What follows below is a transcript of my CNBC interview on The Kudlow Report last night with FDIC Chairwoman Sheila Bair. Ms. Bair wants the FDIC to be the systemic super-regulator capable of shutting down non-bank financial firms (like AIG) and all banks. She is competing with Treasury and the Fed for the spot. Also, she looks to be setting up Dutch auctions for whole loan toxic asset sales, as part of the new Treasury plan using public and private money. Plus she is considering some mark-to-market fair value forbearance for regulatory capital purposes. Note her cautious optimism on the story.
LARRY KUDLOW: We welcome back to the show one of the most powerful women in the financial world—wait, take out financial, in the world. We have FDIC chair Sheila Bair. Miss Bair thank you for coming back.
SHEILA BAIR: Sure.
KUDLOW: Let me just pursue this issue today, to solve AIG and other non-bank problems in the financial world, Mr. Geithner and Mr. Bernanke both said that we need this aggregate, systemic regulator—a super-systemic regulator. Mr. Bernanke cited your agency, the FDIC. Mr. Geithner kind of held back and said, ‘no, no, how about the Treasury’. First of all, do you want the job? Do you want to be the systemic regulator?
BAIR: Well, I think we need two different functions. We need a prudential regulator for very large, systemically important, institutions. Most, but not all of them, are regulated now by the Fed. But we also need, more importantly I think, a resolution mechanism for very large, systemically important financial organizations. We didn't have that type of legal framework. We didn't have the ability of the government to come in and take over an AIG in an orderly way, unwind it, the way the FDIC has the authority for banks…
KUDLOW: Receivership? Conservatorship?
BAIR: Receivership. Or conservatorship. A bridge bank. Yes…
KUDLOW: Essentially it’s quasi-bankruptcy.
BAIR: Yes, but it's a more controlled process. It’s an ability to address the systemic issue through a more controlled, orderly unwinding and enabling the government to come in, repudiate employment contracts, pick and choose who you want to keep, who you want to get rid of, what you want to pay them. Replace the management, get rid of the boards, bring in better management and do an orderly unwinding of the entity. So yes, we think our model is good on the resolution side.
KUDLOW: You have done this before?
BAIR: Yes, we have.
KUDLOW: How many times have you--I mean I always have [former FDIC chairman] Bill Siedman on here talking about this.
BAIR: Well he’s the expert.
KUDLOW: You know something about this?
BAIR: Well we have. The largest institution that we resolved last year was WaMu, and we were able to sell that on a whole bank basis. That was a very seamless process. IndyMac, we put into conservatorship. It was a weaker institution. It took some time to right that ship and get it sold, but the deal just closed last week. Going back in time, Continental Illinois was under FDIC conservatorship…
KUDLOW: So you want the job? That’s what you’re saying?
BAIR: Well I think it makes sense.
KUDLOW: Do you apply? Do you submit a resume? How does this work?
BAIR: I think it would make sense. We’re not lobbying for it. I think it would make sense to give it to the FDIC. You know, closing banks, or putting them into a conservatorship is a cyclical business.
KUDLOW: Do you give like—in the NHL, the hockey playoffs, you give a hip check to the Treasury…
BAIR: [laughter] Get the elbows out.
KUDLOW: Right, a little elbow to get them out of the way so you can head towards the goal?
BAIR: Well Tim [Geithner] and I have talked about this and I think we're all working together to try to figure out what the best structure is. But clearly, the FDIC has a lot of resources and experience, a good model already. This is cyclical work. You know, you go through cycles where you have to close institutions. So to keep multiple agencies fully staffed to be able to do a receivership function probably doesn't make much sense. So I think it does make sense to give it to the FDIC.
KUDLOW: All right, very good. Now, insofar as the public/private partnership, and I myself think Mr. Geithner is absolutely on the right track here, bringing in private capital.
KUDLOW: I think this is a good thing with a lot of potential. The FDIC is basically in charge of the whole loan, of legacy asset program, the whole loan. You're going to set up an institution, you're going to guarantee it. You're the ultimate backstop on this. Just briefly, I want to get some points on this to illuminate it for our viewers. What does the backstop mean?
BAIR: Right. Well the first [inaudible] will be the equity capital investments that will be 50-50 Treasury TARP funds and private investors. And the private investors are being brought in for two very good reasons. One is we think there's significant private investment dollars to leverage government resources better. And more importantly, provide the pricing decision. We didn't want the government making the pricing about what the value of the assets are. So they have the first [inaudible] position. And then the rest of the purchase price will be funded through an FDIC guarantee on debt that will be issued by the PPIF…
KUDLOW: To fund this-- what is it exactly? Is it a number of investment funds or is it one large fund?
