• With: Sheila Bair, FDIC chair

    This is a rush transcript from "Your World With Neil Cavuto," July 23, 2010. This copy may not be in its final form and may be updated.

    NEIL CAVUTO, ANCHOR: Have you ever had a stress test? It’s meant to test your ticker, sometimes under very tough circumstances.

    Now, if your ticker looks good, you look good. If your heart doesn’t look good, well, you might just be a bank. European regulators just putting their finishing touches on a stress test for banks over there.

    Here’s the good news — 84 out of 91 banks passed with flying colors. Here’s the bad news. Seven did not. And some of those seven are pretty big lenders to a lot of risky borrowers.

    The fear is, if they can’t survive a practice test meant to simulate bad environments, what would happen if the real McCoy hit them?

    We have got Sheila Bair here. She’s the FDIC chairman. She’s one of the top banking industry watchdogs on the planet.

    Sheila, what did you make of this test? It’s them. It’s not us. It’s meant to be just a test.

    SHEILA BAIR, CHAIR, FEDERAL DEPOSIT INSURANCE CORPORATION: Right.

    Well, I think I don’t want to comment. I think the market will judge. And the whole point of the exercise was to increase transparency and therefore market confidence in the situation there. So, I think the market will react. And I don’t want to say anything one way or the other that might influence them.

    I think, in terms of the keys to success, I think the stress tests that were done here were credibility, reasonable stressed scenarios.

    (CROSSTALK)

    CAVUTO: They do these sort of not worst-case, but pretty bad-case scenarios.

    BAIR: Right. Right.

    CAVUTO: Protracted recession, a lot of jobs being lost, and they sort of filter this through the system and how the banks hold up, right?

    (CROSSTALK)

    BAIR: That’s right. That’s exactly right. That’s the whole idea, to try to be more proactive and forward-looking in the capital assessment for banks, not as a static point in time now whether they have adequate capital, but in a very stressed economic scenario, will they have enough capital to absorb unexpected losses from the worst economic outcomes?

    So, this is what we did in the U.S. And we did it with some success. I think a key was transparency and a full disclosure of the substance we used for the stress test, and that Federal Reserve Board led this effort and did a great job.

    CAVUTO: So, how did we do vs. how does Europe...

    (CROSSTALK)

    (LAUGHTER)

    BAIR: Well, I think we did very well, in the sense that it did get a very positive market reaction. So, the banks that did have capital needs were able to recapitalize. And the much maligned TARP actually helped in this process, because it provided a government backstop to assure the market that these banks would not fail.

    (CROSSTALK)

    CAVUTO: Do you believe that, if everything hit the fan again, that we would have a lot more banks in a lot better shape than we did then?

    BAIR: Yes, I do. There’s been a lot of — yes, the capital cushions are higher now. A lot of the problem assets, they are still plenty there, but a lot of them have been worked through. So, yes, the banking system is in a much better shape, a much more stable shape than it was then, yes.

    CAVUTO: Because you always get these jaded economists who come on, not — a lot of economists are jaded, but they come on, Chairman, and they say, you know, we’re not out of the woods. These guys are still shaky. They’re hoarding their cash, and they’re not lending. And, of course, their books are going to look better because they’re in a low-interest-rate environment and they couldn’t have a better circumstance right now.

    BAIR: Well, they do have plenty of cash. They have built up a lot of liquidity. That is good, to a certain extent, because you want to make sure we get — the liquidity was also an issue.

    (CROSSTALK)

    CAVUTO: Right. But are they being too tight? They went from being reckless with the lending...

    (CROSSTALK)

    BAIR: And I think the truth lies somewhere in the middle.

    I think perhaps some could do a better job lending. Maybe some are being too risk-averse. But there is a decline in borrower demand as well. And, so, I think, that there is a mix of credit contraction, but also borrower demand.

    And everybody is uncertain about the economy. And that leads to caution.

    (CROSSTALK)

    CAVUTO: But are they more uncertain about that than — forget about regulation, but we have just had this whole financial reform. And I know you were a key player there. But a lot of the critics are looking at it and saying, in that environment, who would want to spend? Who would lend? Taxes going up, regulation going up. So, these guys are just closing ranks.

    BAIR: Well, I think the financial services reform bill is not a factor here, I must say. I think this has been issue for some time now.

    CAVUTO: But it was health care before that. It was...

    BAIR: Right.

    CAVUTO: They have this view of Washington meddlers.

    (CROSSTALK)

    BAIR: Well, I do think — I think there is a significant issue of being transparent and open and clear about how financial services reform is going to be implemented.