WHEN: Today, Wednesday, September 8th at 7pm ET
WHERE: CNBC's “The Kudlow Report”
Following is the unofficial transcript of a CNBC interview with Sheila Bair, Chairman of the FDIC, on CNBC's "The Kudlow Report."
All references must be sourced to CNBC.
LARRY KUDLOW, host: All right, welcome back to THE KUDLOW REPORT, everyone. We continue our special theme: the free market 12-step path to prosperity. Tonight's focus, the free market housing fix. And now from the standpoint of the key banking regulator, we revisit whether there should be tighter, more conservative lending practices and qualifications. Let's bring in tonight's very special guest. We welcome back FDIC Chair Sheila Bair.
Ms. SHEILA BAIR: Thank you for inviting me.
KUDLOW: All right, Sheila, let me just ask you right off the top.
Ms. BAIR: Yeah.
KUDLOW: In your judgment, do we have tight enough lending standards for mortgages? Do we have tight enough qualifications for mortgages?
Ms. BAIR: I'm not really sure we do. The focus of the Fed's current rules are more on the higher-cost loans, and there are some good standards that are incorporated into Dodd-Frank. But I think we can do a better job of having consistent, strong lending standards across the board for both bank and nonbank mortgage originators. And it doesn't have to be complicated, really, just make sure we document income. There's a--there's a bit of a down payment that the borrower does have the capacity to repay if it's an adjustable-rate mortgage. They have the capacity to repay if the--once the interest rate resets. So just some commonsense standards, but applying to everyone.
KUDLOW: Can I focus on the down payment? And we just had on the show...
Ms. BAIR: Sure.
KUDLOW: ...Ed Pinto, who was a former top credit officer of Fannie Mae.
Ms. BAIR: Uh-huh.
KUDLOW: And he is very concerned that government mortgage lending agencies--BA, FHA, Agriculture Department and, believe it or not, Fannie and Freddie--don't have tough enough down payment standards. For example, the FHA only about 4 percent. Why not 20 percent?
Ms. BAIR: Well, that's a good question. I think these are still in somewhat extraordinary times. We have a very distressed housing market, so perhaps differing standards can be justified. I'm not sure. But clearly there is a strong correlation between the amount of skin in the game a borrower puts in up front and how that loan performs. And it's only common sense. Do you put 20 percent down? You're committed to that house. You walk away from that house, you're going to lose a lot of the money that you put in up front. So there's a strong correlation between up-front down payments and performance of the loan later on.
KUDLOW: I mean, these loan packages. Look, right, they've--FHA and VA get package...
Ms. BAIR: Right. Right.
KUDLOW: Ginnie Maes, banks. You're going to supervise banks, and they wind up owning this stuff. Other investors are owned this stuff.
Ms. BAIR: Right. Right.
KUDLOW: I mean, I thought we had learned. And Dodd-Frank, I agree with you that on the high-end mortgages there's some new rules, but they seem to have left it out. In other words, the housing affordability mandates, which caused so much part of this meltdown story, seems to still be in place for the government lenders.
Ms. BAIR: Right. Well, I do--I do think this is very important. The government is taking on a lot of exposure and guaranteeing most mortgages that are being originated these days. So I do think it's a very key issue, and I think the policymakers here are trying to balance the need for prudent underwriting with a need to support a very--what is still a very distressed housing market, and also because so many mortgages, the original mortgages were underwater with the REFIS. If you have more tolerance for a high loan-to-value ratio, don't have to do quite so much for a principal right now, writedown to get the loan refinanced. So I think there are some other factors playing in here with the reduced home values. But certainly going forward, the standard as we emerge from this crisis should be very robust income documentation, ability to repay standards, and some significant down payment.
KUDLOW: So you're not happy with this story as it stands now?
Ms. BAIR: Well, I don't--I don't--I don't judge. You know, I think--I think those housing agencies are dealing with a very difficult situation right now. But I--yes, I do, I think we should all be concerned about the type of exposure that the government is taking on through guaranteeing so many mortgages right now, and make sure that we do have some prudent underwriting standards, and especially documented ability to repay. But you're right, there's a lot of flexibility being provided, especially with FHA with the down payments.
KUDLOW: And, Sheila, another one, look, FICO scores, OK?
Ms. BAIR: Right. Yeah. Right.
KUDLOW: FICO scores. Now, I get the range is, what, 300 to 850, but apparently 6, 650 you can get a loan. Is that good enough?
Ms. BAIR: Well, you know, I don't know. I think there has been some over-reliance on FICOs, and I think the correlation between FICOs and loan performance is somewhat less definitive than it is with loan devalues and healthy down payments. I think FICOs are an imperfect measure of credit quality, so there may be other payment histories that you can look at and still have a prudent underwriting. So perhaps there may be some justification for more flexibility with FICOs. But again, the bottom line is, does this borrower have a steady income to repay the loan, and if it's adjustable rate would pay the loan money when the interest rate resets.
KUDLOW: All right. And let me ask you another thing now. You reported good earnings for your banks, supervised banks, 21.6 billion.
Ms. BAIR: Yes.
KUDLOW: That's a great number.
Ms. BAIR: Right.
KUDLOW: And it does show considerable recovery. I just want to ask you, more generally, how are the mortgage-toxic assets sitting in these banks? Are you still as concerned as you were when we spoke a while back?
Ms. BAIR: Not so much. I think commercial real estate is really what's driving the losses to the deposit of insurance fund now, and the bank failures right now. The housing market has stabilized somewhat. We don't know, with the current economic environment, we might have--if we have a double dip, what that might do to home prices. But right now, at least, I think we're still very focused on commercial real estate. But the banks are cleaning that up, too. The construction development loan balances have been going down quarter by quarter, both delinquencies and charge operates are down. We're down the--in the second quarter. So there is some improvement in credit quality. We're focused more in terms of bank distress and commercial real estate right now.
KUDLOW: And you were reported as saying that you don't--you, Sheila Bair--do not see a double dip.
Ms. BAIR: We are not predicting--I would use the "we" for the FDIC. I rely on a lot of very smart economists at the FDIC in helping us make those judgments, but right now, no, our economic staff do not predict a double dip. We don't--it's, you know, I think the possibility that it could happen, the probability, if you will, has been increasing somewhat. But it's still unlikely in most economists' views. So we're watching it carefully. We're doing some internal stress testing. If we do get into a more distressed economic environment, what that might do to bank failures. But if we did get into a double dip--and, again, we're not predicting that that's going to happen. Banks are in a better position now because loan quality has improved considerably over the last few years, and so I think they're in a better position to withstand it if we have another downturn.
KUDLOW: All right, FDIC Chair Sheila Bair. We thank you very much for your uptake.
Ms. BAIR: Happy to be here. Thank you.
KUDLOW: All right.
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