Q&A with Neil Barofsky
The special inspector general for TARP discusses how and why the program has failed to meet some of its stated goals.
By Robert Stowe England
Neil M. Barofksy was appointed special inspector general for the Troubled Asset Relief Program--SIGTARP--on Dec. 8, 2008. His responsibility under the Emergency Economic Stabilization Act of 2008 is to audit and investigate the purchase, management and sale of assets that are part of the $700 billion TARP. His primary goal is to protect the interests of American taxpayers, who funded TARP by facilitating transparency and providing oversight of the programs, coupled with robust criminal and civil enforcement.
Prior to assuming the position of SIGTARP, Barofsky was for eight years a federal prosecutor in the U.S. Attorney’s Office for the Southern District of New York. In that office, he was senior trial counsel heading the Mortgage Fraud Group, which investigated and prosecuted all aspects of mortgage fraud, from retail mortgage fraud to potential securities fraud.
He 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, including the case that led to the fraud conviction of Tone Grant, the former president of Refco Inc., and the guilty plea in July 2008 by Phillip Bennett, Refco’s former chief executive officer. Before its collapse, Refco was the largest broker on the Chicago Mercantile Exchange. Among other things, its officials hid $1 billion $430 million in bad debts, apparently from trading losses, in an unnamed entity controlled by Bennett.
Barofsky also led the investigation that resulted in the indictment of the top 50 leaders of the Revolutionary Armed Forces of Columbia (FARC) on narcotics charges, a case described by the U.S. attorney general at that time as the largest narcotics indictment filed in U.S. history.
Barofsky is a graduate of New York University School of Law.
Mortgage Banking caught up with him at the office of SIGTARP in Washington, D.C. Even though the spending authorized under TARP officially ended as a program Oct. 4, the auditing and investigative work of SIGTARP, which has a staff of 150, is expected to go on for as long as eight years.
Q: Looking back on how funds have been disbursed from TARP and, in many cases recovered, how would you rate the overall effectiveness of the program?
A: Well, when you’re discussing TARP, there are approximately 13 different sub-programs--so it’s hard to give a thumbs-up or a thumbs-down on any particular sub-program. But overall, I think that TARP has had some significant successes. It’s fallen short on some of its goals in some areas. And the successes at times have come at a significant cost. So, one area where we believe that the TARP has been successful, along with the other programs that were announced in October 2008, programs run by the FDIC [Federal Deposit Insurance Corporation] and the Federal Reserve, in conjunction [with Treasury], helped bring us back from the brink of a deeper financial crisis. [Note: The reference here is joint actions by Treasury, FDIC and the Federal Reserve announced Oct. 15, 2008. Treasury said it would inject up to $250 billion capital into banks by purchasing preferred shares. The FDIC agreed to provide a temporary liquidity guarantee program on new unsecured senior debt of banks, thrifts, U.S. bank and thrift holding companies, and U.S. financial holding companies; this would include guarantees on commercial paper, inter-bank funding, promissory notes and any unsecured portion of secured debt. In addition the FDIC guaranteed non-interest bearing deposition transaction accounts, such as those used for payroll, for amounts above $250,000. At the same time, the Federal Reserve agreed to buy commercial paper to help companies that rely on it for short-term funding.]
When you look at the impact that the announcement of the TARP had, as well as putting hundreds of billions of dollars in a small handful of large financial institutions, we believe that unquestionably that had a positive impact in bringing confidence back to the market so the banks would begin lending money to one another, bringing some liquidity back into the market. If you offer and inject hundreds of billions of taxpayer dollars along with the promise that was made at the same time by [Treasury Secretary] Hank Paulson, that we as government stand by these institutions, it’s not entirely surprising the banks would take the government at its word. [T]hat did help bring back some degree of confidence and help step back from the crisis.
However, TARP had a number of other goals, statutory and otherwise, that were announced at the time of the legislation—for different programs, which haven’t been met. The goal of increasing or restoring lending, as we’ve been chronicling in our own reports, has fallen short. The goal of preserving homeownership has failed woefully to achieve the stated goals of keeping 3 [million] to 4 million homeowners in their homes. The signature program under TARP--HAMP [Home Affordable Modification Program]--has fallen far short, with under 500,000 permanent [mortgage] modifications.
