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HBO History Makers: Understanding the 2008 Financial Crisis

Speakers: Barney Frank, Former Member, U.S. House of Representatives, and Henry M. Paulson, Jr., Chairman, The Paulson Institute; Former Secretary, U.S. Department of the Treasury
Presider: David Wessel, Economics Editor and Columnist, Wall Street Journal
September 16, 2013
Council on Foreign Relations

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WESSEL: Welcome everybody. We're just about to get started in a minute here, if you all wouldn't mind taking your seats.

I'd -- I'd also -- everybody, we're just about to get started in a second here.

And I'd also like -- and I'd also like to welcome CFR members who are participating in this meeting via teleconference here in the United States and around the world.

If you all -- if you would all, please, turn off your cell phones and Blackberries, not just put them on vibrate, because it does interfere with our sound system here. And if you would like to use an electronic device today, we have an overflow room outside of this one where you can use those devices.

And just as a reminder, this meeting is on the record today. And just before we get started here in a minute, the Council is pleased to announced a few upcoming video conferences of meetings taking place in New York. There will be video conference down of some meetings about the -- the U.N. General Assembly next week. So there's more information on that in the -- in your packet for todays -- todays meeting.

So we'll get started in just a second here.

So I'm -- I'm gonna start? Or someone's gonna start?

(UNKNOWN): (OFF-MIKE) You're starting.

WESSEL: OK.

Good afternoon.

I'm David Wessel from the Wall Street Journal. I'm honored to be sitting here with Barney Frank of Dodd-Frank, and Hank Paulson of "Hank" the new documentary.

(LAUGHTER)

Two rock stars of the financial crisis. Welcome to today's Council on Foreign Relations meeting. This is part of the Council's History Maker Series, which features individuals who have made a unique contribution at critical junctures in U.S. foreign policy, or during a noteworthy period in recent history -- which I think the crisis qualifies.

And this series is made possible by the continued generosity of HBO.

Let me start with a question I think is on the mind of a lot of people in the public. When you look at the entire picture, the number of prosecutions, the SEC charges, executive compensation, the public statements of contrition or lack thereof for the leaders of Wall Street, do you think that the people who were responsible for the decisions that led to this devastating crisis have been held fully accountable?

PAULSON: Well, I sure know that's a question on the public's mind. And I'm going to say something that may not resonate a lot publicly.

But if you accept my explanation of the crisis, which is the excesses had been building for years, that a giant credit bubble burst, that a -- that a definition of a bubble is something that the market never fully understands until it bursts, and my explanation that every financial crisis in history has its roots in flawed government policies, and then when it bursts, it manifests itself in the financial system, no matter how it's structured, then you may accept my answer, which is the banks made a lot of mistakes, that there's nothing wrong -- I think we should focus on those mistakes and correct those mistakes, but that the men who were running these banks and the people who were running these banks, men and women who were working in these banks, were dealing with a 100-year storm, something the likes of which they had never seen before, the country would have to go back to the Great Depression to have seen something like that. And so they weren't trying to blow their -- their -- their entities up.

Now -- so I'm assuming that given all the investigations that have gone on, that when people broke the law, they are being held accountable, but I understand that view out there exists.

FRANK: Well, first, our jurisdictions, mine in the committee and Hank's at Treasury, we're not -- we weren't -- he's not the Justice Department. I wasn't the Judiciary Committee. I mean, we had a very important job, which was, A, prevent things from falling apart totally in 2008, and then trying hard to keep them from recurring. So you know, I don't speak to you from direct involvement in that.

Secondly, I would say this. And I want to talk to some of my liberal friends about this. One of the reasons we had to pass a lot of new laws was that a lot of the stuff that was bad wasn't illegal.

And you -- I want to talk to liberals in particular. A central element in due process is that you do not criminally prosecute someone unless he or she had good reason to know that conduct was illegal. And there were ambiguities. And people said, Well, prosecute even if you don't win. You know, I -- Earl Warren wouldn't have let us do that. That's a big part of the problem. Now...

WESSEL: Still around, Earl Warren?

FRANK: I do -- I said "wouldn't have."

(LAUGHTER)

FRANK: I do think this. So I -- that's a major reason for the lack of criminal prosecutions. You had to prove beyond a reasonable doubt that people did things knowing that they were against the law. And I -- that doesn't mean -- you know, ignorance of the law doesn't absolve from that if it was illegal.

On the other hand, I have to say, attitudinally, I am very disappointed in them. I think they are acting, many of them -- we hurt their feelings. If you look at the law...

(LAUGHTER)

FRANK: ... if look at what we did, we didn't stop them from doing a lot of things. I've come to believe people want psychic income from the government, and you have a lot of these guys who are still making a lot of money, just, Oh, my God, how could you have said such rude things about us?

PAULSON: And as a former banker, I was disgusted by a lot of the things I saw, you know, disgusted by the mistakes that were made, the behaviors, and so on. But you can be disgusted, you can be disappointed, but you can still take the basic view that Barney and I have taken, that -- at least I'm assuming, that the legal system, you know, is working.

WESSEL: Barney Frank, Lehman Brothers. Hank Paulson has said a number of times that he tried to save it, he couldn't. They didn't have the legal authority to do it because they were in such bad shape.

You once had a great line where you said that was national free market day, the day that Lehman went down. Do you accept that there was nothing the Treasury and Fed...

FRANK: Yes, I do, based on this. I had a very close working relationship with the secretary. And by the way, you know, people -- whatever happened to bipartisanship? And where did it go? Well, in September of 2008, it was alive and well. When a Republican president in the midst of a presidential election comes to Democratic Congress and said, We've got serious problems. You guys work this out with Paulson and Bernanke. And we did.

We were working closely then. I was in New York at a Democratic campaign committee fund-raiser the weekend that Lehman went under. And as I would -- I came to hate Friday afternoons about 5:00 o'clock because the phone would ring and he would be calling me up to tell me about a new disaster to ruin my weekend...

(LAUGHTER)

-- after most of the markets had closed. So we were talking about Lehman Brothers, and I knew that he was doing everything possible to keep it going.

