Sheila Bair Sees the Seeds of Another Financial CrisisThe Honorable Sheila C. Bair
(Barron’s) – Sheila Bair has demonstrated that she’s not afraid to be the lone person flagging potential problems. The former head of the Federal Deposit Insurance Corp. is best known for her early warnings about the subprime mortgage market, and she’s still spotting problems in the financial system.
Bair has spent much of her career in Washington, D.C., beginning as a staff member for Sen. Robert Dole, and has long been comfortable going against the consensus. In 1992, as a commissioner on the Commodity Futures Trading Commission, Bair was the sole dissenting vote against loosening rules for energy trading companies, arguing that it set a “dangerous precedent.” Less than a decade later, Enron’s collapse proved her right. During the financial crisis, Bair, appointed to lead the FDIC by President George W. Bush in 2006, clashed with other officials, as she pushed for loan modifications and argued against bailing out the big banks.
After leaving the FDIC in 2011, Bair spent two years as president of Washington College, a small liberal-arts school in Maryland, where she focused on another growing problem—student debt. Bair also has served as an advisor to many institutions, including the China Bank Regulatory Commission and the Pew Charitable Trust, where she heads the Systemic Risk Council, a nonpartisan group that aims to improve financial stability. She also serves on several corporate boards, including the state-owned Industrial and Commercial Bank of China, and Paxos, a blockchain start-up that operates a bitcoin exchange.
It’s a portfolio that gives her a good vantage point on the market’s most pressing issues. We spoke with Bair to hear her views on China’s large debt, trouble spots she sees in the U.S. financial system and economy, and what regulators should do about bitcoin.
Barron’s: Investors have worried about whether China’s high debt is a risk to the global economy and financial stability. Is that a reasonable concern?
Bair: We look at their debt and wag our fingers and tsk, tsk. It is high. But they realize it is a threat to financial stability and are dealing with it. Last month, regulators took over privately held Anbang Insurance to keep it from collapsing. [Anbang is a conglomerate that had expanded aggressively overseas, acquiring hotels including the Waldorf Astoria in New York.] It is a sign they are continuing to crack down on reckless growth and excessive leverage.
What else is China doing to stabilize its financial system?
They need to reduce debt, increase transparency, and make sure banks stay on top of credit risk. The banks are very aware of credit quality and nonperforming loans. The words you hear are “prudence” and “sustainable growth,” and there is huge emphasis on risk management right now from bank leadership and regulators. They are also cracking down on wealth management products. That means more loans on bank balance sheets, because these products had previously been off balance sheets. But that’s a good thing because at least it’s transparent.
What questions do the Chinese most frequently ask you?
They are very focused on how Western investors look at them. There is confusion and trepidation about what the U.S. attitude is toward them, but they still want Western investor acceptance. That can work in favor of more transparency and market-driven decisions.
China just proposed abolishing its two-term limit for presidents, paving the way for Xi Jinping to stay in power indefinitely. What risk does that pose to investor acceptance?
It’s too soon to tell. More important will be how he uses his power, particularly in continuing to open markets and improve transparency. I’m struck by the difference in the tone of the political leadership—with Xi talking about deleveraging, constraining asset bubbles, and accepting short-term trade-offs to growth for long-term sustainability. Contrast that to the U.S., where we have a move toward deregulation and borrowing more. It saddens me that we are falling prey to short-termism.
What part of the deregulation push in the U.S. concerns you?
Many postcrisis financial reforms are still being finalized. Though the current administration was elected on an anti-big-bank kind of campaign, it has become very bank-friendly. I don’t have a problem with some deregulation, but I can’t believe we are moving to weaken capital rules for banks.
You are referring to a technical change in one provision of a bipartisan bill expected to hit the Senate floor this month.
Yes. It has a lot of good provisions, such as easing unnecessary supervisory infrastructure on regional and community banks that were caught up in the wider net after the crisis. The focus of postcrisis reforms should have been on the large, complex financial institutions that drove the problem. So that is all fine. But, of course, big banks are trying to ease the capital requirements [set after the financial crisis]. I’m hearing through the grapevine that the Office of the Comptroller of the Currency and the Federal Reserve are also moving on rules to loosen capital requirements.
Why is that problematic at this stage of the economic and credit cycle?
In these benign times, when banks have been profitable for many years and they just got a big tax cut, you want banks to keep building buffers. To loosen capital now is just crazy. When we get to a downturn, banks won’t have the cushion to absorb the losses. Without a cushion, we will have 2008 and 2009 again.
