$700 Billion Bailout Entices Fraud

Everyone who watched their stock portfolios get pummeled in early October can attest:  We need a bailout!  If for nothing else but to create stability in the credit markets and investor confidence, the bailout was necessary.  Though the acts of congress creates immediate relief, the Emergency Economic Stabilization Act of 2008 must be carefully managed over the coming years.  Because of many of the loopholes in the bill, I predict that within the next two years, we will be reading headlines about how the bill created opportunities for fraudulent abuse of the system to the benefit of companies and individuals at the expense of the U.S. taxpayer.  

Upon the bill’s passage, one of the major concerns about the bill was how “distressed assets” would be purchased by the government directly from banks, which could create a scenario whereby the taxpayers take on the major burden of a bank’s mistake and the banks get the upside.  

When Secretary Paulson pressed nine large financial institutions to voluntarily participate in allowing the government to buy preferred shares of those institutions to the tune of $250 billion, this relieved much of my own concern because preferred shareholders are the last to lose money in a company.  Though a great move by Paulson, there are cracks in the bill that will allow fraudulent acts.

The bill itself is 451 pages with only 113 pages dedicated to the bailout.  The remaining pages were other bills passed during negotiations which include the Energy Improvement Extension Act of 2008, Tax Extenders and AMT Relieve, and a Mental Health Parity and Addiction Act of 2008.  

One of the most troubling portions of the act is the excessive promotion for use of the HOPE for Homeowners Program of 2008.  We will address that program in a follow-on post, but I encourage you to read the summary, it’s frankly scary.  Without going into massive dissertation about all the potential fraud of the troubled asset relief program (TARP), let me provide you with two blatant examples for potential fraud in the bill.

Title I, Sec 101, paragraph (c)(3) gives the Secretary the authority to “Designat[e] financial institutions as financial agents of the Federal Government, and such institutions shall perform all reasonable duties related to this Act as financial agents of the Federal Government as may be required.”  In other words, any, and probably most, banks will be involved in buying assets on behalf of the government for one another.  Obviously it is necessary that the government appoint agents because there is no way $700 billion could be invested (spent?) by the Secretary and his staff.  However, this creates a “scratch my back, and I’ll scratch yours” scenario.  Watch the headlines.

In the same section, paragraph (e) states “the Secretary shall take such steps as may be necessary to prevent unjust enrichment of financial institutions participating in a program established under this section, including by preventing the sale of a troubled asset to the Secretary at a higher price than what the seller paid to purchase the asset.  This subsection does not apply to troubled assets acquired in a merger or acquisition…”  Can you say JP Morgan?  Washington Mutual, along with all their troubled assets, were purchased by JP Morgan and under this scenario, the government has given them a loophole to selling those troubled assets to the government at a higher price than they paid.

Can you sense the potential fraud of these two sub-sections?  Watch the headlines in the next two years and hopefully our next president won’t take his eye off the ball and keep good controls over this bill.  Next week we’ll provide you with more details about the incredibly unfair HOPE for Homeowners law.