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Banking Sector, Bailout Reform May Top Obama Economic Agenda

January 21, 2009 at 6:10 PM EST
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Treasury nominee Timothy Geithner went before a Senate panel Wednesday, answering questions on the financial crisis as well as his tax payment controversy. Analysts mull what's ahead for Obama's economic agenda.
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JIM LEHRER: While the president devoted much attention to the economy on this important first day, there was also the business of a confirmation hearing for his treasury secretary nominee, Timothy Geithner. Our economics correspondent Paul Solman has that story.

PAUL SOLMAN, NewsHour economics correspondent: Treasury Secretary-designate Timothy Geithner appeared before the Senate Finance Committee a day after President Obama took the Oath of Office amid what he called “gathering clouds and raging storms.”

Indeed, signs of yet more economic trouble now loom, such as steeper losses at banks Geithner regulated.

The nominee has also been under a storm cloud himself, after news surfaced last week of his failure to pay Social Security taxes between 2001 and 2004 when working at the International Monetary Fund.

But Geithner’s opening statement emphasized the big picture.

TIMOTHY GEITHNER, Treasury secretary-designate: We now confront extraordinary challenges: a severe recession here and around the world; a catastrophic loss of trust and confidence in our financial system; unprecedented foreclosure rates; small businesses struggling to stay afloat; millions of Americans worried about losing their jobs and their savings; a deep uncertainty about what tomorrow holds.

Senators, the ultimate costs of this crisis will be greater if we do not act with sufficient strength now. In a crisis of this magnitude, the most prudent course is the most forceful course.

PAUL SOLMAN: Geithner said the new administration would soon release details of that course. He closed his open with the tax issue, no small matter since the IRS reports to the treasury secretary.

TIMOTHY GEITHNER: These were careless mistakes. They were avoidable mistakes, but they were unintentional. I should have been more careful. I take full responsibility for them. I have gone back and corrected these errors and paid what I owed.

I want to apologize to the committee for putting you in the position of having to spend so much time on these issues when there is so much pressing business before the country.

PAUL SOLMAN: After an audit and advice from a tax preparer, Geithner, who said he’d used TurboTax software to prepare his own return, paid what the IRS said he owed, but not for the first two years, which were outside the statute of limitations. “An honest mistake,” he said.

But that failed to placate Republican Jon Kyl of Arizona.

SEN. JON KYL, R-Ariz.: Yes, I’m sorry to take extra time here, but would you answer my question rather than dancing around it, please? The question is whether it occurred to you, before you were nominated or before you were approached to be nominated, that, in point of fact, you didn’t have to go beyond 2003 and 2004 because of the statute of limitations?

TIMOTHY GEITHNER: I did not think about that until I was going through the vetting process and had disclosed at that point to the transition members reviewing my tax records the entire circumstances surrounding that episode. I had not thought about it in the intervening years, no occasion to think about it, and I might not have thought about it unless I had gone through that process.

But having thought about it then, I did what I thought was right, which was to go back and correct for that error.

Senators question Geithner on TARP

Timothy Geithner
Treasury Secretary-designate
The critical test of this program will be whether we do enough soon enough to make banks strong enough that they can lend and help make sure that credit is flowing to parts of the economy where it can have the most impact.

PAUL SOLMAN: The other big issue hanging over the nominee was his close identification with the government's recent policies, including the $700 billion financial rescue plan, known as the TARP. Democrat Blanche Lincoln of Arkansas.

SEN. BLANCHE LINCOLN, D-Ark.: I've been very, very frustrated with the way that the Troubled Asset Relief Program has been implemented. Reflecting on had you been the treasury secretary during that process, what would you have done differently? And I guess, more importantly, will the program stay on the same track, so to speak?

PAUL SOLMAN: Geithner's answer was non-specific. He would make no promises he couldn't keep, he said.

TIMOTHY GEITHNER: Senator, the president of the United States is committed to fundamental reform of this program. And he wants to make sure that we effectively and credibly address all the concerns raised by you and many others about the way this has been done so far.

And as I said earlier, the critical test of this program will be whether we do enough soon enough to make banks strong enough that they can lend and help make sure that credit is flowing to parts of the economy where it can have the most impact, including to small businesses.

