Q&A: The FDIC's Boss on Banks, Loans and Credit

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Larry Downing / Reuters

FDIC Chairwoman Sheila Bair testifies before the House Financial Services Committee about housing foreclosures on Capitol Hill in Washington, September 17, 2008.

On October 6, TIME's Massimo Calabresi and Barbara Kiviat sat down with FDIC head Sheila Bair. The following is an abridged version of that conversation.

In a way, the FDIC is the last line of reassurance for American account holders. How are you doing in the war against fear?
BAIR: We've undertaken a vigorous public education campaign about deposit insurance and our strong record of nobody ever losing a penny on their insured deposits in over 75 years. In terms of bank failures, we have dealt with a lot worse than this. During the S&L days, they were closing one bank a day for a while. As bad as things are, to some extent depository institutions have been a little bit insulated because there is a stronger system of regulation and capital standards.

What was your reaction when you saw people lining up outside IndyMac branches after you took over that bank in July?
IndyMac was a real wake-up call for us. It saddened me. People were waiting hours and hours in line, and they didn't need to. They could write checks, use their ATM cards. We have done a lot of public education since then, and we have Suze Orman who has done some PSAs for us. I think we've got people calmed down.

Can you trace your thinking on subprime loans and lending standards, starting when you were at Treasury and first looking at this issue and winding up with IndyMac, where you're now doing mass loan modifications?
I came to it as a consumer issue. In 2001 [Senator] Paul Sarbanes asked me to read this HUD/Treasury report on predatory lending. I was pretty appalled. I was convinced that there was a real problem, but we thought it was more from a micro-consumer standpoint. Something national and systemic — I don't think that ever entered any of our thoughts. We put together a group of industry people and consumer groups to develop some best practices. We had to rely on voluntary measures because the regulatory community and the Hill just weren't going to do anything. I left it when I went into academia.

When you came back in 2006 what was your reaction to what you saw going on in securitized loans?
The consumer groups were vocal about what was going on out there and some of our own staff had some concerns, so we bought a loan-performance database of mortgage-backed securities. We saw some pretty astonishing things. The starter rates were very high, between 7% and 9%, and within a couple of years they could jump by 600 basis points. No one could handle that level of payment shock. In fact nobody was — they were just refinancing.

You gave a speech in October 2007 at a mortgage securities conference and starting talking about these issues publicly. Why did you stand up and do that?
I thought they were going to throw tomatoes at me. We had done some industry roundtables in the spring of 2007 to talk about sub-prime and nontraditional mortgages. Everyone gave us all this happy talk that they were going to modify these loans, and I'm sure they meant it as the time. They said it was in everyone's economic interest to restructure the loans instead of foreclose because the losses on foreclosures of these loans are so steep. Then Moody's came out with a report that said less than 1% of these resetting mortgages were being modified. At that point I thought it was important to start asking questions, because I didn't know what else to do. We didn't have jurisdiction. And now we're seeing the external cost of these foreclosures. The foreclosure crisis is still at the heart of our economic problems.

Could you translate that into your concern for the banks that you insure?
We have to get the housing market stabilized, and these loan modifications do need to be done systematically. It's difficult, I'm not going to say it's not difficult. We're seeing this at IndyMac. For a lot of these nontraditional mortgages, income was never verified so as part of the modification process you have to go back and verify income to know how to give them what their affordable payment will be. But it needs to be done. The FDIC did massive loan work-outs during the S&L days. Those were commercial loans, not mortgages, but in a down market when the value of the collateral is falling it makes more economic sense to modify the loan than to try to sell it.

After IndyMac failed, you said you didn't think institutions of any significant size were going to fail. To what extent were you wrong and to what extent was that being in a position where you have to smile?
I was trying to provide some assurance in making that statement, and at that time things had not gotten as bad as they are now. I do think people need to understand that we are there and their insured deposits are protected and come what may they don't need to worry about that. Overall, banks are safe and sound. Some consolidation activity always happens in a credit cycle like this. The stronger institutions take over the weaker institutions. We've already used [the FDIC's ability to act in the face of systemic risk] so people know we will do so again if we have to.

How do you moderate sounding the alarm like you did in that speech and telling people that their money is safe?
Right now we are getting into a confidence situation where even relatively healthy institutions are subject to liquidity stress just because nobody trusts anybody. I think the best way to tackle this is to tell people to have confidence in the system. We're asking Main Street depositors to have confidence in the banking system, and banks should have confidence in each other, too. Look at the numbers. Most banks still have strong capital and loan loss reserves. They have the capability to withstand this if we all keep our heads and maintain confidence in each other. That's the best way to approach it.

Could you give the average American an idea of what to expect going forward?
More banks will fail, but if people are insured they just don't have anything to worry about. It's still a low probability that their bank is going to fail, and even if their bank does fail their insured deposits are absolutely protected. We really need credit to keep our economy going and deposits are an important part of keeping credit going. We are asking Main Street to keep faith in the banking system and keep their deposits in banks.