Yesterday, the Wall Street Journal reported that BofA chief executive Ken Lewis told New York’s attorney general in February that Federal Reserve Chairman Ben Bernanke and then-Treasury Secretary Henry Paulson told Lewis to keep mum about Merrill’s steep losses at the end of 2008, as well as $4 billion in bonuses Merrill intended to pay employees, lest the news spook BofA shareholders and kill the acquisition deal.

Geithner, of course, was neck deep in crafting the bailout strategies under the Bush administration, and now Towns, who heads the House Oversight and Government Reform Committee, has joined forces with Rep. Dennis Kucinich (D-Ohio), who chairs the Domestic Policy subpanel, to ask what role Geithner played in the controversial BofA-Merrill deal.

From the lawmakers’ April 23 letter to Geithner:

If Mr. Lewis’s statement, as reported by the Journal, of discussions that occurred between Mr. Paulson, Mr. Bernanke and himself is accurate, then federal officials were potentially involved in knowingly denying BOA investors material information.

The lawmakers are asking Geithner for “all documents prepared for internal use related to discussions with Bank of America and/or Treasury about compensation packages, bonuses, annual losses at Merrill Lynch, and federal guarantees against losses on Merrill Lynch assets, for the period August I, 2008 through January 19,2009,” as well as “discussions relating to public disclosure of information about compensation packages, bonuses, and annual losses at Merrill Lynch.”

A similar version of the letter went to Bernanke. And unlike the first inquiry over executive compensation limits — which Geithner still hasn’t responded to, even eight days after the requested deadline –  Towns and Kucinich are threatening to subpoena the officials for the information if they don’t get it otherwise.

The implications of Mr. Lewis’ testimony, if accurate, are extremely serious. Under these circumstances failure to comply with the Subcommittee’s request raises the prospect that we will be forced to consider compulsory means to achieve compliance with our request. However, we would prefer your voluntary compliance.

Guess the Obama honeymoon is officially over.

We pointed out a few reasons earlier today why Dodd doesn’t bear the blame (at least no more or less than most others in this town). Yet it’s worth going back even further to understand where the laxity originated that permitted enormous paydays for the same folks who ruined their companies.

Start the clock in September, when Henry Paulson, treasury secretary under the Bush White House, was charged with selling Congress on the $700 billion Troubled Asset Relief Program. As part of his pitch, Paulson, along with Federal Reserve Chairman Ben Bernanke, repeatedly insisted that executive compensation limits should be avoided, lest they hobble the effectiveness of the program.

“If we design it so it’s punitive and so institutions aren’t going to participate,” Paulson told Fox News at the time, “this won’t work the way we need it to work.”

Congressional leaders (including Dodd) caved, adding only a few loophole-filled provisions restricting executive pay, including language that the Treasury “shall require that the financial institution meet appropriate standards for executive compensation.”

Fast forward to December, when Neel Kashkari, appointed by the Bush administration to administer TARP, appeared before the House Financial Services Committee, where he was asked point blank by Rep. Brad Sherman (D-Calif.) whether enormous AIG bonuses — some reportedly as high as $3 million — were indeed “appropriate” considering that the flailing insurance giant had already received $152 billion in federal help. The exchange is eye-opening:

SHERMAN: Sir, have you met your responsibility to require that appropriate standards of executive compensation be imposed on AIG and the other recipients of TARP funds?

KASHKARI: This is an important issue that we must not lump all of the institutions together.

SHERMAN: I’m not.  I’m asking about A-I-G.  Is a three million dollar bonus an appropriate standard of executive compensation, or has the law been violated?

KASHKARI: Congressman, I can’t… I do not have the details of what the bonus levels are at AIG.

SHERMAN: Well, you are the one who is supposed to impose appropriate levels of executive compensation.  Have you done that?  Or, are they making payments of executive compensation that are not appropriate? Or are you just blind to whether they are appropriate or not?

KASHKARI: Congressman, we have imposed on AIG new corporate governance standards, executive compensation standards and expense policy standards…

SHERMAN: Do your standards prevent the payment of a three million dollar bonus?

