Wednesday, November 19, 2008

An Interview with FDIC Chair Sheila Bair

What follows below is a transcript of my interview last night with FDIC Chairwoman Sheila Bair. She's the most important woman in the country right now. Ms. Bair wants more federal help on foreclosures and mortgage modification. She is also rumored to be on an Obama short-list for Treasury secretary.

Larry Kudlow: A few moments ago, I spoke with FDIC chair Sheila Bair, and I began by asking her for a synopsis of this new plan to combat more home foreclosures. Take a listen.

Sheila Bair: Well basically, it’s a proposal to try to provide some financial incentives, some responsible financial incentives, to get these loans modified. There are a lot of loans that are unnecessarily going into foreclosure that could be restructured, and present greater value if they were restructured in keeping the homeowners in the home. So it’s based on the loan modification protocol we developed with IndyMac.

Pretty much, borrowers would get, borrowers with unaffordable mortgages can get a reduction in payment to 31 percent of their principal and mortgage payment related – principal/interest/taxes and insurance -- as a percentage of their pretax income down to 31 percent. Get there through an interest rate reduction, extended amortization, and in some cases, principal forbearance. And then, if the servicer and the investors would agree to modify the loan along those lines, there would be some loss sharing in the event that that loan would re-default later on.

Kudlow: Let me just ask you, because we’ve heard several of these kinds of proposals -- the Treasury, Fannie, Freddie and so forth -- are you going to be reducing the principal amount on the home loan?

Bair: No. The IndyMac protocol does not do that. Most of the pooling and servicing agreements, they provide wide flexibility to modify loans, but most do prohibit principal write-downs, or make it very difficult. So this protocol is based on making an affordable payment, not reducing principal, but getting to an affordable payment, again, through interest rate reductions, extended amortization, and in some cases, principal forbearance, meaning that some amount of the principal might be permanently deferred. But if the loan was refinanced, or the house was sold, it would have to be paid back at that time.

Kudlow: Okay, if a loan is underwater…

Bair: It’s not focused on whether you’re underwater or not. What we strongly believe is key is that most people are willing to ride this out. They view their home as a place to live, not as a leveraged investment. And if they have an affordable payment, they will want to stay in their homes and they will be motivated to stay in their homes and make their mortgage payment. So we’re focused on affordability.

Kudlow: But you are going to give them an interest rate break?

Bair: Yes, there would be an interest rate break.

Kudlow: And how would you determine that interest rate break?

Bair: Well at IndyMac, we pretty much start with giving everyone a 30-year fixed rate mortgage at the Freddie Mac survey rate, the prime rate, which is a little above 6 percent now. Some mortgages have to be reduced further than that to get to an affordable payment. For those, we’ll take the interest rate all the way down to 3 percent for a period of 5 years. And after 5 years, it will gradually increase by 1 percent until it gets back to the Freddie Mac rate. So if you were at 3 percent, getting back to 6 percent, it would be a total of 8 years. So it’s a very gradual reset after 5 years. Also, if that doesn’t get you to 31 percent (debt to income) we’ll extend the amortization to 40 years. And, as I said, in about 10 percent of cases, we also have to forbear a certain amount of principal. But most of the loans we find at IndyMac we can get there through an interest rate reduction.

Kudlow: Now let me ask you this. As I understand it, you’re going to put a federal guarantee behind this. So if there is a default, or a foreclosure, the lender is going to get at least half their money back?

Bair: That’s right. Except for loans with a loan to value ratio of 100 percent or less, it would be a 50 percent loss shared. That would gradually phase out for loans that had very high LTVs of 150 percent or greater. It would exclude early payment defaults though, I think that’s important to emphasize. The loan would have to perform for 6 months, before the government loss share would kick in. The statistics we’ve looked at show that the re-defaults go down pretty significantly once the borrower has been able to demonstrate that they can make the payment at 6 months. So that’s an important condition.

Kudlow: All right. Let me ask you this though. A lot of people have raised a problem with these loan modifications and so forth about re-default. That people get in these deals, but they wind up, 50 percent of them or thereabouts, wind up defaulting anyhow. Since you’re putting federal guarantees behind this it could cost taxpayers a fortune, but at the end of the day, we’re not really going to do a lot on the foreclosure issue. How do you respond to that criticism?

Bair: Well, I have a number of responses to that. First of all, I think some of the re-default rates that you’ve seen, what you’re talking about, you’re including the early payment defaults with that 50 percent figure. We would exclude the early payment defaults. We would also require a meaningful, real, permanent loan modification.

Some of the reason you’re having these high re-default rates is because loans are not being meaningfully modified. The principal and interest may be deferred for a couple of months, and then it’s stuck back into the payments, so that after a couple months the payment is even higher. That’s not a permanent sustainable loan modification. So, to the extent that some servicers have just been kicking the can down the road with even steeper payment hikes after a few months, that doesn’t really solve the problem. We think that has also fed into the high re-default rates.

