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Guest Post: "Dear Mr. Volcker: It’s the Banks, Stupid"

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Guest blogger and former Congressional staffer Lune was kind enough to provide this post on Volcker’s testimony before the Senate Banking Committee today. Enjoy!

From Lune:

Paul Volcker, former Fed chief and currently the head of President Obama’s Economic Recovery Advisory Board, and the chairman of the Group of Thirty, testified to the Senate Banking Committee in today’s hearing on the U.S. financial regulatory system. As summarized by the NY Times, Volcker made the following recommendations:

Mr. Volcker called for the end of the mortgage lending giants Fannie Mae and Freddie Mac as hybrid public-private enterprises, saying instead that Washington should assist borrowers through “clearly designated government agencies.”

He also called for the registration of hedge and equity funds of any substantial size, as well as periodic reporting and disclosure from such firms.

For banks and other firms that are large enough to shake the entire financial system if they fail, he called for “particularly close regulation and supervision, meeting high and common international standards.”

There were other ideas discussed as well:

Among the ideas considered Wednesday was the creation of a super regulatory agency, perhaps within the Federal Reserve, which would be charged with coordinating responses among the diverse alphabet-soup of agencies overseeing financial companies….

House Financial Services Committee Chairman Barney Frank has said the first priority in overhauling financial regulation is to set up an entity to oversee systemic risks of the kind that wreaked havoc on Wall Street last year.

Mr. Volcker’s recommendations are largely drawn from the Group of 30′s report which lists the following core recommendations:

1. Gaps and weaknesses in the coverage of prudential regulation and supervision must be eliminated. All systemically significant financial institutions, regardless of type, must be subject to an appropriate degree of prudential oversight. (Recommendations 1 through 5.)

2. The quality and effectiveness of prudential regulation and supervision must be improved. This will require better-resourced prudential regulators and central banks operating within structures that afford much higher levels of national and international policy coordination. (Recommendations 6 through 8.)

3. Institutional policies and standards must be strengthened, with particular emphasis on standards for governance, risk management, capital, and liquidity. Regulatory policies and accounting standards must also guard against procyclical effects and be

4. consistent with maintaining prudent business practices (Recommendations 9 through 12.)

5. Financial markets and products must be made more transparent, with better-aligned risk and prudential incentives. The infrastructure supporting such markets must be made much more robust and resistant to potential failures of even large financial institutions. (Recommendations 13 through 18.)

While Volcker’s proposals are reasonable, they fail to deal substantively with one of the primary reasons for the regulatory failures we have seen so far. Those failures have not been from the lack of statutory authority invested in such agencies as the Fed and the SEC, but rather the lack of will to exercise that authority.

The Fed already has broad authority to investigate banks and supervise lending standards. And the SEC has ample jurisdiction to investigate such scandals as the ongoing Madoff affair.

Yet both have been asleep at the switch. As a previous article in this blog noted, Greenspan blocked proposals from his own Fed Governors to investigate predatory lending well before the current crisis (quoting from the WSJ):

Edward Gramlich, who was Fed governor from 1997 to 2005, said he proposed to Mr. Greenspan in or around 2000, when predatory lending was a growing concern, that the Fed use its discretionary authority to send examiners into the offices of consumer-finance lenders that were units of Fed-regulated bank holding companies.

“I would have liked the Fed to be a leader” in cracking down on predatory lending, Mr. Gramlich, now a scholar at the Urban Institute, said in an interview this past week. Knowing it would be controversial with Mr. Greenspan, whose deregulatory philosophy is well known, Mr. Gramlich broached it to him personally rather than take it to the full board.

“He was opposed to it, so I didn’t really pursue it,” says Mr. Gramlich, a Democrat who was one of seven Fed governors.

Similarly, the Madoff affair, including today’s testimony of SEC officials before Congress, shows the extent to which the SEC outright ignored whistleblowers’ information and attempts to get the agency to investigate gross abuses.

In today’s crisis mode, there is virtually no limit on the government’s ability to intervene in the financial industry. Yet we’re still getting bad proposals such as the TARP and the bad-bank models which commit trillions of public funds to Wall St. with no significant reform of the practices that got us in our current mess. This is not due to a lack of authority to create a better response.

