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Pity Barack Obama's economic advisers.



Tim Geithner's Black Hole
By David M. Smick
Tuesday, March 10, 2009; A13

<http://www.washingtonpost.com/wp-dyn/content/article/2009/03/09/AR2009030902232.html >

Pity Barack Obama's economic advisers. The blogs are now demanding 
their scalps, and Treasury Secretary Tim Geithner and his colleagues 
face a nasty dilemma: There are no solutions to the banking crisis 
without extraordinary political and financial risks. Thus, they have 
adopted a three-pronged approach, delay, delay, delay, in the hope 
that somebody comes up with a breakthrough.
Here's the problem: Today's true market value of the U.S. banks' toxic 
assets (that ugly stuff that needs to be removed from bank balance 
sheets before the economy can recover) amounts to between 5 and 30 
cents on the dollar. To remain solvent, however, the banks say they 
need a valuation of 50 to 60 cents on the dollar. Translation: as much 
as another $2 trillion taxpayer bailout.

That kind of expensive solution could send the president's approval 
rating into a nose dive. Consider: $2 trillion is about two-thirds of 
the tax revenue the federal government collects each year.

The logical alternative -- talk show hosts' solution du jour -- is to 
temporarily restructure or nationalize the banks and leave taxpayers 
alone. Remove the toxic assets, replace management and cut the too-big- to-fail financial dinosaurs into smaller, nimbler entities. Then 
reprivatize these smaller banks and let the recovery begin.

Oh, if it were that simple. I suspect Obama's advisers would like 
nothing more than to dismantle an irresponsible firm such as 
Citigroup. They are afraid to do so, for one reason: All the big banks 
are connected to a potentially lethal web of paper insurance 
instruments called credit default swaps. These paper derivatives have 
become our financial system's new master.

The theory holds that dismantling a big bank could unravel this paper 
market, with catastrophic global financial consequences. Or not. 
Nobody knows, because the market for these unregulated financial 
derivatives, amounting potentially to over $40 trillion (by 
comparison, global gross domestic product is now not much more than 
$60 trillion), is the financial equivalent of uncharted waters.

Geithner has reason to be terrified. He was part of the Henry Paulson- led team that underestimated the devastating global-contagion effect 
of the collapse of Lehman Brothers. Geithner won't make the mistake of 
underestimation again.

Geithner also knows that the mood in Congress has changed. Were a 
global financial brush fire to break out as a result of bank 
restructuring or nationalization, today's populist Congress might just 
let it burn. Congressional anger is likely to intensify when 
policymakers realize that credit default swaps demand a stream of 
premium payments like a life insurance policy, not just a payment due 
at termination. And recent signs indicate that firms such as 
Citigroup, in recycling their taxpayer bailout funding, may have 
helped other financial firms, including some in Europe, meet these 
payment obligations.

In addition, Geithner worries that because the troubled insurance 
giant American International Group (AIG) is a conduit for the banks' 
use of credit default swaps, a collapse of AIG (as an unintended 
consequence of dismantling the big banks) could be catastrophic. AIG's 
more than 300 million terrified holders of insurance-related 
investments and pension funds, who have investments totaling $20 
trillion (U.S. GDP is $14 trillion), could suddenly rush for 
redemptions -- the equivalent of a run on a bank. Geithner would face 
a worldwide insurance collapse to accompany his global banking collapse.

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