Washington Post business columnist Steven Pearlstein was online Wednesday, April 2, at 11 a.m. ET to discuss financial regulation reform and lessons from the current crisis.

Read today's column: Regulations Need Regulators

About Pearlstein: Steven Pearlstein writes about business and the economy for The Washington Post. His journalism career includes editing roles at The Post and Inc. magazine. He was founding publisher and editor of The Boston Observer, a monthly journal of liberal opinion. He got his start in journalism reporting for two New Hampshire newspapers -- the Concord Monitor and the Foster's Daily Democrat. Pearlstein has also worked as a television news reporter and a congressional staffer.

Read Pearlstein's latest columns.

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Geneva, Switzerland: It is known how much money would have been involved in credit default swap claims if Bear Stern had gone bankrupt? Was CDS the main reason why the Fed could not let BS go under?

Steven Pearlstein: I think we can infer that it was a big reason why the Fed felt the need to build a "firewall" around Bear Stearn in case it failed, which was a real possibility over that crucial weekend. "Counterparty risk" has been a top issue for Tim Geithner, the president of the New York Fed for a numbr of years now, and Bear is a big counterparty in the credit default swap market.

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Fort Wayne, Ind.: From what I know of the mortgage crisis, it seems that much of it can be traced back to the situation that arises from the mortgage originators having no stake in how the mortgage actually performs. The easiest regulation would then be to require the originator to keep enough of a portion of the mortgage on their balance sheet to force them to do quality underwriting. Is this covered in any part of the regulation that was proposed or any other proposal that you have heard?

Steven Pearlstein: The blueprint was focused more on how regulation should be organized, not on what regulations the regulators should issue. But that is certainly part of a different and separate exercise Treasury is now leading, on "lessons learned" from the recent crisis. And the moral hazard of the loan originator making and big fee but having no residual interest or risk associated with the loans it writes is a big issue in that review. I think there will be some sort of effort to require originators to retain some risk, although with modern finance, there will always be ways for them to buy their way out of that or insure themselves against it unless regulators prevent that.

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Washington, D.C.: Steven, I suppose that additional regulation of the markets will also be accompanied with guarantees of government intervention to "socialize" losses in the financial industry. Bringing "stability" to this powerful and wealthy economic caste may have consequences for national competitiveness, social stability, and the print circulation of Das Kapital.

Steven Pearlstein: Very cute. First of all, you mistake bringing stability to a powerful and wealthy economic caste, in which we have little interest, and bringing stability to ordinary homeowners, workers, investors and the broader economy, in which we do have a societal interest. Often the two go together, so you can always rail against bailing out the big guys. But as I've written before, the bailout here is really for all of us. And I think you play cute intellectual games in dismissing that. There is a legitimate tradeoff between innovation and efficiency on the one hand and stability on the other, and it is hard to do that tradeoff because it is like weighing apples against oranges. But it is one we should do without getting into accusations that one side (my side) doesn't care about innovation or efficiency, which is what the Financial Services Round Table and the Derivatives and Swap Industry Association (or whatever it calls itself) invariably do.

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Minneapolis, Minn.: Everyone claims that a consolidated regulatory scheme either like the one proposed by Treasury Secretary Paulson or like the UK Financial Services Authority, would not have prevented the current financial crisis. Certainly, the UK already had to intervene to prevent a run on Northern Rock Bank because the credit crisis. Everyone is, however, overlooking one advantage of at least the UK scheme: that everyone knows who is ACCOUNTABLE for regulating financial services products and firms. While the United States wastes time trying to sort out which regulators should have acted differently, the UK Financial Services Authority is moving ahead to revise the regulations for banks to deal with the securitizations and CDOs. Wouldn't the United States and U.S. consumers and investors be better off if time and money were not wasted trying to sort out blame and instead were concentrated on the appropriate regulations to be put in place to decrease the likelihood of similar problems in the future?Professor from the University of St. Thomas School of Law

Steven Pearlstein: You raise a very good question, which I'll rephrase a bit: wouldn't it be better if we fixed the current regulations, quickly, before any more harm is done, before worrying about restructuring the regulatory apparatus? The answer, as you suggest, could be yes, although at the moment the markets are so down on all the bad stuff that its not likely to repeat the old mistakes very quickly. And you have to ask a second question which is, If you are going to move farily quickly to restructure the architecture, shouldn't you have the regulations and the enforcement of them, and the people writing them, reflect the new structure and the new regulators? I guess where I come down in with Paulson on this one: if you can get the restructuring done in the next two years, it will inevitably be done with new regulations in mind. So I think the new regs will come soon after, and in time to at least prevent a recurrence of the same mistakes. Maybe we'll even get lucky or smart and be able to reduce the damage from the next incident.

