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Wednesday, July 29, 2009

Special Inspector General of TARP, Neil Barofsky, Testimony

Neil Barofsky Testimony

July 22, 2009

The Special Inspector General for the TARP program (SIGTARP) has made a variety or recommendations concerning the TARP program and has worked hard to advance the general understanding of the TARP. With respect to recommendations, one of SIGTARP’s most important oversight responsibilities is to provide recommendations to Treasury so that TARP programs can be designed or modified to facilitate effective oversight and transparency and to prevent fraud, waste, and abuse. SIGTARP’s reports detail these recommendations and provide updates on their implementation. Two categories of recommendations, however, are worth highlighting in particular:

Transparency in TARP Programs

Although Treasury has taken some steps towards improving transparency in TARP programs, it has repeatedly failed to adopt recommendations that SIGTARP believes are essential to providing basic transparency and fulfill Treasury’s stated commitment to implement TARP “with the highest degree of accountability and transparency possible.” SIGTARP’s July 21, 2009, Quarterly Report includes one new recommendation and there are several other additional unadopted recommendations from prior quarterly reports:
  • Use of Funds Generally: One of SIGTARP’s first recommendations was that Treasury require all TARP recipients to report on the actual use of TARP funds. Other than in a few agreements (with Citigroup, Bank of America, and AIG), Treasury has declined to adopt this recommendation, calling any such reporting “meaningless” in light of the inherent fungibility of money. SIGTARP continues to believe that banks can provide meaningful information about what they are doing with TARP funds — in particular what activities they would not have been able to do but for the infusion of TARP funds. That belief has been supported by SIGTARP’s first audit, in which nearly all banks were able to provide such information.
  • Valuation of the TARP Portfolio: SIGTARP has recommended that Treasury begin reporting on the values of its TARP portfolio so that taxpayers can get regular updates on the financial performance of their TARP investments. Notwithstanding that Treasury has now retained asset managers and is receiving such valuation data on a monthly basis, Treasury has not committed to providing such information except on the statutorily required annual basis.
  • Disclosure of TALF Borrowers Upon Surrender of Collateral: In TALF, the loans are non-recourse, that is, the lender (Federal Reserve Bank of New York) will have no recourse against the borrower beyond taking possession of the posted collateral (consisting of asset-backed securities (“ABS”)). Under the program, should such a collateral surrender occur, TARP funds will be used to purchase the surrendered collateral. In light of this use of TARP funds, SIGTARP has recommended that Treasury and the Federal Reserve disclose the identity of any TALF borrowers that fail to repay the TALF loan and must surrender the ABS collateral.
  • Regular Disclosure of PPIF Activity, Holdings, and Valuation: In the PPIP Legacy Securities Program, the taxpayer will be providing a substantial portion of the funds (contributing both equity and lending) that will be used to purchase toxic assets in the Public-Private Investment Funds (“PPIFs”). SIGTARP is recommending that all trading activity, holdings, and valuations of assets of the PPIFs be disclosed on a timely basis. Not only should this disclosure be required as a matter of basic transparency in light of the billions of taxpayer dollars at stake, but such disclosure would also serve well one of Treasury’s stated reasons for the program in the first instance: the promotion of “price discovery” in the illiquid market for MBS. Treasury has indicated that it will not require such disclosure.
Although SIGTARP understands Treasury’s need to balance the public’s transparency interests, on one hand, with the interests of the participants and the desire to have wide participation in the programs, on the other, Treasury’s default position should always be to require more disclosure rather than less and to provide the investors in TARP — the American taxpayers — as much information about what is being done with their money as possible. Unfortunately, in rejecting SIGTARP’s basic transparency recommendations, TARP has become a program in which taxpayers (i) are not being told what most of the TARP recipients are doing with their money, (ii) have still not been told how much their substantial investments are worth, and (iii) will not be told the full details of how their money is being invested. In SIGTARP’s view, the very credibility of TARP (and thus in large measure its chance of success) depends on whether Treasury will commit, in deed as in word, to operate TARP with the highest degree of transparency possible.

Imposition of Information Barriers, or “Walls,” in PPIP

In the April 21, 2009, Quarterly Report, SIGTARP noted that conflicts of interest and collusion vulnerabilities were inherent in the design of PPIP stemming from the fact that the PPIF managers will have significant power to set prices in a largely illiquid market. These vulnerabilities could result in PPIF managers having an incentive to overpay significantly for assets or otherwise using the valuable, proprietary PPIF trading information to benefit not the PPIF, but rather the manager’s non-PPIF business interests. As a result, SIGTARP made a series of recommendations in the April Quarterly Report, including that Treasury should impose strict conflicts of interest rules.

Since the April Quarterly Report, Treasury has worked with SIGTARP to address the vulnerabilities in PPIP, and SIGTARP made a series of specific recommendations, suggestions, and comments concerning the design of the program. Treasury adopted many of SIGTARP’s suggestions and has developed numerous provisions that make PPIP far better from a compliance and anti-fraud standpoint than when the program was initially announced.

