Neil Barofsky on TARP’s record, HSBC and lessons for Canada

A warning: Big banks are even bigger and more powerful than before the crisis

Neil Barofsky, then Special Inspector General for the TARP, testifying before Congress in April 22, 2010. (Harry Hamburg/AP Photo)

Neil Barofsky was the Special United States Treasury Department Inspector General for the Troubled Asset Relief Program, or TARP, the U.S. government’s $700bn program created in 2008 to shore up the U.S. financial system. He resigned in March 2011, criticizing “Treasury’s mismanagement of TARP and its disregard for TARP’s Main Street goals” in a scathing New York Times op-ed. He is the author of Bailout. How Washington abandoned Main Street while rescuing Wall Street. Today Barofsky is an adjunct professor and senior research fellow at the New York University School of Law.

Listen to Charles Reinhardt in conversation with Neil Barofsky:* 

*Please note: Both the podcast and the interview transcript have been edited for brevity.


In an article for Bloomberg you wrote in July 2012 you pointed out that the top U.S. banks are 23 per cent larger today than before the crisis and control fifty two percent of all industry assets. Is the U.S. financial system more vulnerable than it was in 2007, and, if so, what went wrong in your view?

A lot of the things that were broken in our financial system, that helped create the massive financial crisis from which we’re still recovering, are still in place, and in some ways have actually gotten more severe. We had a problem with banks that were too big to fail, and as you just noted, they are even bigger now than they were. They had too much political power, too much regulatory influence over their own regulation back then, and I think what we’ve seen with recent events is that that power too has expanded along with its size.

We see a level of deference from Washington that really, fundamentally, hasn’t changed all that much. There’s maybe a difference in some of the public and political rhetoric, but when it gets down to brass tacks, the banks are still calling a lot of their own shots.

Now on the flip side, the banks themselves are in better shape, thanks to the multi-trillion dollar nature of the bailouts, than they were on the eve of the financial crisis. They’re still under-capitalized but they have more capital than they did then, they’re out of some of the more risky parts of their business, at least for now, and they’ve gone through at least some of those troubled assets, though not nearly enough. So in another aspect, they are in better shape than they were in 2008 going into the crisis, but overall our system and the structures of our system are still very very vulnerable to a systemic shock and another financial crisis, and I think because they’re larger, and because the United States has used up so much of its fiscal gunpowder dealing with the past crisis and trying to pay for the recovery, we’ll have a lot fewer options when that next crisis strikes.

In your book, you talk about some of the difficulties you had getting disclosure on how the TARP money was being used. Can you tell us a bit more about that?

Well, it was different things. I mean, one of the first things I did when I got down to Washington was to make what I thought at the time was not a terribly radical recommendation that we actually require the TARP banks to tell us what they’re doing with all that taxpayer money—they received hundreds of billions of taxpayer money. I thought, hey, in the interest of transparency, as well as to help keep track of money, to see whether it was being used in the manner that Treasury said was their policy goal. The goal was, again, not just to shovel the money into the banks, but that the banks would deploy those funds to increase lending. It seemed to me like a pretty common-sense recommendation. Treasury said “no”, and they didn’t just say “no”, they were almost violent in their response. As I pushed and pushed for them to do so, and eventually said that I would do it myself, using my audit function just to survey the banks, I was told that I was stupid, I was told that I was playing politics, I was eventually cursed out by Treasury Secretary Tim Geithner himself. And I suggested that his failure to do this was contributing to the lack of transparency and the loss of faith in government.

The other aspect of disclosure that was at times problematic was actually prying information out of Treasury. Ultimately, I got what I needed, but usually it was after a long battle, or multiple threats to go to Congress to inform them that Treasury was actually violating the law by not providing us with certain documents or information. But ultimately, we were able to break through that and get what we needed.

You also talk in your book about the failure to fully implement a mortgage modification program that was part of TARP and which was, at least originally, part of the rationale for justifying the bailouts. Could you tell us more about what happened?

People often forget that, particularly those who have a great interest in spinning the TARP as a great success, meaning those in Washington who oversaw the program and those on Wall Street who benefited from the program. They forget that the only way that that bill, the law, gets enough votes in Congress to become law and give Treasury the authority to go out and raise seven hundred billion dollars to rescue the banks was the promise made to members of Congress and the American people that something would be done about the foreclosure crisis, which, of course, was ravaging neighborhoods and communities across America, back in 2008.

[But, in the end,] it was a lot more about extending out the foreclosure crisis for the benefit of the large financial institutions, to give them a chance to recapitalize, in other words, to gain profits from all the other bank-friendly bailout programs and the homeowner, was, quite frankly, subordinated if not completely ignored.

In a recent article for the  New Republic you harshly criticize U.S. authorities for failing to lay criminal charges against HSBC for “facilitating drug trafficking and transactions with rogue terror-sponsoring nations.” You write that the size and systemic importance of banks as big as HSBC is insulating them from legal proceedings and recommend that the Department of Justice should force the largest banks to break up if this is the case. HSBC, however, is a British bank. Wouldn’t this approach be impracticable without some sort of international cooperation agreement?

