Former Congressman Barney Frank visited the Goldman School during “Stop the Clock” week, which provides students and faculty with a chance to interact with leading decision makers who have worked in public policy and government. The following is an excerpt from a conversation between Frank and PolicyMatters Journal editors Joe Broadus and Matt Unrath.
PolicyMatters: How has financial regulation played out over the last five years since Dodd-Frank was passed?
Frank: The move away from having the lenders be the people whom the borrowers had to pay back was very important. The move from “I lend you money, you pay me back” to “I lend you money and then I sell the right to be paid back to other people” was a serious problem, because the discipline inherent in my lending you money if I expect to be paid back dissolved. Essentially the financial incentive for lenders moved from the quality of each loan to the quantity of loans. I think that was the root of the problem, because it was loans that had higher-than-normal rates of not being paid back that were put into the securities and sold again and insured against. They were the bullets that destroyed things. And you had useless credit rating agencies, pretending to know things they didn't.
The regulators apparently believed that credit had gotten too tight, and that if there had to be risk retention [by lenders] it would be too hard for even moderate-income people to get loans. So they adopted a rule that essentially did away with risk retention for all mortgage loans. We have two categories of mortgage loans right now: those that are so crappy that you can't make them at all, and those that have no risk retention. I wanted three categories of loans: ones you can't make, ones that are so good that you don't have to have risk retention, and one in the middle. That's my one problem. Other than that, I think they've been doing fine with it and if you read the financial pages, it's having a very real impact on banks and on behavior.
Comparing it to the ideal, where do you still see areas that need work?
Well, if you had an ideal, we would have merged the Securities and Exchange Commission and the Commodities Futures Trading Commission. Given the economic and social history of America, farmers versus financiers, we couldn't do that. I regret the fact that automobile dealers had the political clout to get themselves exempted from [oversight by] the Consumer Financial Protection Bureau. But it did give us a chance to do a controlled experiment, which we rarely can do in public policy. Because that's the only area of consumer lending exempted from the Bureau, that's where all the crap is happening. All of the bad consumer finance crises have migrated to that one area that's exempted from the Bureau. So it proved that the Bureau was a very good idea.
One of the questions we were discussing beforehand is how much financial regulation differs from other regulation and whether it's unique or just more difficult to work on.
It's more difficult in this sense: it is very arcane, it affects the average citizen in ways that he or she does not perceive, and it is opposed by very powerful and specific interests. It's a paradox: until recently - I think we can put a stop to it - the opponents of financial reform had more success at chipping away at it than opponents of healthcare, even though financial reform is much more popular with the general public than healthcare. With financial reform, the problem is that it's very hard to mobilize support for it. What people feared, we concluded, was that the public would stop paying attention to credit default swaps, collaterized debt obligations - all this very complicated stuff. And that's why the opponents of financial reform finally felt emboldened to take a bite out of it i the omnibus bill last year.
What was very encouraging was the angry and very widespread public reaction to it. Nancy Pelosi blew the whistle and then Elizabeth Warren jumped in. It turns out the public has not forgotten how much they dislike this kind of manipulation. As a result, I now think that the bill is secure and that Obama will not sign anything that chips away at it.
I think it has confounded both critics on the left, who said it wouldn't mean anything, and critics on the right, who said it would shut things down. The stock market has essentially tripled since we started working on the bill. Hard to argue that was fate.
Could you talk a bit about housing more generally, and this broad question about the role of the federal government in encouraging home ownership?
I've long been skeptical of home ownership for poor people. Instead, I want to do really good rental housing. In fact, by 1994 liberals were worried about this and in 1994 - the last year the Democrats had control for twelve years - Congress passed a bill called the Home Owners' Equity Protection Act, which told the Federal Reserve to regulate subprime mortgages. Alan Greenspan said, “No, I won't do that. That's interference in the market.” He wouldn't use the power. By the last years of the twentieth century, the early 2000s, it was clear that subprime mortgages were a problem, that people were making loans they shouldn't be making because they didn't' have to worry about repayment. So several states then began to adopt rules to restrict subprime mortgages - Georgia, New Jersey - and the banks complained.
