Neil Barofsky speaks at this year's Economic Summit at the Granada Theater

Paul Wellman

Neil Barofsky speaks at this year's Economic Summit at the Granada Theater

Bailout Blues at 2013 Economic Summit

Economy Showing Signs of Growth but at the Cost of Moral Hazard?

Thursday, May 2, 2013
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“Too big to fail in 2008 has become too big to jail in 2013,” said Neil Barofsky, former inspector general of the Troubled Asset Relief Program (TARP), this Thursday, remarking that nobody from the financial sector has been prosecuted for actions that led to the Wall Street meltdown of 2008 because the Department of Justice feared such enforcement would upset the global banking industry.

The ostensible headliner at this year’s Santa Barbara County Economic Summit held at the Granada Theatre, Barofsky was actually the first speaker to take the stage, and he did so with a no-holds-barred takedown of what he described as an anemic banking regulation system. By speaking first, Barofsky set the tone of the event where he was followed by NYU economics professor Thomas Cooley and Douglas Elliott, a fellow at the Brookings Institution. In a brief round table discussion between them and UCSB Economic Forecast Project director Peter Rupert, the conversation focused on the social cost of regulation as much as it did on the economic cost.

Barofsky’s front-row view of the Treasury Department did not leave him impressed, nor did it leave them too pleased with their moralizing auditor. When Barofsky accused the department of opacity, Timothy Geithner, he said, yelled at him for “daring to suggest that he was anything but the single most effing transparent Treasury Secretary in the nation’s history,” and, added Barofsky, “he didn’t use the word ‘eff.’

Geithner also didn’t follow through on the TARP’s original mission, which was to buy up bad securities. Instead he infused banks — including those guilty of causing “the financial equivalent of 9/11,” in the words of one of Barofsky’s former bosses — with cold hard cash. Officers kept their obscene bonuses, homeowners never got the help they were promised, and the the government “doubled down” on a perverse financial system that incentivizes risky behavior, Barofsky said.

The regulatory system, he went on, needs just as much reform as the banks. That’s because regulators often come from the industry and think like bankers. And they accrue personal success by not making waves. When Barofsky went out for a drink with Herb Allison, the Treasury official who headed TARP, he claimed Allison told him that he could recuperate his chances for a plum political appointment. “All you need to do is change your tone, be a little more upbeat,” Barofsky said Allison told him.

Barofsky, who once prosecuted drug cartels, thought that he was being threatened with the tactics Pablo Escobar would use to corrupt government officials — by offering a giant bag of gold or a bullet in the head. He has since decided that Allison, who understood how the “go along to get along” culture of Washington works, was simply offering advice. If anything is to change, “aggressive regulation” needs to be incentivized, said Barofsky, who has written a book, Bailout, about his experience.

While Barofsky ended his talk by saying we could be on the precipice of another financial collapse, professor Thomas Cooley said his talk would be even more pessimistic. Cooley opined that the European banking system is four times as risky as the U.S. system. In contrasting the two systems, he said the U.S. benefits from a common fiscal policy, financial burden-sharing, labor market mobility, and uniform deposit insurance.

As an aside, he did point out that the most risk-laden institutions are those that benefited most from the bailouts: Bank of America, J.P. Morgan Chase, Citigroup, Metlife, Prudential Financial, Morgan Stanley, and Goldman Sachs. Forcing banks to raise capital would be a smart regulatory means to avoiding future crises, he said.

Douglas Elliott of the Brookings Institution was both more bullish on the economy and less strident on the need for regulation. “I hear too many people … speak as if we have accomplished nothing because we have not accomplished everything,” he said, adding that the Dodd-Frank Act provided the basic protections necessary for the banking sector (although he “hates” the Volcker Rule). “Much of what happened after the crisis,” he said “would have happened even if regulators stayed home.”

Furthermore, he said “too big to fail” was, at most, 10 percent of the problem, pointing out that without huge banks there would still have been bad mortgages, high risk, and negligent ratings agencies. And he disagreed with Elliott about the imminent dangers of a Eurozone collapse. “I’m not trying to be a Pollyanna here, but I don’t think they’re going to implode,” he said.

Back here in Santa Barbara, Peter Rupert said, things are getting better, slowly. There has been zero job growth in government, the county’s largest sector. But overall, employment is growing and home sales are up. Income, however, lags inflation.

Long-term, he said he remains ruddy as the GDP in the region has grown steadily since 1929 despite blips during the Great Depression and World War II. Pointing at a graph of the logarithm for GDP, he said, “Democrats, Republicans, whatever, it grows like that. So I’m optimistic”

He did warn about a “hollowing out” of the middle class, though, as income over the last few years has grown most for the richest. In discussion afterward, Barofsky echoed the sentiment and restated that the top one percent benefited from the bailout, but that 70,000 kids just got kicked out of the Head Start Program.

The three economists discussed various regulations that could rein in banks — including Dodd-Frank (which Barofsky, unlike Elliott, thinks will be worthless), size caps, a new version of the Glass-Steagall Act separating banking activities, and capital requirements. Heading off another Great Recession, they all agreed, is worth costing banks something. “How big should bank capital requirements be?” asked Cooley. “Big enough so that it doesn’t matter.”


