Would The U.S. Be Able To Endure Another Financial Crisis? Former FDIC Head Says Maybe Not

Oct 1, 2018

With Meghna Chakrabarti

Sheila Bair was the head of the Federal Deposit Insurance Corporation (FDIC) during the 2008 financial crisis. She warns that American democracy may not be able to withstand another bank bailout.

Guest

Sheila Bair, head of the Federal Deposit Insurance Corporation from 2006 to 2011. (@SheilaBair2013)

Interview Highlights

On her concern, in 2006, upon digging into subprime loan data

“We were astonished. I couldn’t believe what I saw. Oh, my gosh. … My history with this goes back to the early 2000s, where we were seeing this kind of abusive lending, but it was the marginal players in the mortgage industry that were doing it. And they were targeting low-income neighborhoods, minority neighborhoods. And so I left and I came back, and these lending practices had gone mainstream. Everybody was doing them and it was a real parade of horribles. They had these things called 228s and 327s — they called them hybrid fixed mortgages, which is completely misleading. They had a “fixed rate,” which is very high, like 9 or 10 percent for the first couple of years, and then they jacked up to an extremely high rate, generally a 30 percent or more increase in your payment. So they were not underwritten so that the borrower can continue paying when the mortgage reset. Plus, there was very little income documentation, people with distressed credit histories, and anybody who looked inside these and did a bit of homework could see what was going on. And that’s why it frustrates me when everybody says, ‘Oh, this is such a big surprise,’ because, if you did a little homework, if you were an investor and you did a little homework, you would have known not to buy these private-label mortgage-backed securities as they were called back then.”

On when she realized this could spill over from a few foreclosures to a full-blown crisis

“I think there was growing recognition we had a very serious problem. Certainly during that period in the fall of 2006, I stepped up both internal and external advocacy of putting some mortgage-lending standards in place, and we really needed the Fed to step up and do that because only the Fed had the power to write rules for both banks and non-bank originators. So we started that effort. But we carefully watched the housing market turn and the delinquencies and defaults starting to accelerate fairly significantly by 2007. I think there was a growing recognition, by the spring of 2007, we were pushing for system-wide loan modifications. We convened several meetings at the FDIC with the securitizers  — Fannie and Freddie and FHA, all of the ones that guaranteed mortgages, the rating agencies, everybody. Tried to get everybody in the same room to say, ‘Look we’ve got a problem. We need to get these mortgages modified.’ It was going to be complicated to do that.

“We got a lot of happy talk — ‘Yeah, we’re going to do that.’ And our solution was just get rid of these resets, just convert these into 30-year fixed-rate mortgages at this starter rate, what they called the starter rate. If they’re performing at the starter rate, let them keep paying at the starter rate. All you had to do is look at these mortgages and know that there was no way in the world those families were going to be able to pay the higher mortgage. It just wasn’t going to happen. They didn’t have it. They didn’t have the money.”

On where our financial system is at right now

“Certainly the system is more resilient now, but I’m very concerned about all this recent rhetoric. And [former Treasury Secretary] Tim Geithner, obviously, he and I have had our disagreements, and they’re policy disagreements, but here’s another one, because his emphasis right now is all about expanding the government’s bailout tools based on the assumption that we’re going to have another cycle, we’re going to have another financial system that’s going to need government help, and so we need more bailout tools. And I think that’s absolutely the wrong system. That’s the system we still have and we don’t want to save that system. We have something called Title II, which we did not have in 2008. That allows regulators, the FDIC, working with the Treasury and the Fed, to put a bank into a resolution process, to break it up, keep its bad assets out, impose the losses on the shareholders and the unsecured creditors — which is where the losses should be and where the losses are also if you go through a traditional bankruptcy — to fire managers, to fire board members, to recapitalize the bank and to bring in new investors and new management, and return the healthy parts of the bank back to the private sector. So, yes, that is basically what you do in a bankruptcy. This is a government-run bankruptcy process. There are some unique things about large financial institutions that make traditional bankruptcy difficult to use. That’s a tool we didn’t have in 2008, we have now. But regulators need to be willing to use it, and importantly signal now, remind the markets, that this is going to be the new paradigm. This is the new process — not bailouts, but accountability.”

