Overrated Volcker Now Sees Disaster of Past Silence/s
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27 July 2010 By David Caploe PhD, Chief Political Economist, EconomyWatch.com
It’s a bit of a cliché that – once they retire – “power elite” personalities in the US suddenly change their publicly stated views on key issues.
The examples are too numerous to mention, but it is fascinating to see how people once strongly associated with certain policy positions
unexpectedly espouse in the later years the exact opposite of what they had supposedly believed in with force and fervor.
27 July 2010 By David Caploe PhD, Chief Political Economist, EconomyWatch.com
It’s a bit of a cliché that – once they retire – “power elite” personalities in the US suddenly change their publicly stated views on key issues.
The examples are too numerous to mention, but it is fascinating to see how people once strongly associated with certain policy positions
unexpectedly espouse in the later years the exact opposite of what they had supposedly believed in with force and fervor.
And now we have this dynamic appearing in the case of the old lion, former chairman of the Federal Reserve, Paul Volcker.
To be perfectly honest, I have never understood why Volcker had such a big reputation,
especially as a “tough guy” on economic and financial issues.
Most people would say it’s because he allegedly “tamed” the inflation
that ran rampant in the US and the rest of the advanced industrialized world during the late 70s,
through the use of high interest rates, and supporting the suppression of wages increases.
Those who take this line attribute that inflation – in part, correctly – to the OPEC oil price revolutions of 1973 and 1979,
and say it was Volcker’s toughness that “broke its back,” as the saying went in those days,
creating the “Morning in America” of Ronald Reagan that has now become –
since all subsequent Presidents, including Clinton and Obama, have been inferior versions of Reagan –
the nightmare the US is now experiencing, and inflicting on much, albeit not all, of the rest of the world.
But a different analysis of that “stag-flation”ary period –
because the inflation was accompanied by an equally vicious collapse in growth –
suggests Volcker’s “tough policy” of high interest rates had nothing to do
with the EITHER the decline of inflation OR the rapid increase in growth that did indeed occur during the 80s –
and of course had even less to do with Reaganomics,
which created the largest deficits in the history of the US to that point,
the accumulation of which is the long-term debt the US will now carry for centuries.
From a “long-wave,” or Schumpeterian, perspective, that stagflation is most logically understood as
the final gasp of a declining energy- and labor-intensive auto-centered economy –
certainly aggravated by the OPEC price hikes –
which, in this view, are ALWAYS “stagflationary”,
to be followed by the “advancing sector” knowledge- and skills-intensive high-tech PC economy,
characterized by the exact OPPOSITE of stagflation:
namely, increasing quality and range of products, accompanied by a DROP in prices.
In this context, Volcker’s high interest rates didn’t “wring” inflation out of the economy,
but, rather, just made many people’s lives more miserable and harder to bear –
until the economy-wide gains of the PC-centered “advancing sector” created the rapid – and yet inflation-free – growth of the 1980s,
which, according to standard economic theories is theoretically impossible ;-),
but nevertheless was the case, as is easily understandable from the Schumpeterian, or long-wave, point of view.
Thus, from my point of view, he was always one of the “academy of the overrateds”.
So it was with a feeling of great pleasure and confirmation that I discovered even Volcker, in his “dotage,” admits he made some key mistakes,
and that his reputation is, at least inferentially, as overestimated as I had always maintained it was.
The first shock is his correct – if anything too complimentary – assessment of the Obama financial “reform.”
If he were a teacher, and not a senior White House adviser and the towering former chairman of the Federal Reserve, he says he would give the so-called “reform” a straight B — not even a B-plus.
For all of what he describes as the overhaul’s strengths — particularly the limits placed on banks’ trading activities —
he still feels the legislation doesn’t go far enough in curbing potentially problematic bank activities like investing in hedge funds.
Like few other policy giants of his generation, Mr. Volcker has been a pivotal figure in the regulatory universe for decades,
and as he looks back at his long, storied career he confesses to some regrets,
in particular for failing to speak out more forcefully about the dangers of a
seismic wave of financial deregulation that began in the 1970s and reached full force in the late 1990s.
Despite his recent efforts to ensure that the financial legislation might correct what he regards as some of the mistakes of the deregulatory years,
he’s concerned it still gives banks too much wiggle room to repeat behavior that threw the nation into crisis in the first place.
“People are nervous about the long-term outlook, and they should be,” he says.
At the age of 82, Mr. Volcker is from a generation of Wall Street personalities
who accepted strict financial regulation as a fact of life through much of their careers.
In his recent push for more stringent financial regulations than he believed Congress —
and the Obama administration, for that matter — were inclined to approve,
he lined up public support for a tougher crackdown from other well-known financiers who are roughly his age,
including George Soros, Nicholas F. Brady, William H. Donaldson and John C. Bogle –
few of whom, aside from Soros, had ANY prominence in either mainstream media or blogosphere discourse about the “reform.”
