>> host: you're watching booktv on c-span2, and now joins us live is the author of "flash boys." michael lewis, what is a flash boy? >> guest: the heroes of the book are the flash boys, and they're people that discover the stock market's got something funny going on and seek to find out what it is and then build a mechanism to prevent predators in the stock market from getting to prey. it's called "flash boys" for a

couple of reasons, actually. one is that the solution that the main characters come up with requires them to be faster than the high-speed traders who are the predators in the stock market. so they've got to be, i wanted speed in the title, but i also wanted kind of superhero in the title because they were these, i mean, these characters presented the story, i felt. they're not doing anything unnatural, but they do have these weird powers in the financial markets right now, and the powers are powers to explain complicated things to people, the power to kind of engender trust in others. but the last reason it's called "flash boys" is i knew i wanted "flash" in the title. a l when i -- because the markets have taken this term, flash crashes and flash orders and flash trading. and i had a title that was kind of an inert title. i thought i was going to call it

the flash trap. i was driving with my kids in the car one day, and they said that's really dumb. ..

>> this happened pretty rapidly over the last six or seven years where the 13 public stock exchanges are all scattered through new jersey. so they know that and there is only a narrow second advantage. they know that we have yesterday's presence. so now we are talking about the divorce rate.

and so there's a lot of unfairness in the system. so that is the problem. and that problem, nobody really knows how big the problem actually is in terms of sums of me. they are essentially being taxed out of investors by wall street intermediaries. >> because of these milliseconds? could yes we met this is something that you write in your book. you write that over the past decade the financial market has changed too rapidly for our mental picture of them to remain true to life. the picture that i bet most people have in the market is still a picture of a human being than a human being might have taken. and it a quicker case with alpha males and color-coded jacket hollering at each other. that picture is dated and the

world it depicts his dad. >> estimate of the picture that i kind of had in my head when i got into this book. a great sense of what happened. it was only three or four years ago they started hearing this phrase. so it's really only been in the last decade that the market has become fully automated. especially mashed inside of computers rather than human beings on the stock exchange. and it's funny. because it is a problem to describe this. but what this new world is, as you can see, you can see how hard it is for people to get their minds around not just the stock market at all financial markets. you watch the tv to see the reports of what is going on. people on the new york stock exchange. the old pictures have been used

because the new picture hasn't been drawn. so one of the things i would hope to do, is to leave the reader with a sense of a different sort of picture. and the problem is in order to generate back, you almost have to imagine time the way a computer does. the computer can do this in the time it takes to make one. it's kind of like geological time. but what can be done in america. >> host: viewer if you were to draw that picture today, would you draw at wall street? >> guest: i would draw in new jersey. the exchanges are all housing

very heavily guarded data centers. and when you go in them, you see there black boxes and ones that is the exchange itself. and the buyers and sellers are connected because the buyer and seller agree to meet at that price. and then you have the boxes of the high-frequency traders who paid $50,000 a month to connect a line directly before everyone office is not what is front-line? >> guest: the idea is almost

like someone who figures out that the show will be sold out, they run up and buy tickets at the box office and then they double the price like it to get skelter. end it with the stock market, what happens often in that they are faster than machines and they are able to anticipate orders. and this includes big and testers. and so it's really important. and actually high-frequency traders now are making decisions by improving things with the timing of milliseconds,

microseconds. a nano second is a millisecond of a microseconds. and so my point is that their ability to divide your intentions and ask about it create this opportunity. but it happens quite a lot. and what is interesting to me about this story about this young man, he finds himself being talked about and even the most sophisticated investors in america, for example, he finds that everyone understands that there is a front runner going on. but no one understands why and so bill atman, a hedge fund

manager in new york often buys and tells big chunks of companies told me that he said before that the main character in the story came to his office and he thought he had insider-trading issue. he was thinking of buying some stock and he would try to buy it and then sell it back for a higher price. so that just captures the flavor. people think learning what you want to do before you do it and doing it to your disadvantage. >> host: michael lewis is our guest in his book is called "flash boys: a wall street revolt." he is also the author of "moneyball" and we have him lie on booktv to take your calls. 202 at 585

if you can't get through, sunday tweet and you can make a commenn her facebook page. so what is your history in the financial markets? >> guest: my personal history? >> host: yes. >> guest: it was brief but lucrative. i stumbled into a job at salomon brothers when i was 24 years old in 1985. and i was trained for six months and i spent two years and at the time i was essentially a derivatives expert. as well as bond salesman. so this is when the financial

markets were studying financial options and it was becoming the rage. my job was to explain them to investors so i was given a crash course as to what the stuff was. and we go out and prioritize. i quit in 1988 and i wrote about the experience working on wall street. since then i have been an interloper, and i have written about a lot of other things. my family, my high school baseball coach. politics. but since the financial crisis i found myself drawn back into wall street to write big narratives. a book called the big short which is about the credit crisis. a book called boomerang, which is about a way it expresses itself in different cultures around the world that shows you

something about the cultures and flash boys, which is about how the stock market has evolved since the current crisis. and so my interest in this is different than when i was working on it, obviously. and so they are, what seems to happen is that because of my history of writing about wall street, i have had some access to these narrative stories that have happened to emerge in this time. and i think wall street at this moment is a rich day of material. >> host: one of the themes throughout is a federal regulation called the regulation national market system. what is that matt and where did it come from? >> guest: it was regulated in late 2007 and the response to

the fear of unfairness in the market. the possibility caused by the fragmentation of the market. and the stock market was basically to new york stock exchange. you can trade it in one place or the other, and that has changed. the stock market is now urging public exchanges and 40 something public exchanges run by goldman sachs and morgan stanley, which you really can't see and you can participate in the sense that you are a big investor. can give the order to goldman sachs and they make the ability to execute this. but you can't see it in real time how it fits into the larger trade and the marketplace. so the market is fragmented and

you can really see what is going on. so in order to protect investors in this, the sec says it is against the rule for a broker to trade outside the whatever the best bid or offer it. so let's say that you want to buy shares in microsoft. and if you took a conglomeration of all the market prices are out there of microsoft and the fiftysomething markets that there are and you add it all up, the market is 2999 or 30. and some are willing to sell at 30. the brokers are not allowed to execute your order at a price higher than 30 because there is

an offer they are somewhere in the market, though it was to protect investors from being cheated by the complexity of the system. but the problem is with reg ms, why the story begins with it, is how to best bid offers are calculated. they are populated slowly. so it takes a long time for all of this information to be gathered. leyna: >> host: are you talking a day or a week to . >> guest: we are actually talking milliseconds. but the technology is slow and wall street has an interest in making it faster. it's about market, that official market is a still market and the people who have faster access to information, all of these

exchanges it gets executed and microsoft will collapse the next millisecond. in the high-frequency trader can now buy it and sell it back to at the a price of 30. so that is what happens. so the meaning and intent is regulated. and this includes the complexity of the market. and they are creating to market that insiders pay to see. and once that happened, the gap opens between this old and stale official price and the insider's

knowledge. includes billions a year, no one knows. the poses i have been is what my main character calculated from the individual predatory strategies. once they are made by the traders for faster information, the right to trade against those orders that are done, all they know is the slow market, everyone is in on it and they get paid a lot of money about high-frequency traders. and honestly they are getting very rich. system is basically okay. we are having a hard time figuring out what is going on in the stock market. so they don't really feel the pain but it is vast.