KASHKARI: I do not believe that they specifically prevent a payment of a three million dollar bonus.

SHERMAN: So have you imposed appropriate standards for appropriate executive compensation?  Are you here to tell this committee that appropriate standards of executive compensation would allow a three million dollar bonus?  How about a 30 million dollar bonus?  Would that be appropriate compensation?  Or would that be prohibited by any standards that met the statutory requirement imposed on Treasury?

KASHKARI: Congressman, in the case of AIG, we replaced with the Federal Reserve the senior management of AIG.

SHERMAN: Sir, I didn’t ask you about corporate governance.  I didn’t ask you about the make-up of the executives.  I asked whether a three million dollar bonus, or a 30 million dollar bonus, is consistent with a statutory requirement that we have appropriate standards on executive compensation.  Let me ask it specifically.  As to 30 million dollars, is that appropriate or inappropriate?  Or you have no opinion?

KASHKARI: I am not in the position to opine on a specific number if it is appropriate or not.

In light of all the recorded statements and testimonies, the GOP’s Dodd-centered criticisms should be easy to shoot down. Then again, no one ever claimed that accuracy was more important than messaging in this town.

And, of course, Kashkari is still in charge of TARP.

Aside from the comedy surrounding that development (the Bush administration’s original refusal to help the automakers was the only reason that Congress took up legislation to begin with), there’s now concern that the administration will manage Washington’s latest bailout attempt as poorly as it did the last. House Speaker Nancy Pelosi (D-Cal.) shot a letter to President Bush last week urging the White House to insist on certain conditions and concessions from the companies in return for the help:

The Administration must now require, as a condition of receiving those taxpayer funds, the same tough accountability and shared sacrifice by all parties –- executives, unions, suppliers, creditors, dealers, bondholders, and shareholders –- mandated in the bipartisan legislation passed by the House this week.

The New York Times reports this morning that the details of the deal are still being worked out, but Treasury Sec. Henry M. Paulson Jr. will take on the oversight responsibilities. GM has said it needs $10 billion to get it through March, while Chrysler would need $4 billion to survive the same stretch.

On CNBC earlier this week, Paulson said “failure by these companies at this time is not something any of us want to contemplate.”

There was no word how any of the bailout’s terms will address the larger reality that Amercans aren’t buying cars now from anyone.

In a Dec. 3 letter to Treasury Sec. Henry M. Paulson Jr. and Federal Reserve Chairman Ben Bernanke, the Republicans questioned the changing nature of the now-misnamed Troubled Assets Relief Program, or TARP.

Changing conditions can require agility in policymakers’ responses. However, the seemingly ad hoc implementation of TARP has led many to wonder if uncertainty is being added to markets at precisely the time when they are desperately seeking a sense of direction.

[...]

The government has burned through nearly $350 billion of TARP funds and is pledging trillions of dollars more through other programs, yet little is understood about how these investments are contributing to the nation’s economic recovery.

Sounding like Democrats, the GOP leaders also asked for more transparency, blasting Paulson for his slow response to questions from House Minority Leader John Boehner (R-Ohio) sent before Halloween.

More than a month ago, on October 29, the House Republican Leader sent a letter to the Treasury Secretary questioning the use of TARP money for executive bonuses and bank acquisitions by other banks, as revealed by various news organizations. It was only today that Treasury provided a response, and the response did not answer the questions that were asked in the Leader’s letter.

White House spokeswoman Dana Perino was incredulous today at the thought that the administration has a history of being unresponsive to Congress. Perhaps today’s letter will trigger an epiphany.

Mr. Geithner also oversaw and regulated an entire industry whose decline has delivered a further blow to an already weakened American economy. Under his watch, some of the biggest institutions that were the responsibility of the New York Fed — Bear Stearns, Lehman Brothers, Merrill Lynch and most recently, Citigroup — faltered. While he was one of the first regulators to smartly articulate the potential for an impending disaster, a number of observers question whether he went far enough to stop the calamity.