The idea of protecting jobs, which is one of the goals of the TARP legislation--obviously we’ve seen unemployment continue to go up since TARP began. And the overall economy, again, while it has certainly helped Wall Street [and] the large financial institutions, it helped stabilize them, when you look at the overall economy, jobs, housing, the poverty level, etc., TARP hasn’t necessarily fulfilled those goals.
At the beginning of your question, when you mentioned cost: While it is indeed good news that the objective losses for TARP continue to trend downward, we’re still talking about $50 [billion] or $60 billion, the most recent estimates, of taxpayer money that is expected never to come back. That’s a significant amount of money. But it is certainly good news that it is a lot less than had previously been expected.
But I think it is important to take these projections for what they are: projections. They’ve changed radically in the last 12 months or so. It’s good news that they’ve changed downward, but when you look at the government’s plans with its exit strategy with respect to AIG [American International Group], the government is taking a tremendous amount of risk that depends on the markets and on the share prices for common stock in a number of different institutions. So, while the promise is there for reduced losses, we should be a little bit cautious about not getting ahead of ourselves.
And some of the declarations we’ve heard recently--such as there is a good chance that TARP will cost the taxpayers nothing--I think those statements have to be taken for what they are, which is very optimistic speculation.
Q: Was the TARP program necessary, as advertised, to stabilize the financial system? Was it in any way an over-reaction?
A: I think to make a judgment over whether it was an over-reaction would be outside the scope of work we have done in this area. I also think it becomes a dangerous area of second-guessing because there’s no real way to know for certain what would have happened had there been no TARP program, particularly with the infusion of capital. Due to our audit work, in our interviews with the decisionmakers at the time, they all truly did believe that we were on the precipice of a cataclysmic event for the financial markets.
I think the impact of TARP relies mostly on its psychological impact, the assurance that the government was going to stand by these financial institutions no matter what. What the TARP gave was a back-up to that assurance, that they could point to this giant mountain of taxpayer dollars and say we are going to stand behind these institutions, and the markets knew that it was not just an empty promise. . . .
They--by they, I mean Hank Paulson, [Federal Reserve Chairman] Ben Bernanke and [then-New York Fed Chairman] Timothy Geithner--evidenced that very forcefully by putting $125 billion into the largest nine banks on a single day in late October 2008. They backed it up shortly thereafter with $40 billion in taxpayer dollars going into AIG, an initial $40 billion going into Citigroup and Bank of America.
I think it’s difficult to say what would have happened if none of those promises had occurred and none of those actions had taken place. But I do think those actions, in connection with actions taken by the FDIC and the Federal Reserve, brought a sense of security to the marketplace that the United States government was going to stand behind these things.
Q: To what extent do banks hold the same assets today that were deemed toxic in 2008? Doesn’t Citigroup still own all those super-senior tranches of collateralized debt obligations [CDOs] now worth only a fraction of their original value? Are the toxic assets still a hidden danger to the banking system? Was the problem just covered over with equity injections?
A: I think one of the potential areas where the TARP did not meet its stated goals was exactly as you said--cleansing banks of the toxic assets that were polluting their books. There’s been no real effort on the part of the TARP program to address that issue, even though that was how it was originally sold to Congress and the American people--a $700 billion fund to purchase those toxic assets and get them off the books of the banks.
There was the shift to capital injections and a later promise to address that issue. The promise, of course, was announced in February 2009, when [Treasury] Secretary Geithner announced the Public-Private Investment Program [PPIP] and [Term Asset-Backed Securities Loan Facility (TALF)] programs, and contemplated that they might be as large as $2 trillion [combined--$1 trillion each] to address the issue of toxic assets. It didn’t really occur.
The PPIP program is a small shadow of what was originally contemplated, with $30 billion in total purchasing power. The entire half of it that was going to be done by the FDIC was abandoned. A large percentage of it was to funnel legacy residential mortgage-backed securities [RMBS] through the Federal Reserve TALF program, another TARP-related program. That never happened, either.
So, this $2 trillion promise of potentially curing toxic assets became a $30 billion PPIP program, and a TALF program that dealt with maybe $12 billion of legacy commercial mortgage-backed securities [CMBS]--nothing of residential mortgage-backed securities. So, the TARP program certainly did not succeed in getting those toxic assets off the [books of the] banks. They are still out there somewhere. We haven’t done audit work to confirm that they are still on the books and records, and I know that is the Congressional Oversight Panel’s comment on this as well--that they are, in fact, still out there.
