TARP Watchdog Casts Doubt on Financial 'Reform' Law's Promise to End Bailouts

By Edwin Mora | January 28, 2011 | 4:09 AM EST

Neil Barofsky, special inspector general for the Trouble Asset Relief Program (TARP), is sworn in prior to testifying before a House committee on Wednesday, Oct. 14, 2009. (AP Photo/Alex Brandon)

(CNSNews.com) - The use of TARP funds to provide a safety net for “too-big-to-fail” institutions is a “recipe for disaster” that can lead to more bailouts, according to a report by the TARP inspector general.

Special Inspector General for TARP Neil Barofsky, in a quarterly report to Congress, said it “remains to be seen” whether the Wall Street Reform and Consumer Protection Act, sponsored by Democratic Sen. Chris Dodd and Rep. Barney Frank, will achieve its intended purpose of ending government bailouts. That's because big institutions still believe the government will bail them out, he said.

In the report, Barofsky also blasted Obama’s Home Assistance Modification Program (HAMP), which -- as CNSNews.com previously reported -- has not achieved its intended purpose of bringing down foreclosure rates by helping struggling homeowners.

“TARP’s most significant legacy [is] the moral hazard and potentially disastrous consequences associated with the continued existence of financial institutions that are ‘too big to fail,’” Barofsky stated in the report.

“The continued existence of institutions that are ‘too big to fail’ — an undeniable byproduct of former Secretary [Henry] Paulson and Secretary [Tim] Geithner’s use of TARP to assure the markets that during a time of crisis that they would not let such institutions fail — is a recipe for disaster,” noted Barofsky. “These institutions and their leaders are incentivized to engage in precisely the sort of behavior that could trigger the next financial crisis, thus perpetuating a doomsday cycle of booms, busts, and bailouts.”

Barofsky pointed out that the Dodd-Frank financial reform legislation falls short of solving the perception that the government will not allow an institution to fail because “the largest institutions continue to enjoy access to cheaper credit.”

The inspector general noted that the intention of the Dodd-Frank legislation, which was signed into law by President Obama in July 2010, was in part, to end “too big to fail” and “to protect the American taxpayer by ending bailouts.”

Nevertheless, according to Barofsky, Obama’s Treasury secretary in December 2010 – a few months after the Dodd-Frank financial overhaul was enacted – indicated that the government would once again rescue a bank if its failure threatens the overall financial system.

 “Secretary Geithner, in a December 2010 interview with SIGTARP [Office of the Inspector General for TARP], likewise acknowledged that despite the ‘better tools’ provided by the Dodd-Frank Act, ‘[i]n the future we may have to do exceptional things again’ if we face a crisis as large as the last one,” Barofsky reported.

“To the extent that those ‘exceptional things’ include taxpayer-supported bailouts, his acknowledgement serves as an important reminder that TARP’s price tag goes far beyond dollars and cents, and that the ultimate cost of TARP will remain unknown until the next financial crisis occurs,” he added.

Barofsky noted that when testifying about the Dodd-Frank bill before the Congressional Oversight Panel in June 2010, shortly before President Obama signed it into law, Secretary Geithner said the bill’s reforms will terminate “too big to fail.’’

Regarding Obama’s foreclosure programs including the two-year-old HAMP program, the largest one, and other newer ones, Barofsky’s report revealed that such initiatives are struggling in achieving their intended purpose staving off foreclosures.

According to Barofsky, the number of permanent modifications made under HAMP are “anemic.”

The approximately 500,000 permanent modifications as of Dec. 31 “pale in comparison not only to foreclosure filings, but also to Treasury’s initial prediction that HAMP would ‘help up to 3 to 4 million at-risk homeowners avoid foreclosure’ by reducing monthly payments to sustainable levels,” added Barofsky.

Barofsky testified on Wednesday, Jan. 26, before the House Committee on Oversight and Government Reform, which is chaired by Rep. Darrell Issa (R-Calif.).

Rep. Patrick McHenry (R-N.C.), chairman of the Oversight Subcommittee on TARP, Financial Services and Bailouts of Public and Private Programs, commented on Barofsky’s report in a statement, saying that all the Dodd-Frank bill has done is create a disadvantage for smaller institutions that do not benefit from the “too big to fail” mentality. 

During Wednesday's Oversight committee hearing, McHenry said he expects to hold subcommittee field hearings where he will hear from actual HAMP participants who have been hurt by the initiative as well as those individuals who have benefited from it.  

Barofsky warned that unless “too big to fail” institutions “are either broken up so that they are no longer perceived to be a threat to the financial system, or a structure is put in place that gives adequate assurance to the market that they will be left to suffer the full consequences of their own recklessness, the prospect of more bailouts will continue to fuel more bad behavior with potentially disastrous results.”

In his report, Barofsky acknowledged, “There is a chance that TARP may break even or possibly turn a profit on one of its most controversial transactions,” Barofsky stated.

Barofsky also acknowledged that TARP helped tame the financial crisis and that the program’s cost to taxpayers has been declining.

"Not only did TARP funds help head off a catastrophic financial collapse, but estimates of TARP's ultimate direct financial cost to the taxpayer have fallen substantially," Barofsky stated in the report.