Sorkin also questions how effective Geithner has been in helping Treasury Sec. Henry M. Paulson Jr. manage the administration’s bailout strategy. Some observers have fingered Geithner as a proponent of the controversial decision to let Lehman Bros. fail:

Perhaps what has most people on Wall Street stirring is Mr. Geithner’s role in the fall of Lehman. At the time of its bankruptcy, he, along with Mr. Paulson, appeared to be the most vocal in supporting the government’s refusal to bail out the firm, according to people involved in various meetings. With hindsight, many in the financial industry blame a deepening of the global financial crisis on the government’s decision to let Lehman crumble.

That, Sorkin suggests, has led the Obama folks to try to rewrite the history books on the Lehman deliberations in order to let Paulson absorb all the blame:

These include the suggestion that Mr. Geithner was not in league with Mr. Paulson over Lehman; that Mr. Geithner pressed to save the firm from bankruptcy; that he was a lone voice on the subject and was overruled by Mr. Paulson and Ben S. Bernanke, the Fed chairman, on this issue.

In the confidence game of high finance, maybe none of this matters, and the reaction of Wall Street investors alone is enough to justify Geithner’s promotion. Still, you’d like to know that the guy at the helm of the Treasury Dept. knows which direction to steer.

…underlines the contrast between the administration’s activity in this area and its failure to take similarly decisive action to reduce mortgage foreclosures. As I told Secretary Paulson when he informed me this morning of his decision to provide funds for Citigroup, I believe it is essential that TARP funds be used immediately to fund mortgage foreclosure relief… There is no good reason for further delay.

Sounds like the honeymoon for these two finance wizards might be reaching its end.

Bring on the finance regulations.

That’s the message this week from a growing number of Democratic leaders, who are increasingly irritated by the reluctance of the financial industry to put capital it received from the Bush administration’s $700-billion bailout to work.

Lenders not lending. Executives keeping large pay packages. Banks distributing dividends to shareholders. The reports have been numerous. This is not, according to Sen. Chris Dodd (D-Conn.), chairman of the Senate Banking Committee, the way the program was supposed to work.

“Let me say as clearly as I can: hoarding capital and acquiring healthy banks are not — I repeat, are not — reasons why Congress authorized $700 billion in emergency funding,” Dodd told finance industry representatives during a Thursday hearing on bailout oversight.

Illustration by: Matt Mahurin

Dodd called on the industry to step up its efforts to stem foreclosures, accelerate lending and rein in executive pay. “And if that progress is not forthcoming,” he added, “we are prepared to legislate — now if possible, but next year if necessary.”

Like many Democrats, Dodd seemed surprised that banks and other financial institutions would be driven by profit motives. So Democratic leaders share part of the blame. After all, they caved in to administration pressures and included only minimal restrictions on how the bailout money would be spent.

The debate is at least partly ideological. The administration and many congressional Republicans oppose more industry regulations, arguing that free markets work best when governments stay out of the way. But in the middle of an economic whirlwind caused largely by poor investment decisions by banks and other financial firms, that argument has lost some steam.

“What we’ve learned over the last number of months is that consumer protection and economic growth go hand-in-hand,” the Connecticut senator said. “In fact, when you fail to do the first, you end up doing severe damage to the latter.”

Dodd’s comments come a day after Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, largely echoed Dodd. Charging that mortgage servicers have been too quick to refuse loan modifications, Frank said legislation is likely needed to encourage them.

The two Democrats’ remarks arrive as the struggling financial industry — the recipient of billions of dollars in federal help in recent months — has been slow to use the money as Congress intended.

Instead of increasing lending to thaw out frozen credit markets, for example, some banks have bought other banks. Instead of using the capital infusion to modify home mortgages and prevent foreclosures, many lenders continue to pay out dividends. In some cases, banks participating in the bailout program have given large bonuses to some employees.

Sen. Tim Johnson (D-S.D.) called for “punitive actions” if bailout funds are “misused.” Dividends and large pay packages, Johnson added, “should be rewards for a job well done — and that is currently not the case for many in this industry.”

Appearing before the Senate panel Thursday, representatives for some of the nation’s largest banks — including Bank of America, Wells Fargo and JP Morgan Chase — vowed not to use bailout funds for executive pay. But they defended the continuation of dividend payments, contending that those funds come from a pool of “retained earnings,” not the “capital-base” pool recently supplemented by the bailout. Also, they said, that practice will not likely change.

