FDIC’s Bair: Economy Signaling Improvement


FDIC’s Bair: Economy Signaling Improvement

FDIC’s Bair on Special Assessment Outlook FDIC’s Sheila Bair on the credit industry and private equity’s role in resuscitating the banking sector.

FDIC Chairwoman Sheila Bair spoke exclusively with FOX Business Network’s Alexis Glick and said that commercial real estate losses are going to be “a much bigger factor” next year and “there’s not a whole heck of a lot we can do about it.”

Below are excerpts from the interview:


On the residential and commercial real estate markets:

“Commercial real estate is ticking up more. I think later in the year into next year, the commercial real estate losses are going to be a much bigger factor. We’ve known it’s been coming for some time—there’s not a whole heck of a lot we can do about it.”

“The more traditional commercial real estate loans are showing some distress and that is derivative of the economic situation, so we will have some time working through that and I think it will be a big driver for bank failures in the next year.”

On the rules that the FDIC put out yesterday:

“They are good rules. I think there are some issues about timing because as you know the industry is still under some distress…I think the issue is more of timing as opposed to whether the rules are the right thing to do. If we’d had them a few years ago, there would have been more capital in the system, so it would have been nice to have it back then and we’re doing the right thing now although the timing is troublesome.”

On the economic recovery:

“As the economy improves it will take a bit longer for the banks to fully recover, but we have some challenges ahead. They’re manageable and we’ll work through them.”

On whether the FDIC can cover the cost of bank failures:

“We have a lot of cash—we have $22 billion cash on hand to cover the cost of failures.”

On the role of the FDIC:

“We pride ourselves on being the Main Street bank supervisor.”

On the common ground between herself and other regulators:

“We all agree that we need to end ‘too big to fail’ and we need a resolution mechanism that will allow these even very large institutions to be closed down and for shareholders to take losses as part of that process.”

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ALEXIS GLICK, FBN HOST: Thank you very much, Dagen.

Welcome to Washington D.C. We’ve been here throughout the morning, and we’re covering one of the big stories of the day. And that is the second-quarter banking – second-quarter banking report that just came out from the FDIC earlier this morning. Joining us exclusively right now is the FDIC chairman, Sheila Bair.

Good to see you.


GLICK: You just released the data just moments ago.

BAIR: Right.

GLICK: I guess crib notes version, likes and dislikes about the report.

BAIR: Right. Well, the industry had a net loss, but it had some fairly substantial nonrecurring expenses, including a $5.5 billion insurance assessment, so operating income actually stayed a bit in positive territory. So all in all, it was a challenging quarter.

But there were some bright signs. The noncurrent loan rate was going down a bit. The credit distress continues, but the rate of increase seems to be slowing a bit. So, I think there were some glimmer of hopes, but, you know, it’s going to take time for banks to clean up their balance sheets and work through this.

And when the crisis started, we were dealing with a lot of complicated products that should not have been made and loans that should not have been made. And now we’ve kind of worked through that, and what we’re seeing now is credit distress rate deriving from the — you know, the economic situation, people losing their jobs, having their hours cut back, and it will take some time to work through those credit losses.

The banking sector also tends to be a lagging indicator, so as the economy improves, it will still take a bit longer for the banks to fully recover. But they’re — so, we have some challenges ahead, but they’re manageable, and we’ll work through them.

GLICK: Very much like unemployment in the lagging indicator effect, but there’s a great deal of concern about the residential and commercial real estate markets in particular.

BAIR: Right.

GLICK: Do you see the residential situation starting to stabilize, and is the commercial one the sector that you’re now more concerned about?

BAIR: Right. That’s a really good question. Well, the second-quarter residential mortgages are still a bigger percentage of credit distress than commercial real estate. But the commercial real estate is ticking up more. So, yes, I think later in the year and into next year, the commercial real estate losses are going to be a much bigger factor.

We’ve known that’s been coming for some time. There’s not a whole heck of a lot we can do about it.

And again, a lot of this early on, the losses were for some high-risk construction and development loans in the residential sector. We’re working through that, but again now, the more traditional commercial real estate loans are showing some distress, and that’s derivative of the economic situation. So, we will have some time working through that, and I think it will be a big driver (INAUDIBLE) next year.

GLICK: Number one concern for people out there is you insure $4.5 trillion in deposits, you have $10 billion in the deposit insurance fund. I understand you have some additional reserves for future losses.

But the question in the industry is whether or not you will either go ahead with a second assessment or you’ll tap into the treasury line.

