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TARP Special Inspector General Neil Barofsky.
Photo from SIGTARP site.
As CQPolitics described yesterday, the latest report from Neil Barofsky, the Special Inspector General for the Troubled Assets Relief Program, is leading to calls from both parties for Secretary of the Treasury Timothy Geithner to resign. From the article:
Rep. Kevin Brady , R-Texas, told Geithner during a Joint Economic Committee hearing Thursday that “the public has lost all confidence in your ability to do your job. It really is time for a fresh start and I would urge you to consider that.”
The report can be found here (large pdf). Unfortunately, one needs only to read as far as the Executive Summary to realize that while removing Geithner from his job would be a good move, it would not address the real problems raised by Barofsky in the report.
The summary first notes that the financial system does appear to have moved "back from the brink of collapse". The report then moves to discuss the costs of the steps taken to prevent collapse.
First, Barofsky notes that although there have been reports of some TARP recipients repaying (with interest) funds they received, when the overall TARP funds are considered, "full recovery is far from certain".
Next, we get to the term "Moral Hazard". In the margin of page 3 of the report, a text box provides a definition:
Moral Hazard: A term used in economics and insurance to describe the lack of incentive individuals have to guard against a risk when they are protected against that risk (for example, through an insurance policy). In the context of TARP, it refers to the danger that private-sector executives/investors/lenders may behave more recklessly believing that the Government has insulated them from the risks of their actions.
Now that the term is defined, this section needs to be read in its entirety:
Moral Hazard: Market behavior is bound to be impacted by the massive infusions of Government capital into the very institutions that caused the crisis; by the modifications of mortgages for homeowners who may have borrowed irresponsibly; and by the provision of cheap, non-recourse loans to incentivize the purchase of the same volatile and over-valued asset-backed securities (“ABS”) that were a major cause of the current crisis. The firms that were “too big to fail” last October are in many cases bigger still, many as a result of Government- supported and -sponsored mergers and acquisitions; the inherently conflicted rating agencies that failed to warn of the risks leading up to the financial crisis are still just as conflicted; and the recent rebound in big bank stock prices risks removing the urgency of dealing with the system’s fundamental problems. Absent meaningful regulatory reform, TARP runs the risk of merely re-animating markets that had collapsed under the weight of reckless behavior. Section 3 of this report addresses the role of rating agencies in particular, their crucial role in the financial system, and their impact on the current financial crisis.
I don’t think the importance of this paragraph can be overstated. Barofsky is sounding the alarm as loudly and as clearly as he can that the underlying structural problems that led to the financial crisis have not been addressed. We have not solved the "moral hazard". Firms still believe that they can make large, risky gambles that will lead to large profit if successful and a government bailout if they fail. This will lead us once again to financial disaster because there is no incentive to guard against risk. The conflict of interest inherent in the bond ratings agencies has not been solved and so the markets are still unregulated in an area already known to lead to disaster. Further, the "too big to fail" firms are now bigger than they were before the crisis after the consolidation that ensued.
That is why the calls for Geithner’s resignation, although necessary, are being backed up by the wrong reasons. Here is a key sentence from the CQPolitics report:
Lawmakers have jumped on the inspector general’s report in recent days, calling for investigations of the AIG payouts.
Yes, the AIG bailout was entirely secretive and probably only served to prop up Goldman Sachs, the home base of much of Obama’s financial team. But Barofsky is telling us that in addition to following the misapplication of funds in TARP, we face a renewed crisis if we do not address the structural problems that led to the crisis in the first place. We face the same crisis again if we do not restore the real risk of financial losses when big firms make large, risky gambles and lose.
While yesterday’s preliminary success on the auditing of the Fed was a giant first step in that direction, there doesn’t seem to be an effort from anyone in Washington to take on the real structural problems of the economy. In addition to auditing the Fed, where is the call for ending the conflict of interest for the bond ratings agencies? Where is the call to regulate the markets so that the gigantic players can’t bring the system down through overly risky behavior? Where is the call to restore risk to large financial firms?
