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GWEN IFILL: Now, the government`s proposal for revamping the way the financial system is regulated. Jeffrey Brown has the story.

JEFFREY BROWN: In proposing the broad overhaul of the federal government`s financial regulatory system, Treasury Secretary Paulson said it was not a direct response to the current downturn and credit crisis.

HENRY PAULSON, U.S. Treasury Secretary: Some may view these recommendations as a response to the circumstances of the day. Yet that is not how they are intended.

JEFFREY BROWN: But the sweeping plan does seek to reorganize over the short and long term the ways in which the federal government oversees many sectors of the financial world that have been in turmoil in recent months.

HENRY PAULSON: This model would have three regulators: a regulator focused on market stability across the entire financial sector; a regulator focused on safety and soundness of those institutions supported by a federal guarantee; and a regulator focused on protecting consumers and investors.

JEFFREY BROWN: Under the plan, the Federal Reserve will have new oversight to ensure market stability. It would watch for threats to the financial system from mortgage lenders, insurance companies, investment banks, and hedge funds, in addition to the more traditional banks, which it already oversees.

HENRY PAULSON: Our second regulator combines all federal bank charters into one charter and consolidates all federal bank regulators into a single prudential regulator.

JEFFREY BROWN: This regulator would oversee businesses that have government guarantees behind them, such as savings and loans and federally chartered banks. It would take over responsibilities now held by the Office of Thrift Supervision and other agencies. A third regulator would be aimed at protecting consumers and investors, merging responsibilities of several agencies, including the Securities and Exchange Commission and the Commodity Futures Trading Commission. The plan also envisions establishing a Federal Mortgage Origination Commission that would set broad standards for mortgage-lending, one major fault line in the current downturn. And we have a two-part look at this plan and what it might mean. First, I`m joined by Treasury Undersecretary Robert Steel. Welcome to you.

ROBERT STEEL, Undersecretary of the Treasury: Thank you, Jeffrey.

JEFFREY BROWN: What exactly is the problem here that needs fixing?

ROBERT STEEL: Well, Jeffrey, thank you for having me today to talk about this. I think what we`ve thought about is, over a year ago, the secretary had a conference where we had people from all parts of the American economy to talk about it, to talk about the issues and the challenges. And among them were Warren Buffett, former Treasury Secretary Bob Rubin, and former SEC Chair Arthur Levitt. And one of the issues they focused on was the fact that the reality is we have a financial regulatory system that was developed over 70 years in a piecemeal basis and, as a result, lots of seams and cracks and a patchwork- quilt approach. And what we tried to do was to lay out a green field, if we were starting again, with a fresh piece of paper, what would we design?

JEFFREY BROWN: Can you give a specific example of what would change if there was a consolidation of regulatory agencies?

ROBERT STEEL: Basically, hopefully, it would be more efficient, best practices could be shared, and those people who are regulated would have a very good idea of what to expect. And I think the idea of competing regulation to our perspective really isn`t the right idea. Instead, we should have the best of breed and the regulator that was described in the intro that supervises the specific institutions should have those best skills.

JEFFREY BROWN: A little confusion, I think, even in the commentary since about the long-term issue versus the current situation that we`re in right now.

ROBERT STEEL: Sure.

JEFFREY BROWN: Secretary Paulson was quoted this weekend saying that, "I do not believe it is fair or accurate to blame our regulatory structure for the current turmoil." Why not?

ROBERT STEEL: Well, I think that, when we look at the current turmoil, then our view would be that there are lots of issues that have arisen and there are lots of people for whom responsibility -- among whom responsibility should be shared. Regulators are among them, but also financial institutions, individuals who made bad decisions, rating agencies. We`ve talked about this in other documents that we`ve produced. About two weeks ago, we produced something from the president`s working group that looked at the lessons learned from the recent turmoil. And we focused on specific recommendations as to how to make things better. Our focus today, to be honest, is working on these issues, and the regulatory blueprint presented today is a longer-term issue.

