A CONVERSATION WITH BARNEY FRANK

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.

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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 everybody.

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 19^th 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 substitute.

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 problem.

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 overleveraged, 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 had 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 … 

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 done?

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 recession.

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 foreclosures.

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 prediction.

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 these.

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 AfricanAmerican 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.

PAUL KRUGMAN:  Right.

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 useful.

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 80whatever 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?

PAUL KRUGMAN:  Yeah?

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 policy.

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?

PAUL KRUGMAN:  Oh, boy.

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 amount.

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?

AUDIENCE:  Yes.

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 currency.

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 elsewhere.

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]