July 23 (Bloomberg) -- In the year since I stepped down as the special inspector general of the Troubled Asset Relief Program, the sadly predictable consequences of the government’s disparate treatment of Wall Street and Main Street have only become worse. As the banks amass size and power, Main Street continues to get pummeled.
Part of the current economic malaise can be traced directly to Treasury’s betrayal of its promise to use TARP to “preserve homeownership.” The Home Affordable Modification Program has brought little meaningful improvement, with fewer than 800,000 ongoing permanent modifications as of March 31, 2012, a number that is growing at the glacial pace of just 12,000 per month.
In June 2011, Treasury appeared to take a tentative step toward holding the mortgage servicers accountable for the widespread misconduct in the program by pledging to withhold the incentive payments to three of the largest banks -- Wells Fargo & Co., Bank of America Corp. and JPMorgan Chase & Co. -- until they came into compliance with HAMP’s rules.
Treasury couldn’t even keep this modest commitment. Although Wells Fargo had improved its performance and was awarded all of its withheld incentive payments, JPMorgan Chase and Bank of America continued to fail to meet the baseline standard. Nonetheless, in March 2012, as part of a broader settlement of the so-called robo-signing scandal, Treasury released all of the withheld payments, totaling more than $170 million. As a result, the government hasn’t held any servicer responsible for the widespread abuses of HAMP applicants, nor is it ever likely to do so.
In return for what was touted as a $25 billion payout, the banks received broad immunity from future civil cases arising out of their widespread use of forged, fraudulent or completely fabricated documents to foreclose on homeowners.
The headline number sounds impressive, yet the banks only had to cough up $1.5 billion to provide a paltry $2,000 to each borrower wrongfully foreclosed upon, a few billion dollars more in penalties to the states, and a few billion to provide for borrower refinancing. The remaining $17 billion, however, won’t involve payouts of money, but will be met in the form of the banks receiving “credits” for certain activities. This includes $7 billion that will be “earned” for routine tasks related to the housing crisis, such as bulldozing worthless houses, donating homes to charity, and agreeing not to pursue deficiency judgments against homeowners, whereby banks seek to force a homeowner to pay the difference between the balance of the loan at the time of foreclosure and what is recovered by the bank from a foreclosure sale. This sounds good, but it should be noted that these are all part of the normal course of business for the banks.
The remaining $10 billion in credits are supposed to be scraped together through principal reductions on “underwater” mortgages, but that doesn’t mean that the banks themselves will be taking $10 billion in losses. The settlement grants them partial credit for reducing the principal on loans that they service but don’t own, such as those contained in mortgage-backed securities. Worse still, they can earn additional “credits” toward the settlement through taxpayer-funded HAMP modifications. For example, if a servicer reduces $100,000 in principal for a mortgage through HAMP and receives a taxpayer incentive check for $40,000, it will still be able to claim $60,000 in credit toward meeting its obligations under the settlement.
As a result, the settlement will actually involve money flowing, once again, from taxpayers to the banks.
Another announcement that accompanied the settlement, made by President Barack Obama during his State of the Union address, was the creation of a working group under the Justice Department’s Financial Fraud Enforcement Task Force to investigate toxic mortgage practices. This arose out of the political fallout from the government’s failure to bring any significant criminal cases related to the financial crisis (other than my office’s case against Lee Farkas, the former chairman of the mortgage lender Taylor, Bean & Whitaker Mortgage Corp.). With the statute of limitations fast approaching for much of the conduct underlying the crisis, it seems increasingly unlikely that any criminal cases will be brought.
It is fair to ask why more haven’t been pursued. The president, Attorney General Eric Holder, and Treasury Secretary Timothy Geithner have all answered this question by suggesting that it was greed and bad judgment, not criminal conduct, that contributed to the crisis, and a number of high-profile investigations have been closed.
The answer more likely lies with the Justice Department’s lack of sophistication and the timidity that set in after it lost a high-profile case against two Bear Stearns Cos. hedge-fund executives in 2009. In any event, it seems unlikely that an 11th-hour task force will result in a proliferation of handcuffs on culpable bankers.
It is clear that the criminal-justice system has proved ill-equipped to address the financial crisis. For that, we needed effective regulatory reform. Instead, we got the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act.
My fear about the inadequacy of Dodd-Frank has only gotten worse over the past year. The top banks are 23 percent larger than they were before the crisis. They now hold more than $8.5 trillion in assets, the equivalent of 56 percent of gross domestic product, up from 43 percent just five years ago. The risk in our banking system is remarkably concentrated in these banks, which now control 52 percent of all industry assets, up from 17 percent four decades ago. There is broad recognition that Dodd-Frank hasn’t solved the problem it was meant to address -- the power and influence of banks deemed too big to fail.
More important, the financial markets continue to bet that the government will once again come to the big banks’ rescue. Creditors still give the largest banks more favorable terms than their smaller counterparts -- a direct subsidy to those that are already deemed too big to fail, and an incentive for others to try to join the club. Similarly, the major banks are given better credit ratings based on the assumption that they will be bailed out.
