MS. DIANE REHMThanks for joining us. I'm Diane Rehm. As head of the FDIC, Sheila Bair served an eventful five-year term. She was on the frontlines of battling the financial crisis and subprime mortgage debacle, and she fought to put teeth in the biggest overhaul of U.S. financial regulations in more than half a century.

MS. DIANE REHMSheila Bair is in the studio to talk about overseeing the banking industry and protecting consumers. She is now senior adviser to the Pew Charitable Trusts. We will take your calls, questions, comments, 800-433-8850. Send us your email to drshow@wamu.org. Join us on Facebook or Twitter. Sheila Bair, welcome.

MS. SHEILA BAIRThank you.

REHMCan you take us back to the first time you became really concerned about those subprime mortgages?

BAIRRight. Well, I guess -- actually, I have a long history with this issue, going back to 2001 and 2002 when I was at the Treasury Department. And then this was a very small segment of mortgage lending. And there were efforts on the Hill to pass an anti-predatory lending law that -- it didn't go anywhere. And then (unintelligible) board also had authority to set lending standards to try nip this in the bud.

BAIRAnd they did not choose to use that authority. So I'd worked with Ned Gramlich, the late Ned Gramlich, at the Fed to develop a set of best practices, to try to get the industry at least to voluntarily agree to something that would address these, you know, steep payment resets, abusive prepayment penalties, negative amortization, all of the things that we started seeing flourish, really, later on. So then, though, it was perimeter players doing it.

BAIRIt was viewed as a consumer issue, not a systemic issue. And then I went into academia for four years, and I came back in 2006 at the FDIC. And the FDIC staff were already monitoring this and were very concerned about the degeneration of lending standards, not so much for what banks were doing on their balance sheet but the loans that were being originated for securitization, transfer private label -- what we called private-label of Wall Street securitizations.

BAIRSo we -- they were on it very early on, and I think the more we learned, the more the concerns grew. And so I would say, by late 2006, we were very concerned. And then going into 2007, of course, our efforts ratcheted up to try to get stronger lending standards, proactive -- restructuring these mortgages before they started going bad.

REHMYou, Brooksley Born, Elizabeth Warren, the three of you women, sounded the alarm.

BAIRYeah.

REHMTo whom did you sound the alarm?

BAIRWell, I think, initially, it was with the other bank regulators. We pitched very hard for -- to tighten subprime lending standards.

REHMRight.

BAIRSo we -- it was -- continued the advocacy with the Fed to try to -- they were the only ones that had the ability to write rules across the board for all bank and non-bank mortgage originators. And a lot of this was a product of uneven regulation where you had stronger standards for the banks, not much regulation at all for non-bank mortgage originators.

BAIRAnd, of course, as the banks lost market share, they started lowering their standards. And we kind of had this downward cycle. So I was pushing for stronger lending standards, started in late 2006. Well into 2007, we were able -- after process -- it was longer than I would have liked. And in June of 2007, we were able to get out better, stronger standards, for banks at least, in the subprime area.

BAIRBut things were deteriorating so badly at that point, it really was problematic. Most of the damage had been done. So that was why, simultaneously, we started calling for restructuring these bad loans that had already been made.

REHMWhy do you think it was so difficult to get people who were in positions...

BAIRRight.

REHM...where they could have done something, to heed your warnings?

BAIRRight. Well, I think there is just a sense of -- the arguments we were hearing back then was, it wasn't going to be that big of a problem. And nobody really knew. The people were assuming, you know, maybe an 8 percent decline on home prices, maybe loss rates of 10 or 15 percent, I mean, things very much lower than that we wanted -- what we ended up seeing. So there was a sense that it wasn't going to be that bad.

BAIRThe argument was we were going to tighten lending standards and constrict credit. We hear that a lot, you know, as a rationale for doing bad lending. And so those were the arguments we were hearing. And, I think, they were made in good faith. But, clearly, in hindsight, they were ill-advised because people were getting loans they couldn't pay back. And that's not providing -- that's not expanding credit availability.

BAIRThat's making abusive loans. And the wave of foreclosures that was building through all this bad lending had a terrible impact on home prices. And we continue to suffer from the ramifications of that.

REHMSome have wondered whether -- because the three of you are women...

BAIRMm hmm. Right.

REHM...whether the old boys' network somehow played a role here.

BAIRRight, right. Well, I don't know. You never know whether gender has anything to do with it. And so I don't know. I think there were certainly men, too, like Ned Gramlich. He was very early on. He was the one, actually, who got me focused on subprime abuses in the early 2000s. Paul Sarbanes was another. So there were -- there are certainly -- both genders were trying to sound the alarm here.

