Sheila Bair: ‘I’m nervous, to be honest’

When the woman who was chair of the FDIC during the 2008 global financial crisis says she’s seeing cracks in the economy, maybe it’s time to listen.

“I’m nervous, to be honest with you,” Sheila Bair told attendees on October 14 at the National Association of Corporate Directors’ annual summit in Washington, DC, listing factors such as deregulation, an AI investment “bubble,” and private credit as reasons why.

Specifically with regard to banking, Bair said one measure of bank capital strength, the leverage ratio, has “dropped about down to where it was in 2009.” The weakening of rules about how much capital banks need to hold won’t help, she added.

“The Fed has got yet another series of rules that’ll probably be finalized in December to erode bank capital even more, and I don’t understand why,” she said. “The stated reason has been to expand lending, but we have inflation right now.”

If banks release another “extra couple of trillion of lending capacity, that’s going to be inflationary, and they’re going to be looking to take more risks, because the creditworthy borrowers are pretty much getting the credit they need right now,” Bair added. “So that worries me a lot.”

Bubble, bubble. The fact that “the whole economy, including the financial sector, is heavily exposed to AI,” is also cause for concern, Bair said. “I do think it’s a bubble.” While she believes that AI will improve productivity over time, she thinks that AI companies’ valuations are inflated and that their financing is iffy. (“These circular financing agreements—oh my gosh, they remind me of the trusts back in 1929,” she observed.)

Then there’s private credit, which Bair called, “kind of like the new subprime, not for mortgages, but for high-risk, mid-share companies.” Banks have a lot of exposure to private credit, she said, and “we’re already seeing some stress there.”

But US regulators’ emphasis is “primarily on banks that have insured deposit subsidiaries,” Bair said. She said she thinks the “very siloed” financial system…in the US sometimes impedes supervisory effectiveness…This balkanized system means risk explodes outside the regulated system. This happened in 2008,” she said.

And if the financial system does falter, opportunities for relief are limited, Bair warned. “We don’t have the fiscal capacity to provide the massive stimulus that we did after 2008 and certainly during the pandemic,” she said. “Our tax revenues are declining. If the economy is going great guns, we should be bringing in tax revenue hand over fist to start making a bit of a dent in these deficits, but you’re not seeing it happen.”

Riding out turbulence. Bair’s advice for companies is to monitor risk and be aware of potential threats. While serving onboards, she said, she would have the board and management surveyed separately to see what they saw as the company’s biggest risk. Often, they weren’t aligned. Management, she said, can get “caught up in the day-to-day,” and boards often have a clearer picture of external risks.

Bair also advocates scenario planning and tabletop exercises. “Just by the fact of planning, you start thinking through the kinds of decisions, the kinds of issues that might arise,” she said.

In times of uncertainty, keep the fundamentals solid, she advised. If you have a strong balance sheet, financial downturns “will become buying opportunities for you,” she said. “If you don’t, you’re going to be the one getting bought, or worse.”