Chris Whalen Looks at Geithner’s Record and Finds it Sorely Wanting

We have been less than enthusiastic about the choice of Timothy Geithner to be the next Treasury Secretary. Granted, the idea that we will have someone who is intelligent, knows a thing or two about the markets, and is not from Goldman Sachs makes him a big improvement over the Bush incumbents.

However, competence should be a minimum standard, but the Bush years seem to have lowered expectations for public officials considerably. The commentary about Geithner has been uniformly positive. yet commentators have focused on his experience in a general manner and his personal attributes. Given that he has been actively involved in the central bank’s policy before and during the financial crisis, it would make sense to look at his track record. Yet Geithner has been given a free pass, with some of his noteworthy actions mentioned in the media but not analyzed.

Chris Whalen at Institutional Risk Analytics fills that gap in his current newsletter, “What Barack Obama Needs to Know About Tim Geithner, the AIG Fiasco and Citigroup.” For those readers who may not know of him, Whalen is a banking industry expert (he sells a very high end research product) and has extensive contacts in Washington. After Whalen, we will also provide some hesitant criticism of Geithner from Andrew Ross Sorkin at the New York Times, who pens a piece that is guardedly critical.

Whalen also discusses the ugly consequences of a GM bankruptcy.

From Institutional Risk Analytics::

If you look at how the Fed and Treasury have handled the bailouts of Bear Stearns and AIG, a reasonable conclusion might be that the Paulson/Geithner model of political economy is rule by plutocrat.

Facilitate a Fed bailout of the speculative elements of the financial world and their sponsors among the larger derivatives dealer banks, but leave the real economy to deal with the crisis via bankruptcy and liquidation. Thus Lehman, WaMu, Wachovia and Downey shareholders and creditors get the axe, but the bondholders and institutional counterparties of Bear and AIG do not.

Few observers outside Wall Street understand that the hundreds of billions of dollars pumped into AIG by the Fed of NY and Treasury, funds used to keep the creditors from a default, has been used to fund the payout at face value of credit default swap contracts or “CDS,” insurance written by AIG against senior traunches of collateralized debt obligations or “CDOs.” The Paulson/Geithner model for dealing with troubled financial institutions such as AIG with net unfunded obligations to pay CDS contracts seems to be to simply provide the needed liquidity and hope for the best. Fed and AIG officials have even been attempting to purchase the CDOs insured by AIG in an attempt to tear up the CDS contracts. But these efforts only focus on a small part of AIG’s CDS book.

The Paulson/Geithner bailout model as manifest by the AIG situation is untenable and illustrates why President-elect Obama badly needs a new face at Treasury. A face with real financial credentials, somebody like Fannie Mae CEO Herb Allison. A banker with real world transactional experience, somebody who will know precisely how to deal with the last bubble that needs to be lanced – CDS…..

…. until we rid the markets of CDS, there will be no restoring investor confidence in financial institutions….

1) Start with the $50 trillion or so in extant CDS.

2) Assume that as default rates for all types of collateral rise over next 24-36 months, 40% of the $50 trillion in CDS goes into the money. That is $20 trillion gross notional of CDS which must be funded.

3) Now assume a 25% recovery rate against that portion of all CDS that goes into the money.

4) That leaves you with a $15 trillion net amount that must be paid by providers of protection in CDS. And remember, a 40% in the money assumption for CDS is VERY conservative. The rise in loss rates for all type of collateral over the next 24 months could easily make the portion of CDS in the money grow to more like 60-70%. That is $40 plus trillion in notional payments vs. a recovery rate in single digits.

Q: Does anybody really believe that the global central banks and the politicians that stand behind them are going to provide the liquidity to fund $15 trillion or more in CDS payouts? Remember, only a small portion of these positions are actually hedging exposure in the form of the underlying securities. The rest are speculative, in some cases 10, 20 of 30 times the underlying basis. Yet the position taken by Treasury Secretary Paulson and implemented by Tim Geithner (and the Fed Board in Washington, to be fair) is that these leveraged wagers should be paid in full.

Our answer to this cowardly view is that AIG needs to be put into bankruptcy….pay true hedge positions at face value, but the specs get pennies on the dollar of the face of CDS. And the specs should take the pennies gratefully and run before the crowd of angry citizens with the torches and pitchforks catch up to them.

