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A Matter Of Trust At Treasury

Barely settled into office, Treasury Secretary Timothy F. Geithner may be developing a credibility problem that could set back global economic recovery and endanger his place in the Obama Cabinet.

Last autumn, the financial community saw Geithner — then president of the Federal Reserve Bank of New York — as a savior. The global banking system faced imminent collapse when Geithner, collaborating with Federal Reserve Chairman Ben Bernanke and then-Treasury Secretary Henry Paulson, helped push emergency bailout legislation through a reluctant Congress. The announcement that President-elect Barack Obama had chosen Geithner to succeed Paulson rallied a plunging stock market in late November. In the process, it created very high expectations for the nominee.

Then the problems started. Before Geithner’s confirmation hearings, the Obama transition team disclosed that the future Cabinet officer had failed to pay about $34,000 in taxes, primarily for Social Security and Medicare, for 2001 through 2004. Geithner paid the 2003 and 2004 taxes plus interest when his returns were audited in 2006, but he did not pay the amounts relating to the earlier years until after he was nominated to the Treasury post. As Treasury secretary, Geithner is in charge of the Internal Revenue Service, so his personal probity on taxes is important to a lot of people.

Geithner’s tax issues are old news and have nothing to do with the economy’s condition. However, his explanations at his confirmation appearance before the Senate Banking Committee came across, even to nonpartisan observers, as coy and disingenuous. Under surgically sharp questioning from Arizona Republican Sen. Jon Kyl, Geithner refused to acknowledge what was obvious to every tax professional: that he did not pay the 2001 and 2002 taxes at the time of the 2006 audit because the statute of limitations for those years had expired. Legally, he did not owe the taxes any longer, and the IRS did not assert otherwise. Geithner ultimately paid the taxes in 2008, after his nomination, because it is impolitic for a Treasury secretary to be seen as relying on the limitations statute even though he is entitled to do so.

Business and household spending collapsed in tandem over the past six months, along with employment, because two things became very scarce: money and the confidence to spend it. Money is scarce because banks, not knowing whom to trust or what their government bailout sponsors want them to do, have cut back sharply on credit. Businesses, in turn, cut back spending and employment, leading consumers to close their wallets regardless of their own employment status, just to be safe. Reduced consumer spending led to further cutbacks by business, in a vicious cycle.

To break the cycle, government leaders must get the business community and the public to trust them when they say they have effective recovery plans and the skills to execute them. By appearing untrustworthy on his personal tax matters, even when simply explaining why he did what he did, Geithner undermined his own ability to command the respect he needs.

Another concern is that the administration’s inaugural budget proposal calls for a federal deficit of $1.75 trillion this year, a staggering 12.3 percent of projected gross domestic product. We have not seen deficits on this scale since 1942. Back in those days, however, the deficit was almost entirely financed through War Bonds and other domestic sources. Today’s budgetary IOUs will have to be sold largely to foreign buyers. They get American paper. We get their autos, petroleum, leather goods and a host of other products that make up our trade gap, paid for in dollars that are returned to us when we sell Treasury debt abroad.

Because its obligations are denominated in our own currency, the Treasury can print as many dollars as it needs to repay its debts. It will never default. But this is little comfort to foreign buyers unless they have absolute confidence in the integrity of the people who run our Treasury, most of all the secretary and, of course, the president. Any hint of a tendency to cheat or dissemble could lead overseas investors to conclude that we might try to stick them with worthless paper. Demand for our national debt could fall, interest rates rise, and our economy could quite literally run out of gas.

It is generally not a good idea for a Treasury secretary to be seen as having a political agenda, though of course the secretary owes loyalty to the administration’s priorities. Guarding the national wallet is a management exercise. A good secretary will be seen as having excellent technical and stewardship skills. In fact, Wall Street’s initial enthusiasm was based on Geithner’s credentials and reputation as a technocrat whose background at the Fed, the International Monetary Fund, the Council on Foreign Relations and the Clinton Treasury had prepared him to grapple with the worst economic retrenchment in generations.

