Neil Barofsky on Bailouts
Sep 3 2012

Neil Barofsky, author of Bailout and the former Special Inspector General for the TARP program, talks with EconTalk host Russ Roberts about his book and the government bailouts by the Bush and Obama Administrations. Barofsky recounts what he learned about how Washington works and the incentives facing politicians and bureaucrats. His book and this interview are a workshop in public choice economics. Along the way he unravels some of the acronyms of the last few years including TARP, TALF, and HAMP. The conversation concludes with lessons learned by Barofsky and what might be done in the future to prevent the corruption and ineffectiveness of past bailouts.

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Explore audio transcript, further reading that will help you delve deeper into this week’s episode, and vigorous conversations in the form of our comments section below.


Sep 3 2012 at 8:32am

Excellent podcast!

Huge amount of stuff in there that drew my attention, but one question stayed with me throughout: How would/did China do all these financial market manipulations?

The part about trying to increase lending, but failing due to incentives, was very reminiscent of China’s own policy of explicitly setting lending goals through its state owned banks. It seemed to me at the time, and still does, that a lot of the behavior during the bailouts was the Fed trying to mimic China’s financial policies(despite lacking the tools to do so).

That being said China’s financial system is a very obscure topic to me. Would love a podcast on it or some reading recommendations.

Thanks for the great listen!

Jim Bryan
Sep 3 2012 at 11:10am

Confirmation that the FED works FOR the banks!

It is so disgusting, I will leave it at that!

Sep 3 2012 at 1:22pm

What the money is used for is more or less impossible to track, even with the best of intentions on all sides.

It displaces other money used for the same thing, even if used for what you want.

It’s like lottery revenue being dedicated to funding schools.

The decision actually made is what the funding for schools should be, trading it off against other uses for money. Then the lottery revenue is subtracted, and general revenue added only to finish the decided sum.

The net result is that lottery revenue, with the best of intentions, simply goes into general revenue.

Sep 3 2012 at 1:50pm

On saving banks, aka saving creditors: it saves people who don’t even know that they’re bank creditors, and I thought that was the point. Money market funds would be a good example, several times removed via commercial paper.

The justification was that it was a government screwup that caused the problem in the first place, so the government owed the money to prevent the collapse as well. Whether the creditors are saved along with the bank or just the creditors were saved didn’t matter much.

There was less reason to bail out homeowners, who after all still have the house at the price they were willing to pay.

Sep 3 2012 at 2:50pm

AIG bail out Not only saving creditors. Back when the world was ending I recall hearing that the political heavy weights of both parties were invested in AIG. Wondering if there was an influence from this source not to let AIG go.

Greg Strebel
Sep 3 2012 at 6:26pm

Michael, you may be interested on the item on AIG from the Corbett Report. It is far worse than you might think:

Tom Gates
Sep 3 2012 at 9:07pm

A good podcast, but still treating the 2008 debacle in bits and pieces. There is a reason that unlike the S&L crisis where 2,000 crooks were convicted and sent to jail, the 2008 crisis has resulted in zero reported jailed to date. Not even the head of Countrywide. Why?

I think Gretchen Morgenson’s book, “Reckless Endangerment” does a great job of outlining the entire picture of how the housing crisis evolved starting in 1994 and the role the politicians, government, GSEs, Fed, regulators, commercial banks, investment banks, mortgage brokers, rating agencies, credit reporting agencies, appraisers,investors and consumers played in this mess. Nobody has gone to jail because everyone was complicit in one way or another.
Russ, I think she would make a great podcast guest!

Sep 4 2012 at 10:31am

Sebastian says in the first comment that the Fed actions reminded him of China and that occurred to me as well. In China, the authorities control credit by ordering the banks to increase loans by the desired amount. The difference is that the Chinese banks will do as they’re told. There’s no liquidity trap because the banks will push the money out the door one way or the other. A good description of China’s financial system is Red Capitalism by Carl Walter and Fraser Howie.

Great podcast.

Sep 4 2012 at 12:33pm

Forbes has a scathing libertarian critique of Barofsky’s book here, its a great read.

Here is a quote regarding one of the key issues Barofsky talks about, TARP recipients tight lending:

“Regarding the tight lending standards of banks that were recipients of so much TARP money, lost on Barofsky is that the bailouts, far from boosting lending, actually made it tighter. Figure banks that needed TARP funds were necessarily insolvent and gun shy. Their ability to lend was “impaired.” But if they’d been allowed to fail, healthy banks could have purchased poorly run institutions and their assets at bargain basement prices. For being able to buy at the market bottom, healthy banks would have been much more aggressive lenders. Naturally this never revealed itself. Market solutions rarely reveal themselves when the subject is banks.”

Bradley Reali
Sep 4 2012 at 1:27pm

Forgive my lack of knowledge on banks, but I don’t understand the Forbes quote. I was under the impression that the whole problem was that almost every bank was directly or indirectly tied to these troubled assets. The whole issue was that pretty much all of the financial world realized that nobody had cash, and everyone had been leveraging debt to assume more debt. Banks would not lend to other banks to purchase anything, let alone another bank.

Sep 4 2012 at 1:45pm

Forbes is making the anti-bailout argument, which I think Russ would agree with. The argument is that if those banks had simply been allowed to go bankrupt, we would have had a temporary crisis followed by an explosion of new healthy lending and growth as the big troubled banks died off and more prudently run institutions took over.

The central flaw in the pro-bailout viewpoint is the proposition that a “financial meltdown” would have been a bad thing. On the contrary, killing off those huge banks with their outsize political influence was EXACTLY what this country needed. he Forbes review actually makes an analogy with Japan after WW2. Their economy had literally been nuked, yet their post-war recovery was the biggest boom they’ve ever had. A healthy capitalist market thrives in that kind of “clean slate” environment where the old suppliers are gone and there is tons of demand waiting to be met.

Robert Kennedy
Sep 4 2012 at 2:04pm

Bradley Reali writes:

…. I was under the impression that the whole problem was that almost every bank was directly or indirectly tied to these troubled assets…

My understanding was it was NOT almost every bank. I believe that is was only big players: Citi, BofA, etc. Lots of small & mid sized banks were not exposed at all to any of these assets. But regardless, if the assets were available at bargain prices when these institutions folded, some healthy entity, bank or otherwise, could come along clear them effectively, I think.

Chris Meisenzahl (@speedmaster)
Sep 4 2012 at 2:09pm

Absolutely fantastic interview, I couldn’t walk away from it.

And I think that Mr. Barofsky wrapped-up the entire thing quite well with this:

“And what I saw firsthand was, and perhaps the thing I learned the most was, just how little difference there was between the Republican Administration and the Democratic Administration. It’s not that one was better or worse than the other. It’s just that they were remarkably the same. The same exact arguments. I think the tricks were a little dirtier with the Obama Administration, but I don’t think that’s attributable to the political party. I think it’s just that they had more time.”

Bradley Reali
Sep 4 2012 at 4:25pm

Here is what I have been able to surmise with my vast education in economics (1 macro econ class, and lots of TV).

Banks were buying and selling home loans. Those home loans were backed by the value of the house. The value of the house was inflated, so the value of the debt was inflated. When the bubble popped, the value of the debt adjusted to compensate.

The Gov stepped in, because they thought that if the banks took a hair cut on the debt, that it would trickle down and massive amounts of wealth would be lost. They were afraid that the momentum of debt destruction would carry past what the bubble had done to prices. Money would then lose its value because it’s a representation of the assets that back it. We would then go into a financial dark ages.

The non-interventionist side thinks that the down fall might be sharp, but that the economy would bounce back after the price adjustments were done.

We know what happened, the gov stepped in, but we can’t really say if that was the right move. I believe the banks should have gotten money but with some strings. The most important would have been that if a bank received money, it would then have to be audited at their expense. If it was found to be stable enough to survive then a payment plan would be set up. If it turned out not to be safe, it would be broken up and auctioned off. This could have slowed the momentum and lessened the overreactions of the market while removing the worst banks and deflating the bubble.

The problem with doing nothing and letting the markets sort it out, is that the markets caused the collapse in the first place. Sure, there were incentives that promoted bad behavior, but why would letting them fail remove those incentives?

We saw how the market felt when Lehman fail. I think many banks should have been left to die, but the death should have been controlled.

D. Edwards
Sep 4 2012 at 4:50pm

Re the comments about the Forbes article:

James cites the following: “But if they’d been allowed to fail, healthy banks could have purchased poorly run institutions and their assets at bargain basement prices.” Then later comments: “On the contrary, killing off those huge banks with their outsize political influence was EXACTLY what this country needed.”

But if that (i.e., huge banks) was the problem and if they then get bought up by healthier banks wouldn’t these healthier banks become even bigger than the failed banks thereby just recreating the problem with some different players(not to mention an even greater concentration of financial institutions).

Sri Hari
Sep 4 2012 at 7:35pm

Excellent podcast!!

Very informative, details were precise, Barfosky sounded very sincere and unbiased in his observation. If one listens to this podcast after listening to the podcast by William Black, it gives a disturbing picture of American economy. Is America killing its free market infrastructure at a steady rate?