and so no one on wall street has any interest in exposing or talking about it and this is why we finish it. the stock market has really become incredibly secretive and why take a detective to figure this out. how on earth does it operate? has people on the inside, they really don't want to talk about it very much. >> host: one more question. this is about the culture of wall street. ronan says it is a whole industry and in reading the book i notice he is a wall street person. but i notice that the f-word is thrown around a lot. >> guest: yes, every time that i come on c-span i hear about

that. i have to defend the purity of the language. but it is true. in some weird way, this world of tech and trading is ridiculous. i've said many times just put in the women in the decision-making jobs. but everything would be cleaned up and fine. but the women would not do be with the men are doing. or something about testosterone and connecting to the markets. but ronan, the name is irish. but a lot of them are

immigrants. ronan is an irish guy in his whole life, he discovers investment bankers and financial people and he wants nothing more than to be a wall street person and he spends 12 or 13 years on wall street and he can't. arguing that they call themselves high-speed traders, yet he works in fiber optics. the boxes that you buy to make your trains go faster. they call it speed in a box. and he finally gets hired and is paid a million dollars a year to be a big figure on a wall street trading floor. then after about a year he says why did i even want to be here?

and he becomes almost instantly dissolution. >> host: our first guest is on the phone. >> caller: hello, something that you probably know about, level two quotes, my feeling is that i used to be able to look at that and make a decision as to the depth of the market. but it changes so quickly and it's my contention that these high-speed computers are corrupting information. >> guest: okay, when you say that you are trying to make a decision, what are you looking at when you look at this?

>> and who is providing with the information. >> caller: [inaudible] >> host: what you do for a living? >> caller: i am retired. >> host: but you are an investor or trader? >> caller: i used to be, but i'm not anymore. >> host: what is able to quote? >> caller: it is on an investment screen, you will be a list of any stock and they will show you a list of the orders often in pennies. one hundred dollars plus 10 cents. and they will tell you how many shares are offered on its side and that is to be able to see that on a steady basis and i

could digest the information. and now these numbers change the way. besides changes so quickly that the information is useless to me. >> guest: there's a big discussion here. what you really want is the subject of my book here. but the exchanges and able to high-frequency traders to use quotes tactically to buy or sell stock so they will be looking at high-frequency traders will spook the market and they will make it look like they want to buy a lot of shares, looking like there's a lot of demand out there. if they are able to look at out

that anytime they tried to act on it it's gone. and that in itself isand that im with traders and they are trying to defeat each other about what the market really is. and it's a different problem spawned by this. and many people have to make the exchange itself or it the software is incredibly complicated to satisfy the needs of the traders and all of the tactics that they want to deploy. they create instability in the system and this is why it was one of the things that was interesting. one big thing, goldman sachs, when presented with the story of

the main character that they have to tell, they have a choice and in exchange that is simple and fair with the sole purpose and not getting one trader or the other, but goldman sachs basically said that this is a moment of trust because we actually think that what has been done in the u.s. stock market to accommodate high-frequency trading is creating conditions and if we don't make right choices with their exchanges, that this will happen at some point we will get blamed for it. and it's all a result of changes of funding of the market. early just to accommodate and maximize profit.

>> host: we have an e-mail that says the frontrunning is illegal, why is writing software for it not illegal. >> guest: one of the questions i asked myself in the story his wife is available and wiser and not more outrage about the subject. it wasn't that nobody had noticed it. a lot of people have really noticed that someone had not cried out about it. but it was that war numbed by two things. and the stock market has been booming. whatever skinner is really isn't noticeable in the context

triples. everyone is making money and the second thing is this point, which is in this question. when it's done it's not just a liability, people have a sense that there is not willful human action behind it. and they also have a level of complexity and they actually need to parse the algorithms so create a smokescreen and i think an internal moral defense and i think they will direct something

that they will never do them of if they actually had to physically do it. >> host: linda e-mails and saying what you think of collecting a small fee and then applying this to the federal and state needs, pennies would be turned into the lands of dollars turned into the lands of dollars >> guest: the issue of levying and maybe this is a good way to distort the market. but as a solution to this particular problem, any sort of tax and it may actually get the bad guys and we may get some satisfaction there. but it will have all types of

situations. and there is a solution. this is what is so great in the story. it's like a choice that society is being presented with. a very small part of our society. but it's actually in all of our financial markets. but that market is so important with who we are and the choices between fairness and unfairness in this exchange has been built. and it is part of the solution to the problem which is transparency. people understand how the stock market is being handled and people are being given a choice which way to direct the stock market orders and if they choose whatever market is fair, it will gut the system and go forward. >> host: we have a tweet, do we really need hedge funds and

derivatives and leveraging? >> guest: know, do we need them? well, we need love and food and water. but do we need hedge funds and derivatives? >> host: and leveraging. >> guest: well, he is going to the complexity of it. so i think this is a very good point. a useful discussion. if you look back that has occurred since the early '80s, you can see that things were created. collateralized obligation, specialized access for high-frequency traders. masquerading as efficiencies but are innovation. and they are complicated to the people that were making more money than anyone else. and then we have this metaphor. every ton of aspect of the

economy always seems like kind of a good thing. because it is true that any innovation in the financial sector can be maligned. it seems like it's progress, but it's not progress. i would not say or list as a malign influence the structure of a hedge fund. it's a structure for a money manager to use. depending on the money manager, it can be useful. but the problem is that we have a little bit of a taste for it and we don't recognize the social cost of that. so that is a problem. some of the derivatives, if there could be a watchdog who had to -- if you introduce the government to the process, you introduce a lot of other problems. but if you wave a wand over wall

street and you never have created these default swaps, we would all be better off. >> host: in the cbs news sites on the story from 60 minutes, i don't know if you had a chance to look at some of the comments that people made on the story. here's one. i like 60 minutes, but this piece is a crock. they 80 if it is true, it affects large buyers of mutual funds. however, i can limit anything i put in by price and if i don't get it that's fine by me. and what i got from the show, we are talking a few pennies a share. >> guest: let's talk about this. his point is there are already damages. so no doubt there has been incredible and we are much

better off because of computers trading in the stock market than we were before it was automated. and so the problem is technology flowing to investors to customers and people that make telephone calls and they are incredibly cheap compared to where it used to be. wall street has captured some of the benefits for the elf, totally unnecessary by introducing this inefficiency in the market. well, then what is the cost of document what is the cost of letting wall street insert itself to buyers and sellers of stocks and take out a few pennies. what you could say is it is not that big of a deal. and it's not that different than what was before. over the market, a few pennies a

share, it's probably not even that come and accept many billions of dollars per year. so what is that? ten to $20 billion per year. attacks on it. if your tax levied on the economy levied by the richest people in the economy. about $20 billion, i'm already starting to get a little worked up. and then i think, what have they done in order to cure this? structuring the market in order to make it possible. well, they compromised this and it is a collaboration of nathan exchanges and made it much less stable than it could and should be. so we have things like ipos and

outages. that cost is a declining cost of the market. getting right at the core and the whole thing runs on trust. so what is the cost? well, it's not cheaper for corporations and it goes out. we start talking about a broad economic effects. but they were willing to go there and say a, who cares. a little bit of trust. wall street and etc. so we go that far. we are creating in our financial system and have for 20 years a model of success in life that is pertinent and pernicious.