JEFFREY BROWN: But -- I`m sorry, go ahead. But could you tell us now that, if these were in place, if these changes were put in place, would it forestall the kind of problems we`re having now?

ROBERT STEEL: I think the reality is, is that regulation will never be able to stop all kinds of issues or problems. And there is a lagging effect of regulation generally. What we`ve tried to do in this blueprint is focus on the longer-term perspective, if you were starting afresh, and we describe it as an objective- based perspective. And there are three objectives. One is soundness of the overall system. Two is that institutions that have a federal guarantee have a strong regulation. And, third, that we put the issues related to investor protection and consumer protection into a separate organization that`s focused just on that. So the three areas or the three focuses each have a specific regulator that`s focused on their issues.

JEFFREY BROWN: Critics who have come out already -- and we heard Senator Dorgan in our news summary -- suggesting that there is not enough teeth here in the kind of shifting of regulation that you`re talking about. For example, giving new power to the Federal Reserve, is it a power to watch over it? It has a new power to watch over some institutions like hedge funds, for example, that in the past it didn`t. But does it actually have the power to stop risky practices?

ROBERT STEEL: Well, we think it does. First of all, let`s be straightforward about this. This is authority and responsibility that doesn`t exist today. This is an expansion of what they had been doing. So now areas that historically have been outside the aperture of understanding with specificity now are understood. And so basically this new overall regulator would look at unregulated activities, such as hedge funds, private equity, and things like that, and have a point of view. And they`d have full license to go in and understand and learn about these institutions and what they`re doing.

JEFFREY BROWN: Another senator, Chris Dodd, this week said that the premise here is wrong. The failure in the past was a failure of leadership, he said. Congress gave the Fed massive regulatory authority; they just never exercised it at all. What is to suggest that the kinds of changes you`re putting in now or would like to put in now would change how the Fed responds?

ROBERT STEEL: We don`t accept the premise that the Fed has misplayed this. And, in fact, the secretary has said repeatedly that he thinks he supports the action of the Fed and that they`ve done a good job.

JEFFREY BROWN: What about helping out homeowners or borrowers who are in trouble now? Why not do more in a plan like this? Or how much do you think it does do for consumers, and especially for the borrowers who are in trouble now?

ROBERT STEEL: Well, this plan that we announced today is not about that issue at all. It`s about a longer-term perspective. I think you ask the right question, and it really is the day-to-day focus today of us at Treasury and other people in the government. Basically, our goal is to help keep homeowners in their home. We began talking about this on August 31st, when the president tasked Secretary Paulson to work on this, and we`ve been diligent, we believe, since then. They have things we`ve done with the Hope Now Alliance, which helped over a million people. A million homeowners have had help from the Hope Now Alliance to stay in their homes. And there have been other things that we`ve been asked for, also. There are specific things we`ve asked from Congress, too. On August 31st, the president asked Congress -- and Secretary Paulson seconded this -- to help us with three things. One was the forgiveness of debt, so that it`s not a taxable event. And two was FHA modernization. And, three, what was basically comprehensive reform with regard to GSEs. Congress has done number one, but not done number two and three. And if they want to help, they can help by doing those two things.

JEFFREY BROWN: All right, Robert Steel, undersecretary of the Treasury, thanks very much.

ROBERT STEEL: Thank you, Jeffrey.

JEFFREY BROWN: There`s been a mix of reaction to the proposal so far. We get some of our own now with Paul Krugman, professor of economics and international affairs at Princeton University and an op-ed columnist for the New York Times. And Robert Glauber, adjunct lecturer in public policy at Harvard`s Kennedy School of Government. He is former CEO of the National Association of Securities Dealers and served in the Treasury Department under President George H.W. Bush. Well, Paul Krugman, starting with you, you wrote in your column today that this new proposal is, quote, "all about creating the appearance of responding to the current crisis without actually doing anything substantive." Please explain.

