Most Powerful Women

Sheila Bair on Ben Bernanke, banking, and what's next

October 2, 2012: 12:28 AM ET

Sheila Bair was the lead banking regulator when the financial crisis hit in 2008, and she's now ready to tell all. She spoke to Fortune's Stephanie Mehta at the Most Powerful Women Summit about what happened. 

Below is an unedited transcript of the interview:

Sheila Bair

Sheila Bair at MPW

STEPHANIE MEHTA:  Thank you all for being here. Sheila Bair is the former chairman of the FDIC and she's currently a senior advisor of the Pew Charitable Trusts, and the author of "Bull By The Horns," the book we're going to discuss this afternoon.  In preparing for this session with Sheila, I went back and read one of my favorite profiles of her, and there have been many wonderful profiles of Sheila written in the last several years, but the New Yorker did a piece called The Contrarian by a writer named Ryan Lizza, and what I liked about Ryan's piece, which went into a lot of the banking crisis that Sheila lived through in great detail, but he also went into a great bit of detail about her background, and where she comes from.

Sheila is a lifelong Republican who was raised in Kansas, and the Lizza piece talks a lot about the populism and the spirit of Kansas.  And I think it's telling that Sheila is from Kansas, but specifically that she was born in a town called Independence.  (Laughter.)  So, with the spirit of independence in mind, I wanted to kick off our conversation, Sheila, by asking you to talk a little bit about why you decided to write this book.  You lived through it.  It was painful.  And then you reopened the wounds.

SHEILA BAIR:  Yes.  You know, I did.  I thought maybe it would be cathartic, and it would get it all out of my system.  And really, I just got mad again as I was going through all my memories, and my notes, and e-mails and things.  But it is one of the reasons I wrote the book, because I think a lot of the genesis of my anger, just simple things that could not get fixed.  Like, oh, my gosh, why didn't we have mortgage lending standards?  There was legal authority to have mortgage lending standards, and the government never did it.  Why did the FDIC spend a lonely battle fighting off rules that would have allowed big financial institutions to take on more leverage leading up to the crisis?  So, we should have been raising capital as the housing market became frothier and frothier, we should have been raising and not lowering capital requirements.  And why did Congress just take the authority away from any regulator, whether it was the SEC, the CFDC, the State insurance regulators, pretty much everybody was told to stay out of regulating or even monitoring over the counter derivatives markets.

So, it is frustrating.  A lot of it could have been avoided.  You're always going to have cycles, but you hopefully aren't always going to have potential economic cataclysms, and that's what we were confronting for a time.  But now it's not really getting fixed.  That's the sad truth of it, and I fully support my former regulatory colleagues.  I know they're trying to do the right thing.  But if you look at the pace of reform, it's just still not getting fixed.  And I do think that it is symptomatic of a larger problem in Washington, which is the financial services industry, the perspective of very large financial institutions has really co-opted, I think, both parties, all branches of government.  There is a tendency, and we saw it with the bailouts, to see the world and our economy, and our economic well-being through the prism of very large financial institutions.

And I'm not anti-industry, I'm not anti-financial institutions, but I do think their interest and the public's interest are separate, and there needs to be that greater separation.  But even when those regulators, and others try to assert that separation, the town still bats them back.  You can see it with the money market mutual fund reform.  I didn't even mention that in my book because I just thought it was such a no-brainer it would be fixed.  I can't believe that it has not been done yet.  We had a bailout.  We know it's unstable.  We know it's a problem.  We had another mini run last summer when there were so many prime funds that were so exposed to the European banking system.

The SEC and CFDC, they have to go year-by-year to Congress to get an appropriation just to operate.  And you see industry law using that process to try to stymie reform, to try to de-fund rules related to OTC derivatives, or just general harassment.

So, there are people who say good things about reform in Washington, but at the end of the day you've got to wonder why it isn't getting done.  So, I don't think this gets fixed until it becomes more of a mainstream political issue.  I think it has to become as much of an issue as the economy, as jobs, financial reform needs to be front and center, it really does.  And that's why I wrote this book to try to explain why we had the crisis in very accessible language, what some of the key problems were, and to get people more engaged and counter this, because I don't see that it will get fixed.  I think the good industry players have to get more active, too, and I know that can be difficult.

I unfortunately find that so often lobbying is driven in Washington by the worst in the industry not the best.  And I think we saw this pre-crisis when we were trying to tighten lending standards and raise capital requirements.  There were a lot of banks that agree with this, but they sat on the sidelines, they just didn't want to stick their neck out and disagree with others who were pushing in the opposite direction.

So, that's really at the heart of why I wrote the book.  I want people to understand why it happened, people to understand it's not getting fixed now, and people to understand that they have to play a role in this, in countering special interest influences on this whole process.

STEPHANIE MEHTA:  And we're going to go through, I think, a couple of those.  You call this accessible language.  I think some would call it very blunt.

SHEILA BAIR:  I prefer blunt than a tell-all.  I have a chapter in the book called "Squinting In The Spotlight."  It's about dealing with the press and the words.  And I try to think that gender is not a factor in this type of thing.  But, the words frequently that are used to describe some of the advocacy roles I took.  And I got so frustrated, because when we would be trying to have ‑‑ we would always try to get things fixed quietly in meetings, but there are certain areas that needed public exposure, but there were important policy disagreements at heart.

And the press so often would turn that into personalities.  So, it's like these ‑‑ we weren't having a meaningful discussion about whether we should have risk retention of securitization.  We'd have a thing about Sheila squabbling with Tim Geithner or John Dugan.  And I've seen a little bit of that with the book, you know, tell-all and blunt.  Thank you.  Blunt and honest I like, tell-all I don't like.