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Banks that are too big to fail are too big to "regulate": We didn't learn a single thing from Enron--the frauds are virtually the same. I don't see any way to regulate our financial system unless there was some sort of real time reporting of all trades, with an army of professionals to monitor it. Even then, what could the regulators actually do? The only solution I see would be to break up the mega-banks and then impose limits on how much leverage they could use. What public benefit did they provide? They're just platforms for traders and executives to take out hundreds of millions of dollars.

Steven Pearlstein: That's probably too sweeping, although I think you are right that the big advantages promised by consolidation haven't fully materialized, while we've learned some of the downsides of having these mega institutions that were not only not acknowledged by the companies and regulators, but aggressively denied. The bigger problem with Citigroup isn't that it can't be regulated but that it can't be managed!

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Thoiry, France: I have, in an amateur manner, tried to explain to my wife the basic principles of the $45 trillion credit defaults swaps market: Imagine that instead of going to a regulated insurance company we insure our house with a neighbor. We do this without knowing if our neighbor has sufficient funds to pay us if our house burns down. Our neighbor goes down to the local bar and (without telling us) sells the insurance contract to a stranger without making sure that he has funds to cover a fire in our house. Ten other people in the bar decide to get in on the action and sell and buy among themselves five contracts insuring our house against fire (i.e. making bets that our house will or will not burn down). In the end there are six insurance contracts on our house between people who do not know each other and who may or may not have funds to cover a fire. Imagine the mess if the house burns down...My wife does not believe that anyone would be this stupid. I claim that there are thousands of investment bankers and hedge fund managers with million dollar bonuses who are in fact this stupid. Is this correct? And what will happen when companies start to "burn down" in the coming recession?

Steven Pearlstein: You have it precisely correct. I am laughing out loud at reading your comment because I tried to do the same thing with my wife, using the same analogy, and she looked at me as if I was nuts. But it is important for everyone to understand this market, because it is a good metaphor for how we've run off the track. What started out as a legitimate hedging instrument, perhaps, has now morphed into an instrument not only of speculation but unfetterd market manipulation (SEC, please note). Moreoever, what you didn't explain to your wife is that these insurance contracts are then bought and sold on secondary markets using large amounts of debt--debt that in many cases is given by the very banks whose "house" was being insured. So you get investors who may be doubling down on their insurance bets by borrowing from the same banks, or from hedge funds that have borrowed from the same bank. That's why this is so complex, why it is so intertwined, and why nobody knows what would happen if one major institution fails, although we can surmise that the ripple effects would be significant and difficult to know in advance.

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Beaufort, S.C.: Somewhat off the topic for today, but what effect will the huge write-offs at the banks and investment banks have on N.Y.C., N.Y. State, and federal tax receipts? Will these only add to the financial woes for these governments?

Steven Pearlstein: You betcha. New York State and City are already anticipating big declines, and while federal budget officials have already raised their deficit estimates for this year to $500 billion from about $425 billion, they are probably going to have to revise it again. The impact of financial sector activity on tax receipts are becoming greater and greater the more that governments rely on the income of corporations and rich people for a greater and greater percent of their revenue, which is the trend. And one of the things we have to start thinking about is how to put some of that overage aside during the good times, so that we have a rainy day fund to keep vital services going when we most need them, during the down times.

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Arlington, Va.: Steven, you've said several times that you don't feel the Iraq war has been a negative factor in our current economic problems. What say you to the assertions of Joseph Stiglitz, which seem to contradict your own?

Steven Pearlstein: He's won a Nobel prize in economics and I've never taken an economics course. But having said that, I observe that the big driver in our problem has been the bursting of a very large credit bubble which has its roots in a worldwide savings glut, a persistent US trade deficit, poor regulation and misguided tax incentives and lack of professionalism on Wall Street. To the degree that higher oil prices are driven by the war, and these have been like a big fat tax on the economy, the war has been a secondary factor, in my opinion. To the degree that it has incrased the federal deficit, it has been a tertiary factor.