President-elect Obama and the American people have a choice: embrace financial sanity and safety and soundness by deflating the last, biggest speculative bubble using the time-tested mechanism of insolvency. Or we can muddle along for the next decade or more, using the Paulson/Geithner model of financial rescue for the AIG CDS Ponzi scheme and embrace the Japanese model of economic stagnation….

Our friends at Katten Muchin Rosenman in Chicago wrote last week in their excellent Client Advisory: “On November 13, 2008, Lehman Brothers Holdings Inc. and its U.S. affiliates in bankruptcy, including Lehman Brothers Special Financing and Lehman Brothers Commercial Paper (collectively, “Lehman”) filed a motion asking that certain expedited procedures be put in place to allow Lehman to assume, assign or terminate the thousands of executory derivative contracts to which they are a party. If Lehman’s motion is granted, counterparties to transactions that have not been terminated will have very little time to react and will likely find themselves with new counterparties and no further recourse to Lehman because, by assigning contracts to third parties, Lehman will effectively receive, by normal operation of the Bankruptcy Code, a novation.”

The bankruptcy court process also allows for parties to terminate or “rip up” CDS contracts, something that has also been fully enabled by the DTCC. The bankruptcy can dispose and the DTCC will confirm….

By embracing Geithner, President-elect Barack Obama is endorsing the ill-advised scheme to support AIG directed by Hank Paulson et al at Goldman Sachs and executed by Tim Geithner and Ben Bernanke. News reports have already documented the ties between GS and AIG, and the backroom machinations by Paulson to get the deal done…

The bailout of AIG represents the last desperate rearguard action by the CDS dealers and the happy squirrels at ISDA, the keepers of the flame of Wall Street financial engineering. Hopefully somebody will pull President-elect Obama aside and give him the facts on this mess before reality bites us all in the collective arse with, say, a bankruptcy filing by GM (NYSE:GM).

You see, there are trillions of dollars in outstanding CDS contracts for the Big Three automakers, their suppliers and financing vehicles. A filing by GM is not only going to put the real economy into cardiac arrest but will also start a chain reaction meltdown in the CDS markets as other automakers, vendors and finance units like GMAC are also sucked into the quicksand of bankruptcy. You knew when the vendor insurers pulled back from GM a few weeks ago that the jig was up.

And many of these CDS contracts were written two, three and four years ago, at annual spreads and upfront fees far smaller than the 90 plus percent payouts that will likely be required upon a GM default. That’s the dirty little secret we peripherally discussed in our interview last week with Bill Janeway, namely that most of these CDS contracts were never priced correctly to reflect the true probability of default. In a true insurance market with capital and reserve requirements, the spreads on CDS would be multiples of those demanded today for such highly correlated risks. Or to put it in fair value accounting terms, pricing CDS vs. the current yield on the underlying basis is a fool’s game. Truth is not beauty, price is not value.

If you assume a recovery value of say 20% against all of the CDS tied to the auto industry, directly and indirectly, that is a really big number. The spreads on GM today suggest recovery rates in single digits, making the potential cash payout on the CDS even larger.

As Bloomberg News reported in August: “A default by one of the automakers would trigger writedowns and losses in the $1.2 trillion market for collateralized debt obligations that pool derivatives linked to corporate debt… Credit-default swaps on GM and Ford were included in more than 80 percent of CDOs created before they lost their investment-grade debt rankings in 2005, according to data compiled by Standard & Poor’s.”…

The impending blowback from a CDS unwind at less than face amount is one of the reasons that the financial markets have been pummeling the equity values of the larger banks last week. Any bank with a large derivatives trading book is likely to be mortally wounded as the CDS markets finally collapse. We don’t see problems with interest rate or currency contracts, by the way, only the great CDS Ponzi scheme is at issue – hopefully, if authorities around the world act with purpose on rendering extinct CDS contracts as they exist today. Call it a Christmas present to the entire world.

Now from Andrew Ross Sorkin at the New York Times:

President-elect Barack Obama unveiled on Monday an economic team with deep experience handling economic crises. But does the man at the center of this star-studded cast, Timothy F. Geithner, the nominee for Treasury secretary, have what is needed to take the nation in a new financial direction?…

Mr. Geithner is clearly a 47-year-old wonder boy….

