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Is TARP Investigator on Collision Course With Treasury on Bank Assets?

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This could get interesting. The Financial Times tells us that Neil Barofsky, the special investigator general for the TARP, is looking whether banks cooked their books by overvaluing assets to qualify for TARP funding, Remember, bank had to fall into this funny construct of being sick enough to need help, but not so sick as to be terminal.

And since we are widely reading reports of banks carrying lots of mortgage paper at higher than 80 cents on the dollar (we’ve even seen reports of over 90 cents on the dollar being common) it would appear that Barofsky’s suspicions are well founded.

So play this out: we have the public private partnerships designed to hoover up assets at well above market levels. These programs are voluntary, so the banks most decidedly will not sell assets unless they get a price that is above the current carrying value on their books. And recent research suggests that, contrary to the Treasury’s claims otherwise, the current market values are likely to reflect accurately what this dreck is worth. So taxpayers are being asked to overpay substantially for junk in an opaque and unnecessarily costly subsidy (the need to bring in the private asset managers as a fig leaf only adds costs, since they need to somehow see decent odds of a positive return). And doing it this way, by making an indirect subsidy to the banks, excludes the overpayment from what the government calculates as its subsidy to each bank. The more the taxpayers perceive they have given to a Citi or a BofA, the more they are entitled to demand control, or at least more restraints (particularly on risk taking. Why should these banks be gambling with taxpayer funds to enrich shareholders?). So muffing the equation helps the plutocracy.

But now Barofsky is likely to find the banks overvalued their assets to make themselves look less sick. That’s tantamount to saying they defrauded the government, and that the PPIP is overpaying for assets by an even larger margin than previously thought.

Let’s hope he does not get muzzled.

From the Financial Times:

Neil Barofsky, special inspector-general for the troubled asset relief programme, told the Financial Times he was seeking evidence of wrongdoing on the part of banks receiving help from the fund, which was designed to ease credit conditions and support distressed industries…..

Large banks from Citigroup to Goldman Sachs and hundreds of regional banks have taken billions from Tarp to rebuild balance sheets weakened by the financial crisis.

But institutions applying for Tarp money had to show they were fundamentally sound, potentially prompting them to mis-state their assets and liabilities.

Mr Barofsky also said the Treasury’s expanded term asset-backed securities loan facility (Talf) was ripe for fraud.

The former New York prosecutor said the decision to expand the Talf to encourage investors to buy distressed, or “legacy”, assets from banks could put public money behind investments that were backed by fraudulent mortgages.

“One of our strongest recommendations of the last report was do not expand the Talf to buying legacy assets. If its structure is not changed considerably it’s very, very dangerous,” he said.

“We know the triple A rating [ascribed to the securities by credit rating agencies] was a sham. We could be buying securities that are backed with assets that we know were likely riddled with fraud.”

Mr Barofsky revealed at a Congressional hearing earlier this month that he was involved with “probably more than a dozen” investigations into possible wrongdoing and fraud. He told the FT that potential fraudsters would pay attention when his team began seeking indictments. “Indictments can serve as great deterrents,” he said….

With scant reporting requirements when the bail-outs began at the end of last year, banks had a fairly free rein on what to do with Tarp money. Concerned about a lack of transparency, Mr Barofsky has written to all of them to ask how the funds were spent.

“We haven’t served a single subpoena,” he says. The preliminary audit will be published in the next few weeks, after analysis of the “pretty detailed descriptions with what banks say they’ve done with the money”.

That fulfils part of his office’s transparency remit and is not necessarily a trawl for fraud. But big banks are potential targets…

“One of our main areas of focus [on executive compensation] is to see if there was a significant communications breakdown as to how that policy decision was made,” says Mr Barofsky.

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19 comments

  1. mntlblok

    Does anyone actually know how much power Neil Barofsky and Elizabeth Warren wield relative to the Treasury Department and the Fed? TIA

  2. Anoddamoose

    “And recent research suggests that, contrary to the Treasury’s claims otherwise, the current market values are likely to reflect accurately what this dreck is worth.”

    … I’ll see your recent research and raise you a FASB Mark to Model. Have the toxic asset marks not just been vindicated/validated? Rest assured that those marks come from some model or another, no matter how thin the conceptual underpinnings. That leads us into the “assumptions swamp,” from which no one has ever emerged.

