A conversation with the House Financial Services Committee Chairman.
Question: When do you expect financial reform to be enacted?
Barney Frank: I'm hoping it'll be done in March. The senators are working hard. Senator Dodd has been doing a very good job, but he does have the problem of the 40 vote barrier. It's unfortunate that the Constitution has been amended de facto to say that you need 60 senators to pass something. I don't think that's the spirit of majority rule, but that's where we are. He's working on it and we've been in touch. I expect him to be able to get a bill done by March. We have the February break coming up and I do think the bills will be close enough. There's a great similarity. We've been working together, working with the administration so that it won't take us more than a week or so to reconcile the two, so I am very hopeful the President will assign that before we break for spring.
Question: What will it look like?
Barney Frank: It's going to be a significant improvement in every area. There will be much tighter regulation of derivatives which caused a great deal of problems. Most importantly, there will be an entity, probably a counsel of the existing Federal Regulators, who will be charged with something that no one was charged with before. Looking out for systemic risk, looking out for that pattern of activity or individual entity that could cause such problems that the whole system would fall. And, we deal with that in two ways in our bill, and I think their bill will be very close.
First of all, we give the regulators the power to stop it. Stop issuing credit default swaps. Greatly increase your capital. In other words, we want to stop people well before they get to the cliff. If for some reason that doesn't work, and some institution does become so indebted that its failure to pay its debts would cause systemic problems, that institution is a balance. There will be no more too big to fail. If you get into trouble, you will fail. As I've said, we will enact death penalties in the Congress, but they'll be for financial institutions that ought to be put to death.
There may be the need for the Federal Government to pay some of the debts if we give them the power to pick and choose. The problem we had in 2008 was that as interpreted by the Bush Administration, Secretary Paulson, Fed Chairman Bernanke, Bush appointees-- they believe that if an institution failed and owes a lot of money in ways that would cause problems, they had to pay everybody or nobody. They had no option. And we say no. The assumption should be pay nobody and if you have to pay to avoid terrible damages, you can do that selectively. And most importantly, the money won't come from the federal taxpayer. It will come from fees raised by the financial institutions themselves.
AIG is the most egregious example of a federal intervention where we probably won't get the money back. It was a Bush Administration decision without any Congressional input. Chairman Bernanke and Secretary Paulson came to us in September of 2008 and said, "We have decided to use powers that the Federal Reserve has-- to use money they control to bail out the people who AIG owed money to." We curtailed that. In the future, the Federal Reserve, if our bill's passed, will not have the power to go in and make payments to a particular company.
An addiction, and this is very important, we have created a Consumer Protection Agency. Right now consumer protection is done almost as an afterthought, frankly, by the bank regulators. The Federal Reserve is the largest holder of consumer statutory powers, consumer regulatory powers. They don't focus on that. Alan Greenspan, in particular, didn't believe in it as a philosophy. He thought the market would take care of everything. To his credit, he's admitted that was wrong. We create a separate Consumer Financial Protection Agency. The banks are finding that hard and that's one of the major things that Senator Dodd is trying to save over there in the Senate.
I should add we also have a very important provision involving what's called securitization. Thirty years ago, if you borrowed money, the person who lent you the money was the person you were going to pay back. And if I'm going to lend you money and you're going to pay me back, I'm going to be careful about the person I lend to. Then came securitization whereby people lend money and then sell the right to be paid back and not surprisingly, they're not as careful. We are requiring the regulators to say that if you do that and you sell the loan, you have to retain five percent of it and you get the first five percent of loss. And if it's a risky loan, you've got to keep 10 percent of it. That may not seem huge but if you look at the percentage of the profit that represents, it's significant.
We also say if you're making a very safe conventional loan, a 30-year fixed interest rate mortgage with a significant down payment-- in that case the regulators could allow, if they think it's very safe, to hold none of it. But we think that will be very helpful.
And finally I should say we give the regulators the power to break up institutions. Congress repealed, I voted no, the Glass-Steagall Act 10 years ago. It allowed banks to become conglomerates. I don't think you can now retroactively order them all to be broken up. That would cause more chaos in a weak time in the economy, but we are saying to the regulators, "If you see a particular institution that's getting into trouble or it's too over-extended, you can order them to sell this piece or sell that piece, and you can order them to reduce in size." That's the essential package.
Oh, one last point. We are specifically banning the kind of sub-prime mortgages, irresponsible mortgages, mortgages given to people who shouldn't have gotten them, who couldn't afford them, who had interest rate triggers that were going to go way up. We simply make those illegal.
Question: Do you believe policymakers were/are captured or co-opted by the financial industry?
