Too Big to Fail Redux?

Neil Barofsky on TARP, SIGTAP, IGS and Elizabeth Warren

By RUSSELL MOKHIBER

We spent $700 billion to bail out the too big to fail banks on Wall Street.

And yet, we might have to do it again.

Why?

Because the big banks are still too big to fail.

And next time, we might have to spend $5 trillion.

It ain't a pretty picture.

As Neil Barofsky knows better than most.

He was the Special Inspector General for the Troubled Asset Relief Program.

Known in Washington as SIGTARP.

He's now a adjunct professor at New York University Law School.

"The largest banks are now 20 percent larger today than they were going into the crisis," Barofsky told Corporate Crime Reporter in an interview last week. "They are systemically more significant, they are bigger, they are more important. And we just haven't seen the political or regulatory will to take on the fundamental problems that are presented by these institutions."

"Standard and Poors recently put the U.S. government's credit rating on watch. And one of the things they talked about was the contingent liability to support our financial institutions. And they estimated that the up front costs of another bailout could be up to $5 trillion."

"And when you think about the focus on our budget issues, our deficit and our debt – what happens with the next crisis and we have to come up with another $5 trillion to bail out our system once again?"

"It's a terrifying concept. One of TARP's biggest legacies is that it emphasized to the market that the government would not let these largest banks fail. And we haven't done anything to address this problem. So, we are going to be right back where we were in late 2008 – if not in a worse position."

During the debate over financial reform, the Senate voted on the Brown-Kaufman amendment, which would have limited the size of big banks – making them no longer too big to fail.

The measure was voted down, with only 33 Senators voting for it.

Barofsky says that it would have passed had the Obama administration gotten behind it.

Instead, Treasury Secretary Timothy Geithner lobbied against the bill.

"The reason it didn't pass was because the Treasury Secretary lobbied individual Senators to convince them to vote against this bill," Barofsky said.

And what was Geithner's argument against the amendment?

"As it was explained to me, it was – this was too blunt of an instrument to accomplish this. It would be better to give the regulators the power to treat the problem with a scalpel."

And your response to that?

"The regulators have failed spectacularly in the run up to the financial crisis," Barofsky said. "They have demonstrated that they are human beings. They are fallible as human beings. They, like the rest of the market, have repeatedly proven to be unable to see bubbles as they are being formed, and to comprehend the consequences of the concentration of risk and size."

"The reality of financial systems is such that there is no omniscient person who can understand and see around corners. Having a system that tries to see things before they happen and tries to deal with crises before they happen is doomed for failure."

"The FDIC's Sheila Bair has been very forceful about advocating for the use of Dodd Frank tools to address the size and significance of institutions, requiring them to spin off business, become less complex, have more capital. That is the one path that is out there. She is putting forth a path that has a chance at success. 

Unfortunately, she is stepping down in a few weeks."

Barofsky pushes back at the suggestion that there have been no major criminal prosecutions to come out of the 2008 financial crisis.

"I always like to take issue with the claim that there haven't been any big prosecutions," he says.

"At SIGTARP, we uncovered a multi-billion fraud that was being run by Lee Farkas, the chair of Taylor Bean & Whitaker – one of the country's largest non-depository mortgage companies," he says.

"It was an historic fraud. It's not that often that you run across multi-billion dollar criminal accounting frauds. Our agents uncovered that fraud. It had been going on for six or seven years. We already had seven convictions, including that of Farkas after trial."

"We got involved after they tried to steal $550 million of TARP funds through Colonial Bank, which was closely related to Taylor Bean & Whitaker."

"But the question you are referring to is this thirst for accountability for the largest Wall Street financial institutions."

"These cases and these investigations were really outside of our jurisdiction. Our jurisdiction started after the crisis ended. It started with the passage of the TARP funds in October 2008."

"So I was never privy to the evidence being gathered in those investigations."

"I'm always a little reluctant to make a judgment on whether the prosecutors looking at those cases are making the right or wrong judgment."