so people are able to celebrate what their job is, to figure out how to take money for middle-class people and transfer it themselves rich people. so what does that do? and compromises our educational system. some people on wall street. it perverts their ambition and it creates this is a moral problem. it's a technical problem and a moral problem. and this problem of what you get in the end is what we have right now. which is a financial system that nobody trusts that can persuade anyone to trust them because they were watch what they did in a financial crisis and who is interested with those of the larger society. there are many people in this society. some of my best friends work on wall street. we don't want our relationship. the society can't function if

the interest on a line. because then what you get is people with money influencing political process in the direction of regulations. you can get to that collaborate. and that is the problem with this and this is a microcosm. but the story is so much more competent than that. >> host: up next is shown in battleground washington. they do so much for holding. >> caller: mr. lewis, you're just touching on things. it seems like conservatives like charles murray and think tanks, what they are doing is projecting on to or people all of the corruption and wickedness that they themselves are guilty of. fifteen years ago in the summer of 1999, roger ailes was a guest with brian lamb and it was

instrumental with cnbc and rush limbaugh and all that. and then the specialist firm, accorsi blew off my question. within five years later the knee late something close to $250 million with fines on the specialist firms for frontrunning pâté. in one and you can address those questions. the country would be surprised to know that our nation is run by cocaine snorting frat boys. [laughter] and so it's really a crime if it's turned into a motion picture. so i think that liar's poker would be even better than the willful wall street. >> host: we have a lot of callers, let's leave it there. thank you.

>> guest: i will start by recommending hollywood and listen to what you said. but one morning i have for the story that i just told, it is cause an uproar and more of an uproar than anything i have ever had in my life. it was in a smaller scale than "moneyball." especially rethinking that environment. in the case you have disrupted." especially rethinking that environment. in the case you have disrupted entrepreneurs introducing reform through the market in wall street, which is a much bigger stage. but my fear is that because it may be party politicized.

when eric holder, as he did yesterday and ounces as they should, it just does department investigation, all of a sudden it becomes liberal versus conservatives, democrats versus rich wall street guys and republicans line up because they can generate campaign funds behind wall street and nevertheless we get back to this poisonous sort of debate or everything is something. i love about the story is that it is in that way. conservatives see that this is a market solution in the spirit of the heroes of this book, it is a very conservative spirit. they are not looking to the government to fix the problem. and so i think the broader question, who is to blame for whether wall street is properly

regulated. i think it is more complicated than a political problem. i think that the problem is that for a bunch of reasons wall street all of a sudden started making much more money than he used to make. and i'm talking about a break happening 30 years ago and it's very hard for a society to regulate this and if the person who is being regulated makes more than 10 times of the regulation, then it will never happen. something like that. but in every case you're dealing with where regulation is called for and it ends up being an argument between specialist. so much smoke and dust can be thrown into both sides in the and the public can participate. it's too complicated. unless you're going to spend your whole life paying attention to that one regulation.

so it ends up being a backroom deal. and it's part of a deal to always achieve what society would like them to achieve. >> host: calling, you are on with michael lewis. >> caller: hello, i'm not worried about oldman sacks but i'm wondering how we can fix this problem and not stoop to the only market that we can invest in and not jeopardize the portfolios of loki. >> guest: the market is clearly on easy, made uneasy by things that are happening. things like the flash crash and others. the problem with that in a market structure is not a problem of appearances but reality.

is in inherently unstable thing even if people have c@ even if people have confidence that will be shattered. so how do you fix the problem? you expose the problem and he worked with people who have a solution to the problem. and that is what the story is about, fixing the problem. people that actually figure out a way to make the market stable and reliable and trustworthy. and goldman sachs have thrown their weight behind it and so i think that, i feel that it's funny. the first half of this book is kind of depressing when you are learning exactly what happened. but the inhabitants about guys figuring out the solution, and it's extremely helpful and the choice is stark between fairness and unfairness and there's so much noise about what you've

done. >> host: who is surrogate [inaudible name]? >> guest: key is how i personally became interested in telling the story and it was the first time that a high-frequency trader caught my eye more than anyone else's. he was a high-frequency trader computer programmer and goldman sachs in 2007 and 2008 and he leaves goldman sachs and 2009. and he mails himself some of the computer code, which he has been working on and goldman sachs sees this former employee and goldman sachs panic. instantly in a matter of hours and days, cause the fbi and the fbi instantly arrest him and a trial is held eventually in the

sentence for this and in the end his conviction was reversed, but only after he spent a year in jail. so, i. there were three questions. we've just come through this financial crisis and we've had a lot to do. the only person who ends up in jail is the person who they won't put in jail. and i thought that's very strange. why? so what did he do? what was such a big deal that he deserves a better deal and people don't have any kind of criminal exposure. so the second thing was the prosecutors who are after them, they could get back on the street because it was so dangerous to have someone who had access to this because it could be used and it could be

used for disrupting markets and if this code was in the wrong hands when that happened, about goldman sachs is in the right hands? we're supposed to believe that these firms have codes but that is okay in the sky who is left or we can't trust him he crashes the market and i didn't know what was in many don't know what it was either and that is clearly so valuable that cause them to hit the panic button with the fbi. no one does that. but you don't really do that on wall street.

and so i started to ask around about what this was what high-frequency trading. because at that point he had been wandering through the offices and some of the most sophisticated areas of the planet. in telling what they had found out who was at that time among them. and people said there's a lot of noise about the subject right now. there's no one who can describe the like this guy. and they say i have no idea why he know so much or how he has figured it out. it's an aim. he made them. how does he do this. so we needed to figure out whether it was really valuable for what it was him or should he

be guilty. he helped us under cannot. he helped me understand the tragedy that happened in the judicial process and there's no way anyone can give a through understanding of what has happened. but they were explaining thhey s with the stock market and i thought, what a story. so became a book in any magazine piece. but the real thing was this young man who is part of this entire financial system. >> host: we have jim frystem. >> host: we have jim from dubuque, iowa. >> caller: thank you so much for bringing this to our attention.

there's an obvious manipulation of the gold and silver market where they are following this on behalf of possibly the government. this is certainly a local market system. >> guest: first responses i have no idea, but the second response is there's an observation, as one who has been watching the commodities market and the foreign exchange market over the last five or six years, and that is that it is amazing how much manipulative activity has been going on or accusations of it. and it raises the question.