I did take people to task, but only when I thought there was a good reason for it, and you can judge for yourself whether I was fair in that process.  But, there were fundamental policy disagreements that I think people should understand, because they're really still at the heart of the approach we're using now to try to reform the system.

STEPHANIE MEHTA:  When we talked a little bit about the book ahead of time you said that you actually held back a little bit.

SHEILA BAIR:  You know, I did, there were 180,000 words.  I took 30,000 words out.  I did.  I actually did tone some of it down and take out some things.  I really did.  There is some tough language in there, but it is descriptive of how I felt.  But, I do think, and I have taken care in talking about the book.  And as I say in the book, in the concluding passages that I think everybody I was working with, they were really trying to do the right thing as they saw it.  But, the problem is, and I think this is particularly true with banking regulators, and this is not a new issue to raise about banking regulation is that the regulators have too much of a tendency to view their jobs as making the banks profitable, as opposed to protecting the public.

Bank profitability; the banks were profitable prior to the crisis, and I use banks generally to include investment banks, mortgage bankers, all the financial institutions that had a role in this.  They were very profitable pre-crisis, but it blew up in their face and it blew up in our face.  So, you have to look more broadly at that, especially if they have a lot of insured deposits, if they had access to the Fed's discount window.

You have to look more broadly at the public interest in your regulatory functions and I think that the underlying philosophy of the bailouts, which continued in 2009, was to make the banks profitable.  And the rest of it would take care of itself.  And we did succeed.  Boy, did we make the banks profitable again.  Their profits now are close to where they were pre-crisis in the so-called golden years of banking.

But, has it helped our broader economy?  No, it really hasn't and I think that's ‑‑ the bailouts, especially in 2008, we did what we had to do.  I think in 2009 the system had become stable.  That was the time to impose some accountability, get the balance sheets cleaned up, replace boards of management where it was necessary.  Get the toxic assets off the balance sheet.  We really didn't do that.

And I do think that is a factor now in this sluggish economic growth that we have, but again, the overriding principle was make the banks profitable, that's what we need to do.  Get the banks profitable again.  And their interests, and the broader public interests are just two separate things.  But, I think that perspective permeates what we did in both 2008 and 2009 and I think it's still a fundamental challenge in the approach especially in banking potential regulators take towards supervision.

STEPHANIE MEHTA:  We're going to open it up to everybody in just a few moments.  And I know you write about this a little bit in the book, but throughout this process what were some of the hard moments, when did you really feel like either the frustration level had just reached maximum peak, or was there ever a point where you felt defeated, or felt like you couldn't move ahead?

SHEILA BAIR:  I did.  In early 2009 I did almost quit.  And we had been struggling to get some type of meaningful foreclosure prevention program in place.  The problem with securitized loans, everybody focuses on the skewed economic incentives securitization created on the origination end of it, so on the front end.  People were originating mortgages, selling them off to investors, they had a saying, "I'll be gone you'll be gone," because they weren't keeping the risk of the mortgage defaulting.  They had very low incentives to make prudent loans.

But, on the tail end securitization created a problem, too, because of the incentives for services, and the conflicts of investors, the normal market pressure you had to get loans restructured when that makes economic sense didn't work.  Loan modification is a time-tested tool.  Bankers, if they had that loan in portfolio, and probably there are some bankers out here, you're going to try ‑‑ if you have a credit-worthy borrower who can make a reduced payment and avoid a default, that's what you're going to do, right, because your foreclosure is almost ‑‑ whether it's commercial real estate, residential real estate, your foreclosure is almost always going to impose more losses than you will lose if we just reduce the payment and try to rehabilitate the loan.  That's your economic incentive if you own the loan, and you're also servicing the loan, you're also dealing with the work out.  But, when you separate that ownership, when the investors are the ones owning the loans, and someone else usually a big bank is servicing the loans, the servicer, the entity that you're looking to, to get the loan restructured, doesn't have its own economic incentives.  And the servicing compensation system did not provide any incentives to restructure loans.  If anything it provided incentives to go to foreclosure, because you got a flat fee, no matter whether the loan was performing or not, and also the longer you waited to go to foreclosure, you had to keep advancing principal and interest in the securitization trust, you got that paid back when you got into foreclosure.

So, you would have thought, well the investors, they would create pressure on the servicers to restructure the loans, because they want to mitigate losses and they want those loans restructured.  But, that didn't work either, because of the different tranches.  And for the senior tranches they had significant over-collateralization, and so foreclosures, the credit losses created by foreclosure wouldn't touch them.  But, if you reduce the payment through a modification everybody in the securitization trust, all tranches of investors, would take a reduced payment.

So, you could not rely on the market, the self-correcting market to deal with these troubled loans.  And we tried so hard to communicate that and I had at the FDIC some of the best securitization experts in the country.  I mean the FDIC had pioneered securitization in dealing with all the troubled assets in the RTC days.

So, I couldn't get a program through.  TARP was supposed to be originally about troubled asset relief.  We did capital infusions anyway.  Hank promised, and his staff, said they were going to do a loan restructuring program, as well.  I couldn't get them to launch.  I went to these internal meetings.  It was maddening.  My hope was that since both McCain and Obama had talked about foreclosure prevention, big programs, I mean, McCain was out there, he wanted an old homeowner's loan corporation, what we did during the Depression, set up a government facility and buy all those loans.

