inside the meltdown

Barney Frank

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Chairman of the House Financial Services Committee (D-Mass.), he was closely involved in the crafting of the TARP legislation. This is the edited transcript of an interview conducted on Dec. 3, 2008.

“People said, 'Oh, let them go belly up,' and then it turned out dead bellies aren't as much fun to look at as maybe right-wing theology predicted.”

What was your assessment of [Chairman of the Federal Reserve Board] Alan Greenspan [when he was leaving office in 2006]?

I never joined in the worship. I divide my evaluation of him in two. I think he did a surprisingly good job for a conservative in recognizing that you could get unemployment down without getting inflation. … I don't join the criticism of him for keeping interest rates down. If he had raised interest rates, he would have raised unemployment. ... Under Bill Clinton, unemployment actually went down to 3.9 [percent], and Greenspan did a very good job there. It was a pragmatic and flexible one.

On the other hand, he was terribly mistaken, as he finally acknowledged, in his refusal to regulate. When they said to him, "You've got to deal with bubbles," whether it was the dot-com bubble or the housing bubble, his answer was to pose a false choice: "Oh, you want me to deflate the whole economy. I can't do that." Well, I think he was right not to deflate the whole economy, because that would have inflicted a lot of pain on marginal workers. ...

But there was a third choice, which was to regulate. He could have, for instance, during the dot-com bubble, tried by increasing margin requirements to slow down excesses in the stock market. And he certainly could have restricted the issuance of irresponsible subprime mortgages.

In fact, in 1994, there is a partisan element here. 1994 was the last time there was a Democratic majority in Congress before this current Congress. Congress passed a law telling the Federal Reserve to regulate subprime mortgages and not to allow mortgages to be granted to people who couldn't pay them back. Greenspan specifically, explicitly, said, "I won't do that; that's regulation." That's what he apologized for, and that is what he should have apologized for. If he had used the authority he was given to regulate subprime mortgage issuance, we would not be in the current crisis. And to the argument that the law was flawed, he couldn't use it, ... [Federal Reserve Chairman] Ben Bernanke, at the urging of the Democrats in Congress and after we had passed a bill in the House, used exactly the same authority from that 1994 act that Greenspan refused to use, and imposed some rules that are going to keep bad, subprime mortgages from being made. ...

Greenspan comes back up to the Hill [in October 2008] and says he was wrong. What did he say?

That he was wrong and not just in a specific but in a systemic way. That was a very important moment ... comparable I think to [Secretary of Defense under Kennedy and Johnson] Robert McNamara's confession of error with regard to the Vietnam War, because what Greenspan was saying was not simply that "I called that one wrong; this one I was off by X," or "I miscalculated." He was saying: "My fundamental approach was wrong. I thought that the market would be self-correcting. In my view, what happened was not supposed to be able to happen." And that is very important, very profound, and will have a big effect, because as we go forward for the rest of this year, we are going to be adopting regulation now, which people like Alan Greenspan used to resist. Greenspan's acknowledgement that the market is not as self-correcting as he thought is now going to be a very important piece of that argument. ...

… By when are the cracks appearing in the dike?

I would say in 2004-2005 you began to see a pattern of subprime mortgage failures. I don't remember it exactly. I do know that in 2004, when the Bush administration ordered Fannie Mae [Federal National Mortgage Association] and Freddie Mac [Federal Home Mortgage Corp.] to increase the number of mortgages they bought from people below the median income, I complained and said, "Look, you are going to jeopardize them, and you are going to push people into mortgages [they] can't afford."

I do remember very clearly, by 2005, several members of the Committee on Financial Services -- again, the Republicans were in the majority during this point -- two from North Carolina, where there has been real leadership on this, [Democratic Reps.] Mel Watt and Brad Miller, and myself, working with the Republican Spencer Baucus [R-Ala.], started to see if we could draft the legislation to restrict bad subprime mortgages. A couple of others were trying to do this, too, [Reps.] Paul Kanjorski [D-Pa.] and Ed Royce [R-Calif.].

