Speeches & Testimony Remarks by FDIC Chairman Sheila Bair;
American Banker's Banker of the Year Awards Keynote Speech; New York, NY
December 4, 2008
Good evening everybody. And thank you for that very kind introduction.
I hardly recognized myself. And I'm very flattered to share the stage with
Ken Lewis and the other luminaries of the banking world being honored tonight.
Several years ago when they lured me out of the serene world of academia
to take this job, I was given several promises. They promised me it would
be regular hours, nine to five, Monday through Friday, no weekends. They
promised me trips to the Swiss Alps to talk about global capital standards.
And they said my only headache would be whether Wal-Mart should own a bank.
So much for promises backed by the full-faith and credibility of the United
They were right about one thing: I'd be getting a lot of phone calls from
reporters at the American Banker. All those calls and interviews resulted
in good, solid, well-balanced stories. At least that goes for most of them!
Honestly, the financial press has been great to work with. But now the
mainstream media have discovered the FDIC. They want to talk about what
we do, and they want it in five-second sound bites. So I can get lost translating
the jargon into common English. I was on a TV news show in October talking
about the need for our new temporary liquidity guarantee program. I said
the program was intended to bring down LIBOR. The interviewer, of course,
asks me: "What's LIBOR?" You should have seen the look on the poor guy's
face when I said: "about 400 basis points."
Managing the Crisis and Planning for the Future
All kidding aside, I want to take this opportunity tonight to talk about
some of the lessons of the ongoing crisis in the financial services industry,
how we got here and what the future may look like.
As you all know, it's now official: the U.S. has been in recession for
the past twelve months. While most of us suspected this was the case, the
announcement formalized for the nation the daunting challenge of how to
emerge from what could become the longest recession in post-World War history.
So, how did we get here?
Clearly the two biggest factors are the boom and bust in housing and a
dramatic loss of confidence in the financial system. It turns out that securitization – the
process that transformed the credit markets – is related to both of
these. While securitization has created market efficiencies and broadened
and deepened the credit channels, the current crisis exposes a few of its
Chief among these is misaligned incentives. Mortgage brokers, originators,
underwriters, ratings agencies and investors all got paid in ways that created
incentives for maximizing their own short-term profits, while allowing the
accumulation of huge, undetected long-term risks.
Originators and underwriters usually did not retain a financial stake in
the long-term performance of their loans. They got paid on day one, when
the loan closed or the security was issued.
Securitization drove the boom in housing. Issuance of private residential
mortgage-backed securities totaled over one trillion dollars in 2005 and
2006. But as of the third quarter of this year it had declined to virtually
zero. Investors have lost faith in many of the market practices that securitization
was built on.
Securitization will eventually come back. But fundamental reforms will
be necessary to ensure that the incentives are aligned to produce transparency,
stability and confidence by all market participants.
This loss of confidence required the government to step in to the financial
markets in unprecedented ways and to enable the banking system to be the
engine that helps drive the country toward economic recovery. During the
last six weeks, the FDIC Board has invoked the systemic risk exception three
times in order to provide assistance outside of our normal least-cost requirement.
These actions were undertaken with the goal of preserving the stability
of our system as a whole. We stand ready to take additional action if necessary
to maintain the stability of our system.
We're also raising deposit insurance premiums and rethinking our approach
to assessing premiums according to risk. These measures are not intended
to impose hardship on the industry during a difficult time. They are
intended to restore the deposit insurance fund – and the public confidence
that it generates – to its proper size and to make our system fairer
toward those banks that work hard to contribute to financial stability.
More broadly, the FDIC, the Treasury and the Federal Reserve have worked
together to put in place a number of extraordinary programs to bolster confidence
and restore stability to our financial markets.
The Treasury instituted the Capital Purchase Program through the TARP,
and the FDIC created the Temporary Liquidity Guarantee Program. Treasury's
program is designed to bolster the capital base of FDIC-insured banks and
their holding companies, and to give them the capacity to recognize losses
and support new lending. The FDIC's guarantee program is designed to stabilize
the funding structure of these institutions. This will help ensure that
banks can roll over their existing liabilities when they come due, and expand
their funding base to support the extension of new credit.
