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Secretary Loophole

From his unprecedented power grabs to his personal income taxes, Timothy Geithner has made a career of bending the rules and threading the needle.

By From the May 2009 issue

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When Timothy Geithner worked at the International Monetary Fund, he managed a feat that probably very few Americans have even contemplated: he got himself reimbursed by his employer for taxes he never paid.

You see, foreigners working at the IMF don’t have to pay U.S. income taxes or payroll taxes, and so to create parity between the foreigners and the Americans, the IMF reimburses the Americans for their income taxes and for half of their payroll taxes.

But the IMF also doesn’t withhold taxes from its employees’ paychecks or pay the employer half of their payroll taxes. That means American IMFers, as with freelancers and contractors in any industry, need to pay the “self-employment tax,” which is both the employer and the employee portions of the payroll taxes funding Medicare and Social Security. Geithner, for four years, didn’t pay the payroll taxes he owed, but still managed to get the IMF to reimburse him for the taxes he would have paid had he been obeying the law.

This episode was extraordinary for Geithner only because it didn’t work—he eventually had to pay all the taxes.

But the effort—trying to wind his way through an impossible path—was typical of Geithner’s career. From his time at the Federal Reserve Bank of New York to his turbulent four months so far at Treasury, Geithner has made a career out of seeking—and usually finding—ways to do what most people thought the rules wouldn’t allow.

His nose for loopholes was critical to his orchestrating the bailout that sparked the bailout inferno: the March 2008 save of Bear Stearns. Similarly, his Treasury Department has wielded the Great Wall Street Bailout in ways Congress never imagined its law would be used. Even his hiring practices at Treasury involved finding narrow and dubious loopholes in President Obama’s ethics rules. Geithner admitted that it was his staff that requested the bonus loophole in the executive pay law—the loophole that allowed the AIG bonuses that sent Wash ing ton into convulsions for a week.

This trait of Geithner’s is important going forward, and it also may explain why Obama has gone to such lengths to save him, both before confirmation and after. Surely Geithner hasn’t made the administration look good, nor does he give the impression of supreme aptitude. Why was he worth saving while Bill Richardson, Tom Daschle, and others could be cast overboard?

It could be that Geithner’s value for Obama— in these unprecedented times and given Obama’s unprecedented ambition—is precisely his ability to find his way around the rules.

The Banker’s Bank Bails Out a Non-Bank

THERE WAS A TIME WHEN corporate bailouts were shocking to the American media and the American populace. The U.S. Constitution didn’t set up any mechanisms for the federal government to bail out private companies, and the unpopularity of bailouts has made Congress hesitant to change the law to allow them.

But today, bailouts are commonplace. We all assume that more struggling industries will get on the federal dole in the coming months, and in our next recession we can expect bailouts as a matter of course.

The sea change came in March 2008. It came in the form of a slightly complex bailout of Bear Stearns. And it came thanks to some crafty navigation of the law by the president of the Federal Reserve Bank of New York, Timothy Geithner. The behind-the-scenes workings of the bailouts of 2008 are still mostly unknown, but all accounts of them have placed Geithner at the heart of the Bear Stearns bailout.

In school, teachers call the Federal Reserve “the banker’s bank.” That’s where banks keep their reserves—the fraction of all deposits that federal law requires them to actually have on hand. The Fed also lends money to banks from its “discount window,” which requires collateral from the banks.

In March of 2008, Federal Reserve chairman Ben Bernanke and Geithner, who also served on the Fed’s Board of Governors, decided Bear Stearns needed a bailout loan. The problem: Bear Stearns wasn’t a bank. To be more precise, Bear Stearns was an investment bank, not a commercial bank, and thus the company was not regulated by the Fed nor was it eligible for a loan from the Fed.

Bernanke and Geithner could have called on Congress to pass an emergency bailout law, as Jimmy Carter did for Chrysler in 1979 and President Bush did for the airlines after 9/11—but that would involve messy politics and democracy-type stuff.

Instead, Geithner and crew dusted off Section 13(3) of the Federal Reserve Act—a special exception created during that fabled period of government growth, the Great Depression. This section of the law allows a Federal Reserve Bank “in unusual and exigent circumstances,” to open the discount window to non-banks.

