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									                            KENNEDY LIBRARY FORUMS
                                  Monday, April 28, 2008

TOM PUTNAM: Good afternoon. I‘m Tom Putnam, the Director of the John F.
Kennedy Presidential Library and Museum. And on behalf of John Shattuck, CEO of the
Kennedy Library Foundation, and all of my Library colleagues, I thank you for coming
out on this rainy spring evening to this very special forum.

I'm pleased to acknowledge the underwriters of the Kennedy Library Forums, including
lead sponsor, Bank of America, represented here tonight by Massachusetts State
President, Robert Gallery, and our other generous sponsors, Boston Capital, the Lowell
Institute, the Corcoran Jennison Companies, and the Boston Foundation. Our media
sponsors are The Boston Globe, WBUR and NECN.

In this hour of economic uncertainty, I'm reminded of a speech given in 1962 by
President Kennedy at Yale University, in which he articulates the need for business,
labor, and government to meet their respective responsibilities to restore confidence in
the national economy. Let‘s listen to a brief excerpt.


TOM PUTNAM: One of the most formidable and influential members of Congress
today, Barney Frank assumed the Chairmanship of the House Financial Services
Committee in 2007. In that role, he has proven to be an inspiring national figure in
confronting the sub prime mortgage crisis and the current turmoil in financial markets.
Never one to rely on old clichés, in fact a master of reinterpreting them, Congressman
Frank recently reminded us that the notion emanating from the 1960s, that a rising tide
lifts all boats is seriously flawed. For if you are among the many in our society too poor
to afford a boat and are standing tiptoe in the water, he quips, the rising tide goes up your
nose. [laughter]

Described as a liberal who understands markets, he suggests that under-regulation is not
just a factor, but the single biggest cause of the fix we are in today and advocates for
government regulations as effective safeguards against irresponsible risk taking in the
market. Congressman Frank began his career as Chief Assistant to Boston Mayor Kevin
White and has always shown a keen aptitude for recognizing creative policy innovations
and knowing how best to implement them. After 14 terms in office, he‘s currently one of
the most expert members on Congressional rules and calls himself not a policy wonk, but
a wonk about how to get things done. We are a better country for his creative talents,
tireless efforts and legislative accomplishments.

Our moderator this afternoon is Paul Krugman, Professor of Economics and International
Affairs at Princeton University, columnist for the New York Times and one of our
nation‘s most well informed, trenchant commentators on the interplay between politics
and the economy. His most recent book, The Conscience of a Liberal, is a history of the
growing economic divide in the United States and a prescription on how those trends can
be remedied. His columns capture with striking clarity the underlying sources of our
national economic problems. For example, in a parody of President Kennedy‘s words,
Professor Krugman wrote, ―In the wake of the insider trader scandals, that the philosophy
motivating the indicted corporate CEOs seems to be, ‗Ask not what a high stock price can
do for your company, ask what it can do for your personal bottom line.‘‖

He concludes his earlier book, The Great Unraveling: Losing Our Way in the New
Century, with a tribute to the late James Tobin, former Nobel Laureaute and economic
advisor to President Kennedy, who, he writes, had a ―faith in the power of ideas. That‘s a
faith that grows harder to maintain as bad ideas with powerful political backing dominate
our discourse.‖

Confronting bad ideas with powerful political backing was at the heart of JFK‘s address
at Yale. In his effort to lead the national dialogue out of the ―bog of sterile acrimony‖

President Kennedy articulated the requirements for restoring America‘s confidence in
itself and its economy.

Tonight, we are honored to listen to a conversation between two public figures who daily
restore confidence in our country‘s ability to engage in an enlightened political debate –
respecting the free market while not deifying it – and to right the nation‘s economy in
service to all of its citizens. .Please join me in welcoming Congressman Barney Frank
and Professor Paul Krugman. [applause]

PAUL KRUGMAN: There's so much to talk about, let‘s just start with something very
charming. I was thinking about, as I was getting ready for this, sort of how things have
evolved over the past couple of years. So two years ago today, we were being told how
great things were. One year ago today, there was this thing that had sort of emerged
called sub prime, but the buzzword at the time was contained, it was all contained. And
now, we're sort of hanging on there, wondering, How did we get here? How did we get
into this mess?

BARNEY FRANK: Well, you're exactly right about the case. In November of 2006
when the Democrats won, I became the Chairman-in-waiting of the committee, and I was
deluged with the arguments, if you remember, that if we did not substantially deregulate
our financial institutions, everybody was going either to England or to Hong Kong and
Shanghai, depending I guess on their culinary tastes. [laughter] But we were going to lose

And, I mean, people are going to go back and look at this overwhelming consensus in
November of 2006 from all the experts you had, the committee that Hank Paulson picked,
Mayor Bloomberg and Senator Schumer had the McKinsey Report, and of course we are
now in exactly the opposite direction and people forget that. Then what happened was, I
think, innovation in the financial sector, securitization, lot of liquidity and this mindset of
no regulation. And I think if you go back, Ronald Reagan gets hailed for his ideas. Let‘s
remember his central idea, as far as domestic policy was concerned. I remembered from

his first inaugural, ―Government is not the answer to our problems. Government is the
problem.‖ And that philosophy is why we're here today.

PAUL KRUGMAN: Here's a question, a couple of branch-offs. Why now? I mean,
we've been deregulating, what caused it to break at this point?

BARNEY FRANK: Well, that's something where I would defer to you and other
economists in economic concerns. It does seem to me there are some parallels. There is
this tendency for innovation in the private sector to flourish. And at first to be very
welcome, and in fact to do a lot of good, whether it‘s the large industrial enterprises of
the late 19th century, or the stock market in the middle of the 20 th century. But it outstrips
reasonable rules. And there you go, you get all these innovations, nobody controlling
them. And at some point, the problems have accumulated.

I guess it maybe -- maybe this is true in the depression era -- you reach a point where if
anything, if a normal kind of economic pause comes, you're so over-leveraged, you're so
over-extended that the consequences become disastrous.

PAUL KRUGMAN: Let‘s back up. I mean, there are a few arguments I hear, one of
which is that this is basically about the housing bubble and the housing bubble was going
to happen anyway. Or maybe it had less to do with regulation than it had to do with
Greenspan keeping the rates too low too long. Where do you stand on all of that?

BARNEY FRANK: First of all, you said correctly people were telling us over a year
ago, ―Oh, this is going to be contained.‖ Well, in fact, that is exactly what didn't happen.
As you say, that was a key issue because it was not just the housing bubble. The fact that
people made mortgage loans that shouldn‘t have been made and then leveraged them now
means you can‘t sell municipal bonds, that 100 percent guaranteed student loans can‘t
sell in the market. So clearly what happened was the housing – I mean, essentially,
people made a lot of investments they shouldn‘t have made in the housing market. When

they got burned by that, they then decided to make some that rationally they should
make. But clearly, the housing thing just totally poisoned the rest.

And what happened was, people … I think it‘s a very fairly simple thing, in retrospect.
Until maybe -- what, 20, 30 years ago -- 20 years ago, loans were made by institutions
that expected to be repaid. You lent money to people and they repaid you. And then you
got into securitization where you lent money to people, you sold the loan, it was then,
thanks to technology, split up so nobody kept track of it and we've lost the
lender/borrower relationship. And then we were told, ―Okay, don‘t worry. We have these
substitutes for that, we have risk management. We have the rating agencies, we have
quantitative models, we have diversification. And it turns out that if you make enough
bad loans in the first place, none of those things work. You get them so obscure, the
rating agencies—I mean, there are a lot of problems with rating agencies. I think
essentially the problem was they were telling us more than they knew, more than
anybody knew, they were making things up as long as they went by these rules of thumb.

But the key is that the problems that started out in mortgage loans being made that
shouldn‘t have been made multiplied throughout the system and it turned out, again, the
lender/borrower relationship had more inherent discipline. We took that discipline for
granted when we got into all this exotica and securitization; we haven‘t found a

PAUL KRUGMAN: This is going to be a funny question, but did you see any of this?
Because I mean, let me say, I saw the housing bubble. I saw that it was going to be nasty.
But the financial chain reaction had caught me completely flat-footed. I wasn‘t at all
ready for this.

