Neil Barofsky: "suspicions that the system is rigged...are true"

In her NY Times' column, Gretchen Morgenson reviews former Special Inspector General for the Trouble Asset Relief Program Neil Barofsky's new book, Bailout, in which he describes his experience with the Washington - Wall Street power game.

His conclusion is that the financial system is rigged in favor of the banks and that Washington, both the policymakers and the regulators, have been effectively captured.

Nearly four years after Washington began its huge rescues of banks with taxpayer dollars, an important player in this, one of the great financial dramas of all time, is offering a damning account of how the Bush and Obama administrations handled the whole episode.

Regular readers know that the Bush administration chose to pursue the Japanese model for handling a bank solvency led financial crisis.  Under this model, bank book capital levels and banker bonuses are perserved at all cost.  The selection of this policy for addressing the crisis is not surprising given that the  Treasury Secretary at the time was a former senior officer from Goldman Sachs.

What was surprising to your humble blogger is that the Obama administration came in and embraced the Japanese model and protecting the banks at all costs too.

What was well known at that time was the existence of an alternative policy:  the Swedish model.  Under this model, the real economy is protected as banks absorbed all of the losses hidden on and off their balance sheets.

Even more surprising, was the Obama administration's failure to appoint a modern day Pecora Commission to examine exactly what caused the crisis.  Everyone knew that the Financial Crisis Inquiry Commission did not have the budget or time to do more than a cursory job.  Even working with  these severe limitations, the FCIC found that the financial crisis was preventable.

Regular readers know that the financial crisis would have been prevented if the financial regulators had performed their primary function under the FDR Framework and prevented Wall Street from making sizable areas of the financial system opaque (structured finance securities, banks, Libor).  It was these areas that blew up.

I say it was surprising that there was limited investigation of the causes of the financial crisis because it meant that when financial reform legislation was passed it was not informed by what had gone wrong. Rather, it was legislation written by and for the industry (the exceptions being Elizabeth Warren's Consumer Financial Protection Bureau and the Volcker Rule; both of which had sponsors with the capability of taking their story directly to the American people).

He is Neil Barofsky. Remember him — the man whose job it was to police the $700 billion Troubled Asset Relief Program? ... 

His story is illuminating, if deeply depressing. ...  

Government officials, he says, eagerly served Wall Street interests at the public’s expense, and regulators were captured by the very industry they were supposed to be regulating....

Mr. Barofsky confirms the same behavior that was described in the Nyberg Report on the Irish financial crisis.

Where there was suppose to be a counter-balance to the banks, there were instead regulators and policymakers who were complicit in supporting what the banks were doing.

Thus the collision course was set between Mr. Barofsky and a crew of complacent, bank-friendly Treasury officials. He soon discovered that the department’s natural stance of marching in lock step with the banks meant that he had to question its policies and programs repeatedly to ensure that taxpayers weren’t at risk for fraud and abuse.

Why would Treasury's natural stance be to march in lock step with the banks?

If this is true, wouldn't this imply that the Financial Stability Oversight Council which has all of the financial regulators on it and is chaired by the Treasury Secretary would march in lock step with the banks?

If this is true, then the Office of Financial Research is truly where transparency goes to die as it reports to the bank friendly Treasury.

[This confirms your humble blogger's observation that the "Mother of All Financial Databases" needs to be run by a conflict of interest free independent third party whose only business is ensuring transparency.  This database should contain all of the global asset, liability and off-balance sheet exposures for each bank as well as observable event based collateral performance data for each structured finance security.]

If this is true, then the inescapable conclusion is that the Dodd-Frank Act truly was written by the large banks for the large banks.

“The suspicions that the system is rigged in favor of the largest banks and their elites, so they play by their own set of rules to the disfavor of the taxpayers who funded their bailout, are true,” Mr. Barofsky said in an interview last week. “It really happened. These suspicions are valid.”

Please re-read the highlighted text as it stands on its own merit.

To be sure, Mr. Barofsky and his team were up against a powerful status quo. And that meant that they ran into plenty of brick walls....

during which, he says, Washington abandoned Main Street while rescuing Wall Street. 

The Japanese model for handling a bank solvency led financial crisis is all about abandoning Main Street in favor of Wall Street.  It is all about transferring onto Main Street the cost of the excess debt in the financial system and as a result, sacrificing the real economy.

“There has to be wide-scale acknowledgment that regulatory capture exists, dominates our system and needs to be eradicated,” Mr. Barofsky said in the interview. “It was my job to bring as much transparency to taxpayers so they knew what was going on. Writing the book, I tried to bring the same level of transparency so people understand how captured their government has become to the financial interests.”...

Please re-read the highlighted text as Mr. Barofsky explains why despite four plus years of terrible results from pursuing the Japanese model, Washington remains committed to continuing to pursue it.

Your humble blogger continues to point out that under the Swedish model, Wall Street rescues Main Street.  I continue to point out that our modern financial system was designed so that the Swedish model would be the policy of choice.

With the existence of deposit insurance and access to central bank funding, banks can operate with negative book capital levels and continue to support the real economy.  As a result, rather than burden the real economy with the excess debt in the financial system, banks should absorb the losses on the excess debt.

The choice Washington faces continues to be Main Street or banker bonuses.

Mr. Barofsky’s assessment of his former regulatory brethren is crucial for taxpayers to understand, because Congress’s financial reform act —the Dodd-Frank legislation — left so much of the heavy lifting to the weak-kneed. 

“So much of what’s wrong with Dodd-Frank is it trusts the regulators to be completely immune to the corrupting influences of the banks,” he said in the interview. “That’s so unrealistic.”....

Please re-read the highlighted text as Mr. Barofsky summarizes why the Dodd-Frank Act is a failure and the financial system should not be dependent on financial regulators for stability and proper functioning.

Finally, Mr. Barofsky joins the ranks of those who believe that another crisis is likely because of the failed response to this one. “Incentives are baked into the system to take advantage of it for short-term profit,” he said. “The incentives are to cheat, and cheating is profitable because there are no consequences.”

This is why there is the need to bring transparency to all of the opaque corners of the financial system.  With transparency it is dramatically harder for the bankers to cheat.