January 28, 2011 – In a speech before the Native Sons and Daughters of Kansas, FDIC Chief Sheila Bair discussed a wide range of topics including her role as a public servant, causes of the housing bust and suggestions on how to prevent another financial crisis.
Ms. Bair noted that she has spent most of her life in public service to make a difference and to help people. “Throughout my career, I like to think that I have helped people in their daily lives. That is one of the reasons why I have found my tenure at the FDIC so rewarding, notwithstanding the severe pressure, long hours, and high stakes”. The FDIC was able to prevent depression style runs on the bank and massive banking failures by providing confidence to depositors that their money was safe, according to Ms. Bair.
As much as she enjoys her work, Ms. Bair noted that it is not an easy time to be in government service due to inflamed rhetoric and a “pot-stirring media” that has inflamed anti-government sentiment.
As an example of how difficult things have become, Ms. Bair made the disconcerting disclosure that most individuals serving in high profile positions have “received hostile communications, if not direct or implied threats of physical harm. At the FDIC we have received our share of threats from people who have lost money in failed banks. Just recently, a disgruntled trader whose registration was revoked put out a $100,000 bounty on the lives of the heads of the SEC and CFTC”.
In this writer’s opinion, Ms. Bair has done a commendable job containing the banking crisis during the biggest financial crisis this country has ever faced. Ms. Bair has probably provided the most honest assessment of any public official on the root causes of the financial crisis as well as what steps must be taken to avoid further financial meltdowns. In any event, threats against public figures do not contribute to a solution and should not be tolerated.
Ms. Bair acknowledges that regulators were not “sufficiently vigilant” in supervising financial markets and also cites government policies that fueled an unsustainable housing boom which lead to trillions of dollars in losses. Government policies must be changed to discourage reckless behavior by large financial institutions that feel immune from the risk of failure under the “too big to fail” doctrine.
Perverse government economic incentives and favorable regulatory treatment also lead to the excesses in the securitization of mortgages, according to Ms. Bair. By selling off mortgages to investors with little risk of recourse, lenders lost the incentive to properly underwrite loans. Millions of unaffordable mortgages given to unqualified borrowers resulted in huge losses that put the entire financial system at risk.
Ms. Bair also blames “government-encouraged risk taking” which lead to excessive financial leverage by many of the country’s largest financial institutions. Excessive levels of debt were not backed by adequate capital to absorb losses. If government policies are not changed, Ms. Bair feels that they will again encourage risky, short-sighted behavior which caused the financial crisis.
Ms. Bair candidly admits that regulation is doomed to fail unless the government eliminates policies that lead to excessive risk taking and rewards policies which contribute to the nation’s long term economic prosperity. “There will always be greedy people and imperfect regulators. We must tolerate and accept their weaknesses. And we can write thousands of pages of government regulations to help compensate. But if government is providing the wrong economic incentives in the first place, regulation is doomed to fail.”
In hindsight, we can see why the financial crisis occurred. Going forward, Ms. Bair provides the framework for establishing a sound financial system. The biggest issue not addressed by Ms. Bair, however, involves the huge financial power, political muscle and lobbying dollars of the banking industry which will strive to weaken most of the regulatory reform she favors. It would not be a surprise if the banking industry gets its way with Congress and regulators.