>> rose: welcome to the broadcast. tonight, an exclusive conversation, paul volcker, the former chairman of the federal reserve weighs in on economic recovery and the need for regulation. >> all reasons to think that this recovery will be slower. we've got this underlying adjustments to make. we can't just pump up consumption and pump up housing again. it might carry us for a year or two, but, you know, the impalace got us into trouble in the first place. we've got to work toward producing more goods, selling more goods abroad, being more

competitive abroad, maintaining a decent rate of savings, bringing budgetary... federal budgetary situation back into something that's sustainable. and all those things... and plus the financial market is wounded. there's no doubt about that. and it won't recover from those wounds, deep wounds, for a while. >> rose: paul volcker part one for the hour. captioning sponsored by rose communications

from our studios in new york city, this is charlie rose. >> rose: we begin tonight with an update on the health care debate in the congress. the senate finance committee, the last committee to take up reform, voted today reject a public option. president barack obama has publicly lobbied for such a plan though his administration has declared it not essential to reform. five democrats joined ten republicans to oppose a proposal by senator jay rockefeller. a similar proposal by senater chuck schumer was also voted down in a closer 13-10 vote. this vote signifies divisions between moderate and liberal democrats and a looming struggle to unify democratic reform proposals in the weeks ahead. here's a look at the debate in the committee today. >> my job is to put together a bill that will become law. in the senate, that means my job is to put together a bill that gets the 60 votes. now, i can count.

and no one has been able to show me how we can count up to 60 votes with a public nopgs the bill. >> a new government plan that's nothing more than a trojan horse for a single payer system in washington. >> we need this option because insurance companies have failed to meet their obligations in this whole matter of how do you unroll health care reform. the insurance companies, in my judgment, are determined to protect their profits and put their customers second. >> rose: we will continue to follow this debate in the weeks ahead, but we turn now to paul volcker for this hour to talk about the economy and has advice to president obama on the way forward. paul volcker is here, as the economic crisis continues, many turn to him to understand the rapidly changing global economy. he has had a remarkable career

in public service. he was chairman of the federal reserve from 1979 to 1987 during which he was widely credited with taming rampant inflation. today he serves as chairman of president obama's economic recovery advisory board. i am very pleased to have paul volcker back at this table. welcome. >> thank you. nice to be here. >> rose: very good to see you. let's begin with what's transpired in the last year. how did the government do? >> well, the government was faced with a crisis of proportions that haven't been seen since the 1930s, anyway, and when you got to the fall and this kind of exploded in a rate they certainly didn't anticipate with succession of failures and new failures starting with their decision to support faepld and faekd which are already government supported institutions, things deteriorated and they reacted very strongly at that point with supporting the remaining investment banks, a.i.g., the

world's biggest insurance company, they recapitalized or began to recapitalize in a matter of weeks the biggest banks in the united states. meanwhile air, broad something similar had been going on, but basically the financial system was taken over and supported by the federal government, a really remarkable event. and then as things have evolved, the government has provided not to sole source of credit in the the economy, but amazingly a large proportion of the flow of credit through the economy, which is diminished, has been by courtesy of the federal government. so it obviously needs a very big challenge as to how you restore what we think of as a reasonably functioning private enterprise system, competitive, able to finance small business, big business. >> rose: did they make the right decisions in terms of the particular institutions, in terms of the dramatic consequences of the moment? >> i think they certainly made the right decisions in the sense of preventing a collapse that could have been more severe in

terms of the economy. you know, after this. ... the days in late september, early october, the economy did decline despite the fact that the financial institutions were bolstered up, the economy declined at the most rapid rate of speed i have ever seen in the first quarter of this year, pretty much paralleled around the world. so looking at that experience, i think you would have to say they were right in providing massive support. >> rose: so you give interpret high marks to bernanke and geithner and paulson... >> faced with those marges they did what they had to do at the time. the complaints could be why did we get that situation in why did it that i can emergency action? why were they faced with that crisis? >> rose: answer your own question. how did we in our global economy ghetto that situation? >> well, i think two factors

interacted. one is the global economy itself was quite unbalanced. we've talked about that before. the united states for ten years has been a very high consumption economy. it gave up on savings, basically it didn't do much historically in terms of business investment. and to satisfy our consumption habits, which have required a lot of input, we imported a lot, we financed that sending over dollars which came back to us in the form of short-term financing in all markets. now, the ease of that financing helped facilitate a lot of financial shenanigans. >> rose: yes. >> and as they built up over time, you know, one of my favorite complaints is fancy financial engineering we got during this period where some very smart people thought they had manage the complexitys of the market to the point that the risks were not great. they had been redistributed in a way that would not present a challenge. and the market came under pressure, that did not prove to