But Mr. Geithner’s involvement in several ultimately ill-fated efforts to buttress the American financial system is the very reason some Wall Street C.E.O.’s — a number of whom spoke on the condition of anonymity for fear of piquing the man who regulates them — question whether he’s up to the challenge….

While Henry M. Paulson Jr., the current Treasury secretary, has taken a drubbing for the changeable nature of the government’s efforts to bolster the financial industry — some of which clearly contradicted each other — Mr. Geithner has managed, for the most part, to remain unscathed. He’s been widely praised as a bright, articulate out-of-the box thinker who is a bailout expert, to the extent anyone can truly be an expert at fast-changing emergencies.

Behind the scenes, Mr. Geithner was the point person for weeks of sleep-deprived Bailout Weekends. It was Mr. Geithner, not Mr. Paulson, for example, who put together the original rescue plan for the American International Group.

And, of course, Mr. Geithner also oversaw and regulated an entire industry whose decline has delivered a further blow to an already weakened American economy. Under his watch, some of the biggest institutions that were the responsibility of the New York Fed — Bear Stearns, Lehman Brothers, Merrill Lynch and most recently, Citigroup — faltered. While he was one of the first regulators to smartly articulate the potential for an impending disaster, a number of observers question whether he went far enough to stop the calamity.

Perhaps what has most people on Wall Street stirring is Mr. Geithner’s role in the fall of Lehman. At the time of its bankruptcy, he, along with Mr. Paulson, appeared to be the most vocal in supporting the government’s refusal to bail out the firm, according to people involved in various meetings. With hindsight, many in the financial industry blame a deepening of the global financial crisis on the government’s decision to let Lehman crumble.

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  1. wintermute

    I stopped rating Geithner 6 months ago when I read a quote from him in the WSJ. (Think it was in the context of high oil prices). Anyway he railed against “speculators and arbitrageurs”.

    That stopped me cold. Speculators, maybe. But arbitrageurs? They play a vital role in free markets! They smooth out price differences between correlated products. They are the good guys who keep markets on an even keel. If Geithner does not know what they do – then he is unfit for high office.

    I commented in the WSJ at the time – and Yves doubts about him have further confirmed my own thoughts..

  2. doc holiday

    This is an add on story:


    Bernanke, working closely with Henry (Hank) Paulson, the Treasury Secretary, a voluble former investment banker, was determined to keep the financial sector operating long enough so that it could repair itself—a policy that he and his Fed colleagues referred to as the “finger-in-the-dike” strategy.

    > I just wanted to add-on here, that in the day of Greenspan, we seldom heard much from the fine folks at The Treasury, and now we have this out of control duel puppet show between Bernanke & Paulson who as a tag team have added confusion and chaos to an insane time. They have failed as a team and if Geithner is help America in any way, he should keep his mouth shut and then Obama should give Bernanke the boot and replace him immediately. The current Fed has lost all confidence and ability to control, as has Treasury, and IMHO, it will be a massive mistake to keep Ben in place — we need a new face, like ahhhh… Volker.

  3. ndk

    Chris understands precisely where and how risk (and risk premia) can be reduced in the markets. I would feel vastly better if his advice on the automakers were followed, even though I don’t think it’s a long-term solution. The CDS are definitely the issue.

    Is it ideology, legal issues regarding sanctity of contracts, or the sheer size of bailout necessary that prevents the shredding of CDS contracts, though? I honestly don’t know. Chris flashes some numbers that are staggering.

    … the CDS dealers and the happy squirrels at ISDA, the keepers of the flame of Wall Street financial engineering.

    Any man who can put that in a newsletter is okay by me.

  4. vlade

    Re IRA on GM CDS: Non-issue, as most of those are already paid out in collateral, so GM going belly up would have about 0 effect on the CDS market and cashflows. Except for the luckies like BH with AAA ratings, who would suffer.