Mr. Volcker and the Group of 30 are correct that we need to reform the regulatory structure. But the problem today isn’t so much with the structure itself as the fact that that structure is so thoroughly captured by the industry it’s supposed to regulate, that any authority vested in it becomes toothless.

In particular, the creation of a “systemic risk” regulator smacks of trying to isolate all the bad-cop duties of the regulators into one underfunded, powerless authority so that the rest of the agencies don’t have to do the unpleasant task of standing up to the banks when they get too big. That way, they can focus instead on serving as boosters for the industry that they will lucratively enter once their terms in government are over.

Who will stand up for the systemic risk regulator, and give it real power and influence? No one in Congress will ever get campaign contributions serving as the protector and benefactor of a regulatory agency whose sole purpose is to say “No”. Especially when by definition, the systemic-risk regulator will have to say “No” to enormous financial players with lots of money available to spend on extensive lobbying.

It is telling that in the case of financial firms that are so large and entrenched that they become Too Big To Fail, Volcker can only suggest “particularly close regulation and supervision, meeting high and common international standards.” Pardon me, but I thought that was what they were supposed to be subjected to right now. Why haven’t they been, and what in Volcker’s recommendations will actually succeed in doing it in the future?

While structural reforms are necessary, I assert the real answer to preventing the next crisis is to prevent any one firm from becoming Too Big To Fail in the first place. The advantages to the financial system of creating giant banks, aside from the stratospheric executive compensation that follows, appear to be nil. Indeed, most of the Too Big To Fail banks in this world are insolvent, and rapidly taking the world’s economy and governments with them. Eventually, most of them will be brought under (de facto if not necessarily de jure) public receivorship, broken up, and sold as parts.

We should use that opportunity to make sure they stay as parts, and don’t re-assemble into Citi-sized godzillas again.

Volcker took a courageous stand as Fed chief when he raised interest rates to stamp out inflation, even at the cost of real economic pain. And similarly, he has been one of the few inside-the-beltway economists who quickly realized the magnitude and dimensions of the current economic crisis. He should call up that courage once again and use his considerable reputation and influence to force the current goliaths to disassemble from their current Too Big To Fail sizes. Otherwise, all his reasonable recommendations on regulatory reform will be quickly made toothless by the financial industry and the government officials who serve it.

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37 comments

  1. Anonymous

    He did say in his verbal statement that the Fed may have been reluctant or unwilling to exercise as necessary its prerogatives to regulate the banks

  2. alexblack

    I am tremendously inspired by Mr.Volcker’s courageous call for large banks to be supervised. So inspired in fact, that as I have been sitting here watching thugs stealing my automobile, beating my dog, and raping my daughter, I now fully intend to write a very harsh letter to the editor of my local newspaper, likewise declaring that this sort of thing must be regulated!

    I thank you, Mr. Volcker. Your example has moved this man to action!

  3. Lune

    That’s true, and therein lies the issue: how do you get the Fed to exercise those prerogatives? Even today, with the entire global financial system disintegrating before our very eyes, we can’t get the Fed or the Treasury or the SEC to use their current powers. If the current people won’t use their powers now, during such a crisis, how does Volcker expect them to use their powers during more normal economic times?

    Our elected officials are too afraid to ask bank executives to accept a “mere” $500k / yr salary when probably 90% of the population would enthusiastically vote for the first Congressman who proudly displays a bank CEO’s head on a spear in his office. Do you think they’ll have more resolve when the electorate is not so anti-bank-industry?

    That’s the crux of the matter.

  4. Don

    “We should use that opportunity to make sure they stay as parts, and don’t re-assemble into Citi-sized godzillas again.”

    When Wachovia got in trouble, the FDIC called in Citi. When TARP was passed, Wells-Fargo used the TARP tax provisions to enter the bidding process and won.The tax provisions were to encourage private takeovers. When Lehman was failing, I believe the B of A and Barclays were called in. In other words, the process is to sell failing banks or investment firms to larger ones, presumably because they have the resources to buy them or take them over. What would happen in the future?

