[This review was published in the Fall 2012 issue of The Journal of Social, Political and Economic Studies,

pp. 367-375.]

Book Review Bailout: An Inside Account of How Washington Abandoned Main Street While Rescuing Wall Street Neil Barofsky Free Press, 2012 When asked what would you do if you were made a dictator?, the eminent Austrian economist Ludwig von Mises replied I would resign, a response fully in keeping with his libertarian bent. We might well think that our answer would be the same if asked that question. But before resigning, a reluctant dictator-designate would do well to issue at least one edict: that every intelligent member of the society read Neil Barofskys Bailout. If there is any one book that lucidly and engagingly tells the story of the U.S. governments response to the recent economic crisis and at the same time reveals the depths of American political and financial venality, it is Bailout. Without being a Washington insider, Barofsky has been ideally situated to give an inside account of the massive bailout that began with the enactment of TARP (the Troubled Asset Relief Program) in late 2008. He was named by President George W. Bush, and confirmed by the U. S. Senate, to be the Special Inspector General of TARP (thus, the acronym SIGTARP), and continued in that capacity under President Barack Obama. In all, he served as the inspector general from December 15, 2008 to March 31, 2011. While formally on the organization chart of the U.S. Treasury Department, Barofsky was intended to be, and was, an independent watchdog. As the book makes clear, his independence consisted of a tenacious refusal to be anyones lapdog. Before he was appointed, he was a tough-minded prosecutor in the U.S. Attorneys office for the Southern District of New York, among other things going after the vicious narco-terrorist FARC (Revolutionary Armed Forces) cartel in Colombia before proceeding to a major accounting fraud prosecution. One would hardly have expected President Bush, a Republican, to name Barofsky the SIGTARP, since Barofsky is a Democrat and had just contributed to the 2008 Obama campaign. (It is worth noticing this, because the book is nonpartisan in its scathing criticism of both administrations coziness with Big Money and ham-handed administration of public business.) Even without counting the billions in American stimulus spending and voluminous quantitative easing by the U. S. central bank, the financial bailout has indeed been massive. U.S. government commitments have amounted to an amazing $23.7 trillion dollars (although Barofsky is quick to explain that a commitment is different from an actual pay-out, which came to what we might call a mere $4.7 trillion dollars before repayments reduced the sum to $3 trillion). Certain truisms come to mind: that programs of such size almost inherently rule out careful administration; and that gigantic piles of cash (called Whales by those in the know) will inevitably serve as powerful magnets attracting extraordinary cupidity. (Along these lines, but citing an instance in a totally different connection, Barofsky refers to the pervasive fraud in the Iraqi reconstruction effort.) When the monetarist economist Milton Friedman was asked what he would do to stop a depression, he joked that he would get a helicopter and simply drop cash on the society. That pretty well characterizes the response of the Bush/Obama administrations to the financial crisis. What Barofsky describes is amazing a blunderbuss approach with little supervision or caring about supervising, and much corruption, both legal and illegal.

For most of us, the conundrum throughout the crisis has been: How can we possibly know all that has been going on, both in detail and in broad overview? In short compass, Barofskys book supplies that need. He was centrally situated to witness the events as they unfolded and to have the information we all wish we had. Moreover, his independent mentality and outspoken tenacity make him the ideal observer. A cravenly observer whose reporting was skewed by partisan bias or who would shrink from the truth out of concern for his career would produce a book of little value. This makes Bailout a gem much to be valued. As it turned out, TARP and its add-ons had many facets. Its declared purpose at the time Congress approved it was to buy up the toxic mortgages, and the bonds based on them, that were so befouling the balance sheets of banks and other investors after the collapse of the housing market. Doing so would have put the U. S. Treasury Department in a position to modify the mortgage loans, saving a great many homeowners from foreclosure. The Secretary of the Treasury during the final months of the Bush administration was Henry Paulson, who, reacting to the immediacy of the financial crisis, quite soon changed TARPs direction, shifting it from toxic mortgage purchases to direct injection of money into banks through the purchase of the banks preferred stock. This was called the Capital Purchase Program (CPP). After Barack Obama was sworn in as U.S. President on January 20, 2009, his Secretary of the Treasury was Timothy Geithner, and Geithner renamed TARP the Financial Stability Plan (FSP). He immediately launched four new initiatives amounting to some $3 trillion (which Barofsky observes was larger than the entire federal budget) . One of these, known as the Public-Private Investment Program (PPIP), involved the use of money from the Treasury, the U.S. Federal Reserve, and the FDIC (Federal Deposit Insurance Corporation) to buy up to two trillion dollars worth of legacy assets (i.e., securities that were on the books of banks and had lost much of their original value). This, of course, was a return to the purchase of toxic assets. Other components of the bailout included the pumping of money into the consumer credit market through TALF (the Term Asset-Backed Securities Loan Facility). The Federal Reserve Bank of New York would provide up to $200 billion in cheap loans to hedge funds, financial institutions, and other qualified investors to buy bonds that had been generated from pools of car loans, student loans, credit card debt, or small-business loans. And there was the auto bailout, under which Treasury committed $49.5 billion of TARP funds to General Motors and $14.9 billion to Chrysler, with the government receiving 60 percent ownership of General Motors. In addition, there was a mortgage-modification program known as HAMP (Home Affordable Mortgage Plan), funded by $50 billion from TARP and $25 billion more from the quasi-federal housing agencies Freddie Mac and Fannie Mae. It is easy to get lost in all of this, and it becomes a little confusing for a reader because Barofsky isnt writing a textbook explaining each program so much as he is telling a personal narrative of his dayto-day experiences in confronting what became a hydra-headed giant. The narrative focuses mainly on the sorts of failings and susceptibilities to fraud that an inspector general would be most charged with seeing. It is here that we find the reasons for the books subtitle: An Inside Account of How Washington Abandoned Main Street While Rescuing Wall Street. In sum, Barofsky says that TARP was little more than a massive transfer of wealth from taxpayers to undeserving Wall Street executives. Although in this review we can only scratch the surface of the books content, here are some of the failings Barofsky came upon: In the Capital Purchase Program, the contracts that the banks had to enter into with the government failed to include terms that would provide incentives to increase lending, with the result that the banks were telling the press they were using their taxpayer-supplied funds for just about everything other than the increased lending that had been Treasurys justification for CPP. Nor did the banks have to account for how they used the money, with Treasury officials having what Barofsky considered spurious reasons to justify why the banks couldnt do so. The contracts did put some restrictions on the banks, such as on their executive compensation, but Treasury had neither the manpower nor much inclination to monitor the TARP recipients compliance. The banks came out

