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Why Sheila Bair wants to bail out consumers

The FDIC chief is the consistent voice of reason in her focus on homeowners as the key to saving the economy

By Betsy Morris, senior editor
Last Updated: December 12, 2008: 2:56 PM ET

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Sheila Bair, head of the Federal Deposit Insurance Corp.

NEW YORK (Fortune) -- Sheila Bair may now be a lightning rod, but at least she's finally getting some respect.

For months, her agenda was a non-starter. Her proposals to try to turn distressed mortgages into performing loans through a loan modification program were getting absolutely no traction with either Federal Reserve chairman Ben Bernanke or Treasury Secretary Hank Paulson.

When the three of them testified before Congress last month, Bair, the chairman of the Federal Deposit Insurance Corp., got practically zero air time (one banker complained that every time it was her turn to talk, the TV cameras cut to a commercial).

Bloggers dumped all over her, saying she was irrational, self-serving, arrogant and gave the private sector "a bad case of shingles." Just last week, Bloomberg News reported that Tim Geithner, Obama's pick to head Treasury, was trying to get rid of her.

Now though, she's Page One news and her ideas have to be reckoned with.

Congress has introduced proposed legislation to launch a loan-modification program, similar to her proposal, to be paid for with money from Hank Paulson's Troubled Asset Relief Program (TARP).

This wasn't the only recent show of support for Bair. In a speech last week to a Fed conference on housing and mortgage markets, Bernanke vindicated her position when he called for more aggressive action to stop foreclosures. One of his recommendations: the very loan-refinancing program instituted by Bair at IndyMac, the failed California bank, in which government will share some risk if a lender refinances to reduce monthly payments and keep the loan performing.

Talkback: What should happen to fix the housing crisis?

Bair's staff, meanwhile, signed a petition on petitionsite.com singing her praises and asking Obama "that you please retain her as our leader." TV stock picker Jim Cramer joined in the chorus, saying: "Don't kick out Sheila Bair! She knows the numbers." If she's not a team player, blogged Cramer: "Thank Heavens!"

Sounding a wake-up call

Her plan at IndyMac may be slow and imperfect, helping only 5,300 of more than 60,000 delinquent borrowers at IndyMac so far. But amid a lot of ambiguity and tortured explanations for all of Washington's various bailout efforts, she has been consistent and logical (not to mention courageous). She says the things nobody else wants to say, or explains matters that others would like to leave, well, ambiguous. Among her inconvenient truths:

1) You can't scapegoat the Community Reinvestment Act for this mess. That law, first passed in 1977, requires lenders to make loans in low-income neighborhoods if they want to do business there. But as she explained to the Consumer Federation of America last week, the CRA was a factor in only about one-fourth of the shaky, high-priced home loans made in the subprime go-go years of 2004-06.

2) Beware a political backlash if hedge funds and other investors try to stand in the way of mortgage modification efforts as if business were usual.

Business isn't usual. Already 1.6 million mortgages are more than 60 days delinquent and the FDIC expects an additional 3.8 million of those next year. Home prices have fallen nationally by an average of 21% since peaking in the first quarter of 2006, according to the S&P/Case Schiller Home Price Index.

"Investors will have to take some losses here," she said at a Fortune 500 Forum in Washington last week. "The system broke down in a lot of different places. A lot of these very sophisticated hedge funds and investors didn't look at the mortgages underlying these securitizations. If they had, they would have seen the high LTVs (loan to value ratios), the lack of documentation, the steep payment resets. To now say, 'Oh gee, we didn't know' ...I think that's a bit problematic. There is plenty of blame to go around and plenty of losses to go around and everybody is going to have to take a little."

3) Bankers and regulators must win back what Bair constantly refers to as "the public's trust." When so much of the bailout activity has been driven by politics, ideology or myopic vision (in other words, what's good for Wall Street must be good for the rest of us), Bair has kept her eye on the ball.

She's a pragmatist, aiming to prevent a deflationary spiral in housing prices that, along with accelerating job losses, will further devastate consumers, who are just as critical to a healthy economy as strong banks. Ironically, she's a Republican who has taken on the role of populist to restore confidence in the system. "I'm a capitalist. I believe in markets," she told an American Banker awards gathering last week.

But as FDIC chair, she knows only too well that public trust and consumer confidence are the economy's life support. She's a lot less worried about whether some undeserving types take advantage of her mortgage refinancing programs than about saving the economy and protecting the FDIC. Because if the FDIC looks shaky, then all bets are off.

From the beginning of the crisis, she has been more focused on consumers than have Paulson, Bernanke or Geithner, which is important considering that consumer spending has been the major growth engine of the economy. Foreclosures depress home prices, sometimes beyond any reasonable level, aggravating consumer distress even further.

"We're going into this self-reinforcing cycle," she told the Fortune conference last week. "We really need to do a lot more."

A Cassandra silenced

Her plan may be a torturous way to address the problem. Investors are filing lawsuits. Redefault rates can be high, though Bair believes that can be controlled by refinancing in such a way as to make the loan truly sustainable.

But at least by speaking out loudly and courageously, Bair has thrust the corrosive issue of foreclosure to center stage. From an economic standpoint, just a 3% reduction in defaults will preserve $500 billion in homeowner equity, she says, and result in $40 billion to $50 billion in the consumer spending that's so critical right now.

Not only would that help the economy, it would lessen the drag on the banking system and relieve the stress on the FDIC.

And Bair is a mother bear about the FDIC. That has got her into hot water with the other regulators, who are more focused on stabilizing institutions like Citigroup (C, Fortune 500) and AIG (AIG, Fortune 500). They didn't like it when she reversed her position on a Citi-Wachovia merger in late September when Wells Fargo (WFC, Fortune 500) came in with a deal that alleviated the need for government help.

When Citi required a capital infusion last month, she stood firm about limiting the FDIC's exposure, according to a person knowledgeable with the negotiations, and attached some conditions, for example requiring Citi to modify troubled mortgages along the lines of IndyMac's program.

Her vigilance is less about ego than it is about protecting the FDIC and all that it stands for. Created by Congress in 1933 to restore public confidence in the nation's banking system, the agency is funded not by the government but by fees from the bank whose deposits it insures. So it's not a bottomless pit.

As its list of problem banks swelled to 171 by the end of third quarter, up from 90 in the first quarter, its deposit-insurance fund fell to $34.6 billion, down from $52.8 billion. The agency has lines of credit with Treasury that it can tap if it ever came to that. But that wouldn't exactly induce more confidence. No wonder Bair doesn't want to be a spendthrift.

So Bair may look like a troublemaker when she stands up to the boys at Fed and Treasury. But that's because she's got different opinions and a willingness to stand behind them. If that gives some people a bad case of shingles, maybe the conflict is worth it.

Look what happened when Brooksley Born, former head of the Commodities Futures Trading Commission, tried to raise alarm bells about unregulated derivatives a decade ago. She was run out of town and we are all very much worse off for it. To top of page

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