It is disheartening and disappointing to note that regulatory capture which is extremely bad in democratic India and institutionalised in communist China, may become the accepted structure for large economies, if America slowly drifts to crony, government subsidised capitalism- can the world aspire for a better economic activity in the near-term?? Sounds very unlikely!!

Sri Hari
Sep 4 2012 at 7:52pm

Excellent podcast!!

Very informative, details were precise, Barfosky sounded very sincere and unbiased in his observation. If one listens to this podcast after listening to the podcast by William Black, it gives a disturbing picture of American economy. Is America killing its free market infrastructure at a steady rate?

It is disheartening and disappointing to note that regulatory capture which is extremely bad in democratic India and institutionalised in communist China, may become the accepted structure for large economies, if America slowly drifts to crony, government subsidised capitalism- can the world aspire for a better economic activity in the near-term?? Sounds very unlikely!!

Patrick R. Sullivan
Sep 4 2012 at 8:08pm

I’m a big fan of Russ’s podcasts, but not this one. For one thing, Barofsky isn’t an economist and it shows. I’ll bet he hasn’t ever read the chapter on The Great Contraction in Friedman and Schwartz.

But, I know Russ has read it, so I’m puzzled why he let so many rather fundamental misunderstandings of Barofsky go unchallenged. The purpose of the ‘bailout’ was to save the banks BECAUSE that is also in the interest of the country, not in spite of it. When we didn’t do that in the 1930s we had a catastrophe.

It was almost funny to hear Barofsky’s ‘Oh, by the way, the bailout worked.’ It just didn’t go as neatly and squeakily clean as Barofsky would have liked. Well, if you want sausage to eat, maybe you shouldn’t visit the sausage factory. I’m not too surprised Barofsky came in for a lot of verbal abuse from those trying to save the financial system. They probably thought he was in over his head. They were probably astute in so believing.

Russ Roberts
Sep 4 2012 at 9:40pm

Patrick R. Sullivan,

The lesson of Friedman and Schwartz was that the Fed let the money supply collapse. What the Fed did this time was to make sure few or no banks collapsed. Not the same thing. That’s not capitalism and it’s horrible for the incentives to behave prudently in the future.

Bradley Reali,

I accept your point that we don’t know what might have happened had we let banks collapse and markets correct themselves. I do not agree that Lehman illustrates what would have happened. See John Taylor’s analysis of Lehman. But even if you argue that the bailouts saved us from a horrible catastrophe (and I am agnostic about how horrible it might have been), you can’t just go forward and pretend we’ve now solved the problem. If you treat the financial sector like a ward of the state when times are bad but let them be profitable when times are good, you have a different kind of catastrophe for a democracy that pretends to be capitalistic.

Bradley Reali
Sep 4 2012 at 11:33pm

Please don’t get me wrong, I’m not defending the bail out, I’m defending intervention.

The markets were frantic and over reacting to everything that was happening. Lehman was an excuse to over react. I was in favor of the government doing something, but not giving money away for nothing. We just saw the largest shift of wealth the world has ever seen. Not only that, but we just told the private industry that if you mess up, mess up big and that is probably worse that doing nothing.

The gov could have offered money, but with the stipulation that would be audited. If they pass, they work out a re-payment plan. If they fail, they go to auction. This would have make any bank that came out, appear far more safe. The credit ratings meant nothing so something wold have been better than nothing. Certainly there was something to be worried about, but sharpness of the decline did not have to be as severe.

The biggest issue is that the underlying problem was never even touched. There is nothing to stop the banks from doing it all over again, and asking for another shift in wealth, to protect the fabricated wealth.

Also, I cant believe that Russ actually commented on my comment of his show.

Cecil Cooper
Sep 5 2012 at 6:09am

Perhaps I’m over simplifying or missing something.

As an investor in banks, I’m always asking the same question as the TARP donors: what are they doing with my money? We already have a means to answer this that’s been developed over decades and is produced every 3 months without fail. The cash flow statement!

The way I look at things, given the irrefutable fungibility of cash, the cash flow statement is both the most practical and accurate way of answering the question, what cash came in and what cash went out.

Naturally, the statements are opaque and flawed but if we want better answers, why not focus on improving what we’ve got rather than creating something new (which is bound to be a morass of useless micro-detail anyway, from my investor perspective in any case).

Greg G
Sep 5 2012 at 7:16am

I think most people are thinking about this in terms of too big to fail when the primary problem is too interconnected to fail.

In the 1930’s banks failed because retail depositors panicked and refused to do business with them. In 2007 it was financial institutions themselves that panicked and started refusing to do business with each other. Even the strongest banks knew they could not survive mass failures of their counterparties. And they had no way to tell which counterparties were sound.

Whether the bailouts were right or wrong, they were done much more out of a desire to protect the larger economy than out of a desire to protect big banks. Right or wrong, the Fed did fear that that allowing the collapse of major financial institutions would result in a catastrophic contraction of the effective money supply.

In principle, I think it would have been much more desirable to give counterparties a haircut, prevent AIG bonuses, replace failed managements etc. but the truth is existing laws did not permit much of that without going through a long bankruptcy process while the economy was having the financial equivalent of a heart attack. Reforms that would permit that kind of emergency government intervention are routinely attacked as socialist central planning.

Paul Kamp
Sep 5 2012 at 7:55am

An excellent podcast that points to the trouble we have with our government. Fundamentally, why wasn’t there financial reform and prosecution for some of the Wall Street bankers after the 2008 election.

As a taxpayer I find it is appalling that the Fed did not negotiate a haircut for all the investors. TARP bailout money going to pay bonuses to AIG management for their failure is absurd. The limited oversight that was proposed was rejected by the banks. They really were not in a position to negotiate.

The simple solution to that was that if they took the TARP money they needed to agree to the conditions. Otherwise, let them fail. Someone would have bought up their assets for much less.

In many ways this podcast is very enlightening and depressing. It shows how much our government, both the Democrats and Republicans, are captive to the monied interests instead of the people. I believe that professor Lawrence Lessig is correct, we need campaign finance reform. Perhaps someone you can have on a future podcast.

Todd Rogers
Sep 5 2012 at 10:33am

Great show this week. I will do a double take. It was refreshing to hear a self-proclaimed “life-long Democrat” admit (declare?) that there’s almost no difference between Washington Republicans and Washington Democrats.

Patrick R. Sullivan
Sep 5 2012 at 12:23pm

The lesson of Friedman and Schwartz was that the Fed let the money supply collapse. What the Fed did this time was to make sure few or no banks collapsed. Not the same thing.

Well, Friedman and Schwartz seemed to think it was the same thing. I.e. the money supply collapsed because the banks collapsed and took money out of circulation.

But, how would you have prevented the money supply from collapsing while letting numerous banks fail, Russ?

Patrick R. Sullivan
Sep 5 2012 at 12:33pm

But even if you argue that the bailouts saved us from a horrible catastrophe (and I am agnostic about how horrible it might have been), you can’t just go forward and pretend we’ve now solved the problem.

No one is doing that, Russ. We realize that there are two separate problems. It seems to me it’s Barofsky who is conflating the two.

Also, Ed Conard, in his (badly titled) ‘Unintended Consequences’ has some astute things to say about the supposed fixing of the long run problem of moral hazard in Dodd-Frank. He asks why the ‘living wills’ would work any better in a crisis than what Bernanke, Paulson and Geithner ginned up for this one.

Artful Monk
Sep 5 2012 at 12:49pm

I am often perplexed as to the assertion by Friedman in Monetary History that the Fed Reserve failed in the 1930’s due to its actions of reducing the monetary supply. Money supply slightly dipped in 1930 but for the most part it was stable or increasing during the period of 1925-1940. Was Friedman trying to say that the Fed didn’t provide sufficient liquidity to counteract the lower demand (or nominal GDP target)?

In terms of the bailouts it is frustrating but it seems like in this country we have gone through 3 cycles:
1. Bailouts from early 1900’s (JP Morgan backed) to the 1930’s (Richard Whitney led).
2. A relative silent period from the 30’s to the 70’s
3. Another upturn from the 1980 to 2008

It would be interesting to have a guest who can explain those distinct periods. Was the silent period due to Glass-Steagall or the fact that bankers were reacting to market forces requiring more sound lending or concern that people would not bail them out (or some combo of the 3)?

Similarly, are we underestimating the power of the Lehman bankruptcy and bailout backlash in affecting the decision making process of those bank CEO’s? It has been nearly 4 years since the bank bailouts and are we in the midst of another 40 yr stretch without bailouts? Sadly I have a feeling that in 40 years, we will have another bailout and at that time people will be rehashing similar stories of repealing Dodd-Frank (Glass-Steagall ?) or whatever explanation one can conceive.

Patrick R. Sullivan
Sep 5 2012 at 5:52pm

Artful, your graph is of the monetary base, which has two components; currency and bank deposits. It was currency that increased, because people held more money outside of banks for reasons of safety. Because of the numerous bank failures that the Fed failed to stem.

Also, those banks that did survive held more of their money as reserves than prior, which had the effect of keeping it out of circulation.

Those two effects resulted in less money actually circulating throughout the economy.

Bruddah IZ
Sep 6 2012 at 3:03pm

can’t remember if it was Zingales or Stiglitz that spoke about Bernanke and “cognitive capture”? Niel drives it home in this podcast that Bernake is not the only one subject to cognitive capture. One of my favorite albeit depressing podcast.

