The government’s $700 billion financial rescue plan may itself be in need of rescue, if early assessments are any indication. The credit markets are still floundering, and questions are arising already about the Department of Treasury’s administration of the plan. Before the ink was dry on the Troubled Asset Relief Program (TARP) — it was signed into law October 3 — Treasury officials had decided not to use the money to buy troubled assets at all, as the program envisioned. Instead, they decided to follow the lead of foreign governments and pour cash directly into banks to improve their balance sheets and persuade them to resume lending. Treasury so far has injected more than $150 billion in capital into 52 institutions, but the nation’s businesses and consumers have yet to see credit loosen. The crunch is so bad that vehicle sales in the United States plunged to their lowest rate in 26 years in November, helping to push automakers to seek their own bailout. The Government Accountability Office (GAO), while allowing that the TARP program is new and the challenge daunting, warns that Treasury has not yet put into place a system to gauge the program’s success. The department does not have conflict of interest rules in place, nor any monitoring of the bailout law’s requirement limiting compensation for executives of participating banks, the GAO said. Treasury interim Assistant Secretary Neel Kashkari said in a letter to the GAO that “more can and will be done” to improve transparency and communication, and he agreed that Treasury needs to develop a means to ensure compliance with provisions of the law. But Elizabeth Warren, chairwoman of Congress’ own panel overseeing the bailout, has raised a more fundamental question — whether Treasury understands why banks aren’t lending, and whether more attention should be paid to shoring up the finances of households instead of banks. Treasury Secretary Henry Paulson has maintained that TARP should not be seen as the sole remedy for the ailing economy, but a program “to first stabilize a financial system on the verge of collapse.”

Follow-up:
A key point person in ensuring accountability of the TARP program will be a special inspector general (IG), who is charged with auditing and investigating how the federal aid money is spent; the IG will also have the authority to make criminal referrals. It took six weeks for the Bush administration to name veteran New York federal prosecutor Neil Barofsky for the job, and he was confirmed by the Senate on December 8, after a delay caused by an anonymous senator who had put a “hold”on the nomination. Meanwhile, President-Elect Obama, who is eyeing an economic stimulus plan that could dwarf the size of the initial bailout, has signaled a departure in policy from Paulson in saying he wants to see some of the $700 billion in TARP funds used to help homeowners struggling with their mortgages. Mortgage default and foreclosure rates have reached the highest level seen in the 29 years that the Mortgage Bankers of America has been keeping records, and they are expected to increase further.

Photo credit: Department of Energy

The Clinton administration departed with an unprecedented $127 billion budget surplus, but two prolonged wars and a plummeting economy under President Bush have left the country reeling with a record-setting $455 billion deficit for fiscal year 2008. At a hefty $12 billion per month during 2008, the war in Iraq is one factor that accounts for the runaway red ink. The overall jump in annual defense spending, which ballooned from $295 billion in 2000 to $547 billion in 2007, was another factor. Meanwhile, the rising cost of health care, the economic downturn, and the Bush administration’s 2001 tax cuts have compounded the problem. (Without the tax cuts, for example, the nation would have had a budget surplus as late as 2005.) During Bush’s first year in office, the deficit stood at $32 billion; by 2002, the deficit had skyrocketed by nearly 1,000 percent to $317 billion. In historic terms, the deficit remains a comparatively modest 3.2 percent of gross domestic product — as opposed to the deficits of the mid-1980s, which hit a record 6 percent of GDP after President Reagan’s tax cuts. But that’s scant comfort for citizens who have watched record surpluses turn into historic deficits, with more bad news likely on the horizon. In September, Office of Management and Budget Director Jim Nussle blamed the deficit on “the slow economy and the bipartisan decision to enact a stimulus package.” The solution, said Nussle: growing the economy “by keeping spending in check.”

Follow-up:
In October 2008, the Congressional Budget Office estimated that the deficit for FY 2009 could reach up to $700 billion. But that was before the full impact of the slumping economy and the financial bailout became clear; now some experts say the deficit may rise to a staggering $1 trillion in 2009. That sort of deficit could reach a record-breaking 7 percent of GDP. And it could well constrain the scope of President-Elect Barack Obama’s ambitious agenda.

