Does Volcker give the Fed too much credit?

Jan 18, 2010 16:50 UTC

Paul Volcker’s speech to the Economic Club of NY last week (pdf) was generally reported as the latest example of the former Fed Chairman calling for more substantive financial system reform. He did repeat those points, but the focus of his speech was about the importance of the Fed maintaining its regulatory and supervisory authority over the banking system. At a certain point, this seems the stuff of absurdist theater. If the Fed never intends to use its regulatory authority, why insist the authority be maintained?

The problem with his speech is that while he acknowledges the Fed is badly staffed — mostly with economists/mathematicians, few from business/banking — he doesn’t address the clear failure on the part of the FOMC to 1) grapple with bubbles nor 2) to get serious about sensible reforms. He bemoans “reform light,” but that is precisely what the Fed is delivering.

Volcker wants tougher rules for derivatives trading, yet Pat Parkinson — the man Bernanke appointed as the Fed’s top bank regulator — has long favored a hands-off approach to derivatives. Volcker argues proprietary trading and other risky activities should be spun-off from commercial banks. It makes no sense for such risky activities to be backstopped by the financial system safety net — deposit insurance and last resort lending from the Fed. Yet Bernanke has done nothing to indicate he’ll separate the two.

Volcker is correct that the Fed should play a vital role in regulating the banking system. But this assumes the guys in charge actually use their regulatory power. Bernanke hasn’t done so. Instead he adopted his predecessor’s deregulatory zeal and penchant for bailing out the system.

Continuing the pattern of the last 25 years, the next financial market emergency is likely to be more disruptive than the last. The Fed has already lost so much credibility that when the next one hits, it’s not hard to envision it being neutered.

Is Fed’s choice tough enough?

Oct 23, 2009 19:44 UTC

An insider’s insider. That’s how Patrick Parkinson, the Federal Reserve’s newly appointed head of bank supervision and regulation, has been described.

A 30-year Fed staffer, Parkinson is a long-time defender of derivatives and an architect of Treasury’s proposal to give more regulatory authority to the Fed. His appointment is the latest indication that policy makers aren’t prepared to take bold steps to corral the banking sector.

Earlier this week, Bank of England Governor Mervyn King called it a “delusion” to believe regulation can prevent speculative activities from resulting in failures.

Like Paul Volcker, King says banks need to be split in half. The essential services they provide shouldn’t be polluted by risky investment banking activities.

American regulators, however, appear willing to settle for incremental reforms likely to perpetuate the status quo. Sheila Bair is intent on ending too-big-to-fail, but when I asked her at The Economist’s Buttonwood conference whether she would support policies to proactively shrink big banks she said: “No, I don’t know how we would do that.”

At the same conference, Larry Summers bemoaned the structural problems of banking, yet on policy he hedged: “Too-big-to-fail is too-big-not-to-be-regulated.”

Others, including Alan Greenspan, say too big to fail is too big to exist. (Greenspan, incidentally, calls Parkinson a “superb choice” for the job)

Daniel Tarullo, who heads the Fed’s committee in charge of bank supervision and with whom Parkinson will be working closely, also says regulation is the way to go.

If regulation is the path we’ve chosen, it would make sense to hire a strong regulator.

Yet “the credentials Parkinson brings are more political connections than supervisory savvy,” contends Fordham law professor Richard Carnell. “He’s the perfect senior staff insider to help cement the Treasury’s commitment to the Fed as systemic risk regulator. But does he have the savvy to supervise banks?”

A good question since bank regulation is an insiders’ game. “There’s no political constituency for bank soundness regulation until it’s too late,” Carnell says.

Good regulators lean against the wind, forcing banks to raise capital when times are good or restricting risky activities that put the system at risk.

Parkinson’s record suggests he’s unlikely to get tough on Wall Street. As Zero Hedge noted, Parkinson dutifully supported the Commodity Futures Modernization Act, which deregulated the derivatives market and sowed the seeds for last year’s systemic crisis. (A spokeswoman for the Fed declined to comment.)

This augurs badly. While Wall Street gets back to business as usual, Washington dithers with watered-down reforms that won’t interrupt the party. Those in charge have demonstrated a remarkable lack of courage in taking on the big banks. My hope is that Parkinson proves the exception to the rule.


Much worse than a 30 year old, the candidate is a 30 year “staffer” of the Fed.This is somewhat like handing command of the Navy, post Pearl Harbor, to a battleship admiral at the very moment your aircraft carriers have found the enemy fleet off Midway.

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