If Sheila Bair was still a banking regulator, there might have been a lot more banks "failing" the stress tests.
Bair, now a senior adviser at the Pew Charitable Trusts, has argued that banks need to be regulated by terms of debt-to-equity. She sat down for a Q&A with Ronald D. Orol, a reporter at Dow Jones sister publication MarketWatch, and sharply criticized the Fed's stress tests.
Here's an excerpt from MarketWatch:
Some of the biggest banks in the U.S., including Goldman Sachs Group Inc. and J.P. Morgan Chase, passed the Federal Reserve's stress test but would be considered overleveraged if Sheila Bair were running the examinations.
Bair, chairman of the Federal Deposit Insurance Corp. between 2006 and 2011, told MarketWatch that the Fed should have focused more heavily on limiting leverage as part of the stress test conducted on 19 big banks.
The following is an edited transcript of the conversation:
MarketWatch: You've expressed concern about parts of the Fed's stress tests on the 19 largest banks, arguing that the central bank should have focused more heavily on a bank's leverage ratio — can you explain?
Sheila Bair: The whole point of the exercise is to see how these banks would perform in a stressed scenario. In such a situation, as we saw in 2008, the market only cares about the bank's leverage ratio [which measures the institution's tangible common equity to total assets]. The market doesn't trust the risk-adjusted capital, which allows a bank to lower its capital if those assets are viewed as low-risk.
Unfortunately, the Fed really drove their decision on dividends based on the institutions' risk-based ratios, and I think that was ill-advised. I don't think any capital distribution should be allowed that would bring a bank holding company's leverage ratio below 4% in a stressed environment. Of course, that means that in a normal environment, the leverage ratio needs to be much higher.