be the case. and i think that combination of the kind of confidence, the facade of confidence which are developed by these financial engineers, they were veryring th were very richly compensated and they went ahead and took some big risks. >> rose: right. because they had no restrictions on their leverage. >> and now meanwhile, you can talk about the failures of the institutions, but you can ask where were the regulators. but there was a... we weren't regulating in those days, the markets were going to take care of themselves. this is free enterprise, self-correcting free enterprise, efficient markets. and that, in fact, market operators themselves, it certainly affected the attitudes of regulators. stiff regulation would not have been very pop you particular the late '90s and the early part of this century. >> rose: if, in fact, regulators

had used the regulations that they had in hand and had applied them, would we have avoided the crisis? >> well, you think you could have avoided the severity of the crisis, but you have to ask whether that was a realistic possibility. it would have taken very vigorous and unpopular regulatory action. people thought they had, for instance, capital requirements of banks pretty high. they were as high going into this conversation... crisis as they've been for some years. now, could they have been so high? yes, but it would have been, i think, probably unrealist dwrik think they could have pushed them much higher. xepl do all these thing after the crisis. it's a lot easier to do them before the crisis. which is the perpetual problem of financial regulators. >> rose: your reference to financial engineering is that mathematicians and a lot of other people who did not have what skill? >> they didn't have the skill of thinking... remembering that they were human beings in

markets. these things are not natural events. they're not... you know, independent of observation. it's not like a physicist looking at some event that follows a nice, normal distribution curve. but they thought they were dealing with normal distribution curves. that's what you learn in mathematics. and they forgot. >> rose: they couldn't fact knorr the human emotion. >> the human emotion. and then markets, what happens today affects what happens tomorrow. they're not random events. but the whole philosophy of financial engineering is built up on the idea that these are all... any def united nations from normal city random. >> rose: that brings to this question. two things that will or will not change. one, the impact of financial engineering, and, b, whether, say, asia will change its consumption habits and america will change its saving habits. >> those are two big corrections we have to make. we won't have the same, i don't think, confidence in financial

engineering, institutions have learned something. and some of these deficiencies are now pretty clear. it's hard to change that, because people want to make money and rely upon this kind of fancy manipulation. but i think harder think, yes, is changing the consumption habits of the united states. consumption habits of china, china's too little, we're too much. we need to save more, china needs to consume more. and that was kind of the subject of the g-20 discussion over the last few days. it's not just china and the united states but we're the two polar opposites and the two big countries in this thing. and they talk very optimistically about how they would keep this under surveillance and they would see what progress china's making and increasing consumption, presumably seeing what progress we're making in increasing savings. >> rose: is the chinese stimulus-- which is huge, $500

plus billion-- going to create a consumption and a demand for chinese products? >> i think their foreign surplus has disappeared... not disappeared, but it's been reduced in the last year or so because their economy is surprisingly going faster than i think almost anybody projected. with a huge stimulus program. as you mentioned, their stimulus program is much bigger relative to the size of their economy than ours. and with a still importantly controlled economy, it's had a big impact and the rest of the world isn't buying so much of their stuff and they're importing more so their surplus has disappeared. not disappeared. halved, maybe. >> rose: right. >> but i don't think there's been much progress toward that basic habit of consumption. the chinese are not used to consuming a lot. they have a lot more than they used to but the population.... >> rose: they have more money to spend, but they're not. >> that's right.

>> rose: what about us saving? >> recessions are supposed to be curative. >> rose: right. >> think had some curative aspect. obviously with the loss of personal wealth, the loss of paper wealth, the loss of housing values in the united states people are waking up to the desirability of doing a little more saving. so the savings rate is going up. it's going... i don't know if it's as high as it should be but it's getting much closer to that. the question is, will that remain so as people feel better when the economy recoveries. that's going to be tough. >> rose: to change those habits. my father was a young man during the depression. he would never borrow money after the depression. paid 100% cash for homes that he purchased. everything: cars, homes, never did... bought anything on credit. >> you're supposed to pay 100% borrowing. i don't know how you... one extreme the other, right. >> rose: exactly. so we had that period.

where are we snowed where are the toxic assets and what's going to happen to them? >> well, the toxic assets are wearing away with time and a lot of those losses have been taken, still a lot more to come. but i think we're at a phase now where the non-toxic assets are going bad. if you think of the toxic assets of the extreme subprime mortgages and similar very extreme loans and other sectors of the economy, they are not the whole of the economy, they were important enough to upset us, but ordinary loans, ordinary mortgage loans, what would have been considered good loans after a decline in housing prices of 30%, 35%, some of those loans are under water, people are unemployed. so they're in trouble. consumer credit losses are rising. the biggest single... not the largest, but the biggest single threat until credit area right