So by 2005 there was a recognition that too many bad mortgages were being issued, and we were trying to work something out. And then [Texas Rep.] Tom DeLay, as the Republican leader, sent word to [Rep.] Mike Oxley [R-Ohio], the chairman of the committee: "Stop it. You are not going to get any bill up." ... First we tried to push Greenspan to use the authority, and he wouldn't do it. And secondly, we then tried to draft a bill, and Tom DeLay said no. ... If we had been able to stop it in 2005, we would have diminished this crisis.

[Prior to the summer and fall of 2007], were you actively worried about the economy and the depths of this?

... I did, along with others, see the problem of too many subprime mortgages being granted. I did not see, as I think few saw, the extent to which modern, sophisticated financial techniques were going to take these bad loans and rocket them through the system. The extent to which bad, subprime loans granted in America caused the worldwide crisis, I did not foresee.

When did you start to worry? Some people we've talked to say August '07, ... the system is in trouble.

... We weren't holding back. 2005 was when we were starting to do subprime loans. And when the elections of 2006 put us back in the majority and I became chairman of the Financial Services Committee, one of the first things I did was to go to my colleagues from North Carolina and say, "OK, let's now start redrafting that bill to block bad subprime loans." So we were sufficiently worried by 2007 to make it a priority.

We passed a bill that summer to block bad subprime loans, only we couldn't get it through the Senate. And we were also urging the Fed to do that. In 2007 we were worried about the bad subprime loans, and there were indications that the rot was spreading.

So when you hear about Bear Stearns in March 2008, what do you think? Do you think, oh, my God, here we go? ...

You tend to be operational. We don't sit around and say, "Oh, isn't this bad or that bad?" Our job is, what are we going to do about it? We increased our efforts to do two things: first of all, to stop bad subprime loans from being made going forward; and secondly, we had begun this in 2007 to try and reduce the number of foreclosures. ...

So when we heard about Bear Stearns, it didn't change our position. We were already, those of us on the Democratic side here, working as hard as we could to ban future bad subprime loans and to get measures adopted that would alleviate the number of foreclosures.

What was the contagion that took Bear down?

People made a lot of subprime loans. Those were the bullets. The guns were these very sophisticated measures of collateralized debt obligation [CDO] derivatives. What took down Bear and ultimately a lot of others, Lehman Brothers, and put Merrill Lynch in a weakened position and Wachovia bank and some others, were their purchase of collateralized debt obligations of securities that were based on mortgages that should never have been issued, and it was the fact that so many of these mortgages were defaulting, far more than anybody anticipated.

The key here is something very simple. Thirty years ago, if you get a mortgage, you went to the bank and that bank frisked you pretty good before giving you the money, because the bank expected you to pay the bank back. And then we came up with one of these great financial innovations called securitization, which does do a lot of good. Under securitization, a mortgage lender lends money to a lot of people and does not expect to be repaid by them, but bundles up the right to be repaid by them and sells it to a lot of other people.

We forgot one simple thing: ... Most people are more careful with their own money than they are with other people's money, and the constraints on bad loans being made consisted of being expected to being paid back dissolved. And we haven't found a substitute. And that's what happened. So many bad loans were made that they got dispersed and weakened everybody.

And the other factor was this. The assumption was, "OK, well, maybe this individual won't be able to repay her loan. We will just take her house and we will sell it to somebody else." Then the problem became that the prices of houses dropped so much so that the loans were now more than the house was worth. So if someone defaulted on his loan, you couldn't make up for that default by taking the house, because the house wasn't worth what the loan was. That is what caused it.

When Bear goes down, what's the response? ... What is the Washington response over the summer of '08, which a lot of people called the summer of assurances?

What you have here is, and people should understand, it wasn't that Bear Stearns was bailed out. The shareholders of Bear Stearns didn't do very well. It was -- and this was a pattern -- the creditors of Bear Stearns were bailed out.

What the administration recognized, I think correctly, was that because Bear Stearns was so indebted to so many other people, that their failure to repay their debt or pay their debt would cause a cascade of other failures, because people to whom Bear Stearns owed money wouldn't be able to pay the people they owed money to, etc. So there was this hope that that would stave it off.

