Title: Bailout: An Inside Account of How Washington Abandoned Main Street While Rescuing Wall Street
Author: Neil Barofsky
Publish Date: 2012
Publisher / Edition: Free Press
It is now cliché to recite that a conservative is a liberal who has been mugged by reality. Reading Neil Barofsky’s Bailout: An Inside Account of How Washington Abandoned Main Street While Rescuing Wall Street one keeps expecting that at some point he will draw the obvious conclusion from his sordid tale of serving as the Special Inspector General for the Troubled Asset Relief (SIGTARP): that political opportunism, personal ambition, and special-interest influence will be inherent in any government activity, especially bailouts specifically designed to pick winners and losers in the marketplace, and if you don’t want politics, dishonesty, and special-interest influence, then don’t put government in charge of handing out $800 billion to politically-powerful interest groups. Setting up a piece of cheese of that size to be handed out through the political process is going to draw rats to the feast.
Yet throughout his tome, Barofsky repeatedly remains shocked to find politics at the heart of the TARP process. Even at the end he seems to believe that such programs can and should be insulated from political pressure—all that is necessary is to put people like him in charge and allow them to do what is right. But, of course, this dream of eliminating politics from government decision-making and the allure of putting unaccountable do-gooders in charge of the government are the same warmed-over naive platitudes that are so responsible for the soaring growth of government and special-interest rent-seeking since the Progressive Era first foisted the model on America at the beginning of the twentieth-century: appoint more wise and incorruptible people like me and everything will be fine. If only it were so easy.
To be sure, Barofsky’s tale is sordid indeed. He is obviously a man of integrity and character, an able lawyer, and—like any good prosecutor—a terrific storyteller as well. He was as tenacious and as fearless as anyone could possibly hope during his tenure at SIGTARP (and his successors have been diligent and professional as well in taking on some political hot potatoes). And despite his “only honest man in Washington” tone, Barofsky’s tale has an undeniable ring of truth about it. His portrayals of the many people involved in the financial crisis—Henry Paulson, Neel Kashkari, Timothy Geithner, and the many lesser minions, hangers-on, and careerists in the Bush and especially Obama Administrations—are well-drawn and credible. His portrayals of the dim-witted and arrogant Wall Street recruits brought in to administer the TARP are particularly effective and persuasive.
And some of his revelations are jaw-dropping even for the most cynical observer of government and its response to the financial crisis. For example, Barofsky reports the constant preoccupation of TARP officials that they couldn’t afford to place too many restrictions on TARP recipients or insist on too much accountability and transparency because to do so might frighten banks away from participating in the program. In other words, the bailout mentality was so entrenched in Washington that those running the program essentially allowed the big banks to hold them hostage by the threat that the banks would not accept the taxpayers’ welfare. (Notably—and completely ignored by Barofsky—General Motors and the United Auto Workers similarly dictated the terms of its TARP bailout, including the absurd “cash for clunkers” program, by refusing to make plans for a proper bankruptcy filing thereby trying to make its threat of a messy bankruptcy and self-fulfilling prophecy that would force the government’s hand into a bailout.) Barofsky also clearly lays out the astonishing story of the AIG bailout, which again was really a backdoor bailout of AIG’s counterparty banks by making sure that they would be paid almost in full. And Barofsky alleges a cynical motivation between the government’s HAMP program (Home Affordable Modification Program)—ostensibly established as a foreclosure rescue program for homeowners—Barofsky argues that in fact it was yet another bank bailout that was intended simply to “foam the runway” for banks by promoting temporary mortgage modifications that would stretch out the resolution of the foreclosure crisis and soften the blow against the banks, not to actually promote permanent modifications that would eliminate defaults in the end.
But despite his ability and tenacity at overseeing the integrity of the TARP process, in the end Barofsky (like many powerful, unaccountable bureaucrats) forgets Eastwood’s rule: “A man’s gotta know his limitations.” When Barofsky strays from his comfortable ground as prosecutor and watchdog onto the terrain of economic policy and the substance of the government’s responses to the financial crisis—which he does with surprising regularity—his analysis collapses into puerile New York Times conventional wisdom (he finds the op-ed columns of Tom Friedman and Paul Krugman particularly sage) and an excess of self-righteousness and intellectual arrogance (which appears to be a job requirement among federal prosecutors these days). In Barofsky’s worldview, all of his proposals—including his utterly uninformed policy proposals—are well-learned and the product of common sense (not to mention supported by the editorial page of the New York Times). Those who disagree with him are usually corrupt but sometimes merely stupid.
