Neil Barofsky vs. Tim Geithner: Who’s Right on the Bailouts?

WASHINGTON - JULY 21: Neil Barofsky, Special Inspector General for the Troubled Asset Relief Program (TARP), speaks during a hearing of the Senate Finance Committee on Capitol Hill July 21, 2010 in Washington, DC.

Photo by Brendan Smialowski/Getty Images

I had dinner last night with some Yale students spending their summer interning in D.C. and got asked what I think about Neil Barofsky’s new book and the controversy around it. The short answer is that beneath the obvious mutual loathing between Barofsky and Tim Geithner, and the dueling teams of journalists around each man, is a relatively narrow disagreement about public policy. Unfortunately the nature of the dispute between the two teams’ media proxies—see, e.g., Jackie Calmes for Team Tim and Gretchen Morgenson for Team Neil, both in the New York Times—tends to obscure what the actual disagreement is about.

It’s useful to start with what the Treasury Department says they’ve been doing regarding the financial system since they took office. What they’d tell you is that they’ve been doing two things. One is trying to create the kind of healthy well-capitalized banking system that’s crucial for broader macroeconomic health. The second is trying to create the kind of well-regulated banking system that’s less likely to blow up in the future.

What does Barofsky think they’re doing? His interview last night with Ezra Klein is useful on this. He agrees, for example, that Team Tim is in fact trying to better regulate the banking system and that it’s being fought in this effort by the Republican Party:

“Romney is offering them a better deal potentially from their perspective than Obama is,” [Barofsky] said. “They hate anything that could possibly eat into their profits and their ability to exploit their size and power. And Mitt Romney is offering the repeal of Dodd-Frank.”

“So Dodd-Frank was actually very helpful in preserving the status quo for the banks,” Barofsky continued. “But better to have nothing. Better to go back to the go-go days of 2006 and 2007 when they could print money on the backs of American homeowners.”

So does Barofsky also agree that Team Tim is trying to create the healthy and well-capitalized banking system that’s crucial for broader growth? Well only sort of:

“In almost every critical juncture when it came to really meaningful choices in conducting the bailout, this administration and the prior administration—there’s no meaningful difference  between the two—consistently chose the interests of Wall Street banks over that of homeowners, over that of the broader economy,” former TARP inspector general Neil Barofsky told guest host Ezra Klein on The Rachel Maddow Show Wednesday.

This gets us to the actual dispute. Team Tim would say that they’re trying to create a well-capitalized banking system in order to bolster the broader economy. Team Neil counters that the broader economy would be better served by a policy that imposed steep losses on banks and instead repaired household balance sheets. Beneath all the anger and accusations and counter-accusations is a fairly wonky policy disagreement about the relative importance of household balance sheets versus the credit channel to laying the preconditions for growth.

So who’s right? I think this is actually a much more difficult question than partisans on either side are willing to acknowledge. Team Tim has bolstered their argument with the overblown notion that homeowner bailouts “launched the Tea Party” via Rick Santelli and are therefore politically impossible and thus one doesn’t even really need to address the merits of the case. On the other hand, Team Neil has never really presented a coherent alternative course of action that takes real account of the consequences of imposing very large losses on the banks. From the original winter 2008-09 argument over bank nationalization along Swedish lines, I’ve rarely heard it acknowledged that these courses of actions would likely have required hundreds of billions of dollars in additional “bailout” money. I think that still would have been the optimal policy, but it’s not a no-brainer and I think the administration’s left-wing critics would have been very disappointed if the White House made universal health care take a back seat to a second round of bank equity injections.

Fortunately, as a monetary policy guy I can also say that I don’t actually think this disagreement was nearly as consequential as either side seems to think. The administration made a catastrophic blunder in failing to appoint and confirm a team of Federal Reserve governors who were committed to reflating the economy to something approaching its pre-crisis trend level of aggregate spending. Had they done that, the banking policies they chose would have worked. Having failed to do that, even alternative superior banking policies would have failed.