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Madison, Wis.: Thanks again for an excellent article. You deftly countered the arguments by anti-regulators that increased regulation would inhibit innovation and efficiency in capital markets. I wonder if you've heard feedback from within the lending industry itself. My impression is wholesale lenders brought a lot of this mess on themselves by stressing meaningless underwriting checklists rather than paying attention to fundamentals (like whether the loan applicant has a job, for example).

Steven Pearlstein: I think the industry associations generally don't bother to respond to me any longer because they've given up on me. They just write letters to the editor. I actually find that rather amazing. SIFMA, the derivatives dealers, the securitization forum, the financial round table -- not one of the chief executives has called me up and invited me to lunch or breakfast in the last year, even while I've been writing constantly about the misjudgments of their members. In the old days of Washington, that wouldn't have happened. But these new guys just aren't interested in having a dialogue or getting to know people. They are into brute force.

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Great Falls, Va.: I agree that the blueprint is a productive submission, and it should jump start an important discussion. But I'm wary of the SEC/CFTC combination. I'd suggest that the CFTC has been a relatively productive regulatory agency, in large part because of the modernizing legislation in 2000. The SEC has been inefficient and often asleep at the switch. If the merger could make the amalgamation more like the CFTC than the SEC, great. The blueprint seems to call for that. But we all know it won't. By dint of the SEC's sheer size and the natural Washington process of compromise, we'll have a hybrid SEC/CFTC. And I suspect that would be a net loss for all involved: the markets, the market participants, and the investors.

Steven Pearlstein: The SEC has been bad at regulation and oversight, particularly of a prophelatic sort, and better at after-the fact enforcement. THE CFTC has not been particularly good at enforcement-- there's a lot of market manipulation going on that they don't catch in the futures area--but I'd suggest it hasn't been particularly effect at oversight, either, because it is governed by a political philosophy that the market will discipline itself.

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Bow, N.H.: Mr. Pearlstein: I am skeptical that we can or should try to regulate stupidity out of the market. I, for one, took some perverse pleasure in seeing the investment bankers who engineered and sold these complex financial instruments getting burned by their own failure to understand the economic and cash flows and risks involved. They laughed when they sold these sorts of things to Orange County or Gibson Greetings, but who's laughing now?

Steven Pearlstein: Stupidity that is practiced on a huge scale and that can cause market meltdowns is the kind of stupidity we have to be concerned with. That's not the vanilaa variety mistakes of investing in the wrong company or making the occasional bad loan. But when a major, federally-insured bank is allowing hedge funds to finance spread-arbitrage with leverage ratios of 33 to 1, that goes beyond stupidity. That is an invitation to systemic risk.

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The frauds are the same as Enron?: Come on, that's silly. Find me one example in the current crisis of hiding liabilities off of the books, in a manner prohibited by GAAP. There's definitely a similarity between Bear Stearns and Enron; they both got caught in a run on the bank. That's an interesting and legitimate discussion to have. But it's ignorant to throw the term fraud around without basis.

Steven Pearlstein: First of all, there was rampant fraud involved in the subprime lending, on the part of borrowers as well as some of the originators. There was possibly fraud involved in the rating process. And in failing to fully disclose risks and liabilities of off-book vehicles to shareholders and counterparties and lenders, that's fraud as well. so I am sorry to disagree with you on this one. We can debate whether it is civil fraud or criminal fraud, perhaps -- I'm not particularly up on that distinction. But in my book knowingly misleading investors and lenders and regulators is fraud by another name.

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Anonymous: Hello and thank you for your Q & A invitation. We are hearing that the proposed reforms will take months or years to percolate through an approval process. Certain regulations were desperately needed Yesterday! What are causes of all the delay?

Steven Pearlstein: Well, there are new regulations that may be needed quickly and there are changes in the regulatory structure and philosophy that are just so fundamental and sweeping and involve so many special interests that will seek to derail the process or bend it to their will that it is just going to take a long time.

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Silver Spring, Md.: Mr. Pearlstein: I am a longtime mortgage professional and have taught loan officers throughout the country. I have always thought that this is a national business that should be regulated nationally and that the state regulators are overwhelmed by the job of regulating mortgage brokers and often don't have strong laws behind them. Is that your position, as well?

