The ‘grand bargain’ is just a start

March 29, 2011

Where the Bailout Went Wrong

By NEIL M. BAROFSKY

Washington

TWO and a half years ago, Congress passed the legislation that bailed out the country’s banks. The government has declared its mission accomplished, calling the program remarkably effective “by any objective measure.” On my last day as the special inspector general of the bailout program, I regret to say that I strongly disagree. The bank bailout, more formally called the Troubled Asset Relief Program, failed to meet some of its most important goals.


From the perspective of the largest financial institutions, the glowing assessment is warranted: billions of dollars in taxpayer money allowed institutions that were on the brink of collapse not only to survive but even to flourish. These banks now enjoy record profits and the seemingly permanent competitive advantage that accompanies being deemed “too big to fail.”


Though there is no question that the country benefited by avoiding a meltdown of the financial system, this cannot be the only yardstick by which TARP’s legacy is measured. The legislation that created TARP, the Emergency Economic Stabilization Act, had far broader goals, including protecting home values and preserving homeownership.


These Main Street-oriented goals were not, as the Treasury Department is now suggesting, mere window dressing that needed only to be taken “into account.” Rather, they were a central part of the compromise with reluctant members of Congress to cast a vote that in many cases proved to be political suicide.


The act’s emphasis on preserving homeownership was particularly vital to passage. Congress was told that TARP would be used to purchase up to $700 billion of mortgages, and, to obtain the necessary votes, Treasury promised that it would modify those mortgages to assist struggling homeowners. Indeed, the act expressly directs the department to do just that.


But it has done little to abide by this legislative bargain. Almost immediately, as permitted by the broad language of the act, Treasury’s plan for TARP shifted from the purchase of mortgages to the infusion of hundreds of billions of dollars into the nation’s largest financial institutions, a shift that came with the express promise that it would restore lending.


Treasury, however, provided the money to banks with no effective policy or effort to compel the extension of credit. There were no strings attached: no requirement or even incentive to increase lending to home buyers, and against our strong recommendation, not even a request that banks report how they used TARP funds. It was only in April of last year, in response to recommendations from our office, that Treasury asked banks to provide that information, well after the largest banks had already repaid their loans. It was therefore no surprise that lending did not increase but rather continued to decline well into the recovery. (In my job as special inspector general I could not bring about the changes I thought were needed — I could only make recommendations to the Treasury Department.)


Meanwhile, the act’s goal of helping struggling homeowners was shelved until February 2009, when the Home Affordable Modification Program was announced with the promise to help up to four million families with mortgage modifications.


That program has been a colossal failure, with far fewer permanent modifications (540,000) than modifications that have failed and been canceled (over 800,000). This is the well-chronicled result of the rush to get the program started, major program design flaws like the failure to remedy mortgage servicers’ favoring of foreclosure over permanent modifications, and a refusal to hold those abysmally performing mortgage servicers accountable for their disregard of program guidelines. As the program flounders, foreclosures continue to mount, with 8 million to 13 million filings forecast over the program’s lifetime.


Treasury Secretary Timothy Geithner has acknowledged that the program “won’t come close” to fulfilling its original expectations, that its incentives are not “powerful enough” and that the mortgage servicers are “still doing a terribly inadequate job.” But Treasury officials refuse to address these shortfalls. Instead they continue to stubbornly maintain that the program is a success and needs no material change, effectively assuring that Treasury’s most specific Main Street promise will not be honored.


Finally, the country was assured that regulatory reform would address the threat to our financial system posed by large banks that have become effectively guaranteed by the government no matter how reckless their behavior. This promise also appears likely to go unfulfilled. The biggest banks are 20 percent larger than they were before the crisis and control a larger part of our economy than ever. They reasonably assume that the government will rescue them again, if necessary. Indeed, credit rating agencies incorporate future government bailouts into their assessments of the largest banks, exaggerating market distortions that provide them with an unfair advantage over smaller institutions, which continue to struggle.


Worse, Treasury apparently has chosen to ignore rather than support real efforts at reform, such as those advocated by Sheila Bair, the chairwoman of the Federal Deposit Insurance Corporation, to simplify or shrink the most complex financial institutions.


In the final analysis, it has been Treasury’s broken promises that have turned TARP — which was instrumental in saving the financial system at a relatively modest cost to taxpayers — into a program commonly viewed as little more than a giveaway to Wall Street executives.


It wasn’t meant to be that. Indeed, Treasury’s mismanagement of TARP and its disregard for TARP’s Main Street goals — whether born of incompetence, timidity in the face of a crisis or a mindset too closely aligned with the banks it was supposed to rein in — may have so damaged the credibility of the government as a whole that future policy makers may be politically unable to take the necessary steps to save the system the next time a crisis arises. This avoidable political reality might just be TARP’s most lasting, and unfortunate, legacy.


Neil M. Barofsky was the special inspector general for the Troubled Asset Relief Program from 2008 until today.

OPINION

MARCH 31, 2011.

Handicapping the Economic Recovery

Japan, Europe, oil and the deficit all pose problems. But chances are growth will continue.

By ALAN S. BLINDER

If you're searching for a metaphor for the U.S. economy right now, think of an athlete who is recovering from serious injuries and must navigate a difficult obstacle course. She's getting into better shape but there are hazards along the way that might keep her from reaching the finish line.


