This is my sixth word association in a series of articles that I've called "Seven Deadly Sins of the Government Debt Debate." Basically, I've been cataloging the many ways in which government budget and debt projections mask the true severity of our debt problem. And I've added the competitive element of a word match challenge. Well okay, there's not much competition involved, but have a look at the diagram below and see if you can match the seven "sins" on the right to the seven topics on the left. In this article, I'll suggest a match for topic #6: "Behind-the-scenes decisions." It's not necessary to see my first five matches to follow this one, but here's a one sentence summary of each to give you the general idea:
- Government economic scenarios: The most glaring double standard of public vs. private financial management.
- Unexpected events: The world's most complete estimate of the budget slippage that renders government debt projections worthless (but if you know of a more complete estimate please let us know).
- Pension fund accounting: The problem with state pensions in a single chart that even Richard Scarry could appreciate.
- Entitlement program accounting: A more subtle but equally egregious double standard of public vs. private financial management.
- Net government debt: The deduction from reported debt totals that public officials shouldn't be allowed to get away with.
Topic #6: Behind-the-scenes decisions
In an ideal world, we could track the key decisions that led to sins one through five and others and figure out exactly what went wrong. The problem is that it's hard to know who decided what and when. Unless your name is Lieutenant Daniel Kaffee, you'll never get to the bottom. Occasionally, though, we get clues from insiders who take their stories public. Last year, for example, we heard from former CBO economist Lan T. Pham, former Special Inspector General of the Troubled Asset Relief Program (TARP), Neil Barofsky, and former FDIC Chief Sheila Bair, among others.
Pham was fired by the CBO after a brief 2 ½ month stint in 2010, during which she questioned the organization's approach to research. In one of her main points in a letter to Senator Charles Grassley and a separate statement posted by ZeroHedge, she wrote that her superiors dismissed emerging news about irregularities in mortgage securitizations and foreclosures, such as the robo-signing scandals. She was instructed that these issues were merely media "sensationalism" and that she shouldn't highlight them in her banking and mortgage sector reports. After Pham's dismissal, though, it became clear that robo-signing was merely the tip of the iceberg. The mortgage business was laced with illegalities and fraud at every stage, such that banks were unable to produce titles on vast numbers of the mortgages they serviced. Lenders had also widely ignored the contractual underwriting standards that were meant to guide securitizations.
Pham was right and her supervisors were wrong. Naturally, her tenure was short. But at least the CBO came under some scrutiny for its research practices. Pham reports that she was instructed to take key components of her analysis from research that the CBO had sourced from outside advisors. And according to the Wall Street Journal, this prompted Senator Grassley to add his voice to ongoing efforts by congressional staffers to learn the identities of those advisors. As described in the WSJ article, there were several "private confrontations" in early 2012 between congressional staffers and senior CBO executives who aren't "generally obligated to respond to document requests or other demands for detailed explanations of [their] conclusions."
And why the secrecy? Maybe it's because Pham reveals that she was instructed to rely on research by Morgan Stanley (MS), in particular, and also Goldman Sachs (GS). In other words, her views on the consequences of our largest banks' misconduct were expected to be shaped by some of those same banks. This certainly seems to validate the efforts of those whom the WSJ reports were "examining whether Wall Street firms or others exert influence that compromises the office's independence." And so does the CBO's response. It issued a statement defending its objectivity and openness and describing its research process in general terms. It also highlighted its reliance on "a diverse set of outside experts." But the statement made no mention of its mortgage research or dealings with banks and concluded with its policy of not commenting on "individual personnel matters" (read: Pham) or "interactions with Members of Congress." Call me cynical, but it seems to me as though the CBO responded to the criticism that it lacks transparency by sharing its policy of not being transparent.
Now Pham's superiors may not have needed Morgan Stanley and Goldman Sachs to convince them to adopt a soothing, optimistic narrative. An "all is well" attitude caters to our built-in tendencies toward optimism and generally serves people well. Those who choose a different approach - drawing attention to the problems lurking below the surface - are never popular and rarely stay in the same place. But for our largest banks, the soothing and optimistic narrative is like oil to a car. It's not enough to say that they ignore the problems below the surface. They manufacture those problems and then actively conceal them, and we have ample evidence of that. What's more, they rarely own up to their mistakes, and this is a trait they seem to share with the government officials whom they "advise," such as those at the CBO.
Barofsky and Bair take us inside the asylum
While Pham's story was briefly noted by the media in early 2012, Barofsky has been in the spotlight for the past four years. As the Special Inspector General of TARP until March 2011, his job was to be that unpopular person - the one who looks for the problems below the surface. And man did he find them. His 2012 book, Bailout: An Inside Account of How Washington Abandoned Main Street While Rescuing Wall Street, may be the most damning account of government incompetence and dishonesty since All the President's Men. Barofsky describes how the Treasury Department misled Congress and the public about many aspects of their efforts at fighting the financial crisis, including both the goals and results of key programs.
