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April 24, 2009, 1:42 a.m.
TARP Looking More Criminal by the Minute
The issue of TARP corruption may now extend from corporate CEOs and federal regulators to New York’s attorney general.
By Donald Luskin
Is TARP a criminal enterprise? When a CNBC producer called me on Wednesday to see if I’d debate that question on the Kudlow Report that evening, I thought the allegation was ridiculous. How could the U.S. Treasury’s Troubled Assets Relief Program to rescue the banking system possibly be compared to the Sopranos?
But now I’m not so sure. Yesterday’s sensational claims by New York Attorney General Andrew Cuomo — that Ken Lewis, CEO of TARP-recipient Bank of America, was pressured into what amounts to securities fraud by the Treasury and the Federal Reserve concerning his bank’s acquisition of Merrill Lynch — throws the question right into the headlines. It raises issues of corruption all around, and at the highest levels — from corporate CEOs and federal regulators to Mr. Cuomo himself.
What originally prompted my friend Larry Kudlow to ask if TARP is a criminal enterprise was Wednesday’s report to Congress by TARP’s special inspector general, Neil M. Barofsky, in which it was disclosed that “nearly 20 preliminary and full criminal investigations” are underway, including “large corporate and securities fraud matters affecting TARP investments, tax matters, insider trading, public corruption, and mortgage-modification fraud.” When I first read that I rolled my eyes and said to myself, “Hey, what do you expect?”
But then I started thinking a little more deeply and realized there’s something more here — even before the controversy about Bank of America became known. The more I thought about it, the more I realized how that enormous pot of TARP money has in fact corrupted both the private and public sector.
For example, Barofsky says he’s doing an “audit” to respond to reports that “external parties may have sought to influence decision making by Treasury or bank regulators in considering and deciding on applications for funding” from TARP. Perhaps this refers to the controversy that surfaced last January when it was said that Barney Frank (D., Mass.), the powerful head of the House Financial Services Committee, intervened to get TARP funding for a favored constituent, Boston’s OneUnited Bank. According to the Wall Street Journal, “Mr. Frank, by his own account, wrote into the TARP bill a provision specifically aimed at helping this particular home-state bank. And later, he acknowledges, he spoke to regulators urging that OneUnited be considered for a cash injection.”
Is that the “public corruption” Barofsky is talking about?
Barofsky says he also is “auditing” the “Treasury’s decision making regarding the first nine institutions to be considered for TARP funding in October 2008.” His report says nothing more than that, but inquiring minds want to know — and this inquiring mind can guess.
It’s easy to guess that Barofsky is looking into the possibility that Treasury Secretary Henry Paulson coerced the CEOs of the nine largest banks to accept capital investments from TARP, even though several of them didn’t want the government as a stakeholder. Wells Fargo chairman Richard Kovacevich, for example, says that he was “forced to take the TARP money.” Philip Swagel, who served at the time as assistant secretary for economic policy at the Treasury, admits that “there is no authority in the United States to force a private institution to accept government capital. This is a hard legal constraint.”
Is that the “public corruption” Barofsky is talking about?
But then again, the Emergency Economic Stabilization Act, the statute that authorizes TARP, doesn’t give the Treasury the power to make direct investments in banks at all. It gives the Treasury the power to buy troubled assets and to write insurance against losses in troubled assets. But there’s not one single solitary word in the act that authorizes the Treasury to buy stock in banks.
And there’s not one single solitary word in the act that authorizes the Treasury to do anything at all for auto companies like General Motors and Chrysler. The act only authorizes helping “financial institutions.” Yet billions of TARP dollars have gone to the two automakers.
Is that the “public corruption” Barofsky is talking about?
Or is it the matter of the Treasury’s role in Bank of America’s acquisition of Merrill Lynch? Barofsky says he’s “auditing” that “decision making process” too. For months now that acquisition has been shrouded in controversy. It was completed at year-end, even though BofA discovered that Merrill had suffered horrible losses in the fourth quarter, far worse than anything expected when the acquisition was first announced in September. Andrew Cuomo, the attorney general of the state of New York, has been investigating why large bonuses were paid to Merrill employees before the deal closed, and why the large Merrill losses weren’t revealed to the public until January.
The bonus matter is populist drivel. The substantive issue is the failure to promptly disclose to investors Merrill’s losses — losses so great that Bank of America came near to walking away from closing the acquisition deal. According to a letter to Congress from Cuomo yesterday, that failure — which surely raises the most troubling issues of securities fraud — was instigated by government coercion. Cuomo writes that according to a deposition by CEO Lewis, “Bank of America did not disclose Merrill Lynch’s devastating losses . . . and would have done so but for the intervention of the Treasury Department and the Federal Reserve.”
In Lewis’s own words from the deposition, he “was instructed that ‘We do not want a public disclosure.’” Cuomo’s office asked, “Who said that to you?” And Lewis responded, “Paulson.” On the face of it, that would seem like a smoking gun — placed in Lewis’s innocent hand by the secretary of the Treasury of the United States of America.
Is that the “public corruption” Barofsky is talking about?
Maybe. But then again, maybe not. In his letter, Cuomo goes on to say that “Secretary Paulson … informed this Office that his discussions with Lewis regarding disclosure concerned the Treasury Department’s own disclosure obligations” with respect to the commitment of future TARP aid — not the matter of Merrill’s loss.
Indeed, this very distinction is made by Lewis himself in the same deposition. Lewis was asked, “A public disclosure of what?” He responded, “Of what they were going to be doing for us until it was completed” — that is, the TARP commitment. Lewis was then asked specifically, “How about of Merrill fourth-quarter losses?” His response: “That wasn’t an issue that was being exchanged.”
It would appear that Cuomo may have significantly misrepresented Lewis’s testimony by claiming that he “would have” disclosed the Merrill loss “but for the intervention of the Treasury Department,” since by Lewis’s own testimony the Treasury’s intervention wasn’t even on this subject. And Cuomo appears to mislead Congress when he says that Paulson “informed this office” — as though by way of clearing himself of culpability — of the very thing that Lewis himself already said.
If true, this is serious prosecutorial misconduct, very much in the mold of Cuomo’s predecessor Eliot Spitzer. The strategy seems to be to try the case in the media — which can be relied upon to uncritically carry the prosecutor’s message, as indeed the Wall Street Journal already has done — and to avoid the rigors of an actual courtroom, in which the accused will have the opportunity to defend himself.
Is that the “public corruption” Barofsky is talking about?
TARP may indeed have been necessary to save the banking system from implosion last year. But its cost will exceed its $700 billion budget. And its true cost includes the corruption of private rent-seekers and public power-seekers, drawn by that astronomically large pot of other people’s money like fleas to a dog.
A $700 billion budget buys one heck of a big dog — apparently a dog that attracts some pretty big fleas.
— Donald Luskin is chief investment officer of Trend Macrolytics LLC, an independent economics and investment-research firm. He welcomes your visit to his blog and your comments at don@trendmacro.com.
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