The Fed and the Treasury Need to Come Clean About Where The Money Is Going


Three months ago, the country was galled by Treasury Secretary Henry Paulson's offhand request that taxpayers hand over billions to a tanking financial sector with no strings attached. Lawmakers keen on salvaging the bailout rushed to add amendments intended to ensure proper oversight of the Troubled Asset Relief Program (TARP). The bill that passed established a Congressional Oversight Panel, a tiny, underresourced but committed watchdog team that on December 10 issued its first report in the form of Questions About the $700 Billion Emergency Economic Stabilization Funds. The panel wrote, "We are here to ask the questions that we believe all Americans have a right to ask: who got the money, what have they done with it, how has it helped the country, and how has it helped ordinary people?"

So far, the answers are: the banks that made billions and risked more; they've stockpiled capital injections in reserves while withholding credit; and it hasn't helped any ordinary people. The Government Accountability Office put it bluntly: "Treasury has not yet set up policies and procedures to help ensure that [TARP] funds are being used as intended."

The fact is, no accountability is possible until the recipients of the bailout funds are forced to operate with the transparency that democracy requires -- and this goes for TARP benefits as well as for other aid. There's a shroud of secrecy around the loan facilities set up by the Federal Reserve and other Treasury Department measures (together totaling more than $7 trillion) now propping up Wall Street. In return for loans, the Fed has taken on nearly $3 trillion in credit-risky collateral, including subprime and other underwater asset-backed securities like lower-standard mortgages, small-business loans and securitized credit card payments, none of which can be sold into the capital markets. In addition, Treasury agreed to back $1.4 trillion of FDIC guarantees if needed, and Congress voted to back a half-trillion of Fannie Mae, Freddie Mac and FHA mortgages. Cash injections and backups have become regular features of federal banking policy.

All of this should be sounding alarm bells about what exactly is going on between Wall Street, the Fed and the Treasury. Yet opacity remains the rule: Bloomberg News' repeated attempts to use the Freedom of Information Act to discover details of the Fed's lending program for financial firms have been stymied.

Some basic moves toward greater transparency and accountability are necessary if we are even to begin to ensure that the bailout money is not being squandered.

For starters, the firms that want to be rescued by the government must make clear their true position.

Quantifying the scope of risk and magnitude of further potential losses is key to determining a bottom-line value to this crisis. This requires more disclosure from Wall Street, including lists of assets and market prices for the assets (which are super-low, given the collapse of liquidity for these assets, but still worth knowing). Every institution that wants a loan on ridiculously good terms from the Fed or a bailout from the government should have to disclose this information. It might be an ugly number -- which, like all bad news, will rattle the stock markets -- but it will come out sooner or later and should be revealed now.

Second, financial firms must fully disclose the leveraging (or borrowing) in which they have engaged using these assets as collateral. They should be required to explain their leverage procedures to Congress, as well as to the Fed.

Subprime mortgages have been blamed for the financial crisis, but we're spending more than five times more money (in Fed loans, injections, bailouts and guarantees) than the value of every subprime loan in the country combined. Of the subprime loans issued during the boom years between 2003 and 2007, roughly $1.5 trillion are outstanding. If the system wasn't so leveraged, and each of them defaulted to zero (which hasn't happened), they would represent a $1.5 trillion loss. It should be clear by now that something other than subprime loans defaulting -- or a "housing correction," as Paulson puts it -- is wrong with the system. How were those loans packaged and leveraged into what amounts to a $140 trillion global pyramid of junk?

That is hard to answer, because the way individual loans got dispersed multiple times throughout the global financial system is not transparent. Still, if legitimate borrowers were allowed to renegotiate payable loan terms (and stay in their homes), certain related losses propagated by the existing financial framework would cease. FDIC head Sheila Bair adopted this strategy when the FDIC took over failed Pasadena-based bank IndyMac, and she suggested a similar one to stop 1.5 million foreclosures at a $24.4 billion cost, yet TARP funds have not been opened to this more see-through approach.

Indeed, instead of having to explain their leveraging procedures, the most leveraged companies are getting the best deal. Former investment banks Goldman Sachs and Morgan Stanley were allowed to become bank holding companies, thereby widening the net for which the government is on the hook, and giving them the same status as consumer-oriented institutions. These were the same companies that got the SEC to approve their ability to leverage themselves thirty to one, instead of twelve to one. They are inhaling the Fed lending facilities and government bailout money and brokering new FDIC-backed bonds, even though they created their own problems. Instead of egging them on, the SEC should be reducing the high leverage ratios that still exist.

During a time of supreme weakness and lack of transparency, it's an especially bad idea for the government to allow institutions that were already "too big to fail" to merge with other institutions, thereby creating bigger, riskier firms. But in the cases of Bank of America-Merrill Lynch, Wells Fargo-Wachovia and JPMorganChase-Washington Mutual, that is what has been happening. Other mergers are in discussion. Not only will their enhanced size prove a bigger risk to the public if they fail; their merged balance sheets will by definition be more difficult to understand and monitor, even if the current regulatory structure was effective.

Instead, we should be talking actively about reregulating the banking industry and maintaining financial entities in manageable pieces. Before it was gutted by deregulation, the Glass-Steagall Act protected the government and taxpayers by isolating rather than combining risky firms with more consumer-oriented ones. Perhaps the exact details of the 1933 legislation would require modification, but reviving its essence would go a long way toward solving this financial crisis -- and avoiding future ones.

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