Volcker Calls for Regulation, Questions Loyalties of GSEs

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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.

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  1. Peripheral Visionary

    The simple problem with any effort to reform the Federal Reserve is that they are currently viewed (by the markets and also by themselves) as the saviors of the economy. Not until the Fed is exposed as being unable to control the economy will any calls for reform gain traction.

  2. eightnine2718281828mu5

    Frome June 3, 1987; prescient.

    President Reagan, in a short appearance at the White House briefing room, said he had accepted Mr. Volcker’s decision ‘with great reluctance and regret’


    The main philosophical difference between Mr. Volcker, a Democrat, and Mr. Greenspan, a Republican, appears to be in their views of the structure and regulation of the banking system. Mr. Volcker has tended to resist deregulation of banks while Mr. Greenspan is more favorably disposed to it.


  3. Chicago Boss

    Bernanke = Moral Hazard Incarnate

    He will do all of the dirty work before being replaced. See, no more moral hazard!

    Just like in the movies…

  4. Anonymous

    “out serving the interests of their shareholders?”

    This country and it’s financial structure are hosed. Profit no matter how it is made is acceptable, a system for the rich by the rich. Politically, economical, socially and morally this country is bankrupt and a total collapse is what it will take to fix it. Any bandied that is used just to cover the rot for a short time and will not last. Both political parties are evil and equally responsible as are the American people who voted for them and allowed this to happen.

  5. Rory

    Volcker said. “This new system has failed the test of the marketplace.” It appears to me that the marketplace failed to test the new system. People buying securities that they didn’t understand with risks that they couldn’t gauge. Was it Warren Buffet or someone else who advised, “Don’t invest in businesses that you don’t understand”? A marketplace founded on ignorance cannot provide any useful regulation of risk or assessment of value. What can we do but try regulation?

  6. Richard Kline

    *wow* To me, this sounds like a major _revision_ of Volker’s position, using the same language and tone of voice. My impression of his earlier statements was that he felt that the Fed was operating beyond the firelight of its legal authorization and by so doing extending a dangerous and lasting blank check to the financial industry. True enough. Now, he seems to be saying, Let’s expand the legislation to get this undesireable extention of authority within the law and properly governed. If that isn’t a restatement, I couldn’t tell you what is. He doesn’t seem to like it anymore now than a few weeks ago—but he seems to accept it.

  7. Doug

    In a world where shareholder value fundamentalism reigns supreme, and the Fed’s single answer to all problems is to ‘save the shareholders of the capital markets’, why exactly should we condemn GSEs for using shareholder value as the trump card for all strategies and choices?

    The executives and other employees of the GSEs have chosen this new orthodoxy. This is what they, as people, believe in and stand for. It is core to their character as people and as Americans.

    And, it is the rule, not the exception, for most executives and other employees in the vast majority of companies.

    Any who believe in changing this had better get used to the challenge of getting people — in their role as executives and employees — to make some core shifts in values.

    Can regulation help? Yes. Can criminalization help? Yes.

    But, it will take more than either of those to cause executives and employees to choose new strategies and approaches that remove shareholder value as ‘king of the hill’ and put it and other values on an equivalent footing as the basis for sustainable success in markets.

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