This obviously kept getting worse and worse. It turned out that the proliferation of bad loans was greater than people realized. Housing prices were dropping faster than people realized. There were more defaults than people realized. So the inability to pay off creditors just spread.

... You talked about Greenspan. What is Bernanke like? ...

A much more flexible guy, very intelligent, very thoughtful guy. Let me say both [Henry] Paulson, [Treasury Secretary, 2006-2009], and Bernanke [are] very decent, very well motivated, trying very hard to do the right thing. In Bernanke's case, a conservative, but not the rigid ideologue with regard to regulation. I think he shared Greenspan's pragmatism in setting interest rates. And Greenspan was this odd mix of pragmatist in the macro sense and rigid ideologue in the micro sense.

[Bernanke] is a very sober guy but very open, and -- I give him credit for this -- an economist that understands the limits of economic knowledge, so that he was not locked in to any one formula but was prepared to try things.

And Paulson, when he arrived in Washington?

He has been, on the whole, a very good influence, because he came to be secretary of the Treasury at the request of the administration. He was able to stand up to right-wing ideologues in the Bush administration who previously had disregarded Treasury secretaries.

For example, one of the first things that I did when I became chairman was to work with him to get the regulations of Fannie Mae and Freddie Mac in place that people had been talking about for a long time. … What he understood and what was important to me was to combine the regulation of Fannie Mae and Freddie Mac with the provision that took some of their funds and put them into affordable rental housing. ... And he did a very good job of persuading the administration to accept an approach to Fannie Mae and Freddie Mac that included an affordable housing trust fund.

Then, when the economy began to go sour in the end of '07 and, as we now know, was entering the recession, he overcame rigidities among the Bush administration officials to get them to support a stimulus. And he continued to push them to do more about mortgage foreclosure. Until fairly recently under the rescue plan, I think he has been very good. I have serious differences with him recently.

Do you imagine it's been a long walk for Hank Paulson to go from Goldman Sachs to the guy presiding over all of this?

Oh, yeah. It's been a long walk for a lot the conservatives. Remember, Paulson is conservative in his thinking. I was elected to Congress in 1980, so I was standing on this Capitol plaza there when Ronald Reagan in his first inaugural said, "Government is not the answer to our problem; government is the problem," a stark, very extremely conservative view. Twenty-seven years later, you have the secretary of the Treasury in another very conservative administration, and his motto is what used to be a bad joke that conservatives would tell: "I'm from the government. I'm here to help you."

It is even an evolution from 2006. When the Democrats won the election in 2006 and I was about to be the chairman, I was told that our important job was to deregulate. There was a committee in Harvard Law School run by a very thoughtful professor, Al Scott, and it was called the Paulson Committee, because Paulson had brought it into existence. And they were saying: "You know what? We are overregulating. People are going to leave America and go to England. We are not going to have IPOs, initial public offerings. We've got to cut back on Sarbanes-Oxley [Act]."

So as recently as two years ago, the philosophy of Paulson and others is that we have overregulated. I give him credit for being pragmatic. He understood that the absence of regulation was a problem. ... It hasn't been so much that we have deregulated as that we did not regulate in the first instance with new phenomena. And I give Paulson a lot of credit for the flexibility there. ...

My criticism of him is, I think he's had a hard time breaking away from his kind of cultural identity with the people in the financial institutions. He tends to trust them more than I think reality justifies. He has been reluctant to push them as hard as he should.

And that would be what, the guys who run all of the investment banks?

The commercial banks as well as the investment banks.

Let's talk a little bit about Freddie and Fannie and the conservatorship. An appropriate step, a necessary step?

Probably. I think the answer is at the time that it was necessary for Freddie, maybe not necessary for Fannie. But given the way the markets work, if you had done it for Freddie and not Fannie, then it would have been necessary for Fannie. They now have been arguing that Fannie had overestimated some of its returns, so I think it was a good thing for both of them, because as a result of the conservatorship -- which, by the way, grew out of legislation we passed and enabled them to do, and it was part of the good cooperation with Paulson -- Fannie and Freddie are now being useful instruments in terms of trying to help with the mortgage crisis.