Especially comical is Barofsky’s diagnosis of the underlying causes of the financial crisis (government policy to expand homeownership, the role of Fannie Mae and Freddie Mac, and Federal Reserve monetary policy are notably absent from his discussion) and his prescriptions for foreclosure remediation (massive principal reduction for underwater homeowners). Although one cannot help but admire Barofsky’s tenacity and “tireless efforts” (a phrase that recurs repeatedly throughout the book in describing the efforts of Barofsky and his staff) to learn economics on the fly, sometimes one cannot help but feel sympathy for his adversaries at the Treasury Department and Federal Reserve who have to—well, tirelessly—try to politely deflect his ignorant (but highly confident) expositions on the nature of the financial crisis and his views on the proper policies for foreclosure remediation. There is no indication that Barofsky’s views on these matters are informed by the slightest grasp of basic economics much less any relevant empirical knowledge. But Barofsky’s temptation to opine forcefully on issues outside his narrow area of expertise for which he has little knowledge is itself a useful warning about the dangers of vesting too much power in unaccountable bureaucrats.
Barofsky’s tendency to demonize those who disagree with him as venal tools of self-ambition and special-interests reveal a much deeper flaw with Barofsky’s book—his inability to see that the underlying problems he identifies are inherent in any program like the TARP or any other government program that implicitly or explicitly picks winners and losers in the marketplace. We have known since Gordon Tullock that if the government is in the business of handing out billions of dollars of prizes and punishments, special interests are going to compete to try to capture those prizes for themselves and to avoid the punishments. Inevitably special-interests will try to influence the process and political entrepreneurs will recognize the potential gains from handing-out these prizes. Constitutions exist to restrain the opportunism of politicians and special interests who stand ready to use any crisis to expand their power and discretion. Instead (p. 184), he applauds Paulson, Geither, and Ben Bernanke as providing “a lesson in Negotiation 101” when they strong-armed those banks that didn’t need and didn’t want TARP funds into taking them anyway (“the government made clear that it wouldn’t take no for an answer”). One bank CEO that eventually caved told Barofsky that he thought that he “did not have a choice in the matter”—which Barofsky sees as a testament to government strength rather than an appalling shakedown of one of the few responsible banks that didn’t need a bailout.
Barofsky avoids the seemingly ineradicable link between bailouts and rent-seeking by the convenient method of denouncing any activities that offend his Manhattan Democratic sensibilities while ignoring or praising those of which he approves. So, for example, while he uncritically accepts the claim that diverting TARP funds to GM and Chrysler was necessary to save a million jobs and the entire automotive industry in America (he says it saved them from “oblivion”), he makes no mention that taxpayers stand to lose some $26 billion in TARP funds solely through preferential treatment of the United Auto Workers above what they would receive in a standard bankruptcy not to mention the widespread political meddling in the business management of General Motors. His first day on the job he approved Henry Paulson’s diversion of tens of billions of TARP funds to bail out the auto companies with only a cursory analysis of the statutory language from which he concluded that, “Under TARP, Paulson could make any loan or investment in any company that struck his fancy.” (p. 50). Does he really think that’s what the statute means? And if so, why did Congress later feel obligated to vote specifically on whether to bail out the auto industry (which the Senate voted down)—and why did Hank Paulson himself originally tell GM and Chrysler that TARP could not be used to bail out the auto industries and that they would need to receive an appropriation from Congress?