And I went home and I remember I said to Jim -- my husband, then, you know, was (ph) date -- Well, Barclays Bank is going to buy Lehman Brothers. You know, Paulson told me that. And then the FSA -- turned out they knew what they were doing -- pulled the plug. So no, I know he tried very hard to do that.

My comment was -- of course, a lot of my conservative friends had said, Let them go bankrupt. Don't -- you shouldn't have done Bear Stearns. Let it fall. So Lehman was allowed to fall, and of course, the consequences were so terrible, a consensus came that you couldn't let that happen again. That's why I said the one day of Lehman, until AIG, was national free market day.

PAULSON: And David, the other thing, which Barney allowed me to tell the story in the prologue that's just come out with the reissue of "On the Brink," was it wasn't too long after Lehman went down -- excuse me, that Bear Stearns went down that the markets -- and again with Bear Stearns -- Bear Stearns had only been saved because a buyer in the forms of JPMorgan emerged, and we had had -- the Fed had assisted that buyer.

But we had learned at that time that we didn't have the necessary authorities to save a failing investment bank without a buyer. So Ben Bernanke and I went and talked with Barney when he chaired the House Financial Services Committee. We explained we didn't have the powers, the emergency powers that we had for commercial banks. We didn't have these for investment banks, to wind them down and keep them outside of the -- to wind them down outside of the bankruptcy process.

And Barney explained what we knew was true, after he explained it, that we weren't going to be able to get those authorities from Congress. The only chance of getting them was to say, We'll have a huge crisis if we don't get them because maybe Lehman would fail, and that would have brought it on us. But they ended up actually enacting those authorities as part of Dodd-Frank.

FRANK: Yes, let me say, by the way -- and I have to again make a factual partisan point -- the opposition was coming much more from the Republicans than Democrats. You had a strong wing of the Republicans, particularly on the Financial Services Committee, who said, you know, Let it happen.

But I realize I didn't fully answer your question. Yes, Hank convinced me and Ben Bernanke that here was the problem. If an institution did fail, they had one of two choices. They can either pay all of the debts or none of the debts. And neither one was acceptable.

Lehman, they paid none of the debts -- bad stuff in the economy. AIG, they paid all of the debts. Everybody is in a bad mood. So what we did in the bill...

(LAUGHTER)

What we did in the bill was to give them the authority, when an institution failed, first of all, to put the institution out of business. Let's, you know, be very clear. We had death panels -- we had death panels in our bill in 2010, but they were for big banks, not old ladies. They weren't in the children bill. They were in our bill.

And they are put out of business, and then the authorities can step in and pay only as much of the debt as they think is necessary to avoid further contagion, recovering it from the financial -- but that was a -- that was in the bill. It was in the bill because Hank and Ben Bernanke had asked us to put it there. And he was absolutely right. He had no legal authority. It was all or nothing. And we said, No, do as much as you have to and no more.

WESSEL: All right, so Hank -- so...

PAULSON: And I'd say just even just on Lehman, we didn't even have all because we couldn't guarantee or put in capital. AIG, the Fed was able to make a loan because it was secured by the insurance...

FRANK: But also, let's just make it -- that was another thing though. But the Fed did -- apparently, Herbert Hoover had signed a bill giving the Fed the power, essentially, to give money to anybody it felt needed it to keep the economy going, section 13-3. That we repealed, so you don't have that unrestricted power anymore.

WESSEL: So a number of people, from Bob Diamond, the former CEO of Barclays, to Elizabeth Warren the senator from Massachusetts, have said that we did a lot of nice things in Dodd-Frank, and I'm glad that the banks have more capital, but we haven't solved the problem of "too big to fail."

Do you think we've solved it?

PAULSON: Well, here's what I'll say. First of all, I have no doubt "too big to fail" has to end. We have -- this is not the thing that I'm most about because as a result of Dodd-Frank, regulators now have the tools to manage the failure of any large financial institution and to keep it out of bankruptcy.

So what I've said is "too big to fail" is a misnomer anyway because it's not just size. It's complexity. It's interconnectedness, number one.

I go on to say that no bank is to big to liquidate. Almost any bank of size is too big to liquidate immediately in the middle of a crisis.

WESSEL: And if we had another global one, is the system to set up to handle a global collapse?

PAULSON: Well, in terms of -- what we can is deal with what we've got in the U.S., and regulators now have authorities I really wish we'd had then, and much better tools to work with.

If you're asking me whether those tools have been refined (ph) globally, I would say the answer is that there's more that needs to be done. We're -- financial markets are global, they're integrated. They're not regulated nationally. I don't think we can ever get there. We can do a better job of harmonizing it. We don't have a perfect regulatory system in the U.S. We've got five different regulators now arguing and fighting with each other. It's even more problematic globally.

But -- so is it perfect? No. But Dodd-Frank, you know, has required, you know, the living wills, the plans to liquidate these large institutions. It's given regulators the authority to do so. And I think the reason that the things we did -- one of the reasons -- a lot of reasons the things we did were unpopular, but one of the reasons they're unpopular is that, as Barney says, you should not -- if an institution fails, they shouldn't be propped up in their current form. And that's what we were forced to do...

(CROSSTALK)

FRANK: Yes, let me say I -- here's the way the bill clearly works. An institution -- there are institutions that are "too big to fail" and ignore the consequences. That means there are institutions which, if they fail and then cannot pay their debts, that will have these negative knock-on effects.

What's different is you can no longer legally -- nobody in the federal government, not the Fed, not the secretary of the Treasury, can do what was done for AIG. No one can advance such an institution which cannot pay its debts money and keep it alive.

The prerequisite is that the institution is put out of business. People are fired. The shareholders are gone. The board of directors is dissolved. The FDIC takes it over as the resolver, although it's an odd semantic thing. In financial terms, "resolve" means "dissolve." I don't know where it became "resolve." But they get rid of it.

Now, what then happens is the secretary of the Treasury may find that there's not enough assets in the bank, there's not enough money from the shareholders to pay enough of the debts -- not all of them, enough to stop things. But the secretary of the Treasury in the law is mandated, then, to recover any penny by assessing financial institutions over $50 billion.

