the number of regulators is much smaller and they can coordinate with each other. there's only really five institutions in total that are really overseeing the canadian financial system. so when there was a financial problem, you could actually get all five people in the room and immediately say, right. what do we do? lew do we deal with the problem? canadian financial institutions also carried a lot more capital, and much lower leverage than many other large banks. this was partly because of regulation, but also partly because of culture. >> dare i say, canadian banks were more boring? >> and criticized for it. >> criticized for it. >> in 2005-2006, can you find lots of examples of stock analysts highly critical of canadian banks for not having a strong enough risk appetite, which actually turned out at the end of the day to be a positive thing.

to be honest, the canadian financial system doesn't do a lot of innovation first. it tends to watch what goes on in the united states and say, that seems to work pretty well. so, you know, then canada will start doing thing. as we saw increased numbers of subprime loans being done. canada had far, far fewer subprime loans. so at one point 40% in the u.s. subprime. in canada it got up to, i think, 4.5% to 5% was subprime. so when the financial system ran into difficulty, really for canadian financial institutions it was a liquidity crisis. banks weren't willing to lend to other banks. so the government, or the central bank stepped in and said, okay. here's liquidity to get you through the crisis. once the global financial system settled down, the canadian banks came right back to life and operated very well. >> okay.

before i move on to the next question, very quickly, the dodd-frank question wasn't posed to your end of the -- yes, no, qualified yes, no, from you, craig and also you peter. >> the dodd-frank bill does provide greater oversight of the financial system. would it have completely stopped whatted? absolutely not. there were too many other factors in play. >> peter? >> i agree with that. i think that many crucial elements of dodd-frank bill could have helped ease some parts, but at the same time, perhaps you'd also be looking at a higher cost of capital, which may or may not have been desirable. >> and i didn't pose the question to you, adam. >> i agree. dodd-frank would not have stopped it. >> so we haven't even won the last war? >> no. dodd-frank happened after we lost the last war. >> yeah, but normally -- okay. >> i think the more important, actually, from a global perspective, basil 3 is

important. saying, listen, banks should actually carry adequate capital to ensure if you have something go wrong they remain solvent, and you need to reduce the leverage you have in your system to ensure that when a shock hits it's not too big. so while we tend to look at what's going on with dodd-frank, actually, the basil 3 accord is far more useful a device for ensuring written reduced risk. >> fair enough. now, everybody knows what happened between t.a.r.p. 1 and t.a.r.p. 2 and the minski moment, eventually passed, thankfully, and the system was saved. answer banks are now back to where they were before the crisis. in terms of looking at the recovery and assessing whether the recovery is durable. clearly the role of the housing market is critical and the degree to which it has

delevered. was it a mistake in 2008-2009, not to have a t.a.r.p. equivalent, some kind of really mattive bazooka for main street? the kind of bazooka there for wall street, for the u.s. housing market? i don't want to sort of formatively go, one two, three. please, just sort of pitch in, whoever wants to pitch in first. was it a mistake not to have a big policy to address the housing market in '08 and '09? >> yes. >> we've been edging towards it for three years now, and unfortunately, facts get created that can't be reversed, once you start to go into foreclosure. once you lose your home. once the mortgage defaults. yes. huge mistake, and we're taying f paying for it. >> a liquidity trap, zero interest rate because money's not circulating the way it should and part of the core reason it's not circulating is because of the impediments

coming from a housing market that is continuing to decline. >> pete? >> and there are other elements to this, which is, we have a good resolution -- in the u.s., we like to hold as a point of pride that we have a resolution process for corporations. we've got chapter 11 when a company gets in trouble, there's a discipline process where the company's viable to write down its debt so it goes forward. some companies can't be saved even by chapter 11 and have to be liquidated. the reverse is happening in housing. before the securitization, if a barerer got in trouble, through the bank's mind, the bank owned the mortgage, is he worth more to me dead or alive, in the vast majority of cases, the bank would restructure the mortgage. do some sort of mortgage modification. very quiet. no social jealousy, nobody would know. now there are servicers in the middle for a significant amount of housing debt. servicers have no incentive.