We have a dual banking system in America: there are state-chartered banks and federally-chartered banks. And the Bush Administration used federal constitutional power to say that no state could act to regulate a national bank. Very sweeping. There's always been the rule that a state couldn't do something that conflicted with what the federal government said, but in this case, they did something called a"field preemption.” They said that no state may regulate any of the practices of a national bank that deal with banking. And that was done because states had started to regulate subprime mortgages. So when that happened, we then decided we had to pass a federal law to regulate subprime mortgages. We started working on it, and the Republican leadership killed it.
So, the earlier attempt to regulate subprimes was more to protect homeowners.
It was originally consumer protection. We came to see subprime mortgages as having negative implications for society as well - but yes, the impetus was consumer protection.
We'd like to ask you more generally about inequality, which is coming up a lot these days: is there anything to the attention that Republicans are now giving this issue, or is it all rhetorical?
It's a serious problem. I think it's the major problem that Democrats have with white working-class guys: that inequality has gotten worse, that they have been the victims. They have this expectation, they think if government really cared about a problem we could fix it, and our inability and unwillingness to try is - I think - their major problem. These are people who are anti-government not because they're philosophically Ayn Rand supporters but because they think the government let them down.
The single biggest thing has been the massive destruction of unions in the private sector. That was conscious public policy, without any question. Another thing that hurts: federalism. You have this state-by-state competition for industry, and that is a leveling-downward factor. You also see it with the attacks on public employee compensation. Some of the pensions are out of whack, but some of it has gone too far. But it is very real, that there has been a shift toward great inequality.
You've mentioned unions. What else would you do to address inequality?
Obama is right about the community colleges. It's short-term vs. long-term. Education is a big deal, community college is a big deal. And increase the public sector. Tax rich people more and put more money into good public sector jobs. You know, as a family gets richer, it hires people to do the gardening, do the driving, etc. Well, as a society gets richer, we can have more of us working to keep ourselves in good shape. Fix the parks. Fix transit. You can let the public sector have these decent jobs.
So you're here at a professional policy school, an institution that is training people to be policy analysts and policy leaders. What skill would you say is in shortest supply in DC right now?
Accounting. CPAs. Is the Social Security system moving around their money or not? What are the effects of taxes? I wish I had paid more attention to accounting - I'm averse to mathematics, to economics in general. This whole notion of thinking like a lawyer- there's no such thing as thinking like a lawyer. I went to law school. Think like an economist. There are things that economists think that are not instinctive. For instance, the notion of opportunity cost. I would teach more economics, and particularly accounting. All these arguments are about whether thing that are profitable or not profitable. People hide behind accounting. So that's the major thing.
There's one course I would like people to take that doesn't exist very much: legislating, which is a very unusual kind of work that involves several hundred very ambitious people who have to work together. Now, in most of your formal relationships, you are governed by one of two principles, or sometimes both. There's hierarchy: she's the boss, and those people report to her, but then she's got the Board of Directors, and almost everybody on the Board of Directors is elected by the shareholders, and so on. Or, money: if you're willing to paint my house, I'll give you money to do it. But members of the legislative body have to work together and there is no hierarchy and you're not allowed to bribe each other. The Speaker is more influential than a freshman on the other side, but nobody in the US House of Representatives or the Senate may order any other Representative or Senator to do anything. That's very unusual: even with academic tenure, you ca be told that you have to teach a certain course. So that's an unusual set of skills that are required, an unusual process that I wish people knew more about. Legislating sometimes looks to people like it's pure willfulness; it's not, there's a logic to it. But I would start with accounting.
Joe Broadus and Matt Unrath are both first-year students at the Goldman School of Public Policy and PolicyMatters Journal Editors.
For more, watch Barney Frank's two UCTV webcasts titled Frank Talk: Gay Rights, Wall Street and the Federal Reserve and Reducing the Military Budget: Necessary to Improve Our Quality of Life.
This article was originally posted on the Spring 2015 edition of Policy Notes, a bi-annual publication released by the Goldman School of Public Policy.