So far, this program seems to be working well. About $37 billion of debt
was issued by participating institutions as of Tuesday. The premiums we're
charging for the debt guarantee program are significantly higher than those
charged for deposit insurance. We expect to make a profit on this program,
and we'll put the proceeds into the deposit insurance fund.
The Federal Reserve has initiated a number of new lending programs over
the past year, to provide additional liquidity to the markets.
We're working hard to ensure that the benefits of these programs will work
just as well for small and mid-sized institutions as they do for the largest
Expanded Safety Net Must be Temporary
I'm a capitalist. I believe in markets. The expansion of the federal safety
net which has been so necessary in this crisis cannot be considered a permanent
fixture of our financial system. Even as we manage the crisis, we need to
plan ahead in terms of how we scale back these protections against systemic
risk. That means that banks will need to improve their own processes for
managing credit risk, market risk, operational risk, and liquidity risk.
Going forward, you will need to convince your customers, your counterparties
and your regulators that you have covered all the bases ... and that you
truly are prepared for the worst. And the sooner you prove you have things
under control ...and can keep them under control ... the sooner we can move
back to a system where your shareholders earn the rewards, but bear the
full consequences of the decisions that you are paid to make on their behalf.
Lessons for Bankers and Bank Regulators
The current crisis highlights both the important role that depository institutions
play in smooth functioning of credit markets and in the overall economic
well-being of the country. The FDIC hosted a conference a few weeks ago
at which Paul Volcker and Bill Seidman, your honoree last year, each delivered
some remarks. Both of them stressed what they saw as the central importance
of a stable bank deposit franchise in the functioning of our financial system.
A strong deposit base is a source of stability, and is the reason bankers
can take the long view when it comes to managing risks. And most of all,
core deposit funding is the anchor that holds fast in a crisis ... especially
with the ultimate backstop of federal deposit insurance.
As this financial storm has destroyed certain other segments of the financial
services industry, most banks have remained relatively strong. Your reliance
on stable deposit funding backed by deposit insurance -- as well as the
regulatory regime that entails -- has insulated most banks from the harshest
consequences of this crisis.
The Future of Banking
So, what will the banking industry look like in the coming years? If this
crisis has taught us anything, it's that both bankers and their regulators
are responsible for maintaining the public's trust. This means we must work
together to ensure that the public's trust is well placed.
First, from a regulatory perspective, I think we need to return to the
fundamentals. This crisis period has shown the need for a more systematic
approach to regulation overall, as well as a greater focus on financial
incentives. By a systematic approach, I mean that we need to plug any gaps
that allow regulatory arbitrage, which was a major factor in the blowup
in the mortgage securitization market.
The regulatory system also needs to make certain that the right people
have skin in the game and get paid not for short-term gains, but for taking
the long view. The most problematic mortgage loans were made to people who
couldn't afford them, were unable to make the payments over the long term,
and who may not have fully understood the terms of the deal. Protecting
the consumer is essential to risk management and safe-and-sound banking.
Regulation also needs to promote transparency and control complexity. As
financial instruments have become ever more complex, the analysis that supports
them has become less well-grounded in experience.
Complex instruments in many cases have become a tool for inflating leverage,
which as you know is a time-honored recipe for financial instability. That
is why we need to have meaningful constraints on leverage -- not just on
bank balance sheets, but across the financial system.
The extraordinary measures that have been undertaken by the federal government
in recent months do not come with the unconditional support of the American
public. The public will only support these programs to the extent that you
use them in good faith to serve the interests of your customers and your
Look at it from the industry's perspective. The future of banking will
depend a great deal on how bankers embrace their role in maintaining the
public's trust, and by how you respond to the current crisis. This is an
opportunity for bankers to demonstrate that the public's trust in them,
is well-placed. In many ways it means the industry must return to the fundamentals
It means accepting the obligation to make credit available to qualified
borrowers on reasonable terms. It means re-asserting the banking industry's
central role as the engine of economic growth and prosperity. It means forging
ahead to find the path to success where others have failed in the current
If this industry will embrace that role, that challenge, and that public
trust, then I believe that the future of banking will be bright indeed.