However, Treasury has declined to adopt one of SIGTARP’s most fundamental recommendations — that Treasury should require imposition of an informational barrier or “wall” between the PPIF fund managers making investment decisions on behalf of the PPIF and those employees of the fund management company who manage non-PPIF funds. Treasury has decided not to impose such a wall in this instance, despite the fact that such walls have been imposed upon asset managers in similar contexts in other Government bailout-related programs, including by Treasury itself in other TARP-related activities, and despite the fact that three of the nine PPIF managers already must abide by similar walls in their work for those other programs.

If nothing else, the reputational risk that Treasury and the program could face if a PPIF manager should generate massive profits in its non-PPIF funds as a result of an unfair advantage, even if that advantage is not strictly against the rules, justifies the imposition of a wall. Failure to impose a wall, on the other hand, will leave Treasury vulnerable to an accusation that has already been leveled against it — that Treasury is using TARP to pick winners and losers and that, by granting certain firms the PPIF manager status, it is benefitting a chosen few at the expense of the dozens of firms that were rejected, of the market as a whole, and of the American taxpayer. This reputational risk is not one that can be readily measured in dollars and cents, but is rather a risk that could put in jeopardy the fragile trust the American people have in TARP and, by extension, their Government.

TARP in Context

During the last 36 hours there has been considerable media coverage and interest in section 3 of SIGTARP’s July Quarterly Report, which attempts to place the TARP into context in terms of how it has evolved and of the greater government-wide effort. TARP, as originally envisioned in the fall of 2008, would have involved the purchase, management, and sale of up to $700 billion of “toxic” assets, primarily troubled mortgages and mortgage-backed securities (“MBS”). That framework was soon shelved, however, and TARP funds are being used, or have been announced to be used, in connection with 12 separate programs that, as set forth in Table 1 below, involve a total (including TARP funds, loans and guarantees from other agencies, and private money) that could reach nearly $3 trillion. Through June 30, 2009, Treasury has announced the parameters of how $643.1 billion of the $700 billion would be spent through the 12 programs. Of the $643.1 billion that Treasury has committed, $441 billion has actually been spent.


As massive and as important as TARP is on its own, it is just one part of a much broader Federal Government effort to stabilize and support the financial system. Since the onset of the financial crisis in 2007, the Federal Government, through many agencies, has implemented dozens of programs that are broadly designed to support the economy and financial system. In our most recent quarterly report, we summarize these programs and the total potential support to the financial system as of 6/30/09, there is approximately $3.0 trillion outstanding, $4.7 trillion is the total support to date, including money that has been paid pack and programs that have ended. In total, the potential federal support through all of these programs is approximately $23.7 trillion.


SIGTARP is in the process of completing audit reports concerning executive compensation restriction compliance, controls over external influences on the CPP application process, selection of the first nine participants for funds under CPP (with a particular emphasis on Bank of America), AIG bonuses, and AIG counterparty payments. In addition, SIGTARP is undertaking a series of new audits, as follows:
  • Follow-up Assessment of Use of Funds by TARP Recipients: This audit will examine use of funds by recipients receiving extraordinary assistance under the Systemically Significant Failing Institutions program, the Automotive Industry Financing Program, as well as insurance companies receiving assistance under CPP.
  • Governance Issues Where U.S. Holds Large Ownership Interests: The audit, being conducted at the request of Senator Max Baucus, will examine governance issues when the U.S. Government has obtained a large ownership interest in a particular institution, including: (i) What is the extent of Government involvement in management of companies in which it has made sizeable investments, including direction and control over such elements as governance, compensation, spending, and other corporate decision making? (ii) To what extent are effective risk management, internal controls, and monitoring in place to protect and balance the Government’s interests and corporate needs? (iii) Are there performance measures in place that can be used to track progress against long-term goals and timeframes affecting the Government’s ability to wind down its investments and disengage from these companies? (iv) Is there adequate transparency to support decision making and to provide full disclosure to the Congress and the public?
  • Status of the Government’s Asset Guarantee Program with Citigroup: The audit examining the Government’s Asset Guarantee Program (“AGP”) with Citigroup, based upon a request by Representative Alan Grayson, will address a series of questions about the Government’s guarantee of certain Citigroup assets through the AGP such as: (i) How was the program for Citigroup developed? (ii) What are the current cash flows from the affected assets? and (iii) What are the potential for losses to Treasury, the Federal Deposit Insurance Corporation, and the Federal Reserve under the program?
  • Making Home Affordable Mortgage Modification Program: This audit will examine the Making Home Affordable mortgage modification program to assess the status of the program, the effectiveness of outreach efforts, capabilities of loan servicers to provide services to eligible recipients, and challenges confronting the program as it goes forward.

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