This is the clause the Fed invoked in order to lend money to Bear Stearns. But to trigger this extraordinary clause the law requires “the affirmative vote of not less than five members” of the Fed’s Board of Governors. At the time, however, the Board of Governors had two vacancies, meaning there were only five members total. A Federal Reserve memo explains why this presented a problem:

Section 13(3), which relates to discounts to individuals, partnerships, and corporations, generally requires an affirmative vote of at least five members of the Board to approve an extension of credit under that provision. One member of the Board was unavailable at the time of the Board vote because he was en route to the Board from Helsinki, Finland.

So this 13(3) route had a roadblock—but Geithner found safe passage elsewhere in the Federal Reserve Act: “Any action that the Board is otherwise authorized to take under the second paragraph of section 343 of this title may be taken upon the unanimous vote of all available members then in office.” If someone is traveling from Helsinki, he is not “available,” now is he?

It was a loophole, and Geithner drove the New York Fed through it.

But it doesn’t end there. In order to keep Bear Stearns alive, the Fed called on J.P. Morgan to buy Bear Stearns. J.P. Morgan was willing to go along, but it didn’t want to own the “toxic assets” on Bear’s books. Couldn’t the Fed just buy the toxic parts of Bear and let J.P. Morgan buy the rest? No, the Fed isn’t allowed to buy stuff. They would need another loophole. It would come in the form of a “Special Purpose Vehicle,” that pillar of Enron’s financial shenanigans.

The website Talking Points Memo quotes an expert on how this loophole worked:

By law, the Fed isn’t allowed to buy assets—it can only lend, as lender of last resort. That was a problem for the Bear Stearns bailout, because JP Morgan said it would only buy Bear if someone else assumed responsibility for the crap. Fed came up with this idea to start a shadow company, called a special purpose vehicle (…the New York Fed called their SPV “Maiden Lane LLC” for name of the street the NY Fed is located on in southern Manhattan). The deal then was JP Morgan put $1 billion into Maiden Lane, the Fed put $29 billion in cash into it. Maiden Lane paid Bear Stearns $30 billion, which went straight back to JP Morgan as this deal happened simultaneously to JP’s purchase of Bear. So Morgan got $30 billion in cash ($29 billion net) and the Fed got stuck owning the crap, but was legally only making a loan to Maiden Lane, who was the legal owner (Maiden Lane was incorporated not in NYC, but in Delaware to avoid paying taxes).

So, while a few citizens’ groups, left and right, have sued the Fed for its Bear Stearns bailout, it appears that Geithner, Bernanke, and the Fed always followed the letter of the law, even if they followed it somewhere nobody ever thought it could go.

AIG = Additional Ingenuity From Geithner

I EXPLAINED THE COMPLEX Bear Stearns bailout in some detail to illustrate how Geithner and the Fed, acting under many seeming constraints of the law, had to find ways to change the Fed’s nature without breaking the law. For the AIG bailouts, the details are even more arcane and the loopholes nearly as fine.

Here’s a brief synopsis: The Bush brain trust, with Bernanke and Geithner at the helm, wanted the government to buy AIG in order to bail out those companies to whom AIG owed money—AIG’s “counterparties” as they put it. But no regular government agency could buy a private company without an authorization and appropriation from Congress. The Federal Reserve Bank of New York, headed by Geithner, on the other hand, could make up money out of thin air—that’s sort of why Congress created the Fed in the first place. Once again, though, Geithner’s bank couldn’t go buying up companies. What to do? In the end, the New York Fed loaned AIG $85 billion (eventually, it would loan more), and in exchange, the federal government—but not the Fed—got 79.9 percent ownership in AIG.

In fact, nobody really knew just who took ownership of AIG, which led to the lack of oversight regarding those bonus payments that caused such an uproar this March.

And, oh yeah—those AIG bonuses? They were made possible by another Geithner loophole. Obama had demanded that his stimulus package include a provision limiting employees’ pay at businesses bailed out by government. Geithner’s Treasury Department, however, requested that pre- promised bonuses be exempted from this restriction. It wasn’t until weeks after the uproar ensued that Geithner admitted his team had written the bonus exception into the stimulus.

Taking a step back, the whole AIG bailout on its face is akin to a loophole. Bailing out AIG is really bailing out its counterparties, such as Goldman Sachs and Deutsche Bank. Before the Great Wall Street Bailout, AIG was a backdoor way to funnel cash, with no appropriations and no obvious fingerprints, to ailing Wall Street firms.

But bailouts aren’t the only area where Geithner has shown his flexibility in recent months.

The Loophole Lobbyist

COMING INTO OFFICE, Obama promised to end lobbyist influence in Washington. As a signal of his seriousness on this score, his first executive order was an ethics order curbing the actions of lobbyists in his administration and slowing the revolving door between government and lobbying.

