As chairman of the Federal Deposit Insurance Corp.—the agency charged with protecting accounts at the nation's 8,500 banks—Sheila Bair is knee deep in the government's efforts to resolve America's most harrowing financial crisis in a generation. She recently sat down with U.S. News to discuss the cancerous effect of home foreclosures and why she believes government should ramp up its efforts to prevent them. Excerpts:
Asking lenders to voluntarily modify troubled loans is a cornerstone of the Bush administration's response to the housing crisis. How's progress?
[Treasury] Secretary [Henry] Paulson has been aggressively involved in calling senior management of servicers and telling them they need to modify loans. But because of the scale of the problem, the pace is just not what it really needs to be. So I think we do need additional strategies, additional government intervention.
What would you say to responsible borrowers—those who pay their mortgage on time and stayed away from exotic products—who consider it unfair to spend taxpayer dollars to rescue struggling homeowners?
First, we've seen a lot of situations where borrowers were in point of fact duped. They did not understand the terms of their loan. Secondly, there were some people who just got in over their heads. But even if you don't have sympathy for these borrowers, the foreclosed properties are going to impact the surrounding neighborhood properties. Vacant houses contribute to crime and erode the tax base, while distressed sales force down the value of nearby properties. In a broader sense, widespread foreclosures tend to undermine the confidence that home buyers and lenders have in the housing markets. That confidence will be essential to the recovery of our financial markets and economy.
Why does the foreclosure problem warrant government intervention?
I am increasingly concerned about the foreclosure rate and the potential for a downward spiral, where we have too much inventory, additional foreclosures adding to inventory, which forces home prices down, meaning fewer people can refinance—leading to more foreclosures and more downward pressure on home prices. If this downward spiral takes hold, there could be much broader ramifications for the economy as a whole. So I think we need to come to grips with the need for government intervention. It's not politically popular. We just need to be honest with people that we have a significant problem here and that additional measures are going to have to be taken. And yes, it may cost money.
Democrats in Congress have introduced plans that would allow struggling borrowers to refinance into more affordable loans guaranteed by the Federal Housing Administration. What do you think about that plan?
I think we need to be realistic about what FHA can do. A refinancing process that is going to modify loans one at a time is going to take time. So we are also brainstorming on other ways where additional assistance could be provided in a cost-effective way that would be faster.
Can you give me an example?
One idea is to provide loans directly to troubled borrowers to pay down principal. For example, if you used $50 billion to pay down 20 percent of the principal on troubled mortgages, you could modify 1.1 million loans. So $50 billion, that's a big number—but I've seen a lot bigger numbers. The stimulus package was $150 billion. So I think by leveraging existing resources, I think there may be ways to reach a fairly significant number of mortgages with a cost somewhat less than the stimulus package.
When do you think the housing crisis will be resolved?
My hope is that we will be turning the corner by the end of the year. I think in terms of government policies and potential interventions, we should be thinking about that now. The cycle in foreclosures that leads to more inventory, leading to further downward pressure on home prices, is something that I am becoming increasingly concerned about. But I think there are ways to tackle this problem by working with Congress. But we need to act within the next couple of months, I would say, to have a meaningful impact.
How likely is a large-scale government effort to stabilize home prices?
I think the probability is increasing. We may not be there yet. Most people are paying their mortgages and are understandably asking why there should be a broader intervention. I have a 15-year fixed-rate mortgage—my family and I are very conservative mortgage borrowers—so I can understand that sentiment. But I think there needs to be an open dialogue—a candid dialogue—with the public about what we are potentially facing if we don't try to do a better job of stemming these foreclosures. Because these declining home values and these vacant properties are hurting everybody.