ON THE LEGAL RIGHTS OF MORTGAGE HOLDERS
TPM: The next question goes to mortgages, to shift a little bit. Countrywide executives testified before your committee last summer that they were requiring borrowers who had loan modifications to sign away part of their legal rights ... a recent investigation found that Fannie and Freddie now make the same waiver requests of folks who are getting their loans modified. Were you aware of that? Do you think that's a troubling trend?
FRANK: Yes, uh, it's a very troubling trend. We were not aware of it. As a matter of fact, by the time that question was posed, Countrywide had been bought by Bank of America, and Bank of America has ended that practice. ... I have friends who said 'well, Bank of America's too big, shouldn't we stop them from buying Countrywide?' ... [M]y answer was, I would have been happy if Syria bought Countrywide, because it was one of the most irresponsible institutions out there. Bank of America has done a very good job ... I did not know until you just told me that Fannie and Freddie were doing that and I can pretty much guarantee you that we will have put an end to that within a few days.
ON THE BAILOUT
TPM: So as it stands now, using what Paulson did with that first [bailout] tranche as a model, do you think that taxpayers will ultimately recoup the money that we invested?
FRANK: I believe we will recoup it. Going forward, though, we did change the terms and the thing that was in the bill - [which] you acknowledged that isn't going to pass but to which they're committed -- any new money that goes to financial institutions in the form of a capital purchase can only go if there is an agreement as to what will be done with it.
So, we have buffed up the warrants a little bit. But mostly what we've said to the new Secretary of the Treasury is before you give money to any new bank or financial institution, you have to get an agreement from them on how they're going to spend it. Now that doesn't mean that every dollar is going to be re-lent, but the great bulk of it we expect will be in such agreements... Now where you have banks that have a capital deficiency, and remember there is this problem, banks are required only to lend a certain percentage, a certain multiple of their capital. As the value of assets has deteriorated in society, bank capital has deteriorated. That has legally required them to lend less, so there is some argument for giving them capital -- not so that they will lend more, but so that they won't be forced to cut back. But that's got to be very carefully calibrated, and in most cases there is going to be capital over and above that, and so as I said the main difference we're going to have in the bank lending program is, banks are going to have to tell us what they do with the money.
TPM: Do you think it actually might be time to increase that percentage of capital that banks are required to lend? Might you do that by law?
FRANK: Well, it's best left, I think, to the regulators, to be able to make a judgment, but here's a problem, if you increase the capital base for banks right now, you'll cut lending back. You want to be careful; there's a difference between what we want to do short-term and long-term. There is no question that longer term, to avoid another set of crises like these, you have got to increase the capital base on which lending takes place. ... We're going to first of all make sure that no lending activity by any institution, any kind of institution, a bank, an investment house, a hedge fund, private equity, that none of it takes place without full transparency and capital requirements. Then we would have to look at what the adequacy of the requirements is for those institutions that have already had it.
ON FINANCIAL REGULATION
TPM: [T]he next one sort of speaks to priorities. The president-elect has said he wants to tackle financial re-regulation ... by spring, April and May has been discussed. Do you think that's a realistic timeline? And would you consider perhaps bringing the CFTC inside the SEC or elsewhere?
Frank: Well, that a very good question ... We've got to adopt risk regulation is what I was just talking about. We have got to by the spring have rules in place so no one engages in risky financial activity without capital requirements. Nobody should be out there incurring debt without a reasonable assurance that that institution can pay off the debt.
So we're going to regulate all of that. I think what you're going to see there is the Federal Reserve set up as an overall systemic risk regulator across the board. Then you have the other questions of investor protection and market integrity. And they are not unimportant but they're not as central as getting that systemic risk thing in place. That's when you get into questions of the SEC and CFTC. I think it's fairly clear that if you were starting from scratch, you wouldn't have a separate Securities Exchange Commission and Commodities Futures Trading Commission. You wouldn't have a separate Office of the Comptroller of the Currency and Office of Thrift Supervision, but you do. And in politics, institutions acquire a certain amount of political muscle. It's unclear what we're going to wind up doing there. I think it's important, first of all, to put some constraints on excessive risk taking. That's what we're going to do right away and can be done fairly quickly. Then we'll get into the tougher political battles, which are tougher politically and important -- but not as important -- economically.
TPM: Interesting. So if you impose these capital requirements, then this [financial] bureaucracy will ultimately be sort of making a down payment on future better rules and better regulation.