So my question to people is, what do they think is going to go wrong? Now, I've seen one -- one group says, Oh, you know what? If a major financial institution was in trouble, there were the overwhelming political pressure not to put it out of business but to keep it going.

In what country?

(LAUGHTER)

FRANK: In America, with George Bush and Barack Obama and all the congressional leadership and everybody else, we were barely able to get the TARP through! The notion that the American public would demand that we all go to the rescue of a big bank and keep it going is fantasy.

Now, the one plausible thing -- Dimon didn't have a (inaudible) You showed it to me. What about internationally? We can control an American bank. What if a bank somewhere else with a lot of branches -- that still has to be addressed.

But then the last question -- you said what about a global failure, a massive failure? Our scheme would have worked in 2008. People said, Well, what if they all failed? Remember, in 2008, Lehman was in trouble. Lehman went under. AIG was in trouble, a couple of others were. But Goldman and Wells Fargo and JPMorgan Chase -- Hank had to force them to take the money. They didn't need the money. He had to insist that they take it so as not to stigmatize the others that needed it.

So yes, it could be if there was a massive drop -- I guess -- my only -- (inaudible) but I want to quote Yitzhak Rabin. He was once asked, What is your plan if the Soviet Union invades Israel? He said, For some things, you cannot plan.

(LAUGHTER)

WESSEL: When Hank Paulson, asked me to do this, I said, You're not going to get a word in edgewise with Barney on the thing. And he says, Don't worry. I'm really aggressive.

(LAUGHTER)

PAULSON: I would say the -- to me, the -- where politics could enter in -- and so I agree with Barney we've got a lot of the tools we need, and on top of that, the banks are better capitalized, better regulated, and so on. And as you know, my focus is on other issues. Not that the big banks aren't a problem, not that we don't have more to deal with with the big banks, but I'm much more focused on Fannie and Freddie, and you know, the shadow banking markets, and so on.

But I do want to say we will know how these things work when we have a crisis and when the people who are sitting in the seats use the authorities because, again, the place where politics could come in, OK, is partly my making because the things we did were so unpopular, really unpopular. I mean, that -- there were polls when I left office that showed tortured scored higher, more favorable than the TARP.

(LAUGHTER)

PAULSON: I mean, it was -- yes, it's funny now. At the time, I got to tell you, I...

FRANK: And you weren't up for reelection. We were.

(LAUGHTER)

PAULSON: I know it. I was -- those that voted for it were a little bit more concerned about the polls than I was, but I was plenty concerned.

And so the deal is, I think -- I think regulators have got the tools they need. But as I said -- and they've got the emergency authorities to guarantee liabilities, put in capital, everything that I think they need. But if -- I think there may be pressure to liquidate these banks and not prop them up too quickly.

FRANK: Yes, the opposite of what the people would...

(CROSSTALK)

FRANK: ... one sentence that's -- because the question is, Well, what if too many of them fail? We can't guarantee that no one would fail, but what Hank just outlined showed that if one does fail, the others are going to be in much stronger condition. That is, the likelihood of their being blown over easily by this wind has been diminished by the fact that they will have had to strengthen themselves.

WESSEL: If you could have added one more title to Dodd-Frank, what would it have been?

FRANK: Well, I would have -- I would have merged the SEC and the CFTC. In no rational universe -- but you know what the problem is? The CFTC is the farmers, the SEC is the East Coast and West Coast financial...

WESSEL: (inaudible) Senate committees.

FRANK: It would have been politically very difficult. You would have had Shays rebellion break out again.

(LAUGHTER)

PAULSON: You wouldn't have had rebellion on the West Coast and the East Coast. It would have been in Congress, for people not...

(CROSSTALK)

FRANK: That -- I mean, there's no ration way you would have set them up -- look, what happened was, the CFTC, when it was started, dealt with corn and pork, et cetera. Then what happened was the financial derivatives came to the fore, and that's what caused the confusion, before you had financial derivatives.

And I did propose a solution at one point, short of abolition, which was that we should give the CFTC jurisdiction over everything edible...

(LAUGHTER)

FRANK: ... and the SEC had everything else. But the agriculture people wouldn't give it up.

(LAUGHTER)

WESSEL: Fannie and Freddie -- you mentioned Fannie and Freddie, big piece of unfinished basically. We've now basically nationalized the mortgage market. What should we do? What are the principles we should use?

PAULSON: I'd say -- I'll get to that. I just want to say the first thing that Barney and I and members -- you know, Democrats and Republicans worked on in getting done was, you know, these extraordinary authorities for Fannie and Freddie.

And I think they haven't got as much attention as they might have because we acted before they became unglued. You know, these organizations were, in totality, nine times larger than Lehman Brothers. They were in the market sometimes auctioning $20 billion in securities. If you'd had of those auctions gone bad and people started dumping these securities, it would have been terrible.

Can you imagine where mortgage prices would -- where home prices would have gone and the number of the defaults we would have had if those institutions were put into conservatorship? So I think they are about as effective as anything we did during the crisis, and it's sort of the biggest untold story.

Now, I'm very concerned because right now, you know, roughly 90 percent -- maybe not quite, but roughly 90 percent of mortgages in America, new (ph) residential mortgages, have got some kind of government support. And so I argue that that means that government subsidies are setting the price and terms, not -- not the private marketplace.

So my thought is -- you know, I'm no longer Treasury secretary. I don't have to come up with a specific proposal. But what I do say is, come up with principles. And I do like, you know, the Corker-Warner bill, but we could have anything that really shrunk their mission, you know, that they're -- I'm not someone that says that they shouldn't exist, but I would phase them out and whatever -- and then have some clear roadmap for what will succeed them.

And I think anything we do should have -- private market participants should be at risk. Any government guarantee should be very explicit. The government should be paid for that guarantee. And the price should be sufficient that there's room for a private mortgage market.

And then I would limit the mission in terms of either the size of qualifying mortgages, you know, the income of the borrower or first-time home owners, or all of the above.