First of all, Fannie and Freddie are the holders of some of these subprime mortgages or mortgages just above subprime, and they are taking some actions to reduce foreclosures. Secondly, they are going to be making money available to bring down rates in the future. So the conservatorship of Fannie and Freddie preserved their ability to be very useful in this crisis.

... Should they have let Lehman go?

In retrospect, no. In all fairness, I wasn't one of the ones saying that at the time, although, once again, I would say with regard to Bear Stearns or Lehman or AIG, Congress was never consulted. We were never asked our opinion. We were informed that this was happening.

It does now appear that the failure to [protect] the creditors of Lehman, ... that does appear to have had a negative effect. ...

But at the time, not even you knew how connected --

You had a conservative secretary of the Treasury and a conservative administration. There was right-wing criticism over Bear Stearns. I had the Republican members of the Committee on Financial Services wanting to tear into Paulson and Bernanke for what they did to Bear Stearns. I was sort of defending them against their own Republican colleagues.

Why were they after them? What was the argument?

It was the violation of the principles of free enterprise: Let the chips fall where they may; let the market deal with it. And I think that is what happened with Lehman. You had people saying, "Hey, look. This is the market. If you don't let some people go belly up, then you lose the discipline of the market." ...

And I think that they probably felt that politically they had to; they couldn't intervene. It is then the case that the consequences of Lehman have now neutered our position to further interventions. People said, "Oh, let them go belly up," and then it turned out dead bellies aren't as much fun to look at as maybe right-wing theology predicted. ...

… How did you feel when you heard that AIG was in trouble and needed government help?

We didn't hear that they were in trouble and needed government help. We heard they were getting government help. That is, we were told. Paulson and Bernanke asked us to meet with them and said, "We are giving them $85 billion."

I said to Bernanke, "Do you have $85 billion?" And he said, "I've got $800 billion." That's when I realized the depth of his capacity under this Depression statute. ...

Under the law that was passed in the '30s, the Fed has the ability to lend anything it wants to any entity in America, as long as it is adequately collateralized. The Fed has a lot of money. And what he said was: "I have $800 billion. I can lend anybody anything I want to as long as I think I'm getting adequate collateral." I was not fully familiar with that statute, and a lot of other people weren't either.

But I thought at that point it was an unfortunate necessity to keep AIG from defaulting. I also felt at the time -- and I still do -- that we are probably protecting, in that AIG is a good example of the importance of regulation and the dangers of its absence. AIG is a collection of well-regulated insurance companies that are still making money today, and the holding company at the top that took the profits generated by the insurance company and speculated in the most irresponsible, unregulated way.

So I do think over time we will get our money back from AIG, because those insurance companies are continuing to throw up profits.

[On Sept. 18, 2008, you're invited to a meeting at Speaker of the House Nancy Pelosi's office with Bernanke and Paulson. Tell me about that meeting.]

We didn't know what was going to be there. It was a Thursday night. We walked in. It was the House and Senate Democratic leadership and the House and Senate Democratic and Republican leadership of the committees on Finance Services and Banking. They said they needed the authority to give $700 billion to unstop the credit market. The credit market was stopping up, and they needed it. They said to us they needed it by Monday.

So we said: "Well, that's not reasonable. We will look at this." And so a process began then of our [drafting a bill]. They ultimately got it two weeks later. But they said that, and plausibly, credit markets would stop. If people couldn't get credit, then auto dealers would go out of businesses, and small-business people can't fund their inventory; states can't roll over their debts. We agreed that that was very important. And Paulson and Bernanke together have a lot of weight.

It's also the case that even if there wasn't going to be a credit crisis -- and I think there was -- having Paulson and Bernanke, the secretary of the Treasury and the chairman of the Federal Reserve, announce that there will be a crisis if you don't do X, then there is going to be a crisis, given the role that confidence plays in this. So I don't think it was a self-fulfilling prophecy, but it was, perhaps, a reinforcement of the prophecy.