We were going to get a meaningful program, and then Obama came in, he appointed Tim as Secretary of the Treasury.  And Tim and I had already clashed.  Tim's bailout philosophies were not something I agreed with.  And so that was a punch in the gut, as I say in my book.  And then when we started talking with him about foreclosure prevention what they ended up doing was actually a program that one of the economists in the Bush Treasury Department had devised that we thought wouldn't work.  It didn't provide enough economic incentives.  It was administratively complex.  I had critiqued it in detail to Hank, and he didn't pursue it.

STEPHANIE MEHTA:  Hank Paulson.

SHEILA BAIR:  Hank Paulson, but the Obama people picked it up.

So, here we were into 2009, stable system, we were still bailing out Citi, and anybody over $100 billion at that point we were saying we're going to bailout.  We did do the stress test, which I think was important, and I do give credit for that.  And then we get this very tepid loan restructuring program, and I did, at that point, I was about ready to quit.  I was just so exasperated.  But, again, it just shows this mindset about take care of the banks, make the banks profitable, it's going to take care of everything else.  It really just had co-opted the whole town, both parties, just the thinking.  And so I did end up staying, though, because bank failures were really going up in 2009, they actually peaked in 2010.  We had done a lot.  I mean, there's been so much coverage and focus of the policy disagreements I had on bailouts and foreclosure prevention, but my day job was dealing with all those failed banks, and protecting insured depositors, and I cared about that a lot.

People ask me my proudest accomplishment at the FDIC, and it was making sure people were always protected.  And nobody lost a penny, not only that, but they had seamless access to their money when we had this wave of bank failures.  And I had done so much to rebuild the agency, morale was climbing, I just didn't think it was fair to leave them at that point, and I was worried, especially in 2009, that it would send a wrong signal if the Chairman of the FDIC stepped down.  So, I decided to serve out my term, and I'm glad I did because I think we did make a difference.  I think we won as many as we lost on many issues, and I think we did make a difference, though it wasn't nearly, especially on foreclosure prevention, the programs were never what they should have been.

STEPHANIE MEHTA:  Did the issue of the consumer come up in any of these meetings that you were having with Geithner and Paulson?  It just seems like the banks were the focus.

SHEILA BAIR:  Yes, it was nobody else.  You know, here was the problem.  In 2008, when we had that famous meeting on October 13th, and everybody was told about it, and told to take TARP capital, as I write in my book, and here were really two institutions around that table, Citigroup and Merrill Lynch who were, to me, clearly insolvent.  And Merrill Lynch had been able to access ‑‑ B of A was going to be buying Merrill Lynch.  I think the transaction was overpriced, and created problems for B of A in January.  It's worked out better now, but back then that was a very distressed balance sheet that B of A was taking, and then we had Citigroup where the markets were closed to them, they were not going to be raising capital at any price at Citigroup.  So, I think there was concern about if you just took and put money, government money, into Citigroup, or in Citigroup and Merrill, they would have a big target on their forehead, and that would be destabilizing.  So, we're going to force everybody to take it.

But to force everybody to take it, there was really no legal authority to force everybody to take it, and so I think that by itself, that decision, made it very, very difficult for the government to impose conditions, because they wanted everyone to take it.  They didn't want the outliers to be marked by the market.  And so that was a big part of the problem.  But you would have thought in 2009 we could have done more.  And, again, I think the hope was, we had extra TARP funds to have a foreclosure prevention program, and we just never had one that provided any meaningful economic incentives, or economic penalties to get these loans restructured.

Our piece of the bailout programs was a debt guarantee program, which basically was a huge exposure for us.  We basically guaranteed holding company debt.  I've never done this in my life.  So, here we were at the FDIC guaranteeing Goldman Sachs and Morgan Stanley's holding company debt.  And didn't know anything about them.  I took some comfort in the fact that they had been able to access private capital, but it was a huge risk for us.

STEPHANIE MEHTA:  Buffett's capital.

SHEILA BAIR:  Buffett's cap for Goldman, and Mitsubishi for Morgan Stanley.  And so we did, when we ‑‑ we made very clear that the only reason we were providing this program was to support lending.  We were trying to keep their funding costs down, because it was true that ‑‑ although I think most of them could have bumbled through, there was a liquidity problem.  And to roll their debt, their expiring debt, with market conditions like this would have been really, really expensive to do.

So, we charged a fee that we felt approximated a normalized market to keep their funding costs down so they could keep lending.  But it just really didn't work out like that, and we did issue, and I give Hank Paulson credit for this, he was very supportive of this.  We did issue a supervisory memo to the banks that had gotten this money saying, we expected lending, and the examiners would be looking at this.

And as I recount in my book, we wanted language that basically said there would be supervisory penalties if we found inappropriate use of the government support program, and we couldn't get the other regulators to agree with that.  And actually later we did find that a couple of the banks were using debt guarantees, or the money that they were raising through issuing debt with guarantee was being used to pay dividends.  So, it was not good, and we should have done more.

But I think the rush, especially the rush in 2008, plus the desire not to make the weakest institutions look weak, they made it fairly lenient to get the stronger ones like Chase, and Wells, and others to take it.

STEPHANIE MEHTA:  So, the title of the session is Lessons From the Banking Crisis.  What have we learned, and you kind of laid out what hasn't happened.  What are the lessons, and I guess what is the call to action for the people in this room?