The current calls for Geithner’s resignation flow from the fact, as Brady pointed out in his confrontation with Geithner, that "the public has lost all confidence" in Geithner. I suspect that the public is paying a lot more attention than Congress thinks. It looks to me as though Congress thinks that the misdirection of going after Geithner will be a convenient bone to throw to the public without doing anything of substance to correct the underlying structural problems in the financial system. I think the public has been paying close enough attention to realize that the system has not changed and that the risk of failure still is borne by the government rather than the parties taking the risks. It will be very interesting to follow the next few moves to see if any kind of true grassroots effort at real structural reform gathers steam.
It seems unlikely that Barofsky will be satisfied with merely replacing Geithner. Here is his biographical sketch from the SIGTARP website:
Prior to assuming the position of Special Inspector General, Mr. Barofsky was a federal prosecutor in the United States Attorney’s Office for the Southern District of New York for more than eight years. In that office, Mr. Barofsky was a Senior Trial Counsel who headed the Mortgage Fraud Group, which investigated and prosecuted all aspects of mortgage fraud, from retail mortgage fraud cases to investigations involving potential securities fraud with respect to collateralized debt obligations. Mr. Barofsky also had extensive experience as a line prosecutor leading white collar prosecutions during his tenure as a member of the Securities and Commodities Fraud Unit, which included the case that led to the conviction of the former President of Refco Inc., Tone Grant, and the guilty plea of Phillip Bennett, Refco’ s former Chief Executive Officer. Mr. Barofsky received the Attorney General’s John Marshall Award for his work on the Refco matter. Mr. Barofsky also led the investigation that resulted in the indictment of the top 50 leaders of the Revolutionary Armed Forces of Colombia (FARC) on narcotics charges, a case described by the then Attorney General as the largest narcotics indictment filed in U.S. history.
Since he comes from a background of unraveling financial crimes and pursuing fraud on the large scale, I expect Barofsky to continue pounding on the issue of the structural elements of the financial system still allowing the same problems that led to the meltdown. He may be our best hope of a movement toward meaningful reform.
It is the moral duty of Congress to remove the Moral Hazard from the current structure of the financial system and put the financial risk back on the financial firms. However, that is a duty to which they will come only if they are forced to believe that they face the hazard of lost elections should they fail to act in the public interest.
14 Comments
“It will be very interesting to follow the next few moves to see if any kind of true grassroots effort at real structural reform gathers steam.” ; yes, Jim, it WILL be interesting. Barney Frank is on record as pushing back against the Fed audit idea and the ObamaRahma Admin is doing it’s very best to kill Dodd’s bill.
” And what’s happened is that Chris Dodd said, no, you’ve got to take power away from the Fed, and you have to put a new agency that will control these “too big to fail” agencies. And the administration is opposed to it. I can’t—I mean, I know why they’re opposed to it.
AMY GOODMAN: The administration is opposed to it, and the Republican senators are opposed to it.
ROBERT SCHEER: Yeah, exactly.”
Yeah, getting rid of Geithner would be a ‘bone tossed to the dogs’; what REALLY needs to happen is the end of the train running back and forth between Wall Street and the Executive branch.
But consider this: NY gets an incredible amount of funding from taxation of Wall Street; it’s NY’s number one ‘industry’. Add to that Schumer,Clinton, et all and what would happen to NY fiscally if effective regulation was put into place.
Doesn’t seem a situation that lends itself to meaningful reform because NY hasn’t diversified it’s economy enough to address the changes needed, so the entire country is hostage to the failure of NY politicians to address their economy.
Here are a few snippets from Paul Krugman’s column yesterday, which I didn’t read until after posting this diary:
Thus, Krugman gives us further information on how the financial firms could have been forced to accept at least some losses as a result of their risky activity. However, because those in the government who were making the decisions were basically all from one of the major firms looking at taking a loss, that option was taken off the table. The taxpayers wound up footing the bill for the shortfall.
