Wednesday, January 20, 2010

Summers and Geithner Must Go! (Part II)

I recently argued on this blog that the Coakley disaster arose substantially from the policies of the Obama Administration regarding the economy and financial regulation and the perception that the Administration is too close to Wall Street. The remedy for this malady is a real jobs program and real financial re-regulation. In my prior post, I showed how Lawrence Summers apparently keyed the dilution of the stimulus bill and exchanged out infrastructure investments for trickle-down tax cuts. In this post, I want to show how Treasury Secretary Geithner failed on financial re-regulation.

The Financial Times reports today that: "Even John McCain. . . supports a return to the Roosevelt-era Glass-Steagall Act, which separated commercial from investment banks." This rocked my world! The repeal of Glass-Steagall (during the Clinton Administration, when both Lawrence Summers and Timothy Geithner served in Treasury) paved the way for financial firms to become too-big-to-fail, and allowed commercial banks to expose themselves to the more risky activities of investment banks. Re-regulation in this form would instantly require that banks be cut down to size. President Obama should seize the opportunity of joining with Senator McCain (tomorrow morning) and announce a bi-partisan solution to banks that are too-big-to-fail. Senator Maria Cantwell joined McCain's initiative so bipartisan support is already on the table.

So why hasn't that happened already? According to the Financial Times: "A lot of Democrats - and some Republicans - believe Mr Obama is too beholden to the counsel of Lawrence Summers, his senior economic adviser, and Tim Geithner, on his approach to the banks." Indeed, Newsweek quotes "a senior Treasury official" as stating that re-regulating with Glass-Steagall like restrictions "would be like going back to the Walkman." Banks worked better during the Walkman era! They are broken today.

Noble laureate Joseph Stiglitz worked against the repeal of Glass-Steagall when he served in the Clinton Administration as Chair of the Council of Economic Advisers. He explains:

"by breaking down these barriers, we would wind up with larger financial institutions that would reduce competition, [and] increase the risk of too big to fail. Banks that are too big to fail have incentives to engage in excessive risk taking. And that's exactly what happened. The increase in the concentration in the banking system in the years after the repeal of Glass-Steagall has been enormous, and we've seen the excessive risk taking, which American taxpayers have had to pay hundreds of billions of dollars for."

Professor Stiglitz also makes a compelling point about the supposed cost of reinstating Glass-Steagall:

"You look at the history, and it was clear that the quarter century after World War II, in which we had strong financial market regulations, is that one quarter century in the world in which there was almost no financial crises, no banking crises. It was also the period of most rapid economic growth, and it was also the period in which the inequalities in our societies were being reduced. So it was very hard to say that these regulations had stifled economic growth."

So of course we can go back to a Glass-Steagall world. Geithner's Treasury Depatment is simply acting in a thinly veiled effort to protect Wall Street executives. Stiglitz notes that CEOs have incentives to build larger firms.

I wrote a law review article searching for a means to resolve the problems implicit in too-big-to-fail. I have blogged on the issue here, here, here, here, and here. Other bloggers here have similarly sought to resolve the problems inherent to too-big-to-fail. The fact that a solution is so easily at hand and the Administration dismisses it is very disconcerting.

Could it be that Tim Geithner is the problem? Recently Bill Black, Eliot Spitzer and Frank Partnoy argued that emails and other documents relating to AIG be released to the public. Based upon a limited disclosure of those documents it appears the the NY Fed, under the leadership of Tim Geithner, deliberated acted to deceive the public about payments made under its credit default swap obligations. Certainly, Black, Spitzer and Partnoy are correct that all the information should be disclosed. Geithner was central to the AIG bailout. He must have known that AIG paid 100 cents on the dollar to its obligees on the credit default swaps and the identity of those payees. He should have assured these facts were made public. He is inextricably linked to the sordid AIG bailout.

But, in any event, the voters of Massachusetts can be forgiven if they perceive that Administration is too close to Wall Street interests. There is an easy way out for President Obama. If he wants voters to believe he is not too close to Wall Street (and thereby avoid a Democratic bloodbath in November) he must distance himself from Wall Street. That means Geithner must go. It means Glass-Steagall must be reinstated. It means Wall Street must submit to the rule of law rather than dominate lawmaking.

Look at the poll of the Obama voters who supported Scott Brown or who stayed home:
President Obama can either watch as the Democrats suffer defeat as the party of Wall Street or he can reconfigure his team and tame Wall Street.


  1. Great post. So, today, Obama took your advice announcing that he would propose that large banks become smaller. What do you think?

  2. professor ramirez:

    how close do obama's new proposals come to fulfilling volcker and stiglitz's recommendations? the proposal expressly states it is not trying to reprise glass-steagall.

  3. I was truly amazed at the timing.

    With respect to the substance: I finally feel we are on the right track. It seems to me that banning banks from proprietary trading is effectively Glass-Steagall II.

    I note that neither Summers nor Geithner were on the podium with President Obama.