The Ascent of Volcker

January 21, 2010

So, wow, the Obama administration has reacted very quickly — perhaps too quickly — post the Massachusetts Senate election. After proposing a tax on bank liabilities, Obama is taking an even tougher line, adopting recommendations from Paul Volcker that banks be limited in their size and scope.

Before getting to specifics, it’s worth noting how Geithner and Summers appear to have lost favor. In the preamble to the proposal, Obama mentions neither of them. And when he announced the plan he did so with Volcker and Bill Donaldson standing behind him…Geithner and Summers were off to the side. Could the duo be headed for the exit?

But back to the proposals themselves. Unfortunately they are very vague:

1. Limit the Scope – The President and his economic team will work with Congress to ensure that no bank or financial institution that contains a bank will own, invest in or sponsor a hedge fund or a private equity fund, or proprietary trading operations unrelated to serving customers for its own profit.

In his prepared remarks, Obama called this first proposal the “Volcker Rule,”

2. Limit the Size – The President also announced a new proposal to limit the consolidation of our financial sector. The President’s proposal will place broader limits on the excessive growth of the market share of liabilities at the largest financial firms, to supplement existing caps on the market share of deposits.

These are good ideas, but until we see the details it’s hard to offer unconditional support.

The idea behind the first proposal is that since government insures bank liabilities, it must control bank assets. Bank liabilities are insured explicitly via deposit insurance and implicitly, for the biggest banks, via a general too-big-to-fail guarantee. Deposit insurance is the only one of those two that is defensible and its purpose is to protect the integrity of the payments system. Currently banks use this insurance to obtain cheap funding that supports risky side businesses, like proprietary trading.

But how will prop trading be defined? Will banks actually have to split up? Will they merely have to tweak their corporate structure?

As for the proposal regarding bank size, it doesn’t appear that there will be much to it. Banks won’t have to get smaller or even stop growing. Instead the new rules will just prevent bigger banks from making (any?) acquisitions. They’ll be able to continue growing organically. This probably isn’t enough to reduce systemic risk, unless other reforms can successfully reduce risk-taking. (Personally I think we should break up the banks into baby banks the way we busted AT&T into baby bells….so that none is so large as to be impossible to resolve in a crisis.)

It looks a little clumsy, putting out a plan this short on detail. That said, it seems to mark a clean break with the ridiculous policy that somehow protecting the banks protects America.

The real test for Obama’s leadership, by the way, will probably come if a substantive plan like this passes. Forcing banks to make big changes to their balance sheets will surely crimp the economy in the short-run as it makes it more difficult for banks to extend credit.

That’s not a bad thing. Either we do it proactively in order to contain risk, or we let the system blow itself up again. The latter course will lead to more credit destruction of course. But asking people to voluntarily subject to economic pain will be tough. Hopefully Obama sticks to his guns.


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The ascent of Volcker won’t matter much unless there is a corresponding ‘descent’ of Bernanke.

Posted by sangellone | Report as abusive

Remember Volker is a Neo Keynesian.

Posted by Geoffrey | Report as abusive

First let me state I am not a banker, republican or democrat. I am not a noted scholar, I am a retired, disabled 62 year old soldier, with a little common sense.

Presidents Obama’s idea sounds good up front but lets look a little deeper.

The heart of the American financial system is the banks. There is no such thing as a company that is to big to fail, not even in the United States. There are always people waiting in the wings to take advantage of failures. I dare to suggest that some rich middle eastern country would be happy to pick up the failure of America’s largest bank. Just look what they did not long ago they bailed out a whole country.

What did the market do when they heard about the proposed new taxes and regulations, it went down.

Now let’s look deeper into the subject. The United States dollar is the base currency of the world.

With President Obama’s announcement not only did the markets drop, the value of the dollar went down.

No big deal.

It was a big deal to many countries around the world. This in effect not only raised the price of oil for us but for the rest of the world, too. It also made many countries mad at the United States. Oh say China, Japan, Brazil, India, Canada, Mexico, and Australia, there are others. Just name about any country in the world. Especially developing countries.

Let’s look deeper at the largest developing country in the world and the largest lender to the United States, China. China imports 60% of its energy needs, oh boy, the largest exporter in the world cost of production went up. I do not think they are happy about the rise in price for their fuel.

I know, I am not happy because he just made the cost of my gas, electricity, food, entertainment, and clothes go up. Hey, what is the saying pass the cost on to the consumer, no big deal, right.

We still have not gone deep enough to see all the ramifications.

Let’s look at what will happen to the American banks if taxes are increased and more regulations are placed, only on the big banks, yeah right. What starts at the top of the hill rolls down, fact.

First tax revenues will increase for the government. A good thing, yes. Maybe. Let’s go deeper. More taxes a decline in revenue means less profit to the share holders, not a good thing. Also it will limit the amount of pay increases for the worker bee, not a good thing. Less money for the stock holder and workers equal less taxes paid to the government, not a good thing. Followed by lower value of the stock. Hence less investors in the company, not a good thing.

The tax increase on banks is the least of the problem. The new regulations would require the banks to get rid of it most profitable assets. This fiduciary function would move overseas, the bank would make less money hence lower taxes paid to our government, not a good thing.

The heir apparent for these fiduciary functions is Japan. So now Japan is both mad and is also licking their chops hoping the tax increase and regulations are passed. Oh how happy they would be to receive this profitable prize in their faltering economy.

The worst is yet to come, let’s go deeper.

