the housing market creates such bangst that i hesitate to do it. margaret thatcher preferred increasing home ownership. why? it produces positive externalities. it produces better schools. it produces a whole bunch of things which are not reflected in the prices of the houses. left alone, the housing market will produce too frew houses, -- too freew houses. we had a fiasco in the housing market. we are where we are. there is nothing we can do about that. . .

>> in fact, the deductibility of mortgages, margaret thatcher got rid of that. there are all sorts of distortions in that market. i do not want to be in a position of defending andrew

cuomo's heading upon hud, when he continually pressed fannie and freddie to make loans to people the that they knew could not pay. i do not want to ignore it judge pose near's very important comments about suburbanization. there is more travel, more pollution from cars. but all has to be in there, but i do not think conservatives can content themselves with simply a tax on housing subsidies. or the notable recession of the deductibility of second mortgages. we have to decide whether there are externalities', whether they are positive or negative, and what sort of subsidies are appropriate to that circumstance. that is much harder than just saying, fatty -- freddie and

danny, what do you owe us -- freddie and fanny, what do you aus? it is something like $40 million. that is a lot of money, and we did get it wrong. but it is just one of the things we have to think through. when we socialize at risk, which we have done with health care of course, it does not make it crazy for the president to say we, the government, need to have a role in reducing obesity. the cost of obesity is now socialized. so, if mayor bloomberg is going to protect me from a junk food -- what is the new rule? if you cannot sell soft drinks

to school children because they will not enjoy their pot quite as much if they cannot have a coca-cola with it. [laughter] obesity at about 3% to health care costs. certainly, the taxpayers are paying it. the representatives of the taxpayers have some right to say, hey, wait a minute. there may be other ways to do this, personal insurance if you do not believe obesity is a disease rather than a choice. i do not know how we handle that as conservatives. we lose the fight about the socialization of a risk, and then we are stuck with it, and then and what do we do. it seems to me, want to lose the fight, that's who you are. now the question is, what do you do -- i do not know how many of you play poker. when you get dealt a hand, you cannot switch the hand.

that is what you've got. the question is, what do we do about it? conservatives would do well to abandon the notion that -- no, this is a slippery slope. and watched the president during the n.c.a.a. at halftime ordering a national exercise program during a -- and national exercise program. . there is a common-sense a line that you have to draw up somewhere. it is hazy and difficult to find, but that is what conservatives should be looking for before the president appoint a fat cigar and -- a pointppoints a fat czar.

-- appoints a fat czar. [laughter] government intervention is sometimes necessary to offset instances of a market failure. i understand that there is perhaps a greater danger of a government failure than market failure. for example, my friends at work on health care problems, especially in britain, and they see a huge market failure in asymmetry. the doctor knows more than you do a about health, but some bureaucrat tells you what you can let the doctor do to you. is this a serious problem? if it was a really stupid -- it

was a really serious problem, nobody would buy a used car. but it is a problem. it is a market imperfection, and what i think we have to deal with. but, the danger of a mindless opposition to interventions where there are market failures brings us to the question of how do we deal with systemic risk created by sub-optimal industry structures. that is a mouthful. i will explain it in a minute. consider the recent financial crisis. mortgage brokers had no incentive to avoid risky loans, because they were passing on the risks to other people. they wrote mortgages with no income, no jobs, no assets.

if your income was really too low, the broker help you find another zero somewhere. they had no skin in the game. bank executives, who happened incentive to maximize short- term -- who had incentive to maximize short-term profits, and the rating agencies, who were paid by the issuer's only if the deal went off, were induced to give out aaa ratings to undeserving securities. we know too that politicians had and still have, because they pay no price for this, every incentive to make things available to families that

cannot afford them, even if they are appropriately subsidize. i noticed that someone tried to bring a confession of culpability from to the guy there when he was here -- from the timothy geithner when he was here people -- was here. he made the point, but he did not get the confessions. banks took risks they should not have taken. the result is that we have socialized losses and privatized profits pip. we have three choices in that circumstance. first, we can maintain the status quo. i do not think that is possible. i don't think it will be tolerated. i do not think it is efficient in economic terms to do that.