BARNEY FRANK: I‘ll say a couple of things on housing. First, I will give myself a
little credit because one of the things I have been saying for a long time is that we made a
mistake by providing decent housing for people by helping everybody be a homeowner.
Not everybody can be a homeowner. I wish everybody could afford to be. One of the

things we did was to cut back on rental housing, particularly when the Republicans took
over in 1995; they killed virtually all of the programs to build rental housing and the
mantra was, ―We're going to make everybody a homeowner.‖ And that was part of the

I went to Minneapolis at the request of the congressmen there to listen to the problems as
an audience. And the advocacy groups come up with the examples of problems. And one
man said -- and they told me he was representative -- ―Well, my wife and I got evicted
and we couldn't find another place to rent, so we bought a house. It‘s now in foreclosure.‖
So I did see some potential for the housing market to drop, I did not see the chain
reaction. I did not see that the problems in sub prime would spread as much as they did.
And I think it goes back here to another great conservative saying that I lived with for 12
years when Dick Armey was the Republican leader in the House and he was their Ph.D.
economist, often hailed as their leading congressman. And his motto was, ―The markets
are smart and the government is dumb.‖ And their view was you just keep the
government out of it, so nobody was restraining anybody from doing any of it.

PAUL KRUGMAN: Sorry, I can‘t resist. I‘m an economic textbook author, and Dick
Armey did actually write a textbook and it did so badly as a textbook that there was
nothing else for him to do except take over the country. [laughter]

BARNEY FRANK: I will have to say, maybe that's a point in favor because if his
textbook didn't sell, maybe that's a point for the market. [laughter]

PAUL KRUGMAN: There we are. Now, let‘s …

BARNEY FRANK: Nobody saw this coming. Nobody saw, though I believe people
like Bob Schill (?) and others were very tough and knew about the housing market. I
don't remember anybody saying that it was going to lead to this degree of cataclysm. I
don't think anybody understood, certainly not the people who were perpetrating it, the
extent to which they had interrelated all these things, the extent to which they had over-

leveraged, the extent to which they had interconnected everything and sold each other all
these bad things. They had created this wholly unstable system and it just took this one
big failure in the housing market. I don't think anybody understood how much they ha d
built a house of cards.

PAUL KRUGMAN: The real economy is no worse than I thought it would be at this
point. We‘ll see where it goes from here. But the door through which I thought it was
going to do terrible things was quite different. I thought that the collapse of consumer
reliance on home equity loans was going to hit consumer spending much harder than it
has so far, but I didn't at all see these financial knocks on the way this would end up --
that the Metropolitan Museum of Art would end up suddenly paying high interest rates
because of the effects of sub prime lending.

BARNEY FRANK: I think it is -- and precisely to what you're saying -- it does focus on
the absence of regulation. Because, again, what happened was the financial community
was allowed to do whatever it wished. There was no government intervention. In fact,
they said a year and a half ago we needed less government intervention. And some of
these people, you know, designed the system. I've been told by some, ―Well, you know,
there are some smart people who don‘t agree with what you're saying.‖ I mean, that's
true. No dumb people brought us this problem. This is an economic problem brought by
some of the smartest people, we were told, in the world. And apparently they built this
wholly interconnected, terribly fragile world in which as one thing started to go bad,
other things went bad and then they lost confidence from being – I‘m talking about the
financial community -- among the most arrogant operations in the world, they've now lost
all confidence. They don‘t buy things that they ought to buy.

PAUL KRUGMAN: We're going to bounce around here, but I mean there is a view that
says there may actually be substantial overreaction right now, that the credit default
swaps are valued too little, that there's actually …

BARNEY FRANK: I think there is an overreaction. You know, it‘s the people who
made the mistakes in the first place who are overreacting now. And by the way, I think
that's another strong argument for regulation. What we have now are people afraid to buy
things. People are afraid to buy anything because they were told for so long, ―These are
AAA rated,‖ and they bought AAA rated stuff that went totally down. Good regulation, I
think, is an essential part of bringing the market back because people aren‘t going to buy.
It's like the SEC. If we didn't have an SEC, you would have people not investing in the
market. I think giving people some confidence that what they're buying has some
validity is important. So in rational terms, yeah, we have 100 percent … Look, Senator
Kennedy is working hard on this. We have 100 percent federally guaranteed student loans
we can't sell. Municipal bonds backed -- it‘s a crazy example -- municipal bonds backed
by the full taxing power of the city and the state never fail. They never fail. Moody‘s
acknowledges this. Despite that, they were told by the markets, ―Well, you better get
insurance.‖ Now, requiring a municipal issuer of a full faith and credit bond to buy
default insurance is like making a grandpa buy life insurance. You're insuring against an
event that can‘t happen. But nonetheless, they bought it. But then what happened. So
they have to pay for bond insurance. But then to add injury to the insult, the bond insurers
take these premiums that are coming in a steady stream from the municipal issuers, they
invest in CDO2, having no idea what they were talking about, as now we're investing in,
and their credit goes in the toilet. And so now we have cities and states all over this
country paying higher interest rates to build bridges and schools because their bond
insurers made terrible investments and they went down. So that's an example of an
overreaction, punishing the City of Boston or the State of California because their bond
insurer made stupid decisions.

PAUL KRUGMAN: By the way, I'm not sure if everybody knows what a CDO2 is. It‘s
a collateralized debt obligation where you take basically junky assets, sub prime loans,
package them together, allocate people different rights, and supposedly some of those
rights were AAA rated stuff, except they weren't, actually. And then someone else takes
those things and packages them together and makes another. And out of that …

BARNEY FRANK: Then that‘s squared. But Warren Buffet has been very good in all
this. We asked him for some advice. He came in and met and said, ―Well, I have this rule
that you shouldn‘t own anything you don‘t understand. Because I don't want people to
feel bad if they don‘t understand this. Because the people who sold it didn't understand it,
and people bought it certainly didn't understand it.‖ And what Buffet said is, ―My rule is
I won‘t own anything I don't understand. So we bought some company and I said, ―All
right, bring me the stuff, I want to go over it.‖ And he said, ―The first thing I saw was a
70,000-page prospectus on investment.‖ He said, ―We sold that company the next day.‖

PAUL KRUGMAN: Wow. There is, by the way, if you do a little Googling, you‘ll find
there's a PowerPoint explaining CDOs with stick figure cartoons. It‘s basically got these
various people, there's this steaming heap of garbage in the corner going, ―How can we
get rid of this steaming heap of garbage?‖ They managed to pass it on to somebody else
instead, step by step.

BARNEY FRANK: Again, go back to your central question. Housing was over-priced,
that's a correction. And to some extent, by the way, that's a socially good thing because
people were priced out of the housing market. How did that become a worldwide
economic crisis? How did we get to a situation where a year and a half ago we were
being told America had to deregulate because we were going to lose industry, we were
going to lose economic activity. Instead, we wound up all last year exporting bad
mortgages and causing bank failures in Germany and England. And it is because they
managed to wrap all this up together in badly understood ways and pass it on to each

PAUL KRUGMAN: Now, one of your op eds talks about how in 1994, just before Dick
Armey took over the world, you had passed legislation that gave Greenspan, gave the
chairman of the fed, regulatory power which it didn't use. What should/could he have

BARNEY FRANK: You ask a very good point, and I have a bifurcated view of Alan
Greenspan. And I will say I had it at a time when he was venerated. [laughter] I do think
as liberals we should appreciate that in the ‗90s when a number of people were saying
that if unemployment dropped below 5 percent, that was inherently inflationary and
therefore you had to deflate the economy. He resisted that and he said, ―No, I think
productivity‘s come.‖ And he resisted some Clinton appointee who wanted to bring down
the economy because under Bill Clinton, unemployment ultimately got to 3.9 percent and
it did not cause inflation at the time. So in that sense, I thought he was right.

On the other hand, he has had this rigid ideological distrust for all regulation. I just saw a
comment of his that was quite striking for a man who was the chief financial regulator of
America, because the Federal Reserve is also the big bank regulator. He said, ―The
government never can do a better job than the markets,‖ which just belies what he
presided over for so many years.

But Congress in 1994—again, not an accident that this is the last time the Democrats
were in power—passed a law called the Homeowner Equity Protection Act that gave the
Federal Reserve the power to regulate all mortgages. Remember, our problem has been
that mortgages issued by banks, which were regulated by bank regulators, have not been
the main source of the sub prime crisis. It has been mortgages that came from people
outside the regulated system who weren‘t using depositors‘ funds which are regulated.
And he was given the authority to regulate those and explicitly refused to do it. A great
advocate, economist named Ned Gramlich, former member of the Board of Governors,
told us he asked Greenspan to please use his authority. Ben Bernanke is now in the
process of trying to use that authority. If people look at today‘s New York Times, you‘ll
see an article about how the business community is pushing back and trying to get him to
cut back on things that I thought were already too weak. But Alan Greenspan explicitly
refused to do it.

