'Your World': FDIC Chair on Banks Failing Stress Tests

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.


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.


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?


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...



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.


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.


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


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.


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.


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.

And it really is in the regulators’ ballpark now to implement it. We have set up with a special Web site with our summaries of the bill and Q’s and A’s and a list of rules we’re going to need to implement...


CAVUTO: But in that summary is that we have given up too big to fail.

BAIR: We have.

CAVUTO: If another institution is in a real arrears, we’re not going to rescue it. I don’t believe that.


BAIR: Well, we will not.


CAVUTO: We would let a Citigroup fold? We would let a Bank of America fold?

BAIR: Well, I don’t talk about specific institutions.


CAVUTO: But a big, big institution, we would let it go under?

BAIR: Yes, it is process that can work for very large institutions, absolutely. You set up — it’s a good bank/bad bank model.


BAIR: You set up a bridge institution. There is the ability to provide working capital from the government to keep the franchise operational, to maintain the value as it is broken up and sold off.

But the equity and the unsecured debt is left in the receivership, along with some of the bad assets, again to improve the value of the good bank as it’s sold. And the losses are absorbed by the shareholders and the unsecured creditors.

CAVUTO: You hope. Knock on wood.

BAIR: Well, but the secured creditors are only protected to the extent of their collateral.


CAVUTO: But now you have growing concerns about whether consumers will in the end be protected. I know your name has come up to head this consumer protection agency. Elizabeth Warren’s name comes up.

Would you be interested in that job if it were open?




We have worked so hard for resolution authority and ending too big to fail. And I had to be party to a lot of...


CAVUTO: So, you wouldn’t want it? A big old consumer agency, you wouldn’t want to head it?

BAIR: No, I would not. I think it is an exciting opportunity for the right person. And whoever gets the job, I wish them well.


CAVUTO: Well, they better have strong elbow pads, right?

BAIR: It’s going to be a very challenging job.

CAVUTO: Right. Who is running the show, right? The consumer agency would protect consumers. But it might invade the turf of the Securities and Exchange Commission, which protects stockholders, which might reign on the futures commission, which protects those who trade in futures and that sort of thing.

BAIR: Right.

CAVUTO: I feel a lot of chiefs and not responding Indians.

BAIR: Well, it is focused on credit products, so primary bank products or non-bank credit products.

CAVUTO: You could see where they overlap, right?

BAIR: Right. There is. There are certainly consumer protection issues in the securities, as well as insurance. And securities and insurance are not included with the consumer bureau.

But I think there may be some overlap. But the lines of distinctions are reasonably clear. And like with everything, regulators will have to work together and work collaboratively to make it successful.

But it will be a very challenging job. I think you’re going to be drawing staff from a lot of different banking industries, setting up an infrastructure for non-bank supervision, which we have not had before at the federal level, in addition to writing a lot of new consumer rules. So, I think, in the short run, it will be very challenging.


CAVUTO: To your credit — to your credit, Ms. Bair, you have ticked off Republicans and Democrats.


BAIR: Yes.



CAVUTO: The last president you worked for, President Bush, and I guess sometimes this president, President Obama.

So, my hat’s off to you for being fair-and-balanced annoying to both.



CAVUTO: But I say that with just this curious question. Who got us into the mess? Who do you think is to blame, if there is a central character? I hear out of the White House it was Bush policies and all that that got us into this mess and this sort of laissez-faire attitude that got us into this. Do you buy that?

BAIR: No, this was building for many years. And it was bipartisan.

I mean, I think a lot of the mistakes, you can trace back to the Bush or the Clinton administration. Certainly, the derivatives deregulation occurred with the Clinton administration. And I think the Basel II capital standards, which allowed a lot of the problems, that got its genesis during the Clinton administration, though that was done independently by independent regulators. So, I should say that as well.

CAVUTO: So, lots to blame?

BAIR: So, that’s right. So, I think, if you start — there is so much blame to go around on all of us, with regulators, with industry, and with borrowers, too, who became overleveraged.


BAIR: So, we have tried to just look forward and avoid trying to assign blame.


CAVUTO: Do you think we will ever have what we had in the fall of 2008 again?

BAIR: I hope not. I think resolution authority is an important piece of this.


CAVUTO: You know what happens? We always get another crisis, just different causes.

BAIR: We do. Well, and that’s why you need resolution authority. There will always be cycles, but hopefully nothing as severe what we just lived through.

And so I think we do — you know, you need some basic, commonsense rules of the road. There’s a difference between free markets and free-for-all markets. We ended up with free-for-all markets. So, you need some commonsense standards. Don’t go too far. Don’t be overly prescriptive.

You need market innovation as well, but there needs to be some basic, commonsense rules. And I think, hopefully, the pendulum has swung back and we will hit that equilibrium and have a more sustainable financial system going into the future.

CAVUTO: All right, thank you for that, Sheila Bair, the chairwoman of the FDIC.

Talk about someone who has had a lot on her plate for the last couple of years.

BAIR: Yes, a while, yes.


CAVUTO: Quite a while.

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