    BTW, the good ole “AIG provides cheap regulatory exit for europeans” is not nearly as true as it used to be. For the large reg relief you need your cpty to be AAA rated, anything else will get you significantly lower relief (it still can be large, if your underlying is bad, but not nearly as large as if your cpty is AAA). Last I looked AIG was rated A3/A-, i.e. just a step over BBB rating. Shortly some of the cpties may wish to rip those CDSes up (which is why they may be open to AIG buying them out).

  5. Yves Smith


    Have to differ with you. I saw a chart, which I neglected to feature here, which illustrated quite dramatically the impact of the Lehman and WaMU BKs.

    The collateral posting requirements increase as the credit deteriorates and spikes up when the BK occurs. The liquidity crunch occurs BEFORE the settlement date.

    And a lot of protection writers opted out of DTCC settlement, so you cannot say with confidence what happened with those CDS.

  6. Anonymous

    Well looks like chemotherapy has failed with CDS, radiology will fail too I fear, only thing left will be a knife job and by that time the cancer will be to progressed to save the patient.


  7. mtubin


    Speaking of CDS…here is an update on what the NY regulators have been up to.

    “NY Delays CDS Regulation Plan

    Nov-25-2008 | Source: Derivatives Week

    New York State Insurance Department Superintendent Eric Dinallo said his department has chosen to delay indefinitely its plans to start regulating covered credit default swaps—the part of the market it considers insurance.

    In testimony to the U.S. House of Representatives Committee on Agriculture last week, Dinallo said it would not help if New York started regulating covered CDS, whereby the swap buyer owns the obligations being protected, if a solution does not exist for the market as a whole. “We acknowledge that some amount of speculation can provide useful information and market liquidity. We also recognize that the best route to a healthy market in credit default swaps is not to divide it up among regulators,” he said.

    Because CDS are unregulated, there is no valid data on the number of contracts outstanding, Dinallo added, calling naked swaps dangerous because they are “a directional bet on a company’s creditworthiness.” With covered swaps, buyers have a “material interest in the asset or obligation that is the subject of the contract,” however. He suggested a guaranty fund be set up in case a counterparty fails, that there be clear mechanisms for dispute resolution, and that market data be made available to regulators.
    The insurance department said it would start regulating covered CDS in January (DW Online, 6/23).”


  8. vlade

    I agree that the spike is before the settlement. If I were to believe my bloomberg, GM now trades at 17000+bps (that is, 170%) on it’s 5y CDS (it’s 250% on 6M, i.e. even the 6M is not worth it as you’d pay 25% more than principal in the fee).
    If I look brooker quote from yesterday, it’s 82-85 up front, with assumed recovery of 15, so basically default too.
    You’re absolutely right there would be a spike – but it has already happened (about a week ago). So, from future’s perspective it’s a non-issue (well, if the senior debt would have 0 recovery, there would be another 15c to be paid out, but the majority if the cash is gone already).

    With LEH the spike was after BK, because no-one believed they would be let go. With GM, people think there’s a reasonable chance that they will be let go, and so have already discounted it.

  9. wintermute

    "Citigroup’s crisis escalated as it was forced to take on its balance sheet a number of special units created to invest in riskier securities…"

    This is exactly the problem: Total and utter regulatory failure!

    Citigroup is "forced" to take SIVs onto its balance sheet. Forced, because it 100% OWNS the SIVs . This should have counted against Citi Tier 1 capital from day 1. Regulators pretended it did not. A few years later – billions of taxpayer dollars at risk, squandered!
    Who are these regulators? Step forward Geithner and colleagues…

  10. Richard Kline

    Chris Whalen’s straight talk in plain English is just the kind of analysis which never makes it into the television feed. Every time I read his commentary it’s like a cold beer on a hot day. Will I ever live in a society that get’s the view right like this on a daily basis? We need someone like _him_ at Treasury, but anyone that qualified is exactly too smart to take the brief. Chris buddy, in the mood for a stint of public service, hey?