now is commercial mortgages. and because office building prices and.... >> rose: commercial real estate in trouble. >> commercial real estate in trouble and that's only in terms of recognizing the losses just beginning. so we still have a lot of... a lot of sewage to wade through. >> rose: but as soon as you say that, as you know much better than i do, a lot of people with on wall street are looking in terms of what their strategy is for buying up debt. >> well, some of them are, and that's a good sign that they at least have the courage to step in there and buy some of this debt which... some of which i'm sure has pushed down the prices that are unrealistically low. >> rose: right. so there's opportunity. >> it's a good sign that people are in there and some of the prices of sum of that stuff are beginning to work. but one aspect of people feeling a little better, there are some people... this is not throughout

the financial markets but there are some where happy times are back again, we'll go back to the old habits. >> rose: this is exactly what i was coming. securitization is taking place? >> you see some of the activity on wall street. among other things, stock prices have been very good recently. but you see other money beginning to flow, the kind of things that people are beginning to buy what may have been toxic assets or untoxic assets at low prices. but i think what we have to guard against, the reason as i understand it that the president came up here a week or so ago, he said "don't forget, we've had a major crisis and we're not through the crisis and we've got a lot of reform to do, it's not time to go back to business as usual." >> rose: just in terms of practice, are we going to see other bubbles take place inevitably? >> well, the history of finance has been a succession of bubbles. >> rose: exact lift nothing's going to change about that. >> nothing is going to change. you're going to have excesss from time to time. but this degree of excess is

very unusual. and it reflects those basic unbalances that we were talking about internationally and a combination of mathematical and computer developments that obviously were not known the old days, they had their own ways of making excesses. but this market has, as a result of the complexities, become for opaque rather than more open, more opaque than transparent. and all of that has haded up to a crisis that's as big as any since the 1930s. and we had a big recession in the early is the 80s but the accompanying complications were not so great. and when that recession was finally broken, the economy expanded very rapidly. i think it's questionable how rapidly the economy will expand after this recession because there's a lot of basic adjustments that have to be made. >> rose: how long it l it be before we get the kind of economy that is growing at levels above 4% and have

unemployment declining, say, below 7% or 8%? >> well, i don't want to speak with great conviction about the economic outlook because forecasts are usually wrong one way or the other. but i think there are reasons to think that this recovery will be slower. we've got these underlying adjustments to make. we can't just pump up consumption and pump up housing again. that might carry us for a year or two, but, you know, the impalace that got us in trouble in the first place. we've got to work toward producing more goods, selling more goods abroad, being more competitive abroad, maintaining a decent rate of savings, bringing budgetary... federal budgetary situation back into something that's sustainable. and all those things... and plus the financial market is wounded. there's no doubt about that. and it won't recover from those wounds, deep wounds, far while. >> rose: what permanent damage

has been done that can't be fixed, that it will take a while? >> well, what's emerged as a result of those dramatic actions last fall, hour justified, is they will themselves affect expectations and behavior. and the thing that's bugging everybody these days and concerns me is this idea of moral hazard. that people expect these big institutions to get bailed out by the government and the creditors won't be hurt. to some extent the equity holders were protected. not completely, but they weren't wiped out. the only place that both the creditors and the equity holders were wiped out was lehman, which went bankrupt and everybody now thinks that was a great mistake, rightly or wrongly. >> rose: and you think? about lehman? >> well, i think if it had been rescued somehow i think still think you would have had an attack on the other institutions. >> rose: a.i.g. and fannie mae. >> they would have gone from one institution another.

>> rose: you mean the investment banks and... >> it may not have been as bad but i don't think that would have cured the situation. i don't think the finger in the dike at lehman would have meant we didn't have a serious.... >> rose: they argue that they didn't have the authority to do that. did they? they being paulson, geithner... bernanke. >> i don't know. i wasn't there. but i tell you both the treasury and the federal reserve have gone.... >> rose: you know. >>... through what we kindly call the very edge of their legal authority. >> rose: they did? >> yes. >> rose: did they exceed it? >> well, that's always a question of judgment. >> rose: (laughs) i'm asking of your judgment. >> i don't think anybody's after... you get in these crises you find ways to have an interpretation that fits the circumstances. >> rose: give me the closest example of that, where they were right up against the edge. or crossed it. >> will, section 13-3, famous

section of the federal reserve said in unusual and exigent circumstances you can make loans securities to the satisfaction of the federal reserve. that in all practice has never been used and we didn't use it because we knew once we used it people would think you would use it again. but that has been used to... that says you can lend against good collateral. some of the things they've been doing, arguably, are closer to buying than lending. chechnya is one example. but they're in a form of a loan. >> rose: they have no problem with guaranteeing j.p. morgan's bayh of bear stearns and the risk... >> well, that was a straightforward one but still... even in that case there's no recourse on that loan. >> rose: exactly. >> so that's a question of is it a purchase or a loan? that's company example. but it's interpreted as a loan. there are other examples. the treasury has used some