As a result, the market distortions that flow from the presumption of bailout may have gotten worse. By failing to alter this presumption, Dodd-Frank may have inadvertently sowed the seeds for the next financial crisis.
Although there have been calls to break up the biggest banks, the Financial Stability Oversight Council has still taken no significant action to limit their size or power, and has only just begun to make noises about bringing nonbank financial institutions (such as American International Group Inc.) under its jurisdiction. Even basic steps such as creating and implementing the new rules have lagged, with two-thirds of Dodd-Frank’s rulemaking deadlines blown by May 1, 2012. And in some instances, the regulators have taken a step backward.
For example, one of the best protections against future bailouts is to ensure that banks have thick capital cushions that can absorb potential losses. Although Dodd-Frank called for higher capital levels to be set by the regulators for the largest banks, they still haven’t formally done so. Worse, the Federal Reserve authorized 15 of the 19 largest bank holding companies to drain their capital through cash payouts in the form of dividends to their shareholders and share repurchases. These actions benefit the banks’ senior executives, who own large amounts of stock, and increase the risk to the taxpayer that the banks will once again have to be bailed out.
The banks have also been gaming and watering down the rules and regulations. One of the best examples is with respect to the Volcker rule, which is supposed to prohibit banks from making risky proprietary bets that could lead to large losses and eventual bailouts. The final version contained a number of carve-outs and exceptions that created large potential loopholes. For example, in April 2012, Bloomberg News reported that JPMorgan Chase had moved some of its soon-to-be banned trading operations overseas into its London-based Treasury unit, branding a multi-hundred-billion-dollar trading position in synthetic credit derivatives as a “hedge.”
Legitimate hedging was one of the hard-fought exemptions to the Volcker rule won by the banks, intended to permit them to minimize risk to the system by allowing them to offset specific risks from positions that may remain in their portfolios. But as the New York Times and Bloomberg reported, JPMorgan’s supposed Treasury “hedges” appeared profit-driven and were so large that they moved markets.
After the articles warned that JPMorgan’s positions were potentially destabilizing and were probably difficult to unwind without “causing a dislocation in the markets,” the bank’s chief executive officer, Jamie Dimon, claimed such concerns were little more than a “tempest in a teapot.”
JPMorgan recently disclosed that the trade had cost it at least $5.8 billion.
Hopefully the incident will help embolden regulators to better use Dodd-Frank’s tools to clamp down on risk taking. To date, however, the response has been more accommodating. As Geithner told Congress in March 2012 when confronted with arguments similar to those made by the banks: “We’re going to look at all the concerns expressed by these rules,” he said. “It is my view that we have the capacity to address those concerns.”
Words like these presumably led one of the Volcker rule’s authors, Senator Carl Levin, a Michigan Democrat, to warn that some at “Treasury are willing to weaken the law.” Indeed, words like Geithner’s, when accompanied by actions such as the Fed’s authorization of the largest banks to release capital, send what should be a clear message. We may be in danger of quickly returning to the pre-crisis status quo of inadequately capitalized banks that take outsized risks while being coddled by their over-accommodating regulators. A repeat of the financial crisis would soon be upon us.
As the election approaches, Treasury’s triumphant declarations of mission accomplished for TARP have picked up steam, focusing largely on the reduction in expected losses. While it is good news that the program’s losses will be far less than originally anticipated, the numbers that Treasury has been publishing are incomplete. For example, Treasury continues to offset expected TARP losses by declaring the more than 500 million shares of stock that the New York Fed received in return for a pre-TARP bailout of AIG as part of “Treasury’s investment.” Similarly, Treasury’s projections don’t include, or make reference to, the potentially enormous losses in future tax revenue from AIG, Citigroup Inc., General Motors Co., and others that Treasury exempted through a change in Internal Revenue Service rules.
Treasury’s focus on TARP’s financial costs, of course, detracts from its significant nonfinancial costs, including the worsening of “too big to fail” and the lost opportunity to help struggling homeowners. But a separate cost -- the loss of many Americans’ faith in their government -- may still yield a major benefit.
The missteps by Treasury have produced a valuable byproduct: the widespread anger that may contain the only hope for meaningful reform. Americans should lose faith in their government. They should deplore the captured politicians and regulators who distributed tax dollars to the banks without insisting that they be accountable. The American people should be revolted by a financial system that rewards failure and protects those who drove it to the point of collapse and will undoubtedly do so again.
Only with this appropriate and justified rage can we hope for the type of reform that will one day break our system free from the corrupting grasp of the megabanks.
(Neil M. Barofsky served as the special inspector general in charge of oversight of the Troubled Asset Relief Program and is currently a senior fellow at New York University’s School of Law. This is an excerpt from his book, “Bailout: An Inside Account of How Washington Abandoned Main Street While Rescuing Wall Street,” which will be published July 24 by Free Press, an imprint of Simon & Schuster.)
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