Barofsky: We Are Headed for a Cliff Because of Housing

Editor’s Note: Hera research conducted an interview with Neil Barofsky that I think should be  read in its entirety but here the the parts that I thought were important. The After Words are from Hera.

After Words

According to Neil Barofsky, another financial crisis is all but inevitable and the cost will be even higher than the 2008 financial crisis. Based on the way that the TARP and HAMP programs were implemented, and on the watering down of the Dodd-Frank bill, it appears that big banks are calling the shots in Washington D.C. The Dodd-Frank bill left risk concentrated in a few large institutions while doing nothing to remove perverse incentives that encourage risk taking while shielding bank executives from accountability. Neither of the two main U.S. political parties or presidential candidates are willing to break up “too big to fail” banks, despite the gravity of the problem. The assumption that another financial crisis can be prevented when the causes of the 2008 crisis remain in place, or have become worse, is unrealistic. In the mean time, what Mr. Barofsky describes as a “parade of scandals” involving highly unethical and likely criminal behavior is set to continue unabated. Although the timing and specific areas of risk are not yet known, there is no doubt that U.S. taxpayers will be stuck with another multi-trillion dollar bill when the next crisis hits.

*Post courtesy of Hera Research. Hera Research focuses on value investing in natural resources based on original geopolitical, macroeconomic and financial market analysis related to global supply and demand and competition for natural resources

Excerpts from Interview:

HR: Did the TARP help to restore confidence in U.S. institutions and financial markets?

Neil Barofsky: Yes, but it was intended and required by Congress to do much more than that and Treasury said that it was going to deploy the money into banks to increase lending, which it never did.

HR: Were the initial goals of the TARP realistic?

Neil Barofsky: First, if the goals were unachievable, Treasury officials should never have promised to undertake them as part of the bargain. Second, even if the goals were not entirely achievable, it would have been worth trying. Treasury officials didn’t even try to meet the goals.

HR: Can you give a specific example?

Neil Barofsky: The justification for putting money into banks was that it was going to increase lending. Having used that justification, there was an obligation, in my view, to take policy steps to achieve that goal, but Treasury officials didn’t even try to do it. The way it was implemented, there were no conditions or incentives to increase lending.

HR: What policy steps could the U.S. Department of the Treasury have taken to help the economy?

Neil Barofsky: There are all sorts of things that Treasury could have done. For example, they could have reduced the dividend rate—the amount of money that the banks had to pay in exchange for being bailed out—for lending over a baseline, which would have decreased the bank’s obligations. Or, they could have insisted on greater transparency so that banks had to disclose what they were doing with the funds. Treasury chose not to do any of these things.

HR: Weren’t there other housing programs like the Home Affordable Modification Program (HAMP)?

Neil Barofsky: Yes, but there were choices made to help the balance sheets of struggling banks rather than homeowners. The HAMP program was a massive failure but it wasn’t preordained. It was the result of choices made by Treasury officials.

HR: What could have been done differently in the HAMP?

Neil Barofsky: HAMP was deeply flawed with conflicts of interest baked into the program. The management of the program was outsourced to the mortgage servicers, which were thoroughly unprepared and ill equipped. The program encouraged servicers to extend out trial modifications. It was supposed to be a three month period but it often turned into more than a year. The servicers, because they could accumulate late fees for each month during the trial period, were incentivized to string the trial periods out then pull the rug out from under the homeowner, putting them into foreclosure, without granting a permanent mortgage modification. The servicers could make more money doing that then by doing mortgage modifications. If they had done permanent mortgage modifications, the banks couldn’t have kept the late fees.

HR: Are you saying that the program encouraged banks to extract as much cash as possible from homeowners before foreclosing on them anyway?

Neil Barofsky: Yes. The mortgage servicers exploited the conflicts of interest that were in the program, and blatantly broke the rules, and Treasury did nothing.

HR: When you were serving as Inspector General for TARP, you issued a report indicating that government commitments totaled $23.7 trillion. What was that about?

