fail and, yes, the volcker rule as well. but i want to emphasize something different today. not the problems of the financial system but the imbalances in the real economy and what to do about them. the simple fact is the united states is a high consumption economy. that's been true for years and it's been true recently even when income has lagged. for a decade or more consumption has run through a willingness to save. consumers took on a heavy load of debt in the process, mainly in home mortgages. to some extent that process was propelled by the absence of real income growth for most households extending over a decade or more.

you know, that's something that simply is not supposed to happen in a healthy, growing economy. productivity gains are supposed to be widely shared but instead we've had concentration of income growth at the very top of the population. 1% or less. with an income distribution that has not been seen so top heavy since 1929, which is a kind of interesting point of comparison. something similar went on with the federal budget. we reduced tax rates and increased both military and mandated spending. the financial manifestation of those private and public deficits was rising pvg indebtedness. for the nation as a whole, it also inexorably led to large net borrowing from abroad ranging as

high as 5 to 6% of our gdp. now that didn't appear so threatening when the surplus countries, china, japan particularly, we were eager to sell manufactured goods to us, satisfy our consumption desire and to accept payment in dollars. interest rates were low. got even lower over time, and for the time being, given the problems in europe and japan, in the absence of any strong alternatives to the dollar in the emerging world, our ability to borrow cheaply abroad fortunately remains. but i also think that it's true that borrowing is symptomatic of an underlying disequilibrium that simply can't be sustained indefinitely. who could have imagined that

china during this century would accumulate $3 trillion worth of reserves and other foreign countries in effect financing a large chunk of our budget deficit as well as our payment deficit. the inescapable conclusion to me is that it's not too soon to think some hard -- think hard about the medium and longer term. even if we continue with the stimulus right now. now i know there's no political consensus today for a summit. strong forward looking action appears beyond reach at least in this election year. but if the electoral process doesn't produce some common ground for constructive policy decisions, then i fear that sooner rather than later unbearable pressures will come

to bear on monetary policies and some combination of a weak dollar and rising interest rates. financial institutions and markets, even if reforms were fully implemented, would then again be in jeopardy. the matter that i suspect is new to most of you, the budget deficits certainly grab our attention day by day and the political process and other worries. i think the result has been more political posturing than thoughtful reform. i wonder in all of my own naivety that even in this so far contentious and demeaning election year we could not clarify the issue and at least lay the groundwork for needed

reforms. we have a start in the proposals. the national commission on fiscal responsibility and reform has been named, a long name for the simpson bowles commission. we've had the domenici loveland commission. we've had the aborted budget agreement last summer, in the midst of the debt ceiling debacle and all of that suggests some ground. some common ground. my point is none of those approaches went far enough in terms of the economic prom we really need. to set the stage let's start by setting out some points that seemed to me to command some support in general terms if not in detail right across the political spectrum. do we want a strong military and national security system?

if so, and i think we do, we have to assume that for the time being cuts in those areas will have to be reasonably limited. do we need to pay more attention to our decaying infrastructure? if so, i think that's correct, that means more spending rather than less. much of it through state support and states are very heavily challenged at the moment. we do need to sustain our much admired systems of higher education in particular but education at all levels and the higher education piece in particular is being threatened at the state level by extreme budgetary pressures. we do need to bring about a financial balance in the social security system in the decades ahead. we need to do it without

significantly adding to reliance on already high payroll taxes. of course there's the biggest challenge of all in the health care expenditure pattern. now i have nothing to add to that particular subject, the health care side, but i do want to point out that i have not seen any new proposals that have shown that fees will continue to rise faster than the gdp deflated. it's just a question of how much. today the federal government spends close to 25% of the gdp. that's well above any previous peace time level. some of the budget is stimulus spending which should diminish over time, but even taking literally the most extreme proposals like the simpson