WESSEL: But Mr. Frank, they're doing all the things that you always wanted them to do, right? They're making home ownership available. They're...

FRANK: Oh, that's a -- I've been very skeptical of home ownership. First let me -- because I agree completely with what Hank just said. In the first place, I know there's this argument, Oh, you liberals let them run out of control.

I'm going to have to make a factual partisan point. From 1995 -- 1994, the Congress passed something called the Home Owners Equity Protection Act that said to the Federal Reserve, Please regulate mortgages and don't let mortgages be given out improvidently.

Alan Greenspan now acknowledges that he rejected that authority, said it was an intrusion into the market. And he later testified that he now believes he made a mistake because he didn't think this would go out of control.

Then from '95 to 2006, I was in the minority. The Republicans controlled the Congress. I was originally too sanguine about Fannie Mae and Freddie Mac. I became persuaded things needed to be changed. As Hank said in his book, he became secretary in 2006. It looks like we're going to be in the majority. He called me, and we began working together, and the first serious legislation reining in Fannie Mae and Freddie Mac came in 2007, when I was the chairman and Chris Dodd was. And we did it.

Now, as to the solution, I agree with very much with him. I don't think the hybrid private shareholder public mission (ph) -- there's too much tension there.

Here's the policy debate. Some of the free market conservative purists believe, just pull out altogether. People in the housing business say to us, Look, if you want 30-year fixed-rate mortgages to be available, there has to be a government guarantee. But (inaudible) the government should not be guaranteeing credit risk. There should be an availability for people to buy some kind of interest rate risk if they're going to commit for 30 years, priced kind of to clear.

So that's what we're talking about as a (inaudible) Corker want to do. My piece of this -- and this is what I've always felt. I think people have oversold the importance of home ownership (inaudible) people. I want to see the Affordable Housing Trust Fund that we put into our bill funded. And what I believe we need to do is, first of all, you shut down mortgages that shouldn't be exist (ph), which the bill does. The bill outlaws -- the financial reform bill outlaws the bad mortgages. And you replace that with decent affordable rental housing.

WESSEL: Do you think that the Bush and the Obama administration did as much as they could have to help people who were underwater and in danger of foreclosure?

FRANK: No, but here's part of the problem. It was not either the Bush administration or the Obama administration, it was the "none of the above" administration. This is the first time since the Great Depression that we had a serious problem to deal with during the presidential transition. And even though they moved it from March 4th to January 20th -- look, I -- Hank and I talked about this. I remember this clearly. The first $350 billion of the TARP went out without much about mortgages. We argued about that. It was one of our few differences. But Hank did say to me, Look, I have another -- I can draw another $350 billion. If Obama OKs it, I will ask for it.

I asked the Obama administration to OK It. They said, Look, we're not in charge. They're in charge. And neither Bush nor Obama, frankly, was ready to get engaged. Hank was ready to do it. The Obama administration said, We only have one president at a time. I got in trouble by saying that I thought that overestimated the number of presidents we then had, in December.

(LAUGHTER)

And so we lost an opportunity. And I honestly believe that -- that -- I hope political scientists will study this because I think this is the first case where there was a negative impact of a transition since the New Deal.

PAULSON: I would say one thing, though, in all seriousness. I think George Bush was a great president during this period, and the way he dealt with the fact that he didn't worry about public sentiment, he was determined to do what was right. And I do think that we had -- housing is -- we could spend a lot of time talking about housing finance. It was one of my regrets that I wasn't able to come up with a way to limit the amount of foreclosures, although I do think the Fannie and Freddie actually took -- did more than anything else that was done. I regret that. You know, it eluded the Obama administration also.

But I think the level of -- as I look back at it now -- despite some of the angst I felt during that transition, as I look back at it now, the policy continuity was extraordinary because President Obama picked Tim Geithner. Ben Bernanke was still there. Barney was still there. Chris Dodd was still there.

And so he picked Tim Geithner. Geithner had worked hand in glove with us in designing these programs. So these capital market stabilization programs, they needed. They had the programs they needed. It was in place when they got there. They managed them well.

There was pressure. I have no doubt there was pressure because every new president, there's pressure from the base to get rid of what the other guys had did -- just -- done -- just disavow it. But they basically kept the programs. They managed them well. And so that part...

FRANK: I agree. And Bush did deserve a lot of credit for denying some of his own sort of ideologues and giving, you know, Hank the mandate to do it.

But we did have one difference of opinion because we had written into the TARP bill...

WESSEL: (inaudible)

FRANK: ... mortgage relief. And (inaudible) Hank (inaudible) I know he believed that there was such an urgency to get the first money out that you couldn't wait for some of that. He did say to me he was willing to ask for the second tranche of money, and that would have been used for mortgage relief.

Remember, here's the problem with mortgage relief. The money had to come from somewhere. A group of people owe another group of people money. We couldn't just wave a magic wand and fix it. Somebody had to come up with the money. Now, we could have forced the banks to take a little bit more of a hit at that moment with the TARP. But that's where the transition fell through.

There was another (inaudible) I have to be critical of the secretary of HUD, Shaun Donovan, whom I generally admired. We did take a billion dollars of the TARP money and said, Use that to relieve the mortgage distress of people who have been long-term unemployed. And he got so bureaucratically involved, only half of that was spent.

So I was frustrated that we tried to give some authorities, and they weren't used.

WESSEL: Let me ask one final question before we turn to the audience. The Fed -- how much has the -- or has the very public and contentious fight over who should succeed Ben Bernanke -- Larry Summers withdrawal -- how much has that hurt the Fed, hurt the country?

FRANK: It -- the Fed got (inaudible) I remember when Alan Greenspan was chairman, I was kind of a -- a dissenter from the consensus (ph) that everything he did was wonderful, although I think he did a very good job. I found myself in the last years being a defender of the Fed against a kind of a left-right coalition.