PAUL SOLMAN: Geithner was also asked to explain why the investment bank Lehman Brothers was allowed to collapse in September under his watch. It subsequently had a destabilizing effect on the financial system.

TIMOTHY GEITHNER: You know, we could not force any institution to come in and buy Lehman Brothers or guarantee their obligations. And no one was willing, without the government taking a very, very substantial capital position, and we did not have the authority at that point to do that.

PAUL SOLMAN: Democrat Ron Wyden of Oregon asked whether Geithner should have responded sooner about Citigroup's trouble.

SEN. RON WYDEN, D-Ore.: My view is that the alarm bells should have been going off in 2007. There you had a situation where they had huge losses. The CEO was leaving. Do you think you should have handled that situation differently in 2007?

TIMOTHY GEITHNER: Senator, nobody that has been part of this system as a member of the board of an institution, as a chief executive, as a supervisor, as a regulator, as a central banker, as a Treasury, as a finance minister, nobody who's been part of this system cannot look at this crisis and not be deeply, deeply uncomfortable by the failure of the basic checks and balances in our system.

And to fix this going forward is going to require very, very substantial reform. I believe across our system there has been too much skepticism about the effectiveness of supervision and the necessary role it plays in making our system strong in the future.

SEN. RON WYDEN: Should your supervision have been more effective?

TIMOTHY GEITHNER: Absolutely.

SEN. RON WYDEN: Thank you.

PAUL SOLMAN: Despite the concerns over Geithner's tax problem and his recent record, he's expected to be confirmed by the committee tomorrow.

Obama team needs a 'holistic' plan

Kenneth Rogoff
Harvard University
So the banking sector is sick. We can't have normal growth without credit flowing, without loans, without the banking sector being healthy again.

JIM LEHRER: And now to Judy Woodruff for more on the economy.

JUDY WOODRUFF: President Obama is facing a series of tough choices quickly on a growing storm of economic troubles, including: a new round of tremors in the world of banking; a financial rescue plan that many argue has not helped the system; and a massive stimulus package.

To help us understand how all this plays into some of the president's economic prescriptions, we turn to: Martin Baily, a senior fellow at the Brookings Institution, he was chairman of the Council of Economic Advisers during the Clinton administration; Ken Rogoff, professor of public policy and economics at Harvard University, he's a former chief economist for the IMF; and Karen Shaw Petrou, managing partner of the consulting firm Federal Financial Analytics.

Thank you, all three.

And, Ken Rogoff, to you first. Yes, there are several different areas we're hearing about. What are the most immediate, most pressing problems that the administration, this new administration has to deal with?

KENNETH ROGOFF, Harvard University: Well, I think the Treasury Secretary-designate Tim Geithner, you know, said it very well, that you really need to move very forcefully in a lot of directions. You need a comprehensive plan.

I think that's why he was reluctant to let out a piece of it, because that's really -- this piecemeal approach has really been the problem.

So the banking sector is sick. We can't have normal growth without credit flowing, without loans, without the banking sector being healthy again. It's also true that consumption is collapsing, investment is collapsing, and we probably need heavy fiscal stimulus to fill in. We probably also need some support on the housing front, because that's really the epicenter of this crisis.

So I think the Obama team needs to come forth very quickly with a holistic plan. They've given us a lot of pieces of it, especially the fiscal stimulus. They've been very cautious about saying anything about the banking sector, I think for fear of sparking a panic before they're in place to deal with it. Now they are.

JUDY WOODRUFF: Karen Petrou, I think it is the case that we haven't heard as much, until just the last few days, about the banking sector. What is the problem there? Help us understand.

KAREN SHAW PETROU, Federal Financial Analytics: The problem is a loss of confidence. And we keep going through that, and then the capital markets take some comfort in a policy, and then the policy changes. We've been bouncing around from asset purchases to capital injections to several new ideas on the table now, even as we've seen some of the mainstays of the U.S. financial system -- and, in fact, the global system -- falter.

So that's really at the heart of this lack of confidence, in part because we've still got a world of hurt and all the losses, particularly in the mortgage sector, yet to come.