BAIRBut, certainly, in the regulatory community, it was -- the women were somewhat isolated, whether it was Brooksley with derivatives regulation or myself with the mortgage mess that we were in. So you just never know. But I -- you know, I just try to forge forward and make the best arguments I can make and build alliances where I can because you just -- if it's there, it would never surface. And so I try not to dwell on it, just keep pushing.

REHMFannie Mae's Home Affordable Modification Program has been such a disappointment to so many people. Why hasn't it worked?

BAIRWell, I think it was important to have appropriate expectations. We'd all always said that loan modifications were not going to be a silver bullet. It could have a significant impact on reducing foreclosure rates, but there -- we were still going to have a lot of foreclosures. So, I think, maybe people got their expectations up. Though I do think also, you know, programs are all about operational execution. That's really important.

BAIRAnd, I think, frequently in government -- and I say this as someone who spent most of my life in government. They're frequently -- you're going to have a good idea and a good proposal, and then where there's -- the problem is with the execution. And so, I think, perhaps with the best of intentions, the program became very complicated, which made it harder to comply with all the rules.

BAIRAnd then, as we know now, servicers were simply not putting the money and resources and staff training into their servicing operations to do the leg work that was needed, and still is needed, to deal with all of these troubled loans. So I think it was a combination of factors. But I think there's still some good work being done. It has helped somewhat, even though it's been disappointing. We're certainly better having it than not having it.

BAIRAnd -- but I do think some greater simplification, streamlining of the program could help as well as, obviously, these banks need to put more staff and resources and money into their servicing operations.

REHMDo you think they're going to?

BAIRWell, I was certainly pushing that at the FDIC before I left.

REHMI know you were.

BAIRAnd I think they're -- I hope those efforts are continuing. Obviously, I'm in the -- I'm not in the government anymore, so I'm not privy to those discussions. But we were pushing very hard for that to more staff, better staff ratios, single points of contacts, so a borrower has the same person from start to finish.

BAIRThat, by itself, would require more staff to be hired to have, you know, people who can have that one-on-one relationship with the borrower, which is really necessary. And that's an important quality control as well to make sure that all the rules and liquid requirements are met. Even if foreclosure ends up being the inevitable result, you need to make sure it was done appropriately and in compliance with all the rules.

BAIRAnd by having a single person responsible for that process is a good quality control as well as something that can help consumers. So I believe we had agreement on that, on single point of contact. We also had indicated, and I still believe strongly, given the somewhat high error rates that we have seen in some sampling of loan mod denials, that all loan modification denials need to be reviewed to make sure they were appropriately done.

BAIRAnd so those are things I hope the regulators, the bank regulators are continuing to pursue.

REHMSheila Bair, she is senior adviser to The Pew Charitable Trusts, former chair of the Federal Deposit Insurance Corporation. I look forward to hearing your calls, questions, comments, 800-433-8850. I realize that burning bridges is not something you tend to do.

BAIRNo.

REHMBut I find myself wanting to ask you whether you believe President Obama could be doing more to help homeowners.

BAIRWell, I think he wants to do more to help homeowners. I think he said that publicly, and I have heard him say that in private meetings as well. And so, I think, he does want to do more. I think of a couple of things, as I said, simplifying and streamlining these programs, I think, it would be helpful, having a more senior level involvement, government involvement and better coordination, I think.

BAIRYou have a lot of different agencies involved in housing policy. You have Treasury, HUD, the banking regulators, the SEC, the FTC, the Justice Department, and, of course, FHFA. The regulator of the GSEs, it has probably the biggest chunk of this. There needs to be some coordination. I think there is confusion about what the policies are, and that's never good in terms of program execution.

REHMCould he force Freddie and Fannie to finance any loans because rates are so low?

BAIRRight, right. Well, I think, that's a tough question. I think when loans become troubled, when the loan becomes delinquent, there's a lot of legal flexibility to restructure, to try to work with the borrower, to rehabilitate the loan, to provide a mortgage that can be affordable if it's unaffordable currently to the borrower.

BAIRIn terms of loans that are performing, it's the legal obligations are tougher. Investors obviously complain if you have performing loans that you're reducing interest rate. I'm not saying that's justified, but it does create more legal complications

REHMSheila Bair, former chair of the FDIC. Short break, right back.

REHMAnd here's our first question from a listener for Sheila Bair, former chair of the Federal Deposit Insurance Corporation. It reads, "In the past, the FDIC has taken over failed banks, continued to run them using employees and contractors."

REHM"More recently, the FDIC actually took over very few failed banks, but, instead, made deals prior to the takeover with large banks and investors and transferred the failing institution to the new owners with favorable loss-share agreements. These deals were done in secret, without any open bidding process." How come?