    I’m no expert, but this is the only solution that seems to avert a reversion to the above scenario:

    http://blogs.ft.com/wolfforum/2009/01/putting-an-end-to-financial-crises/#more-315

    “With the government ready to absorb losses, banks are talking outrageous risks knowing that Uncle Sam will cover them if things go south. Raising the trivially low capital requirements of banks, as Paul Volker’s Group of Thirty Commission just proposed, won’t change this behaviour.

    What will change this behaviour is to not let it happen. Banks should be allowed to initiate only conforming, i.e., government-approved, AAA-rated mortgages and business loans. These would be long-term, fixed-rate loans with 20 per cent-down and payments below 25 per cent of income.

    The government, via the Federal Financial Authority, would use tax records to verify loan payment-to-income ratios. It would also spot check collateral. Once approved, the banks would bundle and sell “their” loans within mutual funds.

    Again, traditional bank runs wouldn’t arise. And today’s bank runs, which entail lenders and equity investors avoiding risky banks, wouldn’t either. Why? Because banks would bear zero risk. Mutual fund owners would bear risk, but not the banks. And these lenders would know they were buying government-approved AAA-rated loans, not Bear Stearns‘ CDOs.

    This limited purpose banking is a modern version of narrow banking proposed by Frank Knight, Henry Simons, and Irving Fisher. Banks would hold deposits, cash checks, wire money, originate loans, and market mutual funds, including money market funds with no guarantee of par value redemption.

    With limited purpose banking, financial crises would largely disappear. Banks would never fail, never stop originating loans, never expose the public to massive liabilities, and never see their stock values evaporate. Banks would be stable, boring economic cogs – like gas stations.

    The Fed would also gain full control of the money supply. To expand the money supply, the Fed would continue buying treasuries from the public and supplying cash. But banks wouldn’t be multiplying and contracting M1 (cash plus demand deposits) based on their ever changing decisions about lending deposited funds.

    Milton Friedman, who also advocated narrow banking, blamed the Depression on the Fed’s failure to offset the M1 money multiplier’s collapse. In the past year the M1 multiplier has contracted by over 40 per cent, forcing the Fed to double base money. If the multiplier shoots back up, we could see the money supply and prices explode.

    What about investment banks, brokerage firms, hedge funds, and insurance companies? What’s their right financial order?

    Again, regulate to purpose. Investment banks take companies public and assist in mergers and acquisitions. They shouldn’t be permitted to invest in their clients’ companies. Brokerage firms are here to help us buy and sell assets, not to gamble on spreads. Hedge funds are here to help limit risk exposure. They aren’t here to insure these risks themselves. Finally, insurance companies are here to diversify risk, not write insurance against aggregate shocks.

    The FFA and “less is more” limited purpose banking won’t prevent asset markets from occasionally going nuts. But the functioning of financial markets will no longer be in question. Nor will con artists, parading as “financial engineers,” ever again be free to wreak havoc on the nation’s finances and its citizenry.

    Christophe Chamley is a member of Boston University and the Paris School of Economics. Laurence J. Kotlikoff is professor of economics at Boston University”

    Unfortunately, no FT experts ( I’ve sent in a few comments by mistake, and now just for the pleasure of having someone guffaw at my venturing an expert comment )responded to this idea on Economists Forum, so I didn’t get any sense of how possible this would be.

    This only deals with the banks, and bubbles and market distortions could still occur, but it seems that we have to be talking about this kind of change going forward. Given how well the banks have lobbied so far, I don’t see tinkering as anything more than a bump in the road for big banks.

