The banking industry has already begun to criticize the proposal and Republicans have taken to characterizing it as enshrining taxpayer-funded “bailouts.” Last night, Rep. Spencer Bachus (R-AL), the ranking member on the House Financial Services Committee, and CNBC’s Larry Kudlow went so far as to call resolution authority “TARP in perpetuity,” and “permanent bailout authority“:

KUDLOW: It’ll perpetuate TARP, in perpetuity. TARP will be used to somehow string these institutions along. Is that right, is that fair, is that your question? [...]

BACHUS: It’s a permanent bailout authority.

Watch it:

While it makes sense, politically, to invoke the unpopular TARP to oppose anything that the administration is proposing, Kudlow and Bachus are pretty far off the mark. In fact, resolution authority is meant to ensure that the government doesn’t find itself, as it did last year, having to choose between letting a company’s disorderly collapse ripple through the economy or infusing that company with money to prop it up, indefinitely.

And contrary to Kudlow’s positing, the resolution money will not come from TARP. That said, there is a legitimate question of how it will be raised, and Frank and the administration were looking at two options to find the answer.

The first was having the largest banks pay into an insurance fund that would be used in the event of a failure that required resolution. The second, which Frank and Treasury have reportedly settled on, is having Treasury loan the failing institution money, which will then be recouped from the company’s assets and from a fee on other large institutions, after the fact.

Unfortunately, I think Frank and the administration have this backwards. We already have a system in which the Federal Deposit Insurance Corp. assesses fees on banks, which it uses to pay depositors when an institution fails. I don’t see why a similar system wouldn’t work to build a fund for resolution authority.

The big banks are going to cry foul either way, but at least if they had to pay into a fund, it’d be simple to say that the fee was meant to guard taxpayers against any of them failing. Collecting fees post-failure means that one firm will have to pay for the mistakes of another, directly, with some undetermined formula for how much each institution should pay.

Simon Johnson, professor at MIT Sloan School of Management, said that charging banks after the fact was “a non-starter,” while Rep. Brad Sherman (D-CA) said that “the only way he could vote for the bill would be if it had large insurance premiums levied on the biggest banks.” Indeed, framing the fee as insurance, instead of forcing banks that didn’t fail to pay a penalty, seems like the better way to go.

As the wreckage of the subprime bubble has settled, details have slowly leaked out about the pernicious lending practices that some of the biggest banks employed, particularly when it came to taking advantage of minority borrowers. The highest-profile example of this was Wells Fargo’s “ghetto loans,” in which the bank allegedly pushed minority borrowers who qualified for prime loans into subprime, which can add more than $100,000 in interest payments to a mortgage.

But according to a new report by CAP’s Andrew Jakabovics and Jeff Chapman, Wells Fargo was far from the only bank with obvious racial disparities in its lending. Jakabovics and Chapman looked at the lending data for 14 systemically important banks in 2006 — a year in which these 14 originated more than one out of every three higher-priced mortgages in the country — and the results are fairly appalling:

Overall, 17.8 percent of white borrowers were given higher-priced mortgages when borrowing from large banks in 2006, yet 30.9 percent of Hispanics and a staggering 41.5 percent of African Americans got higher-priced mortgages…Among high-income borrowers in 2006, African Americans were three times as likely as whites to pay higher prices for mortgages—32.1 percent compared to 10.5 percent. Hispanics were nearly as likely as African Americans to pay higher prices for their mortgages at 29.1 percent.

So not only were the banks handing out subprime loans to minorities on a much greater scale, but they were issuing them to lots of low-risk borrowers — households earning more than twice their area’s median income, most of which reported six-figure incomes — at a dizzying rate (which was, again, significantly higher for minorities). I would be interested to hear how the banks explain away that one.

To be fair, many of the banks that have the most egregious stats actually bought their racial disparities, as some of the biggest subprime lenders collapsed and were acquired by the big banks. Bank of America, for instance, acquired LaSalle and Countrywide, both of which were far more likely to offer higher-priced loans to minorities than Bank of America itself. JP Morgan bought Washington Mutual, which was the worst of the banks analyzed, “with fully 56.9 percent of African Americans and 42.3 percent of Hispanics paying higher prices, compared to 16.9 percent of whites.”

