Former Fed Chair Paul Volcker reiterated some of his concerns about the Fed’s recent moves and the evolution of the financial system in prepared remarks before the Joint Economic Committee of Congress. From the WSJEconomicsBlog:
“Whatever claims might be made about the uniqueness of current circumstances, it seems inevitable that the nature of the Fed’s response will be taken into account and be anticipated, by officials and market participants alike, in similar future circumstances,” Volcker said ….
The Fed, he said, “felt it necessary to extend that safety net” to systemically important institutions by “providing direct support for one important investment bank experiencing a devastating run, and then potentially extending such support to other investment banks that appeared vulnerable [to] speculative attack,” Volcker said.
“Hence, the natural corollary is that systemically important investment banks should be regulated and supervised along at least the basic lines appropriate for commercial banks that they closely resemble in key respects,” he said…
He said heavily “engineered” financial markets, using sophisticated mathematical models, led to “enormous complexity” and “opaqueness” in markets.
“In the process, close examination of particular credits with respect to risk has too often been lost; the subprime mortgage is only the leading case at point,” Volcker said. “This new system has failed the test of the marketplace.”
Volcker said the Fed’s role in banking and financial supervision “should be recognized more clearly than in present law.”
“Specifically, direct and clear administrative responsibility should lie with a senior official, designated by law” Volcker said, and more staffing at the Fed will be needed.
Given the global nature of markets, Volcker said reform can’t proceed in a vacuum and urged cooperation with the European Union and Japan, citing past successes in developing bank capital requirements, accounting standards and settlement procedures…
He also warned that initiatives by the Fed and other central banks to boost liquidity in mortgage-backed securities markets raise public policy questions. Central banks, he said, have become “supporters of the mortgage market.”
And he questioned the role of government-sponsored enterprises such as Fannie Mae and Freddie Mac during the recent turmoil in mortgage markets. “Where were Fannie Mae and Freddie Mac?” Volcker said.
“What kind of system do we have” when agencies charged with the public interest in housing are instead “out serving the interests of their shareholders?” he added.