Sep 6 2012 at 8:59pm

Greg G,

I agree with your analysis above, but want to add that if the government doesn’t clean up the CDS market (personally, I’d just ban ALL the naked ones) by putting them on open exchanges without all the crazy exceptions/exemptions that threaten to make such an exchange worse than useless (b/c it’ll be misleading) another counterparty heart attack is inevitable.

There are notionally trillions upon trillions of theses swaps out there but nobody has a good notion what the real exposures are or where (though CDS gambling on Europe apparently tripled from ’08 to ’11). The opacity + the inter-connectednesss + an implicit bailout guarantee will seize up the too-big-to-fail banks again. Except now they’re even more too-bigger-to-fail than the last time.

Unfortunately, Barofsky personal, up-close view of how the dangerous status quo is actually preferred by both parties gives me little hope that real solutions are imminent.

Brian Gibson
Sep 7 2012 at 2:21am

An interesting podcast but not particularly useful. It was a fairly boilerplate rant against bureaucracy.

Mr. Barofsky comes across as wildly idealistic to the point of incredulity. Our government is simply not capable of changing in the way that Mr. Barofsky seems to desire. It is a massive system that resists change. Reforms come slowly and Mr. Barofsky sounds much like a former soldier complaining about how the the army works.

Greg G
Sep 7 2012 at 7:04am


I agree entirely that CDS and other forms of “modernized” derivatives bring huge and unpredictable systemic risks.

I would love to see Russ do a future podcast on this topic. You would think that some of the crazier derivatives would be at the end of the line in a bankruptcy. My understanding is that it is the other way. They are in a privileged position in a bankruptcy.

Russ, Satyajit Das is really good on this topic if you can get him. I did enjoy this interview, but as one commenter pointed out, this is the view from inside the sausage factory. Would love to see the view from a more systemic level as well.

Patrick R. Sullivan
Sep 7 2012 at 12:13pm

Russ and John Taylor have a fantastic video running now.

Unfortunately, there’s no mention of monetary policy’s role in the ‘below trend’ phenomenon. But it indirectly touches on the question above about Friedman and Schwartz’s explanation of how the ‘money stock’ dropped at the same time the monetary base (‘high powered money’ in their jargon) rose. I.e., it happened because the banking system was allowed to collapse.

Sep 7 2012 at 8:01pm

Mr Barofsky and Russ,

I thoroughly enjoyed the podcast. Anyone who feels that Mr. Berofsky is ranting should learn what he went through. I’d say it is far from it rant. I actually bought and listened to Bailout as a result of this podcast.

I lean Libertarian as far as the economy is concerned an I still have great respect for the book and its author.

Greg G,

I am excited that someone besides myself is pushing for a Satyajit Das interview. I would love for him to be a guest soon.


Sep 9 2012 at 10:31am

Banks borrow short and lend long. Any proper stress test will show that in a liquidity/confidence crisis banks will fail to pay. Every audit report should say this. A man from Mars would say “how did you ever allow this”. But we have allowed it, and there is a belief that it mobilises savings to the benefit of all. So get used to runs on banks and government bailouts – it is the price we pay for maturity transformation. (PS. Regulations should presumably limit the amount and extent of banks’ maturity transformation – making them more like money funds. Long term financing should be done through the bond market, not through banks. Incentives (regulations?) should be set to help bring this about. Banks will then become smaller too.)

Jim Feehely
Sep 11 2012 at 3:28am

Hi Russ,

Neil Barofsky’s revelations are startling, given his detailed insider knowledge of the true philosophy and policy of the bail outs in the USA. It reveals a complete absence of confidence in government that the system is safe and self sustaining. Why, then, are we so devoted to preserving this rotten finance system?; the fundament of the laughable policy of ‘too big to fail’.

Perhaps you could add William Cohan’s ‘House of Cards’ to the reading list on this topic. One of the key points I took from Cohan’s book was the blithe impenetrability of the nature of exotic and synthetic ‘assets’ like CDOs, and other exotic derivatives. The CEOs of the banks don’t even understand them. And the regulators only come to understand them in a limited way when they cause a problem; ie after $billions of them are actually in the hands of investors. Then the regulators’ only response is to bail out the creators of the problem.

How can anyone seriously argue for less regulation of the financial system? The first regulation should be to ban derivatives other than direct hedges that provide insurance.

Hopefully, you will land a guest in the future that can explain the good to society of pure speculation in derivatives and currency that are not hedges directly related to a transaction. And that person may also be able to explain the good to society of short selling. Just because it can be conceived, does not make it good or useful.

Jim Feehely

Russ Roberts
Sep 11 2012 at 3:50pm

Jim Feehely:,

You write:

Perhaps you could add William Cohan’s ‘House of Cards’ to the reading list on this topic. One of the key points I took from Cohan’s book was the blithe impenetrability of the nature of exotic and synthetic ‘assets’ like CDOs, and other exotic derivatives. The CEOs of the banks don’t even understand them. And the regulators only come to understand them in a limited way when they cause a problem; ie after $billions of them are actually in the hands of investors. Then the regulators’ only response is to bail out the creators of the problem.

How can anyone seriously argue for less regulation of the financial system?

First, fyi, here’s the link to the EconTalk episode with William Cohan.

Second, you ask how anyone can argue for less regulation. You ask this after listening to an interview that lays out just how pervasively special interests influence government. My conclusion is that we need less government, not more.

Usually, when people do things that go against their interest, the regulation argument is paternalistic–government needs to intervene to protect the people from themselves. But in the financial sector, you argue for regulation to protect me, the taxpayer and the citizen, from the bad decisions of others.

Wouldn’t it just be easier to let them make bad decisions, lose a lot of money, and learn a lesson? I believe that there is a relationship between past rescues of creditors and the ease with which current investors are able to use borrowed money. That to me argues for less rescuing and more lesson-learning.

Bevis Schock
Sep 11 2012 at 6:08pm

The podcast nicely explained the rationale for the bailout and then what really happened.

What it lacked, for me, was the definition of “meltdown”. So I will speculate on what I think the correct definition is. I think “meltdown” meant, at the time, that banks would not have enough funds to pay their depositors, and there might then have been a run on the banks. Now it is my firmly held view that the fellows running the money supply in our nation view that as the ultimate disaster, because they will have to come with federal funds to be sure that people stop lining up to get cash, and to be sure that no one, absolutely no one, concludes that the security of his deposit depends on the strength of his bank. One may note in support of this view that despite the limit on FDIC insurance to $250K per account (or depositor, or whatever), so far, despite countless bank failures in that last 5 years, every depositor in every failed bank has been made whole.

So what does that mean about TARP and the bail-out? I think it means that the govt was going to bail out the banks by pouring money down the pipe from the top or by spreading it out in waves to the depositors. The big boys just made the choice to do the former not the latter. If those big banks had failed the govt would not have left the depositors start lining up.

And what does that mean about the long term? It means that the currency will hyperinflate, bc after another two or three rounds of bail-outs down the road, the people are going to question whether dollar bills (or iPhones with dollars on them), are going to buy coffee. And then the solutions will be much harder to come by.

Bevis Schock, St. Louis

Sep 12 2012 at 11:34am

Russ Roberts,

Reading your response Jim Feehley’s above complaint about allowing banks to use/sell/buy/trade exotic products they aren’t capable of understanding brought a question to my mind:

Did you give your children a couple of books of matches and a gallon of gasoline before you were sure they understood the concept of “fire” so they could be sure to learn the lesson about not playing with it on their own?

Russ Roberts
Sep 12 2012 at 1:29pm


One of the great challenges of parenting is to give your children a chance to fail and to learn from failure. Of course, as a parent, you still have to protect them from irrevocable harm or worse in the classroom of life.

One of the great challenges of government is to treat citizens like adults and not like children.

Mike G
Sep 14 2012 at 9:34am

This podcast seems more to be about the way in which the bailout was implemented rather than the wisdom or necessity of providing a bailout.

I took Barofsky’s bottom line to be that the government failed to defend the public interest in setting the terms of the bailout both because it relied on the banks for information and advice and because many of its officials were captured.

You need additional premises in order to conclude that a bailout should or should not have been undertaken.

Where was the mass media in all of this? Why do I have to find out from a podcast that Congress didn’t ask the banks to tell them where the money was going and didn’t set up a special prosecutor to track it until half the money was out the door? This reminds me of Iraq in 2003. It seems like the people that are most able to look out for the taxpayer in crises like these (be it officials, legislators or reporters) are either captured, too poorly informed or too weakly positioned to make a difference.

Mike Sierra
Sep 28 2012 at 3:02pm

I would have loved to hear Barofsky’s thoughts on Dodd-Frank.

Oct 2 2012 at 5:09pm


I love how honest this guy is. And bright. And unafraid.

And I love how his observations perfectly match what you would predict with even rudimentary understanding of economics. ie Humans decisions are always made to improve the standard of living of the decision maker. Economists would not expect anyone—including a government agent—to act in the interest of others unless it was in his best interest to do so. Human behavior is predictable in so far as the incentive structure around human can be known. That anyone is still surprised by the application of the fundamental assumptions of economics is further evidence of the failure of our education system.

