Following is a transcripted excerpt from Fox News Sunday, March 17, 2002.

TONY SNOW, FOX NEWS SUNDAY: President Bush says phase two of the war on terror has begun. Where should it lead? Senator John McCain will give us his take.

And Brit Hume, Mara Liasson and Juan Williams on this, the St. Patrick's Day edition of Fox News Sunday.

Good morning. Welcome to Washington.

Here's the latest from Fox News.

An attacker hurled grenades this morning into a Christian church located about a quarter mile from the U.S. embassy in Islamabad, Pakistan. Five people died, including two dependents, a wife and daughter, of an American embassy employee. At least 40 people, including 10 other Americans, were injured. President Bush issued a statement expressing outrage at the attack. He offered condolences to the victims and their families and added, "We will work closely with the government of Pakistan to ensure those responsible for this terrorist attack will face justice."

Abu Annas Al-Libi (ph), described by President Bush as one of the world's most dangerous terrorists, has been captured in Sudan. He is considered the mastermind behind the 1998 U.S. embassy bombings. Wire reports indicate he will be turned over to U.S. authorities.

Saudi Crown Prince Abdullah has accepted an invitation from President Bush to visit the president's ranch. No date has been set. Vice President Cheney said his meeting with the crown prince covered Iraq and the Middle East.

And Palestinian leaders have, at least temporarily, dashed hopes for a quick cease-fire between them and Israel. The Palestinians say they won't meet for any kind of talks until Israel withdraws troops from Palestinian areas.

After several peaceful days in the region, violence erupted again today. A gunman opened fire on passengers in the Israeli town of Kfar Saba (ph), killing at least one and wounding at least 10 others. Ninety minutes later, a suicide bomber approached a bus filled with high school students in the French Hill section of Jerusalem. The bomber died; Israeli authorities report 10 other injuries.

Now, President Bush says we have entered phase two of the war on terror. What does that mean? We'll discuss the battle, prisoners of war and other issues with Republicans Senator John McCain, who joins us from his home state of Arizona.

Senator McCain, before we do that, let's take on the very latest news first -- the bombing in Pakistan, just a quarter mile from our embassy. What do you make of that?

JOHN MCCAIN: (R-AZ): Clearly a terrorist act. The question is whether it was carried out by some deranged person who has been affected by this tremendous influx of hatred toward the United States that's being taught all over the Arab world in the madrasas, some of it funded by Saudi Arabia. Or is it part of an overall plan to kill Americans wherever they can plan to do so? And it shows, again, it's a dangerous world we live in.

SNOW: Is it your fear or expectation that the United States is going to have to work more closely with Pakistan to go after targets in Pakistan?

MCCAIN: I think that we have to work more closely, but also the Pakistani government -- and I appreciate and respect President Musharraf and what he is doing, but it's clear that he does not have control over parts of his country and elements of his society, and he's got a long way to go.

SNOW: And what should we be doing to help him?

MCCAIN: Everything that we can -- and I think we are -- including economic aid, including maybe reducing some trade barriers so that their products can be sold in the United States, but more importantly, the very close cooperation with the intelligence services.

SNOW: Senator, there were a couple of days of peace in the Middle East. Then the possibility of talks seemed to break down between Israel and the Palestinian Authority. Two incidents of violence since have erupted. Is that a coincidence?

MCCAIN: I don't know. I think it's very clear that Mr. Arafat either does not want to or is unable to control elements within his Palestinian Authority.

It's clear to me that the Palestinians think they have a winning formula here of trading Palestinian bodies for Israeli bodies, and Mr. Sharon is hurting politically as a result of this present status quo. It makes it even more dangerous to me because Sharon may be faced with a set of choices here that could escalate this very volatile situation.

So I think that we should be telling -- trying to find out whether Mr. Arafat can control his own elements or not, and then make our decisions based on that.

SNOW: We withdrew Anthony Zinni, our Middle East coordinator, earlier saying that Yasser Arafat had to meet a series of conditions, none of which appear to have been met. Was it a mistake to go back?

