The Treasury Department is failing to provide sufficient help to struggling homeowners and boost small business lending through its financial crisis response efforts, according to the Troubled Asset Relief Program's watchdog.

As of March 31, Treasury had spent less than 2% of funds allocated for Tarp on housing programs such as the Home Affordable Modification Program, HAMP, and the Hardest Hit Fund. Yet 75% of Tarp funds that Treasury has spent were used to rescue financial institutions, Christy Romero, the special inspector general for Tarp, alleged in a report to Congress published Wednesday.

Congress passed HAMP in 2008 to authorize Treasury to use Tarp funds to modify mortgages for struggling borrowers. In 2010, President Obama established the Hardest Hit Fund to funnel aid to homeowners in states suffering from the combined woes of high unemployment and home price declines.

Data from Treasury shows mounting defaults in the HAMP program, Romero said. About half the roughly 862,280 mortgage modifications that have occurred via HAMP as of March 31 were paid for using funds from Tarp, while 36% of the borrowers who have had their loans modified have defaulted more than once.

Treasury does not have a good grasp on why mortgage modifications under HAMP do not seem to be achieving their goal, Romero alleges. "What we're saying is not so difficult, which is that Treasury, you need to figure out why people are falling out of the HAMP program and try to address the root causes," she told American Banker.

The government has gathered a significant amount of information from companies that service mortgages that have been modified under HAMP that Treasury should dissect, according to Romero, who says Treasury should develop "an early warning system" that would enable the department to identify and assist to struggling homeowners even before they miss a payment.

For its part, Treasury says it received Romero's recommendations in early April regarding HAMP but has had insufficient time to review them. "I will note that the Office of the Comptroller of the Currency has indicated that HAMP modifications consistently exhibit lower delinquency and re-default rates than industry modifications - something that the OCC attributes to the design of HAMP and we identify as one of HAMP's strengths," Assistant Secretary Tim Massad wrote on April 4 to Romero. "Nevertheless, we will review your recommendations and respond more fully in the future."

Congress established the special inspector general for Tarp in 2008 with a mission to audit and investigate disbursement of funds that banks and other firms received in the bailout.

Romero, who has served as inspector general since last April, also blasted Treasury for allegedly failing to put sufficient muscle into a program passed in 2010 by Congress that aims to create incentives for community banks to loan money to small businesses.

As part of the program, known as the Small Business Lending Fund, or SBLF, Congress authorized Treasury to distribute a total of $30 billion to banks that participate in the program, which requires participants to detail to regulators their plans to up lending to eligible borrowers.

Treasury has distributed $4 billion as part of the program, two-thirds of which went to banks that used the funds to redeem debt they issued in return for funds through the Tarp without increasing lending to small businesses, Romero charged.

Twenty-four banks that received both Tarp funds and more than $500 million in small business lending funds decreased their small business lending by a total of more than $741 million, according to Romero's report.

Fourteen of the 24 banks paid dividends to shareholders while in SBLF, despite failing to lift lending to small businesses. The remaining banks that participated in both Tarp and the SBLF upped lending to small businesses, but they lagged in lending to small businesses compared with non-Tarp banks, according to the report.

Treasury disagreed. "When compared with banks that did not participate in SBLF, former Tarp banks report an increase in total business lending over three times greater than that of their direct peers, and over six times greater than the increase reported by community banks," Deputy Assistant Secretary Don Graves Jr., wrote to Romero on March 28.

Former Tarp banks report a median increase in small business lending of 18.4%, well above the 10% increase that Congress set as the threshold level for earning the maximum incentive under the program, according to Graves.

Treasury also says Romero's comparing lending between banks that received funds through Tarp and lenders that avoided the program overlooks the fact that non-Tarp banks received significant additional capital through the SBLF, while Tarp participants were required to use the proceeds to refinance their Tarp loans. Tarp banks also used funds they received through Tarp to increase lending to small business before they entered the SBLF, according to Graves, who says that Congress required Treasury to allow banks that took part in Tarp to participate in the SBLF.

Romero, who calls the results "problematic," agrees that Congress allowed banks that received funds through Tarp to participate in the program but says Treasury was supposed to identify banks that would up their lending to small business. "The banks got a benefit by leaving Tarp and going into the SBLF, so long as the trade-off was that they increased their small business lending," Romero said.

Treasury should help banks devise new plans to increase loans to smaller borrowers, according to Romero. "Treasury and banking regulators pulled out the stops to help the large companies," she added. "We want to see them pull out the stops to help the small ones and homeowners as well."

Romero also weighed in on how regulators might address interconnectedness among the nation's biggest banks and other financial institutions that critics say renders the institutions too big to fail.

The Dodd-Frank Act, which Congress passed in 2008 in the wake of the financial crisis, requires the biggest financial firms to catalog relationships with trading partners, liabilities that may invisible on their financial statements, promises to creditors and other information in so-called living wills that regulators can use to dismantle the firm in an orderly fashion in the event it fails.

Romero says regulators should use information from the contingency plans to map interconnections among financial firms with the goal of untangling ties that could render institutions too big to fail.

"I think regulators and companies are in a really good position, if the living wills are done right, to get that information not to wind down but to use the information to see where dangers and threats lie within our financial system and then break off those dangers," Romero told American Banker. "Right now, regulators are looking at living wills as a last line of defense, but it could be a first line of offense to take action to protect our economy."

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