As reported on HuffPost last week, Treasury Secretary Timothy Geithner has expressed opposition to the possible nomination of Elizabeth Warren to head the Consumer Financial Protection Bureau.
As John Talbott reported, one can assume that Geithner, being very close to the nation's biggest banks, is concerned that Warren, if chosen, will exercise her new policing and enforcement powers to restrict those abusive practices (at our commercial banks) that have been harmful to consumers and depositors.
Certainly the new financial reform bill is continuing to attract enormous lobbying action from these banks. The reason is simple. The bill has been written to put a great deal of power (as to how strongly it is to be implemented) in the hands of its regulators, some of which remain to be chosen. The bank lobby will spend millions to see that Warren, the person most responsible for initiating and fighting for the idea of a consumer financial protection group, is denied the opportunity to head it.
But this is not the only reason that Geithner is opposed to Warren's nomination.
Geithner sees the appointment of Elizabeth Warren as a threat to the very scheme he has utilized to date to hide bank losses, thus keeping the banks solvent and out of bankruptcy court, and their existing management teams employed and well-paid.
As Kenneth Rogoff explains in his new book, This Time is Different, most crises are preceded by a boom or bubble period in which asset classes, such as homes in this case, reach unsustainable pricing levels. The main driver of most of these asset bubbles is loose bank lending in which banks offer money to asset buyers on very liberal terms, thus guaranteeing that asset prices will inflate abnormally. Eventually, all bubbles burst, and in the worst cases we are led into financial crises. The banks make things even more difficult because as prices fall, the banks end up with substantial increases in problem loans.
To deal with this increase in problem loans, the banks typically pull back on all lending, not just lending in the affected sector. The banks, now primarily concerned with their own survival if they wrote off the problem loans, literally stop almost all new lending, thus driving the economy into a deep recession. Naturally it is difficult to sustain economic activity when there is no credit being supplied by the banking system! instead of lending to businesses and consumers, the banks shift their investments to very safe instruments like US Treasury securities. The result is a risk-free cash flow that over time eventually repairs the banks' balance sheets by increasing their profitability and thus restoring their book equity.
Typically, during crises, the Federal Reserve also lowers interest rates and the cost of bank borrowing so as to make this risk-free profit spread to banks even greater. In the current financial crisis, the Federal Reserve has lowered interest rates to almost zero percent per annum thus assuring that the banks can profit enormously by doing almost nothing, not lending, and sitting on risk free Treasury investments. While good for the banks, one can see how damaging this lack of credit extension can be to an economy trying to recover from an economic crisis.
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