Neil Barofsky: $23.7 trillion was simply the sum of the maximum commitments for all the financial programs related to the financial crisis. The number was misconstrued as a liability but the government never stood to lose that much. For example, the government guarantee of money market funds was a multi-trillion dollar commitment. Of course, not all of that money could have been lost because it would have required every fund to go to zero. The government guaranteed commercial paper but, again, for that commitment to have been wiped out, every company would have had to have defaulted. But the numbers were very important in terms of transparency. All of the data were provided by the agencies responsible for the various programs, so the $23.7 trillion number was simple arithmetic. It was important to understand the scope of the extraordinary actions that were being taken.

HR: What are the potential future losses that the U.S. government—that taxpayers—might have to absorb?

Neil Barofsky: The real issue is the potential for another financial crisis because we haven’t fixed the core problems of our financial system. We still have banks that are “too big to fail.” Standard & Poor’s estimated last year that the up-front cost of another crisis, including bailing out the biggest banks yet again, would be roughly 1/3 of the U.S. gross domestic product (GDP) or about $5 trillion. The resulting problems will be even bigger.

HR: What were the problems resulting from the 2008 financial crisis?

Neil Barofsky: When you look at the fiscal impact of the 2008 crisis, you have to look at it not only in terms of lost tax revenues and increased government debt, but also in terms of the loss of household wealth. People who became unemployed suffered tremendous losses and the government’s social benefit costs expanded accordingly. One of the reasons we had the debt ceiling debate last year, when the U.S. credit rating was downgraded, and why we are facing a fiscal cliff ahead is the legacy of the 2008 crisis.

We have a lot less dry powder to deal with a new crisis and we almost certainly will have one.

HR: Why do you expect another financial crisis?

Neil Barofsky: It just comes down to incentives. A normally functioning free market disciplines businesses. The presumption of bailout for “too big to fail” institutions changes the incentives of a normally functioning free market. In a free market, if an institution loads up on risky assets with too little capital standing behind them, it will be punished by the market. Institutions will refuse to lend them money without extracting a significant penalty. Counterparties will be wary of doing business with companies that have too much risk and too little capital. Allowing “too big to fail” institutions to exist removes that discipline. The presumption is that the government will stand in and make the obligations whole even if the bank blows up. That basic perversion of the free market incentivizes additional risk.

HR: Are “too big to fail” banks taking more risks today than they did before?

Neil Barofsky: Bailouts give bank executives an incentive to max out short term profits and get huge bonuses, because if the bank blows up, taxpayers will pick up the tab. The presumption of bailout increases systemic risk by taking away the incentives of creditors and counterparties to do their jobs by imposing market discipline and by incentivizing banks to act in ways that make a bailout more likely to occur.

HR: Is it just a matter of the size of banking institutions?

Neil Barofsky: The big banks are 20-25% bigger now than they were before the crisis. The “too big to fail” banks are also too big to manage effectively. They’ve become Frankenstein monsters. Even the most gifted executives can’t manage all of the risks, which increases the likelihood of a future bailout.

HR: Since bank executives are accountable to their shareholders, won’t they regulate themselves?

Neil Barofsky: The big banks are not just “too big to fail,” they’re ‘too big to jail.’ We’ve seen zero criminal cases arising out of the financial crisis. The reality is that these large institutions can’t be threatened with indictment because if they were taken down by criminal charges, they would bring the entire financial system down with them. There is a similar danger with respect to their top executives, so they won’t be indited in a federal criminal case almost no matter what they do. The presumption of bailout thus removes for the executives the disincentive in pushing the ethical envelope. If people know they won’t be held accountable, that too will encourage more risk taking in the drive towards profits.

HR: So, it’s just a matter of time before there’s another crisis?

Neil Barofsky: Yes. The same incentives that led to the 2008 crisis are still in place today and in many ways the situation is worse. We have a financial system that concentrates risk in just a handful of large institutions, incentivizes them to take risks, guarantees that they will never be allowed to fail and ensures that the executives will never be held accountable for their actions. We shouldn’t be surprised when there’s another massive financial crisis and another massive bailout. It would be naïve to expect a different result.

HR: Didn’t the Dodd-Frank bill fix the financial system?