Another example, the Federal Trade Act gives the Federal Reserve the power to
promulgate a code of unfair and deceptive practices in the banking area. Now a few years

ago under Bush, the federal bank regulators preempted almost all state consumer laws
involving national banks. So a whole lot of state consumer laws were stricken. I went to
the controller of the currency and said, ―You've killed all these state consumer laws.
Shouldn‘t you be putting something in its place?‖ He said, ―You're right, but it‘s up to the
Fed because they have the right to promulgate the code that I will enforce.‖

I talked to Gramlich, he said, ―That's right.‖ I wrote to Greenspan, ―Would you do that?‖
He said, ―No.‖ So there were two very explicit examples, and I think that is part of the
problem. And then Greenspan would say, ―Oh well, it wasn't my fault. What did you
want me to do? Just deflate the whole economy?‖ I think you can make a similar
argument with regard to the dotcom issue. He didn't even try to do anything about stock
markets. And Greenspan‘s answer always was, ―I have two choices. I can let the abuses
continue, or I can cause a recession.‖ And when that was the choice, people would say,
―Well, okay.‖ He never would use authority in the regulatory area to try and prevent the
abuse or diminish the abuse.

PAUL KRUGMAN: So what would that have been? I mean, he would have tried to
establish a code of conduct for sub prime lending, for example?

BARNEY FRANK: Yes. For instance, basically what we've tried to do, and we passed a
bill in the House last year, and I hope the Senate will get to it, We essentially, frankly,
looked at what the bank regulators do with banks. If a bank were to give a mortgage to
someone who couldn‘t pay it back, the bank examiner would say, ―Why did you do that?
That's not a good idea because we insure the deposit, so we want to get into it.‖ And
essentially what we tried to do is to conceptualize the rules that the FDIC or the state
bank supervisors or the OCC has applied to bankers and make them apply to everybody.

PAUL KRUGMAN: OCC is the Office of the Controller of the Currency, which turns
out to have the authority to tell states that they can‘t do it.

BARNEY FRANK: That they can‘t do it, but go do it themselves.

PAUL KRUGMAN: And use that authority, yeah.

BARNEY FRANK: Exactly. And we have some very radical principles that Alan
Greenspan could have imposed on mortgage originators. Do not lend money to people if
they can‘t pay it back. Do not take collateral that's worth a lot less than what you're
lending. When you tell people how much it‘s going to cost, throw in little incidentals like
taxes. If you are going to give them a loan which pays a certain amount for two years and
then goes up in the third year, since you will have sold it by then and probably aren‘t
going to be the one they have to pay back, please explain to them not just how much it‘s
going to cost in the first two years, but how much it‘s going to cost in the third year.
Now, those are rules we are now trying to impose by statute that Greenspan could have
done by regulation.

PAUL KRUGMAN: How much effect do you think this would have had if it had been

BARNEY FRANK: I think it would have had a substantial effect in diminishing this
problem because if you look at the sub prime loans, the surprising thing was that the sub
prime crisis did have all these reverberations. If all mortgage originators followed the
rules that the banks had followed, we would not have a sub prime crisis. We would have
people going under as prices drop, but the percentage of bad sub prime loans
overwhelmingly comes from the unregulated sector.

It‘s unregulated in two ways. First of all, the people who originated the loans, the brokers
and others, in most states—and the states are culpable somewhat here, too; they could
have done some regulation and didn't. Also, although there are new pools of money
around -- liquidity as we call it -- from various entities not covered by depositor funds. If
you're lending funds that are given by depositors, then the federal regulators want you
because we have to make those up. But there were pools of money, so you had
unregulated originators lending money from unregulated pools of money. And I believe

that without that, you would not have the sub prime crisis and you wouldn't have this

PAUL KRUGMAN: So there's the counter argument. Look, those housing people got
so excited about housing. We've had financial bubbles in lots of things in the past, and
housing was just the latest and that falling home prices are the principle driver of

BARNEY FRANK: I agree with that. But again, I think you asked the central question
in a very honest way about acknowledging that nobody we can think of saw the impact it
was going to have. And people who say, ―I knew it was coming.‖ Yeah, show me the
email. I mean, if you knew it was coming, show me where you sent somebody that

But I think here's the answer. Yes, you're right, of course, there would have been people
who lost their homes. There would have been pain, no question. But I do not think it
would have become a worldwide economic crisis. And the argument for that is this: if
you look at mortgages that were originated by banks, banks are highly regulated. Banks
have all kinds of rules. They have to reserve capital, they even get examiners to come and
second guess different loans they've made. If only the regulated entities known as banks
or credit unions, thrifts, had made the loans, if you look at the percentage of sub prime
there, you don't have a crisis. You would have some increase, but it wouldn't have been
the qualitative leap you've had here.

An example, I notice Citigroup just about a month ago reorganized, again, and they had a
mortgage division that originated mortgages and they had a mortgage division that
bought mortgages originated by other people. And they said that the mortgage division
where they originated mortgages, no problem; the division where they bought mortgages
originated by other people, they abolished that and put the two together. Remember, the
key is this. Mortgages that were originated by the banks were under the rules that had
been formulated when you expected to get repaid. It‘s as simple as people being given the

right to lend a whole lot of money to other people with no incentive to get it repaid. In
fact, to be able to sell it and then make it into these CDOs as you described. And I really
do believe that if only regulated entities had made sub prime loans, if you look at the
percentage of failure, we wouldn‘t be in this situation.

PAUL KRUGMAN: The argument is that if only regulated entities had done it, there
would have been a lot less lending and home ownership; you know, we wouldn't have
succeeded in promoting home ownership.

BARNEY FRANK: Right. Well, we wouldn't have succeeded in promoting people who
owned homes for, like, two years. I mean, that's what we did. We did make a lot more
people homeowners -- unfortunately, temporary homeowners. It was kind of a new, I
don't know, new kind of timeshare. You get to be a homeowner for a couple of years. I
mean, I should be explicit about this. Part of the problem is this notion that everybody
should be a homeowner. And people are, ―Don‘t you wish that everybody could own a
home?‖ The answer is sure, and I wish I could eat more and not gain weight.‖ [laughter]
Part of it was a push factor. People were pushed into home ownership who shouldn‘t
have been there.

We should know, by the way, that's not the whole part of it. A large part of the sub prime
problem, and one of the worst parts socially, came from the refinancing. You talk about
older people, particularly in urban areas, who own their homes and then some sharpie
came and persuaded that person, very often an older woman, to refinance her home.
There was no need for her to do it, she had mortgage payments she could make, and they
wound up getting the homes. The rules that the Fed are talking about, you read today‘s
New York Times, it says, ―Oh, people are saying to the Fed you're tightening up too
much.‖ And people have said, ―Well, if you do what you're saying, some people won‘t be
able to buy homes.‖ The answer is yes, it‘s about time that we differentiate it and that
getting people into a home ownership situation that they cannot economically sustain or
perhaps fully understand is a great disservice to them.

PAUL KRUGMAN: See, I have a hard time being devil‘s advocate here because I agree
with you too much. One thing that I really notice is that the home ownership statistics,
after bopping up during the boom, are now back down, I think, to where they were in the
fall of 2001, basically before the sub prime expansion.

BARNEY FRANK: Now, there is something we can do about home ownership and this
administration, of course, doesn‘t do it. And that is we can attack the continuing racial
and ethnic discrimination that we suffer from. You know, we're here in the Kennedy
Library and my former colleague, Joe Kennedy, did a great piece of legislating about 15
years ago and got through an amendment to something called the Home Mortgage
Disclosure Act, over the objections of many in the industry, and it gives us statistics on
loans by race and ethnicity. And our neighbor here, City Library over at U Mass, they did
a study that showed if you are a middle to upper middle class African-American, you
were likely to get a sub prime loan in many cases than if you were a kind of working
class white person. So there is a reason to go after obstacles to home ownership, but they
are racial and ethnic unfairness.

And there's one other area that we've tried to work on in our committee, and that's
manufactured housing, as we call it, which has gotten kind of a bad rap. We had laws that
discriminated against manufactured housing for a variety of reasons. So we're trying to
extend home ownership, but only if you can reach people who can economically afford it.

PAUL KRUGMAN: One of the things that I've been getting a lot, hearing a lot, is this
sort of pushback from conservatives. And the one story that you do hear is that it‘s the
Community Reinvestment Act that's the villain, that the legislators were forced into

BARNEY FRANK: The Community Reinvestment Act, as people know, is a bill passed
in the ‗70s. William Proxmire, who was then Chairman of the Bank Committee put it
through. I wasn't there when it was done -- of which I can say that fewer and fewer
times, you get responsible for things the more you stay there, [laughter] but that was an

excellent bill. And what it said was, if you are a financial institution and you're taking
deposits in an area, you've got some obligation to put some of that money back into the
area. It is not coercive, it‘s overall general. It‘s generally enforced, by the way, only when
you want to merge. People here will remember. We had a big hearing when the Bank of
America bought Fleet, and we were able to use that as an opportunity to get some
commitments out of Bank of America. They've helped us, from which we still benefit.