has this always been going on we didn't know about it in a horribly in the great age of manipulation or not the center of the market in the stock market or through one of those markets. and so i don't know the answer to that. but i haven't addition to probably what has happened is the technology, information technology has greatly reduced the necessary role of wall street. standing between buyers and sellers is not needed anymore and for the actors have been forced to wind other outlet in one of those outlets is creating complicated things and another may be mucking around the markets in ways that you

shouldn't be mucking around. but i do not know the answer to those questions. >> host: after all the research, what is your understanding of the market? you think you understand it fully? >> guest: no. i understand it well enough to comp ran the story. i understand that it is held by the main character of the book. but it is complicated. and there are 150 basic different order types that can be used to submit their stock market order, a most are designed to move the price around and not to trade. and i don't know all of them, but i know it of them. i think one of them is allowed and is incredible and i could not give you an authoritative account of all the types. but i can give you a broad

description of what they do and a few examples. and i can tell you that i know enough about the stock market and it needs to be simplified and clarified. it needs to be understandable and it shouldn't be a secret and it doesn't need to be the comp located. >> host: are you in the market? >> guest: yes, absolutely. my first impression, i would just take some of my money out completely just so that if this calamity happens, i don't feel like a fool for to having people telling me to watch out for it. and what i don't do is actually bother to pick stocks. i think that is a fools game and certainly for me. i just don't have it.

so i try not to lose my money and i'm in my market two ways. index funds and another version of this. so i buy shares of berkshire hathaway and i figure whatever happens, he will be positioned to explore it and he will be able to defend it. so what i really want to do is not think about it. i want to think about writing stories. so that is how i am in the market. >> host: bill from tucson, arizona. please go ahead. >> caller: hello, my question is regarding stocks having been lifted from the new york exchange and other exchanges. what the reaction is and the feeling that their stock prices are being manipulated by these high-frequency traders. >> guest: that is a great

question. you look at the parties here and there's actually a dance between this as framed in the book and investors in the market. people buying and selling stock for more than a millisecond. and the predator being a high-frequency trader. but there's another part of the transaction that you never hear from and probably should hear from and the purpose of the stock market is to channel investment capital to people who can put it to productive uses. all of this has nothing to do that. it's a lot of financial regulation. and so how do some corporations feel? we are not always happy about the ipo. and i know i have talked to

people about that kind of thing where the glitches were so obvious that they say how can it be like this. but i think that that is a constituency that needs to start to speak up and say, okay. this mucking around the market, depending on how many dollars these guys are taking up, we need this market to be stable and we need our stock rises to feel like they're acting something. so this a long way of saying that i never actually went and interviewed corporate executives and my guess is that in most cases they don't know about it. and they are not that aware of it. it's not high on their list of concerns for their business. but wait it out and they will get interested. >> host: john in alabama.

>> caller: i appreciate hearing what you have to say today. as well as your book. the question i have is the federal reserve and the u.s. treasury, i am trying not to be political, like you said and i agree with you about that. but with all of the things and the money that is being put in by her government, how is that impacting it and then is this making it more unstable? >> stimulus creates instability in the financial markets. and it's trying to lower long-term interest rates to stimulate economic activity.

and there's a panel that disagree with each other and you can see it's a no one knows. and what is clearly true is that the stock market is a huge beneficiary of easy money and for some time now the federal reserve, in my view, it has been too much time worrying about levels of the stock market and i feel like government policies restrict onto the stock market level of is that it's actually a goal rather than something that should just happen and it should go where it goes kind of thing. and so there is a contributing to instability and it doesn't play into it, but i would say no and i would also add that the

problems that they face, ben bernanke, and when the financial system collapsed in 2008, the decisions that they made to deal with the problem was, i think, whether it was ultimately right or wrong, i think it is a great decision and i think it's probably right given the government was paralyzed and anything that happens after that is a secondary concern. i actually think ben bernanke than american hero and i think that what that mandate is incredible and he's taking all kinds of grief and he didn't see

the subprime crisis coming. but given the hand that he was dealt to play, he did what he could and i think a lot of people would've done the same thing. >> host: do you foresee a class action lawsuit given what you've written? >> guest: that's like zero some bickering between political parties. you want people to fix the problem. gimme a solution. here's the problem. let's just do this and not worry about wanting people or the names of high-frequency traders who did all this. don't think people on national tv. it's just not necessary. the more that there is there is a less likely solution because the people who have perpetrated upon feel like they are exposed. and so let's just fix it.

>> host: the thing that we can start looking at this problem? >> guest: yes, i do. the money is funneled into the process with these advantages on these exchanges are the overwhelming debate. and we will see this fog machine in congress and inside the sec with lots of numbers and data and my hunch is that now the problem is expose. and it can do what we need to do. and we do have one new regulation. and the two things that people in congress who are concerned with the issue should keep in mind, is that everything should be in the direction of genuine

transparency. .. are you previewing your next book? are you previewing bigger better faster? >> the book ends -- it will take a long time to get to it. riding along fiber-optic cable laid from chicago to new jersey to cut off two milliseconds,

cost $300 million. no one who was around knew what its purpose was. the thing is it is like a beast underground and i went riding along its on a bike and see while i am writing on the bike and a newly constructed chain of microwave towers hovering on the hills in pennsylvania over the line and those microwave towers are there because they are able to move a signal a couple millisecond's faster than this line that was put in. the mystery is who did that? i ride up to one of the towers and see the sec number on the tower and go figure out. interesting story who did this and why. is not my next book but the bottom of the story is the question do people want to know enough to go and find out how our markets were? it is a challenge to the reader. go on internet and you can figure out whats about an hour 5

minutes. >> i am russ roberts of stanford university's hoover institute. welcome to the special edition recorded in front of a live audience at the hoover institution's washington office. he can't talk is part of the economics and liberty a weekly podcast on economics philosophy

history psychology and whatever i'm interested in actually. sometimes daily life. you can find us on itunes and our archive is that econ talk.org or there are over 400 episodes going back to 2006. today is february 5, 2014 and my guests are charles calomiris and stephen haber. charles is the professor of financial institutions at club universities bratches school of business and he codirects the hoover institution's regulation and rule of law research initiative. stephen haber is the aaa and gene welch milliken professor of humanities and science at stanford university and a senior senior -- at the hoover institution. their book is "fragile by design" the political origins of banking crises and scarce credit which is our topic for today's episode. charles and stephen welcome to econ talk. i want to start with the

fundamentfundament al claim in the book. you reject the idea that bank crises are just bad luck or perfect storm or random events. rather you argue that banking crises consists of fragile by design. what do you mean by that claim and what is the justification for it? >> the basic idea of the book is that banking systems are fragile by design because it is impossible to take politics out of bank regulation and it's impossible to do so because there are inherent conflicts of interest between government and the banking systems such that banks need governments and governments need tanks. those conflicts of interest basic to boil down to three features. first, government simultaneously regulates banks and borrow from banks. second, government simultaneously use their police power in order to enforce debt contracts on behalf of banks but, people who are being let's