Neil Barofsky: Nothing has been done to remove the presumption of bailout, which is as damaging as the actual bailout. Perception becomes reality. It’s perception that ensures that counterparties and creditors will not perform proper due diligence and it’s perception that encourages them to continue doing business with firms that have too much risk and inadequate capital. It’s perception of bailout that drives executives to take more and more risk. Nothing has been done to address this. The initial policy response by Treasury Secretaries Paulson and Geithner, and by Federal Reserve Chairman Bernanke, was to consolidate the industry further, which has only made the problems worse.

HR: The Dodd-Frank bill contains 2,300 pages of new regulations. Isn’t that enough?

Neil Barofsky: There are tools within Dodd-Frank that could help regulators, but we need to go beyond it. The parade of recent scandals and the fact that big banks are pushing the ethical and judicial envelopes further than ever before makes it clear that Dodd-Frank has done nothing, from a regulatory standpoint, to prevent highly unethical and likely criminal behavior.

HR: Is the Dodd-Frank bill a failure?

Neil Barofsky: The whole point of Dodd-Frank was to end the era of “too big to fail” banks. It’s fairly obvious that it hasn’t done that. In that sense, it has been a failure. Dodd-Frank probably has been helpful in the short term because it increased capital ratios, although not nearly enough. If we ever get over the counter (OTC) derivatives under control, that would be a good thing and Dodd-Frank takes some initial steps in that direction. I think that the Consumer Financial Protection Bureau is a good thing.

Nonetheless, the financial system is largely in the hands of the same executives, who have become more powerful, while the banks themselves are bigger and more dangerous to the economy than before.

HR: How are OTC derivatives related to the risk of a new financial crisis?

Neil Barofsky: Credit default swaps (CDS) were specifically what brought down AIG, and synthetic CDOs, which are entirely dependent on derivatives contracts, contributed significantly to the financial crisis. When you look at the mind numbing notional values of OTC derivatives, which are in the hundreds of trillions, the taxpayer is basically standing behind the institutions participating in these very opaque and, potentially, very dangerous markets. OTC derivatives could be where the risks come from in the next financial crisis.

HR: Can anything be done to prevent another financial crisis?

Neil Barofsky: We have to get beyond having institutions, any one of which can bring down the financial system. For example, Wells Fargo alone does 1/3rd of all mortgage originations. Nothing can ever happen to Wells Fargo because it could bring down the entire economy. We need to break up the “too big to fail” banks. We have to make them small enough to fail so that the free market can take over again.

HR: Does the political will exist to break up the largest banks?

Neil Barofsky: The center of neither party is committed to breaking up “too big to fail” banks. Of course, pretending that Dodd-Frank solved all our problems, as some Democrats do, or simply saying that big banks won’t be bailed out again, as some Republicans have suggested, is unrealistic. Congress needs to proactively break up the “too big to fail” banks through legislation. Whether that’s through a modified form of Glass-Steagall, size or liability caps, leverage caps or remarkably higher capital ratios, all of which are good ideas, we need to take on the largest banks.

HR: Do you think the U.S. presidential election will change anything?

Neil Barofsky: No. There’s very little daylight between Romney and Obama on the crucial issue of “too big to fail” banks. Romney recently said, basically, that he thinks big banks are great and the Obama Administration fought against efforts to break up “too big to fail” banks in the Dodd-Frank bill. Geithner, serving the Obama White House, lobbied against the Brown-Kaufman Act, which would have broken up the “too big to fail” banks.

HR: What will it take for U.S. lawmakers to finally take on the largest banks?

Neil Barofsky: Some candidates have made reforms like reinstating Glass-Steagall part of their campaigns but the size and power of the largest banks in terms of lobbying campaign contributions is incredible. It may well take another financial crisis before we deal with this.

HR: Thank you for your time today.

Neil Barofsky: It was my pleasure.

