Neil Barofsky, the man tasked with overseeing the administration of the Troubled Assets Relief Program (TARP), told Congress in a report released Sunday that the bank bailouts have cleared the path to another financial crisis — potentially even more grave than the 2008 crisis.
“(E)ven if TARP saved our financial system from driving off a cliff back in 2008,” Barofsky wrote, “absent meaningful reform, we are still driving on the same winding mountain road, but this time in a faster car.”
The special inspector general for TARP added: “It is hard to see how any of the fundamental problems in the system have been addressed to date.”
Known as the watchdog for the bailout funds or the “TARP cop,” Barofsky is a former assistant U.S. attorney for the Southern District of New York and holds a degree in economics from the University of Pennsylvania’s Wharton School of Business. He was nominated to his current post by President George W. Bush in November 2008.
Barofsky explained in the report that financial institutions labeled “too big to fail” in the last crisis – such as Fannie Mae, Freddie Mac and AIG — lived up to their name even more in the last quarter of 2009 than they had in 2008, and their protected status would only increase the incentive to make risky investments.
“To the extent that huge, interconnected, ‘too big to fail’ institutions contributed to the crisis, those institutions are now even larger, in part because of the substantial subsidies provided by TARP and other bailout programs,” the report said.
“To the extent that institutions were previously incentivized to take reckless risks through a ‘heads, I win; tails, the government will bail me out’ mentality, the market is more convinced than ever that the government will step in as necessary to save systemically significant institutions,” Barofsky wrote to Congress.
Treasury Secretary Tim Geithner, whose department runs the program, recently extended TARP through Oct. 3, which allows Treasury to keep recovered funds available in the event that banks run into further problems with their asset-backed securities.
According to Barofsky, that remaining “war chest” only reinforces the perception among large banks that they will receive further bailouts if they find their balance sheets underwater again. He criticized the extension for coming “at the same time that banks that have shown questionable ability to return to profitability (and in some cases are posting multi-billion-dollar losses) are exiting TARP programs.”
All of these circumstances add up to a “moral hazard” in the marketplace, the inspector general said. In finance, the term means that there is no incentive for someone to adequately guard against risk because they believe they are already insulated from it.
President Obama addressed the problem of systemic risk in a December address, proposing a series of new financial regulations to “bring new transparency and accountability to the financial markets, so that the kind of risky dealings that sparked the crisis would be fully disclosed and properly regulated.”
In his weekly remarks on Dec. 12, 2009, Obama said the regulations would be aimed at avoiding more bailouts.
“They would give us the tools,” he said, “to ensure that the failure of one large bank or financial institution won’t spread like a virus through the entire financial system. Because we should never again find ourselves in the position in which our only choices are bailing out banks or letting our economy collapse.”
Obama’s proposal included allowing the Federal Reserve to heavily regulate large banks and allowing regulators to issue guidelines on executive compensation, and it would make certain transactions — trading derivatives — subject to more scrutiny.
The House of Representatives passed a similar bill the same week on a 223-202 vote.
“The bailouts of Bear Stearns and AIG would not have been possible — made illegal –under this bill,” said Rep. Barney Frank (D-Mass.), the chairman of the House Financial Services Committee.
In a press conference after the vote, Speaker of the House Nancy Pelosi (D-Calif.) said the bill would fix another, more literal, “moral” problem — banks gambling with the money of ordinary taxpayers.
“We are sending a clear message to Wall Street, the party is over,” she said. “Never again will reckless behavior on the part of the few threaten the fiscal stability of our people. The legislation will finally protect Main Street from the worst of Wall Street.”
The House bill, however, notably included provisions to create a new fund that would make money available should banks need further bailing out.
Conservatives in Congress, meanwhile, have stuck to highlighting the “moral hazard” in the financial sense of the term, saying that large banks may simply expect to get more bailouts through political positioning.
Republicans on the House Financial Services Committee issued a statement on Dec. 4 saying the new permanent fund created by the financial-reform bill would “promote systemic risk and undermine financial stability because the government will continue to spare financial firms from the consequences of their mistakes by imposing those costs on others, including the taxpayers.”
In an opinion piece written for Forbes magazine the same week the House bill passed, Rep. Paul Ryan (R-Wis.), the top Republican on the House Budget Committee, said that the existing TARP fund had already “evolved into an ad hoc, opaque slush fund for large institutions that are able to influence the Treasury Department’s investment decisions behind the scenes.”
Ryan called the practice “crony capitalism.”
James Gattuso, senior research fellow for regulatory policy at The Heritage Foundation, also agreed with Inspector General Barofsky’s “moral hazard” argument.
“The IG is entirely right,” he told CNSNews.com. “As the report says, it creates a ‘heads I win, tails, the government will bail me out’ mentality.”
Gattuso, however, said he does not believe that the regulation package proposed by the Obama administration and House Democrats will fix the problem.
“The regulations that have been proposed aren’t the answer,” he said. “First, it isn’t clear at all that the limits proposed will reduce risk — they could even increase it by limiting the ability to balance risks.
“Moreover, the goal isn’t necessarily to minimize risk in all cases. You want some risk taking, that’s beneficial. The trick is making sure the risks are reasonable and justified. Regulators can’t judge that. That’s why you need a properly-functioning market.”
Gattuso explained that he thought the way to get a properly-functioning market without increasing regulation and without risking more taxpayer money was to find away to sidestep the “too big to fail” idea.
“We need a way to let firms fail without endangering the broader marketplace,” he told CNSNews.com. He suggested, “One place to start would be a revised bankruptcy process geared toward financial firms.”
The financial regulation reforms passed by the House in December are now being considered by the Senate. The Senate Banking Committee, chaired by retiring Sen. Chris Dodd (D-Conn.), is expected to consider a bill in February.