Barney Frank: Well, the answer is that you didn't have to capture people who were willing. Under the Bush Administration in particular, but to some extent under the Clinton Administration, the dominant philosophy was the market knows best. In 1994, Congress passed a bill to give the Federal Reserve the power to regulate sub-prime mortgages no matter who gave them, not just from banks. Alan Greenspan explicitly refused to use that power. He said, "Look, the market knows better than I." He now admits that that was a cause of an error because the single, biggest problem you have with all those mortgages that were made that couldn't be paid, that were then sent out and sold out--they were the base of that chain reaction.
And the Clinton Administration was better than the Bush Administration. When the Bush Administration came in, they appointed people who didn't believe in regulation. So it was not that the banks captured them, it's that they volunteered to become parts of that operation.
Question: Who are your philosophical influences, and how do they impact your policymaking?
Barney Frank: I find Joseph Stiglitz, who was the Chairman of the Council of Economic Advisors under President Clinton, and then was fired from the World Bank because he was being critical of their policies that were anti-working people. I have found him to be extremely thoughtful. Paul Volcker, the former Chairman of the Federal who preceded Alan Greenspan, is an example of someone who understands the financial community but also knows precisely because he does, that you need regulation. And Paul Volcker has been someone we have paid attention to. Elizabeth Warren has been a major guide in the consumer area. She's a professor at Harvard Law School who began to look into the consumer area. And one of the things I'm proudest of is when we passed the Bill in the committee I chaired to create a Consumer Financial Protection Agency, not everything we wanted, but more than 90% of it, Elizabeth Warren was very, very congratulatory and she said, and I love this quote, (she came up with the idea of the Consumer Agency): “They told me not even to try to get such an agency because in Washington, the banks always win. Well, they didn't win today." So those are three people who have had an impact. Joe Stiglitz on the overall economic importance, Paul Volcker on the regulatory area and Elizabeth Warren on the Consumer Protection.
Question: How do we credibly commit to not bailing out large firms going forward?
Barney Frank: By making it illegal and we do that in the bill that we passed and I think the Senate will pass. You're right. In 2004 the Republications were in control of Congress. In 2004 some of us on the Democratic side tried to pass further legislation when giving the Federal Reserve the right to regulate sub-prime mortgages. Now, we want to go beyond that and just outlaw some of them. The Republicans in control said, "No. We don't believe in that. That's regulation." They wouldn't do any of what was called for.
What we do in our bill is, first of all, to say that no federal funds can go to keep the institution in business. "Too Big To Fail" meant that the institution would be kept going. We make that illegal. No federal money can go for that. There might be money used to pay off some of the debts if the failure to pay any of the debts would cause a systemic crisis, but that won't be taxpayer dollars.
We also in our bill did a couple of other important things. Under the bill, nothing can be done including paying off some of those debts to prevent a crisis until all the shareholder money is wiped out, until all the Board of Directors and executives are fired. The institution is over. That's statutory and it's illegal to do anything other than that. Before that, we have a systemic risk regulator that steps in and would've said to an AIG, "You are way over extended. You must stop selling credit default swaps. You must greatly increase the capital you have to hold against losses."
In addition, we say with regard to the "Too Big To Fail" operation that you tell them in advance, "We're going to break you up. We don't want you getting into that sort of position where you owe more money than you could conceivably pay." But the fundamental point we make is this: if it does not work and an institution does get so indebted, that institution is over.
And one last point. Over the objection of many in the financial community and not requested by the Obama Administration, we added an amendment hotly contested that said, "Even if you're a secured creditor of one of those institutions, we don't have to pay everything. We may give you a 10 percent haircut." In other words, we want to make people very nervous. I'll tell you one thing I was very proud of. The Securities Industry and Financial Marketing Association, which represents the securities people, they objected to our bill in how we deal with an institution that's going to be put out of business. They said our bill was not 'creditor friendly'. They said the Republican approach was better for creditors. That goes particularly to the question of "Too Big To Fail" and of moral hazard.
In other words, our bill says to the creditors, "Hey, you better check on the security of that institution because if that institution gets over-extended, do not count on us to come to your rescue, certainly not if you're an unsecured creditor and even if you're a secured creditor, we may only pay 90 percent."
Question: When the Bush Administration tried to tighten regulation of Fannie Mae, the New York Times reporting you opposed the move. Do you stand behind this? (Scott Sumner, The Money Illusion)
Barney Frank: No. I changed those views when the Bush Administration changed what Fannie Mae and Freddie Mac were doing. I did believe that Fannie Mae and Freddie Mac should be used to build affordable rental housing. When I said affordable housing there, it's the terms that we used then, I was talking about rental housing. I had been critical of the push for Fannie Mae and Freddie Mac to buy up sub-prime mortgages and in 2003, I did not see a crisis. Of course, I will tell you, I didn't see a crisis with Lehman Brothers or AIG. I did not perceive the crisis as much as it was. I think it was encouraged and brought about by sub-prime lending.