say forced out of their houses because they defaulted on a mortgage are -- so when banking crises occurred governments often have reasons to not enforce those. third, governments are in charge of liquidating failed banks but the biggest group of creditors when a bank is liquidated arts depositors who are voters. governments have incentives to change the rules governing deposit insurance to political ends. they will often extend deposit insurance. because of those three conflicts of interest it's extremely difficult to remove politics from banking. governments have parties inside the government having an

inherent reason for wanting to use the banking system for their own ends and at the same time bankers need the government in order to do things like enforce debt contracts. there's no way of getting politics out. >> the book is a remarkable history of nanking and the banking industry in five different countries and the incredible work of scholarship and economic history combined with the political economy that we are talking about. charles i want to talk about the game of bank bargain which is a central concept in the book. tell us what that is and how do you apply it? >> the game of tank bargains is a phrase that we invented to describe the fact that the outcome of the rules of the game of tanking reflects political alliances that are formed between always involving the parties that are in charge of the government and some other

parties that alight together and form an alliance with the government to determine the rules of the game. the wind is that in the game of tank bargains there is going to be a group of people who are in charge and there are going to be a group of people often who are left out. it won't be a big surprise to you that the people who are in charge will use their power in this game to take advantage of the people who are left out. >> of course they are not a monolithic group. >> in fact be key in this is one insight that i think is important in the book. it's a little different from the way some political scientists think about political struggles where they tend to think struggles are between political parties. one of the points we make in the book is the coalitions that have been involved with say in u.s. history to design the rules of the game of banking have often been bipartisan.

in fact they purposely have structured themselves to be fairly immune to electoral partisan outcomes. and so just as you would expect if you wanted to have a long-lived invaluable coalition you would want it to be fairly robust electoral outcome so sometimes you get a very unlikely person who ideologically or culturally socioeconomically don't see eye-to-eye at all but find a convenience in being allies on a particular arrangement. >> the way i think of it is the democrats and republicans are the same. they have both like to give money to friends. they just have different friends but they have one friend in common which is the financial there and they both scratch backs and get their backscratching return. >> i would go farther to say

that sometimes they may pretend to have different friends more than they really do. >> do you want to give us an example of? >> i'm sure we are going to talk a little bit about the current u.s. crisis eventually but one of the things that i think is really interesting is that one of the contributors to the crisis was mortgage subsidization policies in the u.s.. >> homeownership. >> encouraging homeownership precisely and make way by creating subsidies for taking risks in the mortgage market. if you can encourage homeownership in a lot of ways but it was interesting if you look at the last 15 years or so at that policy what we see is george h.w. bush followed by bill clinton followed by george w. bush followed by barack obama and even though you might think of those people is very different ideologically they actually were part of a continuous thread of very

similar kinds of policies from the standpoint of somebody issues we are talking about here >> i would have to that that unlikely coalition members that set underneath these bipartisan agreements in the case of united states we have activist groups allied to bankers that were in the process of creating megabanks through the 1990s merger movement. to the point that at the federal reserve board hearings activists would show up for example from acorn and testify on behalf of the bank of america merging with nationsbank so this is not the usual roles that you would imagine an activist group taking vis-à-vis a bank merger. so you have these very unlikely partnerships precisely because they straddle partisan bonds are extremely durable and it abe very hard for any party to

deviate from the agreement. >> gets an answer sting coalition because as you point out a lot of voters in this discussion are the homeowners. there are clearly a lot of a lot of those that generally democracies they get treated particularly well so what i see is my somewhat cynical perhaps realistic take it that they are a vehicle that you cover giving money to these much smaller and lyrically powerful groups, the realtors, the homebuilders and the banks that financed them through the political incentives in the system. >> they got everybody who is part of that winning coalition in the game of bargains and did quite well thank you. so the total amount of subsidized credit that was contractually agreed as a quid pro quo for those activist groups to show up at the merger hearings which is an understatement that now they

actually received was almost $870 billion over the period 1992 to 2007 so that is not chump change. >> we have got into the weeds a little bit here and that i think we have to do a little bit of verifying. you were talking about the reinvestment act which i'm going to push back a little bit when we get to it more in detail but we should mention here that people who blame the reinvestment act and playing a role in the financial crisis get challenged. that goes back to 1977 but the peak of the law took place in early 1990s when it became the determinant of whether bank in whether bank emerge or not and that is what started to have an impact grade i just wanted to get that straight. let's go back in history a little bit and we'll start with united states. i wish we had a five or six hour hour -- but we don't. i know you don't like to stay for that but we will not be able

to cover all the aspects of the book but let's start with the u.s. and going back to the history of the united states. you talk about the 19th century as a particular era of banking united states. steve, tell us why the u.s. was so prone to crises. back in the teen century they said oh my -- there was bank run after failure. why why was he was so unstable in that era? >> with the say i'm appalled and the shock that we don't have five hours. i was counting on it. second to answer the more specific question the u.s. in the 19th century has a banking structure like any other country on the planet. it has thousands of banks, thousands of banks. >> tens of thousands. >> by the end of the 21st century tens of thousands which are in most states unable to open branches so every bank is what you would think of as the branches of tank unto itself.

that means in the event of a bank run you can't spread risk across regions if you are tied to the local economy and it meant that tanks couldn't capture scale economies in the so banks were very efficient. >> all this thing seemed pretty obvious. they are an efficient and they are stuck in the local economy. >> so there's a political deal underneath this and essentially just like we were talking about the coalition between populist and bankers and mega-bankers in the 1990s and the early early 2000's there is a coalition between small bankers and farmers in the 19th century. their concern is to get credit to small farmers and small farmers are opposed to big city people and big-city aristocrats.

so you get an alliance of small bankers and farmers against these bankers most particularly and famously is the unraveling of the bank of the united states first in 1811 and the central government realizes it needs a bank and then it gets unraveled again during the jacksonian period. and so in order to make sure than that tanks would not have to face competition in our markets in the early years of bank regulation in most states what happened is they made it illegal for a foreign bank to branch into your state meaning of bank from rhode island couldn't branch into massachusetts. they also made it illegal for a bank to open a branch. most states had laws that precluded branch banking. the point they make in the book

in the take-away of this is and i'm sure someone could write down an economic in which this made sense. you can write down lots of models. that was a joke but this is clearly a political arrangement. there is no efficiency or stability criteria by which to do this. it did however work quite well for local bankers because they had local markets. essentially they ran local anopheles and it works well for relatively prosperous farmers in a particular community because they knew that bank had to lend to them and nobody else because the cost of gathering information at a distance until the 1990s most bank lending in the united states is local really until the computer revolution. that created a sort of cozy arrangement good for local farmers, good in the north in the midwest and good for unit bankers and bad for anybody else who wanted access to credit.