BAIROkay. Well, I guess, I would like to challenge the premise of that question first. Actually, most of our bank resolutions have been community banks, smaller banks, less than $10 million. And the overwhelming majority of those have been sold to other community banks. So this has not been a situation where the smaller banks are being gobbled up by the larger banks. The vast majority of small banks have been bought by other community banks.

BAIRAlso, the process has worked very well for us. It has -- we do run an auction before the bank fails, but it is put on a secure website. Any bidder who is qualified -- it has to be another insured bank -- can go on and bid. It is subject to audit by our IG, by the GAO, and there is a robust bidding process. And the highest bidder is the one that acquires the institution. And the prices -- the bid price is publicly disclosed, as well as the lower bids as well.

BAIRWe withhold the cover bid, the second best bid, for a year. But other than that, it's all public. So I think maybe that -- there's a misunderstanding what our process is.

REHMAll right. And he goes on to say, "Banks such as OneWest..."

BAIRRight.

REHM"...were given deals that guaranteed them no loss..."

BAIRRight.

REHM"...and actually rewarded them for foreclosing on customers due to the terms of the loss-share agreements."

BAIRRight.

REHM"Why did the FDIC continue to reward the bankers who are the cause of the financial crisis by giving them such sweetheart deals?"

BAIRAll right. Well, I guess, I would challenge the premise of that question as well. Actually, with OneWest, which had been IndyMac, we use the old process, the (unintelligible) days, where the FDIC staff actually ran the institution for some period of time before it was auctioned off and sold to an acquirer. So -- and, I think, the loss rates were higher with IndyMac.

BAIRAnd, I think, one of the reasons was because we didn't -- it had to be put under government control for several months before it was sold, so -- which underscores...

REHMSo consumers lost their money.

BAIRSo no consumers lost their money. The depositors were -- insured depositors were fully protected at IndyMac. And the loss-share arrangement -- again, it was the highest bid. We find that our loss-share agreements save us money because when we are asking bidders -- first of all, the executives at IndyMac and the board are gone. They lost their jobs, so there was not -- lower level people stayed. But the top management, they were gone.

BAIRAnd that's typical with all of our resolutions, number one. Number two, we find that the loss-share saves us money because if we're asking new parties to bid on a failed bank, which, by definition, probably has some very weak loans in its portfolio, they're worried about what the extent of those losses are going to be.

BAIRAnd because of the uncertainty of what those losses will be, they will give you a very, very low bid unless we agree to provide some credit support for them purchasing those loans. We have the losses on those loans no matter what. When the bank fails, we own it. We pay off the -- we always protect the insured depositors, and the way we recoup our losses is by selling assets.

BAIRSo we have that loss already. With loss-share, by agreeing to take some of the future losses -- some percentage, not the whole thing -- we can actually increase the bid. And there's plenty of analysis that shows, actually, we've saved ourselves about $40 billion by using loss-share. A final point I do want to make, the loss-share agreements affirmatively provide incentives for loan modifications, not for foreclosures.

BAIRAnd that was a conscious decision we made. We pay on the loss-share. If you modify a loan -- for instance, if you take a 20 or 30 percent loss on the loan by reducing the borrower's payment by 20 or 30 percent, we will pay loss-share on the difference at the time the modification is made. You do not have to go to foreclosure to get paid.

BAIRWe didn't want incentives to go to foreclosure, which is why we say, very specifically, we will pay on loss-share when the loan is modified. So the incentives under loss-share are to modify the loan, not to go to foreclosure.

REHMInteresting, that in dealing with these huge banks, which got so much money...

BAIRRight.

REHM...from the U.S. government, why is it that so many executives have not been held accountable?

BAIRRight. Well, I think, that's a really good question. We have a very robust program of -- that I oversaw when I was there, of holding executives to account for losses that they were responsible for when loans have failed.

REHMAnd how could they be held accountable?

BAIRWe sue them. We sue them, and we go after personal assets, not just insurance proceeds. We go after personal assets, too. So we do think there should be accountability, and it should hit people in their pocketbook.

REHMBut didn't it shock you that so much money came from the federal government, from taxpayers...

BAIRRight.

REHM...to bail out these big banks, and then, for example, AIG...

BAIRRight.

REHM...and others got huge bonuses for their executives?

BAIROh, I couldn't agree more. I could not -- we were not -- and this is full disclosure. We were not involved in AIG. I have no intimate familiarity with the facts there. But just reading the paper and reading some of the public analysis, I did not understand that. I did not understand that at all. I think that's one of the symptoms of the bailouts. If you bail out an institution, if you keep them open, then all those contracts are still enforced.

