Volcker Criticizes Fed Bailout of Bear, Says US in a Dollar Crisis

Former Fed chairman Paul Volcker, speaking at the Economic Club of New York, took issue with the central bank’s controversial loan to JP Morgan to help it effect an acquisition of Bear Sterns. For Volcker, who has steered clear of saying much about current Fed policies, these comments are a coded rebuke. Things have gotten so out of hand that Volcker could no longer contain himself.

In particular, Volcker criticized the precedent of lending against collateral of dubious quality (the monetary authority’s practice in the past conformed with the Bagehot rule of lending against good assets at penalty rates).

From Bloomberg:

Former Federal Reserve Chairman Paul Volcker questioned the central bank’s decision to rescue Bear Stearns Cos. with a $29 billion loan, saying it was at “the very edge” of its legal authority.

“The Federal Reserve has judged it necessary to take actions that extend to the very edge of its lawful and implied powers, transcending in the process certain long-embedded central banking principles and practices,” Volcker said in a speech to the Economic Club of New York….

Volcker, the Fed chairman from 1979 to 1987, had implicit criticism for U.S. regulators and market participants who allowed “excesses of subprime mortgages” to spread into “the mother of all crises.” The Fed’s Bear Stearns loan was unusual, he said.

“What appears to be in substance a direct transfer of mortgage and mortgage-backed securities of questionable pedigree from an investment bank to the Federal Reserve seems to test the time-honored central bank mantra in time of crisis: lend freely at high rates against good collateral; test it to the point of no return,” he said…..

Volcker said the Fed’s loan may send investors the wrong message.

“The extension of lending directly to non-banking financial institutions — while under the authority of nominally `temporary’ emergency powers — will surely be interpreted as an implied promise of similar action in times of future turmoil,” he said.

Volcker said the modern financial system has “failed the test” of the marketplace. When asked whether he predicts a “dollar crisis,” he said, “you don’t have to predict it, you’re in it.”

The dollar has dropped 15 percent against the euro and 14 percent versus the yen in the past year.

Volcker’s critique comes as policy markers struggle to prevent the world’s largest economy from contracting, a prospect Bernanke himself raised last week. The International Monetary Fund today said the global losses from securities tied to commercial real estate and loans to consumers and companies may reach $945 billion.

“The bright new financial system, with all its talented participants, with all its rich rewards, has failed the test of the marketplace,” Volcker said.

As credit markets seized up, the Fed gave the 20 primary dealers in U.S. government bonds the same access to discount- window loans that had previously been reserved for banks. The central bank now auctions as much as $100 billion to lenders a month, and has cut the cost on direct loans to just a quarter- point above the overnight rate on loans between banks.

“The implications of these decisions, and the lessons from the unfolding crisis itself, surely deserve full debate and legislative review in the period ahead,” Volcker said…..

Volcker, 80, said the problems stemmed in part from trading of increasing complicated securities including derivatives that “have taking on a trading life of their own,” and said the turmoil “adds up to a clarion call for an effective response.”

`There was no pressure for change, not in Washington which was spending money and keeping taxes low, not on Wall Street which was wallowing in money, not on Main Street with individuals enjoying easy credit and rising house prices,” Volcker said.

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  1. Anonymous

    Volcker has no inside knowledge of the collateral quality. Neither does anybody else on the outside.

  2. Idaho_Spud

    Agreed, anon. Volcker cannot know this, as the Fed is deliberately being vague about the quality of the collateral, rather than fully transparent.

    Given the distrust that banks have lending to one another lately, and this lack of transparency on the part of the FED, what sort of quality should an outsider assume?

  3. S

    Greenspan made an interesting comment on CNBC this afternoon to the extent that te Fed doesn’t create money and that in essence the Fed and the TReasury are one. I belive those were his exact words.

    The new theme on Wall Street is write ups which will be yet another of the tropes (like Goldilocks, soft landing, V shaped, new paradigm, multiple expansion, expanding margins, dollar devaluation good etc…). The markets have become totally detached from reality. I belive it was Greenspan who also said today that our economy needs these highly leveraged instituions to be able to operate. Another very telling statement.

  4. Anonymous

    Volker’s language was quite precise — “questionable pedigree”, not “questionable quality.” Pedigree references ancestry and provenance, in other words, questionable in terms of what it is.

