naked capitalism

Checks and balances may not be completely dead in the US after all, but we need to see what transpires after the release of the report by Neil Barofsky, special inspector general for the TARP, which is out tomorrow. The New York Times appears to have gotten its hands on the whole report; the Financial Times also provides some details. (I assume they are pre-released and embargoed, but the Times and FT must have gotten them through separate channels as well).

Timothy Geithner will appear before Congress to discuss the report’s findings, and he clearly won’t do much more than try to blunt criticism. However, the most damning comments are on the public private investment partnership, which has gotten a thumb’s down from pretty much everyone except those who will benefit directly from it. The Treasury already opened up the legacy securities portion to more money manager applicants after complaints that the only a very few firms would qualify,. That would reduce the number of possible bidders and presumably lead to lower prices when fetching higher prices presumably is the point of the exercise. But that argument presupposes a fair and open process.

Nevertheless, the fact that Treasury already modified some provisions suggests they will do so again to diffuse attacks. But I doubt that we will see more than cosmetic changes.

From the New York Times:

The Treasury Department’s most ambitious plans to rescue troubled banks — partnerships between the government and private investors, backed by the Federal Reserve — are inherently vulnerable to fraud and should not be started without stronger safeguards, a top government investigator warned in a report to be released Tuesday.

Yves here. “Inherently vulnerable” is stern stuff, as is the call to halt the program unless changes are made. This throws down a gauntlet. Back to the article:

The report also warned that the Treasury’s $700 billion Troubled Asset Relief Program has evolved into a $3 trillion effort of “unprecedented scope, scale and complexity” and comes with too little oversight and too little information about what companies are doing with the taxpayer money they are getting…..

Mr. [Neil] Barofsky [special inspector general for the bailout program] was particularly critical of the Treasury Department’s refusal to demand detailed information from banks and other financial institutions about what they are doing with the money they receive.

Noting the widespread public outrage unleashed over the Treasury’s huge payments to the American International Group, the failing insurance conglomerate, Mr. Barofsky warned that Treasury officials were jeopardizing the credibility of their efforts by not requiring companies to disclose far more about their use of taxpayer money.

“Failure to impose this requirement with respect to the injection of yet another $30 billion into A.I.G. would not only be a failure of oversight, but could call into question the credibility of the government’s efforts,” he said. He was referring to bailout money that had been pledged, but not yet delivered, to the insurance giant.

The inspector general was particularly pointed in his criticism of the Obama administration’s plan to buy up questionable assets from banks. That plan calls for the Treasury to spend $100 billion to buy up troubled mortgages and mortgage-backed securities.

Yves here. We’ll see what we see later in the AM, but the Times deems the report (at points, at least) “particularly critical….particularly pointed”. It will also be noteworthy to see whether the Congressmen fall in with the tone of the report in their questioning of Geithner tomorrow, or are more deferential. Back to the article:

Mr. Barofsky said the plan posed “significant fraud risks,” especially when it came to buying up securities backed by exotic mortgages made during the peak of the housing bubble, when the excesses of poorly documented loans and no-money-down loans reached their zeniths.

The report said that the Federal Reserve intended its lending program, known as the Term Asset-Backed Securities Loan Facility, or TALF, to finance new lending rather than to buy up existing assets. It warned that the Fed was not currently planning to examine the securities that it would finance, and would be relying instead on the evaluation by credit rating agencies that originally failed to spot the dangers of subprime mortgages.

“Credit ratings, cited as one of the primary credit protections in TALF as currently configured, have been proven to be of questionable value,” the report said. “The wholesale failure of the credit rating agencies to rate adequately such securities is at the heart of the securitization market collapse, if not the primary cause of the current credit crisis….”

Yves again, I’m gobsmacked that Barofsky is making an issue of the ratings. Not that he shouldn’t, mind you, but the Fed relies on ratings for pretty much all of its collateral haircut decisions. Admittedly, the agencies’ record was particularly bad on complex structured securities, but this charge, while aimed at the TALF, raises other uncomfortable issues for the Fed.

In general, the failure of the Treasury, either under Bush or Obama, to do anything to revamp the rating agencies’ role is a telling sign of their lack of dedication to reform. There are a number of good ideas as to how to fix them, and unlike just about any other aspect of the mess, this could be addressed in isolation. But no, even the rating agencies seem to be sacred cows. Back to the article:

Senator Charles E. Schumer, Democrat of New York and a member of the Senate Banking Committee, said some of the inspector general’s criticisms about buying up “legacy assets” — usually troubled mortgage-backed securities — made sense.

“There are a few problems with using the TALF program to buy up legacy assets,” he said. “First, it’s rewarding the worst behavior — buying no-doc loans.” Second, he said, the public-private program “is a very rich subsidy program to begin with. You have to ask whether it needs the extra enrichment of TALF, particularly when it involves the most egregious of mortgages.”

Update 2:30 AM The report is live and it certainly passes the weight test.