But I'll you, the moment -- and there really was a moment when this began to go (inaudible) And one reason we couldn't consolidate the authorities and regulation is you couldn't either give power to the Fed or take it away. I mean, they might have been the logical one. People would have gotten upset if you took it away. Greenspan and others always said, I can't -- we can't do monetary policy without some insight.

But here's the moment. When -- and people, I hope, will go back and look at this. When it came out that what AIG, which had been the recipient of $165 bill in what looked at the time like free money -- although it's since been paid back -- when it came out that they had given very large bonuses to people, the pitchforks were out in the street.

I mean, there was a white heat of anger. I actually feared at that time that we were going to lose the capacity for coherent governance. And the Fed -- and you go back, I'm sure this is the case, you look at the polls. That's when the Fed got demonized. The Fed -- first they gave the money to these people, and then they gave all these bonuses.

But Chris Dodd, who had put a bill in to try and restrict the bonuses, got into political trouble because he had constitutionally not tried to lift (ph) them retroactively. People had said, You can't take it away retroactively. He said, OK (inaudible) they blamed him for the bonuses.

So yes, the Fed was weakened, but I don't think this last thing has added to it. I think it happened from the reaction because they bore the major political blame, unfairly, for the -- for the bail-outs.

WESSEL: Do you think the Fed's been hurt by all this?

PAULSON: By?

WESSEL: By the storm over who should replace Ben Bernanke.

PAULSON: Well, I agree with Barney that it has been accentuated by the fire and the storm, the unpopularity of the actions that we all had to take and the Fed took which were very unpopular and the American people never understood, never understood we did these to prevent a disaster, something Barney and I both understood. We could have had something that rivaled the Great Depression.

But Barney was the first one that explained it to me. You know, first time I had heard there, not being a law student, counterfactuals. You know, you're never going to get -- prove a counterfactual. You're never going to get credit for the disaster you avoided.

And I agree with him that the bonuses, legal though they were, you know -- they upset a lot of people. They infuriated the American public.

And so -- but this last thing to get to your specific question -- I hate it. I just hate the political turmoil we've seen and the politics around the appointment of the next chairman of the Fed. I don't like the way this has been handled. I just -- I'd like to have a decision made quickly.

You know, we've got good people. Larry Summers is a very good man. He's highly regarded. He's very able. I don't -- you know, Janet Yellen, outstanding, Don Cohen, outstanding. There are -- the key thing is, you know, we've got some good candidates. This is a very important decision President Obama's got to make.

I've always argued that one of the -- President Bush made some very important decisions. I think picking Ben Bernanke was a very good one and a very important one.

And I think this one is important. And one of the things that really bothers me about Washington is sometimes, if people disagree with you on policy, they go after you then on all kinds of other issues and personalize it, and so on. So these are -- so anyway, I'm saddened by this.

FRANK: Let me just say one of the most distressing things to me about the current political scene -- and I blame -- I'm very critical of the finance community. I go back to -- well, apparently, we hurt their feelings. What you've seen is...

WESSEL: Finance community?

FRANK: The financial, the bankers and the investment people. The Fed has been under very unfair assault, irresponsible assault, people complaining when the Fed stepped in with the swap to help Europe from avoiding disaster.

And the role of the -- what's happened is that the most ideological people -- some on the left but even more on the right -- have now turned on the Fed. And I think the failure of the finance community, which knows better, to defend the Fed against the kind of irresponsible attacks on it as an institution is very, very discouraging and it is ultimately coming back to hurt them.

They may think somebody else is going to do it, but I think they have a responsibility not to allow the Fed to be as attacked, and I think, damaged as it's being.

PAULSON (?): You may be right. I agree with everything you've said, but I'm wondering if, right now, the finance community speaking up for the Fed would help or hurt them.

(LAUGHTER)

FRANK: Yes, no, in this case, it will. Yes, here's what they say. Here's -- I don't mean -- I don't want them to make big public speeches, but they (ph) want them to say, Yes, Congressman X, here's your $5,000, but would you please ease up on the Fed? That can be said very (inaudible)

(LAUGHTER)

WESSEL: OK. With that pragmatic recommendation...

(CROSSTALK)

WESSEL: We're now going to turn to questions. Here's the rules. You can ask a question. A question ends in a question mark. No speeches. These guys make the speeches. Wait for the mike and speak into it clearly. Say who you are because this is on C-Span and everything. And again, keep your questions short. And I have an iPad here, and apparently, there's some corporate members of the Council on Foreign Relations who may have a question.

So can we get a mike in the front here? There's a woman in the front.

QUESTION: I work for the Naval Post Graduate School. I've been struggling since we fell apart to understand how it happened. I never studied economics, but the thing that puzzled me was no one was concerned, as it appeared, that giving loans to people that had no money and that -- the assumption was they were going to have it for a few months or whatever, and then sell it, and the price would go up, I just thought was nuts!

Why didn't anybody raise that question?

FRANK: One, people did -- but here's -- by the way, here's what -- what happened. Fifty years ago, most people who borrowed money were going to have to pay back the person who leant it. And then thanks to liquidity coming from non-bank sources and from information technology, you were able to get into securitization. And it's the one difference I have with the way they're administering the bill now.

So people began to make loans, sell the loans, and not have any further responsibility. And the lender-borrow (ph) discipline slipped. Now, one of the substitutes for that was supposed to be the rating agencies, than which no one has done a worse job in my memory. And so that's essentially what happened. You know, there was this -- people gave loans who shouldn't have gotten loans because the worry that they wouldn't be repaid was a problem.

Now, one of the things we put into the bill -- and this is my one criticism of the administration's implementation. We put in the requirement for risk retention, that the idea would be that if you made mortgage loans, the person who bought those up and securitized them, sold them to general public, had to retain some of the risk. To get 60 votes in the Senate, we had to agree to an exception for that for really good loans.

The regulators, to my dismay -- and I co-wrote an article with Sheila Bair about this -- collapsed those two categories. So now there are some loans we banned. We did ban them. The other thing, though, is -- and if you make the loan for mortgages, you don't have to have this risk retention. That's my most serious complaint.