exceedingly well: they were paid 100 percent of the value of AIGs $62 billion obligation to them under collateralized debt obligations (CDOs); and Barofsky tells of the tens of billions of dollars that were lost by agreeing to allow the banks to keep all of AIGs collateral. From all this, we can see why Barofsky says the bailout of AIG was more a bailout of the banks than it was of AIG itself. When AIG (American International Group, Inc.) received Treasury authorization to pay $168 billion in retention bonuses to employees in its Financial Products division (the very unit whose reckless bets had brought down the company), the TARP team didnt seem to begrudge the AIG executives the bonuses at all and even showed no shame in pushing for ever-higher salary awards. Barofsky favored the auto bailout, which most Republicans opposed, but he nevertheless became a nightmare for prevaricators about it when he revealed a deception concerning it. In April 2010, GM announced that it would soon be paying back a multibillion-dollar TARP loan. Barofsky, however, testified to Congress that GM would be paying back that loan with other money it had received from TARP. As I explained, a good portion of the total $49.5 billion that Treasury had provided GM had been placed in an escrow account and the repayment was being made out of that account. Just the same, the payment was made the next day to loud cheers from Treasury and the White House. Vice President Biden cited it as a huge accomplishment, and [Sec. of the Treasury] Geithner issued a statement trumpeting the repayment. The result was that this use of spin and selective disclosure became a public relations disaster that hurt the governments credibility. Some of Barofskys most scathing criticisms come with regard to how the home mortgage modification program was mishandled. In late 2008, Americans felt great urgency to rescue the economy from imminent collapse, and one would have expected quick action. This didnt materialize in the stimulus spending effort, with projects spread over several years; and neither did it materialize in rescuing the homeowners. Barofsky says that by the end of 2011, Treasury had spent only $3 billion of the $50 billion originally allocated to HAMP. In other words, nearly three full years after HAMP was launched, home owners across the country had benefited relatively little. Speaking more broadly than just about mortgage modification, he tells us that there were hundreds of billions of untapped TARP funds still available in 2010. The HAMP program was set up with little regard to competent administration. The mortgage modification was done through a multitude of servicers, who performed abysmally: they routinely lost or misplaced borrowers documents Borrowers routinely complained that theyd had to send their documents to their servicers multiple times but the servicers would still claim that the documents had never been received and then foreclose. This may well have been because the incentives were perverse: it could be more profitable for a servicer to drag out trial modifications and eventually foreclose. This was because they earn profits from fees, particularly late fees. Readers will find this part of the book especially fascinating as Barofsky goes on to tell of other abuses, including one particularly pernicious type, and illustrates the disaster by spelling out in detail the nightmare experienced by one homeowner in California. The public face put on this debacle by the White House and Geithners Treasury Department illustrates well the disconnect between public presentation and reality. President Obama announced that the program would enable as many as 3 to 4 million homeowners to modify the terms of their mortgages to avoid foreclosure, and the Treasurys website described HAMP as a $75 billion loan modification program to help up to 4 million families avoid foreclosure. By comparison, Barofsky reports that by the time he stepped out of the SIGTARP position on March 31, 2012, there were fewer than 800,000 ongoing permanent modifications, a number that was growing at a glacial pace. Wanting to report progress, the Treasury put pressure on the mortgage servicers over the summer of 2009 to goose their numbers through hundreds of thousands of unverified verbal trial modifications. Barofsky speaks of a parlor trick when Treasury made the absurd claim to us that the program had never been intended to help the 3 to 4 million home owners Instead [we were told] the goal had always been to make 3 to 4 million offers for trial modifications [his emphasis].