Here's my list of the four biggest obstacles to recovery right now—in ascending order of seriousness:
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• The Japanese disaster: Many people view the physical and human tragedy now afflicting Japan as a serious threat to global recovery. Based on what's known so far, I don't. The horrors unleashed by the earthquake, tsunami and nuclear disaster are very real—and monumental in scale and scope. The human cost is incalculable. And the disaster is already causing some economic disruptions (e.g., to production in Japan and to global supply chains). There will be more.


But history teaches us that in well-ordered economies, such events generally prove to be no more than short-term setbacks. And this is Japan we're talking about. Its economy will likely bounce back relatively quickly.


• The European sovereign debt crisis: This one is starting to look like a hardy perennial. For about a year, the on-again-off-again fear has been that defaults or restructurings by Greece, Ireland, Portugal and others might impose huge losses on European banks, which are not too healthy anyway, thereby opening a new and scary chapter in the world financial crisis.


No one knows what the future might bring, but my guess is that history will prove to be prologue. The nations of the European Union have bickered, dithered and delayed time again. But each time, when push came to shove, they got their act together. We'll likely see more bickering and dithering. But a financial implosion in Europe seems unlikely. The stakes are too high, and disaster is too preventable. (Did someone say that in the summer of 1914?)


• The U.S. budget deficit: The unedifying and sometimes irrational political wrangling over our own budget deficit is more worrisome. There are three distinct hazards here.


First, the current budget battle might lead to excessively large cuts in federal spending at a time when the economy is still fragile—much like what is happening in the U.K. Frankly, I don't lose any sleep over this one. Gridlock will protect us.
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Assad’s Alawite army still calls all the shots

By Robert Baer

Published: March 30 2011 22:50

As President Bashar al-Assad’s regime tries to cope with growing unrest and protests throughout much of Syria, he will almost inevitably have to rely on his army to take a wider role in attempts to restore order. But we should not make the mistake of thinking that Syria is about to follow the path of Egypt. Unlike Egypt, few Syrians look at the army as a benign institution. Rather, it is as a palace guard, meant to keep the ruling Alawite sect in power.


The Alawites, an offshoot of Shia Islam, represent about 11 per cent of the population. It is only thanks to their control of the army (and intelligence services) that they keep their grip on Syria. So no matter how bad things become, Syrians would never trust them to oversee any reform, let alone democratisation.


When I was working in Syria in the 1980s, a Syrian officer offered me an insight into the reality of the country’s army. One night not long after the 1973 war, the officer was up late into the night keeping previous president Hafiz al-Assad company. Around three, he watched Assad as he picked up the phone from the side table and asked his operator to put him through to a frontline post on the Israeli border. A lieutenant came on the phone, sleepy and irritated that he had been woken up.


Assad asked him his name. Rather than answering, the lieutenant asked who his caller was. When Assad told him, the lieutenant naturally enough lost his composure and could only stammer his name. He became even more confused when Assad started to ask the lieutenant about his family and village, knowing all the names of his brothers. “Assad had no idea who would be on duty that night,” the Syrian officer told me. “But it is the very reason Assad has so tightly held on to power all these years. It was his army.”


Assad made it a habit to read every officer’s file, committing their personal details to memory. He also personally approved transfers and promotions. But more importantly, Assad instituted an unwritten rule that every large combat unit would be under the command of an Alawite officer. There would still be Sunni commanders, but in name only. They would have no real power over their units and were not permitted to put a single aircraft into the air or drive a tank out of cantonment – without the authority of the ranking Alawite. The Alawite officers were related either by blood or bonds of loyalty that could never be broken.


Assad’s son, having become his successor, has shown few of his father’s sharp political instincts but he has had the good sense to leave his father’s military system in place. Like every other Alawite, he understood that this is a matter of survival for his sect and his hold on power these last 10 years has depended on it.


Over the weekend an Alawite with ties to the Assad family messaged me in frustration about how little the west understands about Syria, what is at stake and how far the Alawites will go to hold on to power. He said the police in Dara’a – the town where the first demonstration started – had fired on the crowd in order to protect the lives of Alawites. At the same time he was worried that things might go too far. The hardliners around Mr Assad say that the Alawites cannot afford to make concessions to the street. If they do so they risk being forced from power. Only decisive and unanswerable force will work, as history has shown.


In February 1982, the Muslim Brotherhood seized Hama, Syria’s fourth largest city. For several days Mr Assad’s father hesitated on how to respond. But when he heard that dozens of Alawites had been massacred, without a second thought, he ordered the army to shell the town. His commanders were told to spare no one in putting down the revolt.


I visited Hama one year later, seeing for myself how Assad’s artillery had all but removed the town from the earth. The Alawites I talked to were not happy, but they believed that the Sunni rebellion was snuffed out only thanks to the regime’s violent reprisal. Then, just as today, the Alawites recognised it was the Alawite-led army that safeguarded their survival.


There is no way to predict whether Mr Assad has the stomach for another Hama, or for that matter, whether things will get bad enough for him to consider it. But the one certainty is that if he and the Alawites are forced from power, Syria will not have an army to fill the vacuum. And then the question becomes whether or not the west intervenes to stop a civil war.


Only a fool would predict what is coming next in the Middle East. But if Hama is any guide, the potential for violence in Syria makes Libya and Yemen look mild. Moreover, chances are good that chaos in Syria risks spilling into neighbouring countries – notably Lebanon, Jordan and Iraq, and maybe even the Arab side of the Gulf, which is already riven by sectarian divisions. This is a worst-case scenario, but the point is if it comes about, there will be no way the west could just stand by and hope for the best.


The writer is a former CIA operative in the Middle East


Copyright The Financial Times Limited 2011