every decade there was a banking crisis. >> is hard to remember in a world that we live in where agriculture is 2% of employment in the united states. in 1900 to about 40% so it's an important sector. people who are in port in that sector will be politically powerful in that region but as we go forward from continually through the 20th century and starting at the end of the 19th agriculture becomes less important as an economic fact your. why didn't the coalition unravel sooner? charles it's a nice story. it's easy to tell a story after-the-fact. explained why did it unravel and why did it not unravel sooner? >> first i want to emphasize how striking it is that it lasted for about 150 years.

many things, there were lots of shocking things going on in the u.s.. two world wars, great depression, a lot of banking crises during the late 19th and early 20th century. even the savings and loan crisis in the 1980s which finally contributed towards its demise but what's interesting is over 150 years of turmoil and inefficiency it persisted. part of the story is federalism in the u.s. because starting from the very beginning the states had authority over deciding what the rules of the game of engagement for banking were going to be within their states and also they had the authority to restrict state banks from participating. so that meant that if you were in kansas or illinois or many other such states the

agricultural interest there wanted to maintain unit banking they just had to win the battle at the state level. so it was a lot easier for this agricultural interest to win the battle at the 50 state levels then it would have been if they had to fight that battle on a centralized basis and we make that argument sort of at length in the book why that is and it contrasts in particular one of the things that explains why the u.s. has such a hard time getting a nationwide banking system going was the decision-making about the loss was at the level of the individual banks. in the 1860s we create the national banking system that sounds like something the federal government is going to do that could have been a nationwide banking system at the bank of the united states or the second bank. what happens is the comptroller of the currency in congress would not let the comptroller

decide differently but the comptroller decided that national banks had to be unit banks. >> a unit banks means one building basically. >> so national banks out in the middle of nowhere. that was it. >> what was the actual amount? >> the charters were the same. they were operated under the same rules under the same chartering authority under the same supervisory authority but in terms of the business they did because one is in the city and what is in the country very particular risks. they couldn't diversify across regions of the u.s. was understood practically making fun of us. canada especially looking at the united states and saying what a ridiculous banking system these people have but it persisted because it was actually pretty challenging to create a

nationwide branch banking movement in the environment of political decision-making that was so fragmented. >> one of the reasons it doesn't unravel earlier is the establishment of the federal reserve which was a lot of people think of the establishment that they fed the central bank of the united states as well while bankers get greedy and people get greedy and they get out of control. they run amok and then he needs someone to clean up the mess neglecting the fact that the mass was baked in as you use the phrase in the fact that they were in a unit banking system. the fed politically was away to mitigate some of the worst effects of the system and keeping it going longer than it would have. is that correct? >> what you you have seen is the reaction of a panic of 1907 and 19 away. there is a national commission created to look into how to fix the banking system. one option they had in fact they

said a banking systems in other countries including mexico which had ranches of two of the largest banks nationwide. they studied canada and they studied mexico and they studied germany. they were quite aware of what the other models were. they rejected all those models in favor of retaining unit banking by propping it up by creating 12 regional fed banks that essentially lands to unit banks by increasing liquidity in times of crisis. >> essentially a safety net for them. >> essentially a safety net or the banking. the same thing happens in the great depression where i'm sure everybody remembers in their high school textbook which talks about how the new deal saved the banking system by creating deposit insurance. what they don't remember is that

that -- i helped my daughter study for the apt test. >> did you do well on that exam by the way? >> i got up for it. >> when my daughter to the exam i panicked. i'm going to hurt her chances. >> i usually did that at english classes. my daughters decided my father does not know how to write. probably right. in the great depression not only did my clients get these in english but the response was again to prop up the unit banking system. >> he could've said this is incredibly messed up. we have thousands of banks fail. instead they said let's move this lever. >> in order to prevent the

consolidation of banks which is what would have happened in the absence of for example deposit insurance which made it illegal to pay interest on checking accounts and the interest rate paid on savings accounts. all to discourage banks from competing with one another and doesn't discourage people from moving their savings from one bank to another. what i want to drive across here is this comes back to something charlie said. there is a coalition of populist in unit bankers that drives that decision. fdr was against deposit insurance. >> when he was governor of new york. explain why. it's important to a starkly understand that. >> actually when he was running for president in 193032 visa deposit insurance would make banks riskier because they would take excessive risks. we call that the moral hazard

problem when you ensure someone against risk they tend to take more risk. he was definitely against it as was the federal reserve by the way as well as the treasury department as was carter glass who had been the architect, one of the architects of the federation way and was the architect of banking reform, some of the banking reform strain the 1930s. steve carreon. >> that someone was in favor of it and someone is the congressman from alabama in the house banking committee and he is determined to protect bankers. he ran deposit insurance through at the last minute and what is interesting about it is it is put in place as a temporary measure that was only supposed to affect very small deposits and years later it is log world

and made far more expansive. .. >> the protection was only on small deposits. now you understand better why he liked deposits.

it was clearly a transferring mechanism from city banks to small country banks, so if you're an alabama politician, it looks good. there were 150 attempts from 1884 until ultimately 1933 to bring the federal deposit insurance legislation forward, and they were all done by similar people under similar circumstances. they never got out of committee until finally in the 1930s. >> so why did the populous coalition fall apart suddenly? >> there's a couple pieces, and we can bounce back and forth about this. one is consistent with changes that were occurring in the banking industry. y'all remember the -- well, you guys are too young. i remember the introduction -- >> oh, the people out there in the audience. >> we're all the same -- we grew up in the days of disco. [laughter] you remember that the 197 os for both famous for district and the

atm. >> yeah. >> and what's interesting -- so the network atm and computer technology that goes with it allowed for two things. first, computer technology allowed bankers to assess borrowers at a distance. they were not seal into a local unit bang, but banks could skirt the laws governing branching by simply opening up an atm anywhere they could rent six square feet of space. >> like a small branch. >> yes. in fact, they took big banks to court over this claiming that the opening of a network atm violated the law. those lawsuits went all the way to the supreme court, which finally in 1885 ruled an atm was not a branch. second piece of this had to do with the fact that a system in which there are regulations

governing interest rates bank can pay, regulation cue, only works at a time when inflation is very low. so, certainly, in the early 1960s, they are dragged by lower inflation. beginning in the later 1960s and especially through the 1970s. government is running big deficits to simultaneously prosecute the war on poverty and the war in vietnam. as inflation climbs off, interest rates paid on deposits become strongly negative. even post-modern english professors i understand under those circumstances take your money out of the bank and move to another vehicle, and so you see the deposits leave the banking system in mass, going to money market business funds and the like. the third part of this --

