Bank bailout may hurt taxpayers, be open to fraud

Original Link: http://www.google.com/hostednews/ap/article/ALeqM5jCjmeGz1fQVGmTDXN3JoJlFtPDxQD97MKAEG0

By JIM KUHNHENN

Taxpayers are increasingly exposed to losses and the government is more vulnerable to fraud under Obama administration initiatives that have created a federal bank bailout program of "unprecedented scope," a government report finds.

In a 250-page quarterly report to Congress, the rescue program's special inspector general concludes that a private-public partnership designed to rid financial institutions of their "toxic assets" is tilted in favor of private investors and creates "potential unfairness to the taxpayer."

The report, which examines the six-month old, $700 billion Troubled Asset Relief Program, is scheduled for release Tuesday.

Using blunt language, Inspector General Neil Barofksy offers a series of recommendations to protect the public and takes the Treasury to task for not implementing previous advice. The report also commends Treasury and the Federal Reserve for creating some safeguards.

The report's warnings about the public-private plan's potential for losses echoes alarms raised by some lawmakers and economists, but Barofksy has significant credibility in Congress and his views are likely to carry ample weight.

Overall, the report says the public-private partnership — using Treasury, Federal Reserve and private investor money — could total $2 trillion. The financial markets responded positively to the program when the Obama administration announced it last month, but the administration is still putting final touches on its implementation.

"The sheer size of the program ... is so large and the leverage being provided to the private equity participants so beneficial, that the taxpayer risk is many times that of the private parties, thereby potentially skewing the economic incentives," the report states.

In particular, the report cited the private-public partnership that would purchase troubled real estate-related securities from financial institutions. Under plans unveiled by Treasury, for every $1 of private investment, Treasury would invest $1 and could provide another dollar in a nonrecourse loan. That money could then leverage a loan from another government fund backed mostly by the Federal Reserve, a step that Barofsky says would dilute the incentive for private fund managers to exercise due diligence.

Barofsky recommends that Treasury not allow the use of Fed loans "unless significant mitigating measures are included to address these dangers."

Treasury officials maintain that the public-private program is the best response to the troubled loans and securities clogging the system. They say that if government did nothing, the financial crisis could linger for years, and that if government intervened alone by closing troubled banks and taking over their bad assets, taxpayers would be at greater risk.

They argue that private investors and taxpayers would share profits equally and that investors would be the first to lose if the asset purchase ends up losing money.

Among Barofsky's recommendations:

_Treasury should set tough conflict of interest rules on public-private fund managers to prevent investment decisions that benefit them at taxpayer expense.

_Treasury should disclose the owners of all private equity stakes in a public-private fund.

_Fund mangers should have "investor-screening" procedures to prevent asset purchase transactions from being used for money laundering.

The report lands as the bailout plan comes under new leadership at Treasury. Last week, the White House announced it had nominated Herbert Allison, the president and CEO of mortgage behemoth Fannie Mae, to replace Neel Kashkari, an assistant Treasury secretary and a holdover from the Bush administration.

In a response to Barofsky's report dated last week, Kashkari acknowledged that "there are risks associated with investing in or lending against legacy assets, which is in part why markets for them are currently frozen." Kashkari said Treasury was considering Barofsky's recommendations.

The report also comes as lawmakers demand evidence that the government's role is unclogging credit and banks are being held accountable. Despite the infusion of government money, bank lending has declined and some banks have began to bristle at the oversight and the restrictions attached to acceptance of federal assistance.

With a sharp rebuke, Barofsky's report notes that the Treasury Department has refused to adopt the inspector general's recommendation that all recipients of TARP money account for the use of their government money.

"In light of the fact that the American taxpayer has been asked to fund this extraordinary effort to stabilize the financial system, it is not unreasonable that the public be told how those funds have been used by TARP recipients," the report states.

Though the report says Treasury is not requiring such information under a new capital assistance program for banks, Treasury informed lawmakers last week that recipients of that money must provide monthly reports that show the volume of new loans. The capital assistance plan would provide additional infusions to financial institutions or convert past loans to those banks into common shares of stock.

"Over the last two months, we've significantly increased the amount of transparency into the programs, including actively measuring lending and requiring banks under the new capital program to report on how every dollar of government resources goes toward increasing lending to consumers and businesses," Treasury spokesman Andrew Williams said.