  5. TallIndian

    One doesn’t require extraordinary prescience to determine the quality of the collateral.

    The NY FED proclaims

    The portfolio consists of collateralized mortgage obligations (CMOs), the majority of which are obligations of government-sponsored entities (GSEs), such as the Federal Home Loan Mortgage Corporation (“Freddie Mac”), as well as asset-backed securities, adjustable-rate mortgages, commercial mortgage-backed securities, non-GSE CMOs, collateralized bond obligations, and various other loan obligations.

    All valued by BSC!

    And the NY FED actually states that even revealing the CUSIPS of these instruments poses a ‘danger to markets’!!!!!!

  6. S

    TallIndian said…

    Watching NY Fed G-man sqirm about when the disclosure would come was classic. Scarier still was watching Dodd play tough guy wink wink. Since when does the FEd get to tell elected Senate what they can and cant see. These guys are trusted with protecting the nations most “family jewels” and yet $30B (of a 12T economy) is too sensitive. The whole charade would be laughable if it weren’t so scary. The new democrats.

    Of course the morons on CNBC cheered his “artful” and “creative” answers. I wonder if Sir MArtin is officially on the Treasury payroll

  7. Anonymous

    I think Greenspan needs to be viewed with great suspicion, because he is in a position to have great knowledge of FBR, SEC, FTC, FBI government powers and uses, to a point where he is a threat to America.

    Greenspan has the ability to help his new shadow-bank hedge fund conartist employer manage to get around regulations, especially by ingenuity or stratagem. This is corruption and collusion and will ensure that Rome burns to the ground, with or without the help of Nero!

    See: The setup circumvented the red tape — Lynne McTaggart

  8. Anonymous

    Re: “nd the NY FED actually states that even revealing the CUSIPS of these instruments poses a ‘danger to markets’!”

    They did that in Florida with the blackrock also, with fund A and b…

  9. Anonymous

    another thing about CUSIPs, if you can’t see what they are, you can’t value them! Prove me wrong! They either do not exist or are worthless, and there is the possibility they are just words on the back of a napkin like a banker letter of credit that someone gave to a hooker, like Spitzer and then called it a million dollar loan.

    These shadow vehicles that have no pedigree have no value and that explains the lack of ownership, contractual obligations, CUSIPS and certifications, audit potential and thus the bottom line that these people should go to jail for false and misleading bullshit!

  10. Anonymous

    There’s been no evidence that the collateral isn’t of a quality that is acceptable under normal (published) discount window rules.

  11. Richard Kline

    So another shoe drops from the poison centipede which did for and buried Bear Stearns: “Another troubling aspect was that shortly after making an initial non-recourse loan to Bear Stearns, and indicating the funds would be available for ‘as much as 28 days.’ the Fed pulled the funding over the weekend. By doing so, the Fed itself forced the de facto collapse of Bear Stearns….” per John Hussman as quoted in a previous post here. That isn’t a public statement, but suggestive. It’s not that Alan Schwartz was too stupid to tell the difference between 28 days and 24 hours; evidently he had a deal (Thursday, 13 Mar? Friday??) from Geithner and/or Bernanke for the former, “subject to approval.” Higher ups disapproved, and reneged on the deal. Over the weekend. That would be Saturday, when Hank Paulson had the head of every ibank call him at home on his personal cell telling him “he must act to save ‘the system.’” Those same ibank heads who had slammed their counterparty windows to BSC on Thursday. And made Tim Geithner eat crow and his own words in the Senate hearings, denouncing any capital extension to Bear as “imprudent.”

    Why did Paulson cave? He wormed out of testifying to the Senate, and the ‘TV puppet’ senators didn’t subpoena him so we don’t know. I suspect, no way to prove it, that he faced a boycott from the other ibanks. They’d declared BSC dead, and told Paulson the toetag read DNR, they wouldn’t do business with Bear again, so giving BSC billions was just throwing public money into the black hole of bond holder and counterparty claims in bankruptcy. Instead, he should give _one of them_ public billions, and oh, by the way, make good on all their existing counterparty claims against Bear if he knew what was good for the Republic and the financial system. Recourse _to them?_ “Get real: you can’t do the deal without us, so forget that.” In such a situation, the public authorities would be powerless—as presently empowered.