Kudlow: So you’re sort of downplaying the re-default rate.

Bair: No I’m not. No…

Kudlow: It’s a tricky business. A lot of economists have looked at this…

Bair: It’s a very tricky business…

Kudlow: You know, I want to just juxtapose that, I want to play devil’s advocate.

Bair: Okay, please.

Kudlow: I don’t know who’s right and who’s wrong. You know more about this than I do.

Bair: Yup. We go through this a lot. Please, ask the question.

Kudlow: I just want to ask you, look, you’ve already seen in the difficult states out West primarily, the foreclosure rates have gone sky high, but the foreclosure prices at resale or auction have plunged and sales are rising. I mean you look at California and Nevada, Arizona, the places that have been hit the hardest, they’re the ones showing the sales coming back the fastest. Now to me, the marketplace is probably best at sorting this out and we’re probably, I don’t know 2/3rds of the way home. So are you gonna put taxpayers on the hook at a late stage in the game? Would it might be better to just let the market finish the job?

Bair: Well, if you’re right, and if the market is starting to bottom out -- and I’m not sure that’s the case because I think these escalating foreclosures are creating more artificial downward pressure on home prices -- the costs should be minimized if the collateral values are in fact bottoming out. If that is the case, that should reduce the cost of the program. We have looked at re-default rates very carefully. And we are assuming a 33 percent, 1/3rd re-default rate with our program in estimating the cost of this program at less than $25 billion dollars. And again, we think that’s a very conservative and prudent re-default assumption.

But again, this is a meaningful loan modification with a meaningful payment reduction. We’ve looked at statistics from a number of servicers, and the re-default rates, again, go down significantly if you get past that early payment default period. And, if you provide for meaningful payment reduction, a lot of the so-called modifications that have been occurring aren’t really modifications. They’ve just been kicking the can down the road for a couple of months. So we have looked at this very carefully.


Kudlow: As I understand it, the Treasury does not want you to take any of their TARP money to provide this loan guarantee.

Bair: That’s right.

Kudlow: They’re sort of harboring this TARP money.

Bair: Right.

Kudlow: I myself would like to put a tarp over the entire TARP. But I guess that’s a whole different segment. But let me go there. Where do you stand on this proposal, if the Treasury is against you, I mean, do you need a congressional authorization on this to start it up? How’s this gonna work?

Bair: Well we continue to talk with Treasury. Secretary Paulson has expressed receptivity to this plan and support for the general concept, but he doesn’t think this is the way to use the TARP funds. So in that area, we do disagree. I think you know, the original purpose of TARP was to buy mortgage related assets, distressed mortgage related assets, and foreclosure prevention and the promotion of loss mitigation and loan modification is expressly referenced in the statutory language. And I think we heard at the hearing today that Congress thought part of this money would at least be used for foreclosure prevention. So we think it’s very, very consistent with what Congress had in mind when they originally appropriated the funds.

Kudlow: So you’re saying in effect, when the new administration comes in, you might see the light of day on this plan.

Bair: Well, we might. I haven’t given up on the current administration yet. We continue to talk to Secretary Paulson and Chairman Bernanke. I think we would really like to see something put into place now. We’ve waited for a long time. We’ve waited too long. We’re behind the curve on foreclosures, and I don’t think that the housing prices are going to find their much needed bottom if we keep having unnecessary foreclosures occur because of the convoluted economic incentives that are currently provided in these private label securitization trusts.

Kudlow: And also, speaking of the new administration, now of course, you are the most powerful woman in America…

Bair: Oh right…

Kudlow: There’s no question about that. Have you had any feelers to become the Treasury Secretary under President-elect Obama? There are a lot of rumors Ms. Bair.

Bair: [Laughing] Well yes, if I had, I wouldn’t tell you. I wouldn’t comment on that at all. I’m very happy with the job that I’ve got. I think we’re doing a great job. I’m very proud of the FDIC staff. They are working 24/7. I hope the public appreciates what a great job and hard work that all the FDIC staff are doing. And we’re a good team there, and I’m happy there, to be at that helm. I do think the new administration should have wide latitude to pick who they want on their economic team. So I will accommodate whatever the new president’s wishes are. But I’m very happy where I am.

Kudlow: But there’s no question, your term goes to when? 2011?

Bair: 2011.

Kudlow: And I don’t hear you, you’re not saying you wouldn’t take the Treasury post if it were offered.

Bair: Well, I think that’s a very prestigious job. I think anybody would have to think twice about turning down a job like that. But I’m very happy with the job I have now. I’m quite content and very, very proud of our team at the FDIC. And you know I think we need to just keep focusing on the job we have to do right now.

Kudlow: All right, Ms. Sheila Bair. As always, we appreciate your coming on the show.

Bair: Nice being here. Thank you.