    Don the libertarian Democrat

  5. killben

    “While Volcker’s proposals are reasonable, they fail to deal substantively with one of the primary reasons for the regulatory failures we have seen so far. Those failures have not been from the lack of statutory authority invested in such agencies as the Fed and the SEC, but rather the lack of will to exercise that authority”

    Exactly…

    WHO IS GOING TO BE THE PARTY POOPER?
    WILL THE PARTY POOPER BE HEARD?
    HOW IS THIS GOING TO BE ENSURED?
    WILL THE REGULATOR WHO DID NOT HEAR THE PARTY POOPER BE SACKED IMMEDIATELY?
    WILL THE GUYS WHO CREATED THE PARTY BENIGNLY WATCHED OVER BY THE REGULATOR BE PUNISHED
    HOW IS RESPONSIBILITY GOING TO BE FIXED AND WHAT ACTION WILL BE TAKEN AGAINST THEM?

    It is not that nobody understood that this ponzi scheme was not sustainable … but nobody wanted to hear these party poopers basically he was shouted down.. and guys who created are walking away not only getting away scot-free but also laughing all the way to the bank … and what about the regulators who were party to the fiasco .. surprisingly they are still holding their jobs while innocent workers are being fired by the thousands .. what about some action on the people responsible for this mess from wall street and regulators

  6. Anonymous

    And Lune, I am coming to believe that the solution is to nationalize the entire banking industry permanently.

    So far, temporary nationalization has been discussed as a way to remedy the immediate problem of bad assets and careening "balance" sheets.

    But we cannot ignore that this industry has been able to overpower and dominate every single institutional check and balance in our society.

    They used their influence to:
    - overturn Glass-Steagall…a firewall so basic that even most conservatives and libertarians I've met would agree that it is an essential regulation. Didn't Milton Friedman himself acknowledge that WoD's regulatory reforms in the '30s were key in protecting the health of the financial system?

    -grow outside the mandate of regulatory agencies (with derivatives), by using Rubin et al to deny any agency the mandate

    -circumvent the regulatory capabilities of the SEC, simply by using political influence to ensure the agency never had enough funds to fully staff the department.

    And these are just three quick examples off the top of my head. If it's that easy…if all they have to do to circumvent oversight is to use their (revolving door) political influence to ensure that an agency's headcount budget doesn't grow with demand…then it's all over. There is no regulation, no amount of reform or oversight that can't be quickly, easily, and quietly overcome. At least Glass-Steagall's demise had a little publicity surrounding it…denial of growth in headcount ten years from now won't even make The Hill.

    And its not like this is a recent experience. We had the Savings & Loan crisis and the Keating 5…we had-oh what was that company back in the '90s-and then we had Enron and Worldcom and all the rest, egged on by the Wall Street analysts responsible for reporting on those very companies.

    And that's just the outright corruption. That doesn't even get in to ever-larger bubbles that seem to come in endless succession, ever since the '80s. Real estate…the Asian financial crisis…the dot com bust. Nor the fact that the industry essentially lobbied for end of the manufacturing industry (I'm mean, if we're going to be blunt).

    We keep hearing about how important it is to let the banking industry enjoy "growth and innovation" in the marketplace, but when you look at all the collapsed bubbles…how many trillions of dollars has this industry destroyed? How much wealth has evaporated into thin air since 1987?

    Why did Goldman Sachs apply for TARP funds and special credit lending facilities, and at the same time send out one of their analysts to my company, and demand that they use the financial crisis as an "opportunity" to downsize…even as my company was reporting yet another quarter of profits?

    Why did a guy at my work walk off our 24th floor cafeteria patio last week…after being told the company was considering layoffs?

    This is an industry that has lost it's "right" to exist.

    Obviously, we need a functioning, well-oiled banking system for a market economy. That doesn't mean that banking system itself has to a part of that market.

    Little of this kind of nefarious activity occurred between the late '30s and late '70s. But then there was a cultural shift. Culture influences institutions, and instituions influence culture. But in this case, a cultural shift has clearly empowered one industry to co-opt every institutional obstacle in it's path. Even on the brink of a very possible depression, the political sphere can't summon the will to tame it. They have become far, far too powerful, and I am beginning to strongly feel that we need to effectively end its existence as a market entity, simply as a means of self-preservation.

  7. doc holiday

    Ohhhh, this all just makes me puke green chunky goo, the color of money! What happens when you have a company like happy-faced Wal-mart that pushes an agenda to build stores — everywhere, where they are not — which is their evil corporate goal, which IMHO, was a large part of the massive collusive tsunami driver that helped push the wave of housing bubble expansion, aka, The Ownership Society (onto the beach).

