Where Did the Money Go?

Just a few weeks ago, we marked the first anniversary of the collapse of Lehman Brothers. To some degree we still do not understand what happened, or fully comprehend the impacts of rescue programs that were undertaken in the wake of the disaster. The ripples and unintended consequences of the disease and the cure will be with us for some time to come. While some of these issues will be debated for decades, we can grapple with some of them today and take the necessary action to control events. One of those issues is instilling transparency into the Troubled Asset Relief Program, otherwise known as TARP. Through the leadership of Congresswoman Carolyn Maloney and Congressman Peter King, taxpayers may be able to track the expenditure of TARP monies through a single database.

The sudden implosion of Lehman Brothers capped a year of uncertainty in the financial sector and touched off a series of shock waves that were felt throughout the capital markets and eventually the real economy. In the days and weeks following the Lehman collapse, the United States and the global economy stood on the precipice of an outright disaster not witnessed since the 1929 crash of the stock market. As a result, the credit markets were frozen, liquidity dried up, consumers stopped spending, businesses started to contract, and we saw the first electronic run on financial institutions. It was as if someone hit a switch and turned the economy off. In short, we were witnessing a rapid collapse of the modern financial system and as a result, the global economy was in danger of plunging into a Depression for the first time since the 1930’s.

To prevent this widespread economic apocalypse, the Bush Administration and Congress decided to take unprecedented and dramatic action to shore up the economy. The first attempt failed when the House of Representatives voted down the proposed financial rescue legislation. This unexpected action by the House sent the financial markets into a deeper tailspin. Treasury Secretary Paulson and the Congressional leadership immediately made a second and ultimately successful attempt and passed the Emergency Economic Stabilization Act. President Bush immediately signed the bill into law.

The centerpiece of the EESA is the Troubled Asset Relief Program. With over $700 billion in federal funding, the purpose of TARP is to stabilize the financial system and help create the conditions for recovery.

The U.S. Chamber of Commerce lobbied for the passage of the EESA and the creation of the TARP program. We viewed the passage of the EESA as critical to economic survival. Recognizing the difficulties our economy faces today, a failure to pass the EESA would have led to the unthinkable. While it goes without saying that the administration of TARP has been problematic, the Chamber continues to support efforts to improve the program to ensure its success.

When banks stopped lending following Lehman’s collapse, businesses lost the liquidity they needed to function. Simultaneously, consumer spending, which makes up 70% of our economy, came to a virtual and historic halt. With these shots to the solar plexus of the capital markets systems, policy makers lacked the tools needed to deal with a modern financial crisis. As the financial system began to shut down, small businesses started to close, resulting in large job losses eventually leading to other catastrophic events, such as the crack up of the auto industry. The impacts of the financial market shutdown continually fed off of one another, spreading from Wall Street to Main Street and back to Wall Street again. The lack of liquidity was strangling the economy in the same manner that a heart attack kills portions of the heart muscle and eventually the rest of the body.

In order for businesses to function and for an economic recovery to take hold, the financial services sector needed immediate alleviation and an infusion of liquidity. TARP became the defibrillator to restart the heart of the economy—our capital markets. If some form of liquidity could be restored, the patient had a fighting chance at survival.

At the center of the problem were the toxic or distressed assets held by the banks and other financial institutions. With the advent of securitization, banks would write loans and mortgages and the income streams for those debt instruments would be turned into securities and sold. Whereas the risk of default used to stay with the lender, with securitized instruments the risk was spread throughout the financial system—domestically and globally. So long as the real estate market continues to rise, these instruments remained a safe investment. However, as the real estate market began to cool in the United States during 2006 and 2007, an increasing rate of defaults began to occur on the riskiest portions of the mortgage market—subprime mortgages.