extraordinary powers and the federal reserve has bought commercial paper. the federal reserve is now buying a lot of things in the market. >> rose: and you say they should or shouldn't? >> well, a lot of the things they're buying they should. some of them i have no stretch of the law in buying long-term government securities. they could always buy long-term government securities. as a mat over law they can buy securities and they're buying as pile of them but that doesn't raise any.... >> rose: so what causes you concerns about the kind of things the federal reserve did? >> whatever they did gives succor to the next institution that gets in trouble and to their creditors in particular and to their customers so that these institutions that are deemed too large to fail will be protected, which will lead to behavior that will be destabilizing. and ultimately, if they're certain to be protected, they

will engage in behavior that will require that they be protected. >> rose: they'll take more risk and get better loans at lower rates if everybody knows they'll be protected. in tend, nobody's going to let them fail. >> right. >> rose: so what would you do about that? >> well, that gets to the heart of this reform exercise. the reform exercise is very complicated and difficult. but what i would do is not change what's called the so-called safety net for banks. the sensitivity of banks with their individual depositors and their central role in the financial system has been recognized for 100 years or more. and all countries provide some protection for their commercial banks no matter how big, and they particularly provide protections to the big ones because they're more important. >> rose: because they provide the credit that runs the economy. >> and they're big and so they will affect the whole thing. a small bank isn't going to affect much. you know, this is a problem that alan smith worried about back in 1776.

so i don't think you're going to change that overnight and probably shouldn't in these disturbed circumstances. but i don't want to extend that sense of protection beyond the commercial banking system. i think commercial banking system is the core. they are in charge of the payment system. they run the payment which is which is fundamental, moving money around. they lend money to you and i or individuals. they lend noun businesses and that's still a very important function. those are basic functions. and that's why we protect them. i don't want to see those banks, however, taking a lot of unnecessary risks. it's risky enough lending money, they don't have to do a lot of trading. >> rose: but that's where the question of definition comes. when you said "i don't want to see them doing a lot of trading is it okay to do a little trading? >> well, a little trading is less dangerous than a lot of trading. (laughs) >> rose: of course but what is your definition of "a little" and "a lot." >> well, in some cases where you can define it, should they own hedge funds? no. obviously they own very few

hedge funds, small hedge funds, it wouldn't make any difference. but still creates conflicts of interest. but the same thing with equity funds, yes or no. >> rose: no, not... >> same thing with commodities which i understand they're playing with these days. no. banks are not out there to deal in commodities and own commodities and own oil tankers and that stuff. when it comes to trading, the argument is okay, some trading basically is related to customer needs and... you want throb to buy, if you buy from the customer you've got to be able to sell them. so some trading activity is natural. but i think at some point it goes from being a natural part of commercial banking operation to a purely proprietary trading. it has nothing to do with your customers, in fact, it may compete with your customers, it may create a conflict with your customers. it's your proprietary trading

desk and they call it a proprietary trading dhaefk is out there trying to make money on margins of trading, buy at $2 sell at $2.0 is or hang on to it and hope the price goes to $3. a reasonable legitimate activity but i don't want to support it with taxpayers' money. >> rose: with respect to commercial banks who did not do these other activities, you're prepared to recognize the idea of "too big to fail"? >> yeah. well, you have to, yes, i think. now, that doesn't say i'm committed to any of these. i want some ambiguity. >> rose: this is beyond deposit insurance and all of that? >> i think you can have a little constructive ambiguity here. but i can't shut off the possibility that if a really major financial institution unexpectedly got in trouble you might have to put some government money in. >> rose: make the decisions that the federal reserve made during the last year? >> at the time, yes, absolutely. now i want to avoid that for institutions that are not banks.

>> rose: i understand. but don't you also say that in some cases it may be that one of those institutions that are not banks have such immense consequence that if they were about to fail, you ought to save them? or not? >> well, i'm not very easy to give the authority to save those institutions. >> rose: what would you do if a goldman sachs or something like that go so big that the consequences of it failing-- like the consequences of a.i.g. failing-- would have enormous consequences. >>s that proposal on the table, in general form anyway, which i support, which the administration supports, which foreign governments generally support in concept. a so-called resolution authority. now what is the resolution snort if you see one of these institutions on the brink of failure, can some government agency be authorized to step in, as you can in the banking world. some agency step in, have the authority to deal with that. he's got a lot of things he can do. the equity may be gone, maybe he ought to be able to force exchanges of debt for equity, which was not much done this

time. if you can do that that takes care of a lot of contingencies. try to merge the norgs an area where you are in full control, you don't have to worry about the stockholder interest because that's already gone. if push coming to shove you can liquidate the organization and we ought to work toward some condition where the organization subpoena prepared for that eventuality in terms of its connection with the rest of the world. so that you minimize the impact, what happened during lehman where one of the big impacts was to undermine money market funds because... particularly money market fund had a lot of lehman paper and couldn't meet their professored obligation to pay it par. so we want to minimize that with a degree of regulation. and for these really... i don't think there are very many of these institutions. there are some that are some so big they might on the face of it

