Monday, April 13, 2009

Tarp investigator seeks evidence of book fiddling

Posted in the Financial Times by Tom Braithwaite:

The official policing the $700bn Tarp fund says he is investigating whether banks have “cooked their books” to secure bail-out money.

Neil Barofsky, special inspector-general for the troubled asset relief programme, told the Financial Times he was seeking evidence of wrongdoing on the part of banks receiving help from the fund, which was designed to ease credit conditions and support distressed industries.

“I hope we don’t find a single bank that’s cooked their books to try to get money but I don’t think that’s going to be the case,” said Mr Barofsky, who has been dubbed the “Tarp cop”.

Just how banks value mortgage-backed securities and other assets on their books has been an issue of intense debate as the financial crisis has unfolded.

Large banks from Citigroup to Goldman Sachs and hundreds of regional banks have taken billions from Tarp to rebuild balance sheets weakened by the financial crisis.

But institutions applying for Tarp money had to show they were fundamentally sound, potentially prompting them to mis-state their assets and liabilities.

Mr Barofsky also said the Treasury’s expanded term asset-backed securities loan facility (Talf) was ripe for fraud.

The former New York prosecutor said the decision to expand the Talf to encourage investors to buy distressed, or “legacy”, assets from banks could put public money behind investments that were backed by fraudulent mortgages.

“One of our strongest recommendations of the last report was do not expand the Talf to buying legacy assets. If its structure is not changed considerably it’s very, very dangerous,” he said.

“We know the triple A rating [ascribed to the securities by credit rating agencies] was a sham. We could be buying securities that are backed with assets that we know were likely riddled with fraud.”

Mr Barofsky revealed at a Congressional hearing earlier this month that he was involved with “probably more than a dozen” investigations into possible wrongdoing and fraud. He told the FT that potential fraudsters would pay attention when his team began seeking indictments. “Indictments can serve as great deterrents,” he said.

Mr Barofsky declined to detail what crimes institutions could have committed. But securities fraud, wire fraud and false statement were all possible lines of inquiry, he said.

In the first public allegation of Tarp fraud, the Securities and Exchange Commission, with assistance from Mr Barofsky’s office, claimed in January that ProTrust, a Nashville-based company, offered clients a fictitious opportunity to invest in the government’s bail-out scheme.

With scant reporting requirements when the bail-outs began at the end of last year, banks had a fairly free rein on what to do with Tarp money. Concerned about a lack of transparency, Mr Barofsky has written to all of them to ask how the funds were spent.

“We haven’t served a single subpoena,” he says. The preliminary audit will be published in the next few weeks, after analysis of the “pretty detailed descriptions with what banks say they’ve done with the money”.

That fulfils part of his office’s transparency remit and is not necessarily a trawl for fraud. But big banks are potential targets.

The energetic – and potentially aggressive – approach to following the money chimes with the belated rush to oversight in Congress and the outrage over how legislation allowed $165m bonuses to be paid to executives at AIG, the bailed-out insurance group.

“One of our main areas of focus [on executive compensation] is to see if there was a significant communications breakdown as to how that policy decision was made,” says Mr Barofsky.

Inspector intent on following Tarp trail

Holed up in a corner of the Treasury with cardboard boxes stacked against a wall, Neil Barofsky is trying to keep track of $3,000bn of taxpayers’ money.

As a New York prosecutor, the 38-year-old took on drug dealers and white-collar fraudsters. His new role is making sure money given to Wall Street and the wider financial sector at the behest of the White House is not misused.

The job of special inspector-general for the troubled asset relief programme – Tarp – is as big as the title is unwieldy. Moreover, Mr Barofsky’s reputation for determination and a strong work ethic belies the fact that it is impossible to keep every Tarp dollar under observation.

Fighting fraud after a financial mess partly created by too much leverage, the strategy of the so-called “Tarp cop” is to leverage his own position – using investigations, public comments and, in the future, criminal charges to deter more fraudsters than he could hope to catch.

“Ultimately, if all we did was sit back, wait for fraud and then try to address it there would be a tsunami of fraud,” he said. The most drastic weapon is clearly primed for use: “Indictments can serve as great deterrents.”

Mr Barofsky said he was investigating whether banks had “cooked their books” to get some of the $700bn (€540bn, £475bn) in Tarp fund bailout money. He declined to go into specifics but said possible criminal offences included “securities fraud, wire fraud, false statement”.

To qualify for the main capital purchase programme, which saw more than $200bn invested in more than 500 banks, institutions had to show that they were fundamentally sound, potentially creating an incentive to exaggerate the quality of their balance sheets.

Mr Barofsky estimates he is overseeing almost $3,000bn of federal money, including billions of dollars from the Federal Reserve that will be used to support measures to improve liquidity across the economy.

His energetic – and potentially aggressive – approach to following the money chimes with the belated rush to oversight in Congress and the outrage over how legislation allowed $165m in bonuses to be paid to executives at AIG, the bailed-out insurance group.

“One of our main areas of focus [on executive compensation] is to see if there was a significant communications breakdown as to how that policy decision was made,” said Mr Barofsky.

Some of this irks banks, especially those who had Tarp money thrust on them. This was because the Bush administration wanted the whole gamut of banks included to reduce the focus on the very weakest, such as Citigroup, that appeared to need the money.

The mood in Washington has changed and now banks that indicate they will pay the money back (partly to avoid edicts from politicians on how they should run their operations) are being encouraged by Congress to do so.

But there is an apparent risk to future programmes from oversight creep, with the Treasury needing the participation of hedge funds and private investors in its attempt to get toxic – or “legacy” – assets off banks’ balance sheets to encourage new lending.

Mr Barofsky is unconcerned: “Every player in the market who is playing by the rules – we won’t be a deterrent to them,” he said.

“I don’t credit any claims that we’re scaring good players out of the programme,” he added.

He is not afraid of butting heads with the Treasury over the extension to the term asset-backed loan facility – Talf – to allow investors to buy legacy assets with the support of government equity and debt.

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