Overseer calls for bank bailout makeover

NEW YORK (CNNMoney.com) -- The $700 billion financial sector bailout needs an oversight makeover, according to a report that an oversight official will present to Congress on Thursday.

Neil Barofsky, special inspector general of the Treasury's Troubled Asset Relief Program, is set to tell members of the Senate Banking Committee that the bank bailout needs tighter regulation, a better investment strategy and new fraud prevention standards.

The committee will hear testimony from the heads of the three key TARP oversight bodies: including Barofsky; Elizabeth Warren, head of the Congressional Oversight Panel; and Gene Dodaro, acting comptroller general of the Government Accountability Office.

In his report, Barofsky says that all TARP agreements must contain stricter oversight language, indicating to all banks in receipt of bailout funds that they should periodically give Treasury an account of how they are using the funds.

Banks have been criticized by lawmakers and the public for not divulging the use of the taxpayer funds they have received. In an earlier report, the Congressional Oversight Panel questioned why Treasury did not require banks to lend, like the British bank bailout program did.

So far, the Treasury has injected into 360 banks nearly $200 billion of the $250 billion allocated for capital injections. It has also sent another $20 billion each to Citigroup (C, Fortune 500) and Bank of America (BAC, Fortune 500). In exchange, Treasury has collected preferred shares or warrants and amassed a large portfolio of investments.

Barofsky's report says that Treasury needs to develop a strategy for what it wants to do with the investments. Namely, Treasury should figure out how to value its portfolio.

"How long these securities should be held and when ... they should be sold into the market are vitally important questions that implicate not only the taxpayers' return on their investment but also the stability of the markets," Barofsky said in his report.

One of the key new bailout programs - the Term Asset-backed Securities Loan Facility (TALF) - is vulnerable to fraud, waste and abuse, the report said. The Fed-supported and Treasury-backstopped program will buy up securities backed by consumer loans, such as auto loans and credit cards, beginning later this month.

The $200 billion program is intended to increase the availability of loans to consumers, and Treasury dedicated $20 billion of TARP funds to backstop any losses that the government might suffer from the purchases.

Barofsky said purchasing asset-backed securities can be a risky business, because many of the underlying loans have been "overvalued due to fraud or lax underwriting." Recent investigations into the mortgage meltdown have shown that many borrowers falsified information on loan applications, and many others were issued loans under false pretenses or illegal conditions by lenders.

The report said reducing risk on the purchases "is critically important to whether the taxpayers' investment is a sound one." Accordingly, the report recommended that Treasury adopt fraud prevention standards to screen out potential risks. Barofsky also recommended that TALF not include purchases of mortgage-backed securities until a further review.

Treasury has faced much criticism from the three bailout oversight groups, including several Congressional Oversight Panel reports that claim the government's bailout efforts are not working. Many lawmakers voted to halt the release of the second half of the bailout funds, though the motion eventually failed and Treasury received the second $350 billion.

Newly appointed Treasury Secretary Timothy Geithner and President Obama hinted that they may detail a revised bank bailout as soon as this week. The plans are likely to include a program that would relieve banks of troubled mortgage assets, and may also feature promises for additional capital infusions or an offer to guarantee the value of some bank holdings.