bowels commission, the spending level would only go down to 21% of the gdp. that's well above past levels. and they under their own planning would take years to reach that goal. so even then we look at that spending level and look at the present tax system, we can't come close to balancing the budget. in fact, the revenue system is so shot through with exceptions, exemptions, and credits that it's leaking badly. the system is so complicated it's hardly comprehensible. as things stand, the tax take is unlikely to regain and maintain its historic average of 18.5% of

the gdp. nor does political reality, administrative capability, or economic analysis suggest marginal tax rates can be appreciably increased across the board and still generate enough revenue. the implication is arduous. very large changes are necessary. they need to be structural. they need debating, and this is the year to pursue that process. debating even beyond the simpson bowles approach. that commission and other informed discussions tend to take a page from the reagan era of reforms of 1986. people forget that ronald reagan improved increases of taxes of some size, i think, three times during his administration after the initial big reductions in tax rates.

in '86 exemptions and credits were in many instances reduced, in some cases they were ended. the result in revenue increases said it would produce lower marginal income tax rates consistent with a net increase in revenues making a contribution toward reducing the budget deficit. so simplification and revenue enhancing may in concept both be possible in one fell swoop. the complementary approach to simpson bowles is taking with respect to the corporate income tax. now all that seems to me part of a constructive debate. it's perhaps politically possible in time but i don't want to stop there. my plea is for greater boldness. we do need tax reform.

we need to think hard about how to rely more on consumption-based taxes, avoid incentives to move business abroad and think about possible integration of corporate with personal taxes. we need to consider the impact of federal spending policies on state finances which consequences for infrastructure support and medicare responsibilities. in that connection i might remind you that between 500 and 600 billion of federal expenditures each year go to the states. we need not so incidentally to those of us at an advanced age clarity and consistency in estate taxation and whatever one says about that debate, clarity and consistency do not apply. we need to consider how all tax and spending decisions bear upon

the desire for energy independence, bear upon the threat of global warming and the environment. so all of that is a tall order, and i could go on obviously much longer. is it impossible to do? all i can say is i hope not. better to set out a large framework than settle for inadequacy before the debate even starts. consider whether there are not, in fact, areas of common concern and possible consensus upon which to build. most important we need to understand how much is at stake. united states is not and cannot be an isolated island. we live in a world of swirling

concerns, economic, political, security that poses large opportunities but also, this is perfectly obvious, grave threats. the problem is, or one part of the problem is the united states can no longer claim almost unchallenged leadership of the world economy. for decades after world war ii it was the american vision and american strength that shaped the world economy. an economy increasingly market driven, open to international trade and investment, with unprecedented standards of living and whole nation s risin from poverty. in relative terms we have lost economic position, but we are

still the largest, richest, most integrative economy able to develop and attract the best talent so we can still bring our influence to bear. for that we have to do better. there is no way the united states can thrive in isolation. we want to help shape those in cohort forces loose in the world. we want to shape them in a direction of democracy and prosperity. we can't do that with military force or political influence alone. indeed, only, only a strong and open economy can support and assure our national security, maintain a sense of global leadership, and provide a bull

bulwark against opposing systems. a strong, attractive economy is worth the efforts that it will take to rebuild some sense of common interest and to undertake economic reforms we need. that's a big challenge. it's a challenge that may seem at odds with the electrical -- electro reality, but when we sit back and the election is over, then we had better be prepared. as was said not so long ago by those in the new administration, let's not let the lessons of economic crises go to waste. let's hope that that can be a slogan for the next administration as well. thank you very much.