SHEILA BAIR:  Well, I do lay out a series of policy recommendations at the end.  And I think if there is one thing the regulators can and should do before they do anything else it is to raise capital requirements.  They need to raise it for large financial institutions, bank and non-bank.  Leverage was really a key driver of the crisis.  It's the reason why you ended up having to do bailouts.  Institutions are always going to ‑‑ you want the institutions to take some risk, there are always going to be some people out there that are going to take stupid risk.  But if you make sure they have enough of a buffer of capital, they will have some loss absorption capacity.

If you let them lever up the way, especially the investment banks were doing prior o the crisis, and if you look at Europe now, they've never recapitalized their banks.  The leverage is still astonishing over there.  You're going to end up having large failures, large institution failures, which are difficult, or you're going to have taxpayer bailouts, and both are undesirable outcomes.  So, I think capital, and he new capital rules only came out for comment in March where I'm already hearing pushback.

I have a chapter in my book called the Senate Cerulean Debate, and it was about somehow pro-reform measures were turned upside down to sound like they were anti-reform measures.  And we're hearing that now with higher capital standards, especially for the largest institutions, what they call the SIFI surcharges, the surcharges for the systemically important institutions.  So now the argument is that this is going to give the big institutions a competitive advantage if we have higher capital requirements for them.  Now, I don't get that.  You have higher capital requirements for them because they are bigger risk, they're harder to understand, they're harder to supervise, they are harder for the market to understand, and if they get in trouble they're a much bigger headache.  It's not some competitive nicety that we're conferring on them.

But we're hearing this argument turned upside down now, and especially getting traction in Europe.  And it is Orwellian, and you don't need ‑‑ I would like all banks to have more capital, including the smaller banks, but I worry less about he smaller banks because, one, they're small enough to fail now, so they generally have higher capital already.  And if they do get in trouble, it's much more manageable.  But that's the kind of problem that you face.  So, I am very disheartened by this.  But it's like money market mutual fund reform, it's just so obvious.  Alan Greenspan right after the crisis was coming out and saying, you can go as high as 20 percent for a capital requirement based on historical analysis.  And he's right if you look at how banks funded themselves early in the last century.

So, it's very frustrating to me, but the difficulty of reform at this point I'm prioritizing and focusing on one thing, and if you could do one thing it would have a significantly higher capital requirement.  And I'd make it a leverage ratio, too.  Most of the capital rules now are driven by what's called the risk base ratio, which again for large institutions gives them a lot of latitude in terms of how they define the riskiness of their assets, which in turn impacts how much capital they have.  A leverage ratio is just tangible common equity to total tangible assets.  And it is a much better predictor of risk as we saw pre-crisis.

STEPHANIE MEHTA:  You also have a chapter in the book called The Audacity of That Woman.

SHEILA BAIR:  Right, yes.

STEPHANIE MEHTA:  What role, if any, do you think gender played in the portrayal of the conflict, and the debates that you had, which you've said are policy debates, but clearly it is interesting that a lot of the people who were on the side of the consumer turned out to be women.

SHEILA BAIR:  Well, they were.  And I think I'm a big supporter of having more women in government at all levels.  I used to be the Republican Co-Chair of the Women's Campaign Fund.  I'm helping several Republican and Democratic women running for the Senate now.  So, I think that diversity of thought is always important, and that's not to say there aren't men who care about consumers, there are.  There are some women who maybe aren't as tough regulators as they should be.  But net-net it just seems to me like the women tend to focus more on the broader population.  Maybe it's our role as mothers, I don't know.  But we do seem to have a bigger identification of that.

You never know if gender is a factor.  Certainly it was hard for us to get into the meeting sometimes, or even when we got into the meeting it wasn't the real meeting.  The real meeting had already been held.  I'm sure you've all had that experience.  You walk in and these guys have already decided what they want to do and so you're stuck, right, trying to talk them out of it, or change course late in the day.

So, there was a lot of that.  And then there was a tendency and I do think this is more likely with women than men.  There is some personalization of what we would say.  I mean the audacity of that woman quote was a prime example.  It was related to an email that John Rich sent to a member of his staff, John Rich was the head of the Office of Thrift Supervision.  We were very concerned about these thrifts, especially WaMu.  It had been on our watch list for a long time and he was just NOTS, we felt was just not on topic.  So, I was more and more getting us inserted, because this was a very large institution that if it failed was going to be a challenging one.  And he personalized that.

It wasn't like me doing my job, okay, John; we've got a couple-hundred billion of insured deposits here.  We need to worry about this.  It was, you know, I was being audacious, or grabbing turf.  I think he called me, I was acting like a super-regulator, and I wasn't a super-regulator.  So, it was all about ego and power.  And I would find that later, too, when we got into the battles with Citigroup, over Citigroup, and the right approach.  It was the same thing.  We were just trying to be territorial and turfy, as opposed to dealing with what was clearly a very challenging situation and one that posed tremendous risks to the government and the deposit insurance fund.

So, I do think there's a tendency sometimes to personalize when women become ‑‑ sort of to personalize it as power grabbing, or whatever, as opposed to us having a prerogative, like everybody else, to do our jobs and stand up for our jobs.

STEPHANIE MEHTA:  I think super-regulator would make a great Halloween costume.

SHEILA BAIR:  That's good.  I like that.

STEPHANIE MEHTA:  If any of you have daughters that's what they should be for Halloween this year.  I'm working on that costume.

Let's open it up for questions and comments.  I know a lot of people in the room have probably got some thoughts, maybe lived through the crisis themselves and have a different perspective.

Barbara?  Wait for a mike and identify yourself for the room.