PAUL KRUGMAN, Professor of Economics, Princeton University: Well, it really has nothing to do -- actually, we just heard the undersecretary say that it has basically nothing to do with the crisis. This was all conceived more than a year ago. And what that meeting, that conference that they called was about was mostly about getting the government off the back of the financial industry. As they saw it, everything was fine except for pesky regulations. You know, it really does not address any of the problems that we`ve got now. It`s not clear that we had a problem with fragmented regulation. What we had was a problem of lack of regulation in sectors that have turned out to be crucial. In a way, the words that you want to look at, they talk about prudential regulation of federally insured institutions. The thing is we`ve just found out that just because an institution doesn`t have a federal guarantee doesn`t mean that the federal government won`t rush in to rescue it in times of trouble. So it`s completely ignoring that. It`s basically saying -- nothing in this would have laid the groundwork at all for dealing with the crisis that we`re in right now.

JEFFREY BROWN: Robert Glauber, does the principle of consolidation of this kind of regulation make sense to you?

ROBERT GLAUBER, Harvard University: Well, I think it does make sense. And I think the fragmentation of regulation in the U.S. is just so much greater than anywhere else. It is an issue. And it`s an issue that Treasury has tried to deal with. But what Treasury is trying to do here goes far beyond that, and that is to adjust the regulatory structure to take account of vast changes in the whole financial landscape. And I really do think that it extends the regulatory authority of the Fed. It really does increase regulation. And it really does try to deal with some of the problems that we`ve seen now. It doesn`t try to deal with directly keeping homeowners in their homes or helping them get new mortgages.

JEFFREY BROWN: Paul Krugman, come back to that, specifically on the new powers given to the Fed. What do you see there?

PAUL KRUGMAN: It gives the Fed the power to collect information. That`s about it. Now, you have to bear in mind that the documents released are incredibly opaque. I think it`s got to be deliberate how hard it is to figure out what they`re saying. But the Fed appears to have more some information-gathering capability. That`s it. Nothing, no ability to say, "Look, you are a" -- to say to some institution, like Bear Stearns, "You are a crucial nexus in the financial system. We think you probably have to have some more capital on hand. We think you need to have some rules about the kind of counterparty trades you`re into." There`s nothing like that in this. The only regulatory power that seems to be in there is for good, old-fashioned banks, which are already pretty well-regulated.

JEFFREY BROWN: Mr. Glauber, do you see more there?

ROBERT GLAUBER: Sure, I think there is more. Clearly, there is information-gathering and disclosure to the market, which is going to make a big difference. But beyond that, the Fed has the right to go in with other examiners and examine on-site these institutions. Never has had that power before. It has the right to participate in the rule-writing regime that these other...

(CROSSTALK)

PAUL KRUGMAN: As I read it, the Fed has the right to do that in the midst of a systemic crisis, so sort of, yes, the day that Bear Stearns is about to go belly-up, the Fed can march in. But this is -- that pretty much happened anyway.

JEFFREY BROWN: Mr. Glauber -- oh, go ahead. Go ahead.

ROBERT GLAUBER: Let me just say I think Paul is right in saying this is a document that`s hard to parse, and particularly in one day. But I think it goes beyond that. I don`t think it`s just in a systemic crisis. I think, as an ongoing responsibility, the Fed, as the markets` stability regulator, has the right to go in and examine with other regulators and to participate in the rule-writing process, so it really does go beyond just collecting information and disseminating it.

JEFFREY BROWN: Well, Mr. Glauber, do you see changes here that would help prevent the kind of situation we`re in now or that can speak to the problem in the immediate sense to help us get out of it?

ROBERT GLAUBER: Well, I think, clearly, giving the Fed more authority to go with the fact that it is now making its lending capacity available to more institutions really will help stabilize these situations. I think if it had understood Bear Stearns better, it could have acted quite differently from what it had to do. It had to actually act with very little knowledge. It will have much more knowledge. Next time might not have to force a merger between Bear Stearns and JPMorgan as it did. So, yes, I think this really will change the ability of the regulators to maintain stability.

JEFFREY BROWN: Mr. Krugman, you`ve talked about what you don`t see in this plan. What did you want to see, what do you want to see, in terms of reorganization of the regulatory scheme?