BAIR: Right. Well, I guess, first and foremost, I want to say to all the insured depositors, they’re absolutely rock-solid no matter what happens. The media, and I understand why they do focus a lot on what our net worth, the deposit insurance fund, what the net worth is, which as you say, that $10 billion is after we’ve already reserved $32 billion for projected failures over the next 12 months.

We have a lot of cash. We have $22 billion cash on hand to cover the cost of failures, the cash outlays that are necessary, and up to $500 billion in borrowing authority. So, insured depositors are absolutely covered. Nobody’s ever lost a penny of insured deposits and never will.

The question is, really, how long we keep relying on our industry-funded reserves or at some point say we can’t keep assessing the industry. We need to start borrowing. I don’t think we’re there yet. I think by the end of the third quarter, we’ll have some more recent data, and the board will be making and deciding whether we have another special assessment, how much it will be and the timing for it.

So, I think we’d like the most recent data possible for making that decision. But we signaled in the second quarter that another special assessment was likely.

GLICK: OK, so I can assume then that no special assessment in the third quarter. You’re going to give it some time. Possibly for Q4 or Q1.

BAIR: Actually, I wouldn’t say that. I think we will meet towards the end of the third quarter to make the decision because we want the most recent data. But the board has not decided what the timing of the special assessment would be yet.

GLICK: A lot of talk about January and the possibility that things could get ugly because there’s some FASB rules that will require off-balance sheet assets to come on balance sheets. The top institutions in the country expected to be close to a trillion dollars in assets.

BAIR: That’s right.

GLICK: How do you wrestle with the fact that reserve levels are crucial, yet on the other hand, you may need to assess them further to help the deposit insurance fund, but that could ultimately hurt earnings and hurt the ability for consumers to get access to credit?

BAIR: Well, you’re right. It’s a balancing act. I would say on FASB (ph)

166 and 167, we put out some rules yesterday that got less notice because of the private equity statement of policy. But you know, we’ve known for some time these rules — and they are good rules. I think there are some issues about timing because, as you know, the industry is still under some distress.

But getting these exclusions back on the balance sheet long-term is absolutely the right thing to do. We’re asking for comment about whether in terms of the risk-based capital requirements we impose on banks, whether we should show some flexibility or some type of phasing period to help ease the additional capital that they will need to hold against these exposures as they come back on balance sheet. And we’ll be making a decision on that later in the year.

So, I think the industry’s known this was coming for some time. These assets coming on balance sheet was reflected during the Fed’s stress test, so it’s something that we’ve been preparing for.

GLICK: So, would you recommend it be postponed?

BAIR: No, well, we can’t — we don’t — FASB — the rules are in place.

GLICK: Right.

BAIR: So, we don’t control accounting standards. And actually, the leverage ratio, by statute, banks must follow GAAP accounting in setting leverage ratios. So, really, the only place where the regulators have flexibility is in the risk-based capital requirements that we have.

And yes, we are asking whether we — there should be a transition period, say, of four quarters, for the impact on risk-based capital and also the appropriate treatment in terms of securitization exposures.

We’re asking for comments on that.

But again, I think the issue really is more of timing as opposed to whether these rules are the right thing to do. They were the right thing to do. You know, frankly, if we’d had them a few years ago, I think there would have been more capital in the system, and so, it would have been nice to have it back then. And we’re doing the right thing now, but the timing is a little troublesome.

GLICK: Let’s talk about some of the decisions that the board made yesterday, particularly on private equity. There’s a perception that when you put the proposals out there and you talked about a risk-based capital level of about 15 percent — yesterday, came out with 10 — that you caved. And yet, people like Wilbur Ross, he says 7 1/2 percent is what you’re going to come back to the table with when you do your six-month review.


GLICK: You’re laughing. Tell me why.

BAIR: Well, that’s right. Well, I’ve got to tell you, no, I think these

— that the private equity firms are — we work with them. We want them bidding in the right way with a long-term commitment to support these troubled banks if they’re going to be acquiring them.

But we know they’re vocal, and we know they play aggressively. So, we started with a very high number because we knew we were going to get a lot of pushback, so we started with a high number and came out with a lower number. but I think we pretty much signaled that all along. Ten percent’s a lot less than 15 percent, but it’s tier 1 common equity that must be maintained at a strict leverage ratio. And it’s twice what, you know, is the normal requirement.

So, I think it still provides a fairly healthy cushion. We maintained strong standards on not flipping the banks, so if you’re going to buy the bank, we want you to, you know, be in there for the long term running the bank, serving the community. Affiliate (ph) restrictions remain in place, too.

