Questions for Geithner

Questions for Geithner
by David Kotok
November 23, 2008

David R. Kotok co-founded Cumberland Advisors in 1973 and has been its Chief Investment Officer since inception. He holds a B.S. in Economics from The Wharton School of the University of Pennsylvania, an M.S. in Organizational Dynamics from The School of Arts and Sciences at the University of Pennsylvania, and a Masters in Philosophy from the University of Pennsylvania. Mr. Kotok’s articles and financial market commentary have appeared in The New York Times, The Wall Street Journal, Barron’s, and other publications. He is a frequent contributor to CNBC programs, including Morning Call, Power Lunch, Kudlow & Company, Squawk on the Street, Squawk Box Asia, and Worldwide Exchange. Mr. Kotok is also a member of the National Business Economics Issues Council (NBEIC), the National Association for Business Economics (NABE), the Philadelphia Council for Business Economics (PCBE), and the Philadelphia Financial Economists Group (PFEG).


NY Fed president Timothy Geithner will face a Senate confirmation hearing about his nomination to succeed Hank Paulson as Secretary of the Treasury. Here are a few questions for the Senators to consider. Politics being what they are, we recognize that some of them may not be asked.

Q. As the NY Fed president, you held a unique position. NY is the only one of the 12 regional Fed banks that is always a voting member of the Federal Open Market Committee (FOMC). The other 11 banks rotate the voting slot, with only four of those 11 presidents are voting at any one time. Mr. Geithner: is this system obsolete? Is there a need for 12 regional banks now that payments are largely electronic? Isn’t the concentration of banks in the north and east (Boston, New York, Philadelphia, Cleveland, Richmond) a reflection of history and not the present distribution of economic and banking activity around the United States? With your experience as the NY Fed president and now as the new Treasury Secretary, would you recommend any changes? Should we have fewer regional Reserve banks? Is there redundancy that can be eliminated and reduce cost? Since Congress is empowered to make any changes in this structure, we are asking you, Mr. Geithner.

Q. As NY Fed president you were involved in the mergers of Countrywide, Merrill Lynch, and Bear Stearns. They were all primary dealers with direct activity under your supervision. They did not fail. Lehman Brothers was also a primary dealer and did fail. Why Lehman and not the other three? For six months after Bear Stearns and during the time that the Fed governors changed the rules under their 1932-legislated emergency powers, your NY Fed was using the Fed’s portfolio to secure overnight repos with Lehman and the other primaries, and it was lending to Lehman. During that time weren’t you able to question Lehman to see if they were developing a workable plan to avoid bankruptcy? Was that the NY Fed’s responsibility? If yes, did you fail? If not, who was responsible? Was there any culpability at Treasury for Lehman’s failure?

Q. Let me follow up on Lehman with another question, Mr. Geithner. On that famous Lehman failure weekend you and your colleagues at the Fed and Treasury faced three firms in crisis: Merrill Lynch, Lehman, and AIG. The Merrill outcome we know. The AIG outcome we know. Re: Lehman did you and your weekend colleagues consider the contagion that would follow if Lehman failed and triggered counterparty failure? Did you see the global collapse coming because of Lehman’s failure? Did you realize that risk premiums would spike in all financial sectors if a primary dealer failed? If so, why did you permit it? If not, what information were you lacking that could have avoided it?

Q. Last one on Lehman. Barron’s (Nov. 24, pg. 32) and others have reported that the Fed has “created special lines for London offices of primary US government dealers after the Bank of England (BOE) cut off its short-term lending to them.” BOE acted “because Lehman repatriated $8 billion to New York from London just before its bankruptcy filing.” Mr. Geithner: what was the $8 billion and where did it go? Did the New York Fed know about it? What is your opinion of the fact that the primary dealers were cut off by another global central bank?

Q. Let’s move from Lehman to the whole notion of primary dealers. Maybe this system is obsolete now? They are now down to 16 firms. More than half of them are owned by foreign institutions and the Fed is dealing with the US subsidiaries of them. The ultimate headquarters of those firms is in London, Paris, and Tokyo. Those firms’ primary supervision is not the Federal Reserve; it is the BOE, the Banque de France (and European Central Bank), and the Bank of Japan. What changes do you recommend, if any? What have you learned as NY Fed president that you can recommend to this Congress for alteration of the laws empowering the Federal Reserve?

Q. Perhaps you can help this Congress restore its approval rating from the lowest level in decades. We have seen the results of Senator Stevens’ home improvement scandal. The Banking Committee chair and his wife obtained two personal mortgages under the Countrywide VIP program. Senator Dodd called it a “non-issue” when questioned about it. Senator Dodd also held up the appointments of two vacancies on the Board of Governors for years. He only allowed governor Duke to be confirmed after former governor Mishkin resigned and that left the Fed with only four Governors and no legal ability to use emergency powers. It takes five votes to use those powers. Did Congress politicize the Fed? Did that widen risk premiums? What would you recommend to this Congress? Mr Geithner, do you have the courage to do it, since we are the ones who vote on your confirmation? And by the way, is there really any difference between Dodd’s behavior and the AIG folks having a party after they got their bailout money?

Mr. Geithner, we Senators also thank you for your answers on the policy issues of the day, as partially recited in the Wall St. Journal: TARP, Fannie and Freddie, foreclosures, financial regulation, international risk, China and other larger Treasury holders, the stimulus package, taxes, etc. And now we will adjourn for lunch, having spent four hours in this carefully orchestrated production.

By the way, Mr. Geithner, please consider that the US stock market is now worth about 59% of the US GDP, about half of its year-ago former self and much below the 80% average from the roaring ’ 20s to present. The yield on the 90-day T-bill is near zero. The VIX (volatility index) is four times higher than a year ago. The tax-free bond of a major state (example Ohio) yields 150% of the taxable bond of the US Treasury. Corporate credit spreads are wide without precedent and have caused business to be unable to finance. The federal deficit will exceed $1 trillion for this and the next fiscal year. Your old employer, the Fed, has tripled the size of its balance sheet in the last few weeks.

Dear Mr. Treasury Secretary to be: are we correct in assuming that the combination of massively stimulative fiscal policy and massively stimulative monetary policy (unlike anything we have seen since World War II) can turn this serious recession and avoid a further deflationary meltdown like we had in the Great Depression? Massive fiscal and massive monetary stimulus has the power to turn deflationary forces into a rebound, so we believe. Are you prepared to increase them, if needed? Would you recommend a deficit of $2 trillion monetized by the Fed, if needed?

We are investing based on this premise, Mr. Secretary to be. We believe that Treasury and the Fed have this power to print money hugely. Are you confident you can succeed? If yes, specifically tell us why and how. If not, we should sell everything and move into a cave with canned food and bottled water.

We wish our readers a happy and festive Thanksgiving holiday and hope that you travel in safety during this holiday week. As we partake of our great bounty in this wonderful and free nation, where political aspirations previously never dreamed of may be reached, let us also remember those who are “food insecure.” The US Department of Agriculture now estimates that number is up to 36 million Americans, 12% of our population.

David R. Kotok, Chairman and Chief Investment Officer,
email: david.kotok- at-

Cumberland Advisors is registered with the SEC under the Investment Advisors Act of 1940. All information contained herein is for informational purposes only and does not constitute a solicitation or offer to sell securities or investment advisory services. Such an offer can only be made in states and/or international jurisdictions where Cumberland Advisors is either registered or is a Notice Filer or where an exemption from such registration or filing is available. New accounts will not be accepted unless and until all local regulations have been satisfied. This presentation does not purport to be a complete description of our performance or investment services.
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