As chairwoman of the FDIC, did you get an opportunity to brief the president on your concerns?

Not in the Bush administration. It was pretty much done at the regulatory level.

So how high could you take your concerns, or who do you talk to?

We talked to other banking regulators at the Fed and the OCC [Office of the Comptroller of the Currency] and the OTS [Office of Thrift Supervision]. We raised our concerns with Treasury. We convened a series of roundtables in the spring of 2007. ...

First we pushed to strengthen lending standards at least that applied to banks for both subprime loans as well as what they call "nontraditional mortgages," which are mortgages that have negative amortization features. ...

We pushed for that and were not able to get a stronger standard for subprime until early summer of 2007. There was a lot of resistance from the industry as well as from other regulators to do that. There were so many loans that were already made that were bad; we knew they had to be restructured. Especially [with] these steep payment resets, we were going to start having a huge wave of foreclosures.

So we convened a series of roundtables with the other regulators: Treasury as well as the securitization industry, their accountants, the tax lawyers, the underwriters, the servicers. Everyone came in, and [we] were able to establish that there was legal authority to restructure these loans. ...

We thought these loans were going to get restructured, and then it just didn't happen. ... At that point the problem wasn't so much underwater mortgages, ... [it] was really unaffordable mortgages, because some of them couldn't even afford the initial payment, and they certainly couldn't afford the reset.

So we were pushing for interest rate reductions, converting them into fixed 30-year mortgages at low market rates as opposed to these really high basic rates that you would see with the subprime. ...

There was clear authority to lower interest rates. There was less legal authority to do principal write-downs. ...

So they can't change the terms of the contract because it's all tied up in some cluster of other securities?

Yes. You can't put enough emphasis on how the securitization model skewed economic incentives to make creditworthy loans to begin with, because you severed the origination process -- the entity that was actually deciding to make the loan -- from those who would actually own the loan. And because of that severance of economic interest, you ended up with a lot of very bad mortgages being originated.

But on the servicing end too it's been the same problem, because the entities servicing the loans -- those responsible for collecting the payments or working with the borrower if the loan becomes troubled -- those people are not the same people who own the loans. ...

During these roundtables we established that there was lots of legal authority to reduce interest rates, not so much legal authority to reduce the principal amount, so we were pushing very hard for significant interest rate reductions on a long-term, sustainable basis.

But you weren't able to get it done?

We were not. We got a lot of happy talk that they were going to do it and then--

Happy talk from?

From everybody. From the servicers, from the investors, from the Wall Street firms doing the securitizations. Everybody said: "It's going to get done. It's an obvious thing to do, and we're going to do it." And then it didn't.

This is the fall of 2007. The roundtables are in the spring, where we got everybody's buy-in to support loan restructuring. That fall, Moodys.com does a survey and finds out that less than 1 percent of delinquent subprime mortgages are being reworked. The vast majority are just going into foreclosure.

That was when I started going public, because I think there were a variety of reasons why this wasn't happening. The servicers were understaffed and didn't really care. They didn't own it, right? If anything, they had financial incentives to foreclosure. ... If you did a restructuring, whatever money they were owed in terms of fees and things had to be put into the restructured mortgage and it would be paid out over time. You do a foreclosure, they're paid off immediately.

And the investors were pushing back. I think not enough attention has been given to that. What we call the AAA investors -- the investors in the securitization trusts that had the most senior, the most protected interest of these pools of mortgages -- they didn't really care, because if the loans went into foreclosure, what they called the "lower tranches" were going to take the credit losses.

So if you reduced the interest rate, everybody in the securitization pool gets a reduced return. But if you go to foreclosure, for the most part the AAA investors are protected. ... The AAA investors, there's a lot of very powerful institutions. They didn't really see it as in their interest for these interest rates to be reduced. ...

So that was the banks and their clients?

Right. So the big bondholders. Fannie [Mae] and Freddie [Mac] held a tremendous amount of the AAA paper.

Pension funds? Insurance companies?

That's exactly right. ...

... You go forward with speeches. You say, "We have a huge problem on our hands" in one speech. What kind of support are you getting from any other part of the government?

Not much. I think we were getting some lip service.

So you’re the skunk in the room?

I was. Somebody called me that actually, said, "Skunk at the picnic." But I didn't feel like I had any other alternative. We had tried internal meetings. We had tried job owning. We'd tried interagency action. Again, these Wall Street firms and a lot of the originators who were funding these mortgages were outside of the insured banks.

We weren't the primary regulator of many of the big banks or thrifts that were doing this kind of lending, number one. And number two, a lot of it was being done completely outside of insured banks. Wall Street, of course, was completely beyond our reach. Those were securities firms.

We didn't really have legal power on our own to force people to do anything, so our only tool was really public advocacy and media pressure and public pressure to try to get it done. That was the strategy we decided to use.

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