In Part One of the recap of my trip to the Treasury, I outlined the questions and answers related to variations on the concept of "extend and pretend" - the refusal to acknowledge bad debts and instead attempt to stick our proverbial policy finger in the dyke and hope that the water will stop spraying out. Most of the attendees have written recaps of the event, and I found Steve Waldman's piece today to be quite well done, as is David Merkel's ongoing recap.
Later in the meeting, I had the chance to ask a Senior Treasury Official (STO) a question related to this testimony last week from Treasury Secretary Geithner (note - Ritholtz has the location wrong - it's actually from the House Financial Services Committee, I believe):
To summarize the video testimony in the link above: Geithner outlined 5 key points to the Administration's proposed regulatory reform bill:
1) The government has to have the ability to resolve failing firms, with losses absorbed not by the taxpayers, but by the unsecured creditors and equity holders.
2) Firms who cannot survive without government support must face the consequences of that failure. The government would facilitate the "orderly demise" of the failing firms, not ensure its survival.
3) Taxpayers must not be on the hook - the government will recoup losses by assessing fees on industry peers
4) The FDIC and FED must have limited authorities with respect to these abilities to take over failing firms
5) The Government must have stronger supervisory authority.
Now, the first three points from Geithner's testimony are the main ones, and they are a good idea - they are pretty much saying that we'd never have bailout like we had the last time, where taxpayers were asked to front the capital that the bondholders (in the form of haircuts and debt for equity swaps) and equity holders (in the form of dilution) should have had to pay for. I think that most of America would agree that these three points are reasonable, and at the very least, a good start. My question for the STO was how these three new ideals jived with the recently announced imminent THIRD round of bailout money for GMAC.
Back in May, I was stonewalled by Barney Frank when I asked him why bank bondholders and auto bondholders faced such disparate treatment in the bailout proceedings - with the auto bondholders being forced to make concessions as they rightly should have, while the bank bondholders went on their merry way and watched the government commit taxpayer dollars to shore up their balance sheets.
Sadly, I had a similar feeling when the STO responded to my question about GMAC, explaining, basically, that GMAC was different. The GMAC bailout was part of the Capital Assistance Plan, where the Treasury stood ready to commit capital to any bank that couldn't raise the capital it needed to raise as identified by the stress tests. GMAC was the only such entity unable to raise its own capital, and the Treasury was making good on its promise. I was told that the new rules were for the future, which left me raising an eyebrow, as I was complaining about a third round of funding for GMAC that was being announced as we were sitting in that conference room at the Treasury! It wasn't the future - some as yet unforeseen disaster - it was happening as the Treasury was announcing policies to say that it wouldn't happen!
The STO clearly didn't want to debate this with me, but must have noticed my squirming, wrinkling my nose, and raising my eyebrows as if I'd just walked into a bathroom at Penn Station, because as he was responding to another question, he briefly addressed me, noting that this was another example of how the rules would need to be flexible.
This was even more disturbing, as I basically took it to mean "there will be no bailouts like we had before, UNLESS there needs to be bailouts like we had before."
John Jansen asked a question regarding the re-opened 3 and 7 year Treasury notes, and the potential saturation of demand due to the massive annualized issuance in these midrange maturities, which he pegged at nearly 1.2 TRILLION dollars a year. John was similarly stonewalled with a response that basically consisted of "why would you think that?" A bit perplexed, John replied that this was simply a tremendous amount of issuance, but was told that he'd need to discuss that with a different Treasury official.
One viewpoint I was surprised to hear expressed by a STO, but one that I strenuously agree with, was the dismissal of the notion that investors were duped into buying much of this toxic paper that has inundated our financial system. It was noted that the products could be understood by those who deigned to actually understand them, and that those who didn't understand what they were buying were responsible for their decisions. It's pretty clear to me that it's not that the buyers were duped by spurious Wall Street salesmen, but rather by their own greed and relentless hunt for yield in a low interest rate environment. Interestingly, I tend to have similarly little sympathy for homeowners who claim they didn't understand their mortgages, which leads me to a quick tangent about consumer protection - another topic which was discussed briefly.
I believe some of this is already in the works, but I'd like to see standardized credit card and mortgage documents that have data just like all food products now do - only instead of listing fat content, vitamins, and calories, these docs would list interest rates, loan length and terms. There should be no fine print - and that goes for television ads too. A pet peeve of mine are auto ads on tv where there is fine print on the screen that I can't even read if I pause my digital video recorder on my HDTV. Consumers need to be protected from their own ignorance.
Tyler Cowen asked if the Treasury was worried about the possibility of the economy falling off a cliff, and was greeted with a response that pretty much summed up the Treasury's options: the response was essentially (and this is not a direct quote) "what else can we do - should we try to pull that potential cliff forward instead of pushing it back?" Before I could jump out of my chair and shout "BUT PUSHING THE CLIFF BACK MAKES IT TALLER TOO!" Tyler Cowen uttered almost those exact words. The STO nodded and pursed his lips - acknowledging the possibility of that reality.
In summary, I think this was an interesting opportunity to gain insights I'd rarely expect access to from senior government officials. However, one of the bloggers summed it up on the way out, saying "the concept of the meeting was probably cooler than the actual meeting," and I was left feeling similarly unsatisfied, considering the relative brush off of what I thought was a very well reasoned question (GMAC). I got the impression that the Treasury officials are still very concerned about what the results of their policies will be, and for good reason. As I've said before, I don't think that continued stimulus or failure to mark to market - the extend and pretend policy - solves anything. To use an overdone analogy: you can't give a drunk another drink to help him avoid a hangover. That hangover is inevitable, and by postponing it with another drink, you're making the eventual reckoning worse, although later!
Unfortunately for the Treasury, much like Tom Cruise's Lt. Daniel Caffy in A Few Good Men, I just don't think America can handle the truth
The truth is that expansion doesn't last forever, even in our economy that seems to rely on expansion (Ponzi?) to run - and that the only way to resume growth is to first acknowledge hundreds of billions, if not trillions of dollars worth of bad debts that need to be washed away. The Administration, politically, cannot tell this to the people - no Administration can - it's a sad fact of politics. In times of trouble, politicians who do the right thing and make the tough decisions sign their own political death warrants. The officials making these policy decisions at the Treasury are clearly not stupid - I think the main realization from this meeting for me was that they really don't feel like they have any other choice but to TRY to resolve the issues in a way that avoids current mass financial pain. Is it possible that the Fed can simply buy up all the bad debts? Maybe - I mean, it looks like they are actually trying to do that. Will the effects of that - potential hyperinflation and pervasive moral hazard be worse than if we "took our medicine" and allowed the system to implode sooner? That remains to be seen.