Should Treasury Bail Out Califonia?

This may come as quite the shocker, but California has bigger problems right now than its wayward Miss USA contestant.  The treasurer of the State of California has asked U.S. Treasury Secretary Tim Geithner to use TARP to guarantee the state’s debts.

California faces a budget shortfall of $13 billion next year.  There’s a state constitutional amendment that says California must always balance its budget, and the state got into a DEFCON-1 fight this year because no one will raise taxes.  Bill Lockyer, the California Treasurer, predicted that the state will be out of money by July, and will have to “delay” paying what’s owed to “school districts, counties, social service providers, vendors,” and other State-dependent agencies.  Lockyer predicts this will force some school districts into bankruptcy.  So, like any financially struggling institution that is too big to fail, they have turned to the federal government.

Lockyer’s request is particularly clever, almost Citibank-like.  He proposes the following: California needs to borrow in order to make up for the shortfall.  It wants to borrow by issuing Tax and Revenue Anticipation Notes (TRANS), which are what they sound like: they sell $X billion in these notes, saying, hey, look, we’re anticipting tax revenue down the road, and we’ll pay you back when this hits.  So investors (banks) buy the notes, expecting that they’ll get paid back what they put in plus interest.  But, as with any investment, there’s a risk involved.  If California defaults, then the banks that they issue the bonds through are left holding the $X billion bag.  They would still be required to pay the bonds off — California isn’t going to file for bankruptcy protection, after all — but no bank wants to take the chance that it will be left holding a multi-billion dollar outstanding debt.  California’s credit rating is the lowest of all 50 states.

So Lockyer has asked Treasury to guarantee California’s borrowing.  If California defaults, he wants Treasury to say, we will step in and buy their debt from you, the banks.  This way, the banks feel confident that they’re going to get paid no matter what, and California will be able to borrow more easily because Treasury has just made them a sure-fire investment.

If this sounds familiar, it’s because it is very, very close to what the intention of the TARP is: Treasury guarantees bad assets, so that banks are more willing to loan money.  Lockyer — and California — are right to say that this is the point of TARP.

Lockyer also argues — again, correctly — that the overall goal of TARP and all its acronymish brethren is to improve financial security and stability in the market overall.  A default by California, or even a major stall in its payments to state agencies, wouldn’t exactly help the nation’s economy.  Please imagine the unequaled BAD of schools staying closed, fire stations shutting down during fire season, mental health centers shuttering, and everyone who works in those places sitting at home, not spending any money.

Now, I’d expect yelling from the right about this.  The governors who have declined (or tried to decline) stimulus spending have all done so standing on the soap box of States’ Rights, which would seem to imply that they believe each state should have to stand on its own.  If California should default, here, then residents of faraway states would end up paying for their debt, at least immediately.  California would still eventually have to pay the government back, but the big outlay necessary to pay off its bank debts would be more money coming out of Treasury and less money that could go toward… well, toward the original goal of the TARP, shoring up banks.

Yet this seems to me a better way to spend that money, or at least a more urgent need.  If California, which is something like the world’s sixth largest economy, has to undertake IMF-levels of austerity in its budget, the impact on the national economy would be dramatic.  This wouldn’t be wilting green shoots: this would be like setting the green shoots on fire and then putting them out by pouring concrete on top.  Hate on Cali all you want, but as it goes, so goes 13 percent of national GDP.

I suddenly feel a need to buy an avocado.  Short of a similar massive national sentiment, the TARP bailout sounds reasonable.  I hope Geithner writes a positive reply to the letter — and soon.

Small Wonder: A Terrible Day for Tim Geithner

Felix Salmon had a nice post today suggesting that major U.S. banks holding Chrysler’s debt are willing to let the company go into bankruptcy instead of taking a haircut on their debt in part because there’s no real way the public could think less of them.  Being the automatic villain gives one a certain freedom to be horrible, and J.P. Morgan Chase and friends certainly find themselves there.

What this made me wonder is, at what point will Tim Geithner hit the so-hated-he-can-do-whatever stage?