present a a threat if they went bad. there ought to be some regulatory authority over those institutions. it could be fairly simple. what is your capital requirement, what is the leverage requirement, what is the liquidity requirement? you don't to have day to day regulation the way you do for a bank, in my opinion. >> rose: but would you change the liquidity requirement and the rev reg and risk ratios? >> well, it's something in banking... yeah, you'd certainly look at it. and they're looking at it now. that's a normal regulatory responsibility. in extreme cases... and the non-banks i would look at it, yes. >> rose: you said the regulatory proposal presented by secretary git nor the same committee you testified right after he testified had practical and conceptual difficulties. are their r their con seven which you will and practical difficultys? >> that's a reference to... i don't know what you call the heart of their proposal but an important element of their proposal is to say we will take systematically significant institutions whether or not they're banks, and subject them

to i guess uniform... not quite spelled out, but the same regulatory standards, the same supervisory standards we would have for a big bank. now, my problem is if you do that, first of all, i don't know how you identify those institutions in advancement some of them are easy, but once you get beyond the first four or five, i don't know where they are. it's not just a matter of size because they would have to identify them. and by bringing them into the tank, so call, you are implying... i don't know if you're saying... legally i don't know how you'd write the law but you're implying that they're going to be protected, too. it just says a bank would be because you put them in the same group. so that's... i want the banks... and they're doing things... i'm not going to prohibit him from trading. i'm not going to prohibit them... there may be a hedge fund. there may be an equity fund. they're off there doing their thing in the capital markets and i want to have a distance

between them and the banking system that they're going protect. and they've blurred that. that's why. >> rose: here's an easy question: did you have full opportunity to express your views on these issues before the administration decided what its position was? >> yes. (laughs) >> rose: so they rejected your ideas? >> they rejected.... >> rose: on this particular point of separation? >> 90% of what they... 80% of what they proposed is no... you know, there's no.... >> rose: and 80% of it you have no problem? >> no. >> rose: and the 20% mainly is what they would allow to be too big to fail versus what you would allow and your basic separation is between commercial and trading? >> well, there's another related area. which agencies are doing what. we all agree... i sometimes think i convinced them. (laughs) but i agree. we all think that there ought to be somebody overseeing the market not from the standpoint of concentrating in individual

institutions, but concentrating on the linkages between what falls between the cracks, what new developments are there that need attention, this rise of the subprime mortgage is one thing. it's not because it was killing individual institutions. it was an unsafe and unsound practice. wasn't somebody look agent it? why wasn't somebody looking at credit default swaps that got to be $60 trillion at one point. well they are looking at that now and it's a good thing. >> rose: but will it be something else that they don't look at? >> well, it's very hard to know what it is. but i think somebody ought to be given that responsibility. and i think that somebody ought to be the federal reserve. now, they proposed a college of cardinals, so to speak.... >> rose: did they propose that or did dodd pro knees? >> well, dodd i think has proposed something regular. >> rose: a council of regulators i think he calls it. >> well, he's got a council of regulators... i think it may be a significant difference. the treasury would be the

chairman. and the treasury would have a staff. that that's one way you can do it. the treasury would put the... put the treasure in that position but the treasury has no tradition, no staff, no expertise, professional background, no traditions in the area of banking supervision. and then i think, you know, you ask... the federal reserve is a natural place... i mean, i assumed when i was chairman of the federal reserve that i had some responsibility for overseeing the whole system. whether i had any explicit authority or not. because the federal reserve has a special role. it's the only institution that, first of all, is independent and has continuity, it's professional, it's involved in regulation and it's got money, which nobody else has, you know, to go running to congress when there's an emergency. >> rose: that's why it can do the things it did. >> that's why it can do the things it did. >> rose: how did it come to want to put it somewhere rather than the federal reserve? what argument, what reasoning led them to come to a different conclusion? >> i can't tell you all that, but what they did was in this...

whatever they call it, teal 1 or something, these group of banks and non-banks, they said they will be supervised in detail by the federal reserve. so they gave the federal reserve... i don't know if it's a bigger or smaller responsibility, but a big responsibility for the detailed day to day supervision as i understand it of a mixture of banks and non-banks. and i... first of all, i don't want the non-banks supervised that closely. but i think in the distribution of authorities among regulatory institutions, it's really the federal reserve that naturally. that should be surveying the whole world, so to speak. it's the federal reserve that has the best, easiest connections with foreign regulators. it's important. we don't discuss it, but a lot of the stuff we're talking about better be pretty uniform. >> rose: everybody now knows that this was a global problem. and that we need in the future global coordination.

