An Evening With Barney Frank

I live in the 4th Congressional District of Massachusetts so Barney Frank is my representative. He also happens to live in my town. Tonight he spoke at the First Unitarian Society of Newton and I went to listen. He spoke about the economy and then took questions for 40 minutes.

He said he mostly agreed with the president's remarks on the economy today. (and why is this White House blog entry the closest I can find to the full text of his speech on the White House's website?)

He described how there have been three times of great trouble in the economy and they come when new innovations come about and there aren't rules to control them. The first was in the late 19th century when huge companies came about that could do (useful) things that small companies couldn't do. They were called trusts and at first that wasn't a bad term, but then we found we needed to regulate them and Teddy Roosevelt became a "trust-buster".

Then with the birth of large companies came the need to raise large amount of capital and stock markets became more important. As they grew unchecked in the 1920s and led to the depression in the 30s and Franklin D. Roosevelt brought regulation to that.

This current iteration was brought about by two innovations. First the securitization of loans and a large sums of money available from non-banks which were not regulated. Second was the invention of CDOs, and CDO² (which I hadn't heard of) and of course CDSs to provide insurance for the CDOs. These instruments aren't inherently bad and allowed for a great deal of real growth in the economy, but since they were unregulated things were able to go too far. He had a lot of funny analogies and used this to describe CDSs. They were willing to insure CDOs backed by mortgages because they thought housing prices would go up forever, but of course they didn't. "These were people selling life insurance to vampires and then vampires started to die."

So his task in the next year is to come up with rules, much like FDR had to. He said a couple of times that "good regulation is pro-market" and told people when they hear arguments against regulation to go back and read the arguments that both Roosevelts faced and notice the shocking similarities. FDRs regulations lasted about 40 years and that's a good run, but starting with Reagan and continuing in Bush we had governments who thought regulation was bad and "government was the problem". It doesn't matter how good the rules are if the regulators don't enforce them.

His plan is a four point program. First, no one will be able to securitize 100% of a loan. They'll need to keep 5% of it to "have skin in the game". This should prevent them from giving out loans that they know the borrower won't be able to pay back.

Second is to control executive compensation. Rather than setting limits, they will let shareholders vote on compensation. And compensation is not limited to just a salary. The problem is there were usually performance incentives. So if the company did well they got large rewards and if it didn't, they didn't. The problem was there was no penalty for very risky behavior. He wasn't specific, but said there would be limits to compensation that encouraged too much risk.

Third he mentioned the phrase "they weren't too big to fail they were too interconnected to fail" and then talked about limiting leverage.

Fourth was to have a system in place to be able to wind down a failed large non-bank (like AIG). Now they have to play it by ear.

The questions were mostly good but unremarkable. He said he was now supposed to call the stimulus package the recovery package because Democratic analysts (both sides have them) said it polled better. But he didn't agree since most people prefer to be stimulated than to recover.

Someone asked why hasn't the liquor taxed been raised in so long. He said he didn't really know the specifics but speculated because there are a lot of people who drink and who don't like to pay taxes.

The one thing he disagreed with the Obama administration was this. Paulson pushed all the large banks to take TARP money so that it didn't look bad for those that took it because they needed it. They also made it difficult to pay it back and then added rules for those who accepted it. Frank thinks that people know there are banks that are in trouble and those that aren't and there are other ways for people to find out which is which, so it only makes sense that we do what can to make it easy to pay back the government. Today Goldman Sachs announced plans to pay back the $10 billion it got and these questions were raised.

Overall, an interesting night.