National Press Club

Rep. Frank Says Regulation is Key

July 28, 2009 | By Richard Lee |

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“Regulation” may be a bad and disturbing word for some members of Congress and many in the banking industry, but for Rep. Barney Frank, D-Mass., chairman of the Financial Services Committee, it is a crucial and necessary part of the fix for America’s ailing economy.

In a Luncheon speech July 27, part economic history lesson, part blueprint for the financial future, and often laced with acerbic wit in the face of grim realities, Frank painted a detailed, sometimes painful, picture of the current economic climate.

“Our primary goal is not to try to undo the past but to prevent its recurrence,” Frank said. “The role of Congress today, with our committee having a major piece of it, is to try to prevent things from recurring, the financial crisis that we have had.

“The problem was non-regulation,” Frank said. “And it’s very important to stress that it’s non-regulation, not deregulation. We have a very healthy phenomenon in this country in which the private sector innovates, and the innovation is very important. And by definition, only those innovations which provide value added are going to survive because it’s voluntary. If someone comes up with a new idea that doesn’t work, it goes away. The only innovations that thrive are those that attract people’s money in a free enterprise society. And that’s a constant process.

“There is a pattern in which some people argue that any attempt seriously to set rules for these innovations will destroy the economy,” Franksaid. “We reject that. We think that, in fact, the most pro-market thing Franklin Roosevelt could have done is what he did do -- the setting up the SEC and setting up rules for mutual funds and setting up the FDIC, in fact, saved capitalism and allowed it to go forward. And we plan to do the same thing if we are successful, to set rules which provide a framework in which this wonderful, vigorous, capitalist system can go forward.

“We now have for the first time since 1993 a Democratic president, a Democratic House and a Democratic Senate,” Frank said. “We have the responsibility as Democrats to come up with a system of rules that allow the free enterprise system to flourish and provide all the benefits it can provide while diminishing the abuses, while protecting consumers, while encouraging investors to feel safe about investing, and basically to give us the benefits of the function of the financial system. And it’s up to us:.

Frank’s “lineup” of what needs to be done is:

“We think you need to put some limits on securitization,” he said. “People should not be able to lend money without having any risk retention. We think there needs to be somewhere in the system an ability to limit and leverage, to put maximum leverage rules in place so that people do not wind up owing not only much more money than they have. Sometimes I think we have in this society as a whole people owing much more money than there is. You have to limit leverage.

“You have to come up with a way to put ailing financial entities out of their misery,” he said. “It’s called resolving power. We have a way to do that with banks. We did not have a decent way to do that with AIG or Lehman Brothers or Merrill Lynch, and all of them caused problems as the Bush Administration legitimately, people of good will, Ben Bernanke and Hank Paulson, tried to avoid terrible financial harm from what would happen.”

A systemic risk regulation regime in place “will limit the kind of leverage that got us into trouble with people being overextended,” Frank added. “That will allow us in the future to deal with an AIG or Lehman Brothers and put them out of business in an orderly way without either shocking the system or having enormous public funds going into them, as went into AIG.

“We need to contain derivatives,” he said. “Yes, they play a very important role, but they have gotten out of hand and we need to do something about it. We need to protect consumers because protection of consumers now has dissipated in ways that result in a lack of activity because there is no way to focus responsibility.

“And we need to deal with executive compensation,” he said. “The problem with executive compensation is essentially from the systemic standpoint, that it gives perverse incentives. If you are a top decision maker, or maybe even somebody else down the chain, you may have a system in which you are incentivized to take a risk because if the risk pays off, you make money. And if the risk doesn’t pay off, you suffer no penalty. Heads you win, tails you break even.”

As for excessive salaries and their amounts, “we think that’s up to the shareholders,” Frank said. “The shareholders who own the company ought to be able to set outer limits on pay.”

The plan, Frank said, has broad support in Congress.

“We are convinced that this is the way to prevent these abuses,” he said. “And I invite the judgment of failure if we are not able to deliver that. And I will tell you, I am not politically inclined to take on responsibility I don’t think I can handle. I am giving us this responsibility because I am confident we are going to meet it. I believe you are going to see during this Congress, I believe by the end of the year, a package that does it.”