In fact, his only substantive criticism of the auto bailouts was that he believed that the auto bailout task force moved too quickly to use the bankruptcy process to terminate franchise agreements and to close auto dealerships around the country. But here his ideological blinders actually overwhelm his legal judgment. As Barofsky correctly notes, GM and Chrysler used bankruptcy to terminate the dealerships because of the extraordinary protections that auto dealers receive under state law, which can make terminating dealerships an expensive and drawn-out process. But he incorrectly claims that using bankruptcy to override these favorable state laws was a violation of the principle of the integrity of contracts—when, of course, they are actually product of special interest influence by auto dealers at the state level. He is also notably silent on the plundering of secured creditors contract and property rights in the Chrysler bankruptcy case to enrich the UAW. On the other hand, to his credit, he did criticize the misleading announcement by GM in April 2010 that it was repaying its TARP loan, as it was Barofsky’s team that pointed out that in fact GM was just using a different TARP loan to pay off the first loan.
Barofsky similarly jumps on his ideological soapbox when discussing the federal government’s efforts at foreclosure remediation (which he again confusingly refers to as the lack of success at forcing mortgage servicers to modify mortgages as an interference with the integrity of contractual obligations). Barofsky is right, of course, that the problem of underwater mortgages is the driving factor underlying the foreclosure crisis because of the incentives it creates for homeowners to default on their mortgages and allow foreclosure. But he also firmly believed (apparently based again on his reading of some New York Times op-ed columns) that the only effective way to address the foreclosure crisis was to force banks to reduce the principal value owed on underwater mortgages. When he advocated this policy to the Obama Administration—which he for some reason seemed to believe was within his responsibility as SIGTARP—his proposals “fell on deaf ears,” as TARP officials correctly noted that forcing widespread principal reduction for delinquent homeowners would raise massive problems of fairness and moral hazard. Barofsky responds with the non sequitur that he “found it beyond ironic that Treasury was not emphasizing more hazard with respect to home owners” when it had so ignored it among banks—well, it may be ironic, but that doesn’t mean it isn’t real (in both contexts). Barofsky says that he “was at first puzzled” by the refusal of the TARP head to follow his sage advice but then his trusted deputy explained that it wasn’t Barofsky’s light-weight analysis that was the problem but “that it was election politics at play.”
Throughout, he expresses his disillusionment that Obama Administration appointees such as Timothy Geithner and others turn out to essentially be no different than the Bush Administration officials that they replaced—indeed, he admits that many Obama Administration officials were even more politically cynical and opportunistic than the Bush Administration. Yet he seemingly holds on to the naïve view that if we just have different and better people picking winners and losers the next time then everything will be fine.
In the end Barofsky refuses to draw the seemingly obvious conclusion—that a bailout culture breeds corruption and rent-seeking and that if government is in the business of picking winners and losers then the end result invariably is going to look like what Barofsky describes. Thus, he sees the value of his efforts not as a Cassandra to warn the public against future bailouts, but rather to preserve confidence in the government so that it can engage in similar bailouts in the future. Barofsky remains convinced that the unpopularity of the bank bailouts with the public was not the result of the bailouts themselves, but rather the government’s lack of transparency in explaining why the bailouts were supposedly necessary. Barofsky finally tells Geithner (p. 171): “I said that I thought our capacity as a nation to deal with what could be a continuing financial crisis was being undermined by a loss of faith in government. If people didn’t believe in their government, I said, they wouldn’t be willing to support the extraordinary measures necessary to engineer a similar rescue when the next crisis inevitably struck.”
Barofsky, instead, seems to hold on to the idea that government can somehow run a bailout culture without politics, so long as it puts people like him in charge. But as we’ve just seen, Barofsky’s approach would simply substitute unrestrained bureaucratic discretion for special interest influence, simply leaving him free to indulge his pet economic theories and biases. In the end, then, Barofsky’s real agenda is to preserve the myth that underlies the big-government experiment of progressive liberalism during the past century: vesting government power in an all-wise, incorruptible elite to manage the economy and tame markets, and he rightly sees the obvious rent-seeking that surrounded the bank bailouts and subsequently Dodd-Frank, as a danger to the public’s willingness to continue to accept this myth.
What is shocking in the end is not what Barofsky sees—an extreme politicization of a well-intentioned federal program. But rather how banal it is. Perhaps even more shocking is the faith that many on the left cling to that good intentions and good people can purify the government process without proper constitutional checks and balances. To the extent that Barofsky’s tale demonstrates the dangers of a bailout culture and government picking winners and losers, he will have done a great service.