Sheila Bair, who headed the FDIC during the dark days of the 2008 financial crisis, recently discussed current dangers to the financial system in a lengthy interview with Barron's. Bair had warned of a coming subprime mortgage meltdown, a major precursor of the 2008 crisis, when other prominent figures, such as former Federal Reserve Chairman Alan Greenspan, disagreed that there was a U.S. housing bubble. "The memories—and lessons—of what drove the crisis are completely being ignored," she told Barron's.

Bair's four big areas of concern, as discussed with Barron's: reduced bank capital requirements, soaring private debt, a ballooning federal budget deficit, and massive student loan debt. She also shared opinions on Chinese debt, bitcoin, and cyber risk.

Impressive Resume

Since leaving the FDIC in 2011, Bair was president of Washington College in Maryland until 2017 and has been an advisor to various institutions, such as the China Bank Regulatory Commission. She is head of the Pew Charitable Trust's Systemic Risk Council, a group promoting financial stability. Among the corporate boards on which she has served are those of the state-owned Industrial and Commercial Bank of China and of blockchain startup Paxos, which operates a bitcoin exchange.

Key Takeaways

  • Sheila Bair, former FDIC chair who saw the agency through the 2008 financial crisis, is concerned about another crisis on the horizon.
  • Bair's four big areas of concern, as discussed with Barron's: reduced bank capital requirements, soaring private debt, a ballooning federal budget deficit, and massive student loan debt. 
  • Others discount Bair's concerns and offer a more optimistic outlook for the near- to mid-term.

1. Reduced Bank Capital

Bair does not have an issue with some bank deregulation, "such as easing unnecessary supervisory infrastructure on regional and community banks."

However, especially regarding the "large, complex financial institutions that drove the crisis," she asserted to Barron's: "To loosen capital now is just crazy. When we get to a downturn, banks won't have the cushion to absorb the losses. Without a cushion, we will have 2008 and 2009 again."

An independent research arm of the U.S. Treasury Department has found that the financial system still would be in great peril if one or more big banks fail, despite reforms enacted after the 2008 crisis. Similarly, economics professor Kenneth Rogoff of Harvard University believes that leading central banks around the world are unprepared to deal with a new banking crisis.

2. Soaring Private Debt

When asked for her opinion on what might trigger the next financial crisis, Bair pointed to soaring private debt. She mentioned credit card debt, subprime auto loans, loans that finance corporate leveraged buyouts, and general corporate debt. "Any type of secured lending backed by an asset that is overvalued should be a concern," she indicated, adding, "That is what happened with housing."

3. Ballooning Federal Deficit

"If we keep throwing gas on flames with deficit spending, I worry about how severe the next [economic] downturn is going to be—and whether we have enough bullets left [to fight it]," Bair opined. "I also worry when the safe-haven status of Treasuries is questioned," she added.

Bair continued: "I don't think Congress has a clue that the reason they have been able to get away with this profligacy is that we are the best-looking horse in the glue factory. But we are in the glue factory. Our fiscal situation is not a good one."

4. Student Debt

Bair also is alarmed about student debt, which is a staggering $1.3 trillion, Barron's says. "There are parallels to 2008: There are massive amounts of unaffordable loans being made to people who can't pay them, and the easy availability of those loans is leading to asset inflation," she observed.

A big part of the student loan problem, Bair said, is that educational institutions raise tuition with impunity because "they have no skin in the game, like [many lenders] in the mortgage crisis." That is, the federal government, not the colleges themselves, bears the risk of default.

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Reforming for Student Loans

Bair supports a system in which the colleges and the government split the cost of student loans 50/50, and repayment is on a sliding scale, as a percentage of future income. She believes that philanthropies also should get "into the mix." The reason, she said: "We need high school math teachers just like we need hedge fund managers, but we have a one-size payment system, whether you are making $36,000 or $360,000."

Another matter of concern to Bair: "Student debt also suppresses small-business formation. Kids who would have started a business in their parents' garage can't do that now because they owe $50,000."

"Prudence" vs. "Short-Termism"

Banks and regulators alike in China are increasingly concerned about risk management, credit quality, and nonperforming loans, Bair says, noting that "prudence" and "sustainable growth" are becoming watchwords.

She adds: "I'm struck by the difference in the tone of the political leadership—with [China's President] Xi talking about deleveraging, constraining asset bubbles, and accepting short-term trade-offs to growth for long-term stability. Contrast that to the U.S., where we have a move to deregulation and borrowing more. It saddens me that we are falling prey to short-termism."

Bitcoin and Cyber Risk

Bair told Barron's that bitcoin has no intrinsic value, but neither does government-issued paper money. The market should determine its value, in her opinion, while government should focus on disclosure, education, fraud prevention, and curbing its use to support criminal activities. She advises people not to invest in it unless they can afford a complete loss.

Given all their other post-crisis concerns, Bair told Barron's that regulators fell behind on dealing with systemic cyber risk. Right now, however, she is happy to see that they have become very focused on it.

A Contrasting Viewpoint

In contrast to Sheila Bair's concerns, a bullish view on the banking sector has been offered by widely followed bank analyst Dick Bove. He believes that U.S. banks are entering a new, decades-long golden age of growing profitability. Meanwhile, the KBW Nasdaq Bank Index (BKX) is up 530% from its intra-day low on March 6, 2009, through the close on March 2, 2018, outdistancing the 304% gain for the S&P 500 Index (SPX).