JUDY WOODRUFF: Martin Baily, why didn't we know this earlier? Or did we and people weren't talking about it?

MARTIN BAILY, Brookings Institution: Well, I think some of it maybe wasn't revealed. Maybe the banks knew more than they were letting on. And certainly in Europe, we know that the banks have not necessarily been forced to mark their assets to market, so we don't know some of the problems there.

I think also, as the economy deteriorates and we get bigger losses than we expected -- and the economy is deteriorating, I think, faster than anyone thought even six months ago -- so as the unemployment rate rises and people lose their jobs, then we see more defaults on credit cards, we see further defaults on mortgages, and that takes capital away from the banks and makes it difficult for them to lend.

In fact, they are really forced to call back some of those loans, sell off some of their assets. And it's that process, so-called deleveraging, that we want it stop by putting capital into the banks and potentially by buying some of the assets that are troubled that the banks have right now.

Nationalization will be necessary

Karen Shaw Petrou
Federal Financial Analytics
I think one of the reasons we're in this predicament is that tough action wasn't taken sooner. One of the big lessons of the S&L debacle of the 1980s and the bank crisis that followed it is that the longer you wait, the worse it gets.

JUDY WOODRUFF: How does fixing that, Ken Rogoff, fit into what I think what you called a holistic approach? I mean, these are complex problems in a number of areas. What are the options that the administration can look at, first off, in the banking sector?

KENNETH ROGOFF: Well, I think Martin Baily is absolutely right, that a piece of this has to be taking some of the badly damaged assets off the books of the banks and then trying to sell them off. We've done that many times in order to sell off bad assets.

But then, beyond that, there's the question of, how do you reconstitute the system? Tim Geithner said we need more regulation. What's it going to be? Where do we want to go? And who's going to pay for this?

Again, Martin Baily said we need to recapitalize the banks, we need to put money in. Should it all be the taxpayers? What about some of the debt-holders holding -- not depositors, but other lenders, the banks, should they bear some of the costs?

I think until now the Bush-Paulson plan has really been too soft on the banks. They've put taxpayer money in, and they really haven't asked enough of the banks. They haven't either put them through bankruptcy or nationalization, which I think is going to be a step that we're going to have to see across many banks before this is over.

JUDY WOODRUFF: Did I hear you say "nationalization"?

KENNETH ROGOFF: Temporary nationalization. I mean, the standard playbook is you nationalize the bank, break off the bad assets, put in enough capital to the good part that it's healthy again, and then you re-privatize it, as, for example, Sweden has done.

I think that kind of procedure is going to be inevitable for some of our banks or something like it. It might be called a "bankruptcy," but be the functional equivalent.

JUDY WOODRUFF: Karen Petrou, you're smiling. Is that something you think this brand-new administration may be thinking about having to do?

KAREN SHAW PETROU: Well, I hope so, because I think one of the reasons we're in this predicament is that tough action wasn't taken sooner. One of the big lessons of the S&L debacle of the 1980s and the bank crisis that followed it is that the longer you wait, the worse it gets.

When problems were manageable at institutions like Countrywide, Merrill Lynch, and others, the regulators and the Treasury Department hoped that, by forestalling recognition, by forestalling takeovers of the institutions, that somehow it would all get better, like putting your head under the covers and hoping for the best, but that really doesn't work very often, and it certainly didn't work here.

JUDY WOODRUFF: And so, Martin Baily, you know, you were talking about putting more assets, putting more of an investment by the government into the banks. How does nationalization fit in?

And the other option, I guess, we're hearing about today is creating what they call a "bad bank." Help us understand what that's all about?

MARTIN BAILY: Well, we have already nationalized Fannie and Freddie, so we own those already. It may come to it on some of the other banks -- I don't know -- I don't particularly want to name names, and we don't know which ones are closest to the edge necessarily, but it may come to the point where we have to nationalize some of the banks, the big banks that really are too big to fail and that we have to keep going.

But this plan on the bad banks -- and there's a lot of difficulty understanding -- that it is hard to understand. Paul Krugman had a blog today saying, "I don't understand this."