But the argument that the Community Reinvestment Act -- you haven‘t heard that
argument quite so articulately since Flip Wilson went off the air. This is an older
audience, you remember Flip Wilson. And Flip Wilson had his character, Geraldine, very
politically incorrect. Geraldine – Wilson offended all manner of groups with his drag
queen, Geraldine. But her defense every time she was accused of some misdeed was,
―The devil made me do it.‖ And the CRA is the devil for these people, the devil made
them do it.

Couple of refutations: first of all, the CRA does not apply to the people who made the
bad loans. I mean, go back to my point before. The CRA, the Community Reinvestment
Act, applies to depository institutions. One of the problems with the CRA is that
increasingly now, loans are being made by institutions not covered by it, and we want to
cover it. But the Community Reinvestment Act covers banks, doesn‘t even cover credit
unions, which I think it should in the larger use of credit units. But CRA covers the
segment of the lending industry that didn't cause the problem.

Secondly, there's a guy named Larry Lindsey who was the Federal Reserve Governor in
the ‗80s under Reagan who was most responsible … They always have one, they have
different responsibilities in the Federal Reserve Board of Governors, as Ned Gramlich,
who I mentioned was under Clinton. Larry Lindsey was the Consumer Affairs guy under
Reagan. He wrote a long letter which I have put into the record and have distributed,
refuting the notion that the Community Reinvestment Act was a cause of irresponsible
lending. He said there is no evidence that it in any way jeopardized safety or soundness.
There's just zero evidence for that, and it‘s particular, as they said in the case, that the

great bulk of the loans that have caused the sub prime crisis were made by institutions not
covered by the Community Reinvestment Act.

PAUL KRUGMAN: And yet I have seen, not citing the act, but I have seen Angelo
Mozilo of Countrywide Financial, which is sort of your archetypal, I guess, villain in this
case saying that, ―It was affirmative action that made me do it.‖ [laughter]

BARNEY FRANK: Yeah. Mr. Mozilo who took down, what, $150 million while he
was helping bankrupt the country, blames the Community Reinvestment Act. Much of his
activity wasn't covered by the CRA. You're talking about a nationwide operation. I mean,
there is a problem in this area not covering entities like that. And, again, there was zero
evidence for it. The CRA, in the first place, does not get into specific loan decisions.
What it says is you should have a certain amount of your activity in the areas where you
take in the deposits. And it‘s a convenient whipping boy. Phil Graham, the former
Republican Senator, who helped put through the bill, the Graham-Leach-Bailey Bill,
which I think removed regulation when it should have been there in terms of investment
banking …

PAUL KRUGMAN: Phil Graham, we should point out, is supposed to be John
McCain‘s closest economic advisor.

BARNEY FRANK: Yes. When Phil Graham ran for President, John McCain supported
him. And Phil Graham has reciprocated. And he tried to kill the whole Community
Reinvestment Act. And there was literally zero evidence that it caused a problem. And I
will go back again, whether it‘s Countrywide or anybody else, and Mr. Mozilo says
affirmative action, not specifically Community Reinvestment Act. But again as to
affirmative action, the Home Mortgage Disclosure Act … well, let‘s put it this way: they
said, ―Well see, we gave all these loans to African-Americans and Hispanics.‖ But what
the Home Mortgage Disclosure Act data shows is yes, a large number of Hispanics and
African-Americans got the sub prime loans. But it‘s not that in a fair situation they would
have gotten zero loans, it‘s that in a fair situation, they would have gotten prime loans. So

there was a disproportionate racial element to the sub prime loans, but it came from them
being discriminated against and pushed into that category rather than being raised up.

PAUL KRUGMAN: Lot of people, in other words, who would have qualified for prime
loans got steered into sub prime and disproportionately, those would have been African-
American and Hispanic?

BARNEY FRANK: That's what the Home Mortgage Disclosure Act data shows, and
that's what the survey at U Mass Boston -- I forgot, there's a very good institute that does
it -- and they documented that race and ethnicity were a factor in people being pushed
into sub prime loans.

PAUL KRUGMAN: Let me give you, well, two more devil‘s advocates, and another
one along those lines. I've been getting a lot—I thought it was a joke when it started—
that zoning is the villain. That it‘s restrictive zoning because our problem was that home
prices were too high and zoning leads to high home prices.

BARNEY FRANK: Well, I do agree that zoning has been used and environmental
arguments have been used to restrict affordable housing, there's no question about it. But
the notion that this caused this crisis is absurd. In the first place, if zoning restrictions
caused high housing prices, why then did prices drop? Because zoning hasn‘t changed.


BARNEY FRANK: If zoning is restricting the supply of housing and raised the price of
housing, then they‘d be going up and up. Because I will tell you, as someone who fights
this, zoning hasn‘t gotten any easier. The public is not getting any happier. By the way,
it‘s a constant frustration for those of us trying to get affordable housing bills, that there
was this overwhelmingly negative reaction, ―Oh, don‘t build it near me.‖ And we built a
lot of affordable housing. Massachusetts took the lead and people like Mike Dukakis
years ago, and it‘s private/public housing. And it was built with the requirement that it be

affordable for low income people for 40 years. Now, the 40 years is starting to expire and
we have this problem because a lot of this housing that was built with restrictions on who
could live there 40 years ago is now eligible to go on the market. And it turns out we
have a new problem. The kind of people who 40 years ago said, ―This housing is awful,
don‘t put it near me,‖ now want to move into it. And they want to displace the poor
people and outbid them. And one of our problems is to try and put some legislation
through so we don‘t lose that. But I do want to note, the very same types of people, you
know, lots of them in 40 years, some of them are no doubt dead, but the ones who aren‘t
that complained about this housing in the first place, have now found it so desirable that
our problem is they want to outbid the poor people for the housing that they didn't want
built in the first place.

PAUL KRUGMAN: Yeah, I actually know someone who makes a living as a
consultant helping developers through that process of making this stuff unaffordable.
Anyway, let me give you a devil‘s advocate question from the other side. You, somewhat
surprisingly, joined … something that's always puzzled me a little bit, which is talking
about the financial innovation, how we don‘t want to stop financial innovation. And it‘s
clear, you know, we say, ―Well, was it a good idea to invent banks, invent the stock
market?‖ I think we‘d all agree that was a good thing. Which financial innovations over
the last, oh, 20 years, 15, what are the good financial innovations?

BARNEY FRANK: Well, I think the secondary market in housing can be a good one if
it‘s run well. I think Fannie Mae and Freddie Mac have on the whole played a
constructive role and it‘s interesting that I'm sponsoring a bill that would increase the
regulation of them. This administration, which started out really wanting to dismantle
them, these are the institutions that buy mortgages in the market so that the originators
can then make new mortgages well run. I think that does increase liquidity and does
increase housing. I think the problem is when it‘s done without any kind of regulation
whatsoever. So I think in that sense, securitization has been useful.

PAUL KRUGMAN: And by the way, as best I can make out, they are the only source
of housing finance now?

BARNEY FRANK: They are, no that's exactly right. It‘s a very good point because
again, you go back two years ago and this administration wanted to put Fannie Mae and
Freddie Mac essentially out of business. And they said, ―No, these are quasi public,‖ and
they are. And now the administration has done a complete reversal and is pushing for
them to be even more and more active. Now, I agree that in doing that we should improve
the regulation. But I think, again, that's an example of how you can have something that's

PAUL KRUGMAN: What‘s the state of the crisis right now? What do you think? How
are we doing?

BARNEY FRANK: Well, I think we're kind of on the edge. If my conservative
colleagues win out and we do nothing, then it doesn‘t get better for …

PAUL KRUGMAN: There actually are two questions. One is the immediate in the
financial meltdown. So I always ask first, how do you think …

BARNEY FRANK: Well, in this one, I think that Ben Bernanke has actually been
useful in this. He‘s taken some flak from some people. If we understand, money that we
need has dried up in a lot of areas: student loans, municipal bonds, metropolitan, I mean,
there're a lot of good investments …

PAUL KRUGMAN: If you don't know the reference, this whole thing, auction rate
securities, which is one of those things I‘d never heard of until it blew up, but it turns out
to be another $330 billion market you never heard of. And things like the Metropolitan
Museum and state agencies finance themselves through it, and it‘s just collapsed.