Q: What do you make of the claims by Jim Millstein, senior restructuring officer at Treasury, that all of the loans and investment made in AIG will be made whole?
A: I think that’s a very optimistic viewpoint. We’re going to be taking a long, hard look at this. . . . But so much of the potential to recover taxpayer assets at AIG, after the proposed restructuring, is going to be based on the trading price of the common stock of three different companies. AIA [Group Ltd., the pan-Asian life insurance business of AIG], which is going to be trading in Hong Kong; MetLife Inc. [New York], which AIG is going to be acquiring a huge chunk of their common stock as part of the sale of [American Life Insurance Co. (Alico)], one of [AIG’s] assets. And, of course, the share-price ability [of AIG shares] to monetize what will be Treasury’s 92 percent interest in AIG.
How the insurance industry performs, how the stock market performs, how these individual companies perform, how the market values their performance, is going to go a long way toward determining whether or not the taxpayer is going to be made whole or not. Back . . . in March, Treasury was projecting a $45 billion loss on its AIG investment. That is a lot of ground to cover in a relatively short period of time. I look forward to hearing from Treasury in a little bit more detail as to why things have changed so significantly in a relatively short period of time. But I hope they’re right.
Q: Part of that calculation assumes that common equity prices will not fall when the government’s preferred shares are converted to common equity. But that would probably dilute the value of the common equity, a factor that does not seem to be taken into consideration with some of these estimates.
A: You’re entirely right. We’re taking a huge step down on the equity ladder by converting this preferred to common [at AIG]. We’re going to be looking at the terms of the conversion in a little bit more detail in our next quarterly report. There is a presumption that the current stock-price level is stable with this tremendous amount of dilution from preferred to common. We’ll have to see how the market reacts.
Q: How does the foreclosures documentation mess affect the prospects for Horsham, Pennsylvania-based GMAC Mortgage, a unit of Ally Financial Inc., and the recovery of taxpayer investments in Ally?
A: Well, at this stage I think it’s almost too early to tell how deep the problem is and how significant it is. We’re going to be taking a close look at that and what’s going on with GMAC/Ally foreclosure issues, as well as Treasury’s oversight of a company they own more than 50 percent of, and therefore have some degree of responsibility for. I think at this point it’s too early to know what impact that’s ultimately going to have on the valuation of the company. I know that General Motors recently had a valuation of their equity interest in GMAC. They valued the company significantly less than the total amount of Treasury’s investment.
Q: This looks like a place where there will not be a recovery of investment.
A: We’ll look to see what the latest estimates are. We don’t do our own estimate of losses. We leave that to Treasury, OMB [the Office of Management and Budget] and CBO [the Congressional Budget Office]. We report their analysis. We don’t do our own independent analysis. The [Government Accountability Office (GAO)] audits Treasury’s financial statements once a year. By statute, GAO has been given that responsibility.
Q: What do you think of the various loan modifications done through HAMP over the past two years? Were they properly designed? Some critics have suggested the programs were designed more to hold off losses for banks than to help struggling homeowners.
A: Whether by design or not, that certainly appears to have been the effect. It’s been recently reported that Treasury officials have been touting that one of the benefits of the program was spreading out foreclosures over an extended period of time to soften the blow to housing prices, so you don’t have a lot of foreclosures all hitting the market at the same time. Personally, I think that was never a described goal; the program was never justified with that as one of the reasons we are allocating $50 billion of taxpayer money. It was described as a program to keep 3 [million] to 4 million people in their homes, and that’s how the program should be evaluated.
The idea of keeping people in their homes for a temporary period of time in order to benefit the owners of these mortgages is one that, in many ways, is potentially cruel, essentially very destructive to homeowners. By this, I’m referring to hundreds of thousands of homeowners in failed trial modifications, which never really had a legitimate chance of getting a permanent modification. The entrants into this program are given hope that they are going to be able to keep their homes. Meanwhile, over a period of three, six, nine, 12 months, they deplete their savings, which could have otherwise been used to get a more affordable rental. Their credit rating gets ravaged. They are often hit with late fees as they come out of the program. Someone who is otherwise current on their mortgage gets a trial mod and gets at the other end of the trial mod and gets hit with a huge bill that not only reflects the difference between the trial payments and their original payments, but also late fees.
Q: What are the dangers for banks in the foreclosure-documentation situation? What are the dangers for the housing sector and the broader economy?