As credit-default swaps and derivatives took off in recent years, lack of authorization to oversee such transactions has forced the Securities and Exchange Commission (SEC) to sit largely on the sidelines, allowing waves of risky new financial instruments to proliferate with little oversight. For example, the volume of credit-default swaps exploded to over $45 trillion in 2007 — twice the size of the U.S. stock market. Without regulation or an electronic system to track such trades, the potential for systematic risk grew markedly. In August, before the government bailed out insurance giant American International Group, it was revealed the company had sold $440 billion in shaky credit-default swaps tied to mortgage securities. Meanwhile, despite more than a decade of warnings about fast-growing credit derivatives— including a plea from the head of the SEC's sister regulatory agency, the Commodity Futures Trading Commission — the government continued to neglect scrutiny of such markets. The resulting toxic mix of risk, little transparency and sparse oversight is frequently cited as a crucial underlying factor in America’s worst financial crisis since the Great Depression. “The regulatory system,” says the Government Accountability Office (GAO), “currently lacks the comprehensive framework needed to regulate today’s highly complex, ever-changing global marketplace.”

Follow-up:
In December, the SEC adopted new rules to stem conflicts of interest and increase accountability for Wall Street’s credit-rating industry. The SEC has also entered into an information-sharing agreement with the Federal Reserve and the Commodity Futures Trading Commission to promote regulation of credit-default swaps. Meanwhile earlier this fall, SEC Chairman Christopher Cox urged Congress to pass legislation that would regulate credit-default swaps and strengthen oversight of derivatives, stating that the market is “ripe for fraud and manipulation.” This year, Cox also launched the 21st Century Disclosure Initiative, an internal inquiry into the Commission’s information-gathering practices. Attempts to strengthen transparency and regulation are likely to remain on the front burner. An SEC spokesman told the Center that enforcement spending is “at a record high.” The GAO recently named oversight of financial institutions and markets as one of 13 urgent issues demanding the attention of President-Elect Obama and the 111th Congress. Obama has called for creation of “21st century standards” for oversight of the financial system. “We need to streamline a framework of overlapping and competing regulatory agencies,” he added.

Photo credit: White House

After years of calls for Congress to create stronger regulatory oversight of Fannie Mae and Freddie Mac, time ran out in 2008 when the two mortgage giants collapsed, forcing a costly government bailout. Congress created Fannie Mae during the Great Depression to buy mortgages and free up capital so that lenders could make more loans, especially to low- and middle-income buyers. Congress launched Freddie as a competitor in 1970. The Department of Housing and Urban Development (HUD) first assumed regulatory duties over Freddie and Fannie in 1992, while an independent office within HUD — the Office of Federal Housing Enterprise Oversight (OFHEO) — was tasked with maintaining their safety and soundness. Unlike bank regulators, OFHEO needed budget approval from a Congress — a Congress on which Freddie and Fannie lavished $170 million on lobbying over the past decade. The two companies also contributed $4.8 million in congressional campaign donations over the last 20 years. Freddie and Fannie’s unique status as government-sponsored enterprises allowed them to borrow money at a lower market rate than that imposed on mortgages they bought up. That status also allowed the companies to put up far less capital behind their investments than banks. As early as 2000, the Treasury Department urged Congress to tighten oversight of the companies, and by 2004 the Government Accountability Office (GAO) explicitly recommended a new, less fragmented regulatory office with greater oversight and enforcement powers. “I believe the evidence clearly shows that the current regulatory structure is not well-equipped,” Comptroller General David M. Walker told Congress in 2005. Should the companies encounter trouble, warned Walker, it could have “destabilizing effects on financial markets.” No reforms came about, however. Fannie and Freddie then expanded their reach into risky subprime securities. Complex summaries of their monthly purchases came streaming into OFHEO, but no alarms sounded until January 2007. Freddie and Fannie went on to report losses of more than $5 billion that year — their first combined loss in a quarter-century. As mortgage delinquencies continued to pile up among Americans, in September the government took over the two companies at a cost then estimated at $25 billion by the Congressional Budget Office. An OFHEO spokeswoman did not respond to a request for comment, but its director told Congress back in February — five years after the office asked for more authority — that “we need a stronger, single, and unified regulator for the housing GSEs [Government-Sponsored Enterprises].”