BARNEY FRANK: The securities that depend on auctions to function, and because of
this overreaction against findings, people won‘t buy. And one of the things we got to do
is get the Securities and Exchange Commission to allow entities to bid on their own paper
because otherwise, they would have been hurt even worse. There have been efforts to buy
government, to alleviate that, and I think the Federal Reserve has done the right thing
there. Again, I wish the problems hadn't arisen, but I think, well, short-term, there are
some things we can do to provide more liquidity. Fannie Mae and Freddie Mac is an
example. This administration went from opposing their existence, really, to now relying
heavily on them. The Federal Home Loan Banks, which were another quasi public entity,
and the Federal Reserve … we're getting more money in the short-term.

What I hope we will have is the following -- and I've been working with Senator Dodd,
who‘s been very involved with this, and at risk of further undercutting his ability to do
things useful, Secretary Paulson. Secretary Paulson, Secretary of the Treasury, I think has
been a flexible and reasonable guy. There are some ideological differences. I think he
represents the more pragmatic wing of this administration in a number of areas. And I do
think he was one of those who persuaded the President that the best response to recession
was not simply to make the tax cuts of 2001 permanent immediately, rather than have
them hold off, that was a major service.

But what we're trying to do is this: we're hoping to pass legislation that will say to those
who hold the mortgages, not the lenders, but the people who bought these complications
from the lenders, and the people who are in charge of them for them, called servicers, that
if they will accept the fact that they lent more money than can ever be repaid in a
reasonable world, and that they would be better off not foreclosing, which can have
negative effects. I mean these are people who invested to make some money, not to
become landlords of vacant property in Cleveland at substantially depressed property
values. If they're willing to write down what they are entitled to legally and be realistic,
we will then have the Federal Housing Administration play a role in guaranteeing the
new lower rates if the people can pay them. We think that will help stabilize the market.
And then have them sold into a secondary market by Fannie and Freddie.

So what we are talking about is a packet of legislation that will give the holders the
incentive to accept their losses, hopefully stabilize the situation. We think by that we can
avert many hundreds of thousands, and maybe as many as a million, we won‘t know for
sure, foreclosures, get some money back into the market -- because the sub prime market
has been the source of the problem -- get some kind of confidence back there, we think
could help us begin to dig out. Housing prices will still, in many cases, go down as they
should but we would hope at a less dizzying rate.

PAUL KRUGMAN: I have to say I support the legislation, but I'm not entirely sure
why, if that makes some sense. Because my problem has been, and this is probably an
economist disease, if it‘s to the mutual advantage of the holders of the paper and the
people sitting in the houses to reach a consensus, why isn‘t it done anyway?

BARNEY FRANK: Two things. One, I do think it‘s economic because the problem
with the economy is that there are people who won‘t do it unless they know that other
people are doing it. ―Well, I‘ll be better off foreclosing if nobody else does.‖ Secondly,
and it‘s a very fair question, but we are, as we both said, in a kind of a psychological
problem. I mean, the market is not acting in even its own rational self interest. And
people having been burned by buying all this stuff are now shying away. They say, ―Oh,
whoever touches the stove and gets burned, he won‘t touch the stove again. But now we
got people who won‘t go near the refrigerator or the toilet, that's the problem. They're
overreacting to the lesson. What we're trying to say is, ―Okay guys, come back in.‖ I
mean, it‘s partly psychological. It is also the case that you may reach a kind of critical
mass where if you know that other people are doing it, it could be helpful. And we do
think having the FHA give the guarantee, that's the other piece of it. We are changing
public policy. It could be in the mutual interest now, but what we are doing -- and the
administration is moving in this direction -- we are loosening the criteria some for the
FHA, I acknowledge that. It does mean that the FHA will probably take a higher loan loss
rate, not enormous, we're talking about three, four billion dollars. If you guarantee $300
billion worth of mortgages, the ultimate cost to the federal government over time might

be four or five billion dollars. But what we're throwing into the lender is to say this -- or
the holder of the loan -- if you take a write down and you write down the new one, we
can very much diminish the chance that you‘ll get burned again. We will make the lower
loan that you're now agreeing to saleable in the market, so you may only be getting 80-
whatever percent of what you were hoping for, but you‘ll get it. You‘ll get it for sure and
you‘ll be out of it and that's what we offer to them. Whereas if we don‘t do that and they
couldn‘t go to the FHA, they'll say, ―Well, okay, I‘ll do that but I may be stuck with
something that's unsaleable.‖

PAUL KRUGMAN: Yeah, at the risk of excessive wonkishness in history, what this
made me think of, in my career I did a lot of international financial crises. Actually, I've
been very grateful that this time there's a financial crisis that I can just take New Jersey
Transit instead of having to fly across the Pacific. But this is reminiscent of the Brady
deals that were done on third world debt at the end of the ‗80s, which ought not to have
been as successful as they were. If you tried to do the psychology …

BARNEY FRANK: Again, the psychology was a part of it, which had to do with debt
of low income countries and it was kind of an exchange that …

PAUL KRUGMAN: We did a Brady deal with Mexico that should not have made a
fundamental difference in their situation, but somehow changed the atmosphere totally.

BARNEY FRANK: But I do think in this case, that's part of that and that's where we
are. But there's also this, we are saying to somebody, all right, look, accept the fact that
you're never going to recover the amount that you originally thought you were because
the problem here is people don‘t have the money. If you let them pay a lower rate, we
will then ease the criteria by which the FHA guarantees it. We're not asking the FHA to
say we're going to lose it. The FHA now has some rules. If you've had a default you
can‘t come. We're still going to ask them to make a decision case by case, but we accept
some decrease in defaults. But the incentive to the lender, the value of this bill is to say to
them … It begins with the private sector people accepting the fact that they take a loss.

There are no taxpayer dollars in that. We are saying that once you've done that, we will
make it likelier that you at least get the reduced figure that you've agreed to. Right now
they can say, ―Well, I‘ll agree to reduce it, and I still have all this uncertainty.‖ And we
say, ―Okay, if you agree to reduce it, we will at that point step in and you can be sure of
what you got.‖ And I do think this is part of the problem. It's the uncertainty. ―What have
I got, and what do I owe and what is it worth,‖ adds to the problem.

PAUL KRUGMAN: What do you think of the other stuff? We've had an explosion of
acronyms now, these various things that the Fed is doing that they …

BARNEY FRANK: Oh, auction secretaries and the like?


BARNEY FRANK: I'm not an expert on them.

PAUL KRUGMAN: No one is.

BARNEY FRANK: Yeah, when we're making them up …

PAUL KRUGMAN: Yeah, it‘s been interesting.

BARNEY FRANK: I do think Bernanke‘s moving in the right direction. Well, let me
put it this way. I have to quote, as I deal with all of this, because it‘s easier to be critical
of any of them. But people forget, no solution can be more elegant than the problem that
it‘s trying to solve. And you have to keep in mind the words of one of my favorite 20 th
century philosophers, Henny Youngman. [laughter] ―How‘s your wife?‖ ―Compared to
what?‖ And I think that has got to be the keystone of public policy today.

You know, it‘s like with bailing out not Bear Sterns, as you know, but the counterparties
of Bear Sterns. Yeah, the federal government stepped in and said to all the people who‘d

made deals with Bear Sterns, ―We‘ll make sure that you're not left hanging,‖ not because
they were the best people in the world and the smartest, but because if they were shorted,
then they would short other people and you‘d get a downward cycle. And people said,
―Well, doesn't it bother you to do this?‖ Well, even the bill that we were just talking
about, yeah, there were people who borrowed money who shouldn't have borrowed that
much money. There were people who bought more house for themselves and their family
than was reasonable. And we're probably going to help them.

Now, they didn't shoot anybody, they didn't mug anybody, they're not morally bad
people; they were somewhat irresponsible. And you might say, ―Oh, don‘t help people
who were irresponsible.‖ The cost of not helping them, however, is probably to make the
situation worse for the economy as a whole. So I'm prepared to acknowledge, the total
lack of regulation in the economy allowed some irresponsible people to take parts of the
economy hostage. And I accept the fact that we're going to have to pay some ransom. My
two criteria for the ransom: let‘s pay as little as possible, and let‘s pay it to the least
undeserving people we can find. There are no heroes, and that would be my justification.

PAUL KRUGMAN: We're close to the end of this part, so tell me your vision. What
should regulation look like to avoid the great financial panic of 2013?