The banks examined in the report were the recipients of 43 percent of the funds dispersed under the Troubled Asset Relief Program (TARP), and Jakabovics and Chapman advocate not allowing any of the banks that still owe TARP funds to pay them back without receiving a passing grade on fair lending practices from the TARP’s Inspector General.

These numbers also make the case for the creation of a Consumer Financial Protection Agency (CFPA) with strong enforcement abilities over fair lending practices. Discriminatory lending is illegal, but these numbers show that not very much was done about it. This was presumably a profitable form of lending for these institutions, which regulators charged with ensuring the safety and soundness of banks would have been loath to pull back.

By removing consumer protection responsibilities from the traditional bank regulators, and placing it with a new agency, consumers will have an advocate within the regulatory system, and discriminatory lending of the sort Jakabovics and Chapman found will hopefully be met with the sort of penalties that it deserves.

Yesterday, Bloomberg News reported that more than 150 banks hold a level of toxic loans that “can wipe out a bank’s equity and threaten its survival.” The number of banks holding this many toxic assets has doubled this year.

One of the most outspoken critics of both Treasury and the Federal Reserve’s bailout programs has been Rep. Alan Grayson (D-FL). Yesterday, The Wonk Room spoke with Grayson and asked for his reaction to the persistence of the toxic asset problem. After introducing us to his friend — a cardboard cutout of President Obama — Grayson had this to say:

[T]he problem is not going to go away anytime soon because a lot of households are underwater. They owe more than they own, so not only is their collateral impaired, meaning their house, the value of a small business and so on, but their value as borrowers is impaired. [...] Now, does that mean we need bailouts? I say no. I voted against every bailout. I’m going to continue to vote against bailouts because I don’t believe taxpayer money belongs in the pockets of private interests. The way we should have done this is we should have taken these assets and liquidated them, we should have taken the management that was in charge of these financial institutions that failed and we should have liquidated them as well.

Watch it:

Transcript:

GRAYSON: Let me introduce you to my friend, President Obama. He’s been on a weight-loss program, he’s very thin.

Q: We had a report from the Congressional Oversight Panel, Elizabeth Warren saying that toxic assets are still a problem, there are still a lot of them.

GRAYSON: For sure, yes.

Q: Is Treasury’s approach of just throwing money into the banks and letting them earn their way out of it working, or have we just postponed the reckoning?

GRAYSON: [To Obama] What do you think? [To camera] He’s quiet today, this is very uncharacteristic for our President, usually he has the right answer.

What the answer is, I think at this point, is that we do have a lot of toxic assets and the problem is not going to go away anytime soon because a lot of households are underwater. They owe more than they own, so not only is their collateral impaired, meaning their house, the value of a small business and so on, but their value as borrowers is impaired.

And although the economy is recovering there are huge regional disparities. The real estate problem is really localized in Florida, Nevada, Arizona, California, Michigan. Those are the states where value has gone down 30 percent or more. That includes my state, my state of Florida. So I think we’re seeing a problem that’s not going to go away immediately and the result of that is that there is going to be a continuing problem.

Now, does that mean we need bailouts? I say no, I voted against every bailout. I’m going to continue to vote against bailouts because I don’t believe taxpayer money belongs in the pockets of private interests. The way we should have done this is we should have taken these assets and liquidated them, we should have taken the management that was in charge of these financial institutions that failed and we should have liquidated them as well. We should have gotten rid of the people who put us in this position, rather than allow themselves to continue to enrich themselves, now at taxpayer expense.

So these bailouts have been conducted in a fundamentally unfair, wrong way. Other countries in similar circumstances have never done what we did, which is to simply hand the money over without any strings attached to it, and we’re missing accountability.

In light of that report, these new numbers from Bloomberg News regarding how many banks are holding a lot of toxic loans are rather sobering:

More than 150 publicly traded U.S. lenders own nonperforming loans that equal 5 percent or more of their holdings, a level that former regulators say can wipe out a bank’s equity and threaten its survival. The number of banks exceeding the threshold more than doubled in the year through June, according to data compiled by Bloomberg, as real estate and credit-card defaults surged.

