Geithner's Legacy at Stake in Congressional Hearings

Treasury Secretary Timothy Geithner will be defending more than his role in the ongoing Libor scandal when he appears before two Congressional committees this week. He’ll be defending his legacy as President Obama’s top economic advisor during one of the most difficult four-year stretches in recent U.S. history.

Geithner isn’t expected to return for a second term if the president wins re-election in November so this could be one of Congress’ last chances to pin him down not only on his role in the interest rate-rigging scandal, but also on broader questions related to financial reform and the government’s role in regulating capital markets.

The Libor scandal will likely take top billing, however.

Prior to his appointment as Treasury Secretary in 2008, Geithner was head of the Federal Reserve Bank of New York, essentially Wall Street’s top regulator. From that perch Geithner was right in the thick of things as the U.S. housing bubble pushed financial markets to soaring highs last decade and then nearly caused their collapse.

To his critics in Washington, D.C., Geithner has always seemed a little too cozy with the Wall Street titans he was supposed to be regulating. Now those critics have a timely scandal to wave in Geithner’s face as proof of their long-held suspicions.

Documents released by the New York Fed in the wake of suspicions that a number of big banks lied about their borrowing costs in order to manipulate the London Interbank Offered Rate (Libor) show that Geithner was aware of the allegations as early as April 2008.

His response – a memo to the Bank of England with suggestions for eliminating future manipulations – is the source of much controversy now.

Depending on who’s describing it, the memo is either proof that Geithner responded tepidly to the allegations of rate rigging and is therefore complicit in the scandal, or, conversely, proof that Geithner was on top of the scandal from the beginning and promptly offered to help English regulators.

Perhaps the most interesting aspect of Geithner’s testimony will be how he explains the context in which he issued his response to English regulators.

The Libor scandal is really two scandals. Barclays (NYSE: BCS), the huge British bank that bought up the remnants of bankrupted Lehman Brothers in 2008, has admitted that some of its traders sought to manipulate Libor rates to benefit positions held by the bank. Barclays recently agreed to a $450 million settlement related to those allegations.

Regulators and prosecutors are reportedly homing in on other traders at big banks who similarly manipulated Libor rates for profit.

Meanwhile, Barclays has also admitted to low-balling its actual borrowing rates in order to project a healthy image at a time when investors and depositors were fleeing banks viewed as unhealthy. Other big banks also apparently misled Libor rate setters for similar reasons.

Did Geithner Tacitly Approve of the Libor Rate Rigging?

The question is whether Geithner will differentiate between the two sets of circumstances. And even if he does, possibly suggesting one is preferable to the other, he might still come under criticism for coddling his Wall Street friends, essentially allowing them to lie about their borrowing costs.

Of course his defense will be that the global economy was at stake.

Geithner received support last week from Federal Reserve Chairman Ben Bernanke, who defended the response by U.S. regulators -- in particular the New York Fed -- to Libor rigging allegations during Bernanke's own appearance before Congress.

Observers expected Congress to push the Fed chief harder over the Libor scandal but that wasn’t the case. It should be a very different scenario for Geithner when he testifies before a House banking committee on Wednesday and a Senate banking committee on Thursday because Geithner was much closer to the scandal and is the face of President Obama’s economic policies.

In addition to explaining his role on the Libor scandal, Geithner will also be called on to defend the two-year-old banking reform legislation passed in the wake of the financial crisis.

That line of questioning will undoubtedly lead to the massive losses reported in May by JPMorgan (NYSE: JPM) and whether the proposed Volcker Rule would have prevented the bank from taking on risk of that magnitude. The Volcker Rule, which hasn’t been implemented yet, would block investment banks from trading for their own profits.

Also fresh in the minds of Congressional inquisitors is the recent collapse of futures brokerage Peregrine Financial Group, whose founder has admitted illegally dipping into the segregated accounts of his clients. It's the second incident in less than a year in which client funds were used improperly by a big futures broker, following MFGlobal's collapse in the fall.

All of these scandals will be fodder for panel members seeking to discredit President Obama’s -- and by extension Geithner’s – policies as the November election approaches. Geithner’s responses will be viewed in two contexts. The first as a defense of the president’s policies and potential justification for his re-election, and also as the first effort in laying a foundation for Geithner's own legacy.

The pressure’s on.