BAIRThey're enforceable. With the FDIC process, a bank goes into resolution. We can repudiate those contracts. So we will make a decision. If it makes sense to keep an employee to preserve the value of the bank, then we might -- you know, again, lower level people. The top executives always go. We will make that decision based on what is in our interest, but there's no contractual obligation to keep anybody or pay anybody bonuses.

BAIRAnd that was one of the reasons why we pushed very hard for resolution authority for large -- all for large financial organizations, not just insured banks, and partly to address this AIG problem, to give the government the ability to repudiate these contracts, where you end up paying people who got the institution into trouble.

REHMYou know, considering what has happened in this country with not only the loss of billions of dollars...

BAIRRight.

REHM...but the loss of faith...

BAIRYes.

REHM...in financial institutions…

BAIRYes.

REHM...are you not shocked...

BAIRYeah.

REHM...that European...

BAIRYeah.

REHM...leaders are now considering doing the same thing we did?

BAIRWell, yes. And I'm very troubled by it. But I think they're somewhat in a box. They don't -- they really don't have a resolution infrastructure in place. With Dodd-Frank, we put infrastructure in place to resolve troubled banks.

REHMExplain exactly what Dodd-Frank does.

BAIRWell, what -- Dodd-Frank basically took the authority that the FDIC has always had to resolve failed banks and insured banks and impose losses on shareholders and creditors. It expanded that authority to include any large -- was -- what is -- would be viewed as a systemic financial organization. So under this process, we can seize the institution with certain procedural safeguards.

BAIRWe can temporarily fund it and keep it operational as it is broken up and sold off. If there are any losses associated with that -- there will be -- the shareholders and the debt holders take the losses. It's a bankruptcy-like process. It's really just an efficient government-run bankruptcy process.

BAIRAnd so -- but it's important for financial institutions -- given that the financial assets can flee an institution very quickly, if you don't have some short-term ability to fund it, to keep it operational as it's sold, you will lose franchise value very quickly. As we see the Lehman Brothers' bankruptcy, the losses there for creditors are going to be substantial because the place just fell apart when they went into the bankruptcy process.

BAIRSo we have that in place, and we have a centralized authority in the FDIC to carry it out. They're working on setting something like that up in Europe, but it's still a ways away. And, of course, it's complicated by all the -- so many different countries, who need to have a buy-in into this process. I think, also, they wouldn't be having to set aside resolution authority.

BAIRYou wouldn't even need to talk about that if, I think, the capital base of those European banks was stronger. We fought very hard for a leverage ratio, for higher capital requirements. With the leverage ratio, you have to keep capital against any asset, even if it's sovereign debt, cash, whatever. But with the capital framework that most European banks are operating under now, these sovereign debts -- instruments, they didn't have to hold capital.

BAIRThey were, basically, viewed as zero risk. So that's another problem why the capitals that absorb loss is associated with this troubled sovereign debt is weaker than it should be.

REHMSo all of this comes down to, how do people stay in their houses?

BAIRRight. Well, I think if you -- I think you should still, unfortunately, need to deal with the servicer, the name of the entity that is on your mortgage statement. There are -- there is much more intensive regulatory oversight now. They are required to have a single point of contact. You should demand that. Have the name of a person, the phone number, the email address and deal with that person.

BAIRIf that person is going to be out on vacation or whatever, that person needs to designate who your contact will be, so I think those are your -- those are obligations now that the major servicers have undertaken. Consumers should know that and know that they have the right to the name of a person to deal with on a continual basis. They should complain as well. They should complain to the bank regulators. They can go to the FDIC complaint center.

BAIRWe will -- unfortunately, we are not the primary regulator for most -- we're not the primary regulator for any of these major servicers. But we can route the complaint to the appropriate regulator to help with the...

REHMSheila Bair, aren't you angry?

BAIROh, yeah. I'm very angry. I -- so much of this was avoidable. And I'm particularly...

REHMReally avoidable.

BAIRVery avoidable.

REHMIf what?

BAIRIf -- well, if we had had, in the early 2000s, we had put in place mortgage lending standards that were applied across the board for bank and non-bank originators, that would have been helpful. If we had not started lowering bank capital requirements and investment bank capital requirements, but increased those capital requirements, this could have been avoided.

BAIROnce, even -- once the loans started going bad, if, early on, servicers had been -- put more resources into their servicing operations and the investors in these mortgage-backed securities had supported them in restructuring these loans, as opposed to some of them who were fighting these restructurings, we could have -- it still would have been a problem. We could have gotten ahead of it much better.

REHMBut, you know, clearly, you are angry. Clearly, so much has gone wrong. Why did it all go wrong? Was it that people, who should have known better, simply refused to pay attention? Was it philosophical? What was it?

