“Bailout”: A Review of Neil Barofsky’s Boiling Book

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Whatever you do, read this review first before venturing out to Neil Barofsky’s docudrama – Bailout. The title pretty much tells it all. Bailout offers an insider’s view of the government’s response, known by the acronym TARP, to the 2008 global financial meltdown. If you fail to heed this warning and go directly to the book, it is very likely that you will fall into a pit of total despair that could even result in damage to yourself or a loved one.

Bailout is about the author’s trips, trials and tribulations trying to bring his version of sanity and financial responsibility to the asylum commonly known as our Federal Government. Owing to the terrifying prospect of a first-ever global financial meltdown, the inmates began acting out in ways that run the range from lies shrouded in denial to some really goofy stuff. Only in retrospect can we judge the level of insanity.

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The beautiful thing about writing Bailout is the ability to finely sand the rough edges of history. Picking on the blotted inept bureaucracy of Washington during normal times would seem to give the author unfair advantage. But doing this in the midst of a financial meltdown nobly casts the author as Spiderman versus Goliath.

First, some bona fides: Neil Barofsky is obviously a very smart guy. Ivy educated lawyer, former assistant U.S. attorney for the Southern District of New York. Neil was also the first (and now former) head of SIGTARP. This government acronym stands for Special Inspector General Troubled Asset Relief Program. By his own description, he was an odd selection for the job. A prosecutor not a bean counter, he had to learn his job on the fly. As a Washington, DC outsider, he came into his new post with less political savvy than a first round loser on TV’s “Are You Smarter Than a 5th Grader?” And, what exactly was his job? There was no written definition, but Mr. Barofsky took on the role of Spiderman in his efforts to protect the $700 billion in taxpayer funds that Congress appropriated for TARP.

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For no other reason than this, Mr. Barofsky deserves an ovation. He also deserves kudos for giving us a privileged insider look at the dysfunctional universe of the United States Federal Government. He is not the first to do so. The stacks of Barnes & Noble are filled with others. As noted, the government is a pathetic target.

I must confess before reading Bailout, I viewed a Republican administration as a bunch of rich, greedy people humbly professing to advance the cause of freedom and help all Americans. On the other hand, Democrats conferred the image of a bunch of rich, greedy power mongers professing to help the poor and underprivileged. Bailout does a masterful job of making everyone look like carpetbaggers irrespective of party affiliation. Yea, Spiderman!

At the end of the Bush administration, Barofsky is certain that his biggest challenge is dealing with Henry Paulson (former head of Goldman Sachs and Treasury Secretary) and Neel Kashkari (another Goldman Sachs alumnus and assistant Treasury Secretary for financial stability). These guys used the good cop-bad cop strategy to thwart Spiderman. Once the Obama administration was sworn in, it became the new Treasury head Timothy Geithner et al. The picture here can be the source of real despair.

Throughout his tenure, Mr. Barofsky paints himself as the man who points out the risks and potential fraud that others blithely ignore. The one thing for which we all must give full credit is the scam the government foisted on the American taxpayer with TARP (and all of its brothers and cousins including CPP and HAMP). Congress funded TARP with $700 billion dollars to enable the US Treasury to acquire troubled real estate mortgages from banks and other financial institutions. With the expected help of private mortgage servicing companies, the government was to renegotiate with homeowners, thereby saving the homes and dignity of over 4 million Americans.

As we know, none of this ever happened. Tons of millions of dollars went pouring directly into bank coffers with no quid pro quo of any kind. The government programs that were created, according to Barofsky’s description, were so generous to the banks (and so risk heavy on taxpayers) that it was no miracle that banks overall were able to repay TARP loans with a generous profit and sometimes ahead of schedule.

It seems there are several flaws in the Spiderman saga. Firstly, the entire perspective is from that of a government auditor attempting to exert control (no matter how noble the intent) at a time of global financial crisis. As a former Wall Street banker and hedge fund manager, I view these regulatory gangsters as obstructionist in every sense. Barofsky, having no securities industry experience, did not have the slightest appreciation for the precarious nature of the world financial system in 2008.

His naiveté was clearly on display in 2009 when, after dispatching his researchers (Spiderettes) to seek the truth, Barofsky sends out a press release announcing that in a worst case scenario, the federal government of The United States of America (a.k.a. you and me) were on the hook for $23 Trillion dollars. Loosely translated, that amount is more than the output of the entire civilized world! Talk about using hyperbole to calm financial markets, this was a Spiderman Spectacular.

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At the outset, I came from the perspective that the middle class has all but disappeared and something had to be done. Democrats to the rescue! After seeing the Treasury Department under Geithner wistfully throw taxpayer dollars at banks with few, if any, strings attached, and with fewer than 75,000 homeowners actually helped by TARP, I owe homage to the Tea Party fanatics. Who needs a government that is not smarter than a 5th grader?

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Neil Barofsky

Though it is not Mr. Barofsky’s intent, the ultimate question is: how did the world financial system become so precariously balanced on the edge of disaster? The starting point goes back even before the Clinton administration and the finger pointing only gathers momentum from there. But that is not the most important point.

In my view, the real change in risk tolerance occurred with the repeal of the Glass-Steagall Act in 1999. Prior to that, commercial banks were barred from owning investment banks. One very major difference is that commercial banks were conservatively regulated in the amount of leverage they could apply to their balance sheets. The guiding principal was to match lending maturities with deposits in some range of mathematical formula. Theoretically speaking, if a bank had 100% of its deposits in checking accounts, it had to keep a maximum amount of cash on hand in the event of an emergency.

With investment banks, it was the Wild West. It was not unusual for investment banks like Bear Stearns and Lehman Brothers to maximize their leverage ratios up to 50:1, meaning for every $1 of collateral on hand they could borrow up to $50 for investment purposes. But unlike commercial banks, Bear Stearns and others were infatuated with the overnight repo market. Take a few of these guys and before you know it you are up to $10 billion in collateral! That will easily get you in hock up to half a TRILLION bucks. More than half the countries in the world are worth less than $500 billion.

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There are two glaring problems with this approach. First the very mortgage bonds that were the object of Bear Stearns’ investment affection were HIGHLY ILLIQUID. On the other hand, loans in the repo market had to be renewed-every night. Get the idea? When the repo lenders got wind of the declining prices of Bears Stearns’ bond portfolio, they turned off the lending spigot. After that, all heaven and hell broke loose.

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Had the Glass-Steagall Act remained in place, would there have been no financial crisis? That is impossible to say. But it is possible to say depositors and taxpayers should somehow be shielded from the leverage ratios of an investment bank (whether or not it’s owned by a commercial bank).

The second glaring problem that Mr. Barofsky does point out (much to his credit) was President Obama’s waffling on granting power to bankruptcy judges to reset mortgages. It does not even take a 5th grader to envision how this would have changed the course of history.

At the time TARP was launched, the cries of foul came from many who argued that giving special treatment to people who default on their mortgage would somehow incentivize every homeowner to stop paying their mortgage. If, however, to qualify for mortgage relief, a family had to file for bankruptcy, the argument becomes mute. Perhaps then TARP would have been more appropriately named Congress’ Reckless Appropriations Program or CRAP for short. And as loyal fans know, Spiderman does not take CRAP from anybody. Thanks, Neil, for a job done honestly.