A new report released today by the Special Inspector General for the Troubled Asset Relief Program (SIGTARP) offers compelling evidence that the government’s bailout programs helped bring the economy back from the brink of collapse. But in tallying up the excessive costs associated with the TARP, the report forces one to consider whether the bailout’s successes have been a Pyrrhic victory for the government and the taxpayer.
As the report points out, some of the bailout’s costs are financial: it is highly unlikely, for instance, that taxpayers will fully recoup their investment from the TARP’s mortgage modification program or from the substantial assistance extended to AIG and the auto companies. But the SIGTARP also argues that one has to look beyond financial costs when analyzing the effectiveness of the bailout.
Moral Hazards and Damaged Credibility
On the issue of moral hazard, the SIGTARP reports that the financial system is still filled with perverse incentives: many of the “too big to fail” firms have grown even bigger, the credit rating agencies still suffer from inherent conflicts of interest, and many banks have enjoyed a rebound in their stock prices and are returning to the same risky activities that led to the current crisis. The report also points to the numerous ways in which the bailout has taken a serious toll on the government’s credibility. Specifically, the SIGTARP argues that Treasury has damaged its credibility and jeopardized the long-term success of the bailout by refusing to require that TARP recipients report on their use of funds, and by making misleading statements about the initial disbursement of TARP funds through the Capital Purchase Program.
Officials Must Continue to Ensure Bailout Programs Are Not Unduly Influenced by Private Interests
The report also provides some interesting findings on the contractors and financial agents that have been hired to assist with the bailout programs, a topic of ongoing concern to POGO. As we wrote back in August, the SIGTARP reports that PIMCO has been hired as a collateral monitor for the Term Asset-Backed Securities Loan Facility (TALF). This isn’t PIMCO’s only connection to the bailout: up until a few months ago, PIMCO was working as an asset manager for the New York Fed’s agency mortgage-backed securities purchase program, and it continues to serve as an asset manager for the New York Fed’s Commercial Paper Funding Facility. Of even greater concern is the fact that PIMCO has a significant financial interest in the types of assets it will be evaluating for the government. According to the SIGTARP, mortgage-backed securities make up 61% of PIMCO’s $161 billion Total Return Fund, and PIMCO manages $983 million in assets under its Mortgage-Backed Securities Fund.
POGO is glad to hear that PIMCO and the New York Fed are taking steps to mitigate conflicts of interest, such as identifying certain “Special Restricted Persons” who are prohibited from trading or valuing asset-backed securities on behalf of anyone but the government. But officials need to remain vigilant in ensuring that PIMCO’s work for the government isn’t being unduly influenced by the firm’s private interests.
A Disagreement About Oversight Authority?
The SIGTARP report also provides an update on Treasury’s oversight of the private asset managers who are participating in the Public-Private Investment Program (PPIP). It’s good to know that Treasury has agreed to require the asset managers to disclose any trades in derivative instruments (such as credit default swaps) where the value is tied to an asset held in the public-private investment fund (PPIF). However, we’re troubled for a couple reasons by the news that Treasury seems to be challenging the SIGTARP’s authority to oversee this program.
First, as the report points out, Section 402 of the Helping Families Save Their Homes Act of 2009 requires Treasury to “consult with SIGTARP in developing certain aspects of the PPIP compliance and conflict-of-interest regime.” But in the final PPIP agreements, Treasury left open the possibility that it could change these rules without even letting the SIGTARP know. The report politely notes that keeping SIGTARP out of the loop would likely be a violation of Congress’s legislative intent: “Although Treasury told SIGTARP that it is likely to discuss significant proposed amendments with SIGTARP, such consultation is, in SIGTARP’s view, best practice and may be legally required.”
Second, Treasury wants to deny the SIGTARP access to the books and records of the private fund managers’ affiliates, even though the private asset managers have already agreed to give this information to Treasury. If it is not given explicit contractual access to this information, the SIGTARP is threatening to exercise its subpoena power:
“These are books and records that relate directly to the American taxpayer’s investment in the PPIF and could provide compelling evidence of a fund manager violating the conflict-of-interest provisions set forth in the PPIF agreements. SIGTARP will conduct oversight over all of the activities in connection with the PPIF whether it is given contractual rights or not. If Treasury refuses to give SIGTARP contractual access to books and records that are critical to identifying conflicts of interest, SIGTARP will not hesitate to obtain these same books and records using all of its tools, including SIGTARP’s subpoena authority, which may be necessary if such documents are material to a PPIF audit or investigation.”
Treasury could avoid a confrontation by giving the SIGTARP the information it needs, but it will be interesting to see if this conflict escalates in the weeks ahead.
Reforming the Credit Rating Agencies
Finally, the SIGTARP dedicates an entire section of its report to the topic of credit rating agencies, including an explanation of what these agencies do, a history of their role in the current financial crisis, and a survey of the proposals that have been introduced to improve how they function. Most of these reform efforts would target the rating agencies’ inherent conflict of interest: since the agencies are paid by the issuers of the securities they rate, they have an incentive to issue inflated ratings (one subprime fund manager compared this system to “cattle ranchers paying the Department of Agriculture to rate the quality and safety of their beef”). The independence of the agencies is further called into question when they advise firms on how to structure their securities to receive the highest possible rating.
POGO applauds many of the reforms introduced in the SEC’s rule changes and Treasury’s proposed legislation, which are aimed at making the agencies more transparent, independent, and accountable. But we hope that future reform efforts address another big problem: retaliation and intimidation within the agencies. A recent investigation by McClatchy revealed that one of the agencies, Moody’s, has a troubling history of punishing analysts who challenge the inflated ratings. One Moody’s official, Mark Froeba, told McClatchy that “This was a systematic and aggressive strategy to replace a culture that was very conservative, an accuracy-and-quality oriented (culture), a getting-the-rating-right kind of culture, with a culture that was supposed to be ‘business-friendly,’ but was consistently less likely to assign a rating that was tougher than our competitors.” When he and others raised concerns about Moody’s methodology, they were “downsized.” McClatchy’s investigation also found that senior managers often intimidated analysts into issuing favorable ratings:
One Moody’s executive who soared through the ranks during the boom years was Brian Clarkson, the guru of structured finance. He was promoted to company president just as the bottom fell out of the housing market.
Several former Moody’s executives said he made subordinates fear they'd be fired if they didn’t issue ratings that matched competitors’ and helped preserve Moody’s market share.
Froeba said his Moody’s team manager would tell his team that he, the manager, would be fired if Moody’s lost a single deal. “If your manager is saying that at meetings, what is he trying to tell you?” Froeba asked.
This is a serious problem, and POGO hopes that any legislation aimed at restoring the credibility of the credit rating agencies includes provisions for holding the agencies accountable when they retaliate against the analysts who attempt to blow the whistle on shoddy ratings.
Even as Treasury plans to wind down some of its TARP programs, the SIGTARP report offers plenty of food for thought about how to make the remaining programs more transparent and accountable.