BAIR: Yes. We will set up individual PPIFs for each pool of assets. And usually those will be probably done on an institution-by-institution basis for the larger institutions. For the smaller institutions…
KUDLOW: Who are coming in to essentially bid and presumably buy these assets?
BAIR: Yes, that’s exactly right.
KUDLOW: All right, I want to ask you, you're going to run an auction. The pricing has always been the vexing part of this.
KUDLOW: Now Mr. Paulson, what is it, six, eight, nine months ago, talked about this, never quite got it done. It looks like it's going to happen. What kind of an auction are you going to run?
BAIR: Well we’re actually going out for comment on that question. We're thinking, most of the input I have gotten so far, people are suggesting a Dutch auction to allow multiple bidders.
KUDLOW: A Dutch auction! Which is precisely what the Paulson Treasury talked about.
BAIR: Yeah, well we think it might work.
KUDLOW: Low bids. In other words, you start the low bid and then you move up from there?
BAIR: That’s right. It’s counterintuitive. It would actually, by executing at the lowest price, you give people an incentive to bid higher prices because they don't have to worry about being undercut. So we think that is worth a try. You know we may have to make adjustments on this along the way, and we are soliciting comment on that very point. But our initial thinking is that we’ll run a Dutch auction.
KUDLOW: What induces these banks to sell the toxic assets? In this case we're talking about the whole loans, the individual loans bundled up into pieces. I guess it's mostly real estate, but there's more in it than that. If you don't give them some mark to market regulatory accounting relief, aren't they going to rip up their balance sheet again and have a gigantic hole in it? I am told, no matter what FASB does, ultimately it’s the regulator that decides to either forebear capital requirements or not. Can you share with us your thoughts on this?
BAIR: Well yes, the regulators decide what the capital treatment is. All the banks obviously must adhere to US GAAP. But we decide on what the capital requirements will be. And I think this program is interrelated with the stress test and depending on how strong the banks are given the stress test, they may be encouraged to use this facility as part of their re-capitalization efforts. They might have to take—probably will have to take a mark at first, especially on the accrual assets, those are being held to maturity, so they haven't been fair valued yet. But we think that that will clean the balance sheet and enable to them to go out and raise private capital to fill the hole...
KUDLOW: I don't mean to interrupt, but a big issue among those proposing mark to market reform is cash flow accounting, rather than just a distressed market accounting.
BAIR: Right, right.
KUDLOW: Will you be tolerant on that? Because that spills over as I understand it into the capital structure.
BAIR: Well I think it's a separate issue. In terms of the assets that remain on the balance sheet, they will not be sold. [inaudible] So they don’t have to be marked. I think we’ll require very aggressive reserving. For the fair-value assets, yes, the FASB has provided some significant more flexibility and guidance in terms of being able to look at underlying cash flows.
KUDLOW: But will you? Will you at the end of the day?
BAIR: Well again, we can’t alter the accounting standards...
KUDLOW: But will you forbear them on capital? If not won't that make them shy away and say I'm not going to do this? I'm not going to sell into this? I’ll wait it out? The yield-curve is upward sloping, the net interest margins are getting better. Profits are coming in, won't they wait it out unless you help them?
BAIR: Well there is that sense. I think there are different ways to do it. One way is to buttress the capital, the additional capital injections from the government. Another would be to provide this facility, we think actually that by cleansing their balance sheets of these assets, they'll be in a better position to raise the private capital over the longer term. So I think in two different ways, the government can increase the capital buffers. No, we haven't used the forbearance word, and that can have a mixed connotation. We do want to make sure that the banks obviously remain solvent and have enough of a buffer to keep lending.
KUDLOW: Are you bullish or bearish on this? This is a giant step. There are a lot of ifs here. I mean, I am very happy with the use of private capital, 50-50 with the Treasury’s capital. I don’t have any problem with the FDIC backstopping it. And I reckon you probably ought to be the systemic regulator of last resort. But this is tricky, okay? You’re going where people have tried to go for the last six, nine months, Bullish or bearish, Miss Bair?
BAIR: Well I'm optimistic. I’m cautiously bullish, I guess I’ll say. I am seeing glimmers of hope. I mean you cited some of the positive news in your opening remarks. So we are seeing some signs of encouragement, but that's not to discount the very challenging situation we still find ourselves in. But I think the market validated the asset purchase program.
KUDLOW: I do too. I think it was a heck of a good sign. It’s sure a lot better than it was a month or two ago. FDIC chair Sheila Bair. We appreciate it very much. Thank you for giving us your update.
BAIR: Happy to be here. You bet.