MCCAIN: I think the United States has to be engaged.

But, look, the premise of the Oslo agreements were that Palestinians and Israelis, over time, would live together. Now, I believe that we have to figure out a way for Palestinians and Israelis to live apart. That's a very difficult thing to do. But the present situation of endless bloodshed on both sides is something that could escalate out of control and could envelop the entire Middle East, and I don't think it has been more dangerous.

SNOW: So, what you're talking about is getting Palestinians out of Israeli-occupied areas and getting Israelis out of areas that have been designated for Palestinian occupation?

MCCAIN: At least set up barriers between the two elements. And I know that would present some difficult decisions, as far as the Israelis are concerned, because of settlements, and it would also entail a huge expenditure of funds. But I don't know how you continue the status quo without us having a major, major escalation which could envelop the entire region.

SNOW: All right, now, the president has said that phase two has begun on the war on terror. A lot of people expect that we ought to be taking action soon against Iraq. Do you agree?

MCCAIN: I agree. I think -- and the Congress has already voted for a regime change in Iraq. I think we should demand a quick and efficient return of the weapons inspectors. We should support the dissident elements within and without Iraq -- the Shi'ites in the south, the Kurds in the north, the Iraqi National Congress -- and also exercise whatever options are necessary.

It is clear that Saddam Hussein constitutes a clear and present danger to the United States of America in his pursuit of weapons of mass destruction, and so therefore there has to be a regime change.

SNOW: What do you make of the fact that some of our Arab allies, principly King Abdullah of Jordan and the Crown Prince Abdullah of Saudi Arabia, both have come out and said, well, you know, we really don't want you to go after Saddam Hussein?

MCCAIN: I think that there is a variety of reasons, including, perhaps, the possibility that the United States may leave again and with Saddam Hussein in power, which I think is a legitimate concern based on what happened in 1991.

But I think also, you know, nothing succeeds like success. Before the Afghan conflict, there were predictions of upheavals throughout the Arab street and that the United States would be bogged down, etc. Nothing succeeds like success, and now that element isn't there.

If we were able to remove Saddam Hussein from power, I believe that any objective observer would agree that the Middle East and the world would be a better-off place.

SNOW: Do you doubt the administration's determination to remove him from power?

MCCAIN: I believe that the administration wants a regime change, but I don't think that necessarily means an immediate, all-out U.S. military attack. I think there are a variety of options, and there's a methodical way of going about this process.

SNOW: So, you think talk about attacking Iraq is premature?

MCCAIN: I think we should in our planning for all options.

SNOW: What do you think will happen? By the end of the year, will there be military action in Iraq?

MCCAIN: I don't know enough about the planning process, Tony. But I do know that, at least in my view, there is some viability to the opposition elements that could succeed. I'm not saying that they will. But I see nothing wrong with making that effort to start with.

Saddam Hussein is clearly much weaker than he was in 1991. How weak is yet to be determined. But I think all options are on the table and should be on the table.

SNOW: Speaking of the Gulf War, Michael Scott Speicher has now been designated as missing in action as opposed to having died in combat. What is your reaction to that, and what ought we to do?

MCCAIN: We ought to make every effort, as we have in the past, to ascertain what happened to Commander Speicher. There is questions, of course, the Iraqis did give back all the other prisoners they held. Why would they hold one? But there is evidence, enough evidence, to bring this whole situation into question, and it has to be a very high priority.

SNOW: What kind of evidence?

MCCAIN: Well, that he ejected from the airplane. At first they thought his airplane had exploded. Now, apparently his airplane hit the ground and there had been an ejection from the airplane.

There is enough evidence here to place him on the missing-in- action list and pursue every avenue we can to find out what happened to him. That's an American tradition.

SNOW: Campaign finance reform coming up for a vote. Do you expect a filibuster of the bill?

MCCAIN: I hope not. I think we have to prove that we have 60 votes, which I think will come sometime early this week. But I don't see a great appetite to continue this fight, certainly not on my part.

