With Meghna Chakrabarti Sheila Bair was the head of the Federal Deposit Insurance Corporation (FDIC) during the 2008 financial crisis. She warns that American democracy may not be able to withstand another bank bailout. Guest Sheila Bair, head of the Federal Deposit Insurance Corporation from 2006 to 2011. (@SheilaBair2013) Interview Highlights On her concern, in 2006, upon digging into subprime loan data "We were astonished. I couldn't believe what I saw. Oh, my gosh. ... My history with this goes back to the early 2000s, where we were seeing this kind of abusive lending, but it was the marginal players in the mortgage industry that were doing it. And they were targeting low-income neighborhoods, minority neighborhoods. And so I left and I came back, and these lending practices had gone mainstream. Everybody was doing them and it was a real parade of horribles. They had these things called 228s and 327s — they called them hybrid fixed mortgages, which is completely misleading. They had a "fixed rate," which is very high, like 9 or 10 percent for the first couple of years, and then they jacked up to an extremely high rate, generally a 30 percent or more increase in your payment. So they were not underwritten so that the borrower can continue paying when the mortgage reset. Plus, there was very little income documentation, people with distressed credit histories, and anybody who looked inside these and did a bit of homework could see what was going on. And that's why it frustrates me when everybody says, 'Oh, this is such a big surprise,' because, if you did a little homework, if you were an investor and you did a little homework, you would have known not to buy these private-label mortgage-backed securities as they were called back then."

"If you were an investor and you did a little homework, you would have known not to buy these private-label mortgage-backed securities as they were called back then." Sheila Bair

On when she realized this could spill over from a few foreclosures to a full-blown crisis "I think there was growing recognition we had a very serious problem. Certainly during that period in the fall of 2006, I stepped up both internal and external advocacy of putting some mortgage-lending standards in place, and we really needed the Fed to step up and do that because only the Fed had the power to write rules for both banks and non-bank originators. So we started that effort. But we carefully watched the housing market turn and the delinquencies and defaults starting to accelerate fairly significantly by 2007. I think there was a growing recognition, by the spring of 2007, we were pushing for system-wide loan modifications. We convened several meetings at the FDIC with the securitizers — Fannie and Freddie and FHA, all of the ones that guaranteed mortgages, the rating agencies, everybody. Tried to get everybody in the same room to say, 'Look we've got a problem. We need to get these mortgages modified.' It was going to be complicated to do that. "We got a lot of happy talk — 'Yeah, we're going to do that.' And our solution was just get rid of these resets, just convert these into 30-year fixed-rate mortgages at this starter rate, what they called the starter rate. If they're performing at the starter rate, let them keep paying at the starter rate. All you had to do is look at these mortgages and know that there was no way in the world those families were going to be able to pay the higher mortgage. It just wasn't going to happen. They didn't have it. They didn't have the money." On where our financial system is at right now "Certainly the system is more resilient now, but I'm very concerned about all this recent rhetoric. And [former Treasury Secretary] Tim Geithner, obviously, he and I have had our disagreements, and they're policy disagreements, but here's another one, because his emphasis right now is all about expanding the government's bailout tools based on the assumption that we're going to have another cycle, we're going to have another financial system that's going to need government help, and so we need more bailout tools. And I think that's absolutely the wrong system. That's the system we still have and we don't want to save that system. We have something called Title II, which we did not have in 2008. That allows regulators, the FDIC, working with the Treasury and the Fed, to put a bank into a resolution process, to break it up, keep its bad assets out, impose the losses on the shareholders and the unsecured creditors — which is where the losses should be and where the losses are also if you go through a traditional bankruptcy — to fire managers, to fire board members, to recapitalize the bank and to bring in new investors and new management, and return the healthy parts of the bank back to the private sector. So, yes, that is basically what you do in a bankruptcy. This is a government-run bankruptcy process. There are some unique things about large financial institutions that make traditional bankruptcy difficult to use. That's a tool we didn't have in 2008, we have now. But regulators need to be willing to use it, and importantly signal now, remind the markets, that this is going to be the new paradigm. This is the new process — not bailouts, but accountability."

"All you had to do is look at these mortgages and know that there was no way in the world those families were going to be able to pay the higher mortgage." Sheila Bair