Fraud probes focus on bailout

WASHINGTON – In the first major disclosure of corruption in the $750 billion financial bailout program, federal investigators said Monday that they had opened 20 criminal probes into possible securities fraud, tax violations, insider trading and other crimes.

The cases represent only the first wave of investigations, and the total fraud could reach into the tens of billions of dollars, according to Neil Barofsky, the special inspector general overseeing the bailout program.

The disclosures reinforce fears that the bailout run by the Treasury Department and Federal Reserve, a program hastily designed and changing rapidly, is going to carry a heavy price of fraud against taxpayers – even as questions grow about its ability to stabilize the nation’s financial system.

Barofsky said the complex nature of the program makes it “inherently vulnerable to fraud, waste and abuse, including significant issues relating to conflicts of interest facing fund managers, collusion between participants and vulnerabilities to money laundering.”

The report said little about who was under investigation and how the fraud might work, but investigators are on alert for a long list of potential scams. Such schemes could include obtaining bailout money under false pretenses, bilking the government with phony mortgage modifications and cheating on taxes with fraudulent filings.

“You don’t need an entirely corrupt institution to pull one of these schemes off,” Barofsky said. “You only need a few corrupt managers whose compensation may be tied to the performance of these assets in order to effectively pull off a collusion or a kickback scheme.”

The risk of fraud is only increasing as the bailout becomes “more complex and larger in scope,” he said.

Indeed, much of the 247-page report to be released today by Barofsky’s office focuses on a segment of the bailout that is only now being put into motion – an effort to buy toxic securities from banks and other investment groups in which the federal government would provide up to 92.5 percent of the money.

That part, known as the Term Asset Backed Loan Facilities Program, or TALF, could be the most vulnerable to fraud, Barofsky said, because investors would have so little at risk.

Among the toughest recommendation in the report is for the Treasury to abandon its planned structure for buying the toxic securities, which include intricate bundles of bad mortgages and loans, before it gets rolling.

Member of Congress and consumer advocates expressed outrage Monday when they heard about the report’s findings.

“It shouldn’t be a big surprise that a huge pot of honey attracts a lot of flies,” said Sen. Tom Coburn, R-Okla., the senior Republican on the Senate Permanent Subcommittee on Investigations, which is also examining the program. “I would guess that 20 investigations, while a good start, is only the tip of the iceberg.”

Said Barbara Roper, director of investor protection for the Consumer Federation of America: “That’s an appalling record. In the midst of this crisis from which they are being bailed out, the same people who created this mess are apparently still breaking the law. What is it with these people?”

In a series of recommendations, Barofsky asked the Treasury Department for greater transparency and greater fraud protections. The Treasury’s bailout chief, Neel Kashkari, said in a letter dated April 14 that the recommendations would be “considered.”

The report underscores how complicated the bailout program has become. What started in October as a $750 billion effort to buy only toxic securities has morphed into 12 programs that cover up to $3 trillion in direct spending, loans and loan guarantees – an amount roughly equal to the annual federal budget.

Today, banks, insurers, brokerages, auto companies, car parts makers and homeowners are just some of the beneficiaries of the program, known formally as the Troubled Asset Relief Program, or TARP.

The report dedicated an entire section to what many experts believe is its most risky operation, TALF.

Originally, TALF was aimed at expanding consumer lending programs for autos, student loans and other types of credit. But the Obama administration expanded TALF to include funding and federal loan guarantees to purchase toxic securities. That program has at least two parts, one to buy up bad loans from banks and another to buy up bundled loans in the form of mortgage-backed securities from investment markets.

The government would split any profits with the private investors it partnered with. That has sparked greater concern because of the possibility that buyers could collude to manipulate prices and extract kickbacks, with the government taking virtually all of the risk.

“When you are buying from the market or the street, transparency comes into question,” Barofsky, a former federal prosecutor, said. “The potential for pricing fixing and collusion becomes greater because the government doesn’t have control or knowledge of who” all the players are.

Rep. Brad Sherman, D-Calif., a CPA who sits on the House Financial Services Committee, said that under the plan, taxpayers would take virtually all the risk, get zero control and receive only 50 percent of the profits.

“That doesn’t sound like a good deal,” he said. “I can’t imagine Warren Buffett signing something like that.”