Published January 31, 2010
The government's bailout of financial institutions deemed "too big to fail" has created a risk that the United States could face a worse fiscal meltdown in the future, an independent watchdog assigned to review the program told Congress on Sunday.
The Troubled Assets Relief Program, known as TARP, has not addressed the problems that led to the last crisis and in some case those problems have festered and are a bigger threat than before, warned Neil Barofsky, the special inspector general at the Treasury Department.
"Even if TARP saved our financial system from driving off a cliff back in 2008, absent meaningful reform, we are still driving on the same winding mountain road, but this time in a faster car," Barofsky wrote.
Barofsky wrote the $700 billion financial bailout has encouraged more risk-taking because bank executives, who are still receiving massive bonuses, figure the government will come to the rescue the next time they steer their ships nearly aground.
"The market mentality now seems fixed that the U.S. government will continue to step in and bail out giant financial institutions," said Sen. Susan Collins, R-Maine, ranking member of the Senate Homeland Security and Governmental Affairs Committee. "The IG's findings confirm my decision to oppose releasing $350 billion in TARP funds last year and my recent vote to terminate the program altogether."
"The SIGTARP's report is just another reminder of how Congress and the administration have ignored the role that politics and government played in causing the housing crisis and the economic collapse while pursing other regulatory reforms will not fix the underlying problem," said Rep. Darrell Issa, R-Calif., the ranking member on the House Oversight and Government Reform Committee.
But House Speaker Nancy Pelosi's spokesman Nadeam Elshami said politics is the reason the government stepped in to save the banks in the first place.
"The American people paid a heavy price because of the reckless economic policies of the Bush administration where the interests of Wall Street were placed ahead of the interests of Main Street. The House passed Wall Street reform legislation to protect taxpayers and consumers and ensure transparency and accountability without a single Republican vote. We hope that House Republicans would drop their unanimous opposition and work for reform instead of against it," Elshami said.
The inspector general's report details stonewalling by the Treasury Department over a recommendation that walls be built between managers of the public-private investment program, which uses taxpayer cash to buy bad assets, and employees of the fund management companies which sell the toxic assets.
Barofsky's report outlined 77 cases of possible criminal and civil fraud, including crimes of tax evasion, insider trading, mortgage lending and payment collection, false statements and public corruption.
One case concerns apparent self-dealing by one of the private fund managers Treasury picked to buy bad assets from banks at discounted prices. A portfolio manager at the firm apparently sold a bond out of a private fund, then repurchased it at a higher price for a government-backed fund.
A rating agency had just downgraded the bond, so it likely was worth less, not more, when the government fund bought it. The company is not being named pending the outcome of Barofsky's investigation.
Treasury said it welcomed Barofsky's oversight but resisted the call to erect new barriers against conflicts of interest. The new rules "would be detrimental to the program," Treasury spokeswoman Meg Reilly said in a statement. The existing compliance rules "are a rigorous and effective method of protecting taxpayers," she said.
"As the report says, 'for various reasons, Treasury has decided that requiring such walls 'is simply not practical in the context of PPIP,' and has refused to adopt this recommendation. It is disappointing but not unsurprising that the Treasury Department under the leadership of Secretary (Tim) Geithner is once again stonewalling transparency," Issa said.
"Frankly, just because it may be inconvenient is not a good enough excuse to justify leaving taxpayer dollars vulnerable to manipulation and fraud," he continued.
Much of Barofsky's report focused on the government's growing role in the housing market, which he said has increased the risk of another housing bubble.
Over the past year, the federal government has spent hundreds of billions propping up the housing market. About 90 percent of home loans are backed by government controlled entities, mainly Fannie Mae, Freddie Mac and the Federal Housing Administration.
The Federal Reserve is spending $1.25 trillion to hold down mortgage rates, and millions of homeowners have refinanced at lower rates.
"The government has stepped in where the private players have gone away," Barofsky said in an interview. "If we take government resources and replace that market without addressing the serious (underlying) concerns, there really is a risk of" artificially pushing up home prices in the coming years.
The report warned that these supports mean the government "has done more than simply support the mortgage market, in many ways it has become the mortgage market, with the taxpayer shouldering the risk that had once been borne by the private investor."
Barofsky's report echoed concerns raised by housing experts in recent months, as home sales and prices rebounded. They warn that the primary reason for the turnaround last year has been billions of dollars in federal spending to lower mortgage rates and prop up demand.
Once that spigot of cash is turned off, they caution, the market will be vulnerable to a dramatic turn for the worse. Daniel Alpert, managing partner of investment bank Westwood Capital, wrote in a report that national home prices are bound to fall 8 to 10 percent below the lows of last spring.
"The lion's share of the remaining decline will occur in markets that saw sizable bubbles but have not yet retrenched," he wrote.
Officials from the Obama administration counter that massive federal intervention has helped the housing market stabilize and prevented more dire consequences.
Barofsky's report also disclosed that, while the Obama administration has pledged to spend $75 billion to prevent foreclosures, only a tiny fraction -- just over $15 million -- has been spent so far. Under the Making Home Affordable program, only about 66,500 borrowers, or 7 percent of those who signed up, had completed the process as of December.
He said the key to preventing future crises is to reform Fannie Mae and Freddie Mac, create and improve loan underwriting and supervision of banks. He stopped short of endorsing specific proposals for overhauling financial regulation, but said many of the proposals would go far to improving the system.
The Associated Press contributed to this report.