PAULSON: I would just -- because I agree with everything that Barney has said, I'm just going to add two additional (inaudible). The first is, ever since World War II, the plethora of policies we've had in the U.S., not just Fannie or Freddie, but the home mortgage interest rate deduction, FHA programs, VA, all the different -- intended to promote home ownership.

And as Barney said, you can have too much of anything, a good thing. And so residential home prices tended to go up in the United States, so all the models and everything (ph) people looked at didn't foresee a big drop in residential mortgages.

If you were an investor and you owned a residential mortgage, the biggest risk was not historically you wouldn't get your money back, it was you would get it back too soon. Rates would drop, people would pre-pay.

The other thing I say that disappointed me in terms of Dodd-Frank and the way that was watered down, the regulators allowed this -- the exception if the mortgage was a qualified mortgage. And the new Consumer Finance Protection Bureau originally had regulations that said the buyer had to be able to afford the home and put 20 percent down, OK?

There was a huge resistance. So -- you know, and affordability is important, that's ability to pay, but willingness to pay is also important, what we learned. And the only way you get at the willingness to pay is the 20 percent down.

So even on that, this new Consumer Finance Protection Bureau, to my judgment, bowed to the political pressure and...

(CROSSTALK)

WESSEL: You both think that the CFPB has weakened...

FRANK: No, no. It didn't get to CFPB. It's everybody else (inaudible) because here was a joint -- and by the way, I don't think it had to be a 20 percent down. There were other ways. If you...

PAULSON: Something down, yes.

FRANK: ... put something -- again, there were supposed to be three categories of mortgages. Mortgages (inaudible) so bad, you can't make them. That's in the law. You can't -- they're (inaudible) you can't make them.

Then there were supposed to be two others, the average mortgage, where there was risk retention of (ph) securitized, and then a small number of really good mortgages. I didn't even -- in our bill, we didn't even have that last exception.

But a couple of senators wanted it. And the one thing about the filibuster rule, that 60 vote rule gives every senator a gun. OK, you want 60, you're going to give me this.

So what the regulator did -- and CFPB disappointed me in this, but everybody else did. You had this coalition, the banks...

PAULSON (?): It was much broader, yes.

FRANK: The poor people's advocates. And I think the liberals -- I am critical of them for this because Hank is right. That I -- the only solace I have is the statutory authority is still there. I hope within a few years, they will reconsider that.

WESSEL: Well, why don't we take the mike down the middle there. There's a gentleman here on the left, and then we'll go to...

(CROSSTALK)

WESSEL: So right here. And then the guy in the green. Yes.

QUESTION: Is there -- you mentioned earlier that there's still a lot to be done abroad. Is there or should there be a contingency plan in case the now very big Chinese banks would run into trouble or even fail?

PAULSON: A contingency plan for what?

WESSEL: He said, should there be a contingency plan unless (ph) one of the big...

FRANK: Chinese banks.

WESSEL: ... Chinese banks fails. That would be popular.

(LAUGHTER)

PAULSON: Well, what Barney said -- there are some things it's very hard to plan for. But there is certainly -- you know, we did contingency planning when I was Treasury secretary. I'm sure they do contingency planning and stress tests for big global banks failing and for the crises starting other places.

You know, even the -- our financial crisis, I maintain, was not a U.S. financial crisis, it was a U.S.-European. The European banks had at least as big a problem. They didn't deal with it the way we dealt with it. And so you look at ours in terms of the timeliness and effectiveness, I think it was better in terms of getting capital.

But yes, there -- I'm sure that regulators have contingency problems (sic) for the things that happen globally. But as Barney said in answer to David's questions, we don't have control in terms of what foreign countries do. We just have to coordinate.

WESSEL: Yes, sir?

FRANK: Can I ask Hank a question on this? Is it the case that that might be less likely, given the fact that the Chinese government would be less constrained by public opinion...

(CROSSTALK)

FRANK: ... that they could step in and stop the bleeding earlier and easier than we could?

PAULSON: Oh, yes. Yes. I didn't deal with the specific there. That's why -- I got a specific question, I dealt with it generally because I didn't want to get into specifically China. But yes, I -- thankfully, I'm not predicting that likelihood. And I would say that all over the world -- I mean, the Europeans started off -- you know, the Germans were bailing out Landesbanks over the weekend and no one was even noticing it, you know, early -- in the early days.

You know, the crisis didn't just start in the U.S. There historically was much less political, you know, concern about bail-outs. And even in the U.S., you know, if -- if you -- that "too big to fail" became an issue -- you know, step back. We've had crises for a long time and regularly. Most of them are manageable, OK? Most of them are manageable. It was only when we didn't have the authorities we needed, and this was just such an extraordinary test, that the American public was hurt.

QUESTION: Two, in a sense, related questions. You spoke about the lack of criminality enforcement, and I understand the positions that you both enunciated. I wonder if you could address the same question from the point of view of regulatory authority and the ability of the regulators to step in and to take action against individuals, executives and board members who engaged in conduct...

FRANK: That's very important distinction because they've argued, Oh, we can't -- I mean, the argument that you don't want to put another big company out of business is, A valid, but B, no excuse not to -- they should go after individuals (ph).

And by the way, going after individuals is a deterrent. Fining the company doesn't bother anybody. So I agree. Here's -- here's -- but here's one -- and I -- let me -- I'm not -- I don't know why. I haven't been there. I've been busy with the other stuff. But here is this one factor I will feed (ph) into their -- in their defense.

The Securities and Exchange Commission and the Commodities Futures Commission are both grievously underfunded. We gave the CFTC a lot of new authority to do derivatives.

Frankly, again, it's a partisan difference. When the Republicans took over the house in 2010, they decided in the budget to significantly underfund -- the CFTC gets about $200 million to run this whole industry. The problem is -- and what they tell me -- I'm just repeating this -- is if we begin to get tough on these people, they will litigate. And they have resources beyond what we have. And a couple of those cases can sort of exhaust us.

So what I -- one of the things I'd hope we could have done in the bill was to give the SEC, for example, the fiscal autonomy that the bank regulators have, and we couldn't get it done politically.