Independent Discussion Guidelines

How do you comment on a necessary evil and knowing that our Government is as much a hostage as any of us are under the Banking system?

dou4now (anonymous profile)
May 3, 2013 at 10:38 a.m. (Suggest removal)

The government is far from a hostage. The government was a perpetrator in this scandal. With the deregulation of Fannie and Freddie as well as pressuring the banks to lend to people that couldn't afford it.

Botany (anonymous profile)
May 3, 2013 at 10:51 a.m. (Suggest removal)

All I can say is that Chase has, like 5 million ATMs, free checking, and the people at the lower State Street branch are really nice and helpful.

banjo (anonymous profile)
May 3, 2013 at 5:06 p.m. (Suggest removal)

That bunk about Freddie/Fannie and the CRA (Community Reinvestment Act) are myths started by the neocons @American Enterprise Institute.

Players with much bigger roles were the commercial mortage originators who kept lowering their underwriting standards so they could profit by selling their loans to the mortgage securitization industry. Of the top 25 originators of subprime mortgages, only 1 was subject to government CRA rules:

PBS Frontline has done some excellent segments on the financial crisis. These cast light on the front-end of the pipeline - the home loan industry:

EastBeach (anonymous profile)
May 4, 2013 at 1:40 p.m. (Suggest removal)

Planet Money did a great podcast series awhile back on the mortgage industry and bank capitalization:

Well worth reviewing ... I bet we'll have another similar crisis in our lifetimes as we haven't learned from the last one.

EastBeach (anonymous profile)
May 4, 2013 at 1:47 p.m. (Suggest removal)

I was given a copy of “How Washington Abandoned Main Street While Recuing Wall Street” by Mr. Neil Barofsky, former Inspector General for the TARP Program/US Treasury Department and the keynote speaker of this economic summit. It was a quick read, seeing that I was already familiar with many of the key aspects of the financial melt-down and our government’s scramble to stabilize it. What I got from the 270 pages of his book was a good anecdotal first-person Kalnienk view into the TARP program.
In my opinion Mr. Barofsky did a wonderful job breaking down some of the complex machinations of our economy but he completely glossed over many key historical facts so he could preserve his main thesis for the book. This was unsettling for you can’t paint something as convoluted and expansive as the subprime mortgage issue (for instance) in a 3-page broad stroke of black and white.
In chapter 5 of his book titled “Drinking the Wall Street Kool-Aid” he lost all credibility with me when in discussing the creation of mortgage backed securities and the problem with the subprime housing bubble he never once mentioned the Housing and Community Development Act of 1977. Most importantly he never mentioned Title XIII of this Act known as The Community Reinvestment Act which from 1992 to 1999 was amended 5 times culminating in the Gramm-Leach-Bliley Act. All of these Title XIII laws were signed into being by then President Bill Clinton who sought to make home-ownership a reachable “American Dream” for anyone with a pulse and the ability to sign their name. This was the creation of Subprime lending. Banks were forced to provide subprime loans and carry a percentage of high-risk, sub-prime loans on their books or face discrimination lawsuits such as the one our current President brought against Citibank in 1995, pressing Citibank to write extremely high risk subprime mortgage loans. – Source –
Bill Clinton, upon signing Gramm-Leach-Bliley into law said it, “establishes the principles that, as we expand the powers of banks, we will expand the reach of the [Community Reinvestment] Act" - Source: Statement by President Bill Clinton at the Signing of the Financial Modernization Bill, U.S. Treasury Department Office of Public Affairs, November 12, 1999.
Subprime was created by the government and then left to the banks to figure out. Banks are “For Profit” organizations and will look for any way to take the opportunities they are given and profit from them. The Government opened the doors and allowed the tight regulations in place since 1933 to disappear. Source - The Nature and the Origin of the Subprime Mortgage Crisis by Thayer Watkins

JPatrickStern (anonymous profile)
May 4, 2013 at 7:45 p.m. (Suggest removal)

Mr. Barofsky’s thesis that all of this was created by the banks as some scheme to make more money (out of greed) is too simplistic and partisan to have any merit. The ultimate responsibility for any individual’s financial well-being starts and stops with that individual. I wouldn’t attempt to buy a house or piece of property that in all likelihood I would lose because it would be too much of a stretch to afford. The banks would have loaned me the money; they were mandated to. And if I had thrown my better judgment aside and purchased and subsequently lost said property it would not have been the bank or the government’s fault; it would have been my fault.

That's the key element no one seems to want to mention. Point fingers at banks. Point fingers at Regulators and the Government. But in reality it's the greed of consumers and the "J. Wellington Wimpy Mentality" (From Popeye... you know? "I'd gladly pay you Tuesday for a hamburger today") of the average American consumer that got us here.

JPatrickStern (anonymous profile)
May 4, 2013 at 7:45 p.m. (Suggest removal)

This is where ultimately I think Mr. Barofsky’s book utterly and completely fails. True to his prosecutorial background he hunts “the bad guy” and identifies several. But he’s guilty of playing a game of “Eeny, Meeny, Miny, Moe” with the facts all the while bemoaning how difficult life inside the Washington DC beltway is for a valiant crusader such as himself. He says that the government should “break-up” the largest banks but then ends the book by saying, “You can’t trust the government.”

JPatrickStern (anonymous profile)
May 4, 2013 at 7:50 p.m. (Suggest removal)

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