We will do the same on the next crisis if nothing changes.
You nailed it.
“Moral hazard” is so easy; who doesn’t want the fast money, the easy life? Making something over time that is sustainable… that’s tough. It requires vision, guts, integrity… and stamina.
Does Congress honestly believe that a vast economy can be sustained by exotic ‘financial instruments’ (which are basically complex math formulas)? Because they seem to think so.
Does Congress honestly believe that a vast economy can remain stable while tax havens, speculative gambles, and fraud eat away at the core of the economic activity? Because we have not yet had any real meaningful action on those issues.
I kind of see the ship starting to sink in 6 months or so while Barney Frank assures us that he’s rearranging the deck chairs at a rapid pace, and the Fed continues to tell us all that lifeboats float.
I fervently hope that the new ‘Pecora-like Commission’ will help reveal what happened, and do it in a way that most of us can follow. We don’t need to know where the deck chairs were on the Titanic; we need to see the ship’s blueprints, the coal supply, and the org chart.
Because personally, I’m done watching Barney rearrange deck chairs.
Beyond disgusting.
These people have lotsa ‘brains’, but very little judgment.
Presumably, they didn’t think that people would start connecting dots – collaboratively.
That’s just dumb.
Hey, you left me a link on a masaccio thread a couple weeks ago and I forgot to thank you. (I think it was to zerohedge.)
I may do a follow-up post, because it occurs to me that we have a strange, perverted reverse moral hazard when it comes to Congress. They spend a huge portion of their time raising money rather than working on real issues, and they are very much at risk of losing that money from people who profit from the status quo if they back legislation that would have real reform effects. Until their funding comes from public sources rather than those with a direct interest in how the legislators vote, their voting pattern will not change.
I agree with the paradox you point at here — although I also think that there’s a problem with educating the public.
I was talking in the past year or so with someone who is a psychologist and works with adults. We were talking about the problem of ‘evil’ (kind of a philosophical conversation).
I was pondering why more people don’t stand up against it.
The psych’s view was that if you recognize it, then you have to DO something about it, OR ELSE how can you call yourself a ‘moral’ person?
(And people do like to think of themselves as ‘moral’, or at least having to bend to ‘necessity’, as we see in the health care ‘debates’ and also the lack of action on financial reform.)
So the easy way out?
Put on blinders.
See no evil? Ah, then you don’t have to do anything.
Americans have to realize that they’re not an ‘audience’, and people have to address their own problems in responsible ways. One of those ways is to push for public financing and free media time.
But the people who don’t want to take responsibility?
Who find it easier to be ‘defeatist’?
They’d rather sit around and piss and moan about ‘corrupt’ electeds.
I’ve seen corrupt electeds up-close-and-personal (charming people, FWIW). You’ve probably seen a few yourself. From their perspective, ‘The System’ works just fine.
If there is any evil, it is ‘someone else’s fault’ (and sometimes that is true).
If someone — maybe Mike Stark ;-))))) — actually did a Task Analysis of the week in the life of a member of Congress, and had to document how many fundraisers they have to involve themselves with, how much of their time is involved in getting elected, then maybe it would be a narrative that would wake people up.
Otherwise, for a lot of people it’s easier to bitch and moan –and paint every elected, even the hard-working, ethical ones who toil mightily — and ‘blame Congress’ without taking a shred of responsibility for this mess.
Maybe the unions will figure out a way to educate their members.
I dunno what the answer is, but I do know that the psych thinks that a lot of people ignore a lot of evil because having to deal with it takes so much time and energy.
So you have to make it EASY for people to realize they only have to do a small action to make a big difference over the long haul.