“These numbers are off the charts,” said Blake Howells, an analyst at Becker Capital Management. Banks are losing the “ability to try and earn their way through the cycle,” he added. Given that Treasury’s strategy has been to prop the banks up long enough to let them earn their way back to health, this a problem. And it’s also troubling for smaller banks, which have toxic whole loans instead of the securitized loans that are plaguing Wall Street banks and don’t have the same sort of financial support that the big banks have received.

The administration’s plan for dealing with the toxic assets (the Public-Private Investment Program or PPIP) folded under the weight of bank indifference (like so many other programs, recently). And as the LA Times reported this morning, the smaller PPIP that is still getting underway may have a loophole that could cost taxpayers billions.

As David Corn put it, “Treasury officials will tell you that they used the [TARP] money to pump capital into banks — rather than buy their garbage — and this stabilized the financial system. Perhaps that worked. But, as the report makes clear, the original sin still stands.” Maybe the banks can keep ahead of the curve and make enough of a profit that the assets won’t be a problem. But maybe not, at which point Treasury is going to rethink the way in which it is trying to salvage the banking system.

The number continued to be cited on cable last night and this morning, with Fox News even claiming that $23 trillion will be the final cost of TARP alone. But Barofsky himself appeared on CNN to explain that the actual outstanding amount for the financial rescues is closer to $3 trillion, including loans that have yet to be repaid. Watch a compilation:

Barofsky’s report clearly states that “these numbers may have some overlap, and have not been evaluated to provide an estimate of likely net costs to the taxpayer”:

[S]ome of the programs have been discontinued or even, in some cases, not utilized. As such, these total potential support figures do not represent a current total, but the sum total of all support programs announced since the onset of the financial crisis in 2007.

But this doesn’t go far enough in explaining how unlikely we are to ever come close to spending so much money. As Floyd Norris explained in the New York Times, Barofsky’s estimate “assumes that every home mortgage backed by Fannie Mae or Freddie Mac goes into default, and all the homes turn out to be worthless. It assumes that every bank in America fails, with not a single asset worth even a penny. And it assumes that all of the assets held by money market mutual funds, including Treasury bills, turn out to be worthless.” If this doomsday economic scenario were ever to occur, the American currency would be rendered worthless.

Media Matters pointed out that both USA Today and the CBS Evening News used the same misleading number. And as Norris put it, publishing such a meaningless number makes Barofsky seem like nothing more than “an irresponsible headline hunter.”

Cross-posted on ThinkProgress.

However, what everyone using this number failed to mention is what it means and how it was calculated. In the report, Barofsky clearly wrote that the number was “designed to suggest the scale and scope of those efforts and not to provide a firm financial statement“:

These numbers may have some overlap, and have not been evaluated to provide an estimate of likely net costs to the taxpayer.

To arrive at $23 trillion, Barofsky simply added together every financial rescue program that has been proposed, including those that were discontinued or never even started. In the New York Times, Floyd Norris broke the number down further:

It also assumes that every home mortgage backed by Fannie Mae or Freddie Mac goes into default, and all the homes turn out to be worthless. It assumes that every bank in America fails, with not a single asset worth even a penny. And it assumes that all of the assets held by money market mutual funds, including Treasury bills, turn out to be worthless. It would also require the Treasury itself to default on securities purchased by the Federal Reserve system.

Norris added that “the sheer unreality of the number did not stop some members of Congress from taking the estimate seriously.” Indeed, Rep. Darrell Issa (R-CA) said that “if you spent a million dollars a day going back to the birth of Christ, that wouldn’t even come close to just one trillion dollars — $23.7 trillion is a staggering figure.”

It’s very unclear what Barofsky thought he would accomplish by publishing this number, since it’s indicative of basically nothing. And if the media are going to report such a worthless number, the least they can do is provide some context. Instead, they told everyone that taxpayers are on the hook for $23 trillion.

The banks, though, think Treasury Secretary Tim Geithner is expecting prices that are too high:

The Treasury has rejected the vast majority of valuation proposals from banks, saying the firms are undervaluing what the warrants are worth…J.P. Morgan Chase & Co. Chief Executive James Dimon raised the issue directly with Treasury Secretary Timothy Geithner, disagreeing with some of the valuation methods that the government was using to value the warrants.

There are two points to make here. The first is that I’m glad to see Geithner rejecting the banks’ initial offers. The system for selling back the warrants was designed in such a way that it almost guaranteed that the banks would lowball the price. If Geithner is truly telling the banks to take their offers and beat it, that’s an encouraging sign.

