Some of us have been expecting this. James Galbraith was among a number of reliable economists who warned that Bush's TARP -- Troubled Assets Relief Program aka bank bailout -- would come back to bite us in the butt. Neil Barofsky is warning that we're well on the road to trouble. Paul Volcker, venerable former Fed chair and now one of the president's most trusted advisors on economic recovery, is weighing in with a solution.
Barofsky, appointed TARP watchdog, publishes his latest warning today.
The problems that led to the last crisis have not yet been addressed, and in some cases have grown worse, says Neil Barofsky, the special inspector general for the trouble asset relief program, or TARP. The quarterly report to Congress was released Sunday.
''Even if TARP saved our financial system from driving off a cliff back in 2008, absent meaningful reform, we are still driving on the same winding mountain road, but this time in a faster car,'' Barofsky wrote.
Since Congress passed $700 billion financial bailout, the remaining institutions considered ''too big to fail'' have grown larger and failed to restrain the lavish pay for their executives, Barofsky wrote. He said the banks still have an incentive to take on risk because they know the government will save them rather than bring down the financial system. ...NYT
Treasury in early spring of '09 -- pursuant to the Paulson, Geithner and the original Bush bailout program, appointed fund managers to effect the buy-out of toxic assets. At least one of these appointees has used the program for his own profit, just as Barofsky warned in April.
Closer scrutiny is needed, but the Treasury Department is balking at making any changes or creating a firewall to prevent skimming.
The report also contains a warning about yet another housing bubble created by government interference.
If what Barofsky has to say throws fuel on Tea Party fires, remember that it's not just the Tea Party that doesn't like TARP. James Galbraith was among many liberal economists who warned back in February '09 that the Bush administration's decision to rush in and rescue banks was a disaster from the get-go. The banks, after all, had been involved in fraud and now held worthless or "toxic" assets which the government would inherit. For "government" read "we the people."
The crucial question is, on what terms does the Treasury plan to guarantee or to repurchase or to otherwise deal with the bad assets that the banks have? These assets are mortgage-backed securities. They are securities derived from subprime loans that were made in an atmosphere of regulatory laxness and complicity and fraud, basically, during the Bush administration, which came to take over the system of housing finance and to infect it with assets which nobody trusts, which nobody can value. And nobody really knows what’s in the files, what’s on the loan tapes of those—that underlie those securities. So the question that I think we need to ask is, before we issue a public guarantee, does the Treasury of the United States plan to conduct a meticulous audit of the assets that underlie the securities that they’re expecting to take off the banks’ books, so that we, the taxpayer, can have an idea of what, if anything, these securities are worth?
And the problem is that when you—the little bit of checking that has been done appears to reveal that a very large fraction of these securities contain, on the face of it, misrepresentation or fraud in the files. And so, we are looking at an asset which nobody, no outside investor doing due diligence on behalf of a client for whom they have some responsibility, would touch. And that is the issue. That’s the problem.
If that is indeed the case, then I think it’s fair to conclude that the large banks, which the Treasury is trying very hard to protect, cannot in fact be protected, that they are in fact insolvent, and that the proper approach for dealing with them is for the Federal Deposit Insurance Corporation to move in and take the steps that the FDIC normally takes when dealing with insolvent banks. ...Democracy Now
In a Times op-ed piece, Paul Volcker takes note of public outrage and warns that staying on the present track isn't an option. Volcker, a White House economic advisor who used to stand behind Geithner, has been moved up to the microphone while Geithner drops back. He offers his recipe for recovery and reform. You can almost hear bankers and the entire Republican party suiting up for battle.
A large concern is the residue of moral hazard from the extensive and successful efforts of central banks and governments to rescue large failing and potentially failing financial institutions. The long-established “safety net” undergirding the stability of commercial banks — deposit insurance and lender of last resort facilities — has been both reinforced and extended in a series of ad hoc decisions to support investment banks, mortgage providers and the world’s largest insurance company. In the process, managements, creditors and to some extent stockholders of these non-banks have been protected.
The phrase “too big to fail” has entered into our everyday vocabulary. It carries the implication that really large, complex and highly interconnected financial institutions can count on public support at critical times. The sense of public outrage over seemingly unfair treatment is palpable. Beyond the emotion, the result is to provide those institutions with a competitive advantage in their financing, in their size and in their ability to take and absorb risks.
As things stand, the consequence will be to enhance incentives to risk-taking and leverage, with the implication of an even more fragile financial system. We need to find more effective fail-safe arrangements.
Chances are Volcker was well aware of Neil Barofsky's latest report/warning when he wrote, in a calming tone, that "governments have long provided commercial banks with the public 'safety net.' The implied moral hazard has been balanced by close regulation and supervision."
Obviously the supervision has to be closer and more effective.
It's always possible that Barofsky has written his new, scathing report to respond to and confirm his earlier predictions. Whether or not that's the case, reform is essential. It's also deeply unpopular with the targets of reform and their beneficiaries in Congress.
Stockholders, for example, would not be protected. (Were they ever in the days before the Bush crash? Wasn't risk always part of the deal?)
The government's role as rescuer would be limited and contained. Failure would be an option.
Limited funds would be made available to maintain continuity of operations while preparing for the demise of the organization.
To help facilitate that process, the concept of a “living will” has been set forth by a number of governments. Stockholders and management would not be protected. Creditors would be at risk, and would suffer to the extent that the ultimate liquidation value of the firm would fall short of its debts.
To put it simply, in no sense would these capital market institutions be deemed “too big to fail.” What they would be free to do is to innovate, to trade, to speculate, to manage private pools of capital — and as ordinary businesses in a capitalist economy, to fail.
Deep structural change is unavoidable. Again, can't you just hear the screams of agony from the opposition and from Wall Street. Watch for the markets, Wall Street lobbyists, and profiteers in the Senate -- like the wives of the powerful during the revolution -- faint at the sight of the guillotine! And here's Paul Volcker assuring them that structural changes are coming.
The guillotine is under construction. Prepare for battle over its use.
I tell you that is no substitute for structural change, the point the president himself has set out so strongly.
I’ve been there — as regulator, as central banker, as commercial bank official and director — for almost 60 years. I have observed how memories dim. Individuals change. Institutional and political pressures to “lay off” tough regulation will remain — most notably in the fair weather that inevitably precedes the storm.
The implication is clear. We need to face up to needed structural changes, and place them into law. To do less will simply mean ultimate failure — failure to accept responsibility for learning from the lessons of the past and anticipating the needs of the future.
First-rate close reading of Volcker's editorial and beyond here.