Anyhow. Mr. Barofsky is delightful. Thank you for having him.

Comments are closed.


About this week's guest:

  • Bailout, by Neil Barofsky at

About ideas and people mentioned in this podcast:Articles:

      • Financial Regulation, by Bert Ely. Concise Encyclopedia of Economics.
      • Housing, by Benjamin Powell and Edward Stringham. Concise Encyclopedia of Economics.

Web Pages:

      • SIGTARP. Home page of the Office of the Special Inspector General for the Troubled Asset Relief Program.

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0:36Intro. [Recording date: August 27, 2012.] Russ: Let's start with TARP, which I always think of as standing for Toxic Asset Relief Program, but the "T" is actually Troubled Asset Relief Program. It was originally proposed by the Bush Administration as a way to purchase so-called toxic or troubled assets from banks to reduce the risk of some kind of financial meltdown. So, give us a brief history of TARP and how SIGTARP, the Special Inspector General for TARP got involved and how you got involved. Guest: So, TARP came about in the fall of 2008, when really the wheels were falling off of the financial system, and the largest banks, the largest financial institutions were suffering these enormous losses, largely because of their exposure to certain real-estate related assets. Bonds and Collateralized Debt Obligations (CDOs) and sort of complex bonds of bonds that were all tied to the American real estate market, and as the real estate bubble popped, those assets, those troubled assets, lost value, creating massive losses for the banks. The original idea of TARP as it was sold to Congress, as then-Secretary of the Treasury Hank Paulson and Chairman of the Federal Reserve (Fed) Ben Bernanke went to Congress, was that they wanted to get authorization to go out and borrow $700 billion in order to buy up from the banks these troubled assets, or as we called them at the time, toxic assets. So that was the original pitch to Congress, that these losses were causing such havoc in the financial system that absent some extraordinary bailout of taking these toxic assets off of the banks' books we would be heading toward another Great Depression. Of course, what happened soon after and really during the whole time period while they are pitching this to Congress, they realize that the original plan of buying toxic assets just wasn't going to work, and that instead they are going to have to actually put money directly into the banks through purchases of shares of stocks, and ultimately that is what they did after they got the authorization. So, that's sort of where TARP came from. SIGTARP was a little-noticed provision that got put into that bill, where Congress essentially insisted that there be an oversight mechanism. As I talk about in the book, the Treasury and the White House wasn't too thrilled about it and they really fought against it, but a couple of Senators, on the Senate Finance Committee, insisted that there be a new agency created to provide oversight of this remarkable expenditure of government money. So they created the Special Inspector General for TARP, or SIGTARP. And our role as Congress defined it was twofold. One, we were going to be a brand new law enforcement agency, a sort of mini-FBI for the TARP; we would go out and police and deter and try to lock up anyone who tried to steal from the program; and second, as an oversight function, to have reports to Congress, to Treasury, the American people, to the Press, reporting what was going on and to investigate and audit the activities of Treasury and the participants in this program. The idea to eliminate waste, fraud, and abuse. That's sort of how the bill ultimately came to pass. Russ: Now, I think it's important to mention--it's easy to forget--the original TARP plan, I think, was 3 pages that Secretary Paulson thought would be enough to get Congress to let him spend $700 billion dollars. Because the world was coming to an end--he said--any minute. It didn't. Congress turned it down, rejected that. It was voted down. And then two weeks later TARP was passed, and as you point out, in the intermediate time, and also I think in the implementation period, that original design of buying up assets was rejected. It may never have been the idea. We have no real way of knowing. But the other point that you make in the book that's important for listeners to understand is that you did not get on the job until half the money was out the door. Is that correct? Guest: That's right. So, TARP ultimately got passed and signed into law on October 3, 2008. I ultimately didn't get confirmed by the Senate until December 8, 2008, and started the job on December 15, 2008. And during that period of time, hundreds of billions of TARP dollars were committed and a good chunk of it went out the door before we got there. And unfortunately, without a Special Inspector General within the Treasury Department looking out for the taxpayer, looking out for potential areas where the money could potentially be gamed by the banks or be vulnerable to fraud or abuse, that voice really wasn't there. And partially, I think as a result of that, the money went out with almost no strings attached, with no mechanism tied to what we were told was the policy goal. Which was of course that the money wasn't just going to be going to the banks and help them avoid failure; but the idea was that the banks would then put it back into the economy to try to improve lending and restore credit. Do something about the incredible credit crunch that was really crushing the country at that time; and also the very, very few protections against fraud. The money just went out; and there was no internal watchdog voicing the taxpayers' interest at that time.
6:19Russ: Now, I hate to suggest that I'm more cynical than you are, but you talk at the beginning of the book about your past as a prosecutor, in a prosecutor's office. Give us 30 seconds of that and then I'll tell you why I mention my cynicism. What did you do before this? Guest: So, I spent 8 years as an Assistant U.S. Attorney in Manhattan, the southern district of New York, where I started off as a narcotics prosecutor. Was down in Colombia a lot going after the big drug cartels. And then the latter part of my career I was doing securities fraud. I prosecuted the principals at Refco for a multi-billion dollar accounting fraud for that commodities giant. And then eventually in 2008 I started up a mortgage fraud group, which was targeting those who were taking advantage during the run-up of the financial crisis of sort of the lax underwriting standards and things that made the crisis possible; and our job was to find them, lock them up, and prosecute those who were ripping off the system. Russ: So, given that past--again, I hate to sound more cynical than you are, because you have had a lot of life experiences that I haven't had, particularly those vacation trips to Colombia I'm sure were really delightful. But I have to say that when TARP passed, I have a simpler view of government. Which is: Whatever it does, that's sort of the purpose. And so what I saw TARP doing was helping banks get money. And the professed goal of the program, which was to increase lending, never struck me as a plausible one. In fact, early on in the TARP program--and you talk about this in the book a little bit, and more about other aspects of it--I remember Secretary Paulson being greatly disappointed that banks weren't doing more with the money, and weren't lending. And I thought: Well, he didn't give them any incentive. He just gave them a lot of money. And if they are worried about the future, and if their books are not very good, it's not surprising to me they are not lending. But you spent a lot of time as the Special Inspector General and talking about it in the book, that you thought this was actually the purpose of the legislation. And there were people who actually pretended that it was? Correct? Guest: Yeah, I think that's an important point of understanding what my job was. So, part of the role of SIGTARP as Congress created us was to be--and this really goes for any Inspector General for any massive government program--was to be on the lookout for what the stated intentions were of the program. And here, it's not incidental. As we all recall, TARP was not a tremendously popular bill at the time, and it failed the first time it went through the House. And it seemed like in the aftermath many political careers were destroyed by it, when it came time for re-election in 2010. But one of the things that Congress insisted upon, because they didn't want to vote for something that was just going to be purely a bailout for the banks, was these other goals, these other conditions. Even more than lending, was helping to preserve home ownership. Russ: Yeah. Guest: And to do something about the raging foreclosure crisis. And ultimately Treasury justified its use of the money in the way that it did by buying shares of the banks to prevent them from collapsing, essentially. Justified it under the idea that the banks were going to take it and use it to increase lending. So part of our job was to track that policy goal and point out the failures that Treasury had in trying to accomplish that goal. And as you said, one of the failures was a complete absence of conditions or requires or even incentives, carrots. Often the banks, to try to get them to deploy that money back into the financial system. And the other aspect of that, which we spent a lot of time, was to try to get more transparency. And the idea that we should know as American people and Treasury should want to know, as the people running this program, what it was precisely the banks were using the TARP money for. And we ran into a real brick wall in the form of Treasury of just refusing to have the banks report on that. And our idea of doing that was one general goal of good government and transparency. But second, it would help Treasury measure implementation against this goal, which was supposedly to get money back into the system. But I think you are right: One of the reasons they fought us so hard on this sort of very basic requirement of getting the banks to behave about how they are using TARP funds is that they didn't want a public record of where it was going. Because they kind of knew that was never really the intent. As we later found out, as we started doing our audit function, our investigative function, at the time that that TARP money was going out, even though Ben Bernanke and Hank Paulson were issuing Press Releases saying how healthy and viable the banks were and they would use this to deploy the capital into the system, privately they confessed to us that they had real doubts about the survival of several of these banks. Bernanke mentioned that Goldman-Sachs was soon to go, and Paulson thought that Morgan-Stanley would have been the next one to go, absent TARP.