    What happens when a Wal-mart Monster is too BIG to fail, because, they simply fall outside some invisible veil of regulation that didn’t exist, growing out of control, unregulated and supported by the powers that be. This type of cancer feeding strategy is not unlike all the asset-backed and linked shit attached to the Too Big To Fail and Now insolvent auto makers like GM and Ford, who play with derivatives (like cheap and easy candy) in the shadows and pretend that what they really do is sell cars, versus play Russian Roulette with a House Of Cards composed of off shore derivatives and off balance sheet casino chips.

    What was my point? Oh … yes, Volker and the 31 odd clowns may attempt to play catch up with regulations, but they are missing the point, if they just focus on one segment of this financial worm, and then cut that into smaller parts and then suggest that surgery on the tail will fix the head, or something to that end…

    Goodnight, bowing, stepping backwards, head down, really don’t care, nodding, sorry to intrude …

  8. Anonymous

    The mirror test for all finance and politicians I fear would fail, hard to see through all the cocaine residue.

    The hole Establishment has been corrupted to its very core, with a few token good types around as camouflage. Hell I would take a beneficial emperor/dictator over this morass of corruption.

    America, home of the scared shit-less, fleeced, divided by belief systems, beggar they own citizens (countryman), where everyone running around in circles are having the long range future ripped from them and now America will no long be able with a straight face proclaim any kind of moral high ground internationally EVER.

    Should the sunlight of truth ever shine in every corner of the system (Government, Wall Street, DJ) I fear the resulting cloud of blood suckers ash would result in blotting out the sun and commence the next ice age.

    Polygraphs for the hole rancid lot I say and in front of the world, for all to see. Then we may come to some conclusion about how to proceed into the future and recoup any dignity, we might have had.

    Skippy

  9. doc holiday

    Lune,

    Obama will certainly be re-elected if the White House Rose Garden has a collection of heads on spikes, sticks and sharp objects — from bankers and financial gurus that are too important to not keep in power, insurance criminals that didn't understand risk, auto executives that were unable to drive home honesty, oil tycoons that were just to slick and most of The Bush Coup & Crooks, along with all the nameless faces which will remain hidden in the sand … at The SEC, DOJ, FBI, DOL< FASB, etc…. oh shit, the coyotes are howling … gottah go!

    FYI: On 14 July, the insurgents set their eyes on the large weapons and ammunition cache inside the Bastille prison, which also served as a symbol of tyranny by the monarchy. After several hours of combat, the prison fell that afternoon. Despite ordering a cease fire, which prevented a mutual massacre, Governor Marquis Bernard de Launay was beaten, stabbed and decapitated; his head was placed on a pike and paraded about the city. Although the Parisians released only seven prisoners (four forgers, two noblemen kept for immoral behavior, and a murder suspect), the Bastille served as a potent symbol of everything hated under the ancien régime. Returning to the Hôtel de Ville (city hall), the mob accused the prévôt des marchands (roughly, mayor) Jacques de Flesselles of treachery; his assassination took place en route to an ostensible trial at the Palais Royal.

  10. Independent Accountant

    YS:
    As long as Washington is dominated by Goldman Sachs, no regulator will do anything. I have long favored a limitation on bank sizes. Total US bank assets are about $14 trillion. My limit would be 1% of this for any bank holding company, or $140 billion. Further, if we are to have FDIC insurance, no entity which holds FDIC insured deposits could do anything other than hold mortgages, consumer credit and working capitial finance. No investment banking, trading, securities sales, insurance sales, no LBO loans, no structured finance department, no off balance sheet nothings and no lobbying expenditures. Don’t like it, don’t hold FDIC deposits.

  11. Independent Accountant

    Doc:
    You are correct. There were only seven prisoners in the Bastille at liberation. How many people would the peasants “liberate” with a successful march on 85 Broad Street?