As this reviewer read Bailout, he found particularly interesting the variety of sophistries that were employed to paper-over what was being done. Heres one: A key tactic is to argue that issues related to high finance are so hopelessly complex that it is nearly impossible for mere mortals to understand the unintended consequences of the legislation [that was proposed to regulate the banks]. Those arguments were advanced when Wall Street convinced Congress to prevent derivatives from being regulated, and they were repeated in the debates over financial regulatory reform. Another: It was said that the bonuses to AIG employees were to be made because the recipients were essential personnel necessary to wind down AIGs complex transactions. Barofsky says this explanation didnt quite wash when he found out that every single employee at the Financial Products group seemed to have received some payment, including $7,700 to a kitchen assistant, $700 to a file administrator, and $7,000 to a mail room assistant. Yet another: When Barofsky raised concerns that Treasury had all but ignored taxpayerprotecting anti-fraud provisions in TARP, their response was always the same: the big banks and the investment firms would never risk their reputations by trying to rip off the government. Barofsky scoffs at this: I always responded by noting that the events of the past two years had proven that the banks seemed willing to put profit over just about everything, particularly their reputations. The mentality that Barofsky ran into was set by the revolving-door interchange between Wall Street (most notably Goldman Sachs) and the government. As he dealt with the Treasury Department, almost all of the people we were dealing with came from the same Wall Street banks. President George W. Bushs Secretary of the Treasury, Henry Paulson, had been the chief executive officer of Goldman Sachs. The first TARP czar, Neel Kashkari, was a former Goldman Sachs vice president. William Dudley, the acting president of the New York Federal Reserve Bank, had been chief economist at Goldman Sachs. After Timothy Geithner became President Obamas Secretary of the Treasury, his chief of staff, Mark Patterson, was a former Goldman Sachs lobbyist. These are just a few examples, but they amply illustrate Barofskys point that the revolving door between Treasury and the giant investment funds and banks just never stops spinning. We see the inevitable consequences in a passage where Barofsky discusses the enormous cash bonuses paid to bank executives and speaks of the Wall Street fiction that certain financial executives were preternaturally gifted supermen. It isnt surprising that he discovered that that belief system endured at Treasury across administrations [our emphasis]. This interplay critically damages the performance of governmental functions. Barofsky says regulators often lacked the political will to successfully regulate the largest banks Through massive campaign contributions, relentless lobbying, and multimillion-dollar payouts awaiting government officials who join Wall Street firms, no legislation can confer the necessary fortitude upon the regulators. For a society that prides itself on being a democracy and not a plutocracy, this suggests a systemic problem thoroughly at odds with its self-image. It would be nice to think that all of this describes the situation as it has been in the past, even the recent past, but surely the problems are being corrected and things will be better in the future. But Bailout shatters this illusion. Going into the future, things are worse, not better. Barofsky believes there is no workable solution so long as the financial institutions are allowed to be so large as to be dangers to the system as a whole, relying on the government to rescue them from future crises. Instead of cutting them down to size,1 what happened was that by encouraging the largest banks to acquire one another, they had made the too-large-to-fail banks even bigger. The prospect: As long as there are financial institutions of such size and with so many interconnections, future massive crises and bailouts are all but inevitable. Despite the Dodd-Frank Acts2 intention of instituting a comprehensive system of
1

A proposal, known as the Brown-Kaufman amendment to the Dodd-Frank Act, would have forced the handful of largest banks to slim down to manageable levels. But this, opposed by Secretary of the Treasury Geithner, was defeated. Barofsky says the result was that Dodd-Frank gave the regulators a scalpel and directed them to attempt to carve up the power of the largest banks through an enhanced and mind-numbingly complex 848-page-long regulation regime. 2 Signed into law in July 2010.

financial regulation, the executives of those institutions still enjoyed all of the short-term profits and benefits of taking outsized risks backstopped by the government. The credit rating agencies continue putting their imprimatur on the system: they continue to give the major banks higher credit ratings based on the assumption that they will once again be bailed out. So far as the Dodd-Frank regulations are concerned, the banks have been hard at work gaming and watering down to rules. Here again we see the disconnect between appearance and reality: Even basic steps have lagged, with two-thirds of Dodd-Franks rule-making deadlines already blown by May 1, 2012 [almost two years after the Act became law]. Bailout is both profoundly discouraging and exhilarating. The exhilaration is that that comes from confronting truth, and is experienced by those (such as, we might hope, the readers of this journal) who hold truth in high esteem. The discouragement lies in the reality Barofsky has described. The crisis is not just that of a passing economic downturn, but of a society in which hubris and character flaws are destroying the economic, political and social fabric. Barofsky concludes his book with a final word: I now realize that the American people should lose faith in their government. They should deplore the captured politicians and regulators They should be revolted by a financial system that rewards failure and protects the fortunes of those who drove the system to the point of collapse and will undoubtedly do so again. They should be enraged by the broken promises to Main Street and the unending protection of Wall Street. Because only with this appropriate and justified rage can we sow the seeds for the types of reform that will one day break our system free from the corrupting grasp of the megabanks. It is my own anger that compelled me to write this book. [his emphasis] Dwight D. Murphey