BARNEY FRANK: Central question. Look, I think bank regulation on the whole works
well. We haven‘t had an enormous number of bank failures. And to the extent that banks
are in trouble, like Citigroup and others, is because they went outside of banking into
investment banking. I think that's essentially what we need to say. That all those in the
financial market, and I mention the Graham-Leach-Bailey Act, we used to have, as you
know, the Glass-Steagall Act, which said you could be a bank, regulated by the
regulators, a commercial bank, or you can be an investment house and not regulated. We
took away that distinction, but we left the distinction in regulation and that had, I think, a
negative competitive effect. The great technical phrase is negative regulatory arbitrage,
which any parent would know, which is, ―Well, you didn't make my sister do it, why

should I have to do it?‖ [laughter] I mean, that's essentially sibling rivalry put into public

And what we needed to do was to say to the investment houses dealing with large
amounts of money. ―Here's the deal. First of all, everything has to go on your balance
sheet. You got to let people know that you have these liabilities. Secondly, you got to get
examined the way banks do. Third, you're going to have to have some requirements.‖ A
bank now, whatever loans a bank makes, it has to keep a certain amount of money as a
reserve against bad loans. The investment houses don‘t have to do that, and they also tend
to be, of course, much more leveraged. I guess in Bear Sterns case, it was 35:1 in terms of
what they owed because the greatly increased averages is part of it.

So I think essentially, and it comes out to this: the lender/borrower relationship having
been dissolved, you need to have regulation that puts some restraints on risk taking that
don‘t exist now in the private sector. And that includes, by the way, compensation for the
top executives. Because you have a situation now where if you're one of the top
executives here and you take a risk and it pays off, you make a lot of money. And if you
take a risk and it doesn‘t pay off, you go home and have a nice dinner, but you don‘t pay
any penalty. And the worst comes to the worst, if you make enough bets that don‘t pay
off, you get sent out to pasture with a very large compensation package to help you be
able to get over it.

So what regulation has to do is to build some constraints on risk taking into the currently
unregulated sector of the economy. And that doesn‘t mean we second guess them, we just
have to … Right now, individual institutions haven‘t seen that they we're paying a
penalty for failure until the whole society paid that penalty.

PAUL KRUGMAN: I think that brings us to the end of the dialogue and we have
questions. I believe you just line up in front of those two mics, and we‘ll call on people as
they come up. Oh, and the generic warning, please ask questions, not speeches. Go ahead.
[applause] Sorry, a little abrupt.

AUDIENCE: As I'm sure you know, economics isn‘t just housing, it‘s gasoline and
food, which is adding to that psychological feeling that things are falling apart. Have you
any suggestions as to what we can do on both those cases?

BARNEY FRANK: Well, I‘ll start with food. Let me say, I did predict the questions
would be how come we didn't talk about X because we were talking about the assigned
topic. But I think with food, I do plan to have a hearing in the community. I think one
thing I am persuaded of is that the ethanol issue is a part of this problem. The focus on
taking edibles and making them into energy with heavy subsidy has been overdone. And
I think that needs to be subjected to a much better set of economics. [applause]

PAUL KRUGMAN: What I would say is it‘s startling, actually, how little political
movement there's been on that despite the power of the farm state vote, the fact that we've
been saying a little bit that if only the first caucuses of the year were in central New
Jersey, maybe we‘d have an outrageous subsidy for diners instead of for this. But
anyway, yeah, it‘s a real problem.

BARNEY FRANK: Well, it‘s absolutely right and we're talking about Iowa. Not just
the time has come, on an unrelated subject, to tell our good friends in New Hampshire
and Iowa their privileged position is over. They have caused us problems in the
Democratic primaries, which the notion that because of those nice people in New
Hampshire and all the other people in Iowa, Florida and Michigan should be in this bind
is intolerable. But it‘s also the case that ethanol is an example.

Let me just say about food policy. The greatest hypocrisy in the history of American
politics comes from my conservative friends who represent agricultural districts and who
preach to us, whether it comes to the minimum wage or labor unions or health care or
housing or any other domestic program, the virtues of non-involvement by the
government of the free market, of no subsidy, of people standing up on their own. And
apparently, there was a footnote hidden somewhere in Friedrich von Hayek‘s book that

says—or Friedrich Hague and Ludwig von Mises -- ―None of this applies to agriculture.‖
And including, by the way, one of the problems you have now, we will not send money
as the United States government to countries where food is a terrible problem, we will
only send them American food. And that is a very expensive and inefficient way to do it.
And a Republican, Andrew Natsios, he‘s a former Massachusetts legislator who was the
AID administrator, and I have been joining in trying to change that.

As to energy, it is harder to think of anything to do in the short run. I do hope given the
good that we got in the oil price situation from invading Iraq that they don‘t think that
invading Iran will be the answer to bringing down oil prices. [applause]

AUDIENCE: I understand you want us to ask short questions, is that right?

PAUL KRUGMAN: That's correct, if you can.

AUDIENCE: The secondary market for mortgages has never been an issue if you have a
well collateralized residential loan. Those functions have worked through Fannie Mae
and Ginny Mae.

PAUL KRUGMAN: Speak up, please.

AUDIENCE: I beg your pardon. And what would you do if you re-ran the tape? You
both agree that neither of you saw this coming. My dad used to call that being asleep at
the switch. But what would you do if you could rewind the tape and put some regulation
in place that might have forestalled this, taking regulation away from just the depository
institutions to the other source of funds that contributed to this?

BARNEY FRANK: Well, I would say, as we mentioned, in 1994, the last time the
Democrats were in control before the past year, the Democratic Congress did pass the
Homeowners Equity Protection Act, which gave the Federal Reserve the power to do
exactly that, to regulate all mortgages. I was not directly involved, my predecessor, a

senior Democrat, John LeFalls from Buffalo, was one of the major advocates for that, I
believe Chris Dodd was as well.

The problem is, from the legislative standpoint, you can sometimes prevent executives
from doing bad things, obviously not always, but you can almost never force them to do
good things. So the regulatory authority was there, it just wasn‘t used. But I do believe—
and I think one of the lessons we've learned now and it has to do with this whole mess—
we were told don‘t worry about the quality of the initial decision because we will have
risk management techniques that will handle it. And I'm now convinced that if enough
bad initial decisions are made, no so-called risk management techniques can undo the
harm. So you need to build in deterrents to making those mistakes in the first place. And
as I said, we did do that in 1994, and Alan Greenspan just specifically and inexplicably
refused to use the authority.

PAUL KRUGMAN: I would just add, I think the kind of loan that might not have
happened is the loan which was 95 or 100 percent of the value of the house, and could
not be paid once the reset took place and was only viable under the assumption that the
home price would go up and that the buyer would be able to refinance. And then when
home prices dropped 20 percent, all hell breaks loose. And if it had been all 80 percent
mortgages, then none of this would have happened. We would have still had some people
under water, given how big the bubble was, fair number of people would have been under
water. But nowhere near as many defaults, nowhere near as many foreclosures, and
hopefully a smaller overall crisis.

AUDIENCE: In the current presidential campaigns, can you give us a brief synopsis of
the candidates? Are any of them addressing the issues, and what do you see as the
potential approach from any of the candidates?


BARNEY FRANK: I think Senators Clinton and Obama have both come out with
approaches to the sub prime crisis. They were, frankly, similar to what we've been talking
about. Senator Clinton, I must say, did talk about a nationwide moratorium on
foreclosures which I think would be unworkable, although one of the things we are going
to be trying to do in the House is to bolster the ability of the states to deal with
foreclosures. There are things the states can do. You know, when you foreclose on
residential property, that shouldn‘t be a free activity. You're the owner of that property
and it‘s sitting in a neighborhood. And you have the obligation, then, to keep it safe and
secure and I think there's more that could be done in that regard.

Senator McCain started out by saying we shouldn‘t do anything, and then he moved into
saying that we should do something closer to where we are. But I honestly believe if you
look at the histories of the three candidates, the two democrats and who they would be
appointed by, I think the two democrats would be, on the whole, supportive of the kind of
regulations we're talking about. Senator McCain, by his history, would not. I will say, and
it‘s not the case of his integrity, but if you go back to Senator McCain, the one time he
got us in trouble, it‘s when he was advocating on behalf of a man named Charles Keating,
who was one of the great advocates of the kind of deregulation that led to our last major
banking crisis, which was the S&L crisis of the ‗80s and the ‗90s. And John McCain was
clearly on the wrong side and was lobbying regulators at that time for a kind of
deregulation that caused the last of these crises.

AUDIENCE: Assuming that nobody wants to be thrown out of their own home by
foreclosure, can this problem be solved by simply going to 6 percent fixed rate of interest
for the remainder of the time? This would require no write down and it would
immediately give confidence to people, that eventually people are going to be repaying
these loans. It seems like the problem is the 3 percent going up to 12 percent after a
couple of years is the disaster.