>> paul, thank you very much. for those of you who don't know, i'm steve clemons, washington editor-at-large of "the atlantic." you'll see that when we do events it's sort of like flying on united airlines. we usually don't let people leave their seats and go in the hall. we do it all at your seats. and we're going to do that. as we're discussing we're going to have staff at the hotel quietly clear your plate. we're not taking a break after this. we're going to proceed. thank you very much. paul, first question. today "the atlantic" issued what i like to call our money issue. they call it our finance issue or economics issue. ben bernanke is on the front. i was talking to peter schiff and other people out of the room who were basically ones who see bernanke as a villain as opposed to a hero. they see bernanke as a villain for keeping interest rates so low that either inflation or

other bubbles are being created. and so if you were fed chairman today, would you have inflation rate -- the fed rate where bernanke does? >> i'm not there so i don't have to make that great judgment. and i have a regular practice of refraining. >> we just wanted to see if you had given up that practice. >> when i saw that bernanke is a hero, bernanke is a villain, it's out there in public, it reminded me even today i occasionally in the streets, somebody comes up to me and says, you're the s.o.b. that presented my poor mother and father from buying a house in the early 1980s because interest rates were 15%. then i go on a block or two and somebody else says, oh, you're paul volcker. thank you. my father bought government securities at 15% which put me through college. thank you very much.

>> david bradley got his house. that's good. let me provoke you for a moment and ask you about your view about what happened during the financial crisis and the creation of financial instruments derivatives which you have said created a lot of confusion and opaqueness and distance, essentially, between regulators and those playing in the markets. >> right. >> some might say, mr. volcker, you're well meaning but you don't understand the new math and that just like steel getting tauter and stronger, that you have a generation of people that despite what happened with the financial crisis, nonetheless there is strength in the kind of leveraging that's out there and that there's been an overreaction to financial innovation. >> i think the answer is evident. i heard all those songs about the benefits of all this very

complex financial engineering and how it was diffusing risk and risk kind of -- compression, risk kind of disappeared. and if we can only sell new gadgets, derivatives to people that have some use for them, that's fine, but we'll sell them to people who just want to gamble with them as well and you have a situation, you know, some of these numbers are kind of enlightening. before the crisis credit default swaps did not exist. they were only invented in 1997 or something like that. they just didn't exist earlier. by 2007, 2008, ten years later there were $60 trillion worth of credit default swaps outstanding. credit default swaps are supposed to provide a kind of insurance policy. you get one of these swaps to protect yourself when you hold a security against default.

case in point right now. but how do you have $60 trillion of credit default swaps outstanding to ensure $6 trillion of the total debt outstanding? it suggests something going on that didn't have a real close connection with the real economy. it was elements of a casino. a very complex casino with all sorts of interdependcies. when that came under pressure, not just credit default swaps or otherwise. when the system came under pressure, it collapsed. i like to use a kind of word and collapsed. i guess most bankers would say collapsed. but i think collapsed is a pretty good description. one that took hundreds of billions of dollars of government support in the united

states, in the uk in europe, in japan to support the system. that's not a wild, die nattic enterprise system, if it's relying on that kind of government support when it came under pressure. that's not to say the entire financial system is to blame for at apart when it was under pressure. >> there was a remarkable op ze d in "the new york times" by a je map who just quick goldman sachs awe patiently today. and orchestrated his resignation letter along the lines that essentially was an indictment of this person of goldman sachs for playing in that economy in what he considered to be irresponsible ways or against the interest of the country. do you have any thoughts on this peace? meese?

>> well, it's a remarkable change in the past 20 or 15 years. goldman sachs, for instance, has long been the most respected of the investment banks, very sensitive to avoiding conflicts of interest and focusing on their client needs. two things to take an example of that firm, i don't want to pick on them, but they went public. it used to be their partners were at risk earlier. in the mid '90s they went public and they bought a big trading operation. and that, like other investment banks, became a trading operation rather than a largely customer oriented underwriting m&a type of operation. and that changed the mentality

and i'm afraid it's a business that leads to a lot of conflicts of interest. it leads to enormous compensation when you're doing well and that's obviously very attractive to very young people. all these firms could attract the best of american graduates, whether they were philosophy majors or financial engineers. doesn't make any difference. if they were good, the rewards were so great that a lot of that talent was siphoned off into wall street. but now we have the question of how much of that activity is really constructive in terms of improving productivity and the gdp. these were brilliant years for wall street. were they brilliant years for the economy? there's no evidence of that. the rate of economic growth did not pick up.