  12. Steve

    Ah, but there’s always an argument to let the good times roll. `Too big to fail’ lost out to international competitiveness. Glass Steagall lost out to synergy. Market transparency lost out to customized instruments. Sane leverage ratios lost out to risk dispersal.

    In the US, business makes a simple offer to the politicians: I make money, you make money.

  13. jyoooo youuu dahh bombbb

    I’m sorry….I love this blog but Volcker did address to big…

    “When is enough, enough?”

    I think you could tell where he stood.

    He cannot make congress do anything but his message seemed clear to me.

    I will admit I admire Volcker greatly so I might be biased.

  14. ndk

    You are correct. There were only seven prisoners in the Bastille at liberation. How many people would the peasants “liberate” with a successful march on 85 Broad Street?

    I have a deep, dark confession to make. When I spent Christmas in Manhattan, I made a special pilgrimage on Christmas Day down to 85 Broad Street specifically to spit on the sidewalk. It earned me a prompt whack on the shoulder and a loud cry of, “Ne-i-to! Bad behavior!” from my Japanese travel companion, who was completely unaware of my intent. It was worth it.

    I also tagged Fitch, albeit with a little contrition because they were the least bad of the major ratings agencies.

    It’s mostly damning of what indignation has come to in our modern America, but I did feel a little better. I’d take it back if they swore off all Fed/FDIC backing and returned the TARP, and I mastered reliquification of evaporated expectoration.

    But if I’m that frustrated, with my sympathies for the unpleasant job bankers do, I really do wonder if popular uprisings are possible here. I’m not sure whether I’d join a protest or not. But judging by the mood, a reasonable majority of the populace would.

  15. Anonymous

    ndk,

    A reasonable portion of the populace is addicted to the tv and the talking heads therein. This is not the story they are being given. If they protest it will be against the hate-of-the-day victim.

    jaded, yes….

  16. Anonymous

    I will gladly leave my $500K+/year job to oversee the financial institutions and publicly traded companies. All I need is $200K/year for the rest of my life.

    It will be a bargain for the U.S. taxpayers. While I will substantially reduce my total earning potential (I’m still young), my personal enjoyment would more than make up for that fact.

    –Griff

  17. Anonymous

    “Now, let me say this,” Obama said. “In the past few days, I’ve heard criticisms of this plan that frankly echo the very same failed theories that helped lead us into this crisis in the first place — the notion that tax cuts alone will solve all our problems, that we can address this enormous crisis with half steps and piecemeal measures and tinkering around the edges, that we can ignore fundamental challenges, like the high cost of healthcare, and still expect our economy and our country to thrive.

    “I reject these theories,” he continued. “And, by the way, so did the American people when they went to the polls in November and voted resoundingly for change.”

    Obama also sought to sway public opinion in his favor through his newspaper column, reiterating many of the same points.

    “In recent days, there have been misguided criticisms of this plan that echo the failed theories that helped lead us into this crisis — the notion that tax cuts alone will solve all our problems,” Obama wrote.

    That was a clear jab at Republicans, who have an alternative proposal to jump-start the economy that depends primarily on tax cuts.

  18. Anonymous

    @ Doc,

    I am a MAD gardener and I do mean MAD, when pruning, it is always prudent to cut back hard to stimulate new growth and remove rot. Heads on spikes in the garden or lawn mum, not much for yard schlock, but what the hell lets start a new trend.

    @ndk,

    Its hard to see someone take that which is good/worthy for all and whore it for their repugnant carnal delights and leave us with the used condom of excessive risk for personal gain.

    @all,

    I’m still waiting to hear one person of authority or note, give a reason for all of this. It is just simply a criminal act beyond historical comparison (people are and will die, due to others criminal acts). Crimes against humanity/nation/treason/grand fraud must be brought, due process must occur, sentencing pronounced or nothing will change and we will be lessor for it.

    If we allow this massive crime against the people of the US and World go unchecked, what will the next crime be, do serial killers stop because of a close call with the law, no they just lay low for a bit and then start all over again with a vengeance.