3 Responses

  1. TARP was a way for the banks to collect property tax or fee money while they were fraudclosing all along. Obama never had any intention of helping homeowners. He has been playing the good guy routine all along and he makes me sick. I am sure TARP was figured in this evil plan years ago. The Government could never implement a program of that size out of no where. THE POLITICIANS ARE THE INVESTORS……THEY ARE WORKING FOR THE CONTROL FREAKS…..THE RICH… and the POLITICIANS ARE THE EXTEND & PRETEND LIARS. They thought we were too stupid to ever figure out it has been the POLITICIANS who have been CALLING THE SHOTS ALL ALONG…NOT THE BANKS …. IN FRAUDCLOSURE COURT it is the judges who are allowing OBVIOUS FRAUD UPON THE COURT……THE FED BANKS ARE INSOLVENT OR THEY ARE NOT…THEY CANNOT BE BOTH….IF THEY ARE INSOLVENT….THEY HOLD NO ASSETS…..YOU CAN’T BE INSOLVENT & WEALTHY….IF THEY ARE NOT INSOLVENT….THESE POLITICIANS SHOULD BE HELD TO ACCOUNT….TAKE THE MONEY OUT AMERICA UNTIL THE SLEAZE BAG POLITICIANS AUDIT THE BANKS..! EITHER WAY, THE POLITICIANS ARE ABSOLUTE SLEAZE BAG CRIMINALS. OBAMA IS AN IMPOSTER & AN OBVIOUS LIAR…. Romney is a FAT CAT MANIPULATOR… Romney is a BRAINWASHER for saying that 47% of the American people want everything for FREE…….THESE ARE NOT ENTITLEMENT PROGRAMS…THESE PEOPLE ALREADY PAID FOR THEM….!!! THE POLITICIANS LIKE ROMNEY AND THEIR CRONIES ON WALL STREET STOLE IT ALL..! This 47% ARE NOT SOCIALISTS WHO WANT TOTALITARIANISM ….THEY ALREADY PAID FOR EVERYTHING….! I WOULD LIKE TO SEE THE POLITICIANS STRIPPED OF ALL THEIR WEALTH…BECAUSE THE POLITICIANS CAUSED THIS…NOT THE PEOPLE…THE POLITICIANS ARE WHO LITERALLY ROBBED THE PEOPLES TRUST.. THEY ARE THE BAD GUYS…IMPOSTERS….WOLVES IN SHEEPS CLOTHING. Romney has revealed he is a jerk, however Obama is a sneak.

  2. “it appears that big banks are calling the shots in Washington D.C. The Dodd-Frank bill left risk concentrated in a few large institutions while doing nothing to remove perverse incentives that encourage risk taking while shielding bank executives from accountability. Neither of the two main U.S. political parties or presidential candidates are willing to break up “too big to fail” banks, despite the gravity of the problem.”

    Senate Banking Committeee staffers etc were stating this in summer 2010. There was really little pretense. The bankers were booking their time solid so you had to slip in on friday afternoons after the lobbyists left for their 3 day summer weekends

  3. Well, aren’t banks pushing to do away with the judicial process as we speak? I don’t think we’ll see Jeff Barnes’ dream come to life any time soon… Especially with people sitting in their homes, oblivious to the war being waged against them…

    UPDATE AS TO FORECLOSURE PROCESS IN HAWAII; WHY THE NON-JUDICIAL FORECLOSURE PROCESS SHOULD BE ABROGATED

    September 19, 2012

    Those who have followed recent foreclosure history in Hawai’i know of the prior enactment of what is known as “Act 48″, which mandated that foreclosures be instituted judicially. This legislation was a reaction to the rampant fraud and irregularities filed in non-judicial foreclosures. Although Act 48 technically expired in July of 2012, the present non-judicial foreclosure statute requires that before the institution of a non-judicial foreclosure, the foreclosing party must apply to the Department of Commerce and Consumer Affaird (DCCA) of the State of Hawai’i and pay a fee for permission to file a nonjudicial foreclosure. Part of this process requires proof that there was a face-to-face meeting with the homeowner in an attempt to resolve the claim, and that all alternatives to foreclosure (e.g. loan modification) were discussed during a Dispute Resolution Program.