Follow-up:
The September 2008 rescue plan finally placed Freddie and Fannie under government conservatorship with a new independent regulator, the Federal Housing Finance Agency (FHFA). Without a federal takeover, the two companies, whose stock fell 98 percent in a year, “could have caused a significant systemic event” in global markets, according to FHFA’s director. The companies have continued to lose money; their third-quarter losses indicate the bailout might become significantly more expensive than expected.

Photo credit: White House

The Securities and Exchange Commission’s (SEC) laissez-faire attitude toward regulation of investment banks is widely believed to have contributed to the depth of the current economic crisis. That the SEC was asleep at the switch was on clear display in March, when its chairman, Christopher Cox, declared he felt “a good deal of comfort” about investment banks’ capital cushions. Just three days later, Bear Stearns collapsed and was bought by JP Morgan Chase in a hastily arranged deal backed by $29 billion in taxpayer funds. The sale of Bear Stearns, one of the first rumbles in the financial earthquake, was presaged by a 2004 SEC decision that loosened capital rules and allowed brokerage units to take on greater debt. Since then, investment firms’ debt-to-assets ratios have risen — in Bear Stearns’ case, to as high as 33 to 1. Simultaneously in 2004, the SEC began outsourcing risk monitoring responsibilities to the banks themselves, while assigning only seven staffers to oversee the five largest investment houses, which controlled more than $4 trillion in assets. Despite the companies’ vanishing cushion against investment losses, the SEC did nothing in the case of Bear Stearns to address the bank’s issues of heightened risk. As an SEC inspector general’s report put it in September, it is “undisputable” that the SEC “failed to carry out its mission” in that case. The public has ended up footing much of the bill.

Follow-up:
SEC Chairman Cox, Federal Reserve Chairman Ben Bernanke, and Treasury Secretary Henry Paulson have all acknowledged recent regulatory failures. In September, prompted by the onset of the worst financial crisis since the Great Depression, Cox dismantled the 2004 program that permitted self-monitoring among firms. An SEC spokesman noted that in October Cox told Congress, “We have learned that voluntary regulation does not work.” Further, the SEC’s oversight responsibilities now largely shift to the Federal Reserve, though the commission continues to oversee investment banks’ brokerage units. Recommendations by the SEC inspector general for tighter limits on borrowing and risky investing practices are also being considered.

Tax avoidance is an old trick, but under the Bush administration, weak enforcement and a spate of new tax credits and loopholes have led to an extended tax holiday for big business. Though the basic corporate tax rate is 35 percent, according to the left-leaning Citizens for Tax Justice, the average tax rate paid among the 275 largest U.S. corporations is closer to 17 percent — lower than that of most individual citizens. Tax avoidance tactics abound, including funneling U.S. profits to tax-free subsidiaries overseas and using previous years’ losses (from up to 20 years ago) to write down a firm’s annual taxable profits. Lower levels of Internal Revenue Service (IRS) audits targeting large corporations have compounded the problem. While corporate tax payments accounted for 23 percent of all federal tax revenue in 1960, by 2007 that figure had dropped to just 14 percent. In fact, as the Government Accountability Office reported in a controversial 2008 study, nearly 60 percent of U.S. companies doing business in the United States paid no federal income taxes for at least one year between 1998 and 2005. Thanks to an increase in corporate profitability, the amount of revenue from corporate taxes increased during fiscal years 2003 through 2006. Yet, according to 2006 IRS estimates, corporations and the self-employed continue to evade some $88 billion in taxes a year. The IRS has previously said that while the number of large corporate audits has declined, it has focused its “resources better on where the noncompliance is,” and plans to make targeting noncompliance with tax laws a “high priority.” In response to a request for comment, an IRS spokesman noted that tax enforcement revenue for corporations climbed to $14.2 billion in 2007, a rise of 33 percent from the previous year.

Follow-up:
Since the onset of the financial crisis, pressure to crack down on tax scofflaws has increased. In the fall of 2008, published reports have revealed that some financial giants turning to U.S. taxpayers for costly bailouts — for example, American International Group, which recently received up to $123 billion in Treasury assistance — had avoided paying taxes for years. In the case of AIG, the company used and promoted an abusive tax shelter that individuals have used to evade at least $3.7 billion in federal taxes (though the IRS has since managed to recoup those funds).

