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Taxpayers still hate the bank bailout

New Treasury Secretary Tim Geithner is taking steps to improve TARP, but he will have to do more to win over skeptical, shell-shocked taxpayers.

Colin Barr, senior writer
January 29, 2009: 3:58 AM ET

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Treasury Secretary Tim Geithner has promised to tighten bailout rules.
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NEW YORK (Fortune) -- The Obama administration is trying to fix the bank bailout process. But they have their work cut out for them.

New Treasury Secretary Tim Geithner put in place new rules this week that restrict lobbying related to the $700 billion Troubled Asset Relief Program, or TARP. Geithner also introduced rules to limit political influence on funding decisions, released the full terms of previous rescue deals, and met with a group of congressional appointees charged with strengthening TARP oversight.

"American taxpayers deserve to know that their money is spent in the most effective way to stabilize the financial system," Geithner said Tuesday.

But if Treasury is to succeed in minimizing the government's losses on its many financial-sector rescue programs -- and dispel questions about how fair the whole process is for taxpayers -- observers say this is just the start of reforms for TARP.

Moves such as the lobbying ban "are a good first step," said Luigi Zingales, a professor at the University of Chicago's Booth School of Business. "But it's clear that more has to be done."

Taxpayers need someone to look out for them

Zingales has called for the government to get tougher with banks seeking federal aid. He thinks the government should force debtholders and equity investors to share in banks' losses -- rather than simply pour more federal funds into firms with modest strings attached.

Under one alternative, he suggested banks could be split in two, to separate the healthy and unhealthy assets. Investors would get stakes in both the good and bad banks, the latter of which would be responsible for running off or liquidating the bad assets.

Zingales noted this would require Congress to pass a law overriding existing debt covenants. But he argued that this plan could work -- even though the losses on the bad banks could be quite large -- because the government would no longer need to inject more taxpayer money into banks. In addition, the healthy bank might be able to boost lending and attract private capital on its own.

Other critics of TARP in its current form, such as former private equity executive Michael Brownrigg, think the government should appoint a group of private industry directors to oversee companies receiving federal investments.

These directors could act as taxpayer advocates and demand changes in management when necessary. They would also be responsible for making the decision to sell the government's stake in a bank once the company has completed a turnaround.

This would ensure that bailout recipients are being scrutinized while freeing officials from charges that they're interfering in politically motivated ways.

"Private companies don't do well when left to their own devices," said Brownrigg, who spent much of the past decade working for the ChinaVest merchant bank. "You need someone who's a strong advocate for stakeholders."

So far, many banks have been resistant to disclose how they are spending TARP money. But Bank of America, which has received $45 billion in bailout funds, did announce Wednesday it was setting up a plan to track and report is lending and investment activity.

And while the Obama administration has promised more rules that would protect taxpayers' interests and make it easier for them to see how their bailout funds are being spent, Zingales said he has been struck by how little of the discussion in Washington has focused on the fairness of the bailout.

"Fairness hasn't been a very conscious concern in the debate," Zingales said. "But if you think the game isn't fair, you withdraw -- and that's what we're seeing from people right now."

Trust has been destroyed

Zingales and Paola Sapienza, a professor at Northwestern's Kellogg School of Management, said a survey they conducted at the end of last month shows the degree to which many Americans appear to have lost faith in the financial system and the government's capacity to restore confidence in it.

Nearly 60% of respondents said they believe the financial system is unfair -- a result the professors called unsurprising given the loss of trillions of dollars of household wealth over the past year.

What's more eye-opening is that those surveyed expressed little to no confidence that the government's efforts to intervene in the markets would help improve conditions. Some 80% of those responding said the government's methods made them less confident in the market.

The findings, dubbed by the two professors as the Financial Trust Index, come amid reports of continuing excess at big companies that have received federal assistance.

Citigroup (C, Fortune 500), the recipient of more than $300 billion of federal capital infusions and loan guarantees, recently reversed plans to buy a $45 million corporate jet after learning of Geithner's opposition.

And even though the state comptroller of New York said Wednesday that Wall Street bonuses fell 44% from a year ago in 2008, the $18 billion bonus pool was still the sixth-biggest ever.

Merrill Lynch, the troubled brokerage firm that was sold earlier this month to Bank of America (BAC, Fortune 500), paid out $4 billion in year-end bonuses even after posting a $27 billion loss for 2008.

Obama team must restore confidence

The fact that big bonuses are still flowing on Wall Street even as each day brings news of deeper job cuts across the nation clearly isn't lost on taxpayers.

Just 40% of those polled in the Financial Trust Index survey said they believe former Treasury Secretary Henry Paulson acted in the interest of the country last year. The same number said he acted in the interest of his former employer, Goldman Sachs.

"That's just shocking," said Zingales. "That shows how deeply trust has been undermined."

Zingales said expanding shareholder access to corporate boards is a must. Sapienza added that the results point to "the need for widescale reform" of financial institutions, including the rules that limit shareholders' voice in corporate governance and the way bailout money is spent.

"We have had a loss of confidence in market structures," she said. "The good news is we have a new administration that has an incentive to do what it can to restore confidence."  To top of page

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