“We would anticipate that dividends will continue to be paid out of our earnings stream and not out of our capital base,” said Barry L. Zubrow, chief risk officer at JP Morgan Chase.

Dodd said he is “a little nervous about this distinction because … money is money.”

Under the $700-billion ressue package, passed in a din of controversy last month, the Treasury Dept. has the power to use the cash on virtually anything it deems necessary to stabilize the flailing economy.

Originally, the plan called for the Treasury to buy up toxic mortgage-backed securities and residential loans on the books of banks and other financial institutions. Treasury Sec. Henry M. Paulson Jr., however, switched gears. The government used $250 billion to recapitalize the firms in exchange for equity stakes in them. Another $40 billion went to prop up insurer American International Group.

The strategy changed again yesterday, when Paulson announced that the remainder of the bailout funds would be used to bolster consumer credit markets. But the administration must first get congressional approval, and that gives Democratic congressional leaders some leverage to alter the program, though they would have to pass new legislation to do so.

There is some indication that they will press for more transparency on how the Treasury is using the bailout money. Rep. Charlie Rangel (D-N.Y.), chairman of the House Ways and Means Committee, said Thursday that the department has abused its authority in implementing the bailout. “We think they’re going beyond the discretion given to them,” Rangel said during an interview with CNN. “We are going to really legislate, if they don’t come clean with this.”

Speaking of greater transparency, Sen. Charles Grassley (R-Iowa) on Thursday announced plans to reintroduce legislation to rein in another largely unregulated sector of the financial system: hedge funds. The bill would require hedge funds to register with the Securities and Exchange Commission. Currently, the funds are exempt from SEC oversight.

Democrats might also push the administration to do more to slow the rate of foreclosures, which triggered the financial crisis. Many experts say the larger economic crisis cannot be fixed without first stabilizing the housing market — and that means curbing foreclosures. Dodd said that it’s “still confounding” why Paulson hasn’t tackled the problem directly.

Meanwhile, the economy continues to tank. In the first week of November, the number of first-time applicants for unemployment insurance jumped to 516,000 — a seven-year high — the Labor Dept. reported Thursday.

The dismal figures may have emboldened Democratic leaders to press the administration to accept economic-stimulus legislation this month aimed at boosting consumer spending.

“Americans losing their jobs every day cannot wait for the next administration to take action,” House Majority Leader Steny Hoyer (D-Md.) said in a statement Thursday.

Central to the plan is new spending on state infrastructure projects like bridges and roads and bailing out Detroit’s automakers — proposals the White House has resisted. In what will likely be the final squabble between the Democratic Congress and outgoing President George W. Bush, lawmakers are expected to return to Washington next week to consider the bill.

Lining up behind the administration, many congressional Republicans have fought these spending programs, as well as new regulations for the finance industry. They question the logic of attaching more restrictions on companies already down. “I think we should be very careful in moving in a direction where we’re going to mandate that mortgage companies have certain behavior,” Rep. Randy Neugebauer (R-Tex.) said this week.

Dodd, however, rejected the idea that government oversight strangles private enterprise.

“I think we need to get over that notion … that if you’re going to protect consumers, it’s going to hurt our economy,” he said. “I think we’ve learned painfully how false that statement is.”

Barney Frank, chairman of the House Finance Committee. (WDCpix)

Mortgage servicers have not done enough to help struggling homeowners avoid foreclosure, a leading Democrat said Wednesday, and Congress must now step in with new legislation to help them salvage their troubled loans.

“We have not seen servicers participating in any significant way,” Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, said during a panel hearing on the foreclosure crisis. “I believe we now have a situation that requires legislation.”

Frank’s call comes on the heels of news that some of the nation’s largest mortgage lenders — including Fannie Mae, Freddie Mac and several large banks — are streamlining programs to modify loans to strapped borrowers.

Illustration by: Matt Mahurin

Frank applauded these institutions for their “constructive steps.” But the powerful lawmaker did not similarly compliment servicers, companies that buy from lenders the rights to manage mortgages. The result has been that more folks are losing their homes.

