Barofsky Interview: Another Financial Crisis All But Inevitable

Written by Ron Hera, Hera Research

Editor’s note: The author has conducted a sobering interview with Neil Barofsky, Senior Research Scholar, Senior Fellow and Adjunct Professor of Law at the New York University School of Law. From December 2008 until March 2011 Mr. Barofsky served as the Special Inspector General for the $700 billion U.S. Troubled Asset Relief Program (TARP) that bailed out the U.S. banking system in 2008.

Click on photo for large picture of Neil Barofsky.

Introduction

In his role as Inspector General, Mr. Barofsky’s mandate was to root out and prosecute waste, fraud and abuse. He gained nationwide recognition for his courage and willingness to stand up to the most powerful people and institutions in Washington D.C. and on Wall Street and for his relentless criticism of U.S. Treasury Department officials, including U.S. Treasury Secretary Tim Geithner.

Prior to his role as Inspector General, Mr. Barofsky served as a federal prosecutor in the United States Attorney’s Office for the Southern District of New York for more than eight years. In that office, he headed the Mortgage Fraud Group as Senior Trial Counsel, to investigate and prosecute all aspects of mortgage fraud, from retail mortgage fraud cases to investigations involving potential securities fraud with respect to collateralized debt obligations (CDOs).

During his tenure as a member of the Securities and Commodities Fraud Unit, Mr. Barofsky gained extensive experience as a line prosecutor leading white collar prosecutions including the case that led to the conviction of Refco Inc. executives. For his work on the Refco matter, Mr. Barofsky received the U.S. Attorney General’s John Marshall Award.

Mr. Barofsky also led the investigation that resulted in the indictment of the top 50 leaders of the Revolutionary Armed Forces of Colombia (FARC) on narcotics charges, which is the largest narcotics indictment filed in U.S. history.

Mr. Barofsky’s critically acclaimed book, “Bailout: An Inside Account of How Washington Abandoned Main Street While Rescuing Wall Street,” is a play-by-play, behind-the-scenes account of insider-dealing and mishandling of financial bailouts by the U.S. Treasury Department.

Mr. Barofsky is a magna cum laude graduate of the New York University School of Law.

The Interview

Hera Research (HR): Thank you for joining us today. Why do you remain a critic of the TARP when the $700 billion has been paid back?

Neil Barofsky: To talk about the TARP only in terms of saving banks is revisionist history. When the financial crisis hit in 2008, then Treasury Secretary Henry Paulson went down on bended knee before the Speaker of the House, Nancy Pelosi, and essentially begged Congress to enact a bailout program in the measure of $700 billion. It was pitched as a bailout program to buy troubled assets including mortgages and mortgage related assets.

HR: Did the TARP go beyond saving banks?

Neil Barofsky: Yes. As the conversation between the Bush administration and Congress continued and the legislation was submitted, voted down, rewritten and eventually passed, a lot of things changed. First, the authority that Secretary Paulson got went well beyond buying mortgage related assets. Second, demands that Congress put on Treasury to authorize the $700 billion included helping homeowners and the economy. When the bill was passed it had sections that dealt with mortgage modifications and stimulating the economy.

HR: So the goals of the TARP changed?

Neil Barofsky: Yes. You have to go back and look at what the initial goals were; at what Treasury said it intended to accomplish and at the promises that Congress required Treasury to make.

HR: Were the original goals ever accomplished?

Neil Barofsky: No. If you look at the original goals, you can only conclude that the TARP was a failure.

HR: How could that happen?

Neil Barofsky: I think many members of Congress didn’t realize how much the definitions in the legislation were expanded so that a troubled asset could be almost anything and a financial institution could be any regulated company, basically any public company and most private companies.

HR: Are you saying that it was bait and switch?

Neil Barofsky: By no means. The leadership in Congress was well aware that the legislation was giving Treasury a lot more latitude. The whole concept of using the money to fill in capital holes by buying shares of stock in the banks instead of buying mortgage related assets was specifically contemplated and in some quarters even encouraged by members of Congress. However, some members of Congress, those who were not in leadership positions, felt like it was bait and switch where instead of buying troubled assets, the program became a giveaway for banks.

HR: Did the TARP help to stem the financial crisis?

Neil Barofsky: Absolutely. It helped deal with a very acute, short term problem. There was a presumption in the market after Bear Stearns was bailed out in a sweetheart deal with JPMorgan Chase—I mean Bear Sterns’ creditors were bailed out—and after Fannie Mae and Freddie Mac were taken into conservatorship, that the U.S. government would stand behind “too big to fail” financial institutions. When Lehman Brothers Holdings was allowed to collapse, the presumption of bailout was removed and it caused an incredible panic. The government had painted itself into a corner by encouraging the growth of financial institutions and the presumption of bailout. So when Lehman Brothers collapsed it caused runs on large financial institutions that certainly would have caused some of them to fail. There was a perceived need for the U.S. government to make a bold statement that they would never let any of these institutions fail. The TARP along with other extraordinary programs undertaken by the FDIC and the Federal Reserve all worked together to prevent the financial crisis from becoming much larger.

HR: How was the Bear Stearns acquisition a sweetheart deal for JPMorgan Chase?

Neil Barofsky: The U.S. government took off about $30 billion of the most toxic assets in Bear Stearns and then, having shifted the toxic assets to American taxpayers, facilitated the purchase of the company by JPMorgan Chase for a song without any risks. They paid $10 per share when it was trading a week before at $69.75 and no longer had those toxic assets.

HR: Did the TARP help to restore confidence in U.S. institutions and financial markets?

Neil Barofsky: Yes, but it was intended and required by Congress to do much more than that and Treasury said that it was going to deploy the money into banks to increase lending, which it never did.

HR: Were the initial goals of the TARP realistic?

Neil Barofsky: First, if the goals were unachievable, Treasury officials should never have promised to undertake them as part of the bargain. Second, even if the goals were not entirely achievable, it would have been worth trying. Treasury officials didn’t even try to meet the goals.

HR: Can you give a specific example?

Neil Barofsky: The justification for putting money into banks was that it was going to increase lending. Having used that justification, there was an obligation, in my view, to take policy steps to achieve that goal, but Treasury officials didn’t even try to do it. The way it was implemented, there were no conditions or incentives to increase lending.