11:32Russ: Well, the less cynical part of me says that they desperately needed to prop up these banks to keep a meltdown from occurring, and this was the politically attractive way to do it. You pretended it was to encourage lending and credit, but what it really did was to salvage the books of the banks in ways that would keep them afloat. The cynical part of me comes back, though, and says: Well, how do you know Goldman Sachs was next? I mean, who told you that? Well, Goldman Sachs, I'm sure. A lot of banks told the Fed and people at Treasury how perilous these times were. There's an event you don't mention in the book that I think about way too often, which is I think it was 24 phone calls between Hank Paulson and Lloyd Blankfein, the head of Goldman Sachs, the week before, or two weeks before the American International Group (AIG) bailout. And we don't know what they talked about. But I don't think it was their kids' summer vacation. I think it was why this was crucial for the future of mankind. I don't think it was a conspiratorial--I hope it wasn't a conspiratorial--corrupt thing where Blankfein said: Hey, we are going to lose $15 billion dollars if AIG goes under; we are expecting $15 billion. I assume he explained how desperately Western Civilization needed this to happen. Guest: No, and I think you strike on one of the major themes of the book, which is: This is part of the problem that existed then and continues to exist today, is that because of this revolving door between Washington and Wall Street, you have a government, and the Treasury Department and federal regulators like the Federal Reserve, that is so captured by the interests of Wall Street, so familiar, that when you are within a crisis or when you are crafting legislation or when you are designing a bailout program, as I saw time and time again, you go to those people for advice and guidance and your information. And not surprisingly, when they provide you that advice and guidance, it is mostly in the interests of those Wall Street banks. Not necessarily in the interest of the taxpayer or the general Main Street or the rest of the country that is supposed to be benefiting. So, I think that there is a lot of asymmetrical information flow that comes from Wall Street into Washington; and because of where these people come from and also who they surround themselves with, these arguments take on more weight than they otherwise should or would. And I saw that over and over again in the bailout. As these programs were designed and implemented, and as I fought for types of what I thought were really basic types of protections and transparency, like, how do you, how are they using the TARP money, they would just call up, get the arguments, and recycle and regurgitate them to me or to members of Congress. And so you have this identification at the highest levels of power in Washington, with the Lloyd Blankfeins and the Jamie Dimons and the various CEOs. Because those are the people that they rely on. And those are the people that they trust more than anyone else as knowing what the right thing to do is. So I think you are absolutely right, actually, and that cynicism is well-founded. So, although, I truly believe that Ben Bernanke and Hank Paulson and Timothy Geithner, who was then President of the NY Fed, truly 100% believed that they had to do exactly what they did lest it be the end of civilization, a lot of that information was coming from the institutions and executives who benefited the most from it. Russ: And I like to remind my listeners that many economists agreed with them; but I also think they have a conflict of interest as well. Because economists benefit from a powerful Federal Reserve [Fed] and powerful Treasury. And I think as economists we should be speaking out against these claims and asking for evidence rather than saying: Yes, yes, it was absolutely necessary. Now, to be fair to the other side, for a minute--don't worry too long, Neil,--but to be fair to the other side one of the complaints that you received, constantly, one of the arguments you received constantly when you demanded some kind of accountability some kind of accountability about what we being done with the money, what was being done with the money, was the response that: Money is fungible. We can't say we can do with this dollar. It's not even really meaningful. How did you try to answer that claim often? Which is a legitimate claim, often. If I give my kid $20 and I say, "I want you to spend this $20 on history books and not on comic books," ultimately what I've done in the standard view of economics is I've given him more purchasing power, and he's going to buy more of everything, perhaps. And he'll just say, well, those are the dollars that went to the history books--and the comic books, I didn't use your money for that. So, what's your response to those kind of arguments?
16:21Guest: So, first of all is to accept the fact that money is indeed fungible. And that is sort of one of these tautological statements that is true. But our point was that that doesn't necessarily mean that you couldn't have some meaningful measures. And, not being an economist myself, I went to some accounting friends. I did have experience doing money laundering investigation, where tracking money was very much part of the job. And you know the counterexample I would use, that I remember saying to Neel Kashgari, who was running TARP at the time, and I think later to Tim Geithner himself, who was then the Secretary of the Treasury, was that I was kind of in a situation where I came into a little bit of money, say $5000, a bonus that I had received. And you know, it's true that money went directly deposit into my checking account. It got comingled with the rest of my money. But what I did was use that $5000 and paid off my student loan. So, if you did it before and after, a snapshot of my personal finances before I got that money and after I got that money, you could pretty much trace that that money went for that intended purpose. And then if you were to ask me and say: Hey, what did you do for that money and did you have any specific plans for it? I could say, well, yeah, I got it and I used in that way. So we tried to build a model around that kind of basic common sense idea of snapshots. What are your positions afterward? First you ask the banks what they were going to do with it, and then you measure the difference. So, what happened to lending levels before and after? What happened to acquisitions? We know a lot of the banks told us that they used it to acquire other banks. Others told us that they used it to pay down lines of credit that they had from other financial institutions that pulled the money out from under them. So what we tried to do was that we were never going to be able to perfectly trace every single dollar. But you could get a good snapshot, so you get a general use. And we also found out, once we asked ourselves these questions, that the banks did try to track dollar for dollar what they did with the funds. Including some of the big banks. So it was a challenge, and it wasn't necessarily easy; but in the interest of good government and in the interest of providing that level of transparency, it made it possible. But one of the interesting things was, as I repeated these arguments over and over again, I never really got a fair listen. I was told that I was stupid. I was told that I didn't understand anything. That I was being political. That I was grandstanding. And ultimately, you know, it was never a real discussion so much as it was a repetition of the lines that had obviously been fed by the banks --that it's just not a possible thing and there's no interest in doing it. Russ: Well, I like the argument that says that if you require the banks to make a report--it could be a flawed report; I accept the issue of your critics that it's hard to do. I don't think it's impossible. I accept the argument of the critics that it's imperfect. But you'd learn something. I think that's the main point. If you had forced the banks to report on what they did with the money, maybe they'd lie. Okay, they'd lie. And maybe the before-snapshot would be distorted. Or the after-snapshot. But you'd learn something. But one of the arguments you kept getting was: Oh, that will cause banks not to participate. And talk about that. Guest: That was not just about this piece, but almost any time that we identified a conflict of interest in one of the TARP programs or vulnerability to fraud, and we said it was important to close this loophole or bring this level of transparency. And even later when it was just enforcing Treasury's contracts with some of the big banks, mortgage modification programs, we would keep getting that same response: Well, the banks will just walk away, the banks won't participate. And you know, with respect to this, my response was a pretty simple one: If you have a bank that is so frightened by a little bit of transparency that they'd rather not participate than disclose this information, wouldn't we be better off with that bank not participating in TARP? Do we really want a bank that is so unwilling to have basic transparency not to make the effort to report on what they did with the money? I mean, it was sort of--I would always attribute it to the fact that they would go out an talk to a couple of banks, and say: What do you think about this? And the banks would always say: Well, if you did this, we would walk away from the program. They specifically told us later on that that was the response from some of the financial institutions. And Treasury was never really willing to push back on that, and instead they sort of went with this: You are going to destroy TARP, you are going to destroy the banking system--as I was later told, when I decided I needed to go out and do my own audit and try to bring some level of transparency to the system.
21:10Russ: Well, while we're talking about transparency, let's talk about one issue that--really, I follow this in the paper, in real time, obviously; it's quite entertaining to read about it in the book. And I should add, the book is a really engaging tell-all about what life in Washington is like, alongside the details of the bailouts. But one of the things that you achieved and that the book talks about nicely is the gap between the public pronouncements of how successful these programs had been versus the reality. So, I'm sure many people have heard that the auto bailout paid for itself; the government's broken even; we made all the TARP money back--there's a few small banks that haven't paid back. And some of these statements might be true; some are not true. Why is there a gap between these public statements--which should be checkable? And transparent as can be? It's our money; why is it that some of the government's statements about these amounts are not accurate? Guest: The program became more and more politicized during my time there. If you can believe that. Politicized as it was when it first started. But over time, I started seeing Treasury's announcements started becoming more and more deceptive. A lot of half truths, a lot of sort of very thinly slicing things so that they would be literally true but really when looked in a broader context were potentially misleading. So, for example, you'd hear a lot about how they made money on the banks, and they would give a number by slicing a few of the TARP programs; but it's not always clear whether they are including, like, Allied Financial, which is a giant bank for which Treasury is going to lose a lot of money; but the response would be: No, that's in the auto program, because that was formerly GMAC, so that doesn't really count. Or they would ignore the bailout of AIG, which was really done to save the banks by paying them out huge amounts of money on money that AIG owed them and otherwise wouldn't have been able to pay. But they'd say: Well, that wasn't really a program about the banks. Or they'll change their accounting method, which was something that they did with AIG, to make it look like the potential losses were going to be a lot less than they ultimately turned out to be. And in 2010, shortly before the midterm elections, Treasury put out this document and secretary Geithner wrote and op ed, and they hit all the cable TV shows talking about how the numbers had gotten so much better for AIG; but didn't disclose that that was mostly the change in accounting methodology. And really, there are so many things that are bad about this, for what it does about how Americans perceive their government and how we perceive the Treasury Department, which is now with almost zero trust, as polls indicate. But it was also so entirely unnecessary. Because in this area of potential losses from TARP, it is one of the few areas of success. When you compare to where we thought we were going to be, back in 2008, and where we were in 2010, 2011, and today, the losses are far, far less. I think the total most recent estimate is about $60-$70 billion that Treasury estimates to be lost from TARP. Which is a lot of money, but compared to the $350 billion that we anticipated back then, this is good news. But there's this need in Washington, over and over again, from the White