The unique Paul Volcker

By Felix Salmon
July 19, 2010
John Cassidy's piece on Paul Volcker: it gives a great sense of how he's managed to use his independence to great and important effect.

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I like John Cassidy’s piece on Paul Volcker: it gives a great sense of how he’s managed to use his independence to great and important effect.

Certainly Volcker has achieved a lot since January 2009, when he refused to show up to support Treasury’s white paper on financial reform. Over the course of the rest of the year Volcker did a good job of distancing himself from the Obama Administration, and eventually, after Scott Brown won in Massachusetts, the Administration threw him a tasty bone.

The White House invited Volcker to come down for a meeting. On Christmas Eve, he had a long working lunch in the West Wing with Geithner and Summers, both of whom sensed that it was time for a policy switch. The financial-reform bill that had passed in the House in early December included an amendment from Paul Kanjorski, a Pennsylvania Democrat, giving the Fed the power to order individual banks to cease certain activities, including proprietary trading, if they were taking too many risks. Adopting Volcker’s proposal would go much further than that, and it would also serve an important political purpose. “We decided there was a way to do it that was O.K. policy and which had a bunch of tactical advantages,” the senior Administration official told me. “It would allow Volcker to align himself more fully with us. Because he was a little separate, people could project all sorts of things onto him. . . . They thought he was for all sorts of stuff he never was. That was damaging for the President, and it just wasn’t good strategy for us.”

The new language was quickly dubbed — by Obama himself — “the Volcker rule”, “thus associating the White House with a figure known for his independence and integrity”, as Cassidy puts it. There was lots of legislative jockeying thereafter, but the Volcker rule did manage to make it in to the final legislation, with some compromises.

This is surely a positive development, even if the rule has little practical effect. Cassidy happily parrots the official Goldman line that “at Goldman Sachs, proprietary trading accounts for about ten per cent of the firm’s revenues” — but that’s a completely made-up number, as far as I can tell. Goldman flacks were telling me straight-facedly a year ago that they had no proprietary trading at all; my feeling is that they upped their number from zero to 10% just so that it would be a little more credible, and so that they could claim to have made a substantive change when they drop it back down to zero again. The fact is that the majority of Goldman’s revenues come from its trading operations, and Goldman traders are using the bank’s own balance sheet to take positions. That looks and smells like proprietary trading, even if it’s covered by the fig-leaf that Goldman is acting on behalf of clients.

My guess is that any attempt to define proprietary trading is impossible, and that so long as broker-dealers have banking licenses, the Volcker rule will prove toothless. But it turns out that there’s more to Volcker than his eponymous rule: he’s managed to insert into the Dodd-Frank bill a brand new job at the Fed, as well.

[The] second vice-chairman of the Fed… will be explicitly responsible to Congress for financial regulation. “I think that might turn out to be one of the most important things in there,” he said. “It focuses the responsibility on one person.”

I like the idea of having a senior Fed official in Washington responsible for financial regulation. The job of president of the New York Fed has historically been the closest to that, but the New York Fed is prone to capture, and often thinks of itself as an intelligence-gathering operation, talking to the markets and acting as a conduit between Wall Street and Washington. That’s an important role, but it’s hard to wear that hat and the tough-regulator hat at the same time. So putting a tough regulator in Washington could well be very smart indeed — assuming, of course, that you pick the right person.

The problem, of course, is that the people in charge of financial regulation are, in Cassidy’s words, going to be “less independently minded men” than Volcker. People like Volcker are rare gems, and off the top of my head I can’t think of a great candidate for the second vice-chairman of the Fed, who would be able to muster internal support for tough crackdowns on profitable activities in the financial sector. The best I can come up with is Joe Stiglitz, but I don’t think he’s respected enough within the Fed. Any better ideas?

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