Small banks need a role at the table in originating residential mortgages, and servicers need to simplify the loan modification process, according to Sheila Bair, outgoing Federal Deposit Insurance Corp. chairman. In an interview with Institutional Risk Analytics, Bair also said she'll involve herself in housing issues this fall when she joins a foundation that she did not identify. "The mortgage origination process has been so heavily concentrated I do think it is important for the smaller banks to participate," she said in a Q&A interview with Christopher Whalen, whose columns also appear in HousingWire's monthly magazine. "We need a more diversified market to protect the banks, and this also benefits the consumer," Bair said. "Smaller banks like the high touch model of customer service. They want to keep the servicing on loans. Any strategies we can come up with to enhance competition and help banks to diversify their business models are good." The Independent Community Bankers of America released a statement Thursday commending Bair's service and crediting her for "understanding the critical issues that community banks faced during the heart of the financial crisis." The trade group said Bair "supported ICBA's efforts to rein in too-big-to-fail institutions." On loan modifications, the FDIC saw a lot of success in encouraging commercial lenders to restructure their commercial exposures but less success with the residential loan holdings, she noted. "On the commercial real estate side, we have seen a lot of progress in restructuring. The process works pretty well and with relatively little political controversy," she said. "To the industry's credit, when we told banks to be aggressive in restructuring commercial exposures, we just did not see the pushback." Things have progressed more slowly on the residential side contributing to a stagnant recovery in the housing sector even though Bair and her colleagues at the FDIC warned of a subprime meltdown and tried some solutions early-on like experimenting with loan modifications at failed banks such as IndyMac. The Obama administration has indicated renewed interest in looking at more mortgage modifications as home prices continue to stagnate. Part of the reason for less success on residential modifications "was an understandable visceral reaction against modifications for troubled borrowers by others who were making their mortgage payments," Bair said. "My frustration is that we did not make the business case for modification and other creative solutions early enough. We kind of missed our window in 2007 to do more home mortgage modifications in a large-scale way," according to Bair, who relinquishes her chairmanship Friday. Servicers, she said, need to work on simplifying the process while being realistic about the volume of distressed assets. "Unfortunately, the low level of resources available to handle modifications is another concern. The second point is that we need to change our strategy to meet changing economic conditions. There have been some programs for the unemployed but we may be able to do more here," Bair told Whalen. She also said underwater mortgages and resetting option adjustable-rate mortgages will mean "a growing number of people will be in too much house." First servicers should consider loan modifications, but if they don't qualify, short sales, cash for keys and other methods need to be immediately considered. "These programs need to be very simple," she said. "With the dysfunction in the servicing sector this is not happening. Banks have not been spending the money on capacity, training and other areas to enable us to work through problem." Write to Kerry Curry. Follow her on Twitter @communicatorKLC.