BARBARA NOVICK:  Barbara Novick with BlackRock.  I just wanted to answer you mentioned ‑‑ (inaudible) ‑‑ the failures peaked in.  What do you think long-term that means for the deposit insurance fund?  And unfortunately I haven't read your book yet.  I'm going to.  But, do you have policy recommendations on that aspect of what did we learn and what should we do differently?

SHEILA BAIR:  Right.  I think, again, the best thing you can do to protect the deposit insurance fund is increase bank capital requirements.  I mean that prevents a failure, it prevents a lot of failures and when you do have a failure it mitigates losses.  We were actually pretty successful in Dodd-Frank in achieving a lot of reforms already to shore up the deposit insurance fund.

When I took over the FDIC in 2006 we had about $52 billion, I think, what we call the reserve ratio, the minimum statutory requirement was 1.25 percent of insured deposits.  But, it was slipping.  And we had just gotten legislation through Congress to start assessing all banks premiums, prior to 2006 Congress had actually banned the FDIC from assessing any bank, a premium for the deposit insurance unless they had a weak supervisory rating.  Of course, that was about 2 percent of the banks.  So, 98 percent of the banks for years had not paid any deposit insurance premiums at all.

So, finally, the FDIC got legislation passed to give it the ability to build up the fund, even when it was at its statutory minimum, and to impose assessments on all banks.  I did that two weeks after I was in office, we had a proposed rule out.  By the end of the year we were starting to collect premiums from everyone.  And here again this is why I get frustrated with industry lobbyists, and I do think ‑‑ people ask me how to mute their effect.  Sometimes I think they shouldn't be able to say anything.  If you want to influence Congress, or the agencies get the CEOs then, because I think a lot of times these lobbyists do things that the leadership of the banks, and financial institutions don't even know anything about.

But, anyway, on this issue we were just hammered by the lobbyists.  I quote some of the letters I received in my book about how you don't need this money and everything is fine, and the golden age of banking, you take this money out of the banks for your premiums and it's going to constrain lending.  Everything was, it was going to constrain lending.  That's just the default argument.

So, we went ahead and did it anyway.  And I love this thing.  We didn't need the money; because of course within a year definitely it was clear we were going to need the money.  But, then later when the deposit insurance fund became depleted and I had to go out and start assessing banks again, because I was going to be darned if we were going to borrow from Treasury, the argument was, you can't assess premiums now, the industry is stressed.  So, there you go, in the good times we can't assess, because I won't need it.  In the bad times we can't assess, because the industry is stressed.  So, there's never a good time to raise premiums.

We did in Dodd-Frank pretty much got any cap lifted off our ability to raise the fund over time.  And I raised the target significantly higher than it had been before.  And we also, and I know a lot of large banks were unhappy about this, but we changed the assessment base, so it's basically all liabilities minus common equity, as opposed to before it was just insured deposits.  And the reason why we changed it was because in the FDIC's resolution process we always protect secured creditors.

So, if a bank, though, relies heavily on secured borrowing, even if it had a relatively small deposit insurance base, excuse me, a small base of insured deposits, it's a very expensive failure for us.  We also found that the larger institutions didn't gain, especially if you rely a lot on foreign deposits, or you rely a lot on short-term funding, that makes you a lot riskier, because it's highly unstable liquidity.  But, that wasn't reflected in our assessment base.  So, now the assessment base has been changed.  It's pretty much all liabilities minus equity.  And that did shift a lot of the burden to the larger institutions, but I think that was an acceptable result.  And the fund is being replenished now.  It was on positive returns when I left.

Going forward the main thing I worry about, in addition to getting capital levels up and just having better potential supervision, because that's really what the FDIC needs to protect itself.  I do worry about a trend now, because wholesale funding pretty much proved itself to be highly unstable during the crisis.  So, a lot of large financial institutions, especially the investment banks, funded short, and they were constantly going to the markets to reissue paper, or debt, and that didn't work, because it dried up when the crisis hit.

So, now there's a tendency to fund more with insured deposits.  And that's more stable.  That's good news, insured deposits stick.  But, it also increases exposure for the deposit insurance fund.  It doesn't bother me so much that short-term funding is being replaced with insured deposits, but now I'm getting worried, because long-term debt is being replaced.

BlackRock is probably very focused on that.  Long-term debt is being replaced with insured deposits.  Large institutions used to have a fairly thick level of senior, unsecured debt, which also is available for loss absorption if a bank fails.  But, they're replacing that now with insured deposits, which of course the FDIC must pay off if the bank fails.  And I have filed a comment letter with the Fed, actually, that suggests that they establish minimums for senior unsecured debt, at the holding company level, which will give you more product to buy.  So you shouldn't ‑‑ but I think it would be helpful, because I do ‑‑ the good news and the bad news is the FDIC proved itself.  Insured deposits stuck, it's good funding.  Rating agencies like it.  Investors like it.  Counter-parties like it.

But, the bad news is, that's created a lot of incentives to put more and more of the burden for funding balance sheets on the FDIC, and that does increase the government's risk.

QUESTION:  For my sins, I'm Marisa Drew, I work for a European bank, Credit Suisse.  But, the good news is we are fully B3 compliant under our regulator, who is really aggressive in Switzerland.  Two questions for you, if I may, one is what's your perspective on whether Glass-Steagall, the repeal of Glass-Steagall would actually solve some of these problems in addition to the higher capital rules.  Then the second question is a perspective on some of the accounting rules, because one of the things that always troubled me through the crisis was you could have two banks, exact same loan position, one marked at 50 cents on the dollar, and one marked at par, because they called that under different accounting rules a performing loan.  And that really troubles me.  It's still there.  So, the cleanup isn't going to happen when we have a different playing field.

