which are not reflected in the prices of the houses. left alone, the housing market will produce too few houses, fewer than the social value of the housing. now the problem is that we've had a fiasco in the housing market. okay. but we are where we are. there's nothing we can do about that. conservatives who would solve the disportions in the housing market by having their favorite pin yours truly toes freddie mac and frannie mae are picking easy targets and have a small problem. what are they going to do about the social value of private housing? it seems to me that -- forget about the current system. anyone who wants to dismantle

the current system, which is dreadfully inefficient, although they never get the mortgage deduction for second homes which seems to me is something we can live without. well, never mind. in fact, the deductibility of mortgages, margaret thatcher got rid of that. so there are all sorts of distortions in that market. and i don't want to be in the a position of defending andrew's heading when he headed hud and continue chilly pressed fannie and freddie to make loans to people he knew couldn't pay. but i don't want to ignore the world important comment that there are social cost with more travel, more pollution from cars.

that has to be in there, i don't think they can have attacks on housing subsidyies. often we have to decide whether there are externalities, whether they are positive or negative, and what sort of subsidy, because i happen to think it'll be positive. what sort of subsidy is appropriate to that circumstances. that's much harder than saying freddie and fannie, what do you owe us? $40 billion is freddie and $70 billion is fannie. that's a lot of money. we did get it wrong. i just think we have to think that through. just as we have to think through lots ofth0 things that libertarians, one of whom is represented here would climb the walls about. when we socialize risk which

we've done with health care cost, it doesn't make it crazy for the president to say we have a role, we the government, in reducing obesity. because the cost of obesity is now socialized. so mayor bloomberg is going to protect me from junk foods. what's the new room? no fizzy drinks to school children because they want to enjoy their pop as much if they can't have a -- enjoy their pot as much if they can't have a coca-cola with it. it adds about 10% to health care. that's $150 billion. southeasternly if taxpayers are paying it, they have some right to say wait a minute. there maybe other ways to do it if you don't believe obesity is a disease rather than a choice.

i don't know how we handle that. it's obviously these are incursions. we lose the fight. then we have stuck with it. then what do we do? seems to me once you lose the fight, that's where you are. now the question is what do you do? i don't know how much of you play poker. you get dealt the hand, that's what you have. the question is what do we do about that? i think they would do well to abandon the notion that now, this is a slippery slope. i can picture the president who i just watched, do you watch the ncaa halftime. really good basketball player. he was dunking them, shooting from the corners. really amazing. ordering the national exercise program. and then i would say, well, you know, if you socialize the risk,

why can't you order -- well, there's the common sense line that you draw somewhere. and it's hazy and difficult to find. but i think that's what conservatives ought to be looking for before the president appoints a fat czar. fourth, -- never mind. the double thoughts occur to me. i know we're on live television. my wife says no, i know she knows what it is that has occurred to me. i won't say it. the fourth thing that i think we ought to think about is government intervention is sometimes necessary. now i recognize the dangerous of government failure. and that market failure is often in the eye of the beholder who,

for example, my friends who work on health care problems and especially in britain. see a huge market failure in inflammation, that is the doctor knows more about what's wrong with you, than you do. therefore, -- what's the therefore -- therefore, some bureaucrat ought to tell you what to let the doctor do you. there is information. now is it serious problem? well, if it was, nobody would buy a used car. because the seller has a lot more information than you do. nevertheless, it is a problem. one i think we have to deal with. but the danger of a mindless opposition to interventions where there are market failure brings us to the question of how do we deal with systemic risk created by flawed incentive systems and suboptimal industry

structures. that's a mouthful. i'll explain it in a minute. consider first problem maltic incentive systems and the lean financial crisis. mortgage strokers had no incentive to avoid risky loins because they were passing on the risk to other people. they wrote ninja mortgages, no income, no assets, and liars mortgages where nobody had to verify your income. if it was too low, the broker helped you find another zero somewhere. they had no skin in the game. the bank executives who had incentives to maximize and securitytize these things for some reason putting all of the risk together in one big security reduced the risk when there was big intercorrelation between the risk of those mortgages. and we know that the rating