His most visible contribution to the current regulatory overhaul effort is what has come to be known as the Volcker rule,
which in its initial form would have banned commercial banks from engaging in what Wall Street calls proprietary trading —
that is, risking their own funds to speculate on potentially volatile products like mortgage-backed securities and credit-default swaps.
As we all know, such bets added considerable tinder to the financial conflagration that erupted in 2008.
Many went horribly awry, and the federal government used taxpayer money to bail out banks, Wall Street firms
and even a major insurer, AIG – or, at least, its counter-parties ON Wall Street.
“I did not realize that the speculative trading by commercial banks had gotten as far out of hand as it had,”
says Mr. Volcker, explaining why he first proposed the rule 18 months ago.
Well, that’s fine, dude – but you were there when it was all happening –
so why the hell didn’t you say something while it was going on,
instead of when, basically, it was TOO LATE to do anything about it.
Volcker thinks Congress has watered down his trading rule —which is of course correct — but rather than roar in protest,
he has resigned himself to the present shape of the Volcker rule as well as the overall legislation.
Which is precisely the problem Volcker so sadly incarnates:
after years of “cover your rear” silence to protect your job,
the habit is apparently just too hard to break.
“The success of this approach is going to be heavily dependent on how aggressively and intelligently it is implemented,” he says,
emphasizing that a new, 10-member regulatory council authorized by the bill will have to be vigilant and tough
to prevent the nation’s giant banks and investment houses from pulling America into yet another devastating credit crisis.
“It is not just a question of defining what needs to be done, but carrying it out in practice, day by day, bank by bank.”
The Obama administration says it is now satisfied with the broader legislation, and in particular with the Volcker rule in its amended form.
Yeah, what a surprise – it allows all their high-campaign contributing banker friends to do pretty much what they want to do in the first place.
Some members of Congress who have backed the bill still say that it is not as restrictive as they would like,
but that a more sweeping bill — one that also hewed to Mr. Volcker’s original conception —
wouldn’t have made it through the Senate.
“The thing went from what is best to what could be passed,” he says.
And that’s the bill to which he gave a B?
Even at Princeton, a school we share, that sounds an awful lot like grade inflation.
Indeed.
The financial bill has been routinely described in the news media and on Capitol Hill as the most far-reaching regulatory overhaul since the Great Depression, which in some aspects it may be.
But it certainly falls short of re-establishing some of the strict boundaries that the earlier laws put in place.
Those laws, most notably the Glass-Steagall Act, forbade commercial banks –
what are now, for example, Citigroup, JPMorgan Chase and Bank of America –
and investment banks, like Goldman Sachs and Morgan Stanley,
from mingling plain-vanilla products like savings accounts, mortgages and business loans
with the more high-octane, high-risk endeavors of trading.
Such rules managed to keep the banks and the Wall Street investment houses —
and the broader economy that depended on them —
out of a 2008-style crisis for several decades.
But the gradual unwinding of those regulations began in the 1970s
as Mr. Volcker rose to prominence,
first as president of the Federal Reserve Bank of New York in 1975, and then as Fed chairman.
Although Mr. Volcker opposed the repeal of Glass-Steagall by the Clinton administration in its “final daze,”
he didn’t go public with his concerns.
“It is very difficult to take restrictive action when the economy and the financial markets seemed to be doing so well,”
he says of his silence at the time – which shows what a profile in courage he was then.
“But eventually things blew up.”
And no thanks to him, one of the few people who –
if he had simply opened his mouth –
actually could have DONE something about it BEFORE it happened.
He also says he failed to anticipate just how wild things would become, post-Glass-Steagall,
which, of course, makes you wonder just how “brilliant” he was:
“Those were the days before credit-default swaps, derivatives, securitization.
All of that changed the landscape, and now some adjustment must be made.”
Yeah, dude, true.
But the problem is people like you – who now, of course, claim you knew better at the time – DIDN’T SAY anything, at the time.
There were other, earlier silences.
Starting in the 1970s, ceilings came off the interest rates banks could place on most deposits and loans.
A rising inflation rate made the ceilings impractical, and competition from unregulated money market funds was siphoning big chunks of deposits from the banks.
“The lifting of interest-rate ceilings was inevitable,” he says.
“I was for doing it more gradually, but it got such a momentum that we moved the limits more abruptly than I wanted to.”
In the wake of those changes, banks were suddenly free to charge more for risky loans, and that encouraged risky lending.
The subprime mortgage market grew out of this dynamic,
as did the panoply of complex, mortgage-backed securities, credit-default swaps and heart-stopping leverage
that finally produced the Black September 2008 crisis.
In retrospect, Mr. Volcker regrets not challenging the widely held assumptions that underpinned much of this.
“You had an intellectual conviction that you did not need much regulation — that the market could take care of itself,” he says.