they get paid to foreclose, they don't get -- even with hamp and other incentives, payments to modify are inadequate. they make money by attenuating foreclosures, basically what's happening now. because they charge more servicing fees, charge more late fees and it requires skills they don't have. you actually need to build significant new infrastructure to have them do these. so a consequence, a huge number of foreclosures in the pipeline. look at housing inventories. that's not telling the real story. the banks have, best estimates, 3 million houses that are somewhere in the foreclosure process, or that is real estate owned. that they haven't put on the market, and another 5 million houses that are in defaulted or in serious delinquency. we have a big overhang here and, again, the services having bad incentives, this -- this program, the new -- federal-state ag settlement is not going to make any

difference. it's too small, badly structured, doesn't solve the real problem which is the sft r servicers and inability to restructure debt in a new way. >> so you're pessimistic about mortgage mod fshification? >> to our hero, on the atlantic monthly cover, i asked the question, why did we wait until 2011, the summer of 2011 to really go after the mortgage backed security market and drive down mortgage rates? the fed should have targeted that market in 2009. we could have got an huge windfall of refinancings, that are not possible now, because those people, once your credit is gone, you can't get a refinancing. this thing snowballed and snow balls. this is a black market against our hero. i like him too, but let's be balanced in our criticism of him, too. >> presumably i haven't asked each of you the same question, but there say agreement, there should have been more aggressive

action on the housing market -- >> let me note that we had a problem that is going to have to be resolved whether the policy input or not. the policy could have made things a little easier, but home prices went way higher than they could sustainably be maintained. home prices, rent ratios, some 30%, 40% some long-term sustainable level. stock of vacant homes rose several million units above a longer term trend. so we had a lot excess inventories that needed to be run down. home building, investment had to drop. home building dropped sharply. home prices, creating a lot of pain to the economy that was not going to be avoided. i maintain. you can't manufacture -- unless we're going to put a lot more people into home ownership, continue along those lines, than was sustainable in the long run, you weren't going to be able

toll avoid a major adjustment for the imbalances that had been created during the bubble. now, at the same time, certainly, there is, there are moves going on in washington today to begin to work off the stock of vacant, distressed properties, the rao, the pilot project we have in place to begin to finance investors more. in a bigger way than had been in the past. housing homeowners are no longer financed. let me throw out if you're going to have principle write downs. if you're going to have, allow people to foreclose, i mean, you're going have to find some way of financing this. government funds are going to have to be put in the picture. then you get into the fiscal problems we're dealing with.

aagree things can be done to ease the problem but there are costs. >> well, why wasn't this done? >> because it smells incredibly badly. we did what we did for the banking system, notably t.a.r.p. >> yeah. >> and it was a sorry spectacle to watch the political process actually do t.a.r.p. we got to see it voted down and then the stock market voted down and then we had congress holding its nose and passing it on the notion that hank was going to buy out assets and quickly changed his mind to recapitalizing the banking system, which was the right thing to do in the first instance. so essentially t.a.r.p. passed because it had to pass. it did not pass the smell test of democracy. as i said, unambiguously. what's favoring a class that in the clear light of non-crisis day would not have gotten the

benefit. i mean, ben essentially told them either you pass it or we will have depression dodd 2. dodd 2.0, your call. t.a.r.p. passed because it had to pass. it didn't pass the smell test of democracy. that's why we didn't do what should have been done at the time, which is to look at the household sector. and it's basic unfairness. t.a.r.p. was unfair. and it would have been unfair then and now to essentially reward with government assistance those who should have been called renters, not owners. homeowners. i think that's why we've taken so long to deal with it. and we're dealing with it now because it's a permanent sort of drag, an anchor on our economy, but it's the notion of fairness. democracy demands some notion of fairness. >> presumably also the fact that it is logistically more difficult to be fair to this administration -- any administration, it's far tougher to deal with millions of mortgage holders.

