WASHINGTON — A controversial $40-billion government program to buy toxic securities from ailing banks has a flaw that law enforcement and financial experts say could allow traders to illegally profit from inside information.
Critics of the program say that without adequate safeguards, traders could use the tens of billions of dollars provided by the government to manipulate prices and exploit the price swings in other trades.
Because the government is providing 75% of the program's money -- $30 billion -- the manipulations could lead to significant losses by taxpayers.
"It is a conflict by design," said Neal Barofsky, the special inspector general for the banking rescue program who has urged tighter controls on the nine trading firms selected to participate.
The Treasury Department, which is in charge of the program, says it intends to closely monitor trading activity to prevent illegal insider trading and profiteering at the expense of the public interest.
But Barofsky said the government probably stands little chance of beating Wall Street at its own game.
"The Treasury cannot possibly match wits with the innovation and aggressiveness of Wall Street," he said. "If you give them a set of rules and there are technicalities and legal loopholes and things we haven't thought of, they are going to find that out, not because they are bad, but because that is what they are supposed to do. They are supposed to seek out profits at all costs."
The program, known as the Public Private Investment Partnership, or PPIP, allows the nine investment firms to use the government money and $10 billion in private funds to buy up toxic securities held by banks.
The firms, chosen last month from a field of about 100 applicants, have already begun assembling pools of private investors to buy the securities, composed of troubled mortgages that have festered on banks' ledger books and hampered their return to health.
The toxic securities, which could total $2 trillion, plummeted in value during last fall's credit crisis and became virtually impossible to sell because of uncertainty over their worth.
Under the government's plan, traders would jump-start the market by making offers to banks for the securities, thereby setting fair prices for the securities and trading them on the open market. Sales could begin as soon as this month.