A generous tax cut was not the only boon wealthy individuals and large corporations received from the Bush administration’s time in office: In recent years, the Internal Revenue Service (IRS) has given their tax returns less and less scrutiny — even as it has stepped up its audit rates among the poor. In 2007, in what the Syracuse University-based Transactional Records Access Clearinghouse (TRAC) calls a “historic collapse,” only 26 percent of corporations holding at least $250 million in assets were audited (compared to more than 70 percent in 1990). Likewise from 1996 to 2006, audit rates of those earning over $100,000 fell by more than one-half, down to 1.3 percent. One contributing factor behind the trend is a slump in IRS staffing: Over the past decade, the number of agents performing audits has fallen by more than 30 percent. Another factor is a 1998 congressional reform bill directing the IRS to focus its audits on those who apply for the Earned Income Tax Credit (EITC) — a credit designed to assist the working poor. By 2006, audits of EITC recipients had risen to account for 40 percent of all investigations. While EITC fraud is a real concern, at a maximum, such fraud accounts for roughly 3 percent of the estimated $300 billion gap between paid and owed taxes. Meanwhile, lighter scrutiny on large corporations and the wealthy — who have the most non-cash income and leeway to game the system — means that those who owe the most also have the best chance of getting away without paying their due. IRS officials have not disputed TRAC’s numbers, but have said they were focusing harder on where noncompliance occurs, especially in private partnerships corporations use to avoid paying taxes. In response to a request for comment, an IRS spokesman noted that in 2007, the agency audited one in 11 tax returns of individuals earning over $1 million, a jump of 84 percent from the year before.

Follow-up:
President-elect Obama has not addressed the audit issue directly, but has indicated that he will give the Department of the Treasury “the tools it needs to stop the abuse of tax shelters and offshore tax havens,” while eliminating “special interest loopholes and deductions.”

Critics believe a lack of government regulation helped fuel questionable accounting practices — practices that allowed the huge energy trading firm Enron to report profits of hundreds of millions of dollars ($979 million in 2000, alone) before collapsing in 2001, in what was then the largest corporate bankruptcy in U.S. history. The erosion of accounting practices was believed to have begun in the 1980s, as firms tried to balance strict standards with a desire to please clients and expand consulting business, but the scandals burst into public view under President George W. Bush. Certainly by the time Bush was elected, there was ample reason to question the overall validity of corporate financial statements, given that restatements of Securities and Exchange Commission (SEC) filings had skyrocketed from just three in 1981 to 270 in 2001. (The SEC says some of the blame lies with the Financial Accounting Standards Board, the private nonprofit organization it designated to set rules for corporate financial disclosure. In 2000, for example, it adopted a rule allowing companies, including Enron, to keep certain holdings off their balance sheets.) As former SEC Chairman Arthur Levitt warned in a now-famous 1998 speech, without adequate government regulation, “Too many corporate managers, auditors, and analysts are participating in a game of nods and winks.” The giant accounting firm Arthur Andersen was convicted in 2002 of obstructing justice for shredding documents in relation to its auditing of Enron. The Supreme Court reversed the conviction in 2005 due to problems with jury instructions, but the firm’s accounting business was essentially ended by the case, amid questions about other Andersen audits. The Enron case left in its wake a host of innocent victims; shareholders — including many pensioners — lost over $80 billion as the value of the company, once considered a reliable blue-chip stock, disintegrated. A series of other accounting scandals followed, raising further questions about the proper regulatory role for the government.

Follow-up:
Following numerous hearings, Congress scrambled to act in 2002. That July, both chambers voted to enact the Sarbanes-Oxley Act, which quickly received President Bush’s signature. The bill established enhanced standards for U.S. public company boards and accounting firms, as well as a new agency under the SEC to monitor and discipline accounting firms in their auditing of public companies: the Public Company Accounting Oversight Board (PCAOB). Last December, Deloitte LLP became the first of one of the “Big Four” accounting firms to be fined by the PCAOB for a $1 million civil penalty. An SEC spokesman told the Center the agency has taken significant actions to increase disclosure of risky positions within the last year, especially regarding off-balance sheet arrangements.