House, from the political arms of Treasury, to take something that looks good and make it look great, even though that isn't necessarily true. And that's just part of Washington. I think lying is so embedded in the culture there that when you say something that's literally true, people really begin to believe that it's the absolute truth and anyone who criticizes it is out of their mind or a partisan hack or has some other malevolent motive, which is ultimately what was ascribed to me as I started pointing out these half truths and potentially deceptive statements that they were making. Russ: Which is a little ironic, because as you point out in the book, you are a lifelong Democrat; you were appointed by a Republican President, but part of the reason you were appointed was you were credible. Guest: And ultimately, I found out much later, because I was a Democrat in part, too, because they thought that that was the one way to get me through the Democrat-controlled Senate. In the waning days of the Bush Administration. But I contributed to Obama's campaign back in 2008; I was a Democrat all my life. But it was somewhat funny when they started spreading rumors in the press and leaking information--one time I was called a closet Republican. Which I thought was funny. A Grassley Republican--Senator Grassley--I'm not sure what that means. And even that I was planning on switching parties and I was going to become a Republican and run in 2010 to be NY State Attorney General as a Republican. I would hear these things, I would hear them from the press: Oh, Treasury is telling me this. That type of lying and that type of character assaults is just so typical in Washington. But that's sort of how it works. I actually think that for a lot of these folks they just don't understand people coming at and making these types of criticisms just because it's your job to do so. It's almost like they have to believe that there's some partisan or political motivation behind it as opposed, God forbid, to just trying to do your job. Russ: Yeah. It's a form of witchcraft. It's a belief that there are these secret forces at work that are casting spells on otherwise good people.
26:55Russ: Let's talk briefly about two programs that we've never talked about explicitly on this show, that it would be nice to get a little bit of education for me and the listeners, which are Term Asset-Backed Securities Loan Facility (TALF) and Home Affordable Modification Program (HAMP). We won't get into the Public-Private Investment Program P-PIP--you talk about that in the book as well. But TALF and HAMP were large-scale programs, or at least hoped to be. What were they and how did they work; and how did they fail when they failed? I wish we had three or four hours for this. But take five minutes. Guest: TALF was sort of a moderately successful program. It was originally intended to restart one of those markets that had been destroyed in the financial crisis, and those were bonds that were backed by consumer loans. Russ: Car loans, right? Guest: Car loans, student loans, those types of things. When the bottom fell out on the other asset-backed securities, the mortgage backed securities, which were of course these toxic assets which were the heart of the crisis, all those other loan-backed bonds, those markets all disappeared as well. And they, like the bigger mortgage-backed market, turned so much on credit rating agencies. And the credit rating agencies which of course assigned their opinion, their letter grade, to bonds based on their opinion as to whether or not they are going to default or not, were so thoroughly discredited that it went beyond just the mortgage-backed securities but went into all these other things as well. And since a large amount of consumer debt in this country comes from these bonds, and investors who buy these bonds enable so many of these auto loans and student loans and others, the idea was to bring that market back. And originally it was imagined to be a $200 billion to ultimately at one point a trillion dollar program. Ultimately I think the number came in the $70s [?]. But one of the sort of striking things in the book, as I was getting up to speed, and I realized--this was a program run by Treasury and the New York Federal Reserve--that they had no fraud protections in there. There was really no concern about fraud. There was no compliance program. And when I was pressing them I eventually got a meeting with Bill Dudley, who of course now is the President of the NY Fed. I think at the time he was the Acting President. And I was on a phone conference with him and I asked him, I said: Well, what are the protections going to be for the taxpayer? Because this program, the way it was originally designed, was just so vulnerable to abuse. Russ: Talk about that. Talk about the details of how it was going to work. Guest: The way it was going to work was that a private investor would put up a small amount, let's say 5% of the purchase price, to buy one of these bonds. And the federal government, through the Federal Reserve, was going to provide the balance--95%. But it was going to be in a loan that they called a non-recourse loan, which meant that the borrower never had to pay it back. So that they could essentially walk away: if the value of the bond decreased more than 5% they could just walk away and the taxpayer would be in the hook. And TARP [?TALF] money was going to backstop those potential losses. So, that created a lot of opportunity for mayhem, in our view. You could have collusion between the bond seller and the bond buyer, a kickback scheme, or you could just have really sloppy underwriting, because the investor-- Russ: the incentives-- Guest: has a lot of upside but a very limited downside. So, that's what we saw, and that's what we pressed--how are we going to protect the taxpayer? And ultimately what Dudley told us was they were going to rely on investors' smartness, and, once again, the credit rating agencies. And my reaction at the time was one of shock, that here we'd just had a financial crisis that proved that credit rating agencies were not to be trusted, and that investor due diligence, even when they are on the hook for all of the money, can't really be trusted; and now the Federal Reserve and the Treasury were going to recreate that system, only put a giant government guarantee behind it. And when I asked him how he could possibly trust the ratings agencies, his response was very telling. He told me that he didn't think that the rating agencies would ever "embarrass themselves again," and that they were going to bet $200 billion of taxpayer money on the rating agencies' suddenly becoming very competent at their jobs because they wouldn't want to embarrass themselves. And I thought that really captured a lot of the capture of Washington and a lot our regulatory system, that they were willing to recreate this very same broken system. And during that same conversation he refused to have any type of compliance regime in place. And that was sort of shocking to me. Fortunately, we were able to go to Congress, go to the Senate, and get enough pressure put on the Fed that they ultimately did make it a much safer program. Russ: And how active was that program, do you know? Guest: I think it was about $70 billion that went out, and I think in large part the protections were able to get them to adopt--I think it's a program where the taxpayer won't lose any money, and may even actually have a little bit of profit from the interest they charge. Russ: But like you--as you point out in the book--my view always was: Why would we want to recreate something that just almost destroyed our country? The whole idea that we have to get back to the status quo, even if the status quo was horrifying, is horrifying to me. The other point I want to make, which I think is really important: Reputation plays a very important role in free markets. It's a very powerful, I think, incentive for prudence and diligence, and honest dealing. But it doesn't work when you have a government monopoly. It doesn't work when you take out the costs or greatly subsidize the costs of losses. So the ratings agencies, they're not really free market organizations. They are--I was going to say government-created; but they are not government-created--but their power is government-created because of requirements by government that if people want to buy your bonds or if you issue bonds, that they be rated by these two or three, I think--I think there's three that are allowed to do it. They did a horrible job. And in a normal world, they'd be gone. Imagine if a clothing company sold you clothes that fell apart or poisoned you or gave you cancer, and they did it for years, and then they said: Well, we won't do that again; we don't want to be embarrassed. You'd go buy somewhere else. But right now there's not such an easy place to go buy somewhere else because of the way this has been structured. I really believe--I don't think anybody was very fooled by it. I think most investors understood--not all of them but most--that they were compromised. As you point out in the book, I think many people understand that. They profited from the ratings that they gave. It was obviously a crummy system. And the fact that it persisted tells you there's something unnatural about it. Guest: And the remarkable thing is that the whole reason why there was a TALF program was because the market said: We're not going to trust the ratings agencies any more. Russ: Exactly. Guest: So we build this program which just puts the government in a position for massive losses and the one thing that gives them comfort is: We will trust the rating agencies. But your argument is correct, and it's the same thing for the largest banks. I kept hearing that same reputational risk defense with regard to other programs with other types of anti-fraud measures that I didn't need to worry because banks would never risk their reputation by putting profit over the public interest. This very Greenspanian concept that reputational risk is all we need instead of fraud controls--it just doesn't work when banks are being supported implicitly and explicitly by the government. Because that changes it. If you know you are not going to fail, your reputation becomes a little bit less important to you when you know you have an opportunity to maximize profit in ways that go up to the line and often cross over it.