On those who are wondering why wait for the next financial crisis to break banks up

“Well, there are people who have that view, and I can understand view. And I don’t think there’s a political will in Washington to do that. And this is bipartisan, unfortunately. You see legislation going through now that reduced — three of the largest banks — have reduced their capital by 20 percent, this bill that just passed, and then that kind of signaled the Fed to weaken some of the capital rules and the stress-testing requirements. And now you’ve got Republicans — I’m ashamed to say because I’m a Republican, and I thought Republicans are market-oriented — a lot of Republicans trying to pressure the Fed to reduce capital even more. So that’s the political environment. Big banks are back in charge. That’s the political environment in D.C. right now. I don’t see that there’s any political will to break them up or do anything else. And my fear is that we’re going to have to have another disaster before that finally happens. But yeah, I mean, if they needed another bailout again, I think our democracy cannot survive that. Our democracy could not survive another round of bailouts. It just — it can’t. Look at what happened. People who discount the role of the 2008 crisis and the 8 million homes lost, 9 million jobs lost, the terrible hit to the public purse, still people struggling in low and middle income families. That started with the crisis and some of that is still remnants of the crisis. And I think that’s a lot of what feeds into the discontent we have right now. So to suggest that we’re going to bailouts again, that that’s going to be the new paradigm, that we don’t really need to bother with regulation and trying to prevent crises, we just need to be prepared with more taxpayer bailout tools — I don’t think democracy is going to tolerate that.”

From The Reading List

New York Magazine: “Sheila Bair on What Hasn’t Changed Since the Great Recession

How bad was the crash, historically speaking?

Pretty bad because it hit the Main Street level. There’s kind of the first wave of people who had these unaffordable mortgages and were getting hit by falling home prices and couldn’t refinance, so we were seeing the foreclosures pick up. When that started hitting consumer spending, and the banks had to pull back on credit because they didn’t have enough capital, then you saw people who had nice, safe mortgages who were losing their jobs because of the broader economic situation.

Are there other market crashes that you could say hit Main Street?

You’d have to go back to the Depression.

If you could change one thing about how it was dealt with from the policy side, what would it be?

That’s a hard one.

Yahoo Finance: “Former FDIC Chair Bair: What I would have done differently during the crisis” — “Former FDIC Chair Sheila Bair says that she did the best ‘with the tools we had’ during the financial crisis.

“But speaking at Yahoo Finance’s All Market Summit in New York on Thursday, Bair says there are a few things that she would have done differently if she could go back and redo 2008.

“When IndyMac, a California bank, failed in the summer of 2008, it closed faster than the FDIC had projected, which Bair attributes to comments made about the bank’s position by Sen. Chuck Schumer (D-NY), which precipitated a bank run on uninsured deposits.

“With a faster than expected failure projected, Bair had to perform an accelerated closure, which was the first major bank to close during the financial crisis. Unfortunately, it was just a bit too accelerated.

“‘I succumbed to the wishes of the primary regulator, the Office of Thrift Supervision, to close it before regular business was over,’ said Bair. The day was a Friday afternoon, a time where people frequently go to the bank to deposit pay or take money out for the weekend, so the move was disruptive.”

New York Times: “Opinion: What We Need to Fight the Next Financial Crisis” — “Ten years ago, the global economy teetered in the face of a classic financial panic, the most dangerous type of financial crisis. In a financial panic, investors lose confidence in all forms of credit, retreating to the safest and most liquid assets, like Treasury bills. The prices of risky assets collapse, and new credit becomes unavailable, with dire consequences for workers, homeowners and savers.

“The seeds of the panic were sown over decades, as the American financial system outgrew the protections against panics that were put in place after the Great Depression. Depression-era safeguards, like deposit insurance, were aimed at ensuring that the banking system remained stable, but by 2007 more than half of all credit flowed outside banks. Financial innovations, like subprime mortgages and automated credit scoring, helped millions to buy homes, but they also facilitated unwise risk-taking by lenders and investors.

“Most dangerously, trillions of dollars of risky credit were financed by uninsured, short-term funding. This made the financial system vulnerable to runs — not by ordinary bank depositors, as in the 1930s, but by pension funds, life insurance companies, and other investors. A Balkanized and antiquated regulatory system made identifying these risks difficult and provided policymakers with limited authority to respond when the panic erupted.”

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