BAIRWell, I think it was -- it's just -- it's the taking away the punch drills -- punch bowl syndrome. Everybody was making money off of this. And for a time, even consumers -- borrowers getting these unaffordable mortgages -- because home prices are going up, they could refinance out of them. They just kept refinancing. And so, for a time there, everyone was making money off of this.

BAIRAnd when everyone is making money off of it, it's very difficult for regulators to come in and say, we're going to stop the party. There was a lot of -- you know, the housing industry, generally, is a very potent political influence in Washington. And so, I think, that was the problem. And I think it's symptomatic of a larger situation where government doesn't act proactively to get ahead of these problems.

BAIRWe wait until the crisis is there, and then we do something. And then it's always too late.

REHMSheila Bair, former director of the Federal Deposit Insurance Corporation. And you're listening to "The Diane Rehm Show." Sheila, did you push for the Federal Housing Finance Agency lawsuits trying to recoup these fraudulent mortgages from the major banks?

BAIRNo. I had no role in that decision making. I think Ed DeMarco is doing a great job. And as the conservator of Fannie and Freddie, it's his obligation to recover what he can of his conservatorship. So he's doing that.

REHMDo you think the lawsuits will accomplish that?

BAIRWell, I think there will be issues to be litigated. And, frankly, I think there is probably fault on both sides in terms of the former Fannie and Freddie management perhaps knowing more than they want to acknowledge in terms of what was going on. That doesn't excuse mortgage originators and those putting the securitization deals together for not adhering to reps and warranties.

BAIRBut I think there is probably -- you know, it was fault on both sides. I think the broader problem is this litigation is -- promises to drag on for many years.

REHMYes.

BAIRI think it could be a real drag on the housing market recovery. And so I think the sooner this can be settled -- and banks need to understand their significant liability there, and they will have to make significant settlements.

BAIROn the other hand, investors need to understand that they had some culpability in here, too, and not be unrealistic about what they should be recovering.

REHMCan you talk about your relationship with Treasury Secretary Timothy Geithner?

BAIRWell, I think, people, perhaps the media -- some of the media have made that more than it is. And that's -- that just goes with the territory.

REHMI'm not making it more than it is. I was just asking you. Yeah.

BAIROh, right. No, you're not. It was not directed at you at all. It was not directed at you at all. I think, you know, we had philosophical disagreements. I think -- I like to think it was not personal.

REHMGive me an example.

BAIRWell, I think -- bond holders, for instance, we thought -- or counterparties, unsecured counterparties for these large institutions, the bailouts were really bailouts for them. And we thought they should take some losses, that -- for instance, we were asked early on, it was suggested to us, that we guarantee all bank and bank holding company debt. Now, we insure deposits. We don't insure bank and bank holding company debt.

BAIRAnd so we pushed back on that very strongly. We had suggested, at one point, that they may perhaps -- that they should all take a 10 percent or that we -- they should only be guaranteed up to 90 percent. There was no agreement on that. And so, what we ended up doing when things really got bad after Lehman, we did agree to guarantee new debt so that banks -- when the markets froze up, they couldn't roll their debt.

BAIRBut we charged a very significant premium for it, and that the program ended up making a lot of money for the FDIC. So if I had had my druthers, I wouldn't have done anything. But, you know, I think after Lehman, there was a strong case to be made, that the liquidity situation was such that, at least for new debt, it needed to be -- there needed to be some support for banks to be able to continue funding with new debt issuances. So we did that.

BAIRBut I think, you know, unsecured creditors -- I think when financial institutions fail, the stakeholders should be taking the losses. That's the way a non-financial -- you know, a commercial entity goes into bankruptcy, and it's the same priority. The shareholders are at most risk...

REHMBut what about that notion of too-big-to-fail?

BAIRWell, I think -- you know, I think, there are some that just won't accept it as a fact of life. And there are others that it really rankles, and it really rankles me. I think, you know -- I grew up as a -- in a conservative Republican household. And you stand on your own two feet.

REHMYou bet.

BAIRYou don't take government assistance unless you absolutely have to.

REHMSheila Bair, former chair of the FDIC. When we come back, your comments, your questions. I look forward to hearing from you.

REHMAnd now, it's your turn. We'll open the phones first to Karen in Ann Arbor, Mich. Good morning to you.

KARENHi, Diane and Sheila Bair. I would like to know if there is any whistleblower bringing the attention of the short sale problem into clear view.

BAIRMm hmm.

KARENThe banking industry has done a terrible job of approving short sales with homeowners.

BAIRRight.

KARENThey either have extremely slow processing or lack of processing. What happens then is that the homeowner actually goes completely into foreclosure. And that means that the homeowners, the current homeowners lose the value of their home, the potential homeowners, the ones that -- who want to buy the home, have lost the home.