the rate of productivity did not pick up. as i noted earlier, the average household had no increase in real income during this period or virtually no increase. so we had an unbalanced economy and since you've given me the opening to have a few advertisements, the so-called volcker rule which was aimed at proprietary trading, aimed at speculative trading, not in general but speculative trading by commercial banks that by their nature are protected by the government and indirectly subsidized by the government and should the government be subsidizing, protecting institutions that are engaged in essentially speculative activity often at the expense of customer relationships? and does it lead to a culture, does it lead to conflicts of

interest that we would just as soon do without? so i hope the reform, we're making a little progress and getting a little rebalancing of incentives in the financial system, more full-throated return to old-fashioned concerns about lending to small, medium sized businesses and doing responsibility and taking care of your deposits and a critically important function of the banking system is making payments rapidly, accurately all over the world and all kinds of contortions. that's a job for commercial banks. that's not a job, in my opinion, for speculative institutions. hedge funds can go out and speculate or people can speculate individually in whatever they want to do, but they shouldn't be protected by the government. i can give you my long lecture which i'm going to give on financial reform.

the difference is those firms are going to be speculating and doing proprietary trading should not be rescued by the government when they get in trouble. that's their own responsibility. [ applause ] and most of them, take the hedge funds, they are largely in the past financed by partners, limited partners. they're financed basically by equity, which is as it should be. banks are basically financed by borrowing. >> let me ask you a question about the volcker rule. as i read the volcker rule you were hoping for a morrow bust version of this than we ended up. is that inaccurate? >> no, i don't think it's a question of robustness. in fact, all this fighting about response from banks and so forth that are all is it's too robust. they're complaining that it's been interpreted -- >> they want to make it a little

b and not a big b. >> they say you've gotten too detailed. you have a he gotten into all of our detail. you're not giving us any room to breathe, so to speak. so it's really a reaction that, no, you're interpreting it too strictly. this gets into, you know, a recurrent philosophical question about financial or other regulation. can you put out some broad principles, try to make sure that the banks or whatever understand the principles, and then you check up on them later without trying to master mind all the particular transactions? that sounds sensible, but it goes against the grain of the regulatory philosophies in the united states, and particularly the philosophy of those regulated. they have all droves of lawyers coming down saying exactly what do you mean by this? exactly what do you mean by that? if we hold the security for three days is that okay but four days is not?

is that what you're telling us that? if you're not telling us that, tell us that. i don't want to do that. you don't want to get into that degree of detail, but that's what this argument is all about. >> in a little while we'll have larry somers up here, bob reuben will be here. one of the people who's coming up is the one that has the key job now, which is gene sperling. gene was profiled in the post the other day and looking at the jobs and infrastructure proposal that they put forward, and as i dug into it, it looked like a lot of those pieces were things that you and austan goolsbee had worked on, thought about sometime earlier. my question is do you think the president is three years too late with his jobs and infrastructure proposal? would you have sequenced some of what the obama administration put forward differently? would you have done more in jobs and infrastructure on the front end and less resuscitation?

>> i would like to say if i was president of the united states i would have figured this all out and would have had a sophisticated program. we haven't got that kind of a problem. what we have is the backlash. it's like a tsunami hit us in the financial system. it did a lot of damage. we've now got to recover from that. the tsunami was debt. debt in this economy relative to the size of the economy doubled, increased by 2.5 times i think. just relevant in the size of the economy over a 15 or 20-year period. at the end of the day, it strangled us. for a while it financed a great boom in home building, but as soon as the crisis that's inevitably going to happen, home building prices went down, we couldn't handle the debt. and people hadn't saved during this period because it was so nice to borrow money. you know, you could borrow on the mortgage and took out the mortgage and you got a home equity loan, then you got another borrowing, and your