FDIC chairman Sheila Bair covers lessons from economic crisis

Speaking to an audience that nearly filled McCosh 50 on Monday afternoon, Federal Deposit Insurance Corporation chairman Sheila Bair reflected on the tensest moments of the financial crisis that began in 2008 and argued in support of recently announced regulations on the financial sector.

As the head of the FDIC, which is responsible for investigating and managing failing financial institutions, Bair, who warned about the danger of risky subprime loans in 2007, rose to prominence during the 2008 financial crisis.

Economics professor Alan Blinder ’67 introduced Bair, describing her as a member of the “smallest minority in the world ... people who came through the financial crisis with their reputations not just intact but enhanced by the events.”

After Bair spoke, Blinder interviewed her for about 20 minutes. The floor was then opened to questions from audience members.

Bair said the 2008 crisis was caused by “very poorly underwritten mortgages” encouraged by “the skewed incentives that arise with the securitization market.”

Bair attributed current problems with failing mortgages to skewed incentives as well, explaining that those collecting payments on securitized mortgages face no risk in the event of foreclosure because they lack incentive to allow homeowners to restructure. Bair said the current weak housing market and the slow-moving foreclosure process pose a serious risk to the economy.

“This economy is not going to get back on a healthy track unless the housing market is fixed, and our housing market is not fixed yet,” Bair said.

Bair said the 2008 crisis was exacerbated by insufficient regulations. “For non-bank financial institutions ... there was no process” akin to the receivership process the FDIC is empowered to conduct for banks, Bair said, meaning that the only options for failing institutions like Lehman Brothers or Bear Stearns were bailouts or destabilizing bankruptcies.

The Dodd-Frank Wall Street Reform and Consumer Protection Act, passed in the wake of the crisis, allows the FDIC to “wind down” failing institutions and forces institutions to create “living wills” showing how institutions can be wound down should they begin to fail.

Bair said the FDIC is creating regulations backed by the new law’s authority — some of which were released for public comment Monday — intended to lead institutions to “be responsible and avoid problems we had in the past.”

As a result of the Dodd-Frank reform and new regulations, “the cost of credit will go up from what it was before the crisis. But it should,” Bair said, adding that she felt credit was too easy to obtain before the crisis.

The new regulations come with increased oversight for financial institutions deemed large enough for their failure to have “systemic” consequences. Bair said the increased regulatory scrutiny directed at “systemic” institutions will make the economic status “not a good thing at all.”

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“For some of the current ones, it will create market demand that they be downsized,” she said.

Bair said the effort to prevent a further crisis is continuing. “There is skepticism out there” that the government will allow institutions to fail, Bair said. She added that credit rating agencies still rate large financial institutions favorably on the assumption that the federal government will provide funding if needed.

“There is some amnesia setting in in Washington,” Bair explained, noting her dissatisfaction that the same individuals who faulted regulators for being “asleep at the switch” in 2008 now complain that the new regulations are too strict. Bair said that, though she is a Republican, she believes in “free markets, not free-for-all markets.”

Bair also warned that financial reform faces political threats. In response to a question from the audience about “regulatory capture,” Bair pointed out that, before the crisis, “financial services money was pretty pervasive” in fields ranging from politics to research and the media. Bair said members of the public should “look at the debate that’s going on here” on the Dodd-Frank law, which has been the target of repeal efforts.

Audience members said the lecture clarified their understanding of the FDIC’s role and made them more confident in its ability to manage financial crises.

“It definitely clarified, particularly, what the FDIC [does] and what [its] role is,” Rochelle Guttmann GS said, adding that she had not previously been aware of the organization’s importance in combating the financial crisis.

“It seems like things are under control now,” Bernette Berman of Princeton Junction said after the lecture.

The lecture was sponsored by the Walter E. Edge Lecture Fund.