SHEILA BAIR:  So, on Glass-Steagall I've remained somewhat agnostic.  I'm a traditionalist in the sense that I would like insured deposits to fund traditional commercial banking activities, which I trust services, loans obviously, payment processing.  I would like securities, derivatives, certainly insurance ‑‑ not many do that anymore ‑‑ outside of the bank.  What I argue for in my book is that I'm okay with keeping it in the same organization so long as there are strict firewalls, especially between the insured depository and these other higher risk functions.  That's not to say that obviously securities is market making, derivates market making, those have legitimate purposes, some of them are used for speculation which hopefully the Volcker Rule will address, but they are higher risk.  They are less predictable.  They are not well understood by examiners, or as well understood by examiners, nor are they as well understood by the market.  And forcing great market discipline by having people go to BlackRock or whoever to fund those activities outside of an insured bank, I think, would create more sets of market eyes on those activities, and make it more expensive to fund them, which I think is a good thing, not a bad thing.  So, that is the framework I would like to see.

I think there are some economies of scale, sharing brand, your IT, your HR, whatever, those types of things, but especially with the insured bank I do think that should be a firewalled off, and for international operations I think if any major foreign jurisdictions to have major operations, I support a subsidiarization model, so that would also make it so much easier to resolve these institutions if they get into trouble when they're multinationals, as most of them are now.  So, I do think that that is the way to go.

On accounting, it's a real problem.  You know, we had in 2009, some of you may recall, it was announced and never executed to do something called PPIF, Public-Private Investment Funds, and the idea was to set up a facility to set a competitive auction process for banks under supervisory pressure to sell bad assets into this facility.  The government would provide some liquidity support, and some financing to help tease out the liquidity discount, which back in 2009 was significant.  Now it's nothing, there's liquidity everywhere, but back then it was hard to get financing to buy toxic assets.  So, that was the idea.

So, with the liquidity support, you could presumably get the pricing up, but we would have some market-based measure of what those toxic loans were worth.  And we never ‑‑ I think that was a key failure of ours in 2009.  We wanted to do it, we approved it, the Fed approved it, Treasury never approved it.  Their approval was necessary, and I finally gave up.  There was a lot of ‑‑ towards the end of 2009, there's a lot of Congressional pressure against doing anything that looked like a bailout, and for better or worse I think there was some inaccurate reporting of PPIFs, and it got tagged with that mantle.  But I think that would have been extremely helpful in providing market price for these assets, because, you're right, it's all over the place now.  There's no doubt in my mind that those assets are being marketed at significantly higher values than a lot of them are really worth.

But just going forward, I don't know why, I think the auditing profession with their regulator should at least do a better job of providing consistency, because, you are right, the auditors can be all over the place.  And that, again, that's important from the FDIC standpoint because the mechanism that triggers a resolution is all about what the capital level is.  But if the marks on the assets are inaccurate, then that's going to overstate capital, and then you end up closing a bank later than you should, and it usually is a lot more expensive than it should be.

STEPHANIE MEHTA:  Other questions, comments?  One back here, please.

QUESTION:  Sylvia Reyes, Chief Investment Officer from Zurich Insurance Group.  Two questions.  We're now five years after the start of the crisis with the Lehman default, and still the economy, the U.S. economy is still struggling.

SHEILA BAIR:  Yes, it is.

QUESTION:  The main issue being banks are just not lending.

SHEILA BAIR:  Yes.

QUESTION:  So, they are holding cash, and just keeping them and not channeling, transmitting this cash into the real economy to get the economy going again.  So, from your point of view, how could we encourage banks to start lending again, and get the economy really growing to its potential?

Second question is now with the QEX from the bank with now buying mortgage-backed securities, what is your take on that and will that be successful, is that a game-changer from your point of view in terms of the Fed action to spur economic growth again?

SHEILA BAIR:  Well, on bank lending, I do think there is some timidity in making loans.  I do think loan demand is down, too, because of uncertain economic conditions, and our fiscal situation.  But I do think banks are not, especially large institutions, are not as willing to lend as they probably would have been if we had made them clean up their balance sheets.

We keep repeating these mistakes.  We lectured the Japanese when they did it, and then we just kind of did it here ourselves.  A bank, if you leave the toxic assets on the bank's balance sheet, they're going to spend their time nursing those loans, working them down, playing it safe with government security investments, or what-have-you, and if they do take risks, they'll probably take short-term risks on their trading book.  They're not going to commit to a loan in an uncertain environment when you've got all these bad loans on your balance sheet already.  So, I do think the capacity of the industry to lend would have been strengthened if we had cleaned up the balance sheets, and we just didn't do that.

Also, getting back to the Glass-Steagall question, I think one outcome of Glass-Steagall, which perhaps should be part of the policy debate more than it is, is if you allow banks to have these huge trading operations as well, they don't really need to loan to make money.  And if you see loan growth post crisis, you'll see the small and mid-sized institutions have done a better job lending.  And I think one of the reasons is they're not pure that's how they make money.  They've got to lend.  And so they don't have these big trading books, and they can't arbitrage their cheap funding here with higher rates overseas.  They just don't have the capacity to do it.  So, if they're going to make money, they're going to have to lend.