35:17Russ: And let's now turn briefly to HAMP. Talk about what HAMP was supposed to do and why it didn't work very well. Guest: HAMP is the Home Affordable Modification Program. And when TARP was passed--we mentioned this a little bit earlier--there were a lot of Democrats particularly in the House who were not keen on a bank bailout of Wall Street. And their pound of flesh--what they demanded be put into the bill--was foreclosure relief. Because a lot of their districts, by October 2008, the foreclosure crisis was raging and really destroying whole neighborhoods. So what they extracted from Treasury was a promise that TARP wouldn't just be used to help the banks but also homeowners. And they even built provisions into the legislation that said that once the Treasury was doing what it supposedly said it was going to do, which was buy mortgage-related assets, and once Treasury owned $700 billion essentially worth of mortgages, the Treasury would then have to do a modification scheme to make these mortgages more affordable--whether it's reducing principle or doing interest rate modifications. And that was sort of what they did to get the Democrats, a lot of these Democrats, to vote for the bill. Without which the bill never passes. Well, of course they leave the original toxic assets purchasing idea. And we come to January 2009, after Obama has been elected; and Larry Summers, who is coming in, the new Administration, trying to get Congress to release the second half, the $350 billion of TARP funds. And Barney Frank and a lot of House Democrats, once bitten, twice shy--they know, we are not going to do this unless you commit to putting up at least $50 to $100 billion to help homeowners. And that's where HAMP was born, in a letter that Larry Summers sent before Obama even took power, promising that there would be this program. Now, the program that was launched--and the President said it would help up to 4 million homeowners stay in their homes--unfortunately it was just a disaster. It was remarkably poorly put together. It trusted the banks' servicing arms to carry out the program on behalf of the Treasury Department. And it was riddled with conflicts of interest that often gave the banks the incentive to actually string homeowners along, rack up a lot of fees, and then pull the rug out from under them; throw them into a foreclosure scrap heap; and then under this incentive-based program, it would actually be more profitable for the banks in some instances to do that than actually modify the mortgage on a permanent basis in the interests of the homeowner. So, as to why Treasury did this, I think it was partly because of just disastrous planning. But part of it also what the true intent of the program was. So, what I talk about in the book, how in late 2009, when it was becoming more and more obvious that this program was never going to come anywhere close to its goal of helping 4 million people permanently stay in their home--today, it's about 20% of that number--we're at a meeting where Secretary Geithner is confronted about: How is this program ever going to meet its goals about helping homeowners? And his defense is very telling. He explained that Treasury believed that the banks could handle a certain number of foreclosures. I think he said it was about 10 million. Over a certain period of time. But anything more than that could threaten the solvency of the banks. And in other words, we could be back to plugging more capital holes in the banks because of the foreclosure crisis. And that he saw HAMP as a way, and the exact words he used, was: Foam the runway for the banks. In other words, to extend out the foreclosure crisis so that all those foreclosures wouldn't hit all at once and give the banks an opportunity, as another Treasury official told me, to earn their way out of it. Help repair their so-called fortress balance sheets, take advantage of the other TARP programs, of the other 0%-interest rates and all the other federal programs to support the big banks, so they could get through that. And once we heard that, and once you understand that, the failures of HAMP start to make more sense. Of why they had these terrible conflicts of interest baked into the program. And even after we pointed them out to Treasury, they stayed in there. Why, when the banks just abused homeowners in this program, just absolutely trounced all over their rights under the contracts, why Treasury refused time and time again to hold the banks accountable and have them actually, either punish them or require them to adhere to the terms of their contracts. It all starts to make sense. This program, just like all the rest of TARP, wasn't really about helping the homeowners as it was, in Geithner's words, to foam the runway for the banks. So, that's why I think the program failed from a homeowner perspective, but was probably successful for Geithner's ultimate goal, which was again to help extend things out for the benefit of the banks.
40:16Russ: While we're talking about Geithner, I want to talk about his role in the AIG bailout. Which you correctly point out, which I always like to do, that it wasn't so much a bailout of AIG as a bailout of its creditors, people who had promised to insure on their various financial instruments. You give the figure I think of $14-something billion for Goldman Sachs. That's number 2. Societe Generale of France, a French bank, was number 1. I can't remember the figures, but quite a bit higher. So, these are the people that benefited from the AIG rescue. Not so much AIG. But of course the executives at AIG. They benefited. They got the controversial bonuses that they were promised. An alternative as you point out would have been to let them go bankrupt. Let AIG go bankrupt and negotiate with its creditors to take what's called a haircut. To say: Well, we owe you $14 billion. You don't have $14 billion; you only get $8 or $4 billion, whatever it would turn out to be. Why didn't that happen? And how did you get involved in that, ex post? Because you were not on the job at that time. There was no SIGTARP. Guest: So, this is part of our audit function, because ultimately TARP ended up backstopping, about $70 billion of TARP money went into AIG as part of the more than $180 billion dollar bailout. As you said, not of the company but more importantly of its counterparties and creditors. And you sort of have to remember, for almost every one of the bailouts, it's partly about the institution and the executives, but it's more so for the people who that bank or institution owes money to. And those are sort of--and whether, what's going on right now, in the European governments-- Russ: Yep, same thing-- Guest: that's really a bailout of the European banks that lend money to those governments. It's almost always about the creditors, and those creditors are almost always about the large, too-big-to-fail, banks. But we got involved--we got asked by Congress to do a review of the decision that was made by Geithner when he was still President of the NY Fed, to pay the banks, as you said, 100 cents on the dollar for what were essentially a bunch of toxic assets, $60-something billion of toxic assets, that AIG had insured and ultimately the government bought those bonds from the banks and ripped up the insurance contracts, at 100 cents on the dollar for a bunch of bonds that were really worth less than half of that amount and which would never have gotten paid but for the government bailout because AIG just didn't have the money. It's why AIG ultimately had to get bailed out, because they didn't have enough money on hand to make the necessary payments under those agreements. And ultimately, Treasury, I mean, NY Fed and Treasury didn't actually have to put AIG in bankruptcy. They could have just used their leverage-- Russ: Correct-- Guest: to try to negotiate those types of haircuts so it wasn't 100 cents on the dollar. And when we started digging around and doing our report, we found that they actually did make some minimal effort. Because even it was apparent to them that this was such an unfair and unjust result that the taxpayers to bail out AIG and Goldman Sachs and Bank of America and the French Banks were all kind of this incredible windfall, for on them was not recognizing the counterparty risk, when they unloaded so much of their own risk onto AIG through these credit default swap insurance contracts. But of course what followed was this incredibly lame effort, negotiated, as we discovered and reported. You have a great contrast between when the government understands that it has leverage and uses it, such as when the original money went to the TARP banks or even going back to the bailout of LTCM more than a decade ago. There is government understanding and getting a result, but none of that was here. None of the CEOs were called. Geithner himself didn't get involved in the negotiations. He had mid-level guys at the Fed call up mid-level folks at the banks and say: Hey, do you want to take a haircut? You don't have to, but if you want to, that would be great. And the banks said: No. And actually, one of the banks even said: Yes. Russ: I love this. Tell this. This is one of my favorite--it's black comedy but go ahead. Guest: So, we do this audit, and this audit is going on for six months. And we're told, time and time again, I even in talking to the General Counsel of the NY Fed, that none of the banks were willing to negotiate. And then, really right on the eve of our report, as we do our sort of final review, someone at the Fed raises their hand and says: Oh, yeah--UBS actually offered to take very much, a 2% haircut. But still, a haircut. And by the way, didn't we tell you that? No, in fact, they hadn't told us that. We later found out that wasn't the only information that they hadn't told us. And when we went back and looked at it, UBS made this offer, but the Fed did nothing with it. Part of the offer was they said that UBS said, Well, gee, others might also might also need to take this similar haircut for us to be willing to do it. Russ: And they all refused. Strangely enough. Guest: But the problem is the Fed didn't even go back to the others and say: By the way, UBS is willing to do this; won't you do this? The Fed didn't go to UBS and say: Enough with them; why don't we take your 2%? They just walked away. They said: Oh, okay, thanks. And moved on and just paid everything out. And it really was this remarkable lack of effort. And I think as somebody once told me from inside the NY Fed: It's almost as if they felt they couldn't be embarrassed enough. It was almost demeaning for the Fed, for them to go out and try to actually negotiate haircuts. There's no effort into it. And as a result, all that money got paid out. And you have another windfall for banks, who again, under a normal functioning market, a free market, get punished for that counterparty risk. Russ: Yep. Guest: For putting such big bets on with AIG. Which they had to have known, that AIG would never be able to pay off if we had a housing crisis. But again, the whole presumption of bailout so underlies our market that we don't have a free market. We have a government subsidized market that encourages inefficiency and encourages really unfair and unjust results. And when actions are taken, like Geithner did with AIG, it just reinforces all of that unfairness and inefficiency in our markets. Russ: I'll read the quote from p. 181, paragraph, it says: "In that respect, Geithner's opening of the spigot of taxpayer cash for AIG was more of a bailout of the banks than it was for AIG itself. The government thereby sent Wall Street a very dangerous message. Counterparties who do business with financial institutions, whose collapse could have devastating consequences for the entire financial system, needn't do due diligence or worry about their counterparty risk. Instead, they can rely on the government to bail them out". And to me, the tragic-comic part of this is the 2% offer. It's like out of guilt. I don't know why it reminds me of it, but in the Robert Caro biography of Lyndon Johnson, in the second volume, he details in great detail the voter fraud that the Johnson campaign perpetrated to defeat, to win the Senate election. And one of the forms the fraud took at one point--there were many forms, but one was--hundreds of people voted who were not registered. And they voted--these extra votes that came in late--were in alphabetical order. They didn't even bother to make it look random. They were in alphabetical order. People just strangely enough, a few hundred people, or dozens, I can't remember the number, just showed up by chance in alphabetical order! Except for one. One of them was out of order. And I always viewed that as the cheater's way of saying: Oh, no, no, it couldn't be deliberate! Look, they are not in alphabetical order! One of them. So, you offer a haircut. There have been negotiations, prior to the government stepping in, where there were serious haircuts being proposed, and Goldman and others were negotiating with AIG. And when the government comes in it's like: I'm done now; I don't have to negotiate. And so, UBS offers 2%? I mean, 1% would be like a total slap in the face. Two is like, well, I didn't offer one! I just find it--it's incredible. Guest: It was the bankers' equivalent of giving the valet, when they pick up your car, a $5 bill. Russ: Yeah, exactly. Guest: And what Geithner did, what the government did, was say: We don't want your money. And it is tragic; it is comic; but those dangers that were impregnated in the system we're still living with today. And we still operate under a system with these [?] to fail banks and these dangers who learned very carefully--markets watched and learned a lesson from 2008 and by having not solved that problem, we still have those inefficiencies and distortions and the absence of market discipline, which is going to set us up for another fall. Russ: Yeah, I agree, obviously.