yes? >> uh-huh. >> rose: how does that manifest itself? >> there is an organization, financial service which is was renamed financial services board where the g-20 some time ago, presumably to give them a little more cloud or something. but this is an arrangement among bank supervisors, whether central banks or somebody else, that is designed to come to a conclusion on some basic matters of banking supervision and regulation. beginning with capital. when i was chairman of the federal reserve board, we really started it then. and we had the first capital requirements between european banks, american banks and japanese banks. and it was by today's standard considered pretty crude but had the advantage of making them more uniform than they would have otherwise been. >> rose: that's what happened in part, what will happen if you don't have some kind of coordination, then it's all going to flow to wherever the lowest level is? >> and this issue will arise and

the kind of outline i have for the commercial banking system there will be big complaints if other particularly european and japanese banks are not governed by... doesn't have to be the same role down to the last dotting of the is and crossing of thes but you have to have a similar philosophy of these big banks, philosophy of regulation or you're going to have a same old question according to the most lax, most open regulators. >> rose: in terms of the global recovery, china and india are going to lead the way or not? >> rose: well, china and india happily, i guess, they're happier leading the way. >> rose: and then their gross domestic product growth is 8%, 9%. >> well, i don't know if it's quite that high. >> rose: next year. >> but it's pretty good right now to everybody's surprise. the part of the world... very

unusual but it's symbolic to the change in the world. instead of the emerging world being the hardest hit by this crisis, the emerging world is coming out of it pretty well. now, they had built up big reserves and so they weren't so financially hit. >> rose: because they serve... well, you're billing up such great reserves. maybe they were wise to do so, but the growth in the emerging world is quite remarkable in the midst of this turmoil. and the emerging world together, you know, it's like that united states in terms of the impact on the world economy. couldn't have dreamed on that 20 years ago, 30 years ago. so that's good. on the other hand it is symbolic or more than symbolic of the relative... less dominant position the united states has, not just in the economy but in leadership in terms of intellectual and otherwise. >> rose: okay, speak that, because that's a big point for the future. >> well, it is and i don't know how we accommodate ourselves to it. i would like to think that given

the history, the past, given the strength-- actual and potential-- of the american economy, we can and still provide a kind of indispensable element of leadership here. but it's not going to be dictatorial, i'll tell you that. and it's very hard to herd these cats together. >> rose: well, you're already beginning to see some questions about in the terms of leadership of these global financial institutions. >> well, you can see, you cannot beb dependent upon these countries for three or four trillion of your debt. and think that they're going to be pass i observers. >> rose: they don't want to play a role. >> and they don't want to have decision making authority. they want to be at the table. they want to be at the table but coming to the table doesn't create consensus. look at the security council. (laughs) >> rose: well, there's veto power there. >> even without the veto power. >> rose: okay. but what should be the membership? should it... it's no longer going to be g-7, obviously. the g-20 was what happened in

pittsburgh. should it be the g 29? because some people argue that it's only g-2 in tend. >> actually, whatever group you make, somebody.... >> rose: somebody outside wants to be inside. >> it's like the institutions that will be outside of the treasury's proposal. i want to be systematically significant proof. >> rose: but the consequences for the united states that financial leadership in the world may be shifting.... >> rose: well, you know. i grew up in the world where the united states is the leader and there's no question about it and when i had responsible positions in the united states government, whether it's the federal reserve or the treasury, you know, gould to a meeting, you were the chairman of the board, so to speak, wherever the seat was. and i think these institutions need kind of coherent leadership. and how do you get it when the membership of the club is and should be more diversified?

>> rose: and is it inevitable in your observation that china and the united states are going to have different priorities? >> well, i think hopeful thing is in a big sense, in the economic world i think they have the same priorities. china's growing, it's got to grow, it's got a big employment problem. it's going to be become a big manufacturing hub. we will want to import from china. we want to export to china, too. we've got to get a more balanced relationship, but i don't think that balanced relationship is inherently antagonistic. >> rose: certainly not a zero-sum game. >> not at all. >> rose: and we should be encouraged by their development and their growth because... >> well, be better accommodated to in a way that satisfies us, too, and i would say the same thing about china. they want to manage their growth in a way that is sustainable. and it's not going to be sustainable if they have... i think their consumption is 35% of the g.d.p. or something and

ours is 70%. that's a real imbalance and they're not going to close it because they're going to have a savings rate. but it's in the interest of both countries that it be diminished, there's no question about that. >> rose: can you make an argument that they're better pauf because they have an economy that is not run by a democratic institution? >> well, i think it made it easier to gate rapid stimulus program rapidly.... >> rose: they can make a commitment to do more faster than we can make a commitment, even things like climate change. they'll make a decision as to how climate change... >> if they make the decision, yes. >> rose:... affects their economic growth. >> in some areas, lack of democratic pressure or public pressure may work against appropriate policies. look at iran. you would like to think that the rebellious forces in iran would lead the a better policy than the dictatorial forces. >> rose: exactly. we clearly hope that.

