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00:00WE ARE TO HAVE THE SECOND ROUND OF THE STRESS TEST OUT TODAY. AS WE SAW FROM THE FIRST, EVERYBODY PASSED WITH FLYING COLORS. THIS TELLS US HOW MUCH CAPITAL IS BEING DISTRIBUTED. LET ME PUT UP A CHART THAT SHOWS SOMETHING. WHEN YOU LOOK AT THE MAJOR BANKS AND THEIR NET LOSSES. THEY HAVE BEEN GOING DOWN AND DOWN, WHICH MEANS THE BANKS ARE PASSING MORE AND MORE. IS THAT BECAUSE THE BANKS ARE STRONGER BECAUSE THE STRESS TESTS ARE WEAKER? SHEILA: THE BANKS ARE STRONGER THAN THEY WERE PRIOR TO THE CRISIS BUT I DO NOT THINK THEY ARE STRONG ENOUGH. YOU GET TO THE END OF AN ECONOMIC CYCLE AND THE VALUATIONS ARE INFLATED, RATES ARE LOW BECAUSE YOU HAVE SEVERAL YEARS OF BENIGN ECONOMIC ACTIVITY. THE STRESS TEST WILL NOT BE AN ADEQUATE REFLECTION OF HOW THE BANKS PERFORM IN A DOWNTURN. EVEN THE FED STAFF ITSELF HAS A KNOWLEDGE THIS IN THE FINANCIAL STABILITY REPORT. THEY SAY YOU CANNOT STRESS TEST ENOUGH TO ACCOUNT FOR THE CYCLICALITY AT THE END OF THE CYCLE. THAT IS WHAT WE ARE SEEING. DAVID: AS I UNDERSTAND, THE WAY THE TESTS WERE DESIGNED WAS YOU CANNOT ANTICIPATE WHAT WILL HAPPEN NEXT, YOU HAVE TO JUDGE FOR A LOT OF DIFFERENT FACTORS. THAT SEEMS TO BE MORE MORE SIMPLIFIED AS A MATTER OF POLICY . DOES THAT UNDERMINE THE WORTH OF THE STRESS TEST? SHEILA: I THINK IT DOES. FIRST OF ALL WE NEED MORE ROBUST LAWS FOR THE STRESS TEST. WE DO NOT HAVE A LOT OF TRANSPARENCY ABOUT HOW MUCH LOSS IS THAT GOING TO CAUSE THE BANKS. THERE IS SOMETHING CALLED A COUNTERCYCLICAL CAPITAL BUFFER THAT WE PUT IN AS PART OF THE REFORMS WE DID AFTER THAT TERRIBLE 2008 FINANCIAL CRISIS. THE IDEA IS TO RAISE CAPITAL BUFFERS TO THE END OF THE BUSINESS CYCLE AS WE ARE NOW. THE FED HAS JUST DECIDED NOT TO DO THAT. CHAIRMAN POWELL, WHO I RESPECT A LOT, HE HAS A LOT ON HIS PLATE, HAS TALKED ABOUT THE MEASURES IN MONETARY POLICY. WE NEED PREVENTATIVE MEASURES WITH SUPERVISORY POLICY. IF WE GET INTO A DOWNTURN IN THE FINANCIAL SYSTEM SEIZES UP AGAIN WE WILL HAVE ANOTHER RECESSION AND IT WILL NOT BE PRETTY. DAVID: DO YOU EXPECT THE FED WILL TELL ANY OF THE BANKS THEY CANNOT DISTRIBUTE THE AMOUNT OF CAPITAL THEY WANT? SHEILA: MY GUESS IS THEY WILL APPROVE CAPITAL DISTRIBUTIONS THAT WILL EXCEED EARNINGS. THE ACTUAL AMOUNT OF CAPITAL THEY HAVE WILL BE DEPLETED A BIT MORE. THE BIG BANKS, THEIR COMMON EQUITY TIER ONE CAPITAL, THE HIGHEST QUALITY CAPITAL HAS BEEN DECLINING SOMEWHAT. I HEAR THE FED WILL EXCEED EARNINGS. ALIX: IS THERE ANOTHER AREA OF THE FINANCIAL MARKET WE SHOULD BE PAYING ATTENTION TO, LIKE REGIONAL BANKS, THE LEVERAGE LOAN MARKET? SHEILA: ABSOLUTELY. THE REGIONAL BANKS -- IT WILL NOT BE SYSTEMIC, THAT IT IS SOMETHING YOU WANT TO AVOID AND PREPARE FOR. IT COULD BE VERY EXPENSIVE TO MILD AGENCY, THE FDIC, SO WE NEED A FOCUS ON THE REGIONAL BANKS AS WELL, AND LEVERAGED LENDING, WHICH IS A PROBLEM IN THE NON-BANK SECTOR IS GROWING WORSE. THERE IS A LOT OF HANDWRINGING ON LEVERAGED LOANS. THERE ARE CONSTRUCTIVE THINGS REGULATORS COULD DO. A LOT OF BANKS LEND TO THE NONBANKS. THAT IS A POTENTIAL SOURCE OF TIGHTENING. THEY COULD WE PROPOSE THEIR LEVERAGED LENDING GUIDANCE. THERE ARE AUTHORITIES AND DODD-FRANK TO DEAL WITH SYSTEMIC ACTIVITIES, EVEN IF THEY ARE BEING DONE BY NONBANKS. THAT REQUIRES THE FCC WORKING WITH THE FED. THERE ARE TOOLS NOW THEY CAN USE TO ADDRESS LEVERAGED LENDING. A LOT OF HANDWRINGING BUT NOT SEEING MUCH ACTION. DAVID: COMPARE WHAT IS GOING ON IN EUROPE WITH UNITED STATES. YESTERDAY IT WAS SAID THEY ARE RAISING CAPITAL REQUIREMENTS TOO MUCH IN SWITZERLAND. HIS UNITED STATES GETTING LOOSER WHILE EUROPE IS GETTING TIGHTER OR IS THAT A MISPERCEPTION? SHEILA: THE GOOD THING WE DID IN THE U.S. IS FOUR-STAR BANKS TO RECAPITALIZE WEEKLY. YOU ARE COMPARING APPLES AND ORANGES. I WANT TO ADDRESS ANOTHER FACET OF THAT QUESTION WHICH IS THE MYTH THAT STRONG CAPITAL REQUIREMENTS RESTRAIN ECONOMIC GROWTH. CAPITAL REQUIRES YOU RAISE MORE MONEY THROUGH EQUITIES AS OPPOSED TO DEATH, IT IS STILL MONEY THAT CAN BE JUDGED AS OPPOSED TO DEBT. IT IS STILL MONEY THAT CAN BE LOANED. DAVID: THANK YOU SO MUCH FOR SPENDING TIME WITH US. SHEILA BAIR OF POKER ALLIANCE COMING TO US FROM WASHINGTON -- OF OLDER ALLIANCE -- OF VOLKER

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Sheila Bair: Banks Stronger Than Before Crisis, But Not Strong Enough

Sheila Bair, founder at Volcker Alliance and former head of FDIC, discusses the 2019 Federal Reserve big bank stress tests. She speaks with Bloomberg's David Westin on "Bloomberg Daybreak: Americas." (Source: Bloomberg)

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