    The only potential positive in Geithner, though a minimal one, is that he has always been an assistant, executing the policies of others. Yes, he was on point at the NYFed, but the call on what to do was made at a higher pay grade. His execution suggests that he will do neither different nor better, but we may have small hope he thinks a tad bigger come the New Admin. Really, though, saving the economy won’t be the work of one man. What really worries me is Obama’s team going in. These are all folks sworn to deregulation and the sanctity of the capital markets, they do not look, any of them, able to think outside the locked box owned and operated by the plutocrats. Their ‘experience’ is in getting everything wrong which is now wrong: how useful is _that_? Thus they will do everything wrong that can be done wrong before they will try to do anything right. And we may not last out their learning curve in that pursuit. It is a bitter cup to hope for, but I hope that we reach the nationalization ‘red zone’ before or concurrently with 20 Jan 08 so that the hands of this sorry crew are forced to do needed deeds before they can commit themselves to ‘more of the same only faster.’ *sigh*

  11. Richard Kline

    20 Jan 09. (Micies ate my date in the last post; I know because Word Verification slipped me the word on it.)

  12. Murph

    Whalen is wrong about CDS.

    The Lehman $400 Billion nominal CDS bomb netted down to some $4 Billion or thereabouts.

    The vast majority of CDS contracts net each other out.

    At that rate, the $20 Trillion Whalen is scaremongering about yields some $200 Billion which would change hands.

    It’s not chump-change but it’s not the end-of-the world.

  13. FairEconomist

    Well, if Geithner is responsible for the AIG bailout and allowing the Lehman collapse bully for him. The original AIG bailout was the only decent one we’ve seen. Given the magnitude of Lehman’s bad debt – the final payout was, what, 8 cents on the dollar? – letting it fail was the right thing too. We all agree that the best approach to bad debt is to write it down honestly and that’s what happened with Lehman.

    My concern with Geithner is that he has also been involved in less savory bailouts, including the king so far, the horrifying Citi bailout. In addition, Paulson and Bernanke seem in general fairly clueless at this point; since they talk to Geithner regularly I have to assume he’s clueless too.

  14. Anonymous

    Whalen is wrong about CDS.

    The Lehman $400 Billion nominal CDS bomb netted down to some $4 Billion or thereabouts

    What about the AIG CDS bomb?

  15. Cris

    Interesting piece from Whalen … but do any of the structured finance experts on here have any comment on his figures?

    I thought that:

    a) the gross notional was survey-based and so there is probably a large element of double counting – both seller and buyer report the same contract

    b) more significantly, most of that nets out – the broker dealers will both buy and sell and be hedged on their aggregate exposure, so the overall net exposure is more like 5-10% of the headline amount

    It’s still a lot, there’s surely still potential for a breakdown/bailout if another large AIG-style seller can’t post collateral/pay (or a number of smaller sellers) and in any case I assume until settlement actually takes place, the total amount of collateral to be posted would be closer to Whalen’s figure than the total net-net, so we could well see another asset firesale. But it doesn’t look to me as if any group of sellers is going to be ponying up $15trn.

    Anyone know if that’s right? Or have I started drinking the DTCC kool-aid on this without realising?

  16. kridkrid

    on the murph post and some of the responses… Don’t I remember reading here that the “netting down” of the Lehman CDS’s from 400 to 4 didn’t necessarily reflect a total? Wasn’t there something about what was and wasn’t reported, or some groups holding the CDS instead of accepting the settled price because they would then need to recognize the loss?

  17. Anonymous

    “somebody like Fannie Mae CEO Herb Allison. A banker with real world transactional experience, somebody who will know precisely how to deal with the last bubble that needs to be lanced” are you serious ? Did I miss some tongue in cheek between the lines? Its time to face the facts of what has been going on. If you work for these companies and were unaware of how they conducted business I feel sorry for you but for the rest of you who just went along its time to grab a hight school business book and brush up on some things.

  18. Anonymous

    I’m sure this man has vast differences from Paulson and Bernanke. Provided your perspective view is an insular myopic view from someplace on 5th Avenue in lower Manhattan.

    Those with a far broader world perspective merely see one more slimy maggot in the teeming mass of maggots that were exposed when the rock was turned over. No functional difference from the rest.

  19. S

    The AIG pump job was all about CDS and it is the very reason the Fed will never ever release the details of the collateral and use of funds. What is tryuly astonishing is the degree to which the US gov't is willing to back failed firms like Goldman Suchs and Morgan Stanley. We know as a nation that we have reached new heights of embarrasment when the CEO Mack scribbles an editorial lamenting those nefarious market forces. Both firms should be a bad memory. Instead the stain will linger.