>> hopefully we get a good plan. but i do think we have a common interest and i think they understand that. now, in other areas, maybe it doesn't look quite so common, but i.... >> rose: it's not clear that they understand that the dollar ought to be the reserve currency in the long term. >> well, that may be right, but who knows about the long term? but they've got a lot of dollars now. (laughs) i mean, they've got certain responsibilities.... >> rose: but didn't the president of the world bank just make a speech about that in the last week or so saying that there will be some real challenges to the dollar as the reserve kurn any. >> well, look, i don't think anything there's any substitute for the dollar now unless we really screw up, and i hope we don't. but that would be the real danger to the dollar. the world... the world needs world currency. the financial world is globalized. it's very much interconnected and when it's globalized, you need something. these pieces of paper have to be labeled something. the blips on the computer screen

have to be labeled something. what are you trading? when you're paying for your exports or your imports, it's very convenient to have something that you can use right away for another payment and that's what the doctor serves. and that's why people hold so many dollars, you may like it or not like it, but it's convenient. and if it's going to be reasonably stable and convenient and usable, it won't go away from a hurry. >> rose: don't we assume that these countries hold a lot of american securities, debt, are going to act prudent in their own breast interest? >> we have been assuming that and i think they will act prudently unless we really give them... don't give them any basis for confidence in the dollar, if we really have a disruptive policy, they're not going to like that. >> rose: you travel around the world and you're respected in all the capitals of the world. is there confidence in the way we're handling this crisis?

>> it's not with the degree we'd like that see it. >> rose: what's the difference? what do they think we're not doing? >> you know, there's a history here and there's great respect for the powers and influence of the united states and the leadership of the united states. this may not be representative but, you know, you hear these comments from people in china or elsewhere in asia, they're actually managing their currency and they are expressing a certain degree of nervousness and raising questions about the role of the dollar in an academic way. they're not doing much. i find when i... i don't want to generalize too far, but i think it's probably true. when you get people quite leaders of the government but they're not on the firing line of managing their currency, say, look, you know the's a dollar problem, we've got much more important things to worry about than whether the dollar is going to be depreciate add little. now the dollar's depreciate add whole lot, then you worry, too. but i think... i think there is

a recognition of larger interest. whether in china sees interest in growing, that's their imperative, they want to employ those several hundred million people who are unemployed. >> rose: because it's associated with harmony in their own country? economic growth and the avoidance of social tension are directly linked in their judgment? >> and it's directly linked with their faced with the rest of the world. i think they come to understand that they can't export pokes ten usually without getting some reasonable balance in their international accounts and without getting a better balance in their domestic accounts. they do have a lack of consumption problem. >> rose: so you walk into the president's office and he says "paul, great to see you, certainly relied on your advice." >> maybe not anymore. (laughs) >> rose: (laughs) oh, you think that? you think they're throng you less now? >> no, no, no. >> rose: they don't like their guy going out and saying he doesn't like everything we're

trying to do. the one area where we were depending on his credibility to help us, he's drawing divisions with us. >> strike that. the president was aware that i had one or two problems. >> rose: so you're in the office there and he says well... he says "i get you in terms of your argument about separating commercial banks from hedge funds and private equity and traders. i get you on how strongly you feel about commercial banks and too big to fail. he then says to you "how about executive compensation? what should i do? am i on the right track or not?" >> oh, that's a subject obviously that has occurred to me and i think executive compensation or wall street compensation, whether they're executives or not has gotten grotesquely large and it's the kind of a game you keep up with the other people and that's the way you measure your success to an extent that i think is harmful.

i would certainly accept what the government talks about and what a lot of private people are talking about in trying to introduce compensation practices that only rewards mature only a period of time and you wouldn't get the rewards if the actions you're taking today don't look so good three or four years out in the future. that's all useful. how you get the mind-set changed that somehow you're entitled to $10 million a year or whatever, almost regardless of what happens, i think is very difficult. but i don't think you can do it by the government just announcing.... >> rose: so how can you do it? >> well, you know, i'd like that think coming out of this really difficult recession would create a different mind-set. that's now specific action, but i would think in effect that business opinion, public opinion would have an effect on

director's responsibilities. i've been on boards of directors they are extremely passive in this area. it's very hard, they find, to tell their chief executive, you know, you're not going to be in upper 20%... percentile because we're a good company and we can't stand if you're below the midpoint that's a terrible thing that spirals everything up. but somebody's got to say, you know, that kind of criteria ought to go out the window. >> rose: how do you say that? >> well, you can say that, how do you do it. >> rose:'s what i mean. you just said it. how do you do it? you do it by.... >> well, the one thing that i have some sympathy with which drives business crazy is having at least a vote by stockholders, an advisory vote as to what the compensation practice should be and since they are not so

personally involved in the process, they're not sitting face to face with the executives that they're colging the salary of you may get a restraining influence. but i think it's going to have to come from some companies standing up finally and saying, look, we're going to introduce a compensation scheme that seems more sensible and lower over time and kind of set a new ethic. >> rose: does that require a different breed of director? >> probably, yes. it certainly requires different directors. directors have been through a lot, too. i don't know if they will be as i'm not sure i see a lot of evidence in this but one would think the directors would be a little less passive than they have been. >> rose: okay, so the pressure says i get you on the presence between commercial and trading. i get you on executive... now stay with me. (laughs) stay with me, i've got you...