BAIRMm hmm.

KARENThe neighborhood, all the people that live near that home also lose the value of their home. And the reason -- I live in Michigan, and we have seen this time and again. You could speak to realtors, mortgage processors, banks...

BAIRRight.

KARENThey would verify what I'm saying. And I understand that there's more than one bank that's involved with the short sale process many times. And I understand that it's difficult. But what ends up happening is that the banks are receiving bailout money. They aren't hiring enough people to process the short sales, and the standards are all low -- you know, they're decreasing in our home values...

BAIRMm hmm. Well, I'm not aware of any whistleblower programs specifically for inattention to short sales. But I certainly agree with you that more needs to be done. And I would say -- I think the GSE is also -- Fannie and Freddie need to do more to facilitate short sales. At the FDIC, under our law share arrangements, we always required first that a borrower -- it'd be determined whether a borrower could be eligible for a loan modification.

BAIRBut if that -- the income was not there to support a loan modification, we strongly encouraged short sales and agreed, if the recoveries were significant to share, you'd provide affirmative financial incentives to facilitate short sales. I think it's very important. It's important to the market clearing to get this done and get this done in a timely way and not to keep the borrowers, who realize that they won't be able to hold on to the house, the ability to sell.

BAIRAnd so, I think, you're right on. We'd also pushed -- I had pushed. I don't know if it's going to be in this global settlement that the state AGs are working on with the servicers...

REHMHmm.

BAIR...but we had strongly suggested that there be a short sale incentive component in that settlement. And I hope when that announcement, if and when it's reached, includes some strong incentives for short sales.

REHMThanks for calling, Karen. Here is an email, and, apparently, there are several similar to this, this from Harry in Stoughton, Mass. "Is it not true that most of these toxic derivative assets are still on the books of the banks?"

BAIRRight.

REHM"And, even more outrageous, is it not true that these crazy derivatives are still a big part of the business the banks profit from?"

BAIRRight. Well, I have -- the collateralized debt obligations that were made out of the lower tranches of these mortgage-backed securitizations, I think, those balances have been wound down. A lot of that has been charged off already, so that particular toxic derivative structure to instrument, I...

REHMAt the very bottom.

BAIRYes. But, certainly, the derivatives market generally is huge. And I do think it's important to differentiate between the foreign currency and interest rate derivative markets. And there are some problems there. I won't suggest there's not. But they were really not a big driver for the crisis. They're more developed markets, and they function better certainly than the current default swap market, where -- really, is where we were seeing the problems.

BAIRAnd that market still concerns me greatly, and I don't think we've done enough. I think it's a highly concentrated market. It excused incentives and in a way that is not a positive. And so, I think, there's some real work to be done there. And Dodd-Frank does authorize a bitter oversight of the CDS market to try to move as much as you as you can onto exchanges.

BAIRIt also includes directives to the Fed to start putting limits on concentrations because the problem with these derivatives is that the bulk of the market is heavily concentrated in just a handful of very large institutions. So if you start seeing a problem, it's all that interconnectedness is what gets you into trouble. That's what we saw in 2008.

REHMAll right.

BAIRCertainly with the AIG, so it's still a problem.

REHMTo Dallas, Texas. Hi there, Mark.

MARKHi. Good morning, Diane.

REHMMorning.

MARKThank you for taking my call.

REHMSure.

MARKFirst of all, I want to make sure that I, along with a lot of listeners, fully understand the financial trail appears, as it were, that we're trying to focus on the match that lights the fuse as opposed to looking at who's holding the bomb when it goes off in their face. Fannie Mae and Freddie Mac were, basically, for a lack of a better word, robo-signing mortgages to people who couldn't afford them and then selling those to the banks, correct?

BAIRWell, I think, there were a couple of things going on. I think Fannie and Freddie's culpability in this, if you will, is that they really fueled the private-label mortgage-backed securities, so it wasn't so much the mortgages that they were buying and securitizing on their own. It was the investments they were making in the private label, the Wall Street securitizations.

BAIRYes. And they were a huge part of that market. I think there was about a third of the market in 2005. They really fueled these toxic mortgage products through their purchases of these Wall Street securitizations.

REHMBut weren't they also being pressured by the Congress to get into the market?

BAIRWell, there was, I think -- I don't know if there was pressure. I think they were making a lot of money off of it. I don't think they needed to be pressured too much. I think homeownership, though, was the rationale. And HUD did give them credit toward their affordable housing goals by buying these securities, which, I think, in retrospect, was not a good decision. So they did fuel it in that context.