Frank: We've got to. It's almost like the emergency medicine situation. We have to stop - well, the bleeding has stopped now, because they bled themselves out. But it'll start up again. You know, the problem we've had -- people talk about deregulation -- is actually less deregulation than non-regulation.
That is, it's not that we used to regulate credit default swaps and collateralized debt obligation derivatives and stopped. It's that we never regulated them; they're new entities. The role of the public sector is, when the financial institutions come up with new approaches, to put regulations onto these new approaches, and that's been the problem. The Bush administration and Alan Greenspan successfully resisted ... these regulations, so we're going to put them on there. And again the biggest thing to do is to put some constraint on risk-taking. ...
Thirty years ago, most loans were made by people who expected to be paid back by the borrower. You wanted a mortgage, you went to the neighborhood bank, and you then paid that bank every month for thirty years. Thanks to technology and to a large amount of money that's now available, largely accumulated by some foreign countries that have done well in trade with America, we invented a process called securitization in which I lend money to hundreds of people and I immediately sell the right for them to pay me back to hundreds of other people -- packages of securities.
[T]here's a fundamental human factor here -- if I lend you money and you're going to have to pay me back, I am going to worry more about your ability to pay me back than if I lend you money and I sell the right to be paid back by you to a lot of other people. And this simple fact led people to make loans that shouldn't have been made because people were going to be out of that process. And then, we were told well, we have these, uh, risk-reduction factors -- the ratings agencies, diversification, quantitative models. None of them worked. So what we have to do is: one, stop certain kinds of bad loans from being made.
Specifically, we're going to re-pass the law we passed in the House that the Senate didn't pass to cut off the bad subprime loans. By the way, the bad subprime loans are really the single biggest cause of this, because they got spread and led to weaknesses elsewhere. In 1994, [under Democratic control], Congress passed a bill telling the Federal Reserve to regulate subprime loans. The next year, the Republicans took power and held it for 12 years, and Alan Greenspan, bolstered by the Republicans in Congress, specifically and literally refused to use the power. He said, "That's intervention in the market." If Alan Greenspan had begun, in 1994, using the power Congress gave him, we would not have this crisis, because you would not have had these subprime loans. ...
[O]ne of the things we're going to do is to stop the bad subprime loans, but beyond that we have got to put constraints on risk. One thing we'll be considering [is], if I lend money to a whole bunch of people, and I securitize those loans -- that is I package them, sell the right to be repaid to a whole lot of other people -- one thing to consider is the law should require me to hold 10 to 15% of that. Right now I can sell 100% of it, so I get my money and if there are losses in repayment, I'm off the hook. Maybe we should say "No, the first 10 percent of losses come out my pocket. I'll be more careful about who I lend to."
TPM: So it's a simple principle: You should have ownership and you should take that responsibility for at least a segment of it. It would seem to reduce risk.
Frank: We have allowed people to make the decision to lend, and absolved them from the consequences of bad loans. Now it turns out they weren't so absolved, because people did such a bad job, the whole system is hurting. But for a long time, the argument was, 'I'll make those loans, I'll sell it, I'll be out of it, and I will not have the ownership of bad decisions.'
TPM: Is a proposal like that, limiting securitization to say 85 or 90% of the loans you make, something you think the industry will put up a huge fight about? Or is it something you think would be doable politically?
FRANK: Both. Yes some of them may put up a huge fight, but their position has been weakened. There was this prevailing conservative philosophy ... there were people arguing, like Alan Greenspan, like George Bush, for total lack of restraint on capital. The argument was that what you should do is simply leave capital alone, don't tax it, don't regulate it, particularly don't restrict its right to flow internationally. And [this argument] said that'll do three things for you.
First of all, it will make everyone in the society better off economically. Second, you will have smooth running because the market will take care of problems, there will be no glitches. Third, it will bring democracy to the world. Well, sadly, you know the Chinese are showing that you can capitalize without democratizing. The internet was supposed to be the great democratizer. Unfortunately the Chinese have shown that you can muffle the internet's democratizing influence. As to making everybody better off, what we've seen is that it's possible for countries, including the U.S., even during the good years under Bush, to increase in wealth but for the average citizen to get none of it, and for inequality to excessively increase. And we will address that. Finally, it became clear that the threat we have to our economic progress is not too much regulation, but too little regulation. The reason I say that is this.
