Geithner on FinReg: No More Lehmans!

Can proponents of the coming financial reform bill claim success if the five or 10 largest banks are still too big to fail? That’s the question Kudlow put to Treasury Secretary Timothy Geithner on Wednesday.

Geithner responded to criticism that the Obama administration had failed to remove the moral hazard of excessive risk taking by saying the new legislation will “constrain risk taking, limit leverage, force much more conservative capital requirements, liquidity requirements on these institutions, so they are much less vulnerable to mistakes, much more able to withstand the shocks that could come from the future.”

What the law also will allow – “And this is crucial,” Geithner said – is that if these banks can’t survive without government assistance, “then we will be able to put them out of existence safely.” In essence, the government could avoid a repeat of Lehman Brothers, or AIG and Bear Stearns for that matter, without exposing the taxpayer to the risk of loss, and “without the fire spreading to a bunch of better-managed, solvent institutions,” Geithner said.

That still leaves questions about derivatives, though. While the banks will trade them regardless of how financial reform turns out, Kudlow noted, those who use derivatives to hedge, say, energy or currencies complain the bill could cost them an extra $1 trillion, meaning they are being unjustly penalized.

There is “no basis for those estimates or those concerns in my view,” Geithner said.

He said the bill preserves the capacity for banks and other companies to hedge the risks of their business. And it allows them to continue to do that “in ways that meet their specific needs, but to make sure the system as a whole is safer, that stuff happens in the light of day with transparency and disclosure.”

“That’s why these reforms are so important in derivatives,” Geithner said, “so that we don’t face the situation again where all this stuff operates in the shadows or firms like AIG can take on huge risks without the capital to back them.”

The Treasury Secretary already made news on Wednesday when he told the “Kudlow Report” that taxes on dividends and capital gains would be capped at 20%. But Geithner touched on a number of other important points as well during the interview, including the economy, Fannie and Freddie, tax cuts and his status as the country’s chief financial officer. Read on for those and more.

Outlook on the economy: “I think this economy is healing. We’re repairing the damage caused by the crisis. We’re growing, and we’ve been growing now for 12 months. We’ve had six months of sustained growth in private-sector jobs. Coming out of the last recession, it took us almost two years before we had a sustained set of month-to-month increases in private-sector jobs. So that’s very encouraging. And I think that the most likely thing is you’re going to see is an economy that is growing at a moderate pace, hopefully strengthening over time. And this growth now you’re seeing is being led by business investment, by exports, by manufacturing. That’s very encouraging too.”

On Fannie and Freddie: “We are going to propose a sweeping set of reforms that’ll end what was broken in that basic model, remove the moral hazard from it, fix the basic things that caused that risk, and we are going to move quickly to do that once we have this financial reform bill in place and behind us. We’ve had a very thoughtful team of people looking at alternatives, and we’re going to cast the net very broadly, across the aisle, to get the best ideas, so we can fix what’s broken … We couldn’t do everything at once, and we decided to try to fix these other problems first, but we’re going to move very quickly to reform Fannie and Freddie .”

On the “bad blood” between Administration and business community: “I think businesses are doing now what businesses always do, which is they want their taxes lower and they’d like to operate with less regulation, as they always do. Our job, though, is to make sure, again, we’re creating the conditions that make this economy work better for the country as a whole. Now just remember, when the president stepped into this job, business of America was out of business. People could not borrow. They were cutting deeply into the bone of the productive capacity of this country. They were completely out of commission; it was almost lights out. And what the president did is to take on the tough things early to bring stability to an economy that was falling off the cliff. And the businesses across this country are in a much, much stronger position today because of the actions he was willing to take. Now people don’t like change, they don’t like these reforms. But he took on things that are absolutely critical to our capacity to grow – in education, in health-care costs, and in the financial system – and by taking those tough choice early, we’re in a much stronger position now to make sure we can prosper going forward.”

On the viewpoint that US corporate taxes are too high: “We’re going to have to take a look at comprehensive tax reform for the corporate sector … now it’s important to recognize that the effective tax rate that US businesses pay now is about the average of what companies face around the world. Our priority right now, and this is what the president is doing, is to make sure that we’re extending tax cuts that go to benefit more than 95% of businesses in America. And as part of that, we want to make sure that businesses are getting continued incentives to invest.”

On the expiration of President George W. Bush’s tax cuts, specifically for the top 2% to 3% of the most affluent Americans: “As you know, we inherited kind of a big mess on the fiscal side. And part of growth in this country, part of making sure interest rates are low over time so people are able to invest is to make sure that people understand that we’re going to start to dig our way of that fiscal hole over time. So we think the responsible thing to do – and we don’t do this with pleasure – is to make sure we are beginning to take the steps that allow us to dig out of that fiscal hole. And part of that, we think it’s responsible to allow those tax cuts that benefited just those 2% to 3% of Americans to expire.”

On remaining Treasury secretary after the midterm elections: “As long as the president wants me to serve, it is my privilege and honor to help him fix what’s broken and make this country stronger. I’ll do it as long as he asks me to.”


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