    If the meeting was held and there was no resolution, the homeowner can convert any non-judicial foreclosure to a judicial foreclosure. Given that protection, there have been almost no non-judicial foreclosure filings, with the foreclosing parties simply electing to institute judicial foreclosures.

    Further, Act 182, which became effective June 28, 2012 (and is retroactive), requires a personal Affirmation from an attorney in the form of an Affidavit that the attorneys signs that he personally reviewed the documents which grant standing upon his client in any judicial foreclosure action. The Affidavit, which must be filed in all judicial foreclosures before or at the summary judgment stage, is subject to the following statutory language:

    During and after August 2010, numerous and widespread insufficiencies in foreclosure filings in various courts around the nation were reported by major mortgage lenders and other authorities, including failure to review documents and files to establish standing and other foreclosure requisites; filing of notarized affidavits that falsely attest to such review and to other critical facts in the foreclosure process, and “robosignature” of documents. Based upon my communication with (employee of the bank), as well as upon my own inspection and other reasonable inquiry under the circumstances, I affirm that, to the best of my knowledge, information, and belief, the Summons, Complaint, and other papers filed or submitted to the Court in this matter contain no false statements of fact or law and that plaintiff has the legal standing to bring this foreclosure action. I understand my continuing obligation to amend this Affirmation in light of newly discovered material facts following its filing. I am aware of my obligations under the Hawaii Rules of Processional Conduct.

    New Jersey enacted similar amendments to its judicial foreclosure processes last year (which were reported on this website) which require the filing of a Certification (a type of Affidavit) that the attorney personally spoke to an identified person who is a representative of the foreclosing Plaintiff as to the accuracy of the information in the foreclosure Complaint, etc. Now that Courts from NJ and HI are apparently thinking the same way, we hope this will spread to all jurisdictions between these two.

    Judicial foreclosures are inherently fairer and afford the proper due process. The non-judicial procedure essentially presumes that a homeowner is guilty from the getgo, and the homeowner has to (a) file an action in court with supporting Affidavit; (b) seek as Temporary Restraining Order against a foreclosure sale; (c) obtain a Preliminary Injunction prohibiting any sale during the pendancy of the foreclosure challenge; and, in certain instances (d) post a bond in order to obtain this protection. Thus, not only does the homeowner have to undertake significant legal proceedings in order to be afforded the right to assert defenses, but has to pay significant sums of money to exercise their rights as well.

    The judicial process, alternatively (and correctly) requires the foreclosing party to prove its case first, just as all other types of civil cases do, before relief can be obtained. In a judicial foreclosure, there can be no sale date until the case results in a Final Judgment in favor of the foreclosing party, and there is no bond requirement to stop any sale during the litigation, as the property cannot be sold unless and until the foreclosing party proves that it has the right to do so. During the litigation, the homeowner also has the benefit of the discovery process.

    From litigating foreclosure cases across the United States since 2008, it has become abundantly clear to us that the nonjudicial foreclosure process should be abandoned and abrogated, as it is essentially unconstitutional. By forcing a homeowner to pay for the right to defend themselves, and forcing them to engage in a costly and intensive legal proceeding just to halt the sale of their home when the foreclosing party does not even have to prove that it has the right to foreclose, the process denies numerous fundamental rights, and utilizes a procedure which is not used in any other type of civil litigation. There is no justifiable reason why a foreclosing party, who is seeking to take someone’s home away, should not be forced to prove their case first, and rather to have the ability to foreclosure simply by filing a few pieces of paper in the public records (a Notice of Default, Notice of Substitution of Trustee, and Notice of Sale) without any of these documents ever being tested for validity, unless of course the homeowner goes through the expense of filing a lawsuit and forcing the issues.

    It is obvious that the non-judicial system had bred corruption, the perpetration of fraudulent documents, and the rampant stealing of homes without any court scrutiny. Enough is enough. The non-judicial foreclosure process has no place in the current mortgage market, which is rife with resales, multiple assignments, securitizations, and the like. The non-judicial process is a dinosaur, and should be declared extinct accordingly.

    Jeff Barnes, Esq., http://www.ForeclosureDefenseNationwide.com

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