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GREGORY: We`re going to take a break now. Coming next, making sense of the big bailout and what it mean for this November`s election. I`ll go one-on-one with "New York Times" columnist Paul Krugman, who says the plan needs some major reworking. We`ll get to that when THE RACE returns.

(COMMERCIAL BREAK)

GREGORY: Welcome back to THE RACE. One vocal critic of the president`s plan to bailout Wall Street is going one-on-one with me tonight. He is Paul Krugman, an op-ed columnist with the "New York Times." Paul, welcome.

PAUL KRUGMAN, "THE NEW YORK TIMES": Hi there.

GREGORY: So as you look at this bailout plan that will be debated in earnest on Capitol Hill starting tomorrow and the Banking Committee, what is your overall impression? Where does it seem to work? More pointedly, to what you wrote today, where doesn`t it work?

KRUGMAN: Well, almost everybody agrees that we need something right now. We do need a rescue. It doesn`t have to -- maybe not today, maybe not tomorrow, but soon for the rest of our lives. The key thing, the praise that`s really driving me crazy is people talk about we`re going to take the bad debts off the books of the banks. And that is going to --

That tells you nothing. The question is, at what price do you take that bad debt off the books? If you take it off zero price, sure, then tax payers get a great deal, but the banks go bust. If you take it off at a very high price, you save the banks, because you`ve thrown a lot of tax payer money at them. But then the public loses a lot.

And is there any -- how does this make sense? How are we supposed to be saving this without throwing a lot of money at them? Paulson has never explained this. What we had was a major case of overreach by Hank Paulson. He basically has not tried at all to explain how this plan is supposed to work. He has basically said, trust me, daddy knows best. By the way, there will be no future review of my actions.

And I have a quarrel with Erin Burnett a little bit. He does not have a great track record. Some people were better than him. What we need is something where we have a plan to actually rescue the system, but tax payers get some ownership in return.

GREGORY: Let`s talk about that. This is from your column this morning. We`ll put it on the screen so everybody can see. "If the government is going to provide capital financial firms, it should get what people who provide capital are entitled to, a share in ownership, so that all the gains, if the rescue plan works, don`t go to the people who made the mess in the first place. But Mr. Paulson insists that he wants a clean plan. Clean in this context means a tax payer financed bailout with no strings attached, no quid pro quo on part of those being bailed out."

But, Paul, are you saying that the era of big government is definitely over, that the government ought to have some ownership of these investment banks?

KRUGMAN: At least transitionally. Look, when the Savings and Loan Industry fell apart, the government took over the banks. Then it sold off the bad assets. It recapitalized them, put in enough money to them grow, and then it reprivatized them again. It`s not that we want government running Wall Street forever. But if the government is going to pump in hundreds of billions of dollars, then it ought to have a stake in the upside here.

That by the way -- since I wrote that column, Senator Chris Dodd has come out with a plan, which, on first read, looks like it`s a going substantial direction -- a substantial distance in that direction. And this is, what you -- people have been drawing parallels. We rescued the savings and loans and the Paulson plan is like that. The Paulson plan is not. The Paulson plan is we`re just going to throw money at the sector without anything accruing back to the taxpayer, except the toxic paper. And we can do better than that.

GREGORY: Let`s look at a new ad from Senator Obama on the economy. Then I have a question about what voters should be looking for.

(BEGIN VIDEO CLIP)

UNIDENTIFIED MALE: We`ve seen what Bush-McCain policies have done to our economy. Now John McCain wants to do the same to our health care. McCain just published an article praising Wall Street deregulation, said he would reduce oversight of the health insurance agency, too, just "as we have done over the last decade in banking." Increasing costs and threatening coverage, a prescription for disaster. John McCain, a risk we just can`t afford to take.

(END VIDEO CLIP)

GREGORY: So, Paul, we have all the back and forth on this. That`s just from Obama. We have the back and forth from McCain as well. But we have a crisis that`s very complex, and that`s unfolding in real-time. So for voters, what is the leadership test on the economy from your point of view?

KRUGMAN: I don`t think voters, realistically, they`ll be able to evaluate the assertions and the plans. This is where one of my beefs with Obama has been that I think he does this post partisan thing too much. Really all that you have to go on -- most of what you have to go on is that there has been a difference between the parties here. The Democrats are the party of more regulation, more oversight. The Republicans have beaten them up about that in the past.

Who is it that you think is more likely to crack down on the kinds of Wall Street abuses that have taken place? The Republican party which believes the markets are right or the Democratic party which believes that markets need to be watched over a fair bit.

The other thing you can do is you can look at the people around the candidates. And look, until just yesterday, McCain`s guru on economics was Phil Gramm, the high priest of deregulation. He spoke glowingly about Allan Greenspan. He once said he propped him up like the guy from "Weekend at Bernie`s" if Greenspan wasn`t able to actually talk. And Greenspan -- if there are two guys that I blame for this crisis, it would be in order Alan Greenspan and Phil Gramm. That`s telling you something.

GREGORY: Let me just show quickly what you wrote in March about Barack Obama more generally: "I suspect that the Obama mystique, his carefully created image as a transformational, even transcendent figure, has created a backlash among those unconvinced that he is interested in the nuts and bolts of work of fixing things."

Do you have a sense of what Obama`s core beliefs are about how government should operate in terms of managing the economy?

KRUGMAN: Yes. He`s a moderate, moderately liberal, pretty conventional Democrat, not too different from Bill Clinton. And that looks pretty good right now, doesn`t it?

GREGORY: To a lot of voters, it certainly would. What do you think would motivate -- are the core beliefs of John McCain?

KRUGMAN: John McCain is essentially -- Politically, he is a Reagan baby. He has been part of -- he came in with the Republican revolution. He has always been in favor of less government, government off your backs, Washington is the problem. His whole mindset is against the kinds of things that a lot of people are thinking we need to be doing now because we`ve had the markets go wild.

GREGORY: Paul Krugman from the "New York Times" editorial and op ed page, always good to have you on. Thank you, Paul, very much.

KRUGMAN: Thanks a lot.

GREGORY: Coming next, what President Bill Clinton says about Obama`s chances of winning in the fall. That`s coming up next when THE RACE returns.

Originally broadcast, 9.22.08