The Derivative Project

The Three Mistakes of TARP – FCIC, Show the American People that Regulatory Capture Has Ended

The Three Mistakes of TARP – FCIC, Show the American People that Regulatory Capture Has Ended

The Derivative Project wrote last week of regulatory capture.  Simon Johnson, MIT Economics Professor and former IMF official, outlined yesterday in his blog, Baseline Scenario , the three mistakes of TARP.  All of these mistakes are the result of regulatory capture.  We believe strongly the most significant of these mistakes is that bankers were not held accountable individually and taken to task for the complete destruction of our economy.

Here are the three mistakes that every voter should care about, in plain English:

  1. Goldman Sachs and every derivative player knew full well that AIG could not support the level of counter party risk in credit default swaps that they took on.  TARP funds and FDIC guarantees were given to Goldman Sachs, certificates of deposits, with no strings attached.  I know full well if I had done the credit analysis on that deal I would have been fired and tarred and feathered by every unemployed American.
  2. Secretary of Treasury Henry Paulson stated to the American people, “these instruments are very, very complicated, we just didn’t understand the risks.”  Mr. Paulson misled the American people.  This is false.  History must show how the administration misled the average American in this time of crisis.  Counter party credit risk is elementary and not difficult to understand or monitor.
  3. President Obama hired Timothy Geithner, who also publicly misled the American people.  Mr. Geithner testified before Congress, about the need for the TARP funds, “Innovation got ahead of our understanding of the risks.”  Baloney.  Mr. Geithner still needs to explain this statement to the American people.  Counter party credit risk is not a new risk.

To move forward, to present this from happening again, we need the comments, the testimony, during the crisis to be examined for the American people.  We need truth to move forward.  We need these individuals to be held accountable.

Let’s hope the FCIC in their upcoming report will take these individuals to task for their misleading statements to protect Wall Street.  It is time to get the facts out there. If they do not do so, once again, the regulatory capture continues. It is time to clean house and a fresh start with FINRA, the  SEC and the Treasury Administration.

Here are the three mistakes from Simon Johnson’s blog, Baseline Scenario, in a post September 30, 2010:

“But three serious mistakes were made in the implementation of TARP.

First, there was no need to be so excessively generous to the financial executives (and their boards) at the institutions that had to be saved. In part this generosity was due to insufficient safeguards in the legislation (a point Ken Feinberg makes persuasively with regard to compensation), but mostly this was a choice insisted upon by key people in President Obama’s economic team.

The bankers were not even embarrassed by what happened – this was extraordinary, probably unprecedented and completely at odds with what the very same administration officials had advocated when their advice (and money from the United States and the International Monetary Fund) was needed by other countries (we cover this in detail in Chapter 2 of 13 Bankers). The historical record on this point is not in question.)

Second and closely related, the Obama administration missed the opportunity to change the structure and the incentives of Wall Street when it had the chance, at the very beginning of 2009. The Treasury line, then and now, was that the “essential functions” of the financial system had to be preserved, and this meant no one could be “punished.”

This is again a complete divergence from best practice, for example as recommended by the I.M.F. (with United States backing) in many situations over the last 50 years. The issue is not punishment or retribution; it is responsibility – and it provides incentives to be careful in the future. (Again, for more technical details, see 13 Bankers.)

Failing to seize an opportunity for reform is not sophisticated or the work of adults (as some members of the Obama administration self-servingly assert); it was simply a political mistake – and terrible economics. The idea that some banks were too big to fail arguably played a role in the run up to 2007-8; we can have that debate. But the notion that our biggest six banks are untouchable today is uncontroversial.

Their creditors know this, so these banks can borrow more cheaply than their smaller competitors, they can become larger relative to the economy, and if you doubt the risks that this poses, just look at the situation today in Ireland.

Third, by the time the administration put forward its financial reform ideas, the big banks were back on their feet – and ready to throw huge numbers of lobbyists and unlimited cash into the fight to preserve their right to take inordinate risk and to mismanage their way into disaster.”