Bailout Inspector General to Warn That Public Private Partnership Open to Fraud

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.

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  1. Jim T

    Is there any way we can get Elizabeth Warren and Neil Barofsky together to fight these fraudsters at Treasury, Fed, Administration, Congress & Senate?

    We may even need to get them into the witness protection program. The SOBs are already going after Elizabeth and after today's hearings they will be going after Neil too.

    These two people are the only honest people in Washington and the only ones looking out for us.

    All of you OBAMA worshippers need to get a grip and realize he is not in your corner! Unfortunately less then 100 days into his administration he has already sold out to the banksters!

  2. Brick

    In a reply to queries published in the congress oversight panel report with Elizabeth warren the treasury had this to say.

    Given the important role that credit ratings play in our eligibility criteria, Federal Reserve economists have conducted due diligence on rating agency methodologies.

    I quite frankly am astonished that the Federal Reserve economist agree with Egan and Jones ratings agency methodologies which show banks in a less than healthy state and price assets somewhat lower than some better known ratings agencies. I guess they did not really mean all agencies then and Egan and Jones was not one of the ratings agencies assessed.

    It is funny then that in 2003 the FED did assess EJR and came to this conclusion according to Richard Johnson, Research Division, Federal Reserve Bank of Kansas City.

    S&P ratings converge toward Egan-Jones Ratings.

    It seems to me that the whole point of these various bailouts is to engineer a V shaped recession regardless of fundamentals. This goes back to the meeting in Davros where economic decision makers decided that the problem was irrational pessimism rather than any fundamental weakness in the exconomy. The whole point of many of these bailouts is that they will be abused to resurrect the financial industry, and all those who overextended themselves.
    Even if the policies do work the amount of moral hazard involved means we will most likely be in the same situation not much further down the road. On the other hand the treasury could be using all its ammunition before it really is needed.

    If enough people like Neil Barofsky keep asking difficult questions and decision makers continue to be economical with answers and the truth then there could be a snapping point when frustrations overflow.

  3. kackermann

    I just want to slip in that I am puzzled over the lack of outrage from the disclosure that Libby holds preferred stock in GS. The stock is converting to common on May 6.

    It’s bad enough Libby, a former GS board member, was hand-picked by Paulson, a former GS CEO, to run AIG, a major GS counterparty, but shouldn’t there have been at least some disclosure up front on Libby’s holdings?

    Legal or not, the whole thing stinks like rotten meat.

  4. "DoctoRx"

    Typo on “Partnership” in the title

    GREAT post

    Keep fighting the good fight. Maybe this time the good guys will win!

  5. Mannwich

    Of course it’s open to fraud. Isn’t that the whole idea with these bailouts? Let’s face it, it’s also the whole idea with our economy over the past few decades. Leave things open to fraud and turn the other way and/or aid and abet it while it happens.

  6. Neal

    The problem is that all of the rescue/bailout efforts are aimed at restoring the economy to 2006 territory. When you talk to people about stimulus and recovery, their benchmark of a “recovered” economy is 2006, not some other slower time.

    That restoration is not possible without the fraud that pretended that real estate inflation was a reasonable substitution for income.

    As a result, there seems to be a focus on achieving that result without developing the understanding that the 2006 economy was unsustainable and will again be unsustainable even if it is possible to re-ignite that old 2006 magic.

    This is setting up to be a major collision between wishful thinking of a restored 2006 and the reality of an economy that has to operate at a significantly slower pace.

    Barofsky and Warren apparently haven’t received the memo as to the importance of restoring 2006 at any cost, and are taking their wathdog roles very seriously.

    Bravo for them in their end of the game. I hope they don’t get destroyed in the process.

    What we really need, though, is a realistic assessment of what level our economy can really operate at and spend our effort and money moving to that instead of trying to restore the unsustainable.

  7. Doc Holiday

    Re: “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…."

    Credit ratings are certainly an important component of the whole package that has been engineered by wall street — a package that includes collusion, accounting fraud, false and misleading information and corruption at virtually every level of managerial authority.

    Re: "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."

    We already went through this bullshit after Enron and after that mess, congress danced around with SIFMA-like lobby groups and pushed hard for PR headlines to calm people down, in an effort to assure us about something …. I forget what they were trying to suggest, but I think the suggestion was that rating agencies are great places to work, because they have no accountability and they can provide false and misleading information and falsify documents, lie, engage in accounting fraud and stuff like that…

    See: Bush Signs Rating Agency Reform Act

    The law also grants the SEC new authority to inspect credit-rating agencies, although the commission would have no say over their rating methodologies.

    "Importantly, the new law gives the SEC the tools necessary to hold recognized rating agencies accountable if they fail to produce credible and reliable ratings," declared Jim Kaitz, president of the Association for Financial Professionals (AFP), in a statement. AFP represents 15,000 members working in corporate treasury and financial management functions.

    >> Too bad The SEC, DOJ, FTC, Treasury are corrupt as well, but that package of collusion and corruption does group all these crooks together!

  8. Dave

    The link you give for the report is a military site related to Iraq reconstruction. I don’t think that is the link you intended to give.

  9. Yves Smith


    That is really quite bizarre. I never visited the other site, did look at the Barofsky report, and copied the address. Am fixing. Thanks.

  10. Doc Holiday


    Yves uses that same link for every story, so relax and welcome… (and go figure). That link always fits in and is always on topic, so I think that’s the point.

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