INTERVIEW: Fed, Banks Unready For Next Crisis: Ex-FDIC's Bair

By Pedro Nicolaci da Costa

     WASHINGTON(MNI) - The Federal Reserve and major banks are not well prepared

to handle another financial crisis as worries about the spreading economic risks

from coronavirus depress asset prices around the world, ex-FDIC Chair Sheila

Bair told MNI.

     "I don't have a lot of confidence," Bair, who played a leading role in

stewarding the financial system through the 2008 crisis and its aftermath as

head of the Federal Deposit Insurance Corporation, told MNI in an interview.

     "Let's face it, reform was pretty incremental. We still have the system we

had."

     At the same time, "market valuations are so high--this is the most hated

market. Everybody knows it's driven by a lot of unsustainable factors" including

the Fed's ultra-low interest rates, she said.

     "People say you can't spot a bubble. That's not really true. You can see a

bubble, you just don't know when it's going to pop," said Bair, who is still a

member of the industry-led Systemic Risk Council.

     Asked about assets other than record-breaking stocks, Bair said: "I worry

more about corporate debt."

     --UNRELIABLE RISK MEASURES

     Bank regulators including the Fed "rely on risk ratios that are not

reliable" as an overall picture of a banks' financial health. In addition,

"they've been letting the banks release capital after the stress tests. That's

insanity."

     Bair was critical of the recent path of Fed monetary policy, which she

argued had become unduly erratic and unpredictable.

     While she has generally argued interest rates have played too heavy a role

in economic policy, Bair also thinks the Fed tightened policy too far too fast

in 2018.

     That's because the central bank was used to moving in quarter-point

increments that worked well when rates were at, say 4% or 5%, but turned out to

be a lot larger in proportion once rates got much lower.

     "They were raising rates too fast," she said, noting that the four rate

hikes in 2019 represented a doubling of the benchmark federal funds rate.

     Bair says the Fed's pivot from a projection of additional hikes in 2019 to

the reality of three cuts over the course of the year didn't do very much for

the economy but "goosed the stock market and reduced their flexibility."

     It also came at the cost of an additional loss of Fed credibility, Bair

added.

     "This whole data-based notion ... they're winging it, there's no other

explanation."

     The Fed is facing a similar risk in 2020 as it all but promised to keep

rates steady at the start of the year, only to be faced with growing market

expectations for rate cuts as the coronavirus epidemic hit.

     A similar phenomenon was behind the disruptions in the repo market that

began in September, Bair said. The Fed underestimated the effect that draining

reserves from the banking system would have at a time when the administration of

President Donald Trump was relying heavily on deficit spending.

     "They were taking out cash at the same time that the Treasury was ramping

up issuance and the system became cash strapped," Bair said.

     She praised the Fed for its intervention in the bill market, which she said

was needed to restore liquidity.

     But she cautioned against the idea that the Fed should get more deeply

involved in the repo market, a key short-term funding source for Wall Street, by

creating a standing facility that would serve as an additional tool for

liquidity provision.

     "Who the hell is going to do business with anybody except the Fed?" Bair

said. "Are they operationally capable of absorbing this massive amount of flow?"

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

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