And here's the sequence. The year after I said that, 2004, the Bush Administration ordered Fannie Mae and Freddie Mac significantly to increase the number of mortgages they bought issued to low income people. I criticized that at the time in 2004. There's another quote that doesn't get mentioned as much in Bloomberg saying, "This is bad for the borrowers and it's bad for Fannie Mae and Freddie Mac." We couldn't overrule that. The Bush Administration put in a significant increase in the number of low income mortgages. In fact, one of the Republican members of the Committee put an amendment in on history which specifically mentioned that 2004 decision by the Bush Administration. The Republicans controlled Congress. They didn't let us stop it.
Once that happened, I did agree that we needed to regulate Fannie Mae and Freddie Mac. I should note, by the way, that during the period, 2003, I was in the minority. I was a Democrat in a Congress controlled by Tom DeLay, so no, I didn't really have the power to decide that. The Republicans during their 12 years of control did nothing to deal with it. In 2005, though, I will say this. In 2003 I didn't see a crisis. In 2004 I was critical of them pushing into those sub-prime loans. We did two things. First, Democrats tried to restrict sub-prime loans. The Republicans wouldn't entertain the bill and Greenspan wouldn't use his authority to do it. Secondly, I joined the Republican Chairman of the Committee then, Mike Oxley, in trying to regulate Fannie Mae and Freddie Mac.
Now, I voted in Committee for a bill in 2005 to regulate Fannie Mae and Freddie Mac. I was in the minority, remember. This was a Republican Congress. The bill passed the Committee. It went to the floor. At that point, the Republican leadership ordered Oxley to put in an amendment that cut out affordable rental housing. I voted against the bill because of that, but I was still for the Fannie Mae/Freddie Mac regulation. But here's the point. This is a Republican Congress. The Republican Congress in 2005 with my support passes out of Committee a bill to regulate Fannie Mae and Freddie Mac in the House. It goes to the Senate and the Bush Administration tells the Senate Republicans who control the Senate that they don't like what the House Republicans did. So the bill then dies because of a fight between the House Republicans and the Senate Republicans. I joined Oxley in writing to the Senate Republicans and saying, "Please pass our Regulatory Bill."
And so again, we're talking about Republican control of Congress. Mike Oxley, the Chairman of the Committee, the man who gave his name to Sarbanes-Oxley, said the reason they didn't get Fannie Mae/Freddie Mac regulation that year was that the Bush Administration blocked it and he said that he got a one finger salute from George Bush. This was quoted in the Financial Times, and that's what blocked it. The Secretary of the Treasury at the time, John Snow, agreed with Oxley that it was a good bill. But the more conservative Republicans, I think, they were opposed to any kind of housing help, so it died.
In 2007, the Democrats became the majority. We won the election in 2006. I became the Chairman of the Committee. In 2007, within a few months of my becoming Chairman, the Committee that I chaired passed a tough Fannie Mae/Freddie Mac Regulatory Bill, frankly tougher than the one that Oxley had been able to get through. Hank Paulson, the Secretary of the Treasury supported it. Unfortunately, it was held up by the Republican-Democratic fighting in the Senate.
In 2003, I said I didn't see a problem. In 2004, when Bush ordered them to do more about sub-prime mortgages and wouldn't regulate sub-prime mortgages, I said yeah, there is a problem. 2005, I joined Mike Oxley in trying to pass a bill to regulate Fannie Mae and Freddie Mac. It was defeated by in-tribe Republican feuding, Republican House, Republican Senate, Republican President. In 2007, when I for the first time was the Chairman and we were in the majority, we passed a good bill. Unfortunately, it was delayed in the Senate until 2008 and by that time, too many sub-prime mortgages had been bought, and it was too late.
Question: How can Fannie and Freddie be structured to avoid the moral hazard problem and a too-cozy relationship with regulators? (Russ Roberts, Café Hayek)
Barney Frank: Yes, in 2004 the Bush Administration significantly increased those housing goals and particularly ordered Freddie and Fannie to start buying up a lot of low income individual mortgages, and I opposed it at the time. I do think going forward we have to separate out the function of providing liquidity for the mortgage market in general and some form of subsidy. They should not be in the same entity. There was a mistake to have them in the same shareholder-owned corporation, and I believe going forward you're going to see a total rewriting of housing finance.
One of the things that happened under the Bush Administration was the FHA, was allowed to deteriorate. We're building that back up again with safeguards. So I think the answer is you separate out the function of providing the equity in general for the mortgage market and doing some subsidy and in my judgment, the subsidy again, as I said before, should be focused on affordable rental housing, not in pushing low income people into owning homes that they can't afford.
