U.S. Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, came to the Harvard Kennedy School (HKS) Monday (April 6) to lay out a four-point program for re-regulating the nation’s financial system.
“We are in a period comparable to the turn of the 20th century and the New Deal,” he told the capacity crowd in the John F. Kennedy Jr. Forum. “For the third time,” he added, invoking the names of the Roosevelts and Woodrow Wilson, “there’s a need for public policy to step in and protect the private sector from its own excess.”
The job of public policy, he went on, is to come up with a framework of rules and regulations that allows the economy to capture the benefits of innovations such as loan securitization, while containing the harm they can do.
He stressed that his proposed reforms, which he promised will be embodied in new legislation, were “pro-market.” They are:
• A ban on 100 percent securitization of loans; lenders, he said, need to retain a share of the loans they originate. “It turns out our mothers were right; people are never as careful with other people’s money as they are with their own.”
• Elimination of the “perverse incentives” in a system that pays enormous bonuses for good results but exacts no penalty for disastrous ones. Incentives have “defied gravity,” Frank said. The current system amounts to “heads they win, tails they break even,” and he intends to see that changed.
• A way to “wind down” failed financial institutions the way the Federal Deposit Insurance Corporation can take over a failed bank. Currently, he said, no statutory mechanism grants “resolving authority,” as it’s called, over a firm like Lehman Brothers.
• Methods to monitor overall “systemic risk.” Consumer protections also need to be beefed up, he said, citing the work of Harvard Law Professor Elizabeth Warren in this area. He noted that hedge funds were allowed to go unregulated because their million-dollar minimum investment requirements presumably excluded all but the most sophisticated investors. In the current crisis, however, some of those big players have lost hundreds of millions of dollars on investments Frank characterized as “sophisticated doohickeys that blew up in their face.”
The financial crisis had its roots, Frank said, in one phenomenon: the ability to make large loans outside the banking system and resell them. Securitization is not in itself a bad thing, he stressed. It helps make more capital available, just as the growth in early 20th century capital markets fueled economic expansion. “Securitization makes it possible … to be somewhat less concerned about being repaid.”
Everyone knows the story, Frank said, of the child who gets burned by the hot stove and learns never to touch it again. The current problem, he went on, is that investors have taken the lesson of the hot stove too much to heart. Now they are reluctant to touch not only the stove but the kitchen sink, the bathtub, and other potentially “dangerous white porcelain.”
He continually decried what he called the Republicans’ “ideological opposition to regulation.” Unabashedly partisan, Frank is obviously a strong admirer of President Obama, but parts company with him on the question of “post-partisanism.” In fact, Frank quipped, Obama has left him with a case of “post-partisan depression.”
The conservative prescription for getting out of the mortgage mess, Frank said, is “to stop trying to help poor people” by pulling back on government programs meant to help people buy homes. The liberal view is to introduce a new set of regulations to help the markets work better.
Frank obviously had most of the audience on his side. But he had a heated exchange with Joel Pollak, a Harvard Law School student and self-described conservative who pressed Frank to admit that he should accept some responsibility for the Wall Street meltdown since it took place “on your watch” — a premise Frank vigorously challenged.
A less contentious question from the floor was asked by Leoule Goshu, the president of Harvard Kennedy School’s Gay, Lesbian, Bisexual, Transgender Caucus, who asked Frank’s advice for people from “stigmatized” or “marginalized” groups who may be discouraged from going into politics. Frank, the second member of Congress to acknowledge being gay, responded, “The country is better than we think,” adding that he now wished he’d come out earlier.
“We have this wonderful set of documents, the Declaration of Independence and the Constitution, that set forth marvelous democratic principles which were only very partially observed in reality. American history has been a series of efforts to take those extraordinarily radical democratic principles … and apply them to groups to which they didn’t originally apply.” It used to be that the only way to get the full benefit of citizenship, “you had to be a rich white Christian man.” But much of that has fallen away: “There is an optimistic strain here in American history.”
This movement of change is particularly true “generationally,” he said, adding that he expected change on the ban on gays serving openly in the U.S. armed services. “We’re going to be able to overturn this next year, I’m confident.”