U.S. bailout program increased moral hazard: watchdog

WASHINGTON (Reuters) - The U.S. government’s $700 billion financial bailout program has increased moral hazard in the markets by infusing capital into banks that caused the financial crisis, a watchdog for the program said on Wednesday.

The special inspector general for the U.S. Treasury’s Troubled Asset Relief Program (TARP) said the plan put in place a year ago was clearly influencing market behavior, and he repeated that taxpayers may never recoup all their money.

The bailout fund may have helped avert a financial system collapse but it could reinforce perceptions the government will step in to keep firms from failing, the quarterly report from inspector general Neil Barofsky said.

He said there continued to be conflicts of interest around credit rating agencies that failed to warn of risks leading up to the financial crisis. The report added that the recent rebound in big bank stocks risked removing urgency of dealing with the financial system’s problems.

“Absent meaningful regulatory reform, TARP runs the risk of merely reanimating markets that had collapsed under the weight of reckless behavior,” the report said. “The firms that were ‘too big to fail’ last October are in many cases bigger still, many as a result of government-supported and -sponsored mergers and acquisitions.”


The report cites an erosion of government credibility associated with a lack of transparency, particularly in the early handling of the program’s initial investments in large financial institutions.

“Notwithstanding the TARP’s role in bringing the financial system back from the brink of collapse, it has been widely reported that the American people view TARP with anger, cynicism and distrust. These views are fueled by the lack of transparency in the program,” the report said.

The inspector general again urged Treasury to disclose more detailed information on how banks have used the taxpayer funds they have received.

The report voiced concerns about conflicts associated with the program’s reliance on credit rating agencies and pointed out their key revenue source consists of fees collected from issuers of securities that they rate.

Among concerns raised by the report are that credit ratings were a key determinant in valuing banks’ capital in regulatory stress tests earlier this year.

Lower credit ratings for securities held in an institution’s investment portfolio meant that the institution would be required to raise more capital. Lower ratings also meant that financial institutions had more difficulty in raising private funds, making them more likely to turn to the government for help, the report said.

A Treasury and Fed securities loan facility also requires that paper pledged as collateral be rated at the highest long term category, or AAA.

“The requirement that TALF(Term Asset-Backed Securities Loan Facility) can only involve AAA-rated securities has had a significant effect on the commercial mortgage backed securities market potentially enhancing the AAA market at the expense of others.”

The TARP inspector general praised a Federal Reserve decision to follow one of its recommendations and adopt a security-by-security screening of proposed collateral for loans from TALF.

“These provisions will mitigate the possibility of ‘ratings shopping,’ i.e., jumping to another rating agency if the first one approached seems inclined to give an unfavorable rating,” the inspector general said in the report.

Reporting by David Lawder, Editing by Andrew Hay