Second, this charge from the banks that Treasury is somehow overvaluing the warrants doesn’t hold much water. According to a report released today by the TARP’s Congressional Oversight Panel, Treasury has thus far sold warrants for 66 percent of their value. From the panel’s report:

Treasury has to date sold warrants only from smaller banks. In those sales, liquidity discounts are likely to be a major factor in a way that they are not likely to be for large publicly traded institutions. If, however, liquidity discounts or any other rationales are accepted as a reason for taking only 66 percent of market value for the full group of warrants Treasury holds, the shortfall to taxpayers could be as much as $2.7 billion.

JP Morgan has reportedly “waived its right to buy the warrants and will allow the Treasury to auction them in the public market.” This, in the end, is the best way for Treasury to dispose of the warrants, as it “has the benefit of stopping any speculation about whether Treasury has been too tough or too easy on the banks” and “permits the banks to bid for their own warrants — in direct competition with outsiders.” If the banks really think that Treasury is expecting too much, then they should all waive their buying rights and let Treasury put the warrants on the open market. Then we’d see whose valuation is right.

The anticipated value of warrants for 10 of the largest banks that repaid their Troubled Asset Relief Plan funds is $3.3 billion using the Treasury’s valuation process, compared with $3.82 billion with a more conventional method, Linus Wilson, a finance professor in Lafayette, Louisiana, said in an interview. Investors are debating whether taxpayers will be fairly compensated for the risk they took by providing rescue funds for the banking industry.

Treasury’s approach to offloading the warrants is to have each individual bank suggest a price for its warrants. Treasury can accept the bank’s offer, or reject it and propose its own price. If the bank then rejects Treasury’s proposal, three arbitrators decide the final price “based on an average of the appraisers.”

But since Treasury is using a lowball determination of the warrants’ value, and the banks “have a solid incentive to bid extremely low,” it’s almost certain that the average will favor the banks, at taxpayer expense. At DealBook, Steve Davidoff made some suggestions for how Treasury can fix this:

First, make the banks’ initial repurchase offer public. They should be subject to public inspection — and shaming — if they try and take advantage of the government. Second, the government should toll the strict time limitations on the proceedings to allow time for it to respond adequately. Finally, to avoid this issue altogether the government should sell as many of the warrants it can now on the open market, before a repurchase request is submitted.

Davidoff’s first point about transparency is important. This is a transaction with taxpayers that we are talking about here, not a private business deal. The more we know about how the banks are conducting themselves in this regard, the better. Hopefully, transparent offers will also keep Treasury honest, as the public will know if Treasury accepts too low a price.

In the end, I think Simon Johnson is correct in that “the only sensible way to dispose of these options is for Treasury to set a floor price, and then hold an auction that permits anyone to buy any part – e.g., people could submit sealed bids and the highest price wins.” (Felix Salmon suggested then giving the banks “the right to match the winning price, if they’re so inclined.”) This approach would both produce a fairer result and ensure that the banks don’t get one final shot in at taxpayers as they wriggle free from TARP.

In addition to returning the $68 billion, the 10 banks paid the government $1.8 billion in dividends on the preferred shares of stock the government owned. That translates to an annualized rate of return of about 4.64 percent on the $68 billion. In all, the government has received $4.5 billion from all bailout recipients, who’ve received $200 billion, for an annualized rate of return since Nov. 12, 2008, when the money was lent out, of 3.94 percent.

As Matthew Yglesias pointed out, this seems to show that “for all the complaining from both the right and the populist left about spending $700 billion on bailouts, the net fiscal cost of the $700 billion TARP program is likely to be dramatically lower.” However, CNBC’s crack economic team isn’t buying it, and spent a segment today discussing how the Treasury is clearly going to put the repaid TARP funds into a government slush fund to bail out “the Boston Globe” and “the guys that make Chia pets,” and thus taxpayers will never see the money again. Watch it:

CNBC contributor Steve Leisman provided a nice moment of sanity during the segment, reminding his co-contributor Stephen Moore that “you were the one arguing that the taxpayers would never see a dime from this, the banks would never pay it back, and now you want us to believe your next new warning?”

