Government Watchdog Says Treasury and Fed Knew Bailed-Out Banks Were Not Healthy

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In a new report obtained by ABC News, the chief watchdog for the governments $700 billion bailout program refutes the Treasury Departments claim that banks cannot be asked to account for their use of taxpayer money.

The Treasury Department and the Federal Reserve lied to the American public last fall when they said that the first nine banks to receive government bailout funds were healthy, a government watchdog states in a new report released today.

Neil Barofsky, the special inspector general for the Troubled Asset Relief Program (SIGTARP), says that despite multiple statements on Oct. 14 of last year that these nine banks were healthy and only receiving government funds for the good of the country's economy, federal officials knew otherwise.

"Contemporaneous reports and officials' statements to SIGTARP during this audit indicate that there were concerns about the health of several of the nine institutions at that time and, as detailed in this report, that their overall selection was far more a result of the officials' belief in their importance to a system that was viewed as being vulnerable to collapse than concerns about their individual health and viability," Barofsky says.

Last October, the government was in the midst of trying to contain the worst financial crisis in decades. On Sept. 7, 2008, mortgage giants Fannie Mae and Freddie Mac were placed under conservatorship. On Sept. 15, the massive investment bank Lehman Brothers filed for bankruptcy. The next day, insurance giant AIG needed an $85 billion government loan to avoid collapse.

On Oct. 13, after Congress had passed the $700 billion financial bailout program earlier that month, Treasury provided capital injections for nine institutions that together held over $11 trillion in assets: Bank of America, Citigroup, Wells Fargo, JP Morgan Chase, Goldman Sachs, Morgan Stanley, Merrill Lynch, State Street and the Bank of New York Mellon. As of June 2008, these nine banks accounted for around 75 percent of all assets held by U.S. banks.

In announcing the initial $125 billion provided to these banks, former Treasury Secretary Hank Paulson on Oct. 14 said, "These are healthy institutions, and they have taken this step for the good of the U.S. economy. As these healthy institutions increase their capital base, they will be able to increase their funding to U.S. consumers and businesses."

That same day, the Treasury Department, the Federal Reserve and the FDIC also released a joint statement reiterating that "these healthy institutions are taking these steps to strengthen their own positions and to enhance the overall performance of the US economy."

Serious Concerns About the Bailout Plagued Government Officials

Barofsky finds, however, senior officials at the Treasury and the Fed had serious concerns about the health of some of these banks. Fed chief Ben Bernanke, for one, told the watchdog that the central bank believed each of the nine institutions faced certain risks given the economic environment.

"Senior government officials had affirmative concerns at the time the nine institutions were selected about the health of at least some of those institutions," Barofsky says. "The Federal Reserve had concerns over the financial condition of several of these institutions individually and for all of them collectively absent some governmental action. And former Secretary Paulson noted concerns about the outright failure of one of the institutions."

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