Steven Pearlstein: Yes it is. State regulation has a lovely, Jeffersonian quaintness about it, and sometimes state regulators do a very good job -- better than the feds. But as a general proposition, it is simply inefficient to ask companies doing business nationally, with national products and national clients, to have to run the guantlet of 50-plus state regulators. There is a reason there is an interstate commerce clause in the constitution.

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Seattle, Wash.: Why did the stock market rocket upward on the news that Swiss banks and credit agencies are writing off billions of dollars and firing CEOs? I would have thought that that would be bad news as it only increases the likelihood of 'runs' on investment houses.

Steven Pearlstein: I can't agree more. Yesterday's market rally is one troubling indication that the markets have decided the Fed will do anything to bail them out, and that is very dangerous. The Fed now has to show it is willing to let some things fail and stare down the market. And it should begin doing this soon, perhaps by reducing some of these new facilities it has made available to banks and investment banks, or setting some limits on the junk it is willing to accept as collateral for loans. And it certainly should let the market know that it will be holding its powder on rate cuts and shouldn't count on a quarter or half a point cut at the next several meetings.

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Re: Bear Stearns' Collapse: I've seen speculation and conspiracies that Bear Stearns went under because of a concerted effort by people short-selling it. Is there any reason to pay attention to those rumors?

Steven Pearlstein: The SEC is certainly paying attention to them, having launched an investigation. Of course there was lots of short selling and of course short-sellers did what they could to keep the rumors flying of an imminent collapse. When free speech gives way to market manipulation -- I'll leave that to the lawyers.

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Laurel: I know your comment about the number of regulatory agencies was principally about different FEDERAL agencies, but was the ability to forum-shop among states providing a convenient 'race to the bottom?' (The way Delaware has created the modern predatory credit card system, since they lend almost all the money but borrow very little.)

Steven Pearlstein: Yes, there is some of that. I note that the US chamber of commerce gets all hot under the collar about forum shopping by plaintiffs lawyers, but doesn't seem to worry much about forum shopping by businesses looking for the lowest taxes or the least regulation. But then we wouldn't exepct anything different from our friends at the chamber, would we? They've long since given up on intellectual honesty.

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Boston, Mass.: So is the lesson here for institutions: it's OK if you screw up and take on too much bad risk, just make sure that you do it BIG so as to position yourself in a way that the Fed has no choice but to bail you out?

Steven Pearlstein: That's always been a problem with too big to fail, there's no getting around it. We just have to make sure that shareholders and executives suffer enough pain that we don't make it an experience they ever want to go through again.

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Norfolk, Va.: I am a prudent, would-be first time home buyer who has been renting and waiting. I would like prices as low as possible. Will any mortgage plan congress enacts prevent housing prices from realigning with incomes? I make about 60 grand and still can't afford anything decent.

Steven Pearlstein: I hope it won't prevent the realignment of housing prices to incomes. Some of the ideas being talked about, like the $15,000 tax credit for new home buyers, strikes me as a stunningly bad idea.

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But I'm wary of the SEC/CFTC combination. I'd suggest that the CFTC has been a relatively productive regulatory agency, in large part because of the modernizing legislation in 2000: The so-called modernization did this: "that certain over-the-counter ('OTC') derivatives transactions are outside of the jurisdiction of the CFTC. Second, under certain conditions, the Act allows trading of future contracts based on single stocks and narrowly-based stock indices, with oversight being shared by the CFTC and the SEC." Didn't this contribute greatly to the current situation?

Steven Pearlstein: I don't think it was a big contributor, but I think it is a bad idea.

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News Anchors & Pundits last night...: spoke as if the market is now headed for smooth sailing. They speculated that the near 400 point rise meant the economy is back and gave the impression it's safe to invest in the stock market again. What are your thoughts about being in safe insured instruments vs. the market now? For the past year the 401k has been in almost all cash to avoid loss and we've slept much better through all the ups and downs. Should we expect more volatility? Thanks, really appreciate your insights.

Steven Pearlstein: I think the news anchors should have producers who have a better understanding of markets, before they go out and give people like you that impression. That is very dangerous.

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Anonymous: Credit default swaps at $45 trillion? How much is at risk?

Steven Pearlstein: The expression is that the swaps have a "notional" value of $45 trillion. How much is really at risk. I'm not sure anyone has any idea, but it is at least in the hundreds of billions, which is enough to be worried about.