"Although there is a lot of smoke in these investigations – and there's Senator Levin's subcommittee's report – to really know whether there is fire underneath that smoke, you have to look at what the evidence is, what the defenses are, what the mitigating factors are, what the arguments are."

"We are talking about an extremely complex accounting fraud at a level that is far more complex than in past financial crises."

"The underlying representations and valuations of incredibly complex structured products are neither simple nor straightforward."

"And it's very difficult for me, without knowing the details of the evidence and the responses, to say they are doing a good job, a bad job, that there has been criminal activity, there hasn't been criminal activity."

"I do think there is something to the argument that much of this behavior, which seems strikingly unethical and inappropriate, may at the end of the day fall short of provable criminal liability."

"We created a regulatory system that blessed in many ways or gave tacit approval to activities that appear to be just downright wrong. But all of this activity has to be looked through that prism of the absence of regulatory activity and to some extent regulatory knowledge of what was going on."

"It may be a little bit too early to write the final story on this. There are ongoing investigations. These investigations by their nature take time. As the parallel civil cases make their way through the courts, there is going to be a lot of eyes taking a look at the same set of evidence, more evidence is going to be uncovered, and it's not impossible or improbable that we are going to see additional prosecutions."

"Whether the country is going to get what it wants – to get a CEO of a major bank – I don't think that is going to happen."

"This is far different from the savings and loan crisis. In that crisis, you had relatively straightforward fleecing of banks by senior executives.

This is a little bit more complex and difficult to prove."

Barofsky concedes that out of the more than 60 Inspectors General across the federal government, only a handful aggressively pursue criminal wrongdoing against the agencies they were set up to protect.

"It's unfortunate that we don't read or hear more from Inspectors General. So much is entrusted with these IGs in the oversight of these federal agencies. And they come in all different shapes and sizes, all different types of experiences," Barofsky said.

"You can have a relatively small shop, like the one run by David Kotz at the SEC. He is quite aggressive. And he gets a lot of information out there to Congress and to the American people. And then you have other agencies whose Inspectors General offices could be five or six or nine times the size of the SEC IG – and yet you never hear anything."

"It can't be that those agencies are just so perfectly run that there isn't a need or important value for those offices to fulfill in exposing misconduct, waste, fraud and abuse."

Barofsky believes TARP would have been better off with someone like Elizabeth Warren on the inside – instead on the outside looking in.

"It is striking how overwhelmingly the key decision makers in the TARP program came from Wall Street."

"When you look back on it, it shouldn't be that surprising that TARP, a program that was designed to help both Wall Street and Main Street, has done a phenomenal job in helping Wall Street and a terrible job in fulfilling its Main Street goals."

"This is not because the people who came from Wall Street were corrupt. It's not because they were out to screw the little guy. It's because of the lack of diversity. They did what they knew best and what they thought was best."

"But you had this uniform group of people from Wall Street – Hank Paulson from Goldman Sachs, the people who were running TARP who came from Merrill Lynch and Goldman Sachs, the investment officers came from a series of Wall Street banks, right down to the housing person who came from Bank of America."

"So, it's not that surprising that your policies reflect Wall Street's priorities."

"Think about how much different this program would have been had Elizabeth Warren – instead of being appointed to provide oversight of TARP – was instead put inside the bubble and was part of the decision making process in designing TARP's response."

"You'd see a much different and a much better program."

And Barofsky is critical of the Obama administration for not appointing Warren to head the Consumer Financial Protection Bureau.

"If the President made the decision that Elizabeth Warren was the right person to stand up this agency, which he essentially did in appointing her as an advisor, then he should have nominated her for the position," Barofsky said. "This was her idea. I got to know and work with Elizabeth when she was chair of the Congressional oversight panel, which also provided TARP oversight. She is doing a terrific job in her more limited role right now.

And she would be a terrific nominee and a terrific director for that agency. By not getting 100 percent behind her early on, they put themselves in a very difficult position. Now, it's going to be difficult to even have a recess appointment – whether it is Professor Warren or whether it is somebody else."