Look – I was being a bit tongue-in-cheek with my recommendation, to a certain extent with the foreign banks. But the complaint that HSBC made, the threat that they made, is one that is repeated every time there is an investigation into one of the largest financial institutions, whether domestic or international. And it’s a true, actual threat. And it goes like: “If you indict us, there is a chance that we will go under, and if we go under, we are so big and so interconnected we’re going to take the entire financial system down with us.”

That is not a sustainable system. That will incentivize institutions to commit crimes, to ignore the rule of law. So we have to come up with a solution. As for whether it’s practical, sure it’s practical. Because again, the Department of Justice wouldn’t be forcing the bank to break itself up. The Department of Justice would be saying, “Look, we’re going to indict you unless you break yourself up. And if you want to make the decision to break yourself up, go for it.” And maybe that bank makes the decision that they don’t want to do business in the United States of America anymore. And they take steps like that, which might be acceptable to the Department of Justice. But giving a bank a slap on the wrist of a penalty worth a couple of weeks’ earnings, without punishing them for having committed that type of crime solely because of their size and status should be unacceptable to the Department. And I think they should use whatever tools they have to prevent that from happening again, otherwise the incentives are going to be all lined up in the wrong direction.

Looking at Canada now, I just wondered if you could extrapolate a little based on your experiences to comment on the situation north of the border. We have a more concentrated banking system than the U.S.; our five biggest banks control around 85 per cent of total industry assets. Last October, Moody’s placed those firms on notice for a possible future downgrade, citing high consumer debt and elevated housing prices.  We’ve had a very rapid appreciation in housing prices in Canada over the last few years. In light of these facts, should Canadians perhaps be looking more carefully at our own system? 

I don’t know enough about the Canadian banking system, but that sounds awfully concentrated. The bottom line is if the banks and markets believe that a bank will be bailed out by the government, the normal laws and rules of capitalism don’t apply. And that gives them incentives to take on more and more risk, knowing that they’ll be able to profit if the risks pay off and if they don’t, well hey, it’s not them that’s bearing the cost. It’s going to be the taxpayers.

One area that I would advocate that’s necessary for the United States is to break up the largest banks. Here in this country we don’t need banks as big and as interconnected and as massive as the ones that we have. You know, the second path that perhaps Canada is trying to do is to make them more like utilities. You know, extremely heavily regulated utilities where the government is making sure that they’re not amassing unreserved and unprotected and undercapitalized risks and are fulfilling the role that banks have to fulfill in a capitalist society of matching up investors or depositors who need to use that capital, to grow and expand their businesses. So without knowing too much about the Canadian structure, I’m reluctant to offer an opinion, but big housing bubbles with large banks having a lot of exposure is certainly something we’ve experienced here in the United States with really devastating consequences. There’s only so much you can do when the bubble is inflated, and you know, I would hope that if that’s a fear that the policymakers are preparing for the inevitable popping of the bubble.

On a similar note, in 2008 the Canadian government stepped in to backstop Canadian interbank lending, not because our banks were insolvent but rather to “level the playing field” as all their international competitors had government support as well. In that scenario, can the world’s largest banks be de-coupled from implicit or explicit government support and should they be? If so, would some sort of agreement or consultation be needed at the international level?

The race to the bottom of bailouts is certainly something we saw in 2008, where every country stood behind banks [out of a] concern that [their] failure would help tear down a nation.

I personally think that the justification that “we’re doing it because everyone else is doing it” is not a terribly persuasive one. Look, I think in a financial market, you look at a bank that doesn’t need to be bailed out or countries that don’t do bailouts, those banks may be more attractive in a normal, functioning, happy capitalistic market than the ones that are backed by a host country. Those types of banks are going to be more efficient, they’re going to be smarter, and they’re going to take fewer risks. They may not have the same level of profits, but that’s only because they’re not enjoying the same subsidy that the large banks get because of the explicit or implicit government backing. But over time, a free market and non-subsidized industries are going to do better and have to do better, than a subsidized one.

What lessons can Canadian financial regulators learn from the American experience in 2008, and if you can think of any, what might American regulators learn from the Canadian one?

I think one of the great lessons that we did learn from 2008 is that we have a deep problem of regulatory capture in this country, of regulators that are serving the interests of the financial institutions that they’re supposed to be regulating on behalf of the American taxpayer. There’s a number of reasons for that, but part of it here is because of the revolving door. The heads of agencies often come from Wall Street institutions that they’re supposed to be regulating and often regulators themselves leave government to go take higher paying jobs on Wall Street. And one, this creates a sense of ideological capture. What I saw in Washington is that when these individuals came from these institutions, they brought all of their Wall Street ideology with them, which led people like Tim Geithner, who didn’t come from Wall Street, but was surrounded by them, to really believe that they were being the most transparent folks ever. Who would knock down ideas like “you should tell us what you’re doing with the TARP dollars” as being impractical or unrealistic or something that shouldn’t be done. You know, I saw that time and time again. This lack of concern about fraud because of this inherent trust in their former employers.

But second, it incentivizes bad regulation. If a reward for a regulator for pulling their punches and pleasing the institutions that they’re regulating is a high-paying job on Wall Street or the Canadian equivalent of Wall Street, that’s not going to be a good incentive on behalf of the taxpayers and the regular people who are supposed to benefit from effective regulation. So I don’t know if it’s appropriate for Canada, but that’s certainly one of the most important lessons that I draw from the last crisis.

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