Mortgage backed securities contained a mix of the best grade mortgages combined with the higher risk subprime mortgages. As the defaults rose with subprime mortgages, the mortgage backed securities began to fall in value. With the new accounting rules known as fair value, the banks and financial institutions had to write down the value of the mortgage backed securities and take the losses. This started a vicious cycle that caused more defaults resulting in higher losses for financial institutions. Eventually, the securitization markets shut down and without a pricing mechanism the mortgage backed securities became worthless. In short, these securitized instruments became toxic.

The Treasury Department grappled with this problem for several months but could never develop the appropriate mechanism to deal with the mounting problem of toxic assets. As originally envisioned, the purpose of TARP was intended to handle the toxic asset problem. With a war chest of $700 billion, the plan was for the Treasury Department to purchase the toxic assets and take them off of the balance sheets of financial institutions. In theory, without the toxic assets, financial institutions would be stronger and able to function. In turn, Treasury would manage the toxic assets and when favorable market conditions returned, they could sell the assets and if things went well the taxpayer would receive a significant return on their investment. Banks would be protected, liquidity would continue to flow, and the economy would be spared the ramifications of the meltdown.

As with any well laid out plan, there was a catch, or in this case there were two catches. Catch number one was that events were moving much faster than anticipated and it was difficult if not impossible for the Government to stay in control of events. Catch number two was that the Treasury Department discovered that it did not have the expertise to value the assets. Valuation was the key to the whole ball game—price them too high and the taxpayer would absorb the loss, price them too low and the capital of the financial institutions would further deteriorate, TARP becoming a vehicle that would accelerate their demise. Under normal circumstances, through the use of Fair Value accounting rules, assets are valued for the price they would fetch on the open market. With the markets shut down, however, valuation was problematic at best. Consequently, Secretary Paulson decided to use an alternative section of the EESA and go a different route. As a result, it was decided that the TARP funds would be used to inject capital into struggling or systemically important financial institutions. Instead, toxic assets would remain on the books and Treasury would pump cash into the coffers of financial institutions to keep them afloat.

While the experience has been painful, a year later we can say that an outright collapse was avoided, the financial sector is stabilizing, and the first signs are appearing that an economic recovery is taking hold.

Under the original TARP plan, the use of monies would be relatively easy to track, and the Treasury Department could demonstrably show tangible assets for the monies spent. However, with the use of cash infusions, combined with a lack of sufficient requirements for transparency, it seemed that the ability to trace TARP monies disappeared.

While the Chamber has stood by the TARP program, we recognize problems with its administration and have supported efforts to improve its implementation. As with any government program, the Chamber believes that there needs to be accountability for taxpayer dollars. This is particularly true with the massive expenditure of government monies through an expedited process. Simply put, the American people have the right to know where and how their hard-earned money is being spent. The systems exist to instill this transparency and some in Congress want to put those systems to work.

Unfortunately, that accountability may be lacking in some of the expenditure of TARP funds. As recently as October 21, 2009, Special Inspector General Neil Barofsky issued a report lambasting the lack of transparency in the administration of the TARP program and decrying the lack of knowledge in how the funds have been spent.

Several weeks ago, President Barack Obama announced that firms who have fully repaid their TARP funds have provided taxpayers with a return of 17%. This proves that TARP can be successful. However, any potential misallocation or misuse of taxpayer dollars may erode support for the TARP program, undermine confidence of the firms in TARP, and possibly harm efforts to stabilize the financial sector. By building transparency into the administration of TARP, accountability will be enhanced and taxpayers can have trust in the program and the expenditure of resources. Accountability for the use of taxpayer dollars helps establish the confidence that is needed for TARP to stabilize the financial sector. Transparency will assist TARP to achieve the objectives it was created for.

Because of the need for accountability and transparency, the Chamber wrote to Congress on June 11, 2009, in support of H.R. 1242, the “TARP Accountability and Disclosure Act.” This bipartisan bill, sponsored by Representatives Carolyn Maloney and Peter King, represents an important step forward in creating and enforcing accountability in the TARP program. The Maloney-King bill will improve the efficiency of information delivery regarding the TARP program and the way in which federal dollars are tracked and monitored. On September 17, 2009, the Subcommittee on Oversight and Investigation held a hearing on the Maloney-King bill, a key step in this legislation moving forward.