    Barofsky has not been muzzled, but I doubt he is going to turn out to be much of an attack dog, because he has much less to attack than he did before the FASB endorsement of fraud, er, I mean Mark to Model.

    So long as there was discussion of Mark to Model at FASB and some reasonable sense by reasonable people (such as Chief Accountants at the banks) that FASB would come down on the side of Mark to Model, and this discussion took place prior to any asset marks, I think the banks get a pass on any fraud assertions.

  3. bb

    you hold trash at 90c, i hold trash at 90c. we both know this subprime waste is not worth more than 50c.
    i borrow from the feds and pay you 95c (97% borrowed non recourse), you do the same.
    we now both hold the same trash and have realized 5c loss, and on the hook for another 3c potentially. total losses should not exceed 8c on the buck in comparison with 50c expected loss on the trash paper.
    merry times for both of us.

    would any investor put his money with dopes like you and me who can only make money in crooked ways???

  4. retread

    Anoddamoose,

    The liberalization was not allowing more liberal use of Level 3 (mark to model) but exempting from mark to market, which means the value has to be hold to maturity. Don’t see how you get to that under any scenario. And shifting too many assets into Level 3 is frowned upon.

    Plus the games were played before the rules were changed.

  5. Russ

    This sure looks like defrauding the taxpayers.

    As for defrauding the government, it seems clear two administrations have intentionally set up the system so it can be gamed in this and other ways.

    Geithner especially has openly declared, over and over, that it is administration theological dogma that these “assets” are greatly undervalued and that the admin will spare no (public) expense in seeing to it the banksters are made whole according to their own measure, which is the one and only criterion for policy.

    So the government has suborned the fraud, as part of its own assault on the people.

  6. Independent Accountant

    YS:
    How is this possible? Aren’t the banks audited by CPAs? Surely I jest. What do the CPAs like say KPMG which audits Citigroup, do there? Answer: a lot of clerical work.
    If the CPAs did their jobs correctly, there would be nothing for Barofsky to find. And pigs will fly.

  7. Anonymous

    And, in turn, if the banks’ marks are false, what does this say about the so-called “stress tests”? As if we didn’t know that this was all a sham already, with the banks and not regulators doing the tests…

  8. fresno dan

    Like a lot of government programs, that essentially want to help everyone with no pain to anyone, the gubermint will have to lie to explain all the rules that are being unequally enforced to help the stupidiest and most venal bankers.

    capitalism has a cold, cruel way to deal with the banks, shareholders, and bondholders – bankruptcy. I own financial stocks through my 401K, and it would be a big hit, as financial institutions have grown to make up an unsustainable part of our economy. But I would be even worse off as long as the gubermint decides to subsidize the most inept amoungst us.

  9. Anonymous

    If Barofsky has real powers, and has honorable intentions of getting to the heart of this nest of oligarchal thieves, he will be silenced, muted or rendered irrelevant at the oppotune moment, no doubt over a weekend.

  10. john

    I’m kinda sick of people getting all pissy about this.

    So, another attempt at a backdoor bailout? Meh.

    Can someone explain to me how this is worse than a month-long bank holiday while the FDIC moves in to figure out how much these banks are really worth?

    The government simply cannot take these banks over in any reasonable logistical manner.

    Death by a trillion paper cuts, yes — but give me a *viable* alternative. One that doesn’t lead to martial law, I mean.

  11. eh

    The former New York prosecutor said the decision to expand the Talf to encourage investors to buy distressed, or “legacy”, assets from banks could put public money behind investments that were backed by fraudulent mortgages.

    I thought that was the whole idea, albeit in a roundabout way.

  12. Let It Sink

    I’m betting Barofsky gets fired. Obama seems to be every bit the criminal, idiot, or frontman that Bush was. I am genuinely surprised the banks stayed in control of the economy through the change in administrations. Democracy in America is done now.

  13. Anonymous

    Fed’s Flood May Leave Democracy Needing Bailout: Kevin Hassett

    April 13 (Bloomberg) — The wise men of Washington keep finding more core beliefs that we have to give up. First it was free markets. Now it’s democracy.

    The financial rescue may be the least popular big-ticket government program in history. If the U.S. Treasury decides it needs more money to keep the bailout going, it is anybody’s guess whether Congress would provide it.

    As a result, Treasury and the Federal Reserve have been running what feels to this lifelong student of fiscal policy like a scam.
    http://tinyurl.com/cmffs9

    Yup!