Recommended. Thanks, Jim. A lot of this high finance is beyond me, but I know Paulson is a crook and GS is at the controls of too much. As for ‘too-big-to-fail’: Wall Street Journal online:
Uh…how much of the TARP did J.P. Morgan get?
OT: Today’s consortiumnews.com, Ray McGovern’s op-ed:
On Topic: Sounds like Barofsky would make a fine Secretary of Treasury, let him bring his own assistants and aids. He faces up to fraud and corruption and takes action. How long since we’ve seen that in exec admin?…maybe JFK.
No problem; glad to be of assistance to others in gaining awareness of the mess called the ‘financial industry’.
“They spend a huge portion of their time raising money rather than working on real issues, and they are very much at risk of losing that money from people who profit from the status quo if they back legislation that would have real reform effects. Until their funding comes from public sources rather than those with a direct interest in how the legislators vote, their voting pattern will not change.”; YUP !
It’s why I keep pushing You Street and other efforts like it. Imagine what might happen if Jane took up the ’cause’.
Is everybody sure this is about corruption? How about fear and the business mentality that when there is a crisis, doing something is always better than doing nothing?
When they were doing the bailouts, I pushed hard (not that I have any cred with the government, but I argued hard) for examining the bailout in reference to the null option. Not only that, I also remember arguing hard that bailing out the industry would amount to the last round of a finite Ponzi scheme, and that bailing out AIG would create a bucketshop — a pipeline of money between the real and nominal economies. Those two are exactly what are being now called a moral hazard, because those two are basically textbook examples of moral hazards.
Everybody was convinced that unless money was spent, and spent fast, the world would end. Now it looks, in retrospect, like a big corrupt solution that has led to problems with creation of moral hazards. We would know for sure if we had examined the plan against the null hypothesis, like any other model or theory. And if we hadn’t accepted the panicky feeling that doing nothing, and doing it quickly, is always wrong.
We know there were ties, we know there is the appearance of conflict of interest. Do we know there was corruption? Or is this merely kicking somebody, anybody, under the bus because we got the wrong outcome, and once again, we need to ‘do something’ to be fixing the problem?
The Barofsky report most definitely makes the case that there is outright corruption in the bond rating industry, noting the “shopping” of bonds by originators for the agency willing to give it the best rating. McClatchy also has documented this.
I also maintain that there is outright corruption in the buying of legislation by the financial industry. They purchase legislation to remove regulations that they see as limiting profit.
As for the “do anything” mentality, I think one also could make the argument that the financial industry was telling the government that if they did not get bailed out, they would take the entire economy down. In that respect, the bailout becomes the largest ransom ever paid.
But it wasn’t the Fed that was responsible either for deciding to bailout or for allocating the money for it. It wasn’t the Fed which put in no stops on salaries, it wasn’t the Fed which did everything in a week or two because the world would come to an end otherwise. Did they examine what would happen without the bailout as opposed to what would happen with the bailout, and if so, where are the figures they got when they ran the numbers?
There aren’t any, because they didn’t do that. You know and I know it’s standard hypothesis testing and standard Occam’s razor. I’m having trouble listening to a Congress who absolutely had to go running and allocate more money in guarantees than the cost of all the wars ever fought by the U.S. combined, and then looks at the managers and says — but weren’t you gonna get me a better price? UBS offered to take 98c on $1? Why should they have got a dime on a dollar? A trusted financial pillar in Switzerland that bets the farm on a $300 Trillion Ponzi scheme deserves to fail. All that happened by bailing out first and ask questions later was that finance whizzes at the banks were talking about taking the bailout money and growing it in CDOs by less than a week later. The best time to reform the economy is when it craters. We have, as the piece by Paul Krugman you quoted says, lost that opportunity. Barofsky can find fault at the Fed, maybe even find criminal wrongdoing there, but the real problem is the entire country really, really believed that the best thing to do was put Humpty-Dumpty back together again, no matter how shattered, so that’s what Congress and the Fed did.