agencies who were paid by the issuers only if the deal went off. so this induced them to give with out triple a ratings to undeserving securities. it's a kind of grade inflation that would curl the hair of university administrators these days. we know too that politicians had -- still have because they pay no price for this, every incentive to make finance available to families that could not afford them. even if appropriately subsidized. i noticed him try to bring from secretary geithner on the part of government officials and he didn't do too well. he made the point. but he did not get the confession. we know the structure of the banking industry encourages

obsessive risk taking. big too big to fail. banks took risk they should not have taken. the result is that we have socialized losses and privatized profits. we have three choices in that circumstances. first, we can maintain the status quo. i don't think that's possible. i don't think that's the voters will tolerate it. i don't think it's efficient in economic terms to do that. and i just don't see a situation where banks will be able to unload their bad paper on the fed forever and then when profits return keep the profits private. i just don't think that's viable. but i'm not a politician. maybe it is. the problem is that the status quo has now come under attack because we understand moral hazard. we bailed out bear stearns for some reason or other. but let's assume we bailed out

bear stearns when the buyers said i'll pay $2 a share. the feds said well, the sellers are very, very unhappy, pay 10. which they did because the markets were about to open. i don't criticize. if i was sitting there with 32 minutes before tokyo opened, i don't know what i would have done either. then along comes lehman brothers which has offers to sell and keeps saying over and over if you look at the notes, well, they will come along. they will bail us out too. they turn down offers to sell the firm because it was less than the $10 thatbear sterns -- bear stearns, that's moral hazard. that means that you reward bad behavior and it's repeated. hank paulsen is not a flaming revolutionary. he among others says this is not

sustainable. now if we can see that that's the truth, it it can move from that option which is doing nothing, to unleasing an army of regulators on wall street. now i'm not in favor of it. i think they are nice people. some of them need work. and i'm glad to see them get it. but the fact is that a swarm of risk averse government regulators pouring over the deal books of banks is not my idea of the path of revival of the entrepreneurial capitalism. it just isn't. so i come to -- oh, i called it a third way. i didn't mean it in the sense of which it is. the government can put in place incentives designed to illicit behavior less likely to produce systemic risk. get the incentives right and a lot will follow. the government can then get out of the way. require mortgage brokers to have some skin in the game. keep 10%.

have rating agencies take their fees in the form of securities which they have rated. [laughter] >> how? [laughter] >> the laughing shows how far we have come that that should be considered a crazy idea. bankers bonuses, subject to clawbacks. now these are just -- remember i said at the beginning, this is thought experiment. and those of you who$x didn't agree with charles murray can feel free to disagree. all we do is thought experiments. we don't take positions. so there's more to it even than the skewed incentives. the system of corporate governance is weak. and so is the compensation system. i'll be very brief on the corporate governance thing. you know, was it 1933 or '36

which when they wrote the great book pointing out the dangers of separation of ownership from control. john says it's 1933. i could check my notes and find out. actually, it was 1932. it meant that the managers of a company were essentially free from control of the owners of the company. and this creates what economist call a principal agent problem. the principal was the owner, the agent is the manager, and the agent is not under the control of the principal and he can do things that he could not do if this were let's say a family enterprise. and they did things. they did a lot of things that they would not do. compensation being the principal one. the compensation was essentially unreviewed by the owners of the businesses. now it was reviewed by directors.