I mean, this has been a totally sucky week to be Geithner.  Consider he went into the weekend with Paul Krugman’s “it’s gonna get so much worse” column and Rachel Maddow having invited the “Hey Paul Krugman” singer onto her show (for the 5 people who hadn’t already heard him sing, “Timothy Geithner, he’s like some little weasel,” via the Internet).  Yesterday, he had the hey-guys, cut-your-budgets Cabinet meeting (check out the body language here, too — that’s Geithner slumped next to Biden).  At this point, I’m not sure the man could buy friends (though I have no doubt at least one commenter will say he’s tried).  Just take the last 24 hours:

• The Special Inspector General issued his report, which initially made news for saying that, contrary to the Secretary’s earlier assertions, firms who wanted to participate on either side of the Public-Private Investment Partnerships would be subject to compensation limits.
• Then it made news because, at The Economist, that sounds like the end of the PPIP.
• Then it made news because there are already 20 fraud cases being investigated.
• Then Felix Salmon pointed out that, within the report, there’s open speculation that it could encourage out-right criminal organization money-laundering schemes.
• The IMF also released its Global Financial Stability Report today, and said that bank losses are over $4 trillion, with more than half of that originating in the U.S.  Oh, and we’re going to need substantial additional investment to recapitalize banks, and may need to nationalize some at least temporarily.  And soon.
• All of this before the real fun started: Geithner testified before Elizabeth Warren’s Congressional Oversight Panel.  You may remember her as the woman who made Jon Stewart feel better last week, or the one who released the highly critical — and commendable, at that — report on the Treasury’s plans so far.  Wanna guess how that meeting went down?  Let Andrew Leonard summarize:

The pattern is now sufficiently well established to be definitive. The treasury secretary appears before a congressional committee, and is asked tough, detailed questions by members of both parties. He invariably compliments and thanks the questioner for a “thoughtful” and “important” question, and then proceeds to answer in vague generalities, rarely committing himself to specifics.

I’ve watched or pored over the transcripts of almost all of Geithner’s testimony before Congress, and it’s getting harder and harder to make a case in defense of his brief tenure. Tuesday’s hearing, before the Congressional Oversight Panel empowered by Congress to watch over the TARP program, ranks as one of his least satisfying performances so far. 

(I would say it was sort of like watching the robot from Small Wonder face off with Minerva McGonagall from Harry Potter — you start off rooting for both sides, but by the end, you just want McGonagall to put the robot out of her repetitve, wide-eyed misery).

• The stock market did rally a bit over Geithner’s assertion that “the vast majority of banks have more capital than they need to be considered well capitalized by their regulators.”  That sounds like great news, until you realize he never said that (he skipped those pages, somewhat dramatically, in his testimony).
• Also, even if he had said that, it was meaningless and earned, again, bafflement and concern (and use of the word “ominous” in the first paragraph) from Paul Krugman.
• Finally, The Wall Street Journal ran an interview with Geithner (“Geithner Weighs Bank Repayments“) where he said he’s considering whether to let banks repay their TARP debt early or not.
• Finance blogger Nemo and a reader point out that, no, he can’t do that — he has to let banks pay the money back whenever they want to.  Strike… what? 56 or so? for Geithner.

It’s those last two points that bring us to the importance of the villain question.  The two banks currently talking about repayment are Goldman Sachs and J.P. Morgan Chase.  Paying back TARP funds would free these two from compensation limits — present and looming — and also make them look strong and solvent.  JPMC CEO Jamie Dimon has called TARP assistance a “scarlet letter,” and he’s looking to shed it as quickly as possible.  This would possibly inspire further investment in these banks and certainly encourage concentration of power into their hands.

Which is partly why the Treasury Department isn’t keen on just letting them repay so quickly.  Banks shedding TARP funds could make other banks want to jump ship — banks whose life-vests aren’t properly inflated.  So you could see Bank of America trying to pay back TARP, and either failing after payback, or failing to payback at all — and either way looking so weak as to inspire (who thought it was possible) less confidence than even now.  Which would, of course, benefit those who do survive the leap — probably a big part of the JPMC/Goldman dream right now.

In fact, the only reason that a firm wouldn’t leave TARP right now is a desire NOT to piss off the U.S. Treasury Department.  It’s in their individual interests to run, even while it might be in the interest of the entire system for them to stay a while.  So let me ask you this: Is Tim Geithner someone you’d want mad at you?  Does a real villain lurk somewhere within the Small Wonder facade, just waiting for the day when it no longer matters what Wall Street thinks — and if so, was today that day?  Does he have enough power, inside or out of the Treasury, to make things more uncomfortable for these banks than they already are?

My guess?  If there’s pressure to be brought to bear, it will have to be done by the President — and if that’s the case, Geithner’s days at the grown-up table are going to be limited.