With the growth of global capital, rising numbers of U.S. corporations are offshoring their revenue to hide from the taxman, and for the past eight years, the Bush administration has taken scant action to stem that tide. While corporations use many tactics, the basic principle involves shuffling their U.S. profits or activities through any number of overseas subsidiaries or shell companies — some which consist of little more than a mail slot in a low-tax foreign locale. From 1999 to 2003 alone, for example, the profits reported by foreign subsidiaries of U.S. multinational companies soared by 68 percent, an increase not accompanied by any gain in real economic activity in popular tax havens. Yet the ability of the Internal Revenue Service (IRS) to provide oversight of these practices has failed to keep pace with their growth. While in the mid-1990s, the IRS had a $4.43 billion enforcement budget, by 2006, that budget had risen by less than five percent, even as the size of the economy grew nearly eight times that amount. The IRS has also reduced audits of offshore taxpayers, which take an average two-and-a-half years to complete (the deadline for completion of an audit is three years). Today, according to Congress, the use of offshore tax abuses costs the U.S. government over $100 billion in lost revenue a year. That’s nearly three times the annual budget of the Department of Homeland Security. Even the nation’s top Iraq war contractor, Kellogg Brown & Root (a former Halliburton subsidiary), was able to avoid paying hundreds of millions in Medicare and Social Security taxes for years — all while receiving $16 billion in plum contracts.

Follow-up:
Members of the Senate Finance and Budget Committees have been particularly vocal on the issue of offshoring revenue, introducing legislation to address the problem, such as the Stop Tax Haven Abuse Act. President-Elect Obama has indicated support for the concept. Congress has held a string of related hearings in recent years, including a July 2008 panel focused on the tropical tax haven of the Cayman Islands, where one office building purports to house 12,748 corporations. The IRS has previously announced plans to step up activity on the issue, unveiling an August 2008 settlement offer to over 45 of the nation’s largest corporations that would allow them to keep 20 percent of the pre-2008 deductions claimed through particular tax shelters, so long as they agreed to stop using those shelters by 2010. In response to a request for comment, an IRS spokesman noted that the agency has embraced various new strategies to increase tax compliance, such as increased scrutiny of mid-market corporations with assets between $10 million-$50 million, and will “closely monitor” its handling of large corporate audits. Meanwhile, Congress’s October 2008 bailout bill included a provision closing a loophole that hedge fund managers have used to avoid taxes on offshore income. As budget pressures tighten, more action on the issue looks likely.

In spite of allegations of cronyism, easing terms on subprime mortgages, and federal investigations into possible partisan awarding of contracts, Alphonso Jackson — a longtime friend of President Bush and former president of a billion-dollar Texas electric utility — remained at the helm of the Department of Housing and Urban Development (HUD) until April 2008. Jackson joined the administration in 2001 as deputy secretary of HUD. In 2004, the Senate unanimously confirmed Jackson as secretary. Earlier that week, Jackson had blocked implementation of consumer protection standards that forced mortgage lenders to disclose kickbacks and stopped their last-minute changes to interest rates and closing costs. Two years later, the HUD Office of Inspector General launched the first of an array of investigations of Jackson; it found that Jackson had encouraged his staff to consider political affiliation when awarding contracts. By spring 2008, the inspector general was investigating Jackson again, while the FBI and Congress had opened their own investigations into multiple allegations of cronyism and retaliation. Jackson allegedly pressured the New Orleans office of HUD to hire a friend for a no-bid contract; the contractor also performed renovations on Jackson’s vacation home. The Philadelphia office of HUD filed a lawsuit accusing Jackson of hindering funding in retaliation for refusing to hand over a $2 million vacant lot at a deep discount to a developer friend. Jackson stepped down in March. Bush said he still had confidence in Jackson, calling him “a strong leader and a good man.” A call to Jackson’s home requesting comment was not returned.

Follow-up:
A Washington Post investigation found HUD management had dismissed repeated expressions of concern about Jackson’s dealings by veteran contracting specialists within the agency. The lawsuit filed by the Philadelphia office was settled in October 2008.

Photo: Former HUD Secretary Alphonso Jackson. Photo credit: Department of Housing and Urban Development