directors usually who were selected for the intensity of their friendship with the ceo. who's salaries they were supposed to control. so when we have proposals from the fcc to make it easier to depose directors, when we have sabane who says the director should be independent. here's some test of independence. we know right away if he's your son, he's not independent. we know right away if you sit on his board, he's not independent determining yours. and i find it very -- the intensity of conservative reaction to these reactions to the floyd corporate governance and compensation systems that we have, i find upsetting. did he get it right? is it possible that it's producing too great risk aversions? yes. all of these things are possible. but it seems to me the least

possible way to preserve capitalism is to have these systems where a ceo wrecks a company, walks off into the sunset with his golf bag swung over his shoulder, and a multi-million dollar good-bye, by directors who are more interested in preserving the nice atmosphere of their country club. and getting future directorships, that is not -- it seems to me, first of all, it's wrong. remember wrong? it's wrong. wrong is -- there was a word wrong once. it's not even relatively wrong, it's absolutely wrong. and i think that to the extent conservatives don't recognize that, they get themselves in a position where they can't get heard. and i think that's one of -- really one of our problem that is we do. anyway, i don't want to go on beating up on the corporate system. because it has produced this

enormous prosperity that we have had. this enormous wealth that we have had. and i think that if we fix it, if we can see that it needs fixing, i noticed, for instance, that there's huge opposition at the the -- to the sec giving shareholders at least a little more power to elect director that is are not recommended to them by the ceo. where does that come from? where does that come from? remember, it was mike milken challenging the incumbents in a lot of these corporations that produced a lot of efficiency that is we got. and i don't want to go into why the establishment got him in the end. but the fact of the matter is that that challenge -- that -- and it has social over tones, that challenge. i mean, i remember in one of the takeovers -- i don't want to say

who, but the president of one of these companies said to my friends from officers when they came in, you jews with your big cigar and diet cokes think you can take my company? actually, we did. it turned out he had a wine cellar bought for him by the company that he tried to take with him. not a chance. there is a thing going on before him on the surface. they ought to line up on social smoke and flexibility. yeah, we're going to take chances. but i think the bigger chance is to do nothing. let me conclude with -- oh, yeah, one other thing. i just -- my conservative friends are opposing consumer protection laws that are going to be built into the banking reforms. now, think about what that

means. banks have been charges for free services, they advertise them as free and in charge. they impose retroactive increases on interest rates on bank credit card balances, how can you be against that kind of -- will it drive up interest rates? yeah, but so what. they will be transparent. people will know what they are getting. i just think we have to think very, very hard about the position that we're taking. and we're apparently opposed to looking at the compensation of banks that have been bailed out by the government. especially when you take the king schilling, you're the king's man. i think we -- i'm going on. the fifth one, now that you've signed on to my other four is i think that is the worst. the government has an obligation to make certain that capitalism produces results that are believed by the great bulk of

the body to be fair or just and therefore sustainable in the long run. now this is a subject when i got to washington i wouldn't touch with a 10 foot pole. because as -- it was i guess will a great economist when asked once. i was on the witness stand about something whether it's fair and he said i suggest you consult a clergyman. the judge was not pleased with that answer. and i recognize that inequality of wealth is an essential feature of a market economy. a lot of observers said that. and all of that. that troubles me a lot. but my position has changed maybe because i got older, maybe because i've been here. but i think if we're going to

respond to critics or liberal status who never met a tax or regulation they don't like that they have to confront the question of equity. otherwise, we will be unable to answer in a coherent way the outrages that have been generated by the government's responses. and i think some of them were essential responses to the current problems. i mean, it is true that wall street was saved and main street wasn't. now forget, i understand the argument. you have to save wall street in order to save main street. if you are living on main street out of work, it's a little hard to understand. i think that we have to cope again with the world as we find it. now i'm not going to wait. i was an expert on that and the

hudson institute would probably do what she does about the piece i've just written about the subject. so i'll pass over. what is relevant here is recognizing two things. we have globalization which has put downward pressure on wages of middle and lower income people president not bad people. there's the lady who's showing t-shirts all her life and scrubbing her kids up and go to school. she's now in trouble because of globalization. which enriches people who can do international deals who are worth billions which opposed to international deals which are worth mere millions. so we have this pressure on the deserving work force. now it'll be corrected in the long run, i think on many colleges and so on. but we'll fix that. i do think we have to have an

answer to this problem. and i don't think we do yet. now it's true we benefit. we go to walmart and buy the t-shirts. i don't know where it's written that the interest of consumers take proceedens over unions that rape companies and produce bankruptcies. there are other producers on how we want to respond to this problem that now exist. i think that one thing we can do is try to develop means of relating executive compensation to performance. now that's not easy. we thought we had the solution when we found stock options. all that did is make them take as much risk as the equity holder did in the company.