“We are getting some progress where the legal authority to modify is clear,” Frank said. “We have not had that where there are servicers.”

The congressman’s comments come as Washington’s economic bailout strategy shifts from Wall Street to Main Street. Experts have long contended that the sinking housing market — and skyrocketing foreclosures — are at the core of the financial turmoil. Still, even as lawmakers have pumped more than $1 trillion into the nation’s financial institutions and insurance companies, they have largely ignored struggling homeowners and consumers. That approach, policy-makers are beginning to acknowledge, treats only the symptoms.

Treasury Sec. Henry M. Paulson Jr. revealed Wednesday that the remaining half of the $700 billion allocated for the bailout of the financial system would be spent largely on easing consumer credit markets. The move would make it easier for consumers to finance car purchases, get student loans and obtain credit cards, he said.

“This market is currently in distress,” Paulson said. “Costs of funding have skyrocketed, and new issue activity has come to a halt.”

The first $250 billion of the bailout went to recapitalize financial institutions. In exchange, the government took equity stakes. The idea was to bolster their balance sheets, which have been pummeled by big investments in toxic mortgage-backed securities. But with thousands of Americans continuing to lose their homes to foreclosure, many lawmakers and housing advocates say the trickle-down strategy of helping homeowners by funding banks has not worked.

Testifying before Frank’s panel Wednesday, finance-industry representatives emphasized that servicers are beholden to investors, not homeowners. That argument didn’t sit well with the financial services chairman. “The servicers have the power to [modify loans],” Frank said, “but we get every indication, anecdotally and statistically, that it is not being done.”

“Servicers do have the legal authority, right and responsibility to modify loans,” said Thomas Deutsch, deputy executive director of the American Securitization Forum, a trade group. But those decisions “must also be in line with the contractual rights and commercial expectations of institutional investors, such as pension funds and mutual funds.”

Michael Gross, managing director of Bank of America’s loan administration loss mitigation, agreed. “Servicers are contractually obligated to choose the home-retention or loss-mitigation option which provides the best return to the investor,” Gross said. “That is a contractual obligation.”

Writing in The New York Times yesterday, the business analyst Joe Nocera summarized this tension between loan owners, servicers and borrowers:

The situation borders on the absurd. Investors will not allow mortgage modifications that would hurt them more than some other investors — thereby insuring that everyone gets hurt even more as foreclosures continue. And as foreclosures continue, the financial crisis continues to deepen because foreclosures on Main Street mean billion-dollar write-offs on Wall Street. And struggling homeowners can only pray that their mortgage is still held by the bank and not sold to Wall Street — in which case they are out of luck. It is like flipping a coin to see if you can hold onto your home.

Faced with this reality, Frank said Congress has to intervene to help people stay in their homes. The “appropriate” role of the federal government, Frank said, is “to induce those who hold the loans to recognize that they are holding loans that are not going to be repaid in full, to calculate that in many cases this would be a worse economic problem if they foreclosed, and to write down the terms of the loan, either by interest or principal or some combination, to a point where that borrower could repay.”

Treasury Secretary Henry Paulson (WDCpix)

His suggestion raised immediate concerns among panel Republicans, who are wary of more government intrusion into private markets. “I am all for encouraging the parties to work together, if they’re willing,” said Alabama Rep. Spencer Bachus, the highest-ranking Republican on the Financial Services Committee. “[But] I’m very hesitant to try to force the parties to an agreement.”

Several programs to modify troubled mortgages are already up and running. The Hope for Homeowners initiative, for example, which launched Oct. 1, puts qualified borrowers into new, 30-year fixed-rate mortgages. But for lenders, it’s a voluntary program — and not a popular one. According to Rep. Steven LaTourette (R-Ohio), only 42 loans have been submitted under the program for modification, and none have been accepted. “All I can say is, what a mess this is,” LaTourette said.

Meanwhile, foreclosure filings for the third quarter topped 765,000, up 71 percent from a year ago, according to RealtyTrac, an online foreclosure database. The situation is likely to worsen. As TWI’s Mary Kane pointed out last week, the subprime crisis is just three-quarters through, and defaults on Alt-A, or “liar”, loans won’t hit a peak until next year.