    AIG was/is the SIV for the LEH CDS bail. So those claiming it it was 8cents are smoking something.

    As for the incremental $1.1 Trillion, its been good for 110 points on the S&P. In other words it only cost the American taxpayer $10 billion per S&P point. So by this measure to get us back to the Oct-07 high we need an incremental $6.5 trillion. As bloom reported yesterday, we have already spend or guaranteed $7.5 trillion. I guess that makes it $13 trillion in new debt and guarantees to get us back to the old high.

    said differnetly, on a market cap basis for the S&P 500 the past 3 days have added 885 billion versus the $1.1 trillion spent. Negative leverage, just like the deterioriating debt to gdp ratios

    Hank, where is the leverage?

  20. Anonymous


    The ISDA has gone to great lengths to portray the Lehman CDS settlement as a non-event. Not.

    Per Yves above, the scramble happened BEFORE. Impossible to parse it out, but a lot of hedge fund position dumping in October was related to CDS settlements.

    And with all due respect, Whalen has impeccable contacts, not just with banks, but with the very large institutional investors who are his customers. He most certainly knows of what he speaks as far as financial products are concerned.

  21. Anonymous

    Maybe it’s just me, but I’d rather go with a quiet unassuming pragmatist (like Bernanke, and perhaps Geithner also fits this description) than a bombastic simplifier who’s far too sure of himself.

    There are always unintended consequences in a tangled crisis situation where all correlations have gone to one. Pull one toothpick out of a pile and sometimes the whole pile shifts and collapses further. In hindsight, playing the moral hazard purist card turned out to be not such a bright idea with Lehman. The same would surely be true for an impatient “cut the Gordian knot” shortcut on CDSs.

    “For any complex problem, there is a solution that is simple, obvious, and wrong.”

  22. Dan

    GM belly up? has he been watching the TV? We are going to bail out the auto industry under the guise of saving jobs.

    And anyone else that needs it.

  23. vlade

    @Anon at 10:49
    The LEH scramble happened before settlement but AFTER BK.

    In GM, the scramble has ALREADY HAPPENED.

    GM bonds are now trading at levels similar to LEH just before the auction (10-20c on $).
    The CDS on GM are basically trading off the recovery rate – i.e the same as if GM had already defaulted.
    These are facts which can be independently verified, not opinions.

    What folllows is that anyone and everyone who had to pay out the collateral had already done so, or went belly up if they couldn’t get the cash.

    The notable exceptions to this being AAA rated cpties (such as Berkshire), who would have to pay it in one lump sum should GM go belly up (AAA rated cpties tend to be extempt from collateral, which is good when it’s good, but disaster should they lose their rating). So, if Mr. Buffet wrote a lot of CDS contracts on GM (I’d be a bit surprised if he did, but you never know), he may well suffer.

  24. Anonymous

    Anonymous, above: Allison was appointed Fannie Mae CEO in September, AFTER it was nationalized. Maybe next time spend 15 seconds getting the facts straight before you start lecturing people?

    re the Sorkin article, I thought investment banks like Lehman, Bear, and Merrill were under the aegis of the SEC, not the Fed.

  25. donna

    I think any of the standard school of economics is going to fail. But perhaps it’s best to start with someone who at least understands very well what has happened, and then perhaps start suggestion the new direction(s) in which to move.

    If anything, the Obama team has shown they are open to new ideas. The campaign was a beautiful effort of bottom up organization. Hopefully enough smart economists can get their ideas heard to make an impact on where we go from here (hint, hint).

  26. Fred

    The revisionist machine has started regarding Guithner who, according to Bloomberg, Struggled to Get Movement on Swap Dangers (Update1)

    Bloomberg on Guithneer

    Nov. 25 (Bloomberg) — Timothy Geithner was among the first policy makers to shine a light on the unregulated $47 trillion credit-default swap market back in 2005. The New York Federal Reserve president has struggled since then to get dealers to carry out reforms.

    (I guess he must not have read his March 23, 2005 speech
    March 2007 – Yves Smith on Guithner Speech

    Timothy Guithner March 23, 2007

    “As of now, though, there are few signs that the disruptions in this one sector of the credit markets will have a lasting impact on credit markets as a whole.”

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