BAIRAnd I think that's unfortunate. And they were trying to make money. They -- it was a nice arbitrage. They were operating like a hedge fund. They could issue debt at very low rates because of their implied government support, and then they could invest in these high yielding mortgage-backed securities. And they were making a lot of money off of it.

REHMAll right. To Smithtown, N.Y. Good morning, Santo. (sp?)

SANTOHi, Diane. Thank you very much for taking my call.

REHMSurely.

SANTOI'm just calling, I think, as a disheartened homeowner. And I think that I represent thousands of people out there. I just received my foreclosure notice.

REHMOh, I'm sorry.

SANTOYou know, that's okay. After two-and-a-half years of applying for modification, I was strung along by my bank. The lady talks about -- Miss Bair talks about the point of contact. Well, I had four points of contact. I had four different relationship managers, so-called. And after three or four months, when it was close to possibly having a decision, a different relationship manager. This went on for two-and-a-half years.

SANTOI sent hundreds of documents talking about this procedure, operational procedure, a great phrase, but it doesn't help the homeowner.

BAIRRight.

SANTOI think what's happened, in a sense, is that the whole system has turned around. And now it's the banker beware rather than consumer beware. In addition to that, the lady talks about standing on your own two feet. I never asked anybody to pick -- to, you know, to stand up for me.

BAIRRight.

SANTOAll I asked was for a hand up.

BAIRRight.

SANTOThat's all I needed, just a little assistance. And this was -- you know, it's very timely that this happened today.

BAIRYeah, well, I'm sorry to hear that. And I wish this is a unique situation. But it's -- you know, when I was a chairman of the FDIC, I would get letters and emails from people all the time, and we -- I...

REHMTo break your heart.

BAIRYes. And I had a couple people on my staff that would track them down, and we could usually -- you know, on a one-on-one basis, the chairman of the FDIC shouldn't have to intervene to get somebody an answer. And I think this is just symptomatic of the larger problem, understaffing, poor training, high turnover and not enough attention to servicing. It's not a profit center, and it's not going to be.

BAIRBut the litigation exposure and the broader economic damage being caused by this understaffing and servicing is really, in the long term, very problematic, even for the banks.

REHMIf you could wave a wand, what are the three things you would do to solve this crisis now, this homeownership crisis?

BAIRRight. I wish I could say there was a solution, but there's really not. I think simplifying the loan modification process -- we suggested a one-time super mod proposal to anybody that was more -- delinquent on their loan, more than 60 days delinquent, offered to take them down to below appraised value, let them refinance, try to reform on the lower principal balance or do a short sale and do it a one-time offer.

BAIRAnd the rate, in return for that, the borrower -- if the borrower agreed, if there was a re-default, then they would have to agree to turn the keys, so you could -- wouldn't have to go on this forever foreclosure process.

REHMThrough it again, yeah.

BAIRSo that was one idea. I think second liens continues to be a problem, an impediment to getting the first lien modified. Too many of these seconds liens are being held as performing assets when a point in fact, the first lien is delinquent and underwater. The second liens, even if they're making a minimum payment every month, those are not good assets anymore.

BAIRAnd so getting those into non-accrual situations so you no longer have economic disincentives to block a modification, I think, could -- and I think there is some progress on that. So, I think, simplifying the government programs, having one government program, I think, it would be helpful. It would help a lot.

REHMIt would certainly help. Do you expect anything like that to come from President Obama?

BAIRYou know, I don't know. I think -- I hope so. I think, you know, these are not really glamorous ideas. We're just simplifying it, making it simpler.

REHMRight.

BAIRIt's not a big press release or anything, but, boy, it could do so much good. And let's face it. You know, getting the banks to staff up more and servicing, we need to do that. But the servicing capacity is what it is. And the simpler their program, the more mods you're going to get. The more complicated you're going to make it with this understaffing, the more difficult it is.

REHMAnd, of course, they're sitting on huge amounts of money.

BAIRYeah, well, you know, banks are profitable. They actually -- the second quarter of this year was pretty good. And so...

REHMBut they could hire more people to help with the servicing.

BAIRThey could. And I got to tell you, long term, it's in their financial interest to do so...

REHMOf course it is.

BAIR...because the litigation building on this is quite problematic.

REHMTo Pompano Beach, Fla. Hi there, Daniel.

DANIELYes. Good morning.

BAIRGood morning.

DANIELThis question is for the former FDIC chair. I have a feeling that the -- our fiscal policy, with us being a lender of last resort, meaning taxpayers of the FDIC, creates a moral hazard, which distorts risk and, thereby, creating the situation that we're in. Shouldn't we be out of the business of bailing out anybody? Why don't they just go through the regular bankruptcy process?