Yesterday, Freddie Mac, Fannie Mae and other major lenders announced that they will begin streamlining their loan modification processes for borrowers who are either in foreclosure or at least 90 days late on their mortgage payments.

Some lawmakers cheered the announcement. Yet there remains the fear that even those programs could fall short of addressing the immensity of the problem. Rep. Carolyn Maloney (D-N.Y.) called the Freddie and Fannie effort “timid and tiny,” saying it will help only a fraction of homeowners in need.

“We need to be thinking in an order of a magnitude that is much bigger,” Maloney said. “Not hundreds of thousands, but millions.”

AIG executives even spent $443,000 for a weeklong retreat at the St. Regis Resort at Monarch Beach, Calif. after the Treasury Dept. rescued the company with an $85-billion bailout.

As the hearing drew to a close, Rep. Henry A. Waxman (D-Calif.), the committee chairman, began circulating a letter to Treasury Sec. Henry Paulson:

Today’ s hearing revealed that shortly after the bailout was signed, executives from AIG’ s major U.S. life insurance subsidiary, AIG American General, held a weeklong conference at an exclusive resort in California. The company spent nearly half a million dollars in a single week at this resort, including thousands o f dollars on catered banquets, golf outings and visits to the resort’s spa and salon.

The hearing also revealed that AIG continues to pay one million dollars a month to an official who helped bring about the company’ s downfall. This official, Joseph Cassano, is the former president of AIG’s Financial Products division, the unit that sold the credit default swaps that caused billions in losses for AIG. Mr. Cassano resigned from his position in March 2008. Yet AIG has inexplicably decided to pay Mr. Cassano up to $34 million in unvested bonuses. Even today, it is continuing to employ him as a “consultant” for one million dollars a month.

Secretary Paulson, this situation is unfair to taxpayers. AIG received $85 billion in taxpayer money, yet it continues to lavish its executives with undeserved payments and perquisites. We urge you to protect the taxpayers’ money and end this profligate spending.

Several committee members quickly signed off on Waxman’s letter, including Rep. Chris Shays (R-Conn.), who has been informally leading the Republican side in the probe into the financial crisis. The unity is notable as Republicans again spent much of today– as they did at a hearing yesterday on Lehman Bros. — arguing that Fannie Mae and Freddie Mac are the primary reason for the crisis. But all committee members seemed appalled at the behavior of AIG’s executives.

Fuld has deflected questions on whether he’s unfair, unethical and has committed fraud. He has spoken deliberately, demonstrated little passion and largely stonewalled lawmaker’s questions as if he were a member of the Bush administration’s Justice Dept. Until Peter Welch (D-Vt.) asked Fuld why the government bailed out AIG but didn’t bail out Lehman.

Fuld became animated: “I do not know why we were the only one.”

He discussed how the Treasury Dept. bailed out fellow investment bank Bear Stearns in March, and Bank of America bought Merrill Lynch the week Lehman declared bankruptcy.

He also encouraged questions from Welch and Rep. Dennis Kucinich (D-Ohio) that AIG was bailed out because Goldman Sachs, where Paulson was formerly CEO, had a reported $20-billion tie to the insurance giant.

With the hearing winding down, Fuld kept saying, “I wake up every single night thinking what I could have done differently. This is a pain that will stay with me the rest of my life.”

On whether the Treasury Dept. should have bailed out Lehman, the committee actually seems in agreement with Fuld.

Henry Waxman (D-Calif.) said in his opening statement: “Many experts think Lehman’s fall triggered the credit freeze that is choking the economy and made the $700 billion rescue necessary.”

The committee holds a hearing tomorrow on AIG.  Will the committee push the line of questioning encouraged by Fuld– that AIG was bailed out, and Lehman Bros. wasn’t, because that was the scenario most beneficial to Goldman Sachs, a rival investment bank to Lehman?

No one is suggesting that Paulson was merely making decisions based on Goldman Sach’s best interests. But the oversight committee’s work may discover that it was at least a factor.