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They Lied: Watchdog Says Treasury and Fed Knew Bailed-Out Banks Were Not 'Healthy'

Matthew Jaffe

FILE - In this Sept. 19, 2008 file photo, President George W. Bush, second left, accompanied by, from left, Federal Reserve Chairman Ben Bernanke, then Treasury Secretary Henry Paulson, and then Securities and Exchange Commission Chairman Christopher Cox, delivers a statement about the economy and government efforts to remedy the crisis in the Rose Garden of the White House in Washington. (AP Photo/Pablo Martinez Monsivais, file)

WASHINGTON - The Treasury Department and the Federal Reserve lied to the American public last fall when they said that the first nine banks to receive government bailout funds were healthy, a government watchdog states in a new report released today.

Neil Barofsky, the special inspector general for the Troubled Asset Relief Program
(SIGTARP), says that despite multiple statements on Oct. 14 of last
year that these nine banks were healthy and only receiving government
funds for the good of the country's economy, federal officials knew

"Contemporaneous reports and officials' statements to SIGTARP
during this audit indicate that there were concerns about the health of
several of the nine institutions at that time and, as detailed in this
report, that their overall selection was far more a result of the
officials' belief in their importance to a system that was viewed as
being vulnerable to collapse than concerns about their individual
health and viability," Barofsky says.

Last October, the government was in the midst of trying to
contain the worst financial crisis in decades. On Sept. 7, 2008,
mortgage giants Fannie Mae and Freddie Mac were placed under
conservatorship. On Sept. 15, the massive investment bank Lehman
Brothers filed for bankruptcy. The next day, insurance giant AIG needed
an $85 billion government loan to avoid collapse.

On Oct. 13, after Congress had passed the $700 billion
financial bailout program earlier that month, Treasury provided capital
injections for nine institutions that together held over $11 trillion
in assets: Bank of America,
Citigroup, Wells Fargo, JP Morgan Chase, Goldman Sachs, Morgan Stanley,
Merrill Lynch, State Street and the Bank of New York Mellon. As of June
2008, these nine banks accounted for around 75 percent of all assets
held by U.S. banks.

In announcing the initial $125 billion provided to these banks,
former Treasury Secretary Hank Paulson on Oct. 14 said, "These are
healthy institutions, and they have taken this step for the good of the
U.S. economy. As these healthy institutions increase their capital
base, they will be able to increase their funding to U.S. consumers and

That same day, the Treasury Department, the Federal Reserve and
the FDIC also released a joint statement reiterating that "these
healthy institutions are taking these steps to strengthen their own
positions and to enhance the overall performance of the US economy."

Serious Concerns About the Bailout Plagued Government Officials

Barofsky finds, however, senior officials at the Treasury and the Fed
had serious concerns about the health of some of these banks. Fed chief
Ben Bernanke, for one, told the watchdog that the central bank believed
each of the nine institutions faced certain risks given the economic

"Senior government officials had affirmative concerns at the
time the nine institutions were selected about the health of at least
some of those institutions," Barofsky says. "The Federal Reserve had
concerns over the financial condition of several of these institutions
individually and for all of them collectively absent some governmental
action. And former Secretary Paulson noted concerns about the outright
failure of one of the institutions."

Merrill Lynch, for example, had suffered several consecutive
quarters of severe losses. One month earlier, Merrill had agreed to be
acquired by Bank of America. Merrill's situation was so dire, though,
that later that winter Bank of America's CEO Ken Lewis
told the Fed and Treasury that he was considering pulling out of the
deal due to Merrill's substantial fourth-quarter losses. In the face of
ensuing government pressure, Lewis and Bank of America eventually
completed the deal and received an additional $25 billion in government

Since last October, the bailout has generated widespread
outrage. While supporters say it saved the system from collapse,
detractors say it helped only Wall Street and not Main Street, since
banks have not boosted lending and unemployment and foreclosures have risen.

Barofsky, who last month called it "highly unlikely" that taxpayers
would recoup their full investment, says the government's "inaccurate
statements" last fall only made the program more controversial.

Watchdog: Inaccurate Government Statements Will Damage American Trust

"In addition to the basic transparency concern that this inconsistency
raises, by stating expressly that the 'healthy' institutions would be
able to increase overall lending, Treasury may have created unrealistic
expectations about the institutions' condition and their ability to
increase lending," Barofsky says. "Treasury and the TARP program lost
credibility when lending at those institutions did not in fact increase
and when subsequent events -- the further assistance needed by
Citigroup and Bank of America being the most significant examples --
demonstrated that at least some of those institutions were not in fact

"The lesson is straightforward," the watchdog advises.
"Accuracy and transparency will enhance the credibility of Government
programs like TARP and restore taxpayer confidence in the policy makers
who manage them; inaccurate statements, on the other hand, could have
unintended long-term consequences that could damage the trust that the
American people have in their Government."

In a letter to Barofsky, the Fed's General Counsel agreed with
the report's findings, noting that "an important lesson illustrated by
the events that shocked the financial systems over the past two years
is that transparency and effective communication are important to
restoring and maintaining public confidence, especially during a
financial crisis."

However, Treasury's Office of Financial Stability did not
explicitly agree with the watchdog's report. While Treasury called the
report "a useful contribution," they also told Barofsky, "While people
may differ today on how the contemporaneous announcements about the
reasons for selecting the initial nine recipients should have been
phrased, any review of such announcement must be considered in light of
the unprecedented circumstances in which they were made."

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