The Geithner Leverage Scam

Henry Thompson

 

The Secretary of Treasury is responsible for paying the bills of the US government. With a government deficit the Treasury borrows to pay the bills, selling US Government Bonds as promises of payment in the future. Buying a bond requires trust the seller will repay. The main job of the Secretary is to generate trust the money will be paid back assuming selling bonds is necessary.

Selling bonds lowers the price of bonds, raises interest rates, discourages investment, and slows growth. The financial collapse of 2008 was due to the distortions of government backed mortgage loans. Government spending to keep failed banks in business has weakened the financial industry.

Geithner increased lending with taxpayer backing in a leveraged financial scam. The Treasury buys bonds from the private sector at 2%. Call such a bond purchaser agent A. Investor A borrows from the Treasury and will pay back the principle plus 2% interest. Investor A can lend to investor B at a higher interest rate with a Treasury guarantee of at most a 5% loss. A private loan could suffer 100% loss if B defaults. The Treasury is effectively providing taxpayer backed default insurance to investor A.

Investor A will charge more than 2% interest to B and make a profit. Investor A will also be able to borrow another 95% of the face value of the Treasury bond from the private sector. Moral hazard occurs since riskier firms will borrow given the taxpayer subsidized default insurance. Investors A and B can easily fraud the system by staging a planned default.

The present financial crisis is due in part to credit default swaps that provide insurance against the default of private bonds. Swaps reduce but do not eliminate default risk. When firms defaulted on their bond payments, the failed banks were overexposed and bankrupt. The Treasury is now attempting to remedy this bankruptcy with credit default insurance of its own, financed by taxpayers. Previous Treasury Secretaries either did not conceive such scams or were honest enough not to pursue them. Imagine the side deals Geithner is making with his associates in the financial industry.

The Geithner scam increases immediate credit but the inefficiency will wear down gains. Investors enjoying the subsidized profits will spend some profits lobbying to keep the subsidy. Taxpayers are financing the campaign to keep Geitner in the Treasury. Government interference in the financial system makes the US less competitive internationally.