>> i also think -- >> that is true. but it's not the fundamental reason we haven't done it. we haven't done it because it rewards, from a moral perspective, those who essentially did what we consider to be immoral, which is took debt that they could not afford. now, if you're a banker that was fine. but if the you're a homeowner on main street america, we want to punish you. >> talking to cnbc, rick santelli is a big part of your explanation as to why this happened? >> hi, rick. >> but i think there also was an underestimation of the ability of the market to actually process the foreclosures in a timely fashion and deal with the problem. i think there was just an underestimation of how difficult it was going to be and how big the stock would get. and, you know, we were in unchartered territory. you can just look at the policy reactions at the time, and it very much was making it up as

you go along, because you truly didn't know all the moving parts. and i think there was a -- >> we've had a lot of time to make up a story on housing. right? >> right. but after t.a.r.p. 1, i think there was increased recognition that there was problems in the housing market. that's where it became, you know, in many cases it was politically too challenging to deal with it. so a great example of that is if we look at mortgage modification, right, about 25% of all the mortgages that are actually directly held by banks have been modified. about 2% of those that are in mortgage-backed securities have been modified and none of the mortgages at the government-sponsored entities have been modified. and the last group is actually 56% of the market right now. so, you know, i think that there became political issues and fairness issues that kicked in, but i think at the start there was an underestimation of how difficult it was going to be with the market to deal with the problem. >> you wanted to jump? >> yeah.

a couple of things -- paul is right. there do tend to be moralistic paintings of what happened. as part of the sort of fairness debate is that we could have had a t.a.r.p. that exacted a lot more in the way of punishment in terms of replacement of bank executives and bank boards. [ applause ] and there was a lot of symbolism -- that would have made a huge difference, witness the audience reaction, in terms of how it went down with the public at large. the second is that there's still a lot of discussion about the yunner tone of the deadbeat borrower. it's now much more complicated than that. the people who really took out the mortgages, the teaser loans, a lot of those have already been foreclosed on. those were the resets of 2007-2008. a lot of the people are gone. the people who were losing their houses now are much more people who lost jobs or who had hours cut back or more normal -- more normal situations like medical bankruptcies, things like that. on top of that there's significant evidence in which the administration hasn't really

wanted anyone to go there, and no one knows the number because there have been no investigations, of servicer foreclosures, where the banks have applied fees inappropriately and will compound them in ways -- for example, you're supposed to apply payments to interest and principle first, they'll apply a late fee first. then you've got the next month late, and then more fees kick in when that happens. and nobody knows how significant it is, but the people who represent homeowners in court say it's actually quite significant. when the few case where's people have hired a forensic accountant, which most people don't do, they've found significant abuses. so the morality tale is a lot more complicated than anyone wants you to believe. >> bearing in mind the condition of the housing market and that we're not likely to see a sort of hail mary moment that's going to solve it all in the foreseeable future, i'd like to ask each of you about how you assess the quality of the recovery we're going through

that right now. we've had three months consecutive months, of joblessness falling by over, almost a quarter of a million. we've seen growth of 3% in the final quarter of last year. we've seen the markets responding as if this is a real bona fide sustainable recovery. is this a recovery the kind of recovery that we're used to prior to '08? is this, on the other hand, a japan-style recovery, a new normal? which side of that debate does each of you fall? let's start again with you. >> i'll try to be short. i'm not a believer that we're on our way to a sustainable recovery. we also had a period at the beginning of last year where admittedly not to this degree but the numbers look better and then the strengthening faded. you know, we still have more downside on housing. the fed has been talking about a fiscal cliff that we're going to

reach in january 1, 2013. they actually thought it would be january 1, 2012, but some of the tax breaks, particularly the lower payroll tax rates, were pushed out another year. but we're going to have, unless other measures are taken, we're going to have fiscal spinning fall off in 2013. if nothing else that is going to be another drag on the economy. >> now, i'd like to just stay a little bit with the discussion we've been having, because i don't think we've framed the problem right. this is washington. we want to get through policy and prescription first. but prescription isn't worth a damn unless you do diagnosis right. now, there are three explanations broadly speaking, of this problem out there. one is a republican american enterprise institute explanation which i call the government failure hypothesis. that means you blame the fed for holding interest rates too low