A: Well, I think the danger is that if this was intentional conduct designed to make misrepresentations to the court--whether it’s false affidavits or trying to foreclose on properties you don’t own--if that was intentional misconduct, you potentially have criminal liability, depending on the size and the scope of the problem. So, that would be a potential problem for the banks. For the national economy, I think it goes to this question of a great degree of further uncertainty in the housing market.
There are many who feel that for those homeowners who can’t be saved, for which there is no modification, it is probably better to get them through the system and let the market correct itself. I think this current issue will certainly slow down this process. Personally, I think it’s far better that this process be slowed down than for somebody getting their home foreclosed on by someone who doesn’t actually own the home, which appears to be present in some of the cases that have been described.
Q: Do you think that when this is all over and TARP is close to paying for itself, people will say, “Well, the TARP program wasn’t so bad”? Or do you think the image of TARP will never recover because, in the end, it was not used for what people said it would be used for? For example, no one imagined it would be used for bailing out automobile companies, and some of the banks that were bailed out paid large bonuses almost immediately, which was ill-advised even if the recipients had earned them. Isn’t there a lot if irony in the fact that it might end up being a success, yet the public will always look at TARP as a bad thing?
A: If you define success as how much money was recouped from it, then it might be ironic. But when you define success against its earlier goals, and the way the program was managed, the anger becomes a lot more understandable. Treasury bears a big portion of the blame for the anger against this bailout. The money was given to Wall Street, to large banks, without almost no conditions, no prescriptions and very, very weak prohibitions, especially in the beginning, for what they could and could not use the money for, which fueled some of that frustration.
They were given a blank check and essentially it was hoped they would act in the best interest of the country, without any firm, guiding hand. And why people were then subsequently shocked to find out that the banks, when given this relatively low cost of capital, acted in their own selfish interests and not to benefit the country as a whole, I think it was a little naïve--or some folks [were just] playing politics--to be surprised by that.
We are a capitalist society. We expect our corporations to maximize their profit, not to carry out the policy of one administration or another administration. I think a good portion of the blame for what they did or didn’t do with the money lies with the Treasury Department, who had every opportunity to put those types of conditions and prohibitions [in place] and chose not to.
I think the fact Treasury has operated this program at times with significant failings in transparency and accountability, putting out statements that were arguably misleading to the American public, all contributed to that anger. It all fueled this sense that you can’t trust the government, whether it was at the outset, the declaration that the first group of banks that received TARP money were healthy banks, when they knew that they weren’t. Or whether it was this last January, when describing a portion of the AIG bailout as being potentially profitable at a time when the Treasury actually projected a $30 billion loss on AIG, or other statements. These half-truths and potentially misleading statements contributed as much as anything to the unpopularity of this program.
[T]his is a program, despite having very specific statutory goals of helping homeowners [and] helping with unemployment generally has done little to nothing to address those goals, but the area of success has been in returning the Wall Street banks that were most responsible for causing this crisis back to profitability. And the fact we may or may not receive more money back as a result of that doesn’t necessarily make it a good program.
I think people are angry at the moral hazard. Not only did we save the banks that were the driving cause of the crisis, and not only, for a large part, [were] their shareholders protected, their management protected, their creditors protected--but now they’re bigger than ever. TARP helped fuel consolidation in the industry. . . . Banks are bigger than ever, and they are reaping these profits in part based on their ability to borrow money and raise capital at a more attractive rate than their competitors because the market still perceives that the United States government is implicitly backing them.
I saw something the other day that projected that it is a half-percentage [point] cheaper for the too-big-to-fail banks to borrow capital. . . . So, I think a lot of the unpopularity is due to the unfairness in the way the program was run and what its effects [have been]. I think, frankly, declaring “mission accomplished” because the ultimate cost of the taxpayer will be less--when you haven’t addressed some of the fundamental problems in the system, and in some ways maybe you made them worse, as well as running the program without transparency, and the benefits have been limited mostly to the large Wall Street banks--it’s not surprising to me that there is still a lot of anger about this program.
Q: It appears to some that the investment banks that benefited perhaps most from TARP, such as AIG’s counterparties--whose very survival was apparently on the line only weeks earlier--have seemingly shown little public appreciation for the benefit they got, and do not seem to have been chastened by the experience.