i'd just do not seeps -- i just do not see a situation where the bank will be able to unload their bad paper on the fed for ever and then keep their profits. i do not think it is viable. the problem is that the status quo has now come under attack. we bailed out bear stearns for some reason or other, but let's assume that we bailed out bear stearns. the buyer said, all take $2 per share. with the world collapsing around me 32 minutes before tokyo opened, i do not know what i would have done either. but then along came a lehman brothers which offered to sell,

and kept saying over and over again, well they bailed out there stearns, they will bail us out to. they turned down offers to sell the firm because a it were offered less than what they're stearns bought -- a a what bear stearns and got. that behavior was rewarded and therefore repeated. this is not sustainable. if we can see that this is true, then we can move from the option of doing nothing to unleashing an army of regulators on wall street. i am not in favor of that. i think that some of these regulators need to work. i am glad to see them get it, but the fact is that a swarm of a risk-averse and regulators poring over the deal books of

the banks is not my idea of the revival of capitalism. it just isn't. so, i come to a third way. i did not mean it in at the sense in which it is. the government can put in place a incentives less likely to produce at risk. get them right, and a lot will follow. the government can get out of the way. require mortgage brokers to have some stake in the game. have a rating agencies to take their fees in the form of securities that they have operated. -- have upgraded -- rated. [laughter] the laughing shows how far we have come, that that should be considered a crazy idea. remember, i said at the beginning, this is a thought

experiment. you should feel free to disagree with me. all we do is thought experiments. we do not take positions. there is more to it even a ban and skewed incentives. a a system of corporate governance is weak. so is the compensation system. i will be very brief on corporate governance. in either 1933 or 1936, there was a great bookplate -- a great book pointing out the deficit -- pointing out the dangers of separation of controls. it meant that the managers of a company or essentially free from control of the owners of a the country. -- of the company.

the principle is the honor. the agent is the manager. the aged is not under the control of the principal, and he can do things that he could not to do if this were a family enterprise. and they did things. they did a lot of things that they would not do, a compensation being one of the principal ones. compensation was essentially reviewed by the owners of the business. it wasn't reviewed by the directors. directors or usually selected for the intensity of their friendship with the ceo, whose salary they were supposed to control. when we make it easier for the sec to depose directors, when they say directors should be independent, and here are some tests of independence, we know right away if you sit on his

board in determining his compensation, he is not independent when it deserving -- when determining yours. the reaction to the flood compensation system we have is upsetting. did sarbanes oxley get it exactly right? no. is it possible to have too much risk aversion? yes. all of these things are possible. but it seems to me the least possible way to preserve capitalism is to have a system where the ceo rex a company, walks up into the sunset with his golf bag slung over his shoulder and a multimillion- dollar goodbye. directors are more interested in preserving the nice atmosphere of their country club.

first of all, this is wrong. remember wrong? there was a word wrong ones. it is not even a relatively wrong. it is absolutely wrong. i think that, to the extent that conservatives do not recognize that, they get themselves in a position where they cannot get heard. that is really one of our problems. i do not want to go on beating up on the corporate system, because it has produced enormous prosperity, enormous welalth. i think if we fix it, if we concede it needs fixing -- i noticed that there is a huge opposition to the sec giving shareholders more power to hire directors that are not recommend to dampthem by the ceo.

where does that come from? remember, it was mike milken and challenging incumbents in many of these corporations that produced the efficiencies that we got. i do not want to go into it, but the fact of the matter is, that challenge -- and it has social overtones that challenge. i remember in one of the takeovers of people -- takeovers of -- i will not say who, but the president of this company said with what you do it with your big cigars and diet coke's think you can take over my company? well yes, we do. he had a wine cellar bought for him by the company.

there is a thing going on below the surface, and conservatives ought to line up on the side of social mobility. yes, we are going to take chances, but i think the biggest chance is to do nothing. let me conclude -- oh yeah, one other thing. my conservative friends are opposing conservative -- consumer protection laws that are going to be built into the banking reforms. think of what that means. banks have been charging for free services. they impose retroactive increases in interest rates. how can you be against that? will it to drive up interest rate? yes, so what? there will be parity. people will know what they are getting.