BARNEY FRANK: Well, it‘s not 3 going up to 12, but the point is this. Yeah, that
would be good, but these are loans held by private individuals. Government can‘t simply

decree that people who signed a contract entitling them to X percent now have to take X
minus 4 percent. I mean you just can‘t do that.

AUDIENCE: I think there are also a fair number of borrowers who can‘t even afford 6
percent. We have had a lot of really marginal borrowers.

BARNEY FRANK: And that's why we do think you need to do the refinancing. Look,
the Bush Administration finally, thanks to Secretary Paulson, began to do some things.
And the first thing they did was to try and get the interest rate increase held off so that
they said, ―Put it off for five years.‖ They reset the interest rate so that people can then
refinance their way out of it. But then the problem became that they couldn‘t refinance
because the property is worth too little. That's why we got into the question of the

But the fundamental issue, you cannot decree by law … you can‘t alter these private
contracts. That would be one of the problems. I'm not obviously a great fan of all the
financial institutions, but some of them would be paying more for the money that they
have got to use than that amount. I don‘t want to cause more failures in all those
institutions. And would you say that for everybody? That's the other problem. We've got
people who can‘t afford it. What about people who can? Do they get a reduction? Do we
reduce everybody‘s interest rate to 6 percent?


BARNEY FRANK: In the whole country?

AUDIENCE: Anybody in a one to four family owner occupied home, this eliminates all
the speculation.

BARNEY FRANK: I'm afraid it would eliminate a lot of the legitimate financial
institutions, and I don't see where we get the Constitutional authority to simply go in and
rewrite all these contracts.

PAUL KRUGMAN: That's interesting. I actually would have thought that you could
write such a law. It might be ill advised, it might be …

BARNEY FRANK: And you are talking about contracts already written. You're
confiscating people‘s property. I'm very skeptical that we could do that in every case.
You could say, ―Well, in emergency case,‖ but if you did it for everybody … although
it‘s interesting. The other proposal we've got, just a sign of the times we're in, the other
proposal that would extend some kind of mortgage that meets everybody comes from
Martin Feldstein, the former Chairman of the Council of Economic Advisors under the
Reagan Administration, I thought that went a little far.

PAUL KRUGMAN: Okay, I think probably the next question.

AUDIENCE: This is probably heresy to say in a country that loves capitalism and
entrepreneurship, but I was wondering, what can be done about people who are unjustly
enriched through this? Yes, you know, Bear Sterns basically might have gone out of
business, but my sense is that a lot of them went out of business with a lot of money in
their pockets.

BARNEY FRANK: Two things: first of all, you raise their taxes. We under-tax the
very wealthy, George Bush made that worse. Charlie Rangel, who‘s a great public
servant … I'm going to tell you my favorite Charlie Rangel story, irrelevant, but it makes
the evening go better. [laughter] During the 2006 election, some right-wingers were
trying to scare people out of voting Democratic. And one piece of literature we saw said,
―Don‘t vote for a Democrat for Congress, because if the Democrats take over, the
Chairmen will be Charlie Rangel, John Conyers,‖ an African-American from Detroit,
―and Barney Frank.‖ The chairmen of the committees will be Charlie Rangel, John

Conyers and Barney Frank.‖ Somebody showed that to Charlie and he said, ―Huh, I didn't
know Barney Frank was colored.‖ [laughter]

But the answer is we raise their taxes in the first instance. I did work on a bill that passed
the House that says that CEO compensation, and a couple of the other top people, has to
be suggested to a shareholder vote, an advisory vote, but still a shareholder vote, and they
have to include in that vote retirement benefits and if they have any provisions for if they
make money and get a bonus, do they get an un-bonus when they lose the money, if that
happens. So that's the other thing.

And the third is I would hope there would be prosecution in some of these cases where
there was some fraud. They did put a bill through the House which would, frankly, get rid
of the alternative minimum tax on a lot of the people here who are about to get hit with it
because of our Massachusetts tax structure, and instead raise the tax on what we call
carry interest for the hedge funds so they pay at the income tax rate and not the capital
gains rate for income that they get. And I think the best way to do that is through a fair
tax system.

AUDIENCE: And I hope this also extends to those real estate agents and mortgage
brokers who actually falsified applications for individuals.

BARNEY FRANK: Well, you need to get prosecution. But there is this problem,
frankly, in fairness to the prosecutors. It‘s hard to prosecute a crime without witnesses.
Part of the problem is, and let‘s be honest about this, in many cases the borrower was
fully complicit in the fraud and it would be very hard to punish the lender and not the
borrower, if only because the borrower is probably going to be advised not to say
anything, and the policy of giving them all immunity and not the lenders does raise some
concerns about equal justice.

But there are investigations going forward, and there is a Justice Department fraud thing.,
They haven‘t been as active as they should be, but nobody‘s talking about immunizing
those people from lawbreaking.

AUDIENCE: And raising taxes is only prospective. You know, those people like the
guy from Countrywide who walked away with all of this money and all of these people
who basically were doing all this out of greed, there's got to be a way to recoup that
money from him.

BARNEY FRANK: Well, there probably isn't. There's no point in kidding yourselves. I
mean, I wish a lot of things. But all you can do, to the extent that you can show criminal
behavior … I take it back. There are civil lawsuits and people can bring civil lawsuits in
some cases. And there will be civil lawsuits … interesting, because often the business
community complains that ―all these citizens are suing me.‖ Of course, the most
significant lawsuits in America in that area are businesses suing other businesses. And
what you have are there are going to be more and more lawsuits of investors who bought
stuff from Countrywide suing Countrywide, etc.

AUDIENCE: I have a policy question here. If you listen to Mr. Greenspan and Mr.
Bernanke, they both are concerned with deflation. And I believe one of the ways we got
into this is Mr. Greenspan threw out so much money that created inflation in the housing
market that wasn‘t real. Now, Mr. Bernanke, like tomorrow they claim he‘s going to
lower interest rates. When you lower interest rates, you create inflation. And now they're
creating inflation in the agricultural market, in the energy markets. And where I'm getting
confused is if you look at capitalism, the way it‘s supposed to work, is you're supposed to
create deflation. You know, bring prices down. But we have two people that are in
control of the Federal Reserve Bank that wants inflation. And so I can‘t understand why
they are into the inflation mode.

And just one other thing: they have no concern of the currency. Because, you know, if
you study history and you look at the Soviet Union and Germany before World War II,

you had inflation there because their currency was so weak because they were printing so
much of it. And, you know, the Federal Reserve looks like they have no concern with

BARNEY FRANK: I disagree. First, you're right. Hyperinflation can be a problem. I
don't think we are in the position of Germany between the wars. They lost World War I;
they were hit with very punitive settlements. So yes, inflation is a problem, but I don't
think we face anything like the threat you saw in the Weimar Republic in Germany or

Secondly, there's a tradeoff here. And on the whole, I have supported many of these
increases. I don't think the housing price inflation was caused by the level of interest
rates. There were problems in pools of money being available that were not subject to
regulation being available for loans. Those have, I think, mostly other causes than high
interest rates -- our trade deficit, the money that was accumulated elsewhere in the world.
And the other side of this is if you focus single-mindedly on just the inflationary impact
of interest rates, then I do believe you get more unemployment if you bring those down.
So I think the causes of the bubble were elsewhere.

One other thing I should have said about fuel, by the way, in terms of cost, and this is one
thing that I think is time for us to look at, and there is something to that when you talk
about the impact in fuel prices. I think it is reasonable to look at the extent to which
financial activity in the futures market has contributed to some increase in fuel prices. I
think it‘s basically a real phenomenon, but I do think there may be a financial factor that
goes upwardly.

But fundamentally, I do not think it would be a good idea to reduce rates. And that's why
my criticism of Greenspan is I would like to see more active regulation. I think there has
to be a micro response. I don't want to see a reduction in employment and economic
activity as a way to get rid of the problem.

PAUL KRUGMAN: I'd just add that what I know, both the Fed in general and Ben
Bernanke in particular, is the example of Japan hangs heavily over there. What we saw in
Japan in the ‗90s was they got behind the curve. They were concerned about inflation,
they were slow to cut interest rates. And by the time they realized that was not their
problem, they got into a situation where deflation had gotten built into people‘s
expectations and where cutting the interest rate, and their equivalent of the Fed‘s fund
rate, was reduced all the way to zero. And it wasn't enough, and they found themselves in
this trap with monetary policy having nothing more to do, no action. And the Fed studied
that intensively and reached a conclusion that the way you avoid that is if you have a
bursting bubble, you respond aggressively and try to get ahead of it, which is what's
happening now.

