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).
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.