    This is why we need the legislation and structures to nationalize damaged financial institutions by when they are still salvageable. At present the Fed has no legal authority to seize a concern not declared insolvent, and no authority to take over a non-member institution at all. Furthermore, the modus operandi of the Fed is not to take over such broken down outfits but to merge them with whole ones having provided backstops against losses. In effect, the Fed can’t run failed shops itself, and so is at the mercy of acquiring financial concerns in such circumstances: the acquirers can name their price. I’m sure they like it that way, hence no push from the industry for ‘powers of nationalization,’ of course not.

    If I line up the pieces of the busted airplane a-right here, then, the industry simply told Paulson what they would accept on the weekend of 15-16 Mar, and he said “Yes, sir; here’s the key to the vault, and I’ll take those plutonium derivatives home with me. Right away, sir.” This is certainly not the image that the public has of its financial regulating authorities, that they allow the plutocracy to write the terms of its own bailout . . . I mean, writing the terms of its own regulation was thought to be sufficient, hey?

    The longer I look at the Bear Stearns steal, the more odious it looks. But in fact, the Fed at least is over a barrel here. They need more powers to regulate, and to directly nationalize failing institutions to avoid industry greenmail in a crisis. Which is EXACTLY what I think has occurred, and may well occur more than once again this year. We won’t get such new tools from the present timorous invertebrates in the Congress, to say nothing of current Administration. Look for many tens of billions more to be siphoned off by the financial industry during the next twelvemonth. All they have to do is hold their breath until they turn blue.


    The true scandal of the Bear Stearns debacle, to me, is that the bondholders of this failed concern were made whole at public expense, and even worse were so cushioned by the deal stripping out risk from BSC’s book and dumping it on the public common. I take this as the substance of Volcker’s cry of disdain, and I agree. Sure, the equity holders at Bear were allowed to snatch a few handfuls of loose change from the till on their way out the door; that’s piffle. The bondholders and counterparties to Bear were explicitly kept toned, tanned, and in the money at par, while the radioactive alien corpses in Bear’s vault were loaded in a used car, covered with packing peanuts, and driven to an obscure parking spot behind the loading dock and the NY Fed. And it so looks like the ibanks have a ring in the Fed’s . . . appendage, and yes, they _will_ try to pull the chain and see if the geek spits out money again in the immediate future. It will take public money to salvage the national banking system; that’s unavoidable since in aggregate it has no capital left. But stakeholders in failed institutions must share the loss. Not so here.

    We don’t have ‘socialized medicine’ in this country because “it’s too expensive.” Might cost, well, $70 B per annum which is already committed to mega-yachts and private (in)equity. No, we only have socialized health care for financial concerns. And those uninsured citizen stakeholders (who are mostly children btw) have to pony up a co-pay even for what they qualify for; to teach ‘em, y’know, that there’s no free lunch and the value of a dollar. You have to be a plutocrat to qualify for a free lunch. Got that, kids?

  12. Anonymous

    There is ample evidence to suggest that this mystery collateral has been hidden in a secret transfer which allows for Level 3 assets — which are unobservable and thus unable to be marked to market, to be placed into a position of safe keeping, where no one can authenticate valuation.

    These securities obviously have no value and this charade to hide debt from crooks is false and misleading and smacks of corruption at the highest levels of government! This is absurd to force taxpayers to be connected to what amounts to drug money from pirates! Rome is burning and we have retards suggesting that secret and unseen collateral has value…..got lighter fluid?

  13. Anonymous

    “The bright new financial system, with all its talented participants, with all its rich rewards, has failed the test of the marketplace,” Volcker said.

    Volcker misunderstands the inherent logic of shareholder value/market fundamentalists. Free markets never fail. Quite the reverse. Free markets always succeed at solving every challenge they face. The only problem arises when government interferes with the free market. When that happens, government interventions fail. But the free markets and all that free markets create cannot possibly fail any test of a free market because free markets always succeed.

    The Fed’s awesome deal with JPM and BSC is simply more evidence of how free markets always succeed and never fail any test. The real problem Volcker should be addressing is the proposed interference by free-market-denying liberals who want to step in and provide help to homeowners in trouble. Typical of government meddling. They just don’t get that you’ve got to let the free market work its magic and if some folks get burned, that’s the price for our perfect free markets.

    Greenspan understood this. Bernanke understands this. Paulson understands this.

    Volcker really is sooooo 20th century.

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