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MADDOW: The interview tonight is Paul Krugman, Nobel Prize-winning economist and columnist with the "New York Times." Mr. Krugman you are the person I most want to talk to right now about Wall Street and the economy. Thanks very much for your time.

PAUL KRUGMAN, NOBEL PRIZE-WINNING ECONOMIST: Sure. Good to be on.

MADDOW: So Goldman Sachs - huge earnings announced today right after the SEC charged them with fraud. We know that Goldman fraud case is sort of maybe changing the politics a little bit around Wall Street reform. How important is what they are accused of?

KRUGMAN: Well, I mean, the specific thing is not that big and the question - basically, they are accused of setting up things, you know, investments that were designed to fail so that important clients who were betting they would fail could make money. That sort of thing - we don`t know how widespread it was. We don`t know how big a deal. It certainly didn`t cause the crisis, but it may have made things worse and mostly, it just, you know - it gives you a picture of our really rotten financial system which is a critical part of the whole story of financial reform.

MADDOW: Is there anything in the financial proposal - financial reform proposal that`s out there now that would prevent the kind of fraud that Goldman Sachs is accused of?

KRUGMAN: It is not clear. I have been actually having a hard time figuring this out which probably means that the answer is no. I mean, the proposals that are out there would make it - would require that derivatives - and I can`t explain that because they are complicated which is the point in a way - that they be traded a lot more openly, more transparently on recognized exchanges, which would have made this kind of thing more visible and possibly headed it off. But probably, it needs to be tightened up. But I think, again, the main thing is not so much would the reform specifically prevent this thing as it is a reminder that Wall Street bankers are not your friends and cannot be trusted to do the right thing.

MADDOW: You wrote recently that the financial sector has essentially become a racket, that it`s essentially predators and prey. And you are either one or the other right now. When you mention that derivatives are hard to explain and that is the point - they are complicated and that is point - do you think that the generation of complex financial instruments in the last generation in Wall Street has in part been to stay ahead of regulation, to stay ahead of even due diligence by the people involved at the sort of lower end of the food chain in finance?

KRUGMAN: Yes. I mean, it is starting to look - I mean, you know, they were sold. These complex things were supposed to diversify risk. They`re supposed to make the system safer. It has now been glaringly obvious that they actually increased the risk, that they concentrated it, that they created lots of promises that couldn`t be honored in the clinch. So, yes. I mean, it is kind of a running game we have here. Now, people talk about - well, we mustn`t stop financial innovation. And then you say, well, name a financial innovation that has clearly been beneficial and you are not allowed to use ATMs. And usually, that stops the conversation because nobody can come up with anything that was clearly a good idea in all of this, you know, vast proliferation of stuff.

MADDOW: Well, it has made a very small number of people dramatically, dramatically wealthy in a short period of time. The Wall Street billionaires aren`t just the firms. They are the individuals, the hedge fund managers and so on.

KRUGMAN: That`s right.

MADDOW: And in terms of their efforts to stay unregulated, is it - I mean, do you think it`s really just to keep the con going so they can keep essentially dupes out there that they can relieve of their money? Or is it because they do think that there is something that could be useful for the country?

KRUGMAN: Well, you know, everybody - nobody thinks he is a villain. Everybody imagines that they are doing something good. So I would imagine that most of these people sincerely believe that what they do is good for the country even as they - some of them are quite deliberately duping people, you know, a little bit of double think there. But the point is that they are - you know, they`ve got this incredibly lucrative business which is of questionable, arguably negative value to the economy but absorbs a lot of resources and pays them a lot of money. So of course, they are trying really, really hard to defend it.

MADDOW: What is good, do you think, about the proposal for Wall Street reform that`s out there right now? What is the most important thing that the proposal that`s out there now would do to protect us from a financial crisis happening again?

KRUGMAN: OK. Well, you know, there is actually - there are four different things. Probably, the most important is thing - resolution authority. You know, we had a stable financial system from the mid-1930s to about 1980 based around the FDIC insuring deposits, but also regulating banks and having the ability to seize a bank if it`s basically going under, protect the depositors and clean out the other guys. We did not have that in clear legal form. So when we were having debates about bank - nationalizing weak banks in early 2009 - you know, it is a highly debated issue. But one thing that was a real problem was, it wasn`t clear exactly where the authority was for something that was complicated. You know, an ordinary, you know, Jimmy Stewart`s bank you knew how to seize. But Citigroup - it wasn`t quite clear what the legal authority was. So this would bring us back to - partly at least to this kind of system that did so well for about 45 years. That is the biggest single thing. Regulation of derivatives, forcing them into the open and to exchanges where you can see what is happening is a big thing. Protecting consumers is a big thing. Requiring that banks have higher capital if they basically have more stockholders` money at stake and not so much borrowed money - that`s a big thing. All of those would - you know, are they enough to prevent another financial crisis? We don`t know. But they would certainly help. They would certainly make it less likely and less severe when it happens.

MADDOW: When the president who is not a president who is given to threatening vetoes willy-nilly - when he recently threatened to veto financial reform if it doesn`t regulate derivatives, do you think that was the right move?

KRUGMAN: Yes, it was, because, you know, this is - you don`t want a cosmetic reform. You want something that`s real. And derivatives is now - what I hear, is the sticking point. They actually - you know, for what it`s worth, the administration people - they think that Republicans are going to cave on consumer protection because they think it isn`t going to be that big of a deal. They will probably, in the end, cave on resolution authority. But they`re going to try and hold out to keep those derivatives, basically to keep the racket going. So this is where the sticking point is and he is prepared to hang tough or at least so he says.

MADDOW: We have been talking a lot about the politics, trying to understand, not only the substance of the Republican opposition but also its likelihood of successfully stopping (UNINTELLIGIBLE).

(CROSS TALK)

KRUGMAN: You are wasting your time on the substance thing. There is no substance. I mean, it`s entirely - you know, there is no coherent case there. But yes, the politics. Sorry. Go ahead.

MADDOW: No, that`s exactly what I was going to ask you. I mean, can you help? How has the Republican Party been making either criticisms on the existing bill or proposals for what they would do instead that makes sense to you as an economist?

KRUGMAN: No. I mean, it is - well, first of all, it`s obvious that they are actually, you know, huddling with the bankers, huddling with Wall Street to figure out ways to stop this thing and then proclaiming that what they`re doing is really preventing future bailouts of Wall Street. But no, there has been nothing there. I mean, if there has been no proposal - the only thing they have been doing is claiming that resolution authority is just setting you up for future bailouts and we should just promise not to have future bailouts. And as I`ve written, it`s just like saying that we have solved the problem of fires by abolishing the Fire Department and then that people will know that their buildings are burned down and so they won`t let it happen. It just not - it is not coherent. It is a dangerous idea, if anything.

MADDOW: Nobel Prize-winning economist and columnist with the "New York Times," Paul Krugman. I always feel very lucky when we can get you to be on the show. Thank you for making time for us.

KRUGMAN: Thanks a lot.

MADDOW: Thanks. So there is a love story to tell tonight. It matches the new very conservative Sen. John McCain of Arizona and what is described as the country`s most retrogressive, mean-spirited and useless anti-immigrant law. In politics, as in the 1970s, love the one you`re with. Stay tuned. We`ll be right back.

Originally broadcast, 4.20.10