Sometime last year Japan, China, Iran, India, Brazil, and Arabia had a secret meeting to discuss replacing the dollar as the base currency, to one of a basket type of currency. This means several currencies would be accepted as payment for oil and other goods whereas now, only the US dollar is accepted. The planned time line for this change is in about 10 years. This is to allow China and other large holders of the dollar to get out slowly, so as not send the currency market into a tail spin, causing a world wide depression. One sign that I will point to is that many countries around the world are purchasing large amounts of gold. I bet that the countries list above are among the largest buyers.

Which leads me to the conclusion, that the coming basket base currencies will be backed by gold reserve.

Do you still think the tax and regulations proposal by President is a good idea. If you do let’s go deeper.

From 1969 to 1974 Mr. Volcker served as under-secretary of the Treasury for international monetary affairs. He played an important role in the decisions surrounding the U.S. decision to suspend gold convertibility in 1971, which resulted in the collapse of the Bretton Woods system, established in July 1944. This took all gold and silver notes out of the system and replaced it with Federal Reserve notes.

In President Obama’s press release he credited Mr. Volcker with bring down double digit inflation in the 1980’s. This was a distortion of history.

Here is how it went down. In 1975 Jimmy Carter won the election beating Gerald Ford. Under his administration he managed to push inflation to 13% and created a stagnant economy. In August 1979 President Carter appointed Mr. Volcker to chairman of the board for the Federal Reserve. In November 1979 a new sheriff was elected, Ronald Wilson Reagan, the lion of conservatives.

His most famous line was “government is not the solution to the problem, it is the problem.”

Under his leadership he lowered taxes, lowered the inflation rate, which kick started the economy, and strengthen the military. I was serving at that time and remember the army had deadline weapons, truck, tanks, and aircraft for lack of money to buy spare parts. The rescue mission to free the hostages in Iran failed due to failure of equipment cause by no spare parts.

I will end with this thought, if the new taxes are passed and the regulations strengthened. The time line for the basket based currency can be cut in half. Then the props under the American economy will be kicked out and we will fall into a depression worse than the Great Depression.

Then we will become a third world country subject to the whims of the countries holding the basket base money.

Not a pretty picture but a true one.

Best regards. MSG(Ret) United States Army.

Posted by MSGret1 | Report as abusive

Volker is a monatarist…and he also,like Giethner, has it all wrong.

Posted by JC | Report as abusive

At the news conference announcing these, Volker was next to Obama; Tim & Larry were not there. I smell a changing of the financial guard coming soon… I’d wager that Geithner at least is gone, Summers possibly as well, and today a few more senators came out against Bernanke, and his reappointment might not make it past the Senate. These changes (and policy changes thereof) could have profound effects. As for me, I’m with Volker.. it’s time to enact some meaningful oversight for these banksters. Ultimately, Obama is a smart guy; this was a really good move in the right direction. Lets hope he continues on this path; he’ll need to apply these smarts come 2011 as I think deflation will begin to bite hard. By mid 2011, things like healthcare and cap/trade will be long forgotten, as will everything else except the economy. Obama started a year late, but I now have some hope we’ll get it right. 010/01/updatecomments-122.html

Posted by Mr.Kowakski | Report as abusive

Bernanke’s zero cost of funds policy is heroic. I work for the website and we have the hottest foreclosure story on the web right now. Also the most read job hunting story; both issues would be a whole lot worse if mortgages and small biz loans were done 300 percentage points higher

Posted by Voomie | Report as abusive

I applaud the steps that this administration is undertaking under the prodding of Paul Volcker. Adam Smith stated…where there is no moral framework, no ethical sensibility, the market ends up devouring all the other sectors and then devours itself. Paul Volcker
understands this and it is evident that most Americans do not.

It is unfortunate that so many Americans fail to take moral or ethical responsibility as beneficiaries of the very institutions they have voting rights to govern. American think that as long as stock prices and dividends continue to improve they can let critical thought rest as their mind drifts into the dilusion of considering themselves responsible citizens.

To conclude that the direction of the stock market is a confirmation that we are being governed wisely is foolish.

Ronald Reagan and his advisors were sadly incompetent when formulating and administering economic policy. The S&L crisis is a case book example of how men and women act on their own self interests without regard to the nations health. Ronald Reagan sowed the seeds of
economic failure and instituted up to then the largest “to big to fail” policy in modern history. Unfortunately our country continues to be consumed with this misguided and foolish economic theory. Our nation should instead deploy its financial and labor resources effectively. This is not a deep and complex concept to grasp and it is essential that we not only grasp but execute on it if we are to remain a sovereign nation.

Sovereignty is not an eternal gift granted by time to the citizens of any nation that refuses to act on their responsibilities. The value of the dollar will sink as long as America continues to think that other countries will continue to purchase our debt regardless of where their funds are being invested.

Posted by csodak | Report as abusive

The markets resposne is a good sign…it says that this is going to change the way banks make their profit.

The present system stinks. Investment banks getting bank status to get a credit line from the fed then hyper-leveraging their free money to make big bucks. Not a lot of skill to that!

Soros and Volcker are right. You need the right regulation that takes out the moral hazard. Investment banks should get their money from the Private sector and Commercial banks should get their money from the Fed(public). This way the Commercial Banks serve as a firewall between riskless funds and Investment bank speculation. And it forces IBs to speculate carefully because they have to invest a lot of capital and energy to convince investors in their magic. What could be wrong with that? This could be the first good policy from Obama.

As Winkler notes, the sacred cow theory of the financial markets is a lot of bull. A false belief. Because the financial system is not a free market, it is structured by government policy and regulation. That regulation needs to be changed. Adjust leverage margins to reasonable levels and pull the Fed’s capital subsidies from IBs.

This crisis was created by overleverage and the inversion of risk. So, put a cap on leverage and get the IBs back in the business of managing real risk. Simple, eh?

Posted by DrSavage | Report as abusive