TARP Squandering Potential, Redefaults Rising at Alarming Rate According to Watchdog
In its Quarterly Report submitted to Congress on Wednesday,
the Office of the Special Inspector General for the Troubled Asset Relief
Program (SIGTARP) looks at the status of "too big to fail" institutions,
calling them still a threat and as the progress and problems in those aspects
of TARP aimed at small businesses and homeowners.
While great efforts must be taken to avoid a future crisis
and bailout the SIGTARP says, we cannot lose sight of the current TARP
bailout. Wall Street may have recovered
but Main Street has not. TARP was always
intended as a bailout of the financial system to protect American
families. Business and homeowners are
still feeling the effect of the crisis and still need help from TARP.
"In its March 2013 TARP report, Treasury writes, 'Thanks to
TARP...struggling homeowners have seen relief, and credit is more available to
consumers and small businesses. '"
SIGTARP says of this, "Lost in this statement is the unfortunate reality
that this improvement is only a fraction of what TARP could and should have
done, and in many ways still can do."
As of March 31, Treasury had spent less than 2 percent ($7.3
billion) of TARP funds on homeowner relief programs including HAMP and the
Hardest Hit Funds while spending 75 percent to rescue financial
institutions. "Treasury pulled out all
the stops for the largest financial institutions, and it must do the same for
homeowners."
Treasury also has a responsibility to insure the help it
does provide is sustainable. In order to
avoid foreclosure through HAMP a homeowner must remain active in a permanent mortgage
modification and only 862,279 homeowners are in one, about half of which were
funded with TARP money. Now many
homeowners are defaulting on these modifications, more than 312,000 to date. SIGTARP is concerned that these defaults are
increasing at an alarming rate. As of
March 31 the oldest modifications, done in Q3 and 4 of 2009, are defaulting at respective
rates of 46.1 and 39.1 percent.
The report says Treasury should work to curb redefaults,
which often inflict great harm on already struggling homeowners when any
amounts previously modified suddenly come due.
SIGTARP recommended this month that Treasury conduct research to better
understand the causes of redefaults and work with servicers to develop an early
warning system so they can intervene before problems occur.
As regards Wall Street, the report says too big to fail is
not just about size, it is about the interconnections the largest financial
firms have to each other and to American households. Regulators were shocked, in 2008, to find how
these large institutions were tied to each other and to counterparties so that
if one went down it pulled other down with it.
Even the institutions themselves did not realize the extent to which
they were linked. Nor did they realize
their exposures to short-term funding counterparties which, as Treasury
Secretary Geithner said, "can flee in a heartbeat", bringing the system down. While the financial system is more stable
now, ending too big to fail is critical to its safety.
In order to prevent a future crisis and another bailout the
Dodd-Frank Wall Street Reform and Consumer Protection Act provided front line
measures aimed at keeping the largest financial institutions safe and sound and
a last line defense designed to let a company fail without damaging the
economy. SIGTARP says some of these
front line measures have not yet been determined nor have the determinants of
which banks will be subject to them.
Without front line measures fully in place, SIGTARP says, "There does
not appear to be enough of an incentive for institutions to break up or break
off dangerous interconnections."
Dodd-Franks' last line of defense is bankruptcy or a new
FDIC process called orderly liquidation authority. As part of this last line, living wills are
envisioned as the way to identify and remove obstacles to an orderly
bankruptcy. However the report says, the
usefulness of living wills is in question.
As in 2008 there may be no time for an orderly bankruptcy or it might
not be a viable option for players who dominate the market in providing a
critical service. Moreover, most
companies operate in different countries with different bankruptcy laws. Because of the interconnections one
bankruptcy may drag down others leaving too few healthy companies to buy up
assets of the failing ones as envisioned in the living wills.
Under FDIC's process the parent company is placed in
receivership, management is fired, and the subsidiaries continue operating and
paying counterparties. Losses are
expected to be borne by shareholders and debt holders not taxpayers. The key to this working is there being a
sufficient amount of debt to absorb the losses, otherwise FDIC must borrow
funds from Treasury. Orderly liquidation
also has cross-border issues.
The report says that the existence of living wills,
bankruptcy, and order liquidation authority have not convinced the market that individuals
firms won't get another bailout; thus they have not been willing to disentangle
their dangerous connections.
The process of developing living wills allows a company to better
understand the risk exposures in their interconnections and either break them
off or be forced to do so. SIGTARP
suggests that regulators think of these as more than part of the last line of
defense; they should also be part of the first line of offense. Regulators should use the information to identify
and remove obstacles to a firm's orderly resolution but also to inform their
broader responsibility to the financial system.
The wills give regulators a clearer vantage point into a megabank's
inner workings than they had in the crisis.
The company is required to disclose off-balance sheet exposures, where
it has pledged collateral, and indentify hedging strategies; "In other
words, so much of the information that caught regulators unaware in the last
crisis should be contained in the living wills."
Regulators should also use living wills to evaluate the aggregate
across institutions of risks, linkages and interdependences. If they expand their use of living wills from
a deathbed document to a roadmap of the financial system they can take
preemptory supervisory action to force the breakup of interconnections that
threaten the system.
SIGTARP also concludes that TARP missed an opportunity to
increase lending to small businesses.
TARP banks that were allowed to enter the Small Business Lending Fund (SBLF)
often did so as a means to exit TARP.
They performed more poorly in lending to small businesses than non-TARP
banks in the SBLF because the TARP banks used approximately 80 percent of the
SBLF funds they received to fund their early exit from TARP. The 24 TARP banks actually decreased their
lending to small businesses and 14 of them paid dividends to shareholders
despite limits on dividends, executive compensation, and luxury expenditures
that were a condition of the program.