that didn't work. especially since there was back dating the options in case it didn't work out quite the way you wanted. so i don't really a solution to that. but i do think we have to avoid, the best statement of that that i saw was in buchanan. we have to avoid confining ourselves to what he wanted the reality that occupy modern economist. i think that's true. we have to restore capitalism. finally, in conclusion -- he always says in conclusion. we can argue for the notion that redistribution reduces the incentive of those that produce the wealth that is being distributed to the i assume the deserving poor. that's not a good thing. we can create forums that create incentives. we can argue that things that

create incentives to anti-social and self-destructive behavior are described by charles murray, dignity, et cetera, if not for sure. we can show the cost of mechanisms is very high. they are complicated and very high. so there you have it. what i would call a neoorthodox program, drawing on the teachings, i think of conservative economist and others, vigorous enforcement competition laws to preserve the dynamic society, regulation of enterprises with significant monopoly power. using revenue neutral taxes if necessary. revenue neutral. remember, i'm against taxes work. so anything i can ring out of taxes i would use to reduce income taxes. subject to budgetary constraints. programs to correct for other

instances of market failure, creation of incentives for corporations and finance sector behavior that align private and public interest and attack dissatisfactions with this and restructuring the financial sector to eliminate one-way betting. i have no illusions about this. policy in the wrong hands can really penalize success. regulation can be heavy handed. coping with taxation can open the door to crazy people and crazy tax policies and dealing with market failure can produce more intervention than we want. but we can't be paralyzed by those problems. because unless we do, we're going to find that it's going to be very difficult to defend market capitalism from those who have programs and do not like market capitalism. we like it. so therefore, we have to, i

think, find programs to defend it from those who see an excuse to i think the word is transform it. and i think that we don't want to do. we want to reform it but not transform it. thank you very much for your attention. [applause] >> we have time for questions. i can't imagine there would be any. hold on, can you wait until they get the mike. who's next so the lady can run over there. can you run over here so he's ready? can you identify yourself? >> jeff campbell, independent advisor. it's been a number of years since i studied antitrust law, when i did the conservative position was not as you represented it. it was -- the issue was whether

or not the possible subject of antitrust investigation had the ability to control price within an industry. and it was the fairly workable definition if not a bright line. the other side, the position of the other side was basically that size, bigness was a negative on to itself. so that you could have conglomerates, they were to be broken up even not on price. >> can i offer so we don't get into a long suggestion, a free copy of the book john and i did? i think that misunderstanding, that statement that you made is probably not connect. the aunt trust laws were always aimed not at bigness but preventing monopolizing behavior, rather than mop hollies, rather than price increases and preventing --

i've never seen the successful consult on con glam -- conglomerates, the market took care of that. it murdered them. it's arcane discussion. but i'm glad to talk to you about it later if you don't mind. >> thank you. great lecture. >> where are you from? you're obviously an intelligent person. >> great lecture. thank you very much. my question is a quick one that many americans peel that china has become the united states bank. and what you see the future and if you can give some highlights between u.s. and india financials? >> sure. >> i'm secretary a vice president of india, i'm sorry. >> okay.

as to china, at the beginning, i pointed out that the notion of free trade in a world in which someone is manipulating its currency is bizarre. it's bizarre. now that doesn't mean i'm a big fan of chuck schumer or any of these people. but it is nutty. and the notion that china which holds the ious, that's somehow a benign fact is also crazy. they are coming here next week, sometimes, the chinese. they will, i believe, agree to modest sanctions on iran, at least meaningless sanctions. they will offer a little bit of currency fluxuation and flexibility in return for us making a private agreement to not sell arms to taiwan and a wh