A couple of years ago, when I became the chairman, I was being pushed to deregulate further. [P]eople say, 'Have you made mistakes?' Yes -- at one point I filed a bill to require hedge funds to register. And it was overwhelmingly unpopular and it had other Democrats saying, 'gee, that's an overreach,' and I had to let it drop -- we shouldn't have let it drop. The point I'm making is this: the political climate has changed. There's that German word: the Zeitgeist, the spirit of the era. Deregulation is now very unpopular. This conservative philosophy of, just take all restraints off capital, and it will give you all these benefits, has encountered a terrible blow. It's called reality. So there is now an overwhelming consensus that you have to do this, and it includes Secretary Paulson and Chairman Bernanke, both of whom have made speeches in 2008 saying we've got to put some restraints on risks. There will be people in the business who don't like it, but they understand it's going to have to happen.
ON MARK-TO-MARKET VS. FAIR VALUE ACCOUNTING
TPM: Very interesting. Paul Krugman writes this morning [January 19] about some comments recently made by Sheila Bair of the FDIC that have been echoed by others in the regulation community about the fair value of assets. If we decide to start buying up some of these toxic securities, kind of shift TARP back to its original purpose, Chairman Bair has said, maybe we just need to buy them at fair value and abandon market to market principles a little bit -- because who knows how to even apply them. If you could talk about your perspective on that; when to do fair value ...
FRANK: If the institution is retaining them, then market to market - well, market to market is a dilemma in this sense. You don't want falsity built in. On the other hand, marking to market can be hard to judge.
In other words, this argument: I long ago decided that my own personal investments would be in Massachusetts municipal bonds, because I can't be accused of a conflict of interest if I'm trying to help the state of Massachusetts, which is my constitutional duty. Now, they pay an interest rate. By the way, municipal bonds pay a higher interest than they should, because they are a very safe investment. And working against my own interest, I'm going to try and bring down those interest rates going forward, I won't be able to get as much interest when I buy municipal bonds, but that's a very important thing if you want to help cities and towns do infrastructure ...
[H]ere's the theory. Under mark to market, because other people don't want to buy those bonds right now, they're worth less on the market. Well, I don't plan to sell them -- I bought them for my retirement income. So, the fact that they would bring me less if I sold them tomorrow is less important to me. On the other hand, institutions rarely buy and hold [assets] forever. So you do have this mark to market requirement. The problem is that when you mark down to market -- and that's what we were talking about before with bank capital -- certain consequences flow automatically. It's a vicious cycle. Assets deteriorate, banks have to reduce their asset base, therefore they have to lend less. Then things deteriorate more. We should give ourselves some flexibility in imposing the consequences.
Because the other thing that Sheila Bair is talking about is - all right, when the banks have these bad assets, let's just swallow hard and take them off their balance sheets so that going forward they can do more lending. Now, that does mean bad news for the shareholders. This is not a free ride for the institutions, and it's not a favor to the institutions. Well, it is in one sense, but what we're saying is, you need people who give you credit for the economy to work and if you don't do something to help them function you're in trouble. But let me just hit now on a major theme of mine that I spoke to last Friday at the Federal Reserve. The opinion of people at the economic top, the opinion of people who would be described as, I guess, the social and economic elites ... that we may have to, there may need to be more public money now to step in and to some extent free the banks from some of the bad decisions they made. Now that's aggravating in one sense, but it may be necessary to keep the economy going.
There's a major division between the opinion of the average citizen and the opinion of the top policymakers, and that's very unhealthy for the society. And the reason is that people see interventions that help in the near term AIG and Citicorp, et cetera, but then they get on unemployment and they lose their healthcare. And what I'm telling the elites, people who think of themselves in that category, they better help us improve the social safety net in America. As long as the average American has to worry that in economic bad times he'll lose his healthcare, she'll have to see her kids drop out of school, et cetera et cetera, they're going to be very resistant to doing things that have the short term effect of helping financial institutions, even if they're necessary for the longer term for society. And I'm using this to strengthen the argument ...
[W]ith the Democrats in power, President Obama, the House and the Senate, what we want to argue to them is, improving the social safety net, protecting people's rights to join unions, providing healthcare, making higher education available for people in working class, if you don't do those as a society, you will lose the capacity to do the kind of things Sheila Bair thinks are in the economic interest of the country. And I agree with her, but they're just not going to happen without broader political support.