The order required all appointees to swear: “I will not for a period of two years from the date of my appointment participate in any particular matter involving specific parties that is directly and substantially related to my former employer or former clients, including regulations and contracts.” Additionally, it exacted this oath from incoming lobbyists: “I will not for a period of two years after the date of my appointment: (a) participate in any particular matter on which I lobbied within the two years before the date of my appointment; (b) participate in the specific issue area in which that particular matter falls.”

In short, this means that if you were recently a lobbyist and now you’re in the Obama administration, you must now avoid the issues on which you lobbied and matters directly affecting companies for which you worked.

While many folks described this as a “lobbyist ban,” it is far from a “ban.” For instance, Tom Vilsack, Obama’s agriculture secretary, was a lobbyist right up until his appointment. But he lobbied for the National Education Association and didn’t lobby on food or agriculture issues. He may have to walk out of the cabinet room when the Education or Labor secretaries start speaking, but he can do everything he needs to do at Ag without crossing Obama’s new ethical barriers.

At least 16 former lobbyists are serving in the Obama administration, and most of them are pretty clearly exempted from the rule—for instance, if it’s been more than two years since they last were registered as lobbyists. For three appointees, however, there has been no avoiding a clash with this rule, and so President Obama has utilized the executive order’s waiver clause if it is “in the public interest to grant the waiver” or if “the literal application of the restriction is inconsistent with the purposes of the restriction.”

But one lobbyist-appointee stands in a class of his own, entering the administration not through any of these clear-cut loopholes, but through an almost impossible-to-believe loophole. And as is typical of this man to whom the rules don’t seem to apply, it was Tim Geithner who brought this appointee in.

Timothy Geithner’s chief of staff at Treasury is Mark Patterson. Patterson was in the very inner circle of Senate Democratic leadership under Tom Daschle. After Daschle’s 2004 defeat, Patterson cashed out, as do many top staff, and became a lobbyist at Goldman Sachs. He worked there as a federally registered lobbyist until April 11, 2008.

Federal lobbying forms show Patterson lobbied Congress on banking regulations, insurance policy, monetary policy, executive compensation, commodities trading, foreign investment, real estate, pension issues, renewable energy subsidies, immigration, tax policy, mortgage lending, copyright, derivatives trading, tribal gaming, and regulation of credit rating agencies, among others.

His employer, Goldman Sachs, is tied up with just about every corner of the financial sector—and many other sectors too. After all, they are too big to fail, right? AIG bailouts, as we’ve seen, are largely Goldman bailouts.

Despite all of this, Patterson hasn’t received a waiver from the president. That seems to mean he must recuse himself from “personally and substantially” participating in any matter involving finance, banking, Goldman, AIG, credit rating, taxes, mortgages, or real estate. Maybe he just collects time sheets and changes coffee filters at Treasury, but other wise, it’s just another example of Secretary Geithner finding a way around the rules.

One Man’s loophole…

THESE EXAMPLES ALL POINT TO what makes a loophole different from a violation. Loopholes are actual holes—places where the seemingly relevant law doesn’t apply. Finding loopholes is, by definition, following the rules.

Similarly, bending the rules is explicitly not breaking rules. Geithner, except for his tax “hiccup,” is no scofflaw.

He’s not Bernie Madoff, the fraudster who ran a Ponzi scheme; he’s Andrew Fastow, the Enron accountant who followed the rules but always delivered the requested result. Geithner knows where he is and knows where he or his bosses want to get—and he finds the way that the rules will allow it. This is why he’s Secretary Loophole.

Remember, President Obama pledged in his inaugural address to “remak[e] America”—not “rebuild” or “renew” America or “remake” government, but to remake the country. He has pledged to “discover great opportunity in the midst of great crisis.” Timothy Geithner put the same ambitious notions in less soaring rhetoric last June: “the severity and complexity of this crisis makes a compelling case for a comprehensive reassessment of how to use regulation to strike an appropriate balance between efficiency and stability.” In other words, Geithner is on board with this whole project of “remaking America.” Expanding government’s power is at the heart of this remaking project.

Surely Congress will give Treasury and the administration new powers in the coming months and years, but it’s just as sure that Geithner will, on his own, find some other new executive powers, maybe dwelling among the penumbras and emanations of the law, as he has in the past.  

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About the Author

Timothy P. Carney is a columnist for the Washington Examiner and the author of The Big Ripoff: How Big Business and Big Government Steal Your Money (Wiley).