There are real questions about where the money repaid from TARP should go, and one of the options is having Treasury hold onto it in case of another economic free fall. This is what Herb Allison, who the Obama administration has tapped to run the program, thinks we should do. Other options include paying down debt or using the funds to aid smaller, community banks.

There is also some ambiguity about Treasury’s plan for winding down its interest in institutions like Citigroup and GMAC, from which there will likely be no repayment anytime soon. But CNBC couldn’t be bothered with a serious discussion, and decided that it would be more entertaining to laugh about the federal government buying Chia pets.

It seems a bit too early to tell whether or not the “adverse” economic scenario laid out in the tests was overly optimistic (even though eventually coming to that conclusion is entirely possible), so I don’t know how much there is to learn from another test right now. But I do think it’s worth endorsing COP member Richard Neiman’s proposal to make some form of stress test a “semi-regular” feature of bank regulation:

“I would certainly support that they utilize this on an ad hoc basis, that we encourage institutions to do these tests and report them to the regulators,” Neiman told the Huffington Post. “And we recommend that the Treasury continue to track the economic indicators to make sure they are tracking the assumptions used under the plan, and to the extent that they exceed those assumptions, that we repeat those tests.” While acknowledging that there would be a “resource issue,” Neiman said that continuing the stress tests is like taking your car in for a check-up, even when it seems everything seems to be running okay.

This is particularly important given that the Treasury Department gave 10 banks the go-ahead today to repay $68 billion in TARP funds. This occurred despite data showing that the “pace of prime borrowers going into foreclosure is accelerating,” and “the default rate on commercial mortgages held by U.S. banks may rise to the highest in 17 years,” both of which could spell trouble for bank balance sheets down the road.

It also ties into concerns that the plan for removing the banks’ toxic assets is dead in the water, due to a lack of interest from the banks. Treasury told The American Prospect’s Tim Fernholz that this isn’t the case, but it’s unclear how Treasury plans to get the ball moving when the banks seem perfectly content to just wait out the recession.

But the assets are still sitting there, and some analysts have concluded that “accounting rule changes and rosy assumptions are making [the banks] look healthier than they are.” In light of all this, giving the banking system a periodic checkup that is transparent and easy to understand seems to make complete sense, provided that the tests are designed to actually put the banks through a bit of stress.

Now that banks are hustling to pay back their TARP money, Treasury has to decide what to do with the warrants, and the options are either selling them back to the original bank or selling them to third party investors. So far, only one bank — Old National Bancorp of Evansville, Indiana — has worked out a deal with Treasury for the warrants. And according to an analysis by Bloomberg News, if Old National turns out to be the model for all the other banks, taxpayers may be shortchanged billions:

Banks negotiating to reclaim stock warrants they granted in return for Troubled Asset Relief Program money may shortchange taxpayers by almost $10 billion if Treasury Secretary Timothy Geithner’s first sale sets the pace, data compiled by Bloomberg show….[Old National Bancorp.] gave the Treasury Department $1.2 million for warrants that may have been worth $5.81 million, according to the data. If Geithner makes the same deal for all companies in the rescue program, lenders may walk away with 80 percent of profits taxpayers might have claimed.

Goldman Sachs and JP Morgan are two of the banks leading the charge out of TARP, and reportedly “want to buy back the warrants and wriggle free of the government.” Linus Wilson, Assistant Professor of Finance at the University of Louisiana at Lafayette, has done the math and come up with what the warrants from these institutions are worth:

The U.S. Treasury holds 88.4 million of JP Morgan’s TARP warrants. These warrants on JPM are worth $20.20 each or about $1.79 billion according to my estimates. According to my estimates, taxpayers’ 12.2 million warrants on Goldman Sachs are currently worth $74.87 each or about $914 million dollars….Instead of JP Morgan and Goldman Sachs buying (or worse being given) the warrants from the Treasury, it is a better idea for the U.S. Treasury to sell those warrants to 3rd party investors.

In some ways, allowing the banks to purchase back the warrants at below-market prices would complete a sorry cycle, since Treasury (under former Secretary Henry Paulson) overpaid for the assets in the first place. But it seems like going the third party route best serves the taxpayers’ interest, which is what Treasury should ultimately be trying to do. As Sen. Jack Reed (D-RI) said, “taxpayers were there at a critical moment. They should enjoy the upside when these institutions recover.”