Currently, information regarding TARP funds that have been expended is spread across multiple federal agencies, using incompatible formats making it a daunting task at best for government officials or taxpayers to gain a clear understanding of how TARP funds are being used. The Maloney-King bill will require the use of existing technologies to create a single publicly accessible database that can track TARP funds in near real time. This level of transparency will help avoid the misuse of funds and develop a level of confidence that is integral to the success of TARP.

It should be noted that Senators Mark Warner and Sherrod Brown have also proposed similar legislation and that the Chamber has also written the Senate in support of the Warner-Brown bill.

The implementation of the Maloney-King bill would provide a benefit that would outweigh any costs. By instilling a higher level of transparency in TARP, efforts to facilitate confidence will be advanced. It goes without saying that the meltdown that occurred after the Lehman collapse was ultimately a crisis in confidence. By restoring confidence in our financial system, efforts to restore growth in the real economy will take hold. It is no coincidence that recent reports of a rise in consumer confidence and spending coincide with the sprouting of green shoots of recovery. TARP transparency isn’t only a good idea for taxpayer accountability, it is at the core of making the program reach its optimal effectiveness.

Nevertheless, in considering the implementation of legislation such as the Maloney-King bill, we must recognize that serious concerns need to be addressed in order for an appropriate balance to be struck amongst competing interests.

Information that will be made available to taxpayers must be relevant and the appropriate context be given in order to provide an understanding of the use of TARP funds. A simple information dump will create confusion and a lack of comprehension ultimately degrading transparency and causing a loss of confidence in TARP. Therefore, an appropriate discussion of the context and relevance of information is needed to facilitate it usage. Such contextual disclosures and discussion are used in corporate financial reports to assist investors in comprehending information and making informed economic decisions.

Similarly, Congress needs to investigate the privacy implications that may impact individuals or businesses that may have been loaned money by TARP recipients using TARP funds. Congress has previously passed legislation, such as the Privacy Act and Gramm-Leach­Bliley that puts in place a number of safeguards to prevent government or financial services firms from disclosing the financial information of individuals or businesses. Those protections should remain in place and a TARP database should have safeguards in place to protect privacy. Thought should also be given to how such a database could be used by non-TARP business competitors to create a competitive advantage.

These issues are not insurmountable and can be addressed. Corporate financial reports are quite voluminous; it is difficult for sophisticated investors to locate and use data from them that is relevant for decision making. However, corporate financial reports are able to track the receipt and expenditure of large sums of monies, over multiple jurisdictions, while protecting the privacy of customers. Many jurisdictions now require that public companies must file their financial reports using electronic data form, commonly using a language known as eXtensible Business Reporting Language (“XBRL”). These electronic database systems allow investors to flag data and use interactive analytical tools to identify relevant information and study it for decision-making purposes. Among the nations that use such an electronic database are Australia, Belgium, China, Ireland, Japan, Singapore, Sweden, the United Kingdom, and the United States.

These systems can be used to implement the TARP transparency that would be mandated by the Maloney-King bill. Furthermore, these systems can create a database that will insure that privacy concerns will be addressed and information properly presented. The technology matches the need and the public policy interests can be met.

As I wrote earlier in the article, the American people have the right to know how their hard earned money is being spent. Indeed, by instilling transparency into TARP, not only will accountability be increased, but the goals of the program, increased confidence, will be furthered immeasurably. By employing existing technology and putting in place safeguards needed to protect privacy, the systems needed for TARP transparency can be implemented. What is needed now is Congressional action. By passing the Maloney-King bill, Congress will not only send a clear signal that the administration of TARP needs to and will be improved, but an opportunity to establish transparency will be upon us.

We have the ability to do so; now all we need is the will. Our economy and the American taxpayer deserve no less.

† Executive Director, Financial Reporting and Investor Opportunity, Center for Capital Markets Competitiveness, U.S. Chamber of Commerce