I think the idea -- it's been done in other countries -- is that there are a lot of assets whose value is very uncertain. They are troubled, so they're not worth what they were originally. These are mortgages, some of which are going to default, some of which are not.

So what you want to try to do is to take them out of the bank, and that reduces the uncertainty in the assets of the private bank that remains, and it can then function more easily.

The government will take them on, which means taxpayers stand to take a loss, but there's a possibility taxpayers may actually benefit from that, because the assets turn out to be worth a little bit more than the market maybe thought they were in the current, very distressed environment.

Politics unlikely to block action

Martin Baily
Brookings Institution
We need that dramatic action, to kind of stop that cycle from taking place, and then I think we can begin to recover. It's not going to happen quickly, but I think it probably will happen, probably by the end of this year.

JUDY WOODRUFF: Ken Rogoff, while the administration is figuring out how to deal with this problem that is emerging, how does that impact the decisions they have to make on the stimulus plan, getting that through the Congress, deciding how to spend that money, and then deciding what to do about the TARP, the rescue program?

KENNETH ROGOFF: Well, if they just go ahead and do the stimulus plan, and then put off fixing the banks for a year or two, they're just wasting their money. It's going to provide a temporary boost, but no sustained growth in the economy. They have to do it together.

Of course, when Franklin Roosevelt took office, he had his famous bank holiday for seven days where he put in deposit insurance, tried to repair the banking system, and open it up. I think we may need to see something similarly surprising, not the same thing, but dramatic action now, not a year from now. It's not something we can put off.

The fiscal stimulus helps boost the economy, prop up the assets of the banks, and make it easier to do, to go through this process. But if you just do the fiscal stimulus, well, Japan did that repeatedly, and it failed.

JUDY WOODRUFF: How do you assess it, Karen Petrou?

KAREN SHAW PETROU: Oh, I agree with that. The banking system is the bedrock of the economy. And dramatic action would, I think, help to sustain it now.

Of course, the tricky bit is, what kind of a dramatic action? And we really do need to be careful as we do these banking system reforms that we look to the economy, to borrowers, to investors, to depositors, not to the shareholders and the banking system.

If we're going to ever have a private banking system again, we're going to have a system in which sometimes investors lose their money. Banks can survive fine. As long as they've got enough capital, they can go quarter after quarter not making much money. But if the capital is in danger, the government should step in very quickly and very decisively.

JUDY WOODRUFF: Martin Baily, how much confidence should consumers, all of us have that this administration is going to be able to make the decisions in the coming days that I hear all three of you saying must urgently be made?

MARTIN BAILY: Well, I think we should have confidence. I think they are going to take dramatic action. I agree with what Ken Rogoff said. I think Obama is committed to that. I think he's got very strong advisers, Tim Geithner, Larry Summers, Christie Romer, and so on, that I think are going to give him the right advice.

At the moment, we kind of have to break that vicious cycle, which is that the economy is going down, the banks are in trouble. As the economy goes down, it pulls the banks down, but the banks are also pulling the economy down, because people can't get access to credit.

So that's why we need that dramatic action, to kind of stop that cycle from taking place, and then I think we can begin to recover. It's not going to happen quickly, but I think it probably will happen, probably by the end of this year.

JUDY WOODRUFF: And how tough all of this is politically, Ken and then Karen?

KENNETH ROGOFF: Well, it's very tough, because the financial services sector is very powerful. They were probably leading contributors to all the House and Senate campaigns, to many of the primary campaigns. It's very, very tough to go up against them.

I think, in many cases, management is going to have to lose their positions. Very powerful people are going to lose out. And that's part of the reason, I think, you have to move quickly to really take them on dramatically and not wait and bleed to death.

JUDY WOODRUFF: Quick final word about the politics?

KAREN SHAW PETROU: I think it's going to be remarkably easy -- hard, but easy, because everyone is convinced that things must change. Even some of the leaders in the industry will be dragged into this. How remains to be seen, but I think for sure it will be done, and done very fast.

JUDY WOODRUFF: All right, we're going to have to leave it there. I want to thank you, Ken Rogoff, Martin Baily, and Karen Petrou. We appreciate it.