we have to take a hard look at the positions we are taking. when you take a king's schilling, you are the king's man. i will talk about my fifth point, now that you have signed on to the other four. the government has an obligation to make sure that capitalism produces results that are believed by the great bulk of the body politic to be fair or just, and therefore sustainable in a long run. this is a subject, when i got to washington, that there would not cut with a 10 ft. pole. a great economist was once asked on the witness stand if something was there. he said, "and suggest you consult the clergy."

i recognize that inequality of wealth and income distribution is the essential feature of a market economy. i recognize that equity is a roguish pimping -- a roguish thinkg. maybe because i got older, maybe because i have been here, i think that if we are going to respond to critics who talk about a liberal status who have never met a tax or a regulation that they do not like, that we have to confront this question. otherwise, we will be unable to answer in a coherent way the outrage that has been generated by the government responses.

it is true that wall street was saved and main street wasn't. i understand the, but if you are living on main street out of work -- i understand the argument, but if you are living on main street out of work, it does not seem fair. i will pass over the specifics, but what is relevant here is recognizing that we have a confluence of two things. we have globalization, which has put downward pressure on wages of a middle and lower income people. not bad people. a lady in north carolina has

been selling t-shirts all her life, sending her kids to school and going to church. she is now in trouble because people who can do international deals are worth billions as opposed to national deals which are worth millions. we have a pressure on preserving the work force. it will be corrected in a long run. but i do think we have to have an answer to this problem, and i do not think we do yet. it is true that we benefit. we go to wal-mart and we buy these t-shirts. but i do not know where it is written that the interests of consumers to take precedence over the interest of producers. there are other producers around in the workforce, and i think we have to think through whether or how we want to respond to this

problem that now exists. i think that one thing we can do is try to developing -- try to develop limiting executive compensation to performance. we thought we had done that with stock options, but all that it did was make them take as much risk as an equity holder in the company. they were backdating options in case they did not work out. i do not really have a solution for that, but i do think we have to avoid -- we have to avoid confining ourselves to be peddling at trivialities that occupy a modern economists.

we have to restore the abilities of capitalism. so, or finally, in conclusion, we can offer and offer empirical support for the notion that redistribution reduces the incentives for those who produce the wealth being redistributed. that is not a good thing. we can create incentives to antisocial and self-destructive behavior and show that the cost of redistributive mechanisms is very high. there you have it, and what i would call neo-orthodox thinking. we should reinforce competition laws to preserve a dynamic and

socially mobile society. regulation of enterprises, internal invasion of externalities', using revenue neutral taxes if necessary -- i am against taxing work, so i would use externalities' to reduce income taxes. programs to correct other instances of market failure. creation of incentives for corporations and financial sector behavior that a line of private and public interests. restructuring the financial structure. i have no illusions about this. policies to preserve competition in the wrong hands can really get out of hand.

externalities -- coping with them through taxation can lead to crazy policies. we could have more market intervention and then we want. but we cannot be paralyzed by those problems. whatever we do, it is going to be very difficult to defend market capitalism to those who do not like it. we like it, and we should cut programs and to defend it from those to see an excuse to transform it. that we do not want to do. we want to reform it, but not transform it. thank you very much. [applause]

we have time for some questions. i cannot imagine there would be time. who is next, so that this lady can run over there? go ahead. >> i am an independent adviser. i have spent a number of years studying antitrust law. when i did, the conservative position was not as you represent it. the issue was whether or not the possible subject of an antitrust investigation had the ability to control price. it was a fairly workable definition. the position of the other side was basically that size, bigness, was a negative and to itself -- unto itself, and so

conglomerate should be broken up even if there was no real effect on price. >> can i offer a free copy of the book and jon and i did so that we do not get into a long discussion of antitrust laws? antitrust laws or always aimed at preventing monopolizing behavior rather than monopoly is preventing exclusionary behavior, rather than price increases. i have never seen a successful assault on compliance and that had no implications in the markets. there was a time that people did not like conglomerate, but the market took care of that. it is an arcane discussion, and it would be insensitive of me to about the other two hundred people here to get into it. but i will give you the book, if you do not mind.

>> thank you, great lecture. my question is a quick one. many people feel that china has become the bank of the united states. how do you feel about that? >> as to china, at the beginning i pointed out that the notion of free trade in a world in which someone is manipulating currency is bizarre. it is bizarre. that does not mean i am a big fan of chuck schumer or any of these people, but it is money. the notion that china, which holds quite a lot of our ious