So we then said OK. The speaker said to me, "Can you start working on this?" And I talked to [Chairman of the Senate Banking Committee] Sen. [Chris] Dodd [D-Conn.], and we started working on it.

How sober was that meeting?

We knew we were in pretty big trouble before. Unlike AIG, where ... I had no indication, we knew there was a credit crunch. We knew that people were having problems. Probably we would hear that from our own constituents.

The way Sen. Dodd told me this morning about it, somebody said, "Well, what if we don't do anything?" And Bernanke says, "There will be no economy on Monday."

The prediction was, yeah, that credit would dry up, and the economy runs on credit. People don't pay cash for a lot of things anymore.

When do you get Paulson's three-page plan? Do you get it?

Yeah. It went to the speaker, and she sent it over to my committee. … The first interaction is between the staff of the committee I chair and the Treasury Department. Shortly thereafter, we begin to work with Sen. Dodd's staff, and our notion was, let's come up with a bill, the House-Senate Democratic bill. At that point the Senate Republicans in the meeting, given the fact the Senate until this new Congress was 51-49, you couldn't get anything done without a good degree of bipartisanship.

So you then began sort of four-part negotiations: the House Democrats, the Senate Democrats, the Senate Republicans and the Treasury. The House Republicans at that point couldn't get themselves organized and couldn't decide and sort of stayed out of it. And the negotiations began, and they were multiple and kept going. The negotiations went until a week from Sunday, when we finally came up with a bill. It then went to the House, and of course it was defeated on that Monday. The Senate then went back and got it passed on Wednesday, and we did it on Friday. ...

So, three-page document up from Henry Paulson saying: "I want to do it. I don't want any courts. I don't want anybody involved in this." What was that?

I don't know, because it was never opened to me. My answer to him was: "Well, what you want is not controlling here. We have to get a bill passed through the Congress of the United States reflective of public opinion to some extent." And we just never took seriously the notion of it being a three-page bill. And he said, "You have to hurry." And we said, "Well, we will do it as quick as we can, but it's got to be done right." Now, the bill was done in about 10 days. People might think that was too quick, but I will tell you this: The amount of time that was put in that bill in 10 days was as much, as many hours as you would usually put in a bill over a couple of months. ...

What were the three or four things you wanted to make sure were reflected in that piece of legislation?

... First of all, we had to have maximum assurance that the federal government would get the money back; that it wouldn't be $700 billion lost; that there would be warrants and other kinds of protections; that there would be restrictions on executive compensation -- those were very important; that there would be some restriction on dividends and that the money would be used to produce the results that we would get these loans.

... There seemed to be some difference of tactic between the idea of injection and the idea of buying up the toxic assets between Bernanke and Paulson.

If you go back to that first meeting, it was actually a Republican, Spencer Baucus, the senior Republican on the Committee of Financial Services, who said to them -- Paulson talked to them as if it was mostly buying up the assets. ... Baucus said no, that you should also buy parts of the company, and Paulson resisted that. And most of the members of the Congress said no, but it was seen as they would be doing both.

People said: "Oh, well, they switched on you. They were going to do the one, and then they did the other." It is only partly true. We thought they were going to do both. Then they only did the injections of capital. But we also got advice from some outside economic advisers, and they talked to the speaker and others, that buying the injections of capital were very important, [would] lessen the danger to taxpayers, etc.

And so we insisted on that, and we wrote that explicitly in the bill. The secretary, oddly, in light of later events, didn't want us to write it into the bill. ...

What do you mean, he didn't want you to write it in? Why?

No, he didn't want us to talk about it. You would have to ask him. I don't know. And I said that it was odd given that he already did it. He seemed to us to be reluctant to use the authority. Then he used it. So he apparently had some tactical reason why he didn't want to say it. ...

I now learned that Bernanke was pushing that more than he was, but I don't understand why he appeared to be so locked in and then, of course, embraced that to the exclusion of the other. But we had always intended that it would be amended.