WESSEL: Gentleman in the back. And there's a woman in the front here. Ma'am? Can you give the woman in the front here in the second row? Sir, go ahead.

QUESTION: Since in 1980, 7 (ph) percent of all mortgages were held by GSEs and 64.5 percent of the American people owned their own home, and today, 90 percent are held by GSEs and 65 percent of all Americans own their homes, my question is to the two of you, what are we trying to end (ph)? In the interim, there's been a savings and loans crisis and what happened in 2008. What are we trying to accomplish as a country with our housing policy?

PAULSON: Yes, that's -- that's the question. And neither one of us are now there, where we're making housing policy. Peter, you heard me say that I thought one of the most effective things we did, which necessary to get through the night, was putting in the conservatorship.

But when we did that -- and I remember talking with -- with Barney, right as we were doing that, and got no -- anything but support from him. But we both said and I said that this is -- this is a timeout, OK? We can't straighten this out right now in the middle of a crisis.

But it never dawned on me, because no one was standing up and saying, Oh, this is a great system, you know, that the -- that -- that public support for private profit, you know, et cetera, et cetera. This is a great system. They all -- we still got it. And right now, because they're making money hand over fist and all that money is in the federal budget, there's actually a -- it's scored as adding to the deficit to deal with it. So you've got some -- some disincentives.

It's got to be dealt with -- I would say it will be dealt with. But it's -- the other thing is I just would say, as you said, it's not just Fannie and Freddie. It's housing policy. Tell me why it's fair that someone should get an interest rate deduction on a million-dollar mortgage and a renter doesn't. Where does that come from? It's just...

(CROSSTALK)

FRANK: If I was starting over again, I not have a home mortgage interest deduction. Unfortunately, it is now built in as a legitimate vested (ph) interest. You couldn't just pull it out.

But we have had a national policy that has treated renting as if it was somehow second class. I'll give you a shocking example of that. The New York Times business section a couple weeks ago had one of the most outrageously bigoted articles I've seen, all about how, Isn't it terrible, all these poor home owners who live in areas where there are foreclosures now have to put up with renters in their neighborhood? I couldn't believe what I was reading.

(LAUGHTER)

I urge you to go back and read this. And it was all about how renters are bad for the neighborhood, you know, being read by all those renters in Manhattan who don't seem to me to be causing all these problems.

But -- so I think we need to move away from this emphasis. But here's the -- and the reason we're not getting rid of Fannie and Freddie, the political science reasons -- there was a brilliant solution in the German constitution after World War II. People were worried in the parliamentary system about the instability of France and Italy, where you kept getting governments overthrown by the coalitions of people who were antis. (ph) And in the German constitution, it says this. You cannot in the parliament, in the Bundestag, overturn a government. You cannot turn a government out unless that same resolution names the new government. So it prevents a coalition of negativism from stopping anything.

There is a majority in the American Congress for getting rid of Fannie and Freddie, but not together on any one version. There are the strong enterprise people in the House who want to simply get out of it. There's the Warner-Corker approach, a kind of a public utility, where you can get an interest rate guarantee. And that's the problem.

By the way, it's not the only example. If you had a two-step vote, should we get rid of the Electoral College, it would win. But you'll never get enough people together on the alternative. So that's what keeps Fannie and Freddie alive.

WESSEL: There's a woman here, and then we'll go to the woman in the back.

PAULSON: Good point.

QUESTION: I had the honor of serving as the treasury attache in Brussels, and before that, I served on the committee. My question therefore is international. What did you learn and what would you advise American policy makers today about American leadership in the financial institutions globally, based on your experience?

Were there any good examples of cooperation? Everyone knows the story about the FSA pulling the plug on Barclays, but there must have been some good things that happened that weren't told. And what have you learned about American leadership in the process?

PAULSON: Well, I would say this. If you read "On the Brink," my book on the financial crisis, where I sort of explain what happened, how it happened, when it happened, that story is told because I think the crisis in many ways -- it brings out the worst in some people, but it brings out the best in many people.

And there was great coordination and cooperation in the way we came together. You know, when you look at the -- it's sort of the three weeks between the time Lehman went down, and we got the TARP legislation, Republicans and Democrats working together to stave off disaster, you also had -- this was not just the U.S. European banks were teetering. They -- six different countries came in to rescue their banks.

When the G-7 met, and we were dealing with that that same weekend where we put the capital in the banks, they came together with a -- with a multiple-point proposal which basically said, We're going to stand behind, you know, all systemically important institutions. We're not going to let them go down. We're going to capitalize the banks if -- to the extent that makes sense. We're going to make sure we have a robust federal deposit insurance.

And there was great coordination and cooperation and communication throughout this. So the structure -- we were dealing with a 100-year storm without the necessary authorities or regulatory system in the U.S. And of course, globally, the U.S. system was ahead of where we were globally. And so I think people actually came together very well.

It's just a -- and to me, that's -- as I look back on it now with the perspective of five years, that's -- at the time, I was very conservative on a lot of things. I now look back with great gratitude at the way various people worked together.

FRANK: Let me build on that. Yes, there was coordination then. More, I think -- and we had a lot of coordination in doing the regulation. You want (inaudible) I'll give it to you. The European Markets Commissioner was Charlie McGreavey (ph) from Ireland. And he and I talked a lot. And I told him we were going to do risk retention -- back to my hobbyhorse.

He went back to the EU and was running to some resistance on risk retention. And he said, Well,the Americans are going to do it. And so they did it. And then when I ran into resistance, I was able to say, Well, the EU did it.

(LAUGHTER)

We literally bootstrapped each other. But we -- we -- there's been more together (ph). Look, Basel has been -- you know, people didn't like the substance, but there's been a lot -- one great example of international cooperation now (inaudible) the media tends to focus too much on the negative. I wish more people knew it. And that's the tax agreements that are coming forward. There is apparently great progress being made multinationally on cutting down people's -- multinationals' ability to pay taxes to nobody. And that's been very helpful.