Leading the cutback in lending are three banks that last week eagerly declared themselves profitable. Two of them — Goldman Sachs and JP Morgan Chase — have also announced their intention to pay back their TARP money soon. The Journal provided this chart to illustrate the situation:

Coinciding with this report, a senior administration official told the Financial Times that “strong banks will be allowed to repay bail-out funds they received from the US government but only if such a move passes a test to determine whether it is in the national economic interest”:

He said the government had three basic tests. It needed first to “make sure the system is stable”. Second, to not create “incentives for more deleveraging which would deepen the recession”. Third, to make sure the system had enough capital to “provide credit to support the recovery”.

This last point is important, and ties back to the Journal’s analysis. If a bank is truly healthy and can pay back TARP money while maintaining lending, more power to it. If, however, a bank is paying back TARP because it wants to get out from under the program’s restrictions — while not lending and clinging to other government funded rescue programs — that’s problematic.

For instance, Wells Fargo (which received TARP money) has posted a profit and maintained lending. If it announces a desire to exit TARP, the administration should seriously consider the offer. However, this is going to make it transparently obvious which banks are in the best shape. The administration will then have to decide whether the others will ever be anything more than zombies — limping along thanks to government support without actually doing any good — and be honest about the need to take them over and wind them down.

Less than half a dozen people are responsible for making the final decisions about which banks get part of the $700 billion in bailout money available through the Troubled Asset Relief Program, according to Department of Treasury officials.

In response to a Freedom of Information Act request made by the Sunlight Foundation in January for the members of the TARP Investment Committee, a FOIA officer recently responded with just four names, including Assistant Secretary, Neel Kashkari; Chief Investment Officer, James Lambright; Acting Assistant Secretary for Financial Markets, Karthik Ramanathan and Acting Assistant Secretary for Economic Policy, Ralph Monaco, all holdovers from the Bush administration.

Real Time Investigations added that “according to a press release from November, there are two more names on the list: Don McLellan, Capital Purchase Program Manager and Howard Scheitzer, Chief Operating Officer.”

Evidently, part of the problem here is that the Obama administration hasn’t yet named some of its appointees to the TARP Investment Committee. But with TARP funds “running thin,” and the program expanding to include life insurance companies, the administration may want to get around to doing that.

The IMF said in January that it expected the deterioration in US-originated assets to reach $2.2 trillion by the end of next year, but it is understood to be looking at raising that to $3.1 trillion in its next assessment of the global economy.

With that harrowing number hanging overhead, the TARP’s Congressional Oversight Panel released its six-month report yesterday. The panel, chaired by Harvard Law School professor Elizabeth Warren, questioned Treasury Secretary Timothy Geithner’s assumption that the toxic assets clogging the banks are merely economically depressed, noting that Treasury’s response “fails to acknowledge the depth of the current downturn“:

If its assumptions are correct, Treasury’s current approach may prove a reasonable response to the current crisis. [...] On the other hand, it is possible that Treasury’s approach fails to acknowledge the depth of the current downturn and the degree to which the low valuation of troubled assets accurately reflects their worth. The actions undertaken by Treasury, the Federal Reserve Board and the FDIC are unprecedented. But if the economic crisis is deeper than anticipated, it is possible that Treasury will need to take very different actions in order to restore financial stability.

The Warren panel also noted that Treasury “has not explained its assumption that the proper values for these assets are their book values.” These are very important observations, and it would behoove Treasury to provide some responses.

For its part, the panel suggested that liquidating troubled banks would be the strategy “least likely to sap the patience of taxpayers,” while also giving Treasury a definitive way out of its entanglement with the financial system. “Allowing institutions to fail in a structured manner supervised by appropriate regulators offers a clearer exit strategy than allowing those institutions to drift into government control piecemeal,” the report said.

As estimates regarding the number of toxic assets climb higher and higher — with Nouriel Roubini claiming there are $3.6 trillion worth — its becoming clearer just how much depends on Treasury finding a workable plan for cleaning up the banks. As IMF managing director Dominique Strauss-Kahn said, “you never recover before the cleaning up of the banking sector has been done.” And right now, Geithner’s clean up is premised on an assumption that more and more people are taking issue with.