TARP Inspector General Barofsky Weighs In
Some weeks it's hard not to have sympathy for Treasury Secretary Timothy Geithner. Last Tuesday he was grilled by the Troubled Assets Relief Program Congressional Oversight Panel; at the same time, two prominent economists and one Fed Bank chairman were calling for additional action on "too big to fail" banks; and on Thursday Neil Barofsky, Special Inspector General for TARP, was before the Joint Economic Committee discussing his latest report on and recommendations for TARP.
The Congressional Oversight Panel and the Special Inspector General don't seem to have divided up their responsibilities very cleanly, and the result is questioning on similar issues from both sides - and the Congressional Budget Office has gotten into the game as well, estimating the subsidy contained in TARP at over $350 billion. The SIG's mandate leans more toward ferreting out waste, corruption, and fraud, but the report also deals with more economic questions such as what banks are doing with TARP money and what Treasury can do to minimize expected losses to taxpayers.
While the 250-page report covers a large number of issues - and includes the best comprehensive, detailed summary of all TARP programs I have ever seen (Section 2), which in itself is a valuable public service - I'll just focus on two that have not gotten a lot of attention in the general public.
The first is the potential for collusion in the Public-Private Investment Program (PPIP) - the most recent plan to combine private capital with public capital and loans to buy troubled assets - discussed on pages 146-51. Within hours of the announcement of the program by Secretary Geithner on March 23, economics blogs and other Internet sites were buzzing with explanations of how banks and investors could manipulate the program for private gain at the expense of the taxpayer.
The simplest model would be for a bank to create a special-purpose vehicle, take out loans from the government, and use it to buy toxic assets from itself at inflated prices, thereby converting those assets into cash at only a small discount. Another possibility would be for two banks to agree to buy assets from each other at inflated prices, with the same effect. More complex variants include using credit default swaps to hedge purchases of these assets. In their simpler forms, these schemes are illegal under the terms of the public-private investment program, but the risk remains that they could be made sufficiently complicated to put them into a legal gray area.
The inspector general report provides examples of these kinds of collusive schemes, and of the simpler (and entirely legal) possibility that private investors may overpay for assets if they already hold similar assets, simply in order to drive up the price of those assets in the market.
The report also details another potential weakness of program that, to my knowledge, has not received attention even among blogs. Apparently, Public-Private Investment Funds set up to buy legacy securities will be eligible for non-recourse loans from the Term Asset-Backed Securities Lending Facility (TALF). (Yes, I know this is getting complicated, but there's no way around that.)
TALF is a program that allows private investors to access non-recourse loans from the Federal Reserve to buy certain types of securities; those securities are then held by the Fed as collateral for the loans. Investors cannot borrow the full amount of the purchase, however. If the securities are worth $100, they can only get a loan for, say, $90; that 10 percent "haircut" makes sure the investor has $10 of "skin in the game," and protects the Fed in case the securities fall in value.
But . . . a Public-Private Investment Fund is already leveraged with a loan from the government. So if you allow it to access TALF loans as well, then some of that $10 of is not, in fact, "skin in the game." Put another way, both the public-private investment program and TALF are designed to ensure that the private investor bears some portion of the potential losses; but when you combine them together and pile leverage on top of leverage, that portion gets considerably smaller.
Geithner's Treasury has shown a preference for complicated solutions rather than simpler ones (such as having Treasury buy troubled assets outright, as in the original plan from former secretary Henry Paulson). There are valid reasons for those complications, so I don't want to get into the question of which is better. But it is undoubtedly true that complicated programs make it easier to engage in these kinds of gaming, creating the potential for value to leak out of the system into private hands.
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