As far as the other stuff is concerned, yes, we are talking about it because -- look, we have this problem, and the financial people -- obviously, I have some differences with them. One of the things -- one of their role models is the teenage child of divorced parents -- Mommy would have let me do that. I'll go live with Daddy because he won't stop me from doing that -- translate to, Well, if I was in England, they'd let me do that. Well, you know, I can go to Japan and get away with that.

WESSEL: Regulatory arbitrage.

FRANK: Yes. And there has been a -- I think what you've seen is...

WESSEL: (inaudible) shopping, yes.

FRANK: We did it by moving first on -- I think there has been the opposite. I think we have been a good influence on each other. And there's been a lot of conversation. And it's not perfect, but I think there is a lot less regulatory arbitrage than people (inaudible)

WESSEL: The woman in the back, and then the gentleman over there.

QUESTION: I also am having serving in the Asian Real Estate Association of America, the D.C. metro chapter. Thank you for talking about housing and thank you for talking about the global financing system.

I've heard the talk about EU and us, I haven't heard we talk a lot about the U.S. and China. And I think there's a lot of imbalance, a gap between our world (ph) financing system and China financing system. And we talk about "too big to fail." Actually, the China economic system base a lot on the SOE, the state-owned enterprises. And that's why all the subsidy...

WESSEL: OK. So you have a question?

QUESTION: Yes. My question is how to protect the American middle class home ownership from people with cash coming in to and buy it from us. We have gravitated from one extreme of not adequate oversight and creating the bubble enterprises. Now we seem to have to another extreme that we only ask people to have 20 percent down and excellent credit scores after all this crisis. The new...

WESSEL: OK...

QUESTION: The new picture (ph) that we have (inaudible) how do we...

FRANK: Well, remember...

(CROSSTALK)

WESSEL: Have we made it too hard...

(CROSSTALK)

WESSEL: Have we made it too hard for people to buy a house?

FRANK: Well, no. The -- in fact, I -- I would like there still to be risk retention. I think people ought to be willing to stand by the loans.

I thought the 20 percent might have been too rigid. Remember -- by the way, 20 percent didn't mean that you couldn't get a mortgage. It meant that you would have to -- that whoever leant you that money to buy your home without a 20 percent down payment had to believe that it was a good enough loan to retain 5 percent of the risk if you didn't pay it.

So I -- you know, this notion, Oh, there's risk retention. If they can't securitized it 100 percent, then they won't make any loans. But there must not have been any mortgages in America before 1985 because securitization didn't exist before that. Securitization (inaudible) and the others brought it forward in the '80s and into the '90s. So no, we haven't made it too hard. We've made it too hard, I think, to give away mortgages that shouldn't be given.

WESSEL: Sir?

QUESTION: I have two questions that may relate. What do you think about the Volcker rule? And what do you think about the movement to make our big banks smaller?

FRANK: I believe you're going to see a Volcker rule adopted fairly soon. And Hank is right, it does take a whole lot of regulators. But I believe they are making progress. They are trying to do it, but they were slowed down because they were trying to accommodate what the financial institutions said, to have this or that.

I think there's going to be a very solid Volcker rule, and I don't think it's going to harm what goes on. You know, we talk about international -- the British are doing very similar with their ring (ph) fencing (ph). So I think that one will work.

As for making them smaller, as Hank pointed out, we give the regulators the power to reduce banks if they believe a bank -- any one financial institution's becoming a problem either by making them shrink in size or by reducing a function.

But reducing them in principle -- well, (inaudible) another point. As Jamie Dimon, in defense of him, points out, one reason the banks got bigger is that we spent a few years asking Bank of America and Wells Fargo and JPMorgan Chase, Please, will you buy this bank because we didn't want to let it go.

(LAUGHTER)

So to some extent, they have a legitimate complaint, although buying Countrywide was Ken Lewis's own idea.

(LAUGHTER)

But we did pressure them to buy Merrill Lynch and JPMorgan Chase to buy Bear Stearns.

My answer is this. I don't think size alone is the problem. One argument is they'll have too much political pressure. And I'll close with -- my answer with this. Anybody who thinks the banks have a lot of political clout didn't watch our legislation. Every -- on every issue, when there was a dispute between smaller banks and big banks, the smaller banks won.

They -- they -- we changed the deposit insurance assessments so that the smaller banks (inaudible) than the bigger banks. The smaller banks get some preference in the CFPB. We increased the deposit insurance from 100 to 250.

I know people sort of have this concern about bigness in general, but I am not persuaded that the size of the banks alone is the problem.

PAULSON: You know, I -- I agree with Barney. It -- the -- my focus right now is on other issues. That isn't to say there aren't issues with the banks, and it's -- you know, the bigger and complicated an organization is, the harder it is to run, et cetera, et cetera.

But I take the view that there's been so much focus on this and that the ultimate defense is capital and liquidity. And I'm all for the new Fed rules, and I think that's a good starting point. And you know, Dodd-Frank in a corporate set (ph) requires that the largest institutions have that.

So again, I'm focused on -- I'm trying to call attention to other things, shadow banking. I'm trying to call attention to Fannie and Freddie because there's so much...

FRANK: I want to ask a question. No one has told me, and I've asked them, Please (inaudible) me. How big should they be? What's the size? Because remember, if you're worrying about "too big to fail" -- Lehman Brothers was -- caused this problem. So that's my other question. What is the size above which they become a threat?

PAULSON: And interconnectedness and complexity is -- is one of the real issues, and that's why I've said innovation is great almost anywhere. You can have too much innovation in finance, in my judgment, complexity. That's why I'm all for if there's too much complexity, hitting the banks with much higher capital requirements against the complex instruments.

I'm pleased that Dodd-Frank requires that over-the-counter derivatives to be traded on central clearinghouses -- again, the transparency there. And so I think there's a lot that's been done. And I'm not discounting it, I just want to learn our lessons and make sure we clean up our messes.

FRANK: The Volcker rule is a major diminution in complexity, if it's implemented correctly.

WESSEL: I think we'll leave it with that. Mr. Frank, Mr. Paulson, thank you for the time. And thank you for your good questions.

(APPLAUSE)

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