The third piece was to give him the authority, and it was part of the buying up of the assets, to buy them up in a way that maximized our ability to reduce foreclosures. And we were very explicit, and I wrote in a lot of language which he has sadly ignored as of today in December.

[Why did the bill fail when it was first brought forward on Monday?]

What happened was the Republican Party decided to vote against it. The Democrats gave a bigger majority in favor than we expected. It was unpopular in the country. It was portrayed as $700 billion of taxpayers' money given away, not accurately because most of it will be recovered. And it did contradict the conservative Republican philosophy.

There was a difference between the House and Senate Republicans. The House Republicans have been more ideologically conservative. Maybe to win a whole state you can't have quite the same ideological fervor. ... And what you saw was conservative Republicans rebelling.

Plus, we already knew that this was not going to be a good year to be a Republican running for re-election. If you think it is going to be a bad year for running for re-election, you are even less inclined to vote for something that is unpopular. ...

Everybody forgets that it was really in the midst of an election cycle, 13 days to the election.

Members of Congress don't forget that. We never do.

Exactly. So that was at play in a very big way here.

True.

... A deal is kind of hammered out. Then there is [the Sept. 25 meeting at the White House with Sens. Obama and McCain.]

That's on the Thursday before the vote in the House. It was precipitated by [Sen.] John McCain [R-Ariz.]. ... Essentially House and Senate Democrats, Senate Republicans and Treasury were coming to an agreement on the basics of a package. The House Republicans were unclear. First they were for it; then they said: ... "Well, we can't accept this. We have some other alternative."

And all of a sudden John McCain burst on the scene and said he was here to protect Republicans from being overridden, and he was going to intervene, because, his argument was: "This has broken down. I will help make a deal." In fact, we were very close to a deal. I thought McCain's performance there most resembled the literary character of Andy Kaufman impersonating Mighty Mouse: "Here I come to save the day."

So McCain announces he is suspending his campaign, ridiculously -- why could he not debate on a Friday night because we were going to have a meeting on Thursday afternoon? -- and flies in and aligns himself with the House Republicans. We do go into the White House, ... because Sen. McCain wants to come. The Democratic leadership of the House and Senate, the committee leadership -- not that the president was crazy about me coming. The speaker said, "You've got to have the people there who are working on the bill."

And we had this very interesting meeting. There was a division with everybody on one side, House and Senate Democrats, Senate Republicans and Treasury. But the House Republicans are saying, "We don't know; we are not for this; we can't tell you what we are for," and McCain sort of defending them. And you have a dynamic in which Sen. Obama, myself, some others try to get the House Republicans and Sen. McCain to tell us what they do want.

There was, to be honest, some exploitation by us of this clear rift between Secretary Paulson on the one hand and the House Republicans on the other. The president sat there looking bemused and after a while just broke up the meeting.

There is a moment where, at least the way it's reported, Paulson goes up and kneels --

That was after the meeting. The meeting breaks up, and it is very frustrating to us because, again, Sen. [Mitch] McConnell [of Kentucky], the Republican leader, says, "My caucus is united, and you have the votes of my caucus from the conservatives to the moderates and liberals." ... But we get this situation where we cannot get the House Republicans under [Rep.] John Boehner [R-Ohio] or McCain to tell us what they are for.

Now, part of the problem is that they have a proposal involving insurance of mortgages going forward -- it doesn't do anything about the current credit crisis -- that Hank Paulson thinks is dumb and that we know he isn't going to approve. He doesn't want to say that in front of them. So we, frankly, mischievously said, Obama said, "What do you think of their plan?" That's when the president broke up the meeting.

But it is clear that the Democrats are saying, "We're here to help you, and you can't deliver you own party." And presumably the meeting was to try and get an agreement, but there is no movement by the Republicans. Boehner and McCain resist even talking about it.

So the Democrats then go in and caucus in one of the rooms outside, and at that point Paulson comes in, and half jokingly he gets down on one knee and says, "I beg you, don't break this up," acknowledging that they had been behaving unreasonably and that he was asking us, "Give me one more chance to bring these people in." ...