“I’m happy that illusion has been shattered.”
But HAS it been shattered ???
The Obama financial “reform” would hardly make you think people have been cured
of this “faith-based” belief that the market can “take care of itself.”
Indeed, the administration initially did not want to separate banks and investment houses,
and wanted federal regulation and protections in place for both the Banks of America and the Goldman Sachses of the world.
Mr. Volcker disagreed.
Let Goldman Sachs and others trade to their hearts’ content,
he argued in Congressional testimony last fall,
and if they fail they can lose their own money, not get a dime in bailouts from taxpayers,
and then be dismantled by the government in an orderly fashion.
Old-fashioned commercial banks that made loans to individuals
and businesses were much more essential to the financial system, he argued,
and deserved broader federal support than pure Wall Street trading shops.
His hope is that the trading restrictions will make the nation’s banks embrace the business of commercial and consumer lending more fully
and move away from speculative trading.
Fat chance, Paul.
To encourage that shift, Senator Carl Levin, Democrat of Michigan, and Senator Jeff Merkley, Democrat of Oregon,
co-sponsored an amendment to the financial bill that would have incorporated the Volcker rule with all of its original restrictions.
The White House, after resisting, signed on to the proposal, and so did Congress after much internal wrangling —
but the legislation now contains what Mr. Volcker considers an annoying and potentially dangerous loophole.
Instead of forbidding banks to make investments in hedge funds and private equity funds,
the amendment allows them to invest up to 3 percent of their capital in such funds,
so long as the fund is “walled off” from the bank in a separate subsidiary.
Banks won’t be allowed to leverage their investments by lending to a hedge fund;
such a loan, if sizable enough, could endanger the bank if the hedge fund should fail.
We’ll see how “tough” the regulators are on this part of the “reform.”
In addition, if regulators discover that a bank is overexposed to a given fund, they are required to intervene
and, in some cases, may even be able to shut down the fund or restrict its activities,
in order to preserve a bank’s well-being.
Maybe. In some cases. We’ll see. We’re dubious.
And for a change, we’re not the only ones.
The lending restriction is not as clear-cut as it should be, cautions Senator Merkley,
according to this outstanding but largely ignored piece in the New York Times
“We have to get some clarification on that,” he says.
Nor is it clear that a bank wouldn’t try to come to the aid of a hedge fund
or a private equity firm in danger of failing
if that failure would also cause financial or reputational problems for the bank.
Gee, I wonder who’s going to determine THAT – AIG “bailout”, anyone ???
Once again, for a change, we’re not the only skeptics in the crowd.
Henry Kaufman, a Wall Street economist and a contemporary of Mr. Volcker –
who, long ago, was known as the one single individual outside the Fed who could set interest rates –
wonders how effectively regulators will enforce any of the bill’s numerous mandates.
Yeah, now – once nobody reading this has the slightest idea who he is or was – he decides to open his mouth.
“The legislation is a Rube Goldberg contraption,” he says –
using our VERY words for both the health “care” and financial “reform” measures –
“and there are very long timelines before the Volcker rule is fully implemented.”
Good point, Henry.
Too bad no one on Wall Street – where your words were once considered oracular – bothers to listen to you anymore.
Given his newfound conscience, it’s hardly surprising Volcker has had a lukewarm relationship with the Obama White House,
where the approach to the economy and financial regulation has been dominated
by Timothy F. Geithner, the Treasury secretary, and Lawrence H. Summers, director of the National Economic Council.
Both men were at the center of the deregulatory whirlwind that swept across Wall Street and Washington over the last decade or so –
and analysts have considered them to be friendlier to Wall Street and less inclined to pursue tougher regulations than Mr. Volcker would be.
Mr. Volcker supported Mr. Obama in the 2008 presidential election,
and the new president named him to lead his Economic Recovery Advisory Board,
a group of distinguished outsiders with little real impact on White House policy —
until Mr. Volcker publicly proposed the ban on proprietary trading by commercial banks.
After the proposal gained support outside Washington, the president embraced it and dubbed it the Volcker rule.
That gave Mr. Volcker more access to the White House and the Treasury on regulatory policy,
but people who work with him say that the White House doesn’t regularly seek his input on other issues.
Which, we guess proves that maybe his “cover your rear” silences –
which were disastrous for the country and the world –
nevertheless WERE necessary for him to keep his various, high-prestige jobs.
And people wonder why the US is in such horrific shape.
When it comes to a final assessment of the financial legislation,
Mr. Volcker says he remains less than impressed.
“We have to have a regulatory system that reflects today’s problems and tomorrow’s potential problems,” he says.
“This bill attempts to do that. Does it do it perfectly? Obviously it does not go as far as I felt it should go.”
Well, it’s good you FINALLY said something, Paul.
See you at Reunions – maybe ;-).
David Caploe PhD
Editor-in-Chief
EconomyWatch.com
President / acalaha.com
