Bailout Fraud Risk High, Warns Watchdog

Friday, February 6, 2009 9:53 AM

By: Michael Kling

A $200 billion Federal Reserve program meant to promote consumer lending is wide open to fraud and abuse, says a government watchdog in a new report.

The Federal Reserve and Treasury Department plan to roll out the Term Asset-Backed Loan Facility (TALF) to jump start consumer later this month, with Treasury kicking in $20 billion of TARP funds.

The trouble with TALF, according to Neil M. Barofsky, the special inspector general for Troubled Asset Relief Program, is that borrowers can put their own value on assets used as collateral — even unrealistically high values.

After they take the government’s money, they could walk, leaving taxpayers holding the bag.

"Treasury should consider requiring that some baseline fraud prevention standards be imposed, such as minimum underwriting standards or some other combination of provisions that will minimize the risk of fraud," Barofsky says in the report.

The Treasury Department should avoid the program until it’s fixed, he recommends.

Under the program, securities backed by car loans, student loans, and other consumer loans would be used as collateral.

Just using minimum credit ratings is not enough to protect against fraud. The government had better watch out if it decides to accept mortgage-backed securities because of widespread mortgage fraud, Barofsky warns.

The overall TARP also has shortcomings, such as accounting from companies using government help, according to Barofsky. Treasury should devise a way to valued preferred shares and warrants of its investments and devise an overall investment strategy.

“The long-term success of the program is not assured,