(LAUGHTER)

SNOW: The president has said defense is the first priority. Why is it more important to vote this week on a campaign finance bill that won't take effect until next year, than on defense spending that the president says he needs to fight the war today?

MCCAIN: Well, the bill that's on the floor is the energy bill, and I think we're going to be on it for several weeks.

MCCAIN: I don't think it's going to take more than a day or so, if that, to finish up campaign finance reform. We've been on it for, off and on, for seven years. It might be nice to conclude it, and I think we can in a relatively short period of time.

SNOW: Let me ask you a couple of questions. I've been looking over the bill, and I'm confused about a couple of things. One of the provisions of the bill says that it limits to $10,000 the ability to do get-out-the-vote efforts, but you can do that in any jurisdiction in America, is that correct?

MCCAIN: Yes. To various organizations, yes.

SNOW: Yes. I looked in the statistical abstract yesterday. There are 87,453 jurisdictions in the United States, 10,000 per jurisdiction. I mean, if somebody really wanted to spend a lot of money, they could spend theoretically $875 million every two years if they wanted to. That's hardly getting money out of politics.

MCCAIN: Well, that money could not be spent for broadcast advertising, could not be solicited by a federal official. It was an effort to try to help organization and get-out-the-vote and voter registration, but it can't be used for broadcast purposes and it can't be solicited by a federal official.

And I think you'll find that there's not a lot of people that want to give unless they think there's something to be gained in return for it. Just as Mr. Reed said in his memo soliciting Enron, it's not the argument on public policy in Washington, it's who you see and by whom.

SNOW: But interestingly enough, at least according to Cleata Mitchell (ph), the single most well-financed campaign in Washington the last four years has been that for campaign finance reform, waged on the part of non-profits. So evidently, there are ways to getting to Congress without having to swap favors.

Does that concern you that non-profit organizations may, in fact, become the new centers of power in this town?

MCCAIN: I think that every organization in America should be able to fund and pursue issues and goals that they seek, including legislation on the part of the Congress of the United States. That's a fundamental right.

But when they are giving -- pumping hundreds of thousands of monies into -- dollars into individuals' campaigns, which take the form of so-called independent advertising, which are all negative ads, then I think that that's not the exercise of free speech. As the Supreme Court said, money isn't free speech, money is property.

In South Dakota right now, the two candidates are seeking an end to the so-called independent campaigns that are being run, which are all negative ads run against each other...

SNOW: So...

MCCAIN: ... funded with unlimited amounts of money. If they want to fund these campaigns with $2,000 individual contributions, that's fine with me -- just like I would have to do if I were running for a campaign.

SNOW: Of course, non-profit organizations don't have to tell who they get their money from or where. Do you think People for the American Way, in its lobbying on the case of Charles Pickering, is that something that will be affected at all by campaign finance reform?

MCCAIN: I don't see how you do, if you are talking about campaign for issues or situations or political situations. The automobile manufacturers and the United Auto Workers just did a great job killing off any increase in CAFE standards last week by showing pictures of a small European car. That is not what campaign finance reform is all about.

What campaign finance reform is, is to stop the unlimited flow of money into American political campaigns. And there may be other evils associated with some of the activities you were just talking about, but very quickly, you really do encroach upon the free speech.

SNOW: So, you don't really see, in the long run, any less money being spent on politics, it's just going to be less money on negative ads.

MCCAIN: I see $500 million taken out of American political campaigns immediately by doing away with soft money, immediately. I think you'll see, for those of us that are growing old, a return to the time of the 1980s when we had to have party organizations, volunteers knock on doors. All our time wasn't just spent on raising huge amounts of money and pouring them into political advertising.

SNOW: OK.

MCCAIN: Pew research showed that 38 percent of the money that's raised in this fashion goes to broadcasts; 8 percent to party building.

SNOW: All right. Senator McCain...

MCCAIN: Thanks, Tony.

SNOW: ... thank you.