    Skippy

  19. Anonymous

    I think even only a slightly more than cursory investigation of the Federal Reserve will reveal that it was brought into existence at the behest of the big banks it is now supporting precisely so that they could engage in this sort of reckless behavior and keep the massive profits therefrom. It has worked like a charm (for the executives of those banks, of course.)

    The only way to stop them is to repeal the Federal Reserve act. No, that is not throwing away the baby with the bath water. The Fed IS the putrid bathwater. That’s the only way to save the baby (the US economy) from this recurring abuse.

  20. donebenson

    I think the tone of the article, and the response of most comments, is trying to blame Volcker for failures of human nature. For those of you who didn’t live through the 1970′s, with runaway inflation destroying virtually everything in its path, you cannot appreciate what Volcker did back then, and the intense criticism he received for having the backbone to do the right thing [very much unlike what Greenspan did].

    What this article seems to demand is that Volcker require only those with similar backbone and toughness be appointed as regulators. While I agree with that attitude in theory, how do you accomplish that in practice?

    What is being ignored here is the inevitability of Hyman Minsky’s stages of speculative finance. As Charles Kindleberger clearly points out, failure of regulation has caused numerous crashes and recessions in the past, and this will unfortunately continue to be the case in the future.

    For those of you who doubt Volcker’s frustration at the current level of politics in Washington, read today’s Bloomberg article entitled, “Volcker Chafes at Obama Panel Delay, Strains With Summers Rise.”

  21. Anonymous

    While I’m sure that better regulatory systems can be designed it is worthwhile to remember we got into this mess one mortgage at a time. Had those mortgages been made to credit worthy borrowers how they were sliced and diced would not be such an issue.

    That being the case then maybe the problem isn’t so much at the macro level but at the retail end of finance. The substitution of FICO scores and mortgage models over commonsense seems to be more responsible for the disaster that is allowing 2+ million homebuyers to default each year.

  22. Richard Kline

    Lune: ” . . . I assert the real answer to preventing the next crisis is to prevent any one firm from becoming Too Big To Fail in the first place.” I completely agree; politically, from the standpoint of common sense, and from my understanding of systemic or in complex systems such as that is.

  23. DoctoRx

    Lune

    Good for you! I’d look forward to more posts from you.

    What do you or anyone think of the idea that systemically too-big-to-fail financial institutions should be prohibited?

    For those readers who don’t know the G30 story, here’s some info. The project director was hardly independent: Stephen Thieke, of RiskMetrics (you can guess what they do). Volcker was Chairman of the Trustees. Guess who was/is actually Chairman of the G30 itself: Jacob A. Frenkel. His job: Vice-Chairman, AIG. (!)

    Anyone interested in checking out how much of an inside-the financial industry story the G30 is can go to:
    http://www.group30.org/pubs/recommendations.pdf. Page 8 starts the list of participants.

    Re how to elimininate too-big-to-fail financial companies:
    Nassim Nicholas Taleb (Black Swan author) propounds regulated or gov-owned depository institutions, and non-systemically important private pools of capital, the latter of which can do what they want while regulated to not tie into and thus cannot ruin the banking system (in the old-style sense of “Banking”. In other words, a John Paulson-type fund can get as big as it wants but if it loses a ton of money, then so be it. He also recommends banning all derivatives other than plain vanilla options.

  24. Anonymous

    I think that “asleep at the switch” is the wrong way of characterizing it. There are really two things that caused the SEC to not do their job:

    1) The classic “Cognitive Regulatory Capture”. They sympathize with the worldview of those that they are regulating, making them ineffective. There should be an adversarial relationship, not one filled with camaraderie.

    2) The Neoliberal/Econo-Libertarian agenda to wholly eliminate agencies has been unsuccessful, so the next best thing is to put people into these organizations who would purposely do nothing. This has been very effective. It’s a step beyond foxes guarding the hen house; in this case, the fox also runs the farm.

    It’s not incompetence or laziness. It’s willful, purposeful hands-off policies.

  25. Anonymous

    regardless of how this happened, it is a generational problem. The financial sector gained control and destroyed everything in its wake.

    Is there any doubt that financial sector “talent” is dangerous?