too long in the last expansion. and you blame the government for interfering in the housing market, fannie mae, freddie mac. community reinvestment act. and the policy prescriptions that come from that are very clear. >> uh-huh. >> number two is what i call the market failure hypothesis. that's what we've heard so far and only what we've heard so far. that's why i'm spending time doing this. here you say there was a failure in financial markets. that failure was due to inadequate regulation, too much deregulation, and arrangements -- incentive pay arrangements that allowed -- that fostered loan pushing instead of sound lending. by the way, that's what i think the administration folks we're going to hear from this afternoon. market failure. >> you are going to link this up to my question? >> very much. this is your dodd-frank piece. that solves the problem but unfortunately financial crisis caused a deep recession and to get out of the deep recession we need fiscal policy. for them that's all you need to continue doing. they solved the problem structurally in their view but

now how long do you continue with this fiscal stimulus. now, the third piece, which is what i call the destruction of shared prosperity hypothesis. what happened around about 1980. we changed horses. we changed our growth model, and we moved to what i call a neoliberal model where we broke growth, the link between wages and productivity growth and in return we started driving the model up the economy with asset price inflation and debt instead of wages driving demand. now, that created demand gap but we papered over the gap. this is the study boom you're talking about. 30-year boom. this is the reality of the great moderation. the great moderation was papering over this structural flaw by pushing assets into the economy and debt. and of course, it went on far longer than any of us expected. >> you're saying your concern is policymakers, namely this administration, are assuming we

can just return to the status quo entity? is that your -- >> now that the thing has broken, we can't go back to driving the economy by debt and asset price inflation. what we're doing is filling in the problem by having the public sector balance sheet fill it in, and that works as long as we can keep that going. that's why there's a 1937 moment. if you start to pull back on the deficit, you're going to have that shortfall. we've got to tackle the underlying problem of income distribution, where that comes from, bad globalization, a labor market flexibility agenda that undermines bargaining power. >> given that, given that joblessness is falling, so are median wages, which is your point essentially. >> this only keeps going temporarily. >> are we heading for another 1937 -- >> no. we're heading for a stagnation.

if we do what paul was talking about i think in the green room, about not doing 1937 all over again, then we will have a depression. >> interrupt us, which i rather enjoyed. that's essentially the 1937 scenario, right? or the december sequestration scenario that we're potentially facing this year? >> i think we have a recovery worthy of the name. will it be different from the recoveries of most of my lifetime? probably. but we are grow iing concern, economy with income distribution issues that trouble me as a citizen, certainly. but, yeah -- >> but not as an economist? you don't worry about the lack of a -- >> troubles me more as a citizen. but it's a real recovery. the key issue for me is it's a recovery that's founded on both the balance sheets of both the private sector and the public sector. and my biggest concern about the longevity of the recovery and the robustness of the recovery

is that the mindset on wall street and also in this town is somehow that the government sector should look for the earliest and first opportunity to exit the stage, which i've, you know, coined cainsian interruptus. we did it in 1987. it did not turn out particularly well. so a particular role for the government. observant role for the fed relative to physical authority is an enduring part of our landscape. if we accept that this is part of our new landscape, bigger government, fiscal policy taking the lead. not just cyclically until we can get out the door. but actually during part of our new reality, then i think we'll be okay. it will not be an exuberant party, but perhaps we at times have a little bit too much exuberance anyway. so i'm frightened to learn that the last 30 years of my life was

my adult life, was but a mirage. that is a little frightening to me. i just turned 55 yesterday. i want to believe that i lived something meaningful. >> talk with me afterwards. >> we've already solved the causes of the crisis. we're on to how to fix it now. do you share this view that this is -- well two out of three say that it's not a real recovery. >> is it sustainable? it's already the weakest recovery in the post-war period. without question. and for good reason. reinhart and rogueart spelled out why. the first time we followed a financial crisis at this magnitude as opposed to a fed-engineered recession. but is it -- well, i'll also note that on the question about vis-a-vis japan, we are not japan. the u.s. stock market is 16% below its previous peak in 2007. japan's is still 70% below its 1990 peak. there's a very different animal there, but we are suffering from some of the same problems.

