spent alot of time learning from Rev Wright, who also had a thing about Jewish bankers.

[PaulL]

I just listened to Dennis Miller interview Sarah Palin on the radio.

Miller said that Palin is twice the woman that David Brooks is.

[Melinda Romanoff]

TM-

You have only a glimpse of what Santelli is allowed to mutter about now. NY leans on him hard.

And just him, as you might imagine.

[David D.]

A thoughtful blog...with good research. I've added to my favorites!

1) It's pretty clear from AIG and LTCM that nobody knows how to regulate derivatives and that even their expert masters cannot control them. So ban them. They have done far more damage than they are worth.

2) Big banks need to get broken up.

3) Big banks need large bondholder haircuts to become solvent again.

4) Homeowners need to have their mortgages reduced to the appraised value of the home.

Then we can get back on track. It will hurt, but the foreclosure/bank capital drain death spiral must be broken.

[CARL]

NO ONE IS POINTING OUT THE FACT THAT THE ECONOMY TURND SHARPLY SOUT WHEN CONGRESS CHANGED HANDS IN 2006

[Gerald]

"Now on the one hand a firm with a $100 billion net worth ought to be able to pay off $32 billion in claims."

Sorry, but that is one of the most business/finance-illiterate things that I have read in quite some time.

If you don't understand why, then I strongly suggest that you stay far, far away from commentating on matters of business and finance.

[srp]

I'm with Tom on LTCM. I just think the "let 'em go bankrupt" plan was still the right idea ten years later. A guy who did some work for Barclay's confirmed what theory would suggest, that unwinding all of Lehman's supposedly opaque and convoluted transactions took a couple of weeks of lawyers working overtime to accomplish.

The thing is, in fall 2008 people were still arguing that the problem was liquidity rather than solvency--it was all just a big bank run of sorts and if we could do the FDIC-equivalent backup for securities and derivatives all would be well. Unfortunately, that turned out not to be the case for many of these firms' portfolios. They were fundamentally unsound ("had no bottom" as Daniel Dafoe would have said) in the sense that the underlying loans were not going to be paid back on any time scale. So bailing out ("insuring") the feckless counterparties, instead of causing an FDIC-style rebooting of confidence and the return of normal business amounted to a partial and unprincipled subsidy of connected insiders that actually reduced overall confidence in the system.