U.S. officials may have harmed taxpayers by needlessly favoring the biggest money managers in choosing participants for a program designed to buy toxic debt from banks, according to an audit of the selection process.

The Treasury Department told prospective applicants in the Public-Private Investment Program that they must show they could raise $500 million in private capital, then waived the threshold for two firms that failed to reach it, according to the 42-page report released Thursday by the watchdog appointed to supervise the government's financial-bailout efforts.

"The taxpayer may have lost the benefit of the participation of qualified, albeit smaller, fund managers because they were avoidably deterred from applying or unnecessarily rejected," wrote Neil M. Barofsky, special inspector general for the Troubled Asset Relief Program.

The PPIP is an effort by the Treasury to spur purchases of devalued mortgage-backed securities that weighed on banks' balance sheets and helped cause the 2008 financial crisis.

Originally envisioned as soaking up as much as $1 trillion in assets, the program was scaled back to a target of $40 billion.

"The report makes clear that PPIP is another Tarp program that defied expectations, helped stabilize the economy, and will likely generate significant profits for taxpayers," Mark Paustenbach, a Treasury spokesman, said Thursday in an e-mailed statement. "At a time of deep economic instability, this initiative unlocked the credit markets, making it possible for small businesses, municipalities and families to borrow again at affordable rates."

Nine firms, including New York's BlackRock Inc., the world's largest money manager by assets, and Atlanta-based Invesco Ltd., were picked to take part in PPIP in July 2009.

The firms have since raised $7.4 billion, to which the government added $7.4 billion in capital and about $14.8 billion in financing.

The managers invested $18.6 billion as of Sept. 30, according to a Tarp review published this week by the Treasury.

Barofsky also said the Treasury required applicants to partner with small, veteran-, minority- and woman-owned asset managers, then failed to provide guidance on their expected role, leaving firms "to their own interpretation."

As a result, only two minority-owned partners participated as money managers, while others took on fund-raising roles and one "appears to provide no assistance whatsoever," according to the report.

No firms were named in the report.

Other PPIP participants are GE Capital Real Estate, Marathon Asset Management LP and AllianceBernstein LP, Oaktree Capital Management LP, RLJ Western Asset Management LP and Wellington Management Co.

TCW Group Inc. was also selected before being forced to liquidate its fund after the departure of the bond manager Jeffrey Gundlach in December. The eight remaining managers reported net internal rates of return of 13% to 37% from inception through June 30, according to the Treasury's Tarp report.

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