But don't just take Barofsky's word for it. Bailout's July release was followed only two months later by a remarkably similar message (not to mention the closely correlated subtitles) in Bair's Bull By The Horns: Fighting to Save Main Street From Wall Street and Wall Street From Itself. It seems that if you thought the worst of the government's handling of the crisis, you were probably thinking correctly. Consider just a few of the ideas you may have had about our public policies, alongside insights from Bailout and Bull By The Horns:
- Did you wonder if you were living in a corrupt, third world country after the New York Fed's famous backdoor bailout of AIG's counterparties? Barofsky offers the details of his team's audit of over $60 billion in derivatives exposures on which the Fed made sure that those counterparties didn't lose a dime. He describes an aborted attempt to obtain concessions to lower the government's costs, concluding that "those negotiations were halfhearted at best and demonstrated a characteristic deference to the banks, taking an almost apologetic approach. It was as if the New York Fed found the whole process of negotiating unseemly." And the Fed also appeared to find the whole process of cooperating with Barofsky's congressionally-mandated investigation unseemly. As described in Bailout, they stonewalled his requests for interviews, made at least a few claims that were later contradicted, and denied the existence of documents that were later proven to, well, exist.
- Did you consider burning your passport and moving to a third world country after hearing of the AIG bonuses (the $168 million that the government allowed the firm to pay its Financial Products unit after their dimwitted bets blew up)? Bair places you in the Oval Office on the morning after the bonuses were first reported in the media, where she sat next to a "visibly angry" president and across from an "uncomfortable" Treasury secretary (Tim Geithner) and National Economic Council Director (Larry Summers). She concludes that "Larry and Tim didn't seem to care about the political beating the president took on the hundreds of billions of dollars thrown at the big-bank bailouts and AIG bonuses," and later added that "Tim had known about the bonuses and had not objected to them. He had also not given the president a heads-up."
- Did you find yourself speculating about politicians' sinister but unspoken motives? Bair specializes in advancing theories about her colleagues' true objectives. Take, for example, Geithner's flip-flop on bank capital requirements just two days before a critical meeting of a global group of central bank governors and bank regulatory heads (named GHOS, or Group of Governors and Heads of Supervision). Having consistently argued for lower capital ratios, Geithner suddenly encouraged Bair to promote a higher capital ratio balanced by looser restrictions in other areas. Bair's interpretation? "I think his real agenda was to blow up the GHOS meeting, with the U.S. delegation being the spoiler. In that event, the question would be bucked up to the G20 finance ministers, who were scheduled to meet in Seoul in November. At that meeting, Tim, not the Fed or the FDIC, would be leading the United States." If I read this passage correctly, and I believe I did, Bair speculates that our Treasury secretary wanted to sabotage one of the world's most critical economic oversight bodies (GHOS oversees the Basel Committee on Banking Supervision) just to enhance his own personal influence. Astonishing. And yet totally believable.
- And for the final example, have I mentioned Tim Geithner? Were you shocked by his appointment to the Treasury after he was so closely involved with everything that's wrong with the financial sector in his role as N.Y. Fed President? (Bair likened it to "a punch in the gut.") Were you perplexed that Congress confirmed the appointment despite revelations that he underpaid his taxes? (Barofsky offered an excellent argument for why Geithner's explanation for the underpayment "didn't seem credible.") Are you creeped out whenever you hear him talk? (Okay, maybe that's just me.) Well, in perhaps the most disturbing (yet entertaining) story of our former Treasury secretary's conduct, and one that needs to be read in full to appreciate, Barofsky recounts a frank discussion he had with Geithner and three other colleagues in late 2009. He took Geithner to task for his lack of transparency, in general, and his failure to provide "full, accurate and complete information about TARP," in particular. Barofsky describes the meeting's crescendo: "Now he erupted. 'Neil, I have been the most fucking transparent secretary of the Treasury in this country's entire fucking history!' he boomed, moving forward in his chair. 'No one has ever made the banks disclose the type of shit that I made them disclose after the stress tests. No one! And now you're saying that I haven't been fucking transparent?'"
So here's my scorecard.
Barofsky and Bair: 599 pages packed with insider testimony of Geithner's and his peers' relentless advocacy of the interests of our nation's largest banks. And those 599 pages also describe their scant regard for moral hazard, not to mention the societal ramifications of a massive, government-sponsored wealth transfer from taxpayers to dimwitted bank executives (to use my variation on an observation made repeatedly by Barofsky).
And my score for Geithner: he made banks do stress tests. The last part of that bears repeating: stress tests. That means Geithner made banks return spreadsheets with financial projections. Because we have so much evidence that we can rely on the projections of bankers. And asking them to do extra projections? And then hand them in to the Fed and Treasury so they can be partially released to the public? What an achievement.
And the answer is …
Getting back to the word match challenge, there are many possible word associations for the internal workings of our key government offices. Individual incentives are surely a big part of any decisions about which information to present and which to suppress. Incentives alone could explain the tendency for published information to resemble propaganda. But the key thread that runs through Pham's, Barofsky's, and Bair's accounts and many others is the influence of our largest banks. The true story is much more than a pliable bunch of government officials and regulators being "captured" by cunning bank executives and lobbyists. It's even more than the huge political contributions that help to buy the favoritism that the banks receive. More fundamentally, with so many of our top officials either sourced from or en route to lucrative positions in the financial sector, the too-big-to-fail banks and our economic policymakers are effectively one and the same. Which explains my word selection for this category: treachery.
Check back next week for the word match finale, including final answers and disturbing conclusions.
 You may say that the policy on "individual personnel matters" isn't unusual, but Pham reports that she granted the CBO full immunity to discuss her dismissal with Senator Grassley's office and they still refused.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.