>> i'm going back to new york, mr. president. >> rose: (laughs) is that what you said? was there any job you wanted? i mean, you were... you were like... a presidential campaign has a certain association that send a signal of gravitas and value and, you know, i'm thinking a whole range of them. certainly senator ted kennedy gave that... bestowed that on senator obama when he was running. certainly admiral crow bestowed that on bill clinton. so much what did you want from that? and did you get it? >> what i wanted was mr. obama to become president. (laughs) >> rose: exactly. that was it. >> but did you want to play a bigger different role? >> no, i am conscious of my age. and i'm... i just had a birthday recently. i'm more conscious of it. (laughs) >> rose: 82. >> going on 83.

once you get to be 83, you're going on 84. >> rose: all right. but you're in good health and you're enjoying fishing and you play a big role and you're enjoying respect... >> i tell you, i feel older than i used to be. >> rose: well, inevitably you're older than you used to be. >> sure. >> rose: but not as bad as you might. obama, he says to you "paul, what about invasion in a lot of people tell me i ought to be worried about inflation." >> you ought to be. you ought to be perpetually worried about inflation. you know, the administration is perfectly conscious of the fact that they've got a big problem if inflation gets out of hand and they say "our hands are tied now, we can't do anything now, unemployment is approaching 10%, the economy is weak, there isn't apparent inflation problem at the moment, prices are nice and stable." but you've got that yawning budget deficit. you've got a portion of the dollar, we've got to be careful about this. but it's a problem for at least

a year out, two years out, three years out. now, i think it's fair to say they say that, but if you have no action, how does that become credible? and it's very hard to make a credible... make it credible if you're not going to raise taxes right now. you have stimulus programs, you're not cutting expenditures right now. you're in the midst of a big debate about health care which has been a big priority which isn't exactly... i don't understand it all, but i think it's safe to say it's not going to save a lot of money. >> rose: but can it be deficit neutral? >> i don't know. they say they're trying to make it. don't ask me about health care, i've got enough things i don't understand.... >> rose: stay with me on this. the president says "look, we've got a bad... i was handed a bad problem with the deficit. what do i do? and is it too high? and how do i make smart decisions?" >> well, i... just in terms of giving signals, it's not just signals, it's very substantive, the i would really love something to be done about social security.

that... compared to medical care and medicare, this is a preeminently solveable problem. >> rose: solveable? >> solveable economically. whether it is politically or not i don't know. but it ought to be solveable politically. and if we could get that done... i mean, i think that would be a useful signal to the world. >> rose: yeah, but you say that at a time that everybody's saying to this... he would say to you "i hear you, and i want to get to that, but they're criticizing me for trying to take on climate change and health care now." >> well, you're telling me there isn't any magic answer to this, i absolutely agree with you. i just say let's put this one in there. it's one that cuts in the right direction. >> rose: but would you say to him... >> and the situation where there's nothing you can do that's...-than-of that... you know, you're not either going raise taxes or cut expenditures right at the moment, unfortunately. once you conceive that, you're

talking about somethat that's going to take place in the future. and how can you deal now with something that's going to have the impact in the future but has that impact with some assurance? i think the one thing you can do or maybe a more immediate impact i think, you know, pay as you go expenditure.... >> rose: in terms of new legislation. >> yes. and just restoring that kind of legislation would be somewhat hopeful. of course, that's been.... >> rose: tried and... >> it's a pledge that's been broken many times in the past but it's helpful in showing a sense of direction. you know, expenditures continue to go up and you've got a big gap between expenditures and receipts, sometimes you're going to have to face up to the taxation question. i don't know how you avoid that. >> rose: soon, soon? >> if you can't get the expenditures under control. >> rose: hard to get expenditure under control when you... a lot of them are paying the debt, a lot of them are military and, you know, when it... a lot of them are fixed expenditures.

>> i am very aware of this. >> rose: i'm not giveing you a lesson on budgeting. >> it's harder now than it was last year or the year before. >> rose: exactly. >> so that's a problem we have. >> rose: that concludes part one of our conversation with paul volcker. tomorrow night he weighs in on taxation and other issues about the deficit. join us. captioning sponsored by rose communications captioned by media access group at wgbh access.wgbh.org