    They need to be given decent work like rebuilding the system under a new set of regulations.

    The chickens have come home to roost. Stock holders cheered with higher prices every time 5,000 -10,000 -20,000 people were fired.

    Let the financial ‘talent’ rebuild the industry on new rules and regulations. If they’re so talented let them work for their money for the public good.

    LeeAnne

  26. Anonymous

    Why do we hold the notion that banks should be engaged in two conflicting businesses? They perform the utility functions: savings, checking, business and construction loans… but on top of that they now indulge in speculative investments, chasing leveraged investments.
    As long as those two things are combined, we will always have the risk of speculative losses threatening needed utility functions.
    There could be government-guaranteed non-profit banks for the utility functions and also a seperate class pure investment houses – absolutely non guaranteed, come what may.

  27. JO

    There is room to improve things but nothing is as important as eliminating fractional reserve lending and the Fed, and take back control of the money and make it honest money.

    None of what Volcker said will really change anything. Also, gov’t intervention through “insurance” schemes such as FRE/FNM need to go because they helped contribute to the mess in a big way.

  28. "DoctoRx"

    Agree w LeeAnne (again)

    Or, since it’s time the layoffs really affect the financial sector, which is bloated, they can gamble with their own money.

  29. Benign Brodwicz

    Small is beautiful not only from a regulatory viewpoint, but as The Economist pointed out in a survey of banking a couple of years ago, there are no efficiencies to mergers that create entities bigger than about $20 billion in assets–it’s all about executive comp following the log of assets.

  30. Anonymous

    I assert the real answer to preventing the next crisis is to prevent any one firm from becoming Too Big To Fail in the first place. The advantages to the financial system of creating giant banks, aside from the stratospheric executive compensation that follows, appear to be nil.

    I agree 100% with this.

    And it reminds me of all the worry domestically about how U.S. banks were becoming small frys compared to the big banks of Asia and Europe. It was nothing but penis envy that moved the U.S. toward the oversized-and-insolvent banks we have today. And we now have the associated social disease.

  31. K

    Yves:
    You and many of your readers seem to have a flair for physics. This analogy may be fun.

    Before the special theory of relativity, people struggled with existence of ether, how Maxwell’s equations would be from the point of view of a moving object, etc. Once Einstein postulated (1) laws of physics are the same from the points of view of two observers moving uniformly with respect to each other, and (2) the speed of light is the same for all such observers, the nature of space-time became so much clearer that the previous confusions and many questions melted away.

    Similarly, we are struggling with questions about bank bailout. Let us accept the following two postulates (1) It is the banking system, not any individual bank that needs to be saved, and (2) Every institution is fully responsible for the consequences of its conduct. I believe much of the confusion melts away.

  32. tyaresun

    The posters here represent minority opinion. My collegues at work have been happily buying bank stocks through Dec.-Jan. in their personal accounts. And yes, we are a modeling shop, building credit risk models among other things.

  33. Zeitgeistbeliever

    @ Anon 4:56′
    The only way to stop them is to repeal the Federal Reserve act. No, that is not throwing away the baby with the bath water. The Fed IS the putrid bathwater. That’s the only way to save the baby (the US economy) from this recurring abuse.

    I COULDNT HAVE SAID THIS ANY BETTER….!
    @DON
    How can ask FED(a private corp of international banks)to REGULATE the BANKSTERS and MONEYCHANGERS THAT GOT US INTO THIS MESS!!!!!!
    OVERTURN THE FED RESERVE ACT! ALL AMERICANS EDUCATE YOURSELF AS TO WHATS GOING ON THIS COUNTRY!!!!!!!!!!

  34. Anonymous

    It took no great courage for Volcker to sacrifice us. He, like Greenspan, turned a blind eye while the problem was created and the banking class benefitted, then squeezed the resulting inflation out of the rest. One group benefits and is bailed out. Another group, who did not gain most of the benefit, bears most of the pain. The bankers will get another bonus when they buy up assets after we have another “jobless recovery.” The Fed works for the big banks. The big banks buy congress. The Fed needs to be nationalized and so does the congress.

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