But I think, finally, to your second question, and these are your interest rate policies that the Fed has pursued, I don't think that encourages lending.  I know it's counterintuitive.  They say, well, reduce the cost of credit, hopefully you'll be increasing the borrower demand, but that's not there.  Consumers and a lot of businesses are over-leveraged, at least he smaller ones, or they have no collateral left.  And then the bank is looking at it, and the economy is uncertain, we're not sure how it's going to turn.  Congress hasn't got their act together.  And you're going to make a multi-year loan into this, and get 4 or 5 percent if you're lucky.  There's just not a lot of incentive to do that.

So, you buy government securities, you buy maybe muni debt, maybe highly rated corporates debt.  You don't go out there and lend because there's so much risk, and the return is just so low at this point.  So, I have spoken out against ‑‑ I didn't ‑‑ look Ben is a hero, and he's doing this for all the right reasons, but I don't see that this helps our domestic economy.  I really don't.  And I think the risks involved with inflation are significant.

I look back to when we had the subprime crisis, and we had very accommodative monetary policy back then, and I think one of the reasons subprime became so attractive was because people were looking for return, because the returns on the safe investments were so low.  And I worry that that's going to be starting up again.  And you can see it with pension funds, insurance companies, normally risk averse investors, are starting to go farther and farther out on the risk curve on investments that don't necessarily create jobs or productivity here.  So, how high can commodity prices go?

I think the risks are quite profound, and the benefit at this point, it was absolutely understandable in 2008, but now I just don't see that the benefits are anything but incremental at best, and the risks are profound.

STEPHANIE MEHTA:  Is there a question?

QUESTION:  Ellen Alameni (ph), Citizens Financial Group.  How do you feel the Consumer Protection Bureau is doing?

SHEILA BAIR:  Well, I support the Bureau, and I also strongly endorse it in the book.  And I think they're doing a good job.  I am, if I have one little complaint, and I do have one little complaint, it is that the rules are still too long and complex.  A lot of the senior people came over to see me at Pew when they became installed at the Bureau to get my thoughts, and the top of my list with all of them was, please keep these rules simple.  I think consumers can understand what their rights and protections are.  Smaller banks have basically gotten out of consumer finance because it's just too hard.  The compliance costs are just too hard.  So, please, please strengthen these rules, but simplify them.

And so, I think they've been strengthening the rules, but not necessarily simplifying them.  So, I do give them a bit of a mixed grade on that.

But they're ramping up.  Finally somebody is examining the non-bank sector, and establishing more of an enforcement presence there, which I think is very important.  And I think they are sending a strong signal to regulated banks as well, but in a way that seems to me, the cases I've seen, are very much justified and in line with their mandate.  So, I don't for the life of me understand why there is this continued controversy and turmoil over the Consumer Bureau.  We did not do a good job protecting consumers of financial products leading up to the crisis.  So, it just didn't happen.  And having a bureau that specifically focused on that I think is a positive thing, and over time it will prove itself.

QUESTION:  (Off mike.)

SHEILA BAIR:  There is.

QUESTION:  (Off mike.)

STEPHANIE MEHTA:  Super-regulator.

SHEILA BAIR:  The Super-regulator, that's right.  An audacious super-regulator, that's right.

QUESTION:  (Off mike.)

SHEILA BAIR:  So, yes.  I do.  You're right.  So, we had not enough regulation for the consumer, and too much, too many, or not too much but too may on prudential.  So, I would go down to two regulators.  I would have the Fed be the holding company regulator, and I would have the FDIC be the bank regulator.  And, again, I would put the traditional stuff in the bank, and have the FDIC focus on that.  And if you want to do securities, and derivatives, or anything else, put that in the holding company, have the Fed worry about that.  And I would give them each back-up authority over each other to keep their eyes on each other, because I think that can be a discipline.  I merged the SEC and CFDC.  I don't know why we have two.  I would create the financials ‑‑

And the irony of this is, Brooksley Born obviously was rolled with Commodity Futures Modernization Act.  She bravely stuck up her head and said, we need to have some regulation of OTC derivatives, and Congress said with Rob Rubin and Alan Greenspan's encouragement, no, we're just going to say nobody can regulate them.  But part o the problem was there, the SEC and CFDC have been fighting each other for so many years over who is going to regulate derivates, nobody was really establishing a presence in the system.  And they need to be merged, my gosh, it's silly that they're not merged.  I would have the Financial Stability Oversight Council take that out of Treasury, have it as a separate independent agency with the constituent agencies as members, as it is now.  And a separate Chairman with his or her own staff.  And then I would have the system wide rules written there, so you don't have this negotiated process, you see the capital rules, or the Volcker Rules, or whatever.

And my bank regulator colleagues gag when I say that.  Oh, you're going to have the SEC and the market regulators in there.  But, yes, I mean we had a lot of capital arbitrage within investment banks and commercial banks leading up to the crisis.  It was really not helpful.  So, I think system wide rules should be written by that entity, and each individual regulator can have their say, and they would still be responsible for enforcing those rules with each of their regulated entities.  And I would also let them say, if you want to have stronger rules, you can, to make sure the FSOP doesn't itself become captured.  But I think that would rationalize the system and end this constantly negotiated process.  One of the reasons we had these really log complicated rules is just the interagency negotiations just go on forever.

STEPHANIE MEHTA:  Sheila, we started out by talking a little bit about your background, and this idea that you have established yourself as an independent.  I was just hoping you could take a minute or two and talk a little bit about your upbringing, and how that shaped the regulator you became.