PAUL KRUGMAN: I think it`s not so much a question of reorganization that we can talk about that. I think what we really need to do is recognize that there are a lot of institutions that we don`t call banks that turn out to have the same problems that led us to regulate banks in the 1930s, that we have institutions that are crucial in the whole functioning of business that have to be rescued when they`re in trouble. And, therefore, they should have some rules. We should have some kind of capital requirements. We should have some -- basically, the prudential financial regulation that`s in this plan, which is basically just consolidating the regulations we already have, should be extended to types of financial institutions that are part of the modern banking system. You know, it does not address the problem that we have of a system that`s designed for a world where banks are big marble buildings that take deposits and make direct loans to a world in which it`s a much more complex system that needs a sort of, you know, 70 years later, an updating of the New Deal regulatory system.

JEFFREY BROWN: Well, Mr. Glauber, this is the crux of the matter, isn`t it, that the world has changed? Go ahead.

ROBERT GLAUBER: Yes, well, I was going to say it is, indeed, the crux of the matter. And I think Paul has put his finger on where the debate will be. It is the question of whether the kinds of bank regulation that exists, where we tell banks quite properly what things they can and can`t do, how much capital they have to hold, because we insure those banks, whether that kind of regulation should be extended to other institutions that we don`t presently insure. And I think that`s where this debate...

(CROSSTALK)

PAUL KRUGMAN: Except we say we don`t insure them, but in practice it turns out we do. That`s the lesson of the last few weeks.

ROBERT GLAUBER: Well, I think we have stopped short of the kind of bailouts that we would do and have done for banks. And I think to extend that kind of regulation to other presently uninsured institutions is to invite them to assume they will be bailed out and to invite all the people that deal with them to assume they`ll be bailed out. And that`s just going to increase the risk in the whole system.

PAUL KRUGMAN: Well, that`s our big question. I mean, I`m in the camp that says we`ve just demonstrated that if you, you know, if you have a Bear Stearns as your counterparty that, in fact, the feds will one way or another step in to make sure that you don`t lose your -- it`s the equivalent of having your deposit insured. And that means we need more regulation. And, of course, this document is quite explicit. They`re not going to do that. They`re not going to extend regulation beyond the currently regulated institutions.

JEFFREY BROWN: Let me ask -- Mr. Glauber, let me just ask the prospects here. I mean, you`ve also been in Washington as well as outside. You`ve got big institutions here, I mean, regulatory institutions that are well-established. You`ve got a political campaign, of course. Do you see this going anywhere?

ROBERT GLAUBER: Well, it`s a very fair question. Certainly I don`t see it going anywhere between now and the election. And that`s probably a good thing. This should be debated, because these are very, very big, complicated questions. And I think even to get the kind of consolidation that the Treasury is proposing may be very difficult, wants to merge the CFTC and the SEC. I tried, together with Secretary Brady back at the Treasury in 1989-1990, to do that with absolutely no success. So even the steps that have been proposed, which are less sweeping than other people have asked for, are going to be very hard to pull off.

JEFFREY BROWN: Mr. Krugman, a very brief answer. What prospects do you see?

PAUL KRUGMAN: Oh, I think something is going to happen, but not until after the election. I think there`s -- maybe not the kind of consolidation, but an extension of regulation. The fact of the matter is a lot of people were very frightened by this crisis. And there`s a large demand that something be done.

JEFFREY BROWN: All right, Paul Krugman and Robert Glauber, thank you both very much.

ROBERT GLAUBER: Thank you.

(BREAK)

GWEN IFILL: The three presidential candidates were back on the campaign trail today. Judy Woodruff reports.

JUDY WOODRUFF: John McCain kicked off a week-long, five-state tour today to reintroduce himself to the voters. The tour opened in Meridian, Mississippi, where McCain was once a flight instructor at the airfield named for his grandfather. McCain spoke of his family`s history of military service and its effect on him.

Originally broadcast, 3.31.08