But after we get a deal with Treasury, Senate Democrats and Senate Republicans, an hour or two later I hear the House Republicans are now trashing the deal and trying to break it up. I call Paulson and say, "What the hell is going on here?" And he said: "I'm not too happy about it. Let me get back to you."

"Bizarre" is the word, I think.

It does underline one of the things we said. This is a real switch from the true-blue Republican ideology. Paulson and Bernanke say, "Hey, you know, reality counts." The House Republicans say: "Who cares about reality? I'm sticking with my view." ...

What happens in the week between Monday and Friday that makes it passable?

We tend to hear from people who are unhappy with what they think is going to happen. So, when it looked like the bill was going to pass, all the people who didn't want it to pass called up and complained. Then it failed, so all the people who wanted it to pass now called up to complain. Plus, what happens is, the day after it is defeated, there is a huge drop in the Dow that day, and not just that, but the treasurer of Massachusetts announced that he can't roll over debt that he needs to roll over. Gov. [Arnold] Schwarzenegger says, "California is in a terrible bind." ...

So what happened was the negative consequences of defeat became clear enough so that some members switched. ...

[On Oct. 13, Paulson holds a meeting at the Treasury Department with the heads of nine banks and tells them they will be forced to accept cash infusions from the government.] How surprised are you by what happened there?

... I was surprised not by what happened but by what didn't happen. I was surprised when he announced that he was not going to do any asset purchases and disappointed when it became clear to me that that meant not doing anything about foreclosures.

So why didn't he do any more than what he did? ...

I don't know. ...

But you are not very happy at the way he is doing it?

No, I'm not. And I can see forbearing on some of the asset purchases. Giving the bulk of the money to President Obama, I think is a reasonable thing. I had two [objections]. The first one was failing to do anything about diminishing foreclosures, because that is still at the heart of the problem.

Secondly, and now this is only as of yesterday and today here in early December, the Government Accountability Office [GAO] says, "Here is the problem with the money you put into those banks as capital: You have no way of knowing whether they are lending it out or not."

And what particularly angered me was Treasury's response, which was: "Yeah, we know. We are not trying to do that. We are not going to judge how each individual institution performs. We are going to look at the overall situation." Well, how can you get the overall if you haven't looked at the component? And that is essentially telling the banks, "Feel free to ignore me." I put out a very strong statement this morning saying that he is now coming perilously close to a breach of faith.

I mean, the combination of not doing as many foreclosures and in effect telling the banks there is going to be no monitoring of how they use the money -- very, very disappointing.

[Was that just his aversion to regulation? Was he just not willing to regulate?]

Well, I would separate it out. By regulation we generally mean talking about rules that govern future activity. I think the appropriate word here is "condition," that we had assumed he would condition these capital infusions, and in effect he hasn't.

Has the role of government in dealing with financial markets changed forever? Is this in some way the end of the Reagan era? ...

I wouldn't say it's changed forever. It has only changed for as long as I can possibly think. It is a very long-term change. Yes, this is the end of the Reagan era. ...

There is now a relearning of the lesson that was learned in the early 20th century, that Woodrow Wilson acted on and that Franklin Roosevelt acted on. The market is a wonderful thing. It is creative, and it does a lot of good. But when you get major innovations, by definition there are no rules that contain them. And the role of the public sector is to come up with a set of rules within which these innovations can function. And so we forgot that for a while.

The view of the Reagan era and Greenspan's view that he has now retracted is, "Leave the market alone." Basically their view was: "If you want a good world, let capital be totally free. Don't tax it; don't regulate it; don't restrict its movement internationally." We now understand that that is a disaster; that capital can be very, very helpful, obviously, in creating wealth. But all you are able to do is within a set of rules. And that lesson has now been relearned, and I think you are going to see in a year actions by Congress in this field that will be comparable to what happened under Franklin Roosevelt or in the first part of the century with the antitrust acts of the last century.

posted february 17, 2009

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