SHEILA BAIR:  That's a good question.  I grew up in rural Southeast Kansas, a town called Independence.  We had several claims to fame.  For instance, Vivian Vance, you remember Ethyl on I Love Lucy, she was born in Independence; and Mickey Mantle played his first little league game in Independence; Walter Cronkite's aunt was from Independence.  So, we had a lot of claims to fame.  But it was a very rural community, quite economically distressed, very isolated, no good roads.  You know, the closest city was Kansas City, it was a good three-hour drive.  So, people had to be scrappy there, because there wasn't a lot of economic growth or health there.

And my father was a doctor, so we were always comfortable, but I went to public schools, and I went to schools with people who had to struggle.  So, I think that gave me some sense of how the broader population live, especially people who don't have a lot of benefits to them when they were born.

So, and my parents were very demanding people, and they were Depression Era, both of them.  My mother grew up in the Dust Bowl.  Her family, they were poor farmer, just a few miles away from Independence, and she would tell me stories about, you know, they got oranges once a year for Christmas, that was their Christmas present.  And waking up covered with dust because of the terrible drought conditions that went on for so long.

So, that was kind of my upbringing, and then I think Kansans just tend to be independent minded, populist oriented in their politics, you can see that with our politicians, our Republicans, Eisenhower, Dole, yes Republicans and conservatives with this strong populist streak.  So, I grew up with that.  And then I worked for Bob Dole for many years, and really cut my teeth on his kind of politics.

And Dole was always a big tent politician, too, and he was a real leader.  He was a Lincoln Republican.  He was a big advocate for civil rights.  He was probably one of the most, if not the most influential legislator in getting all of these disability rights laws that we have now enacted.  So, I saw that side of him, and I worked on all those issues for him.  And that also made a mark on me.

So, when I went into the crisis I had worked ‑‑ I think I had less of a narrow focus on how banking regulators viewed the world, because I had worked the New York Stock Exchange.  I had worked ‑‑ I'd never worked the SEC, but I worked with the SEC back when the NYC was a self-regulator.  And I had worked at the CFTC as a commissioner and acting chairman.  So, I had seen the derivatives side of it.

So, I think that did help me during the crisis, because it did give me a sense of, system-wide, what was going on and made me less parochial in terms of how banking regulators viewed the world.  But, people ask me, well, who should be ‑‑ what kind of person do you want for Treasury Secretary, or for these regulatory jobs, and I really think at the end of the day you want people who will be independent.  And you can find independent people from a lot of different sources.

But, the best way, I think, to guarantee independence is to make sure that you have people there who don't really look to the industry to be their next career move.  I'm not anti-industry.  I deal with the industry a lot.  I associate with folks in the industry.  I'm not anti-industry, but I am pro being independent of the industry.  And you've got to, when you're a regulator, or in charge of economic policy, you've just got to see the world from a broader perspective than the banking system.  And I think the one way to promote that is to make sure that people who take those jobs do not want to go back to an industry that they regulated before.

So, I do think I've argued very hard for stronger post-employment restrictions in this book.  And it's not the political heads of these agencies.  It's the examiners, too.  We've got great examiners, but a lot of them do go work for the industry after they work as examiners and I think that's problematic.  So, I would pay them more, I would make it more prestigious.  But, I would also say, folks, it's a lifetime commitment like the Foreign Service.  You're going to do this and this is what you're going to do.  And when you retire, you're going to go be an academic, or work for a think tank, or something, but you're not going to go work for a bank, or you're not going to go for an accounting firm, or a law firm that works for a bank.  We really want a lifetime commitment from you.

STEPHANIE MEHTA:  And what's next for you, Sheila?

SHEILA BAIR:  I'm really happy doing what I'm doing.  I have a Fortune column that you and I share that affiliation and I really enjoy that.  I love my work at Pew.  I'm chairman of the System Risk Council.  We've got a great bipartisan group of people, Alan Simpson, Bill Bradley, Chuck Hagel, Paul Volcker, Paul O'Neill, Brooksley Born, it's just a wonderful group of current and former government officials ‑‑ excuse me, former government officials and regulators and some great academics.

We're doing some work on housing.  I'm very energized.  We're focusing on what we call the lower truancy issues in housing.  I think one of the people who really got hurt in this crisis were the lower income communities that had these horrible 228s, and 327s, pushed on them.  And they had these nice ‑‑ it's kind of a myth that the sub-prime expanded home-ownership.  For the most part, these were re-fis.  You can see FHA's market share going down and the sub-prime going up.  People had nice, safe, 30-year fixed rate FHA mortgages, got put into these toxic products.  But, it's really ‑‑ that's where the foreclosure wave hit the most.  I think revitalizing those communities is something our housing policy is not focused on.  That's a little niche I'd like to see if we can work on at Pew.

So, I've got in the book, and I've got actually a couple of kid's manuscripts for new kids' books, too.  So, I'm having a good time.  And I have a lot of time with my family, which I didn't have before.

STEPHANIE MEHTA:  Well, I want to thank everybody for joining us this afternoon and especially those of you who are standing at the edges.  We were standing room only, which is truly a testament to Sheila.  I also want to thank Herman Miller.  They've actually provided us with copies of Sheila's book.  Sheila, I think you're going to be able to sign a few copies.

SHEILA BAIR:  Sure, I'd be happy to.

STEPHANIE MEHTA:  And then if you catch Sheila, she's here for the whole summit, which is really wonderful for us.  So, if you can grab her in the hall bring your Sharpie, she can sign your book.

And above all, thank you to Sheila Bair.

A round of applause for our wonderful speaker today.  (Applause.)

It was a lot of fun and we'll see you at dinner this evening.

Thank you, again.

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