That may be wrong, but it‘s not some lack of understanding of history, it‘s a very acute
awareness of recent history. They've got the specter of Japan hanging over them. They
believed that in 2002 we had a near-Japan experience here in the United States and are
desperately afraid of that. And they're starting to get really nervous about food and fuel,
but they're still also really worried about deflation.

AUDIENCE: Every reaction has a counter reaction and are you concerned about the
currency falling 40 percent in the last three years?

BARNEY FRANK: Yeah, we have this problem. Part of the problem, frankly, I wish it
had been .(inaudible) work with me. I wish the European Central Bank would be a little
less rigid in insisting on keeping its interest rates up. Part of the problem is there is this
great disparity now between American interest rates and European interest rates that's
contributing because the single biggest impact in our currency has been vis-à-vis the
euro. The currency issue is mixed vis-à-vis some countries like China, it was too high. In
other cases, it wasn't. We've gotten some adjustment, but the adjustment has not come in
the right places.

AUDIENCE: Hi, in the 1980s, President Reagan spent more than he took into the
federal budget and we found that the interest rates went up higher and jobs were lost. And
it took several years to recover from that. And now we have a Harvard Business School
educated President who is almost doing the same thing. We have a deficit and why aren‘t
things worse than they are at the moment, and what are your views on deficit spending?

BARNEY FRANK: Look, the analogy between the government and the household
obviously doesn't hold. Deficit spending can be very useful. I think the problem is the
long-term budget deficit that we are incurring. Remember, when George Bush took
office, as a result of things that Bill Clinton had done, and the Republican Congress,
some of which I thought went too far in some areas, but in part because of Clinton‘s tax
increases that I voted for in ‘93, which were very progressive, or reasonably progressive,
and other things, in 2001, Alan Greenspan‘s fear was that we were going to run out of
national debt. Because if we didn't have national debt, he couldn‘t do monetary policy. I
mean Greenspan said you needed to not get down to zero in the debt.

And then two things happened: first, George Bush put through tax cuts beyond what
were reasonable. I think some tax cutting aimed at the middle income people in 2001 was
reasonable at the time. And then came the murders of 2001, and the need to respond. Part
of the response I supported, like Afghanistan, and to some extent homeland security. Part
of the response in homeland security, including the one in Iraq, has been excessive. So
what you got was for the first time in American history a combination of two wars and
five tax cuts, which Bush pushed for.

And yes, those are having, I think, long-term negative economic consequences, including
by the way, in the short term. Our ability to respond to the current recession is
constrained by the terrible budget situation. If we were not in such a terrible deficit
situation, going forward then I think we could have responded more vigorously, at least
have opposed it ideologically, they wouldn‘t have had a fiscal argument.

So I do think there was a problem there, but there are answers. If we begin on January of
2009 to withdraw from Iraq, costing well over $100 billion a year [applause] and we let
the tax cuts that George Bush put through expire for incomes over $200,000, you are then
in a difficult situation, but not an extreme one.

And, I‘ll be very clear: social security is not in crisis. As we sit here today, social
security is taking in more money than it pays out. It will then, if it gets credit for all the
interest, be okay. It will start to run into trouble at the current rates in 2041, 2042, at
which point I‘ll be 101, 102, so I suppose I got to worry. [laughter] But at some point,
beginning in 2030, it may be some adjustments would be needed, some increase in the
taxable base, etc. But there is no social security crisis. There is a Medicare crisis only
because Medicare is part of the American heath system, and there's an American health
system crisis. But neither one of those should be scapegoated in this regard. [applause]

AUDIENCE: Actually, I wanted to follow up on the question with regard to deflation.
You mentioned, Congressman, the current account deficit on the federal level and when
you consider the tens of trillions of dollars that we as American citizens borrowed in our
role as consumer patriots, I wonder if anyone has calculated the impact of the withdrawal
from those borrowings from the economy going forward, both on a national and global
level? And is there a prospect for fairly severe deflationary environment?

BARNEY FRANK: Well, I think Paul already said that. We've been actually pleasantly
surprised it hasn‘t been harsher.

PAUL KRUGMAN: Yeah. I mean, there's this problem that Americans do not save
enough, not remotely enough. And they really should save a lot more, but it‘s like St.
Augustine. ―Oh Lord, make me chaste and continent, but not yet.‖ We hope people don‘t
start saving reasonable amounts too quickly because the economy can‘t handle it. We
need that consumer spending.

BARNEY FRANK: But I do think … Let me go back, I mentioned Iraq. If we were to
pull out of Iraq and if we were to do one thing, sometimes we give ourselves too good of
credit. I am prepared to be triumphant about the end of the Cold War. I think that was a
very good thing, I think the Soviet Union was an unpleasant place, and I do not think we
need to continue to build weapons to defeat them. [laughter] We are spending at least
over and above in Iraq; we spent more on the military than the rest of the world put
together. The rest of the world put together is not going to attack us, and if they did, we‘d
be in pretty good shape.

We have weapons that we are building that have one very serious flaw. They have no
enemy. A weapon should have to have an enemy. So yeah, we do spend too much. The
notion that if we were to get out of Iraq and make military spending reasonable, we could
turn it around and we need to start talking about that more. [applause]

PAUL KRUGMAN: We're at the point where we can take two more questions, so.

AUDIENCE: People that paid their income tax electronically are already getting their
rebates. Was the rebate a good idea, and will it have a perceptible or beneficial effect?

BARNEY FRANK: I think the rebate was a better idea than nothing. There were better
ideas than the rebate. Let me give you the history. December 7 th of last year, Nancy
Pelosi convened a meeting of some economists -- Larry Summers, Allen Binder, John
Sweeney, some people from various segments, mostly Democrats, but people who were
businesspeople as well. And they said, ―Trouble is coming, you better start thinking about
a stimulus package.‖ This was at a time when the President was invincibly triumphant
about it all. So we started to do that.

The Democrats began to put one together which included the number one stimulus, which
is unemployment compensation, the most logical one. Some increase in food stamps, and
figuring with the Republicans, tax relief. We then got into a situation where the Speaker
had to negotiate with the President and ran into great resistance. They started out, let‘s

just make the tax cuts permanent. Nancy Pelosi then negotiated, I think, the best deal she
could have, which was to say -- because it is true that there were rebates, and there were
better ways to do this than rebates -- but she should get credit for the progressive nature
of the rebates, which run for people earning between $3,000 to $75,000. People who
don‘t pay taxes, you‘ll get some rebates. I would have liked to have done it better, and we
will try to have a second stimulus package, we should have done unemployment
compensation, some aid to the states.

We put a bill through our committee last week that would provide some very targeted aid
to the states, namely by giving money to the states to buy up property that had already
been foreclosed, put that back on the tax rolls, and in many cases in socially useful ways,
like affordable housing, housing for the employees who work in the city, etc.

As to helping, I think it will help some. People said, ―Well, do you know people are
going to run out and spend money. You know, buy things they didn't buy?‖ If you're
going to arrange people getting it, I think it will be helpful in avoiding spending cutbacks
that would otherwise have come. When you're talking about people making 40, 50, 60
thousand in this economy, I think almost all of it will get spent and they will spend it, not
cutting back on spending that they otherwise would have done. So I would have
preferred a more structured and targeted one, but I think this was better than nothing.

PAUL KRUGMAN: I think last question here.

AUDIENCE: Regarding your comment on health care costs, since seven out of ten
people pass each year of chronic diseases in this country, I know you had co-sponsored
with Speaker Pelosi a bill, HR 3643, the Coordinated Environmental Public Health
Network Act of 2007. And if this does pass, it will save millions of lives and also
millions of dollars in health care costs. Could you please elaborate on the current status of
this critically important bill?

BARNEY FRANK: I, to be honest, can‘t tell you where that bill is. As the Chairman of
the committee, I know on any given day more and more and more about less and less and
less. I know a lot about where things are on our committee. I do run into this problem.
The difference between the two parties -- you know, parties are much more important in
America than people are willing to give them credit for. We have great differences
between the parties. There's never been a democracy in the history of the world that didn't
exist without political parties. And this notion that there's something wrong with
partisanship, if it‘s done right, troubles me.

But one of the biggest differences between the parties has to do with health care and
whether or not you need to have an increased public sector role or you do it entirely
privately. Given the current state of divided government, I am afraid that we cannot look
for any significant advances in our health care system until and unless that changes. If
you get a Democratic President elected in 2008, the kind of changes you're talking about
will go forward. If not, they won‘t. [applause]

PAUL KRUGMAN: Well, thank you Congressman. Thank you. [applause]


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