We did need to strike a balance, though, and we want private equity bidding in the right kind of a way. But they do — any untested, nontraditional investor is going to pose some unknown risk for us. They don’t have a supervisory history that we can look to the way we can with an established bank. And they don’t have a balance sheet standing behind that troubled institution, that failed institution when they bought it.

They typically invest through shells, so they’ll create a shell holding company and just put whatever they need to, in this case, to make the 10 percent ratio. And then their other resources are outside the holding company.

So, these are the mechanism by which they invest, and they’re like a track record. It does present an increased risk for us.

GLICK: So, should they be required, if they can participate in this, to either, one, put funds into the deposit insurance fund if they’re in fact going to be in the business of buying failed banks. And number two, you’ve done some loan loss sharing agreements with some financial institutions, and I wonder whether or not you’re going to be willing to do that with private-equity folks if they don’t have the same skin in the game as the financial institutions?

BAIR: Well, that’s a very good point. And because loss share is available, and (INAUDIBLE) fairly generous, we do want to make sure that there’s enough skin in the game upfront, which is a key reason for the double capital standard that we’re requesting again. And we want to make sure that the assets will be prudently managed because we’ll be sharing in losses. So, and I think a lot of private-equity firms are actually very good at that, managing troubled assets, turning institutions around, that’s what they do, and do well. So, we want them in bidding, but again, we want it the right way.

And they will — yes, they’ll pay assessments once they buy (INAUDIBLE) depositor institutions, they’ll be paying assessments for those insured deposits like everyone else. But you’re right. The exposure we have on loss share over a period of years is another key factor as to why we want to make sure we have committed people coming into the process, and will manage those assets in the bank prudently.

GLICK: You’re very well-known for calling out the subprime mortgage crisis well ahead of many of your colleagues. In fact, I remember an op-ed that you wrote back for “The New York Times” back in October of 2007. And yet, it always appears as though you’re the lone ranger. Why is that? And is that a lonely role?

BAIR: Right. Well, I don’t know. I think, you know, the agency has always been fiercely independent, and I think we have a unique perspective as deposit insurer, and we pride ourselves on being the Main Street bank supervisor, you know, that the people whose deposits we protect are the average Main Street citizens that have their savings and checking accounts in our insuring institutions. So, I think it does give us kind of an on-the-ground perspective that may be a little different from others.

So, I think that’s probably historically — you look at Bill Seidman, for instance, during the S&L days. He was kind of out there as well. So, I think a lot of it is just who the FDIC is and the role we’ve played historically.

But you know, we have very good working relationships with the other regulators and the Treasury. I think that is overstated somewhat. We do have different perspective. Sometimes those are vocalized, but we come to agreement when we need to and act when we’ve needed to. So, and I…

GLICK: Where are those biggest differences right now? Because there is a perception that the white paper, the details that came out about regulatory reform, it was proposed that you and Treasury were going to have an equal sort of share in taking a look at some of these institutions, some of which are systemic risk, and that all of a sudden, when the final paper came out, you weren’t mentioned as one of the leading contenders.

What’s going on there? Is it because of Citigroup negotiations? I mean, the press has got a lot of stories.

BAIR: Right.

GLICK: Clear the press up. What are the differences between you and Geithner and the other regulators?

BAIR: Right. Well, I think, you know, I think there’s a lot of common ground, first of all. I think we all agree that we need (INAUDIBLE), that we need a resolution mechanism that will allow these even very large institutions to be closed down and for shareholders and

(INAUDIBLE) creditors to take losses as part of that process.

We need that to get back to the market discipline that really is sorely needed in the system. I think, you know, the FDIC has strongly supported this new consumer agency. That I know is a White House priority.

We are in favor of a systemic risk regulator, though we think much of that is better done through a council that would truly have responsibility for the entire system that would include both the SEC and the CFDC, as opposed to (INAUDIBLE) and that kind of very (INAUDIBLE) power into a single entity.

So, there are some — but there’s a lot of common ground, and I think we can work out our differences. And ultimately, it’s Congress that will decide. It’s not me, it’s not the administration, it’s not the Treasury Department, it’s not the Federal Reserve Board. And this is the congressional process.

I worked in the Senate for six years, so I know they like to make their own decisions. And when they call us up there to testify, they expect our independent views. And that’s what we provide. But I think the FDIC and everyone else has done this in a very constructive way that will move the costs of reform of that board (ph), and I think the administration will get most of what it wants. And some of the details may vary. That will be Congress’s call.

But I think, you know, they’ve exercised strong leadership and have been an articulate voice for reform. And we’re working with them on that.

GLICK: Chairman Sheila Bair, thank you very much. You’ve got a difficult job. We appreciate you taking the time.

BAIR: Nice to see you. Thank you.


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