Sheila Bair has been an advocate of financial education for everyone from homebuyers to kindergartners since she stepped down as Federal Deposit Insurance Corp. chief a few years ago, but it's not just Main Street that needs economic schooling in her mind.
Big institutional investors demonstrated a profound lack of fiscal skill in the run-up to the financial crisis, she says.
Institutional investors' failure to research the risk associated with the mortgage-backed securities they traded left them exposed when the assets turned toxic, Bair said Tuesday in a speech at the Museum of American Finance in New York City.
"Because [institutional investors] didn't do their homework, they lost market discipline and didn't appropriately price for the risk they were taking, and they were surprised" when the wholesale market soured, Bair said. "And that surprise is one of the reasons the market seized up — they ended up having a very low risk tolerance for taking any losses."
Bair largely avoided naming names in her critique of private investors, although she singled out Citigroup (NYSE:C) — which she has previously argued should have been allowed to fail during the crisis. Financial irresponsibility was pervasive among the majority of institutional investors, she said.
"If big institutional investors had worked a little harder at the basic core principles" of economics such as buyer beware and understanding risk, Bair said, "we wouldn't have had the crisis we had, because the market wouldn't have funded it. You wouldn't have gotten the investment and this kind of excessive risk-taking."
Moreover, Bair said, if investors had followed the lead of Warren Buffet — an investor with a reputation for careful risk management who managed to make money during the crisis — "they would have been in a better position to absorb the losses when the market turned."
While Bair reserved her harshest words for institutional investors, the former FDIC chairman — who currently serves as a senior advisor to the nonprofit Pew Charitable Trusts — noted a few other areas in need of improvement.
Banks should face higher capital requirements, Bair said, which would force them "to put more skin in the game."
"We need to force banks to fund [their activities] with more common equity, which will give their shareholders more of an incentive to monitor risk" and provide banks with a cushion for potential losses, Bair said.
In response to the argument that higher capital requirements could make banks less profitable, Bair pointed to out that Wells Fargo (WFC) — the highest-earning U.S. bank in 2013 — also has one of the highest capital levels. It had a Tier 1 common equity ratio of 11.36% under Basel III in the first quarter.
"Capital is a competitive strength, not a competitive weakness," Bair said.
The financial industry must also face up to the cultural issues that contributed to the crisis, Bair said. She argued that traders who work in large institutions frequently feel disconnected from the effect their actions might have on everyday people.
"Their environment is a blinking screen, their thought process is in algorithms," she said. "They don't interact with real people, but what they do has real-life ramifications."
"Maybe when people go into financial services, they should have to live with a homeless family for a while or stand in the unemployment line for a few weeks," Bair said, noting that her tongue was only partially in cheek.
The idea may not be too far-fetched. Referring to the idea that Wall Street workers should wait in unemployment lines, one audience member spurred a round of laughter with the observation: "I think we've done that in the last few years."