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New York, N.Y.: Steve, by their very nature, the folks at investment banks will always be one step ahead of the regulators because the i-bankers get paid to come up with arcane deals and structures that no one else has thought of. So even though there's no love lost between me and the i-bankers, I'm not sure how streamlined regulation would help. I think the best regulation will come when big pension & mutual funds say enough is enough and they won't buy shares of investment banks. If the CEOs of Bear, Merrill, Citi, etc. don't have any clue what's going on in their own firms, how can an outsider even guess? Thanks!!!

Steven Pearlstein: Look, its not a matter of preventing a couple of sharpies from coming up with a bad idea and making some money with it. The point is to prevent an entire industry from drinking gallons of poisonous Kool-Aid all at the same time -- such as everyone paying ridiculous sums to buy packages of no-doc, no-downpayment mortgages. Or financing buyouts at leverages of 10 to 1. Or peddling packages of BB mortgages with AAA ratings. These were widespread practices a year or two ago and any regulator with eyes or ears could have seen it and done something about it. They didn't, but it wasn't because the investment bankers were so clever that it was hidden from view. It was because they didn't have enough confidence in their own judgment, didn't have the right judgment, or didn't feel they had the political independence to do their jobs.

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Arlington, Va.: It just amazes me that the people in charge, our economists, etc. are so far behind the eight ball. It worries me that these so called "experts" that are running our country, especially Helicopter Ben, are just really without any foresight. I told my friends back in 2004 that every job created from this housing mess would almost be lost and more, and it would drastically affect every other part of the economy. Think about what goes into a house: workers, materials (wood, plastic, metal, concrete), wiring, paint, drywall, carpet, furniture, appliances, etc. Now remove that by the millions. Then when all those businesses have issues, they go into the big purchase items such as cars, eating out, shopping, and so on. It's a linked economy. It should be well known and reported that everything is going to take a hit..EVERYTHING. If an "average" but "smart" person like myself could foresee this, why can't our financial "experts" understand this???

Steven Pearlstein: Because they have bought into this right-wing fantasy that markets always know best.

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Mt. Lebanon, Pa.: So "Bailout Ben" Bernanke and "Crash Dive Hank" Paulson want increased "regulation" and "oversight" for the future when they didn't get the current disaster identified until long after the barn was burned down? The legacy of the Bush administration (and yes, Beranke is a political appointee): "We came, we fiddled, it burned." I wonder what that is in Latin. Thanks much. HLB

Steven Pearlstein: A bit harsh, but not without merit.

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Rockville, Md.: Why increase the price of Bear Stearns share price? So that some fat cat executive doesn't have to sell his prized wine collection? Why didn't the free market Reaganite proponents let the market determine Bear Stearn's stock price? The country has become the government of the rich, by the rich, and for the rich. Anyone thinking otherwise is fooling themselves.

Steven Pearlstein: Again, a bit overstated, but only a bit.

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Washington, D.C.: What has been going on the last few years, which has been fraud on a large scale, is just really disturbing. Capitalism seems to bring out the worse in people the more we progress in technology and time. What's even more disturbing is that when it happens to the small players, the government doesn't care, its part of the "FREE ECONOMY." Yet when their buddies are hurting, they intervene. Wall street wants it both ways...personal profits just for them, yet taxpayer bailouts. You can't have a free economy with this style, WHICH is what is happening. They reaped the profits (while committing large fraud) and now when times are bad, want everyone else to foot the bill. I really think that it makes some sense that the government stops a collapse but that we need most of these people to fail and learn their lessons HARD so it doesn't happen again (or until people forget, like the great depression).

Steven Pearlstein: A widely held belief, yours.

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Re: State Regulation: State Regulation of industries is a great method, assuming that the federal government sets a solid foundation on which states can build and 'experiment.' However, what Bush et al. has brought to the table is the fact that the federal government sets a very weak floor (or no floor) and then says that states can't build on it, so no one gets to regulate. In that context, I would argue that we need to beware "Republicans bearing regulations" the same way the Trojans needed to beware gifts.

Steven Pearlstein: The issue of the structure of regulation is a different one than the substance of regulation. If you want more vigilant regulation, elect politicians who don't run around the country blaming excessive regulation for all of our ills. Maybe we will do that this time, but as for the last seven years, we got what was advertised. Shame on us.

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Steven Pearlstein: That's all for today folks. Next week's chat may be at noon rather than 11 -- check the listings next week for sure. Hope to "see" you then.

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