Geithner has joined other Obama administration officials in pushing the president’s legislative agenda on Capitol Hill. Though this is appropriate, he can damage his credibility when he makes claims that may be seen as misleading.

On March 3, for example, Geithner appeared before the House Ways and Means Committee to support the president’s proposals to increase taxes on business and high-income individuals. One of the most controversial ideas would limit the tax benefit for mortgage interest or charitable deductions to 28 percent of the amount paid, even for taxpayers who are in the proposed top bracket of 39.6 percent. The Associated Press reported that Geithner told the committee this would merely restore a limit imposed by legislation passed under President Reagan two decades ago. What he left out: The Reagan legislation created a top tax bracket of 28 percent, so there was no limitation at all. The tax deductions were worth less only because overall tax rates were lower.

By far the low point in Geithner’s early weeks came on Feb. 10, when he unveiled his plans for using the second $350 billion installment of last year’s financial institution rescue package. Geithner’s presentation, hyped the preceding evening by the president himself in a televised press conference, was an enormous letdown for financial markets. They had hoped to hear how the government would deal, once and for all, with the vast pile of shaky credit that has undermined banks around the globe.

It was surely unrealistic for markets to believe that Obama, Geithner and their colleagues, in office less than a month, could have come up with detailed solutions to all of the world’s financial problems. The secretary’s failure to meet impossible hopes is not his fault. But he did not properly manage expectations in advance of his speech, nor did he articulate clear principles and steps by which the U.S. government would get bad loans off financial institutions’ books and get them back into the business of lending again. His message, essentially, was: “Trust us to figure out the details later.”

Stock market reaction to the Geithner appearance was swift and brutal, and the reverberations continued for weeks. Major indices fell to lows not seen in more than a decade. The credit markets, in the meantime, remained gummed up.

A measure of the credit markets’ health is the TED (Treasury-EuroDollar) spread. Basically, this is the difference in interest rates paid by major banks to borrow money for three months, compared with what the U.S. Treasury pays. The spread reflects the amount of risk perceived in making a short-term loan to a major bank. Normally, this would be a small risk, and the premium or spread would be correspondingly tiny.

From 2002 through 2006, the TED spread averaged about 0.25 percent. It quadrupled to 1 percent as the credit crunch emerged in 2007. The collapse of Lehman Brothers and other debacles last autumn sent the spread gyrating as high as 4.64 percent. Then the bank bailout and other emergency steps took hold, and the spread gradually declined to around 1 percent again by the end of 2008.

Then, the TED spread stopped declining. It fluctuated between 0.9 and 1.1 percent in the first several months of 2009, indicating that we were stalled in the tight credit conditions that existed in the months leading up to last fall’s eruption. Much of the market despair we saw in the first months of this year can be traced to not knowing whether conditions will gradually get better, or merely lead to another meltdown.

A lot of this uncertainty reflects a lack of clarity about what Geithner and other top government officials will do. Now that the autumn emergency has passed, they can and should take a bit of time to work out the proper steps. But when they say something, it is important that decision-makers everywhere, from stock investors to corporate CEOs to homebuyers, trust them to say what they mean and to do what they say. For a powerful public official, credibility is money in the bank.

Geithner has spent too much of his credibility too soon. At 47, he needs to shake the mental and verbal habits of a rising young wonk and mature into the leadership position he now holds.

Early in March, markets reacted with disappointment when Chinese Premier Wen Jiabao stopped short of promising new steps to stimulate his nation’s economy. Edward Yardeni, a well-known market analyst in the United States, called it Wen’s “Timothy Geithner moment.” This is not the type of reputation a Treasury secretary wants to have.

Geithner seems to possess the right intellectual tools and the right resume for his job, which surely is one of the world’s most difficult at the moment. Now he needs to show that he has the character and the discipline to match.

Larry M. Elkin is the founder and president of Palisades Hudson, and is based out of Palisades Hudson’s Fort Lauderdale, Florida headquarters. He wrote several of the chapters in the firm’s book, Looking Ahead: Life, Family, Wealth and Business After 55. His contributions include Chapter 1, “Looking Ahead When Youth Is Behind Us” and Chapter 4, “The Family Business."

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