Where the Bailout Went Wrong
Wednesday, March 30, 2011
By: Neil M. Barofsky
Two and a half years ago, Congress passed the legislation that
bailed out the country's banks. The government has declared its
mission accomplished, calling the program remarkably effective "by
any objective measure." On my last day as the special inspector
general of the bailout program, I regret to say that I strongly
disagree. The bank bailout, more formally called the Troubled Asset
Relief Program, failed to meet some of its most important
goals.
From the perspective of the largest financial institutions, the
glowing assessment is warranted: billions of dollars in taxpayer
money allowed institutions that were on the brink of collapse not
only to survive but even to flourish. These banks now enjoy record
profits and the seemingly permanent competitive advantage that
accompanies being deemed "too big to fail."
Though there is no question that the country benefited by
avoiding a meltdown of the financial system, this cannot be the
only yardstick by which TARP's legacy is measured. The legislation
that created TARP, the Emergency Economic Stabilization Act, had
far broader goals, including protecting home values and preserving
homeownership.
These Main Street-oriented goals were not, as the Treasury
Department is now suggesting, mere window dressing that needed only
to be taken "into account." Rather, they were a central part of the
compromise with reluctant members of Congress to cast a vote that
in many cases proved to be political suicide.
The act's emphasis on preserving homeownership was particularly
vital to passage. Congress was told that TARP would be used to
purchase up to $700 billion of mortgages, and, to obtain the
necessary votes, Treasury promised that it would modify those
mortgages to assist struggling homeowners. Indeed, the act
expressly directs the department to do just that.
But it has done little to abide by this legislative bargain.
Almost immediately, as permitted by the broad language of the act,
Treasury's plan for TARP shifted from the purchase of mortgages to
the infusion of hundreds of billions of dollars into the nation's
largest financial institutions, a shift that came with the express
promise that it would restore lending.
Treasury, however, provided the money to banks with no effective
policy or effort to compel the extension of credit. There were no
strings attached: no requirement or even incentive to increase
lending to home buyers, and against our strong recommendation, not
even a request that banks report how they used TARP funds. It was
only in April of last year, in response to recommendations from our
office, that Treasury asked banks to provide that information, well
after the largest banks had already repaid their loans. It was
therefore no surprise that lending did not increase but rather
continued to decline well into the recovery. (In my job as special
inspector general I could not bring about the changes I
thought were needed - I could only make recommendations to the
Treasury Department.)
Meanwhile, the act's goal of helping struggling homeowners was
shelved until February 2009, when the Home Affordable Modification
Program was announced with the promise to help up to four million
families with mortgage modifications.
That program has been a colossal failure, with far fewer
permanent modifications (540,000) than modifications that have
failed and been canceled (over 800,000). This is the
well-chronicled result of the rush to get the program started,
major program design flaws like the failure to remedy mortgage
servicers' favoring of foreclosure over permanent modifications,
and a refusal to hold those abysmally performing mortgage servicers
accountable for their disregard of program guidelines. As the
program flounders, foreclosures continue to mount, with 8 million
to 13 million filings forecast over the program's lifetime.
Treasury Secretary Timothy Geithner has acknowledged that the
program "won't come close" to fulfilling its original expectations,
that its incentives are not "powerful enough" and that the mortgage
servicers are "still doing a terribly inadequate job." But Treasury
officials refuse to address these shortfalls. Instead they continue
to stubbornly maintain that the program is a success and needs no
material change, effectively assuring that Treasury's most specific
Main Street promise will not be honored.
Finally, the country was assured that regulatory reform would
address the threat to our financial system posed by large banks
that have become effectively guaranteed by the government no matter
how reckless their behavior. This promise also appears likely to go
unfulfilled. The biggest banks are 20 percent larger than they were
before the crisis and control a larger part of our economy than
ever. They reasonably assume that the government will rescue them
again, if necessary. Indeed, credit rating agencies incorporate
future government bailouts into their assessments of the largest
banks, exaggerating market distortions that provide them with an
unfair advantage over smaller institutions, which continue to
struggle.
Worse, Treasury apparently has chosen to ignore rather than
support real efforts at reform, such as those advocated by Sheila
Bair, the chairwoman of the Federal Deposit Insurance Corporation,
to simplify or shrink the most complex financial institutions.
In the final analysis, it has been Treasury's broken promises
that have turned TARP - which was instrumental in saving the
financial system at a relatively modest cost to taxpayers - into a
program commonly viewed as little more than a giveaway to Wall
Street executives.
It wasn't meant to be that. Indeed, Treasury's mismanagement of
TARP and its disregard for TARP's Main Street goals - whether born
of incompetence, timidity in the face of a crisis or a mindset too
closely aligned with the banks it was supposed to rein in - may
have so damaged the credibility of the government as a whole that
future policy makers may be politically unable to take the
necessary steps to save the system the next time a crisis arises.
This avoidable political reality might just be TARP's most lasting,
and unfortunate, legacy.
Neil M. Barofsky was the special inspector general for the
Troubled Asset Relief Program from 2008 until today.