  14. Anonymous

    John said:

    "Can someone explain to me how this is worse than a month-long bank holiday while the FDIC moves in to figure out how much these banks are really worth?

    The government simply cannot take these banks over in any reasonable logistical manner.

    Death by a trillion paper cuts, yes — but give me a *viable* alternative. One that doesn't lead to martial law, I mean."

    Rubbish.

    You have set up a false dichotomy. The alternative to pumping trillions of dollars into banks (via TARP, TALF, backstopping Citi debt and PPIP, etc.) is likely not a month-long bank holiday. Just as Wachovia & WaMu were taken over & married off over the weekend, so Citi & BA could be taken into receivership overnight. Depositors are insured to $1/4 mil. There would be no need for a run on the banks. Deposits would stay put. All that would happen is that the banks's creditors & stockholders would be wiped out. That's all. The latter is inconsequential given their current stock prices. Wiping out the creditors is long overdue (even though some of the money came from IRA's & pension funds).

    A month-long bank holiday (which is unlikely) would be preferable to the continuation of moral hazard that is taking place now with the "heads I win, tails you lose" system that the banks have been operating under. This bailout mentality is corroding the entire underpinning of capitalism. The cynicism engendered by the bailouts paves the way for greater acquiescense to an over-reaching nanny state. We would be lucky if that merely led to decades of economic atrophy. More likely, crushing national debt will lead to our defaulting on sovereign debt, high inflation and a precipitous drop in national wealth. I'd take a bank holiday over that any day of the week. It'd be a healthy kick in the arse in moving away from a debt/consumption based economy to one built upon savings & production.

  15. artichoke

    bb said: “you hold trash at 90c, i hold trash at 90c. we both know this subprime waste is not worth more than 50c.
    i borrow from the feds and pay you 95c (97% borrowed non recourse), you do the same.
    we now both hold the same trash and have realized 5c loss, and on the hook for another 3c potentially. total losses should not exceed 8c on the buck in comparison with 50c expected loss on the trash paper.
    merry times for both of us. …”

    Exactly. Remember the earlier version of TARP, where the idea floated was to provide “insurance” to the banks on the value of the toxic waste? We saw through that and so it wasn’t implemented.

    But this is the same thing (if the banks think that’s the best way for them to use PPIP) and the insurance is radically underpriced to boot. For a fee of 5 cents in the example, they obtain insurance on a notional amount up to $1.00 , on whatever is the worst stuff in their book. They get to decide exactly what to insure at this price.

    My thoughts cannot be written here.

  16. BondsOfSteel

    John said: “Death by a trillion paper cuts, yes — but give me a *viable* alternative. One that doesn’t lead to martial law, I mean.”

    I’m not sure that the plan to continue to bailout the banks -via- backdoor bailouts won’t lead to martial law either. I’ve yet to meet one person who thinks this is a good idea.

    AIG empolyees got death threats (Death threats!) over $163 million. Just wait untill people realize the bill could be closer to $4 trillion… and they’re picking up the check.

  17. Anonymous

    wait, doesn’t the authorizing legislation for Treasury _explicitly_ forbid Warren from investigating how the TARP evaluated the junk?

    OR is it the other way around?

  18. Francois

    John wrote:

    “Death by a trillion paper cuts, yes — but give me a *viable* alternative. One that doesn’t lead to martial law, I mean.”

    This martial law argument is totally baffling. How in the world putting a big bank in bankruptcy proceedings would trigger a social revolt is beyond me.

    “The government simply cannot take these banks over in any reasonable logistical manner.”

    If by that, you mean the government cannot take over a big bank a Friday at 17:00h with 200 of the most experienced FDIC agents without creating pain or big waves in the market…well, you’re right.

    Let’s start with the premise that it’s impossible to take over ALL the big banks that are insolvent at once.

    But, here’s the deal: taking over one big bank isn’t supposed to be a cuddly-confy exercise in goodie two-shoes touchy-feely soft therapy. It is a hard-nosed no-more-accounting-grade-AAA-BS surgical strike on bad management, crappy assets and risk obliviousness. As such, it will be painful, lots of people who took way too much risk would get burned badly, and the markets would sure react with fear and dismay, wondering “Who’s next?”

    No one ever said the creative destruction inherent to real capitalism (as opposed to the crony variety) was pleasant. But any alternative to it has miserably fail the test of history.

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