Question: Will you vote for the tax bill that levies cost to Wall Street in return for subsidies that enables financial communities to survive? (Robert Lenzer, Forbes Magazine)
Barney Frank: Absolutely. I think that the arguments that are being made against this are, to use a technical economic term, entirely bogus. They didn't just get TARP money. They say we repaid the TARP money. Well, they did but you know, getting a loan in a time when no one else will give it to you is a benefit even if you later repay it. But there were many other programs by the Federal Deposit Insurance Corporation and the Federal Reserve and the Secretary of the Treasury to help the financial institutions.
It was very frustrating for many Americans because it was these financial institutions' irresponsibility that had brought about the financial crisis and then to get out of this terrible crisis, to avoid a again, Bush's top economic appointees, Bernanke and Paulson, came to us in September of 2008 and said, "If you don't act, there'll be a total meltdown. There'll be the worst depression ever." By the way, even if you didn't think that was going to be the case, and I think it probably was, when the Secretary of the Treasury and the Federal Reserve say, "If you don't do this, there'll be a meltdown," there's going to be a meltdown. It's a little bit self-fulfilling.
At any rate, we responded and to save the economy, we had to do some things that helped the banks. That was infuriating to people. But there was no other way around it given the centrality of credit in our economy. So yeah, I think it's entirely reasonable now. As a matter of fact, that idea that the banks have to pay for it was in the original bill we passed not at the Bush Administration's request, but at the Democratic Congress' initiative to require that the financial institutions repay this. And it doesn't just have to be what they got out of the tarp. They got aid in a lot of other ways.
They tell us, "Oh, but if you make us pay this tax, we won't have any money to lend." First of all, they're doing a lousy job of lending now and we'll be having a hearing a couple weeks after this interview to force them to do more if we can. But secondly, the bonus' they are giving each other far outweigh every year the taxes. So if paying this $9 or $10 billion a year in taxes is going to be a problem, then what about the $100 billion in bonuses? So that's why I say it's entirely bogus.
Question: “Affordable housing” is equated with subsidized mortgages and mortgages with low down payments. Did we take this approach too far? (Arnold Kling, Econlog)
Barney Frank: Oh, I don't have to use hindsight. I was against it at the time. You have to separate it out. By affordable housing we have generally meant rental housing. One of the great conservative mistakes was to kill rental housing programs and say the way to help low income people with housing is to help them buy homes. Frankly, in many parts of the country, the housing is too expensive for allowing the people to buy homes. I'm very proud that a man named Larry Lindsay, who was a high economic appointee of Presidents Regan and both Bush's cited me as one of the few political figures who specifically was critical of pushing lower income people into home ownership. Yeah, I think that was a terrible idea and I said so at the time. I wanted to do more affordable rental housing.
I had an argument with the Secretary of HUD, Mr. Jackson, Bush's Secretary of HUD. And he said he wanted to cut off Section 8 for people after five years, and that's rental assistance. I said, "Well, Mr. Secretary, where will they live?" He said, "We'll help them become homeowners." So yeah, I think it was a terrible mistake and I said so at the time, to push lower income people into homeownership. Some can do it, but rental housing was better and it was unfortunately ideologically opposed.
Question: Could you support a piecemeal approach to health care reform? (Politico.com)
Barney Frank: I don't know. I overreacted the day of the Massachusetts election and said, you know, “Maybe we have to stop this” because some of my Democratic colleagues are talking about some things that I thought were not procedurally appropriate. That was an overreaction on my part because I wanted to make sure we didn't do anything--some people were talking about well, should we not seat this guy for awhile, or pass the bill before that? It wasn't serious but I really thought we needed to nail that down.
Now I don't know. I do want to try to go forward. This is very important. That 60 vote problem and the Senators there, one question is, "Look, you had Senator Olympia Snowe who voted for reversion of the bill. Is she going to continue to insist on nothing?" I want to do some things. I certainly believe if we can pass a package of things that make the current situation better, that help people with pre-existing conditions, that don't allow a lifetime cap. Sure. I think you always want to try to make things better. But exactly how best to do that is still being discussed now.
Question: Republicans were able to pass major legislation as a smaller majority. Why can't Democrats? (Politico.com)
Barney Frank: Well, one, we have passed major legislation. We passed the Children's Health Expansion. We passed a good bill to reverse anti-discrimination. We passed a good economic recovery bill which has held unemployment down below what it would have been over Republican objections. The other answer, though, is this: When the Republicans were passing legislation, we were in a good economy. Unfortunately, the economy was deteriorating, I think as a consequence of their refusal to regulate the financial industry, and President Obama inherited one of the worst recessions in history, the worst since the Great Depression, and it is much harder to do things in a very depressed economy with revenues tied up and people hurting than it was in a good economy. So by the policies that led to this terrible recession that Obama inherited, things became more difficult.
Recorded on January 22, 2010