i'm encouraged though. i look at what's going on. we've been recovering for the better part of three years, since the trough of the recession in mid-2009, and time is the big healer in this one. we've had an extended period of time with home construction, less than half the rate you need to house the growing population and, as a result, we're working down this excess stock of vacant homes. pretty dramatically. home building can begin to rise to more normal levels over the next year or two, and that's going to be a little extra engine of growth on the plus side. another major development, one of the key things everybody is worried about is household deleveraging. well, there's been a lot of deleveraging. the household debt to income ratio has come down at an unprecedented rate. yes, it rose a lot, but you look at what's happening in the household financing, average household debt servicing, financial obligation

ratio is well below historic norms. debt has come down. interest rates are very low. that helps. and you're seeing credit quality improve, chargeoffs default rates on credit cards are down sharply, and consumer credit, after having declined for several years is now growing at a pretty good pace, and that's supporting consumer spending. it's not a big surprise that we're seeing some at least moderate growth in consumer spending going forward. that's sort of -- that's at the heart of, is this sustainable? now, i agree with paul. there is a black cloud on the horizon here when we talk about fiscal policy and if we take this 3 1/2% of gdp cliff that's coming at the end of the year, bush tax cuts and it gets in place, employment tax cuts, all of this, then we're facing a problem. doug elmendorf had it right that we're looking at 1% gdp growth next year under current law.

but i don't think anybody expects us to go through this without some major modification. the question is, do we begin to do the right things in washington next year? do we begin to tackle the longer run problem with tax reform and entitlement reform, give the market something positive to look forward to as we're taking away this near-term fiscal drag and probably getting a downgrade from the ratings agencies in the process, but at least if we're moving in the right direction, if washington, the two political parties can begin to communicate and -- make some progress, then i think it's definitely sustainable. >> you can look at it glass half full or the glass half empty. half full is america has a more efficient market clearing process than, say, europe? the americans have delevered -- not you, the americans have delevered quicker than other

economies, and, therefore, returning to growth quicker. in terms of the glass half empty perspective is there a concern that there is relevering going on too quickly? consumer borrowing are back up. credit card bills are going back up. the savings rate is losing some of its gains. is there a concern that we're heading back into -- >> i think one of the core concerns is the fact that income growth is so weak. and when you strip off inflation it's very modest. and that means that in order to spend -- and there is enormous pent up demand up there. people aren't saving as much. probably the personal savings rate needs to go back up higher. i think if we continue to see the labor market improve consistent with the last couple of months, then we should start to see income rising a little bit better. but in terms of this question about, you know, is the recovery sustainable? is it japan-like? you know, a normal business cycle with a bad recession is usually like a 2% drop in gdp. and then the year after you grow at 4%, twice the rate you declined at. in this cycle the u.s. went down

5.1%, but the average rate of growth since the recovery started is only about 2.5%. and what it's a reflection of is the legacies of the financial crisis. things like the housing market that still have to be worked out and we're making progress on that. but we need to understand that the magnitude of the imbalance that built up was so big that when the housing market corrected -- if it had unwound really quickly, it would have actually create add depression. so the government cut interest rates and provided enormous fiscal stimulus and tempered how deep the recession came, also helped foster an economic recovery, but we transformed the personal savings problem into a government savings problem, which now has to be addressed, which is going to constrain the rate of economic growth going forward, even if the washington gridlock diminishes. i think fiscal restraint -- or fiscal drag is going to be present on the economy. so when i think about the u.s.

economy, and i have to do, like, a five-year projection as part of our corporate planning, you know, my assumption is the u.s. will continue to grow at about a 2.5% pace now. how you feel about that is whether you're a glass half full or glass half empty person because 2.5% growth is probably close to trend. so we are talking about continued growth, but the problem is you don't get above trend growth you normally get in a cycle. this is an -- >> who is capturing this growth, as well. >> it's important also in terms of the japanese experience when you do the parallel. the stock market is completely different, but japan basically went for you in lost decade, you know, the growth rate has been trend. right? because they have declining population, and then you take a declining labor force, add productivity. their return rate of growth is 1%. what's the return rate of growth for the u.s. economy? the u.s. has population growth, has strong immigration and is an incredibly innovative economy. you add those components