49:28Russ: Now, you tried to get Tim Geithner to justify those decisions. And I'm going to ask you two questions, neither of which is particularly pleasant to answer. One is: how successful were you? And the second is: He's kind of the villain of your book. There are a few, but he's one of them, maybe the big one. What do you think he 'd say--what do you think he will say when he writes his memoir? Guest: Oh, that's actually a good question. I can't imagine it would be remarkably complimentary. He did say after the book came out--he was interviewed on Charlie Rose and mentioned how deeply offended he was by the suggestions in my book. Actually, he said "suggestions." I actually stated it, that he put the interests of the big banks over that of Main Street and of the taxpayers and small businesses and all the other people he was supposed to serve as Treasury Secretary. So, I'm sure we'll see some of that. And ultimately, on the AIG issue, and we saw this a lot, basically indefensible position, is that they don't answer the question and it's stuck in: We had to do it this way. If we hadn't bailed out the, paid 100 cents on the dollar, the financial system would have collapsed, and we had no leverage at that point, and it would have been inappropriate for us to use any leverage that we had. But one question he never answered was why didn't he at least try harder, use some of the same mechanisms he had used previously with getting the CEOs together and really putting the pressure on them personally. I never was able to get an answer from him on that ultimate question. And that's because there really is no answer. Russ: Yeah. Guest: You can't answer a question for which there is no answer, or at least no satisfying answer. And I strongly suspect that when he writes his memoir he will also not answer that question, but instead talk about how deeply offended he was. Russ: Now one of the puzzles of his tenure--and I could be wrong about this so correct me if you know otherwise--he is not part of the revolving door in a literal sense. I think he has never worked on Wall Street. He has hired many people who did. He was put into the NY Fed I think by Wall Street, meaning the help of Wall Street people who recommended him. As far as I know, he is not part of the revolving door in a literal way. Is that correct? Guest: Absolutely correct. I think he worked for Kissinger's consulting firm for a very brief period of time, but he's not--I mean, the way we traditionally think of the revolving door certainly not. But it's important to remember that the type of capture, the type of regulatory capture often happens for people who have not yet worked on Wall Street. And in Tim Geithner's case, he worked for a thoroughly captured institution, the NY Fed, where his board members were Jamie Dimon and [?] of big commercial banks in the NY District. And his peer group and the people he relies on for advice when he was there. And then when he came to Treasury Department, he surrounded himself with Wall Street refugees. His closest counselors were people like Lee Sachs from Bear Stearns, later one of the architects who really oversaw the creation of some of the most toxic CDOs when he was at Mariner before coming back and working for Geithner. The people running the TARP all came from Merrill Lynch, Bear Stearns, Goldman Sachs. So, he surrounded himself, and all of his key advisers, the people he was relying on in forming policy all came from within this echo chamber. And there was no diversity whatsoever at Treasury when it came to the bailouts. Other than perhaps Secretary Geithner. But he was such a creature of that system from where he came. And if you look at--you know, talking about phone records--Tim Geithner, I probably had two meetings with him, 1-on-1, during my two plus years with him, one of which lasted 30 seconds; the other one, he screamed obscenities at me for 45 minutes. When you compare that to the number of times he had telephone conversations with Lloyd Blankfein or any of the other CEOs, it gives you a sense of where he is seeking his advice, where he is receiving his advice. One of the things I often joke about is, Elizabeth Warren, who was the head of the Congressional Oversight Panel, who I dealt with a lot when I was doing my own oversight: What if you had someone like that instead of providing oversight of the bailout actually inside that bubble? Working on the housing program? Some sort of diversity of voice. A consumer advocate, a housing advocate. But it wasn't. And that makes it very easy, of course, to discount those views, to rule them out as being stupid or politically motivated. Which is what Geithner and his team did to any dissenting voices. And when you maintain this kind of echo chamber. And the second part of this is: one of the aspects of the revolving door is that there is a huge incentive for people within the government to get those jobs on Wall Street, and shaping what they do. And I was told point blank by Assistant Secretary of the Treasury that I was harming my own interests in getting one of those jobs one day, by my tone, by my harshness and my criticisms of Wall Street and the government, and that I needed to change my tone. And so there's also still that promise of reward if you do right by Wall Street. I think it's interesting: in Ron Suskind's book, he quotes the Wall Street CEOs as saying Tim Geithner referred to him as "our man in Washington." And there's an eventual payout for that type of role, I imagine. Russ: Well, Mr. Orszag had a very lucrative post-Washington job working, I think, for Citi. Guest: And if you look at it, it's not just Citi. It's Goldman Sachs. So many of the people that I had seen and dealt with while I was down in Washington have now landed in one giant investment house that benefited from TARP or one other giant bank that also benefited from TARP. It's really almost across the board.
55:45Russ: So, how can we, other than educating ourselves, listening to EconTalk and reading Bailout, all of which are good things, of course, how can we do something about this? I like outrage; I think being incensed about this aspect of the Treasury is a good thing. And I think people did pay a political price for failing to, or for being complicit in it--some politicians did. But it doesn't seem we've made a lot of progress. What are your thoughts on how we might get a better relationship between Wall Street and the government? Guest: I think there are a few things we need to do. I think we have to choke off--you have to go to the corrupting influence itself. And to me that means truly ending Too Big to Fail and the promise of future bailouts by breaking up the banks. If you break up their power and influence you can start chipping away at some of this wholesale capture of the regulatory system. There's less power that comes with these implicit guarantees and some of the perverting sense and all of that lobbying money and all of the dangling of those jobs. That will help. I think we have to do something on the regulatory side to change the incentives of regulators. So, I was told point blank that I was ruining my career by being harsh. I think a lot of other regulators aren't told that explicitly, but it's still built into the system that if they pull their punches there's a big cash-out. Whereas if they do their jobs aggressively, they may actually get punished. I think we need to change the incentive structure on the regulatory side. And the third thing we have to do is stop voting for people who are going to affirm the status quo. And when every time we reelect someone who refuses to take on these issues, whether it's a position on Too Big to Fail or the banks or a broken regulatory system, with our votes we reaffirm the status quo. That's part of it as well. Russ: And if I could just make a mildly depressing observation: It seems unlikely that this issue--which I feel is the central issue, other than the size of government--the central issue facing our country is this relationship and the potential for future damage caused by past bailouts and recent bailouts. It doesn't seem to be on the radar screen of the political campaign, and seems unlikely to be. And it just--we might have to wait a little while. Guest: I think that's true, but you do start hearing hints. From very unlikely sources. Romney, the other day, in a campaign speech, talked about how Obama has made the biggest banks bigger. Ryan has flirted with the idea of a Glass-Steagall, in some of his speeches. And I agree with you--I think the money and power are too important, too much flows into the campaign. But the fact that they are even talking about it gives me some slight, slender reed of hope. Probably not in 2012, but maybe 2016, or even maybe hopefully 2014, that we can get a movement going. Russ: Yeah, could be. There's some hope. I want to close with a personal question. You went through some extraordinary experiences with your book; obviously it's imperfect, what it captures. It's not a long book. I think it's 230-something of text. 234. So, that recommends it to the average reader. And if you read it, you'll learn a lot about the bailouts and TARP. But you'll also learn a lot about Washington. And I'm curious what you learned about Washington. You don't reflect on it much in the book. It's kind of obvious that you got hit upside of the head a few times, shocked, jarred, and beaten by the nature of Washington. But I'm curious what your reaction was and if it changed your view of government in any way. Guest: It certainly did. I didn't realize how captured by the interests of Wall Street Washington was. And how often it does not serve the American people as it does, relative to the people who are funding the town through campaign contributions and through lobbying. That seems like a pretty obvious statement most people know and understand. But it was--I think I was a true believer in 2008 of President Obama, and I really believed that everything would be different. And that he was an agent of change and that he would bring the type of meaningful change to our government that we so desperately needed. And what I saw firsthand was, and perhaps the thing I learned the most was, just how little difference there was between the Republican Administration and the Democratic Administration. It's not that one was better or worse than the other. It's just that they were remarkably the same. The same exact arguments. I think the tricks were a little dirtier with the Obama Administration, but I don't think that's attributable to the political party. I think it's just that they had more time . Russ: They got better at it. They had to hone their skills. Guest: But I think that was the thing I learned the most. When you fall into these campaign ads and sort of believe that one side or the other is fighting for your interests, the reality is: You can't listen to what they say. You've got to listen to what they do. And what they do is--there's remarkably little difference when it comes to these types of core issues that have become most important to me. So, it's kind of a depressing thing. But I also did see, on the optimistic side, there are people out there who care. There are some good civil servants. And there's members of Congress who really sacrificed their relationship with the White House in order to go to bat for us and try to give us the power to protect the taxpayer. Even when they were undoubtedly getting calls from the White House chewing them out for being supportive of me and our agency. So, I do think there are some glimmers of hope in that most hopeless of all institutions--Congress. And that's why I say, look, there isn't really a Presidential candidate to vote for who is going to do the types of real, meaningful reforms for our financial system. But there are members of Congress, running for Congress, who will. And to me, that's a good place to start.