>> putting banks in great difficulty because they now department have the flow of funds to pay off the promises made. >> right. this precipitates what charlie wrote about, the savings and loan crisis of the 80s, which is the debt now of our commune advance. think of the s and l crisis, about savings and loans institutions, but it's about not just savings and loans, but lots of small banks heavily invested in real estate. the most technological changes and pressures put on bank by virtue of the fact they compete in a difficult environment and now taking big risks, that precipitates, and there was also a number of shocks that precipitated the crisis, and it's not until the resolution of the crisis that both state governments and federal government begin to seriously reconsider the wisdom of the advancement. >> it's interesting to compare

and contrast, but the savings loan crisis with the fact of the 1920s and 1930s which were times when bank were killing, and what's interesting is i think if henry and those people had not -- already seen in the 1920 #s, almost 20 states from the 1920s until 1939 had relaxed banking restrictions, and we saw exactly the same thing happening at the state level from 1979 until the early 1990s. what -- when banks get weakened and states see a lot of banks failing, they start thinking, well, maybe allowing nation bank to come in from another state might be worth doing, and then the fdic says that makes sense, reducing our cost of supporting that failed bank, and so what's interesting is it did not work in the 20s and 30s, pushed back by stiegl, but in the 1980s and

the 1990s, it did work. part of the story is demographics, that so many people -- >> there were not as many people who were part of that coalition anymore. part of the story steve mentions the atm and that the supreme court decision, i think we could go into other elements, but one very important almost -- element was that the u.s. banks, at this point, internationally, were getting globalizations beginning. globalization of finance. the u.s. banks are losing market share in the 80s, not just outside the united states, international banking, but within the united states. they were starting to see major entry. you may not remember this, but it happened. in the early 80s, japanese banks, german banks, british banks enter the u.s.. it's starting to look like we're really going to be a player in

the global drama of banking, and alan greenspan articulates the problem, and i think that many people are realizing that the u.s. if it wants to continue to play, it has to get serious about creating an efficient banking system. the pieces come together at the same time and push us to a different outcome which now, of course, is irreversible because the federal law in 1994 and branch banking -- once it happens, you can't put the genie back in the bottle. >> move north. let's go to canada. tell us why -- how different canada's experience is from the united states and why that is the case. continue. what happened in canada? >> well, -- >> it's rather remarkable. >> the most important thing to say about canada is what didn't happen, you know? canada is a very boring place. thank god. >> charles, come on.

>> from a banking stand point. >> first you slam the post modern banking professor, and now you're making fun of the canadian neighbors. >> no, no, sometimes boring is good. >> oh, okay. >> canada never has a banking crisis, ever, ever. in 1837 and 1839, some of the problems in the u.s. banking crisis sweeping the country here created a couple of weeks of minor disruption in canada, but no bank failures and no problems. canada never had a banking crisis. this recent turmoil did not cause a crisis in canada. the great depression did not. the 1830s didn't. >> when you say "didn't cause a crisis," not just did their banking industry weather the great depression better than ours, but they had virtually no failures? >> no failures from any bank of any significance, and banks did fail -- small banks failed in canada occasionally, but it was -- >> management. >> yes, mismanagement.

another interesting thing is not only did they not have any bank failures, but their total amount of credit relative to gdp was comparable or better than the u.s. during this history despite the fact they had lesser density of population, other things that might make you expect a very different outcome. they had more abundant credit, more stable credit, and, by the way, analysis of how competitive the banking system is also shows it was more competitive. it's really quite a remarkable difference, and i should mention, also -- >> all that prowess. >> something else, canada did not create a central bank, like a federal reserve system, until 1935. it was not that it was a particular wise central banking policy, they didn't have deposit insurance than much more

recently than the u.s., and so it's really a story about a particular set of rules for engagement, in canada. now, part of that, myself included in the past people looked at this and said, well, that's because canada had nationwide branch banking, and, of course, but nationwide banking was much more efficient, greater diversification of risk, all those things are true, but, you know, as we learned in our own crisis, nationwide branch banking does not always give you stability. that's why we spend a lot of time in the book asking the questions, what was it about canada that made the political rules of the game in banking so successful, and when we dug deeply into that, we found that there was a lot to be uncovered in the political history. >> tell us some of it. >> one of the fundamental differences looking at the basic institutional structure of the

united states and canada. united states found 13 independent colonies. nobody imagines anything other than 13 sorch states which will be brought together in union and the debates is how strong the central government will be. in canada, there's a basic geographical difference. all 13 kohlnys in the united states faced the sea board, and they could trade directly with england. in canada, the best agricultural lands in the timber resources are in the center of the country, and present day ontario in order to get to the sea, you have to pass along the st. lawrence river through quebec. we tend to forget today, but at the time the french pushed the -- the english pushed french out of canada, canada is over 90% french speaking.

that creates a very difficult problem for the british commonnists and british government, which is trying to create a viable coolingny out of canada so that it does not meet the same spate state, and gives rights of suffrage to the population, and at the same time, limit the numerical power of the french in quebec who occupy a key geographic position along the st. lawrence river because right in front of the city of montreal are the machine rapids, building a canal around the rapids, but if the french wanted to hold up british commerce and develop in the interior of the country, all they had to do was block canal development, and, in fact, the british complainedded about this repeatedly. that means in the long and short of things, most of the time we talk about this, basic geography

drives institutions, banking institutions then drive the banking system, that drive, centralization of banks' chartering authority in canada in the central government, it drives the 1860s when given sovereignty and drives decisions in canada that all legislation, all authority, not specifically begin to the provinces goes to the central government, exactly the opposite of the united states. all power is not vested in central government by default go to the state. also, at the time, gives explicit rules that state if the central government will be in charge of banking policies. right from the very beginning, they go down a different route from the u.s., going down the different route in large part for geographic or geopolitical reasons internal to canada, and they then create a set of

institutions that are designed to make sure that the french can want block canada's development. they essentially disenfranchise the french population, and the way they do this is in the senate which is unelected and still is an unelected upper house. officially canada senators serve for life, but now only until late 75. >> close enough for government workers. >> they still actually, unlike the british house of lords, have veto power over legislation. if you look at the issue of canadian banking, there's key moments where legislation that would have, for example, created a step towards deposit insurance policy or a block in the senate and key moments where there's an imptous towards unit banking, and they are blocked in the senate. >> in fact, every one of the sort of populist ways that's happening in the u.s. where banking issues are being brought

to the floor, they're happening in parallel in canada. the difference is that those groups lose in canada because they can't cobble together enough political support within the centralized and sort of blocked political arrangement, but they win in the u.s.. that's what is so interesting. >> this, to me, is the key insight to the book, and this whole approach which economists have, i think, a tendency to see finance as they see many things, essentially, it's just a mathematical problem, figure out the incentives, fix it, and they tend to ignore political side, so if you heard this story, if you think about, well, united states has all these crisis, bank runs, failures, disasters. canada has this fabulous run of great success, well, now we know what to do. be like canada. give me your statutes, and we'll put that in place. economists make that mistake.

well, we know the right solution. we'll advocate for that. it's not that it's, quote, inpracticeble, or too theoretical, but, chaferls, d but, charles, explain why it is -- we want a stable banking system, go to canada, okay, use theirs. why doesn't that happen? >> well, as i was explaning to one person who asked that question once, well, how would you feel about the idea that we would have our senators appointed by the queen of england? [laughter] >> that's a negative, probably. >> they -- that was inconceivable. >> yeah. >> and the reason it's inconceivable is this a country born from troublemakers; right? it was -- it's the farmers armed from the teeth, from the very beginning, who created a revolution and were not about to not be vested with authority in a particular way.

