The Moral Hazard of the “Bad Bank”

I’ve been closely following the various (new & improved!) bailout plans for the big banks — from the modified TARP to the recapitalizations to the “bad bank” plan.

I’ve noticed something I find a bit disturbing about our new Treasury Secretary: He has not yet fully come to terms with his new job, role — and boss. Granted, he’s been in the job for only two days. But given the extraordinary circumstances the financial sector and the economy is in, it is important for the Treasury Secretary to get up to speed as soon as possible.

Consider this statement from Geithner, who said that Treasury  is considering a “range of options” for its financial rescue plan, with the goal of preserving the private banking system.  “We have a financial system that is run by private shareholders, managed by private institutions, and we’d like to do our best to preserve that system.”

No! Defending these idiots was your old gig. In the new job, you no longer work for the cretins responsible for bringing down the global economy. Please stop rationalizing their behavior, and preserving the status quo!

Yesterday’s 13% surge in bank stocks is a clue as to what an obscene taxpayer giveaway this “bad bank” plan is — its free money for the firms that caused the problems, many of whom still have the same incompetent  management in place that caused the problem. Purging toxic assets from bank balance sheets, without punishing the management, shareholders and creditors of these institutions for their horrific judgment will only encourage more of the same in the future. Its moral hazard writ large.

A few reminders for Geithner that are of the utmost importance:

• ▪ You no longer work for the Banks: The NY Fed is a private corporation, doing the bidding of the FOMC and its private sector owners — primarily, the primary dealers. In other words, the President of the NY Fed works for the biggest commercial and investment banks in New York. That is no longer operational for you.
• ▪ As Treasury Secretary, your immediate boss is the President, and your ultimate charge are the citizens of the United States, and the finances of the country.
• ▪ When any conflict comes into play between the nation and the banks, you as Treasury Secretary are on the side of the Nation.
• ▪ You cannot serve two masters, especially when they are in direct conflict with each other.

When the post-script to this era gets written, I suspect we will learn all sorts of unsavory facts about the former Treasury Secretary, and how he unfortunately had a tendency to believe he was working for the benefit of Goldman Sachs.

The new Treasury Secretary has that mental muscle memory of who his former employers were. He needs to concentrate on the new job, and who he works for. Unfortunately, the early signs suggest that he has yet to figure this out. Let’s hope that changes. Fast.

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UPDATE:  January 29, 2009 at 11:45 am

I was just on the radio with Mike Norman, who insisted that the NY Fed is not a private company owned by the primary dealers.

Um, wrong:

Article IV – stock of the bank
http://www.newyorkfed.org/aboutthefed/ny_bylaws.html

Ownership of stock of the Bank, issued to member depository institutions in accordance with law, may be evidenced by advices signed by the President or his/her designate, or by certificates bearing the seal of the Bank and the signature of the Corporate Secretary or an Assistant Corporate Secretary.

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Sources:
Geithner Says ‘Range of Options’ Considered for Banks
Robert Schmidt and Rebecca Christie
Bloomberg, Jan. 28 2009
http://www.bloomberg.com/apps/news?pid=20601087&sid=aCc8REieouZM&

Geithner Says Plan for Banks Is in the Works
STEPHEN LABATON and EDMUND L. ANDREWS
NYT, January 28, 2009
http://www.nytimes.com/2009/01/29/business/economy/29bailout.html

Bylaws, Board of Directors
Federal Reserve Bank of New York
December 20, 2007
http://www.newyorkfed.org/aboutthefed/ny_bylaws.html