TARP Squandering Potential, Redefaults Rising at Alarming Rate According to Watchdog

In its Quarterly Report submitted to Congress on Wednesday,rnthe Office of the Special Inspector General for the Troubled Asset ReliefrnProgram (SIGTARP) looks at the status of “too big to fail” institutions,rncalling them still a threat and as the progress and problems in those aspectsrnof TARP aimed at small businesses and homeowners. </p

While great efforts must be taken to avoid a future crisisrnand bailout the SIGTARP says, we cannot lose sight of the current TARPrnbailout.  Wall Street may have recoveredrnbut Main Street has not.  TARP was alwaysrnintended as a bailout of the financial system to protect Americanrnfamilies.  Business and homeowners arernstill feeling the effect of the crisis and still need help from TARP.</p

“In its March 2013 TARP report, Treasury writes, ‘Thanks tornTARP…struggling homeowners have seen relief, and credit is more available tornconsumers and small businesses. ‘” rnSIGTARP says of this, “Lost in this statement is the unfortunate realityrnthat this improvement is only a fraction of what TARP could and should haverndone, and in many ways still can do.”</p

As of March 31, Treasury had spent less than 2 percent ($7.3rnbillion) of TARP funds on homeowner relief programs including HAMP and thernHardest Hit Funds while spending 75 percent to rescue financialrninstitutions.  “Treasury pulled out allrnthe stops for the largest financial institutions, and it must do the same forrnhomeowners.”</p

Treasury also has a responsibility to insure the help itrndoes provide is sustainable.  In order tornavoid foreclosure through HAMP a homeowner must remain active in a permanent mortgagernmodification and only 862,279 homeowners are in one, about half of which werernfunded with TARP money.  Now manyrnhomeowners are defaulting on these modifications, more than 312,000 to date.  SIGTARP is concerned that these defaults are<bincreasing at an alarming rate.  As ofrnMarch 31 the oldest modifications, done in Q3 and 4 of 2009, are defaulting at respectivernrates of 46.1 and 39.1 percent.</p

The report says Treasury should work to curb redefaults,rnwhich often inflict great harm on already struggling homeowners when anyrnamounts previously modified suddenly come due. rnSIGTARP recommended this month that Treasury conduct research to betterrnunderstand the causes of redefaults and work with servicers to develop an earlyrnwarning system so they can intervene before problems occur. </p

As regards Wall Street, the report says too big to fail isrnnot just about size, it is about the interconnections the largest financialrnfirms have to each other and to American households.  Regulators were shocked, in 2008, to find howrnthese large institutions were tied to each other and to counterparties so thatrnif one went down it pulled other down with it. rnEven the institutions themselves did not realize the extent to whichrnthey were linked.  Nor did they realizerntheir exposures to short-term funding counterparties which, as TreasuryrnSecretary Geithner said, “can flee in a heartbeat”, bringing the system down.  While the financial system is more stablernnow, ending too big to fail is critical to its safety.  </p

In order to prevent a future crisis and another bailout thernDodd-Frank Wall Street Reform and Consumer Protection Act provided front linernmeasures aimed at keeping the largest financial institutions safe and sound andrna last line defense designed to let a company fail without damaging therneconomy.  SIGTARP says some of thesernfront line measures have not yet been determined nor have the determinants ofrnwhich banks will be subject to them. rnWithout front line measures fully in place, SIGTARP says, “There doesrnnot appear to be enough of an incentive for institutions to break up or breakrnoff dangerous interconnections.”</p

Dodd-Franks’ last line of defense is bankruptcy or a newrnFDIC process called orderly liquidation authority.  As part of this last line, living wills arernenvisioned as the way to identify and remove obstacles to an orderlyrnbankruptcy.  However the report says, thernusefulness of living wills is in question. rnAs in 2008 there may be no time for an orderly bankruptcy or it mightrnnot be a viable option for players who dominate the market in providing arncritical service.  Moreover, mostrncompanies operate in different countries with different bankruptcy laws.  Because of the interconnections onernbankruptcy may drag down others leaving too few healthy companies to buy uprnassets of the failing ones as envisioned in the living wills.</p

Under FDIC’s process the parent company is placed inrnreceivership, management is fired, and the subsidiaries continue operating andrnpaying counterparties.  Losses arernexpected to be borne by shareholders and debt holders not taxpayers.  The key to this working is there being arnsufficient amount of debt to absorb the losses, otherwise FDIC must borrowrnfunds from Treasury.  Orderly liquidationrnalso has cross-border issues.</p

The report says that the existence of living wills,rnbankruptcy, and order liquidation authority have not convinced the market that individualsrnfirms won’t get another bailout; thus they have not been willing to disentanglerntheir dangerous connections.</p

The process of developing living wills allows a company to betterrnunderstand the risk exposures in their interconnections and either break themrnoff or be forced to do so.  SIGTARPrnsuggests that regulators think of these as more than part of the last line ofrndefense; they should also be part of the first line of offense.  Regulators should use the information to identifyrnand remove obstacles to a firm’s orderly resolution but also to inform theirrnbroader responsibility to the financial system. rnThe wills give regulators a clearer vantage point into a megabank’srninner workings than they had in the crisis. rnThe company is required to disclose off-balance sheet exposures, wherernit has pledged collateral, and indentify hedging strategies; “In otherrnwords, so much of the information that caught regulators unaware in the lastrncrisis should be contained in the living wills.”</p

Regulators should also use living wills to evaluate the aggregaternacross institutions of risks, linkages and interdependences.  If they expand their use of living wills fromrna deathbed document to a roadmap of the financial system they can takernpreemptory supervisory action to force the breakup of interconnections thatrnthreaten the system.</p

SIGTARP also concludes that TARP missed an opportunity tornincrease lending to small businesses. rnTARP banks that were allowed to enter the Small Business Lending Fund (SBLF)rnoften did so as a means to exit TARP. rnThey performed more poorly in lending to small businesses than non-TARPrnbanks in the SBLF because the TARP banks used approximately 80 percent of thernSBLF funds they received to fund their early exit from TARP.  The 24 TARP banks actually decreased theirrnlending to small businesses and 14 of them paid dividends to shareholdersrndespite limits on dividends, executive compensation, and luxury expendituresrnthat were a condition of the program.

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