canada was a country designed by people to avoid a revolution that created institutions that specifically made it a qint sensual classical liberal democracy meaning that it created all barriers to various kinds of special interests or even ma senior tearian tyranny, and, in fact, as was said, it's ironic that the u.k., which gives us voting power over money legislation of the house of lords in 1911, canada's senate was modeled on that, but canada's senate persists. the house of lords is pretty much emasculated in 1911. >> in england. >> yes. what so interesting is the whole history of canada is a history of people trying to prevent certain bad things from happening. we've got to get brits to migrate to canada. give them enough democracy, but

they don't if the french belong everything. we have to create democracy that's not going to be a french tyranny. also, there are a lot of -- we want to get people no migrate from the united states to canada, quite a few loyalists left canada, and so it's an environment of people who are trying to find a way to have a democracy to have freedom, but to still be within the british embassy. >> that's a positive story, way to tell. let me give the negative story. any reform of the u.s. financial system that takes large sums of money away from people already getting the large sums is not likely to be successful. barring some radical change in the political incentives. do you agree, steve? >> i think there's always been a temptation and certainly since the 1970s in the united states, the look of the banking system as a vehicle for income redistribution off balance

sheets rather than -- >> from the u.s. government? >> yeah. that temptation has been large for governments regardless of the ideological stripes. parties of the stated ideology. that makes the -- it's that basic problem, right, that no party realliments to give up on this. there's parts of the republican party that do. >> that say they do. >> and i believe them. okay? it's not as in -- but that's not a winning coalition. the fundamental problem facing the creation, i think, today, of a stable system of banking in the united states is that bank rules are arcane. hard for the public to understand. coalitions can get created that are designed to channel, to share credit or channel credit to particular groups.

those rules are going to apply to everybody. you know, we're in a democracy after all, and that's going to restore everybody's incentives. borrowers and bankers. the result is that the u.s. is set up because of its sort of long poppism to be crisis prone, and it's a paradox, and what i admire most is the troublemakers; right? farmers woo are willing to go toe-to-toe with the british army, that took a lot of guts. >> yep. >> that didn't happen in canada. one morning people woke up, oh, we're independents. >> it was something of a snow. they terrify the fact they beat us in the war of 1812, not their independence from england;

right? that means that in the u.s., we have a sort of paradoxical history #* that we admire, but generates this sort of use of the banking system for redistributed purposes. that creates this sort of urge by politicians to redistribute rather than using the official system using the banking system and because it occurs off the budget and because it occurs in a way that's very hard for the average person to understand is because it's not -- you don't pay for the bill in the the crisis occurs and everyone needs a bailout, it's not seen. there's a strong temptation to do this. >> if i can just build on that briefly, one of the interesting things about the u.s. is that all of these checks and balances all trained in grade school, what are we talking about? u.s. is liberal democracy, and

we have checks and balances, and checks and balances work to thwart physical policy like inequality, but then there's still a lot of freedom to do things in a hid p way off balance sheets. the support of the gses. >> the government sponsored enterprises. >> right, or the creation of regulation. most people don't understand the arcane aspect of bank regulation to understand whatever implicit transfers in taxes are involved in that regulation, so that means that if you are an ideologically republican representative who wouldn't want to be associated with a particular transfer, you're safe. >> because nobody knows. >> because nobody knows. you can do your feel in a hidden way. ironically, a lot of people that put faith in the checks and balances of the u.s. system are

missing the fact that particularly in the area of banking regulation, which is very big and very important, that that's an area where we have sort of addressed problems, especially inequality problems, instead of addressing head-on, we've addressed them in a droughtive way of using subsidies through a financial system that tend to destabilize the system as the way to do it. you know, even if you're looking at housing policy, australia, which is unicameral legislation is a country that's been stable in terms flghts financial system, but australia, in many ways, is a populist country, addressing issues of inequality directly through fiscal policy. for example, what's an affordable housing policy? australia? giving down payment systems to first time homeowners. that, by the way, creates stability because is subsidizes

more down payments that stabilizes the housing market. what we do is, because we have to do it through the back door, we do the only thing we can do which is to subsidize instability by subsidizing leverage. >> yeah. >> the point is there are some flaws, i say, i don't want to be too judgmental here, but i say there's flaws in the way we address certain problems that kind of push us as steve was pointing out in the direction of using this hidden stuff, and it's coming through the financial arrangements. >> just to echo that, i find it remarkable how little we've learnedded in the financial crisis in terms of the hidden door, subsidies, left pushes back against any attempt to stop subsidizing mortgages, and basically, right now, the federal reserves finances the mortgage market in the united states. this is not what the founders of the federal reserve had in mind or is good, stable policy, but

it's politically attractive to do that, and it's nuts. seems to me. let's talk about the crisis because i want to let you put your exercise on the table, and i want to push back. you put a lot of stock, to my surprise, in the community reinvestment act and fannie mae and freddy mack. they were part of the problem, but you don't talk much about the large private investment banks that if you priefize them, which were enormously large part of the runup in the early 2000s, and, to me, without that, you would have had an unpleasant system, fannie mae go broke, but loans made were not made under the reinvestment act, and seems to me the moral hazard problem is a bigger problem than cause. to me, the housing market, the place that oozed out into, could have been something else. who wants to go first?

>> i'll start, and then charlie will finish. all right, so i think it's important to get the chronology of the facts straight. as i mentioned, private investment banks get in in the early 2000s. >> they see a market opportunity that fannie and freddy placed for them going back to the 1992gse agent. that act has several euroyows features, one of which was it told fannie and freddy they had to repurchase loans from banks that met affordable housing standard criteria. >> they had to give a lot of money to poor people, in poor neighborhoods. >> up until 1992, total cra lendings, 8.8 billion. a lot of agreements between activist groups and banks, but

very little lending. beginning in 1992, and incidentally, this is legislation which is crafted under the first bush administration. to be clear here, this is not a democrat or republican issue. the basic problem that the community banks have or community groups have is what they want to do is get access to more credit, credit channeled through the organization to the constituents, quite reasonably. that's the stated job. banks want to merge. in order to get approval for merger, and i think from the vantage point of today, we don't have aceps -- a sense of how rapid fire and dramatic mergers are. bank of america is essentially 37 different banks in the 1990s. in order to get approval for the mergers, they go before the federal reserve board. community activists show up at those merger hearings and say they can bloke them, and, in

fact, community groups write handbooks how to block a merger. you can download them off the web. they partner with the community groups, and they agree to channel credits through them, but they don't want to hold the loans if they don't have to. they tell the community groups, the activist groups, there's a limit to what we're going to do. the activists, particularly, acorn, but also the neighborhood assistance corporation of america, go to congress, and they push, particularly acorn, and senate hearings in 1991, this is a whole decade before the investment banks get in. you know, this is a story that people like to tell as fannie and freddie followed private banks. they followed them in the sense they are dragged in kicking and screaming into the deal. they don't want to buy the cra loans banks are making. the activists pushing congress to basically make them do it, and the thing they extra