BAIRRight. Well, I think, for insured banks, we've had a system that's worked well, ever since 1933. And, you know -- I think, again, I'm a traditionalist. I like markets to decide how resources were allocated. And, as I said before, I like people standing on their own two feet. But with insured deposits, I think we have a long history of success with the FDIC and the resolution process that we use.

BAIRAnd I do think there is merit in having a safe place for people to keep their money, where they know they can immediately access it, where they know they're not going to suffer any losses.

BAIRAnd by providing that safe haven, you do provide a good boost to credit intermediation. So this process can be used to make loans. That's a traditional banking model, and that's the model that works well. But giving people the peace of mind of protection for their insured deposits, I think, over the years, over the decades of success, it can and is justified. And it's a main street benefit. It's not a benefit for large institutions.

BAIRIt's a main street benefit, and, I think, it is justified. And I would also say the losses -- the FDIC is funded by the industry. So government taxpayers, we do have the ability to borrow from Treasury. We never did during the crisis. The banks pay to cover our losses. So it is a closed system in that sense.

REHMSheila Bair, former chair of the FDIC. You're listening to "The Diane Rehm Show." What's happening in Europe? How do you believe it could affect us?

BAIRYeah. Right. Well, I think, it's a very difficult situation. I still think it's a manageable situation. I think the political -- you know, as we saw with our debt limit crisis, our self-made debt limit crisis here, the political process did not work as well as it should have. And I think we're seeing the same problem in Europe. And, of course, it's complicated because you have so many different governments that have to achieve agreement on this.

BAIRBut -- and here again, my fear is, is that they probably will have to reach near crisis proportions before there's a catalyst for taking really decisive action. And so, you know, these kind of half-measures and incremental steps, they're politically expedient, but aren't solving the problem. And the banks are going to have to take some losses.

BAIRGovernments are probably -- stronger governments are probably going to have to help weaker governments, and I know that's not politically popular. But, I think, that's what's going to have to happen.

REHMAnd then how does it come to rest on our shoulders?

BAIRWell, I think the -- if there were -- if there was a -- there is a lot of -- there's not much direct exposure between U.S. banks and the banks of the weaker countries in Europe. But there is -- for the European banking system generally, obviously, there's a lot of interconnectedness. So I think a banking crisis in Europe could definitely harm the banking system here.

BAIRNow, that said, there are -- in Dodd-Frank, there are -- there is the ability -- if you have what is called, you know, a system-wide event, so, in other words, an event that is destabilizing to the system, not because banks mismanage themselves, but because of an external force, then there is the ability of the Fed and the FDIC to step in with liquidity support. I don't think it would come to that, but those legal tools are there.

BAIRSo I think, under Dodd-Frank, the regulators would have the ability to deal with it if it gets to that stage. But I don't think it will get to that stage. I think it's starting to come to a head here. And I think the politicians in Europe, at least -- maybe I'm being overly optimistic -- are finally coming to the grips of the fact. There's no place to hide on this. They're just going to have to make some tough, politically unpopular decisions.

REHMIs there any place that you feel Americans, people in this country, can now put their money and feel confident?

BAIRWell, I think insured deposits are obviously a -- are proven a place of safety. And so I think if you want something that you know -- absolutely know is going to be protected, keep your money in the bank below the insured deposit limits. I think treasuries actually are still a safe haven, even though the problems we've had with getting the debt limit raised in the downgrade.

BAIRI think that still -- I'm going to, again, be optimistic that we have a process in place that's going to get our fiscal situation under control.

REHMWell, I'm glad you're optimistic. Is there anything you would have done differently as chair of the FDIC?

BAIRAs chair of the FDIC? You know, hindsight's always 20/20.

REHMIt's okay.

BAIRI think -- you know, I think I would have -- we had backup authority for insured banks. We didn't for bank holding companies, where a lot of risk was. So using that earlier -- kind of insisting, even though it would've upset the other regulators, to send our own examiners into some of these large institutions earlier, I would have done that.

BAIRI think one small thing, that I still kick myself on to this day, was when IndyMac failed. We were consulted by the OTS, which was the primary regulator, which revoked the charter, closed the bank. But the decision was made to close the bank prior to normal closing hours. And so you ended up with a situation where people were coming in trying to do their business. And the bank was closed, and that scared people.

BAIRAnd I regret that very much. From then on, the policy was you close them after normal business hours are over with.

REHMSheila Bair, former chair of the FDIC. Here a last email from Lisa in Polkton, N.C. "I propose a Sheila Bair-Elizabeth Warren ticket for president."

BAIROh, there you go. Okay.

REHMThere you go. Thank you so much for being here.

BAIRThank you, Diane. It was fun.

REHMThanks for listening, all. I'm Diane Rehm.