A: Yes, absolutely. But I think, again, some of the blame has to be shared with the government and its regulator. AIG--you talk about the Maiden Lane III facility, the ultimate payment of 100 cents on the dollar to AIG’s counterparties--you can blame the banks, to a certain extent, for not agreeing to a discount or a haircut on this. We did an extensive report on this. It was not like they were asked for all that much ever. It was a dismal, halfhearted lack of effort of actually seeking a discount.
Especially when you compare it with what occurred just a few weeks earlier, when the president of the [Federal Reserve Bank of New York], Tim Geithner, sat with Hank Paulson and Ben Bernanke and told the banks they were going to be accepting $125 billion [as part of TARP’s Capital Purchase Program]. When it came time to negotiate haircuts on the part of the American taxpayer as part of the AIG [bailout], then-[New York Fed] President Geithner didn’t even get involved with the process. Mid-level people called over [to the counterparties]--we detailed this in our audit report--with a very halfhearted negotiation. There’s no type of parallel effort [to the Capital Purchase Program] to impress the importance of them accepting a haircut.
Q: There have been statements since your audit report on the decision to pay 100 percent for the toxic assets in Maiden Lane III to AIG’s counterparties that said that the government and Federal Reserve Bank officials did not have the authority to require less than 100 percent payment. Yet, as you point out, the same officials did not have the authority to compel banks to accept the capital injections, yet they pressured them to do so.
A: The reason I think that is a nonsensical defense is that the regulators did not force any of the banks to take any of the capital. They were prepared to, but they didn’t because they took them in a room and they said to them [that] this is really important and we really want [you] to do this. They were fully prepared to tell them they had to take the capital. They didn’t have to. They summoned them down to Washington on very short notice. They put them all in a conference room. And they said, “This is really what we think you should do.”
Now, [what] if they had done a similar effort of gathering of AIG’s counterparties in a room--with, again, not a mid-level executive at the Federal Reserve Bank of New York, but Tim Geithner himself, and maybe some of the other players and regulators--and said, “We think it’s really important you take a haircut on this because you know it’s important. You’ve gotten this tremendous benefit from the bailout of AIG, which is helping you survive. This is taxpayer money that is going to be put at risk, and we think it’s really important for you to step up and have some shared sacrifice here.”
Would it have worked? [We’ll never know,] because they didn’t even bother to try. So, I find the response that we didn’t have the authority to force a haircut on them to be a very, very unsatisfying response and one that doesn’t really reflect the reality of that circumstance. We know that at least one of the banks would [have been] willing to give a haircut. We know that the French reported on that. We know that the French regulators were at least willing to engage in discussions about potential haircuts, but that was not pursued.
Q: It would seem they had a lot of leverage on their side. They could have said you are going to take what we give you, whatever that is.
A: Potentially, but again, there was no such conversation. Putting aside what leverage they had or didn’t have, they didn’t even try. If they had tried and failed, then these responses of, “Well, there was nothing else we could do” would have some resonance. But, much like how they explained to the banks how important it was for them to take the [Capital Purchase Program] capital, they didn’t have to force them to take the money and that was just loud and clear. And just like the message when you have a functionary call up Goldman Sachs and say, “By the way, you don’t really need to take a haircut on this but, boy, would we appreciate it”--that sends a pretty strong message, too, about how serious you are in your negotiating. Are you seriously trying to seek protection for the taxpayer? Or are you just checking the box to say that you tried? It certainly appears [to be] the latter.
Q: It would seem, because of that exercise, it increased moral hazard in the end.
A: These were speculative bets that the United States government--using taxpayer money--made whole, and it is one of the contributors to moral hazard.
Q: Contrast this experience with what happened in 1998 with the bailout of Long Term Capital Management (LTCM). The investors were completely wiped out. They didn’t have a cent at the end. With the counterparties of AIG, everyone gets 100 percent.
A: I think when the [SIGTARP] audit [of payments to AIG counterparties] came out, I think it was Paul Krugman, in his column in The New York Times, [who] made that very comparison. And I do believe Geithner was involved in the LTCM resolution. The type of conversation that was held with LTCM, again, everyone was brought into a room and strongly encouraged to come up with a solution--it simply wasn’t done here. And I think that was a significant mistake that was made.
Q: The reason I’ve asked so many questions about AIG is that this is the one thing that sticks in nearly everyone’s throat, I think, around the country, when they think about TARP.
A: With good reason. MB
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