The idea we need to loosen up on banks so they can lend more to fuel growth—after a decade of highly accommodative monetary policy, a huge deficit-funded tax cut, and deregulation—is very shortsighted. And it’s not supported by data: Loan growth has exceeded gross-domestic-product growth. There is plenty of debt in the economy. The memories—and lessons—of what drove the crisis are completely being ignored. One outcome of bailing out the big banks was they emerged with a lot of political power.
What does that mean for the health of the financial system 10 years postcrisis?
There was not a lot of accountability imposed after the crisis. That was a mistake. I worry we still have the same system. Yes, it’s safer in that banks have more capital—so far—and more supervision, and the stress tests are helpful. But we didn’t fundamentally change the system.
Where, then, do you see potential problems that could trigger the next crisis?
I’d keep an eye on credit-card debt. Subprime auto has been a problem for a couple years, and valuations on loans used to finance leveraged buyouts are high. Any type of secured lending backed by an asset that is overvalued should be a concern. That is what happened with housing. Corporate debt also has not gotten as much attention as it should. It is market-funded, rather than bank-funded, but the banks still have exposure. Then there’s cyber-risk. It took us so long to get around to the reforms postcrisis that we got a little behind on systemic cyber-risk, but regulators are very focused on it now.
That’s a lot to worry about. What does it mean for the economy?
With tax reform combined with deregulation, and the economy finally picking up steam, the economy could generate pretty good growth over the next year or two. But after that, if we keep throwing gas on flames with deficit spending, I worry about how severe the next downturn is going to be—and whether we will have any bullets left. Hopefully, in a couple of years, the Fed will have gotten interest rates up to the point it can ease on a short-term basis.
But on the fiscal side, there is very little breathing room. I worry about when the safe-haven status of Treasuries is questioned. As the Fed raises rates while we are deficit-spending, it will have a negative impact on stocks. These are things I’d like to get ahead of. I don’t think Congress has a clue that the reason they have been able to get away with this profligacy is because we are the best-looking horse in the glue factory. But we are in the glue factory. Our fiscal situation is not a good one.
You have also raised concerns about the $1.3 trillion outstanding student debt. Could that trigger a financial crisis?
That debt is all on the government’s balance sheet, so no, not a market crisis. But there are parallels to 2008: There are massive amounts of unaffordable loans being made to people who can’t pay them, and the easy availability of those loans is leading to asset inflation. In 2008, that was reflected in housing prices. Today, that’s tuition. It’s too easy to raise tuition because kids will borrow to pay for it. If the loan defaults, the primary beneficiaries—educational institutions—have no skin in the game, like in the mortgage crisis.
What is a possible solution?
Income-share agreements allow students to repay a loan based on a percentage of their income over a long period. It’s impossible for an undergrad to know what their earnings and repayment capacity will be when they graduate, yet student debt is fixed. We need high school math teachers just like we need hedge fund managers, but we have a one-size payment system, whether you are making $36,000 or $360,000.
Does anyone use such agreements?
Some, like Purdue University, are experimenting with it. It has to be structured so colleges fund $1 and the government funds $1, and they share the students’ payment. That way the college’s return on investment depends on whether a student graduates and gets a job, aligning institutional incentives with student success. Private investors are leading a lot of this, but that makes me uncomfortable.
Private investors look for big risk premiums. I fear they favor STEM [science, technology, engineering, and mathematics] majors who will have high paychecks. We need a program to support a wide array of disciplines. We need to get philanthropies, the government, and endowments into the mix. Instead of owning master limited partnerships, university endowments should be putting some money into their kids.
How does student debt affect inequality and the economy?
Student-loan stories always feature someone who borrowed $90,000 to go to grad school or med school. But those people generally get jobs and have earnings potential, and debt-forgiveness programs disproportionately help them. The distress and high default rates are among the kids borrowing $10,000 to go to a for-profit school and dropping out; $10,000 may not sound like a lot to you and me, but for a first-generation student or someone without a college degree, that’s a lot of money. Student debt also suppresses small-business formation. Kids who would have started a business in their parents’ garage can’t do that now because they owe $50,000. Beyond that, it’s just a terrible financial burden for our kids that didn’t exist 20 years ago.
We also didn’t have bitcoin 20 years ago. Some central bankers are concerned about the mania around cryptocurrencies. What is your view?
Don’t put any money into bitcoin that you can’t afford to lose. But I don’t think we should ban it—the green bills in your pocket don’t have an intrinsic value, either. The value is based on what others think is its value. That’s true of any currency. Regulation should be focused on good disclosure, education, warding off fraud, and making sure it is not used for illicit activities. Let the market figure out what it’s worth. That is what it is doing now.