Paul Volcker (USA Former Chairman of the Federal Reserve) – THE FED AS REGULATOR CONFERENCE Keynote Address (Sep 2018)
Chapters
00:00:11 Paul Volcker's Contributions to Academics, Government, and Economic Stability
Introduction: Paul Volcker, a Princeton graduate and former colleague of the speaker, is being introduced as a distinguished individual who represents Princeton’s motto of service to the nation and beyond.
Princeton Ties: Volcker has close connections to George Washington University through scholarships and graduate fellowships. Princeton highly regards him as an exemplary embodiment of their motto, “Princeton in the Nation’s Service.”
Government Service: Volcker worked in the federal government for nearly 30 years, holding significant positions such as Chairman of the Board of Governors of the Federal Reserve System and Undersecretary of the Treasury for Monetary Affairs.
Economic Navigation: During his tenure as Chairman of the Federal Reserve, Volcker successfully guided the organization and the nation through a period of economic turbulence, including high levels of inflation. He is widely credited with ending the high inflation of the 1970s.
Post-Federal Reserve Career: After retiring from the Federal Reserve, Volcker held leadership positions in the private sector, including Chairman of Wolfensohn and Company.
Commission Leadership: Volcker has served as the chair of various prominent commissions, such as the Independent Committee of Eminent Persons investigating dormant Holocaust victim accounts in Swiss banks and the board of trustees of the International Accounting Standards Board.
Recognition: Volcker is highly regarded for his contributions to economic policy and financial regulation, both domestically and internationally.
00:02:58 Federal Reserve's Role in Financial Regulation
Background: Paul Volcker, former Federal Reserve Chairman and Chairman of the Board of Trustees of the Group of 30 and the Trilateral Commission, discusses the Federal Reserve’s role in financial regulation.
Volcker’s Alliance: In 2013, Volcker launched the Volcker Alliance, a nonpartisan organization focused on catalyzing new thinking and action related to federal, state, and local government in the United States.
Volcker’s Remarks: Volcker emphasizes the importance of human behavior in economic decision-making, stating that “behavioral economics” is about “human beings involved.”
Federal Reserve’s Role: Volcker highlights the Federal Reserve’s role as a bank regulator and its involvement in financial regulation.
Syracuse Debate: Volcker mentions attending a debate on behavioral economics in Syracuse, where he spoke about the significance of human behavior in economics.
00:05:35 The Federal Reserve's Role in Financial Stability
Volcker’s Key Points: Alice Rivlin emphasized that avoiding financial crises is now the central bank’s main job, which was the original intent of the Federal Reserve. Volcker strongly believes that the Federal Reserve bears significant responsibility for ensuring financial stability. The current regulatory system is outdated, with inconsistencies, overlaps, gaps, and lax oversight. Despite numerous attempts at reform, no significant changes have been made to the financial system. Volcker and his new Volcker Assembly are tackling this issue, inspired by recent proposals from the Paulson Treasury and the Bipartisan Policy Center. Dodd-Frank made some changes, but a comprehensive overhaul was rejected.
Challenges and Frustrations: Not everyone agrees with Volcker’s belief in the Federal Reserve’s responsibility for financial stability. Academic economics often overlooks the importance of financial markets. The current regulatory system is universally criticized, but attempts to reform it have failed.
Volcker’s Determination: Despite the challenges, Volcker refuses to accept that nothing can be done about the financial system. He believes the time is ripe for action and is working with the Volcker Assembly to address this issue.
00:13:08 Banking System Reforms: Decentralization and Accountability
Shifting Landscape of the Financial System: The financial system has undergone a significant transformation, with shadow banking now accounting for approximately 70% of the total financial landscape, while traditional commercial banking has declined to around 30%. The regulatory focus has primarily been on commercial banking, neglecting the expanding and less regulated shadow banking sector.
Rise of Enormous Financial Institutions: Individual financial institutions have grown to enormous sizes, leading to concerns about their manageability and potential systemic risks. The rapid expansion of banks, from restrictions on interstate banking just two decades ago to nationwide banking, has contributed to the growth of these large institutions.
Compensation Practices and Fiduciary Responsibility: Compensation practices in the financial sector have challenged the traditional concept of fiduciary responsibility, prioritizing short-term financial gains over long-term stability. This compensation structure creates incentives for excessive risk-taking and undermines the duty to act in the best interests of clients and stakeholders.
Overlapping Regulatory Turf and Political Influences: The regulatory landscape is fragmented, with multiple agencies vying for authority and protecting their turf, leading to a lack of coordinated oversight. Political considerations and lobbying efforts further complicate the regulatory process, hindering effective reforms.
Recommendations for Comprehensive Reforms: The Alliance for a Just Society has conducted extensive research and consultations to develop recommendations for financial reforms. The primary focus is to avoid concentrating banking and financial supervision solely in one organization, even the Federal Reserve. Centralizing economic and political power in a single entity raises concerns about the preservation of democratic principles and constitutional traditions.
The Role of the Treasury: The Treasury represents political authority and broad economic policy. Treasury’s involvement is crucial during crises, requiring cooperation, participation, and leadership. FSOC and the Office of Financial Research were established to formalize Treasury’s role. Criticism exists regarding the Treasury’s involvement and authority. Treasury should be involved but not in charge of the regulatory process.
Role of Agencies: Agencies are responsible for supervision and have expertise in their respective areas. Clearer definition of individual and collective responsibilities is needed. Overlaps, lapses, inconsistencies, and dispersion of checks need to be addressed. Building a strong supervisory staff with adequate pay and independent financing is crucial.
Role of Small Banks: The issue of special relief for small banks is complex and potentially dangerous. Expanding relief to small banks can lead to a slippery slope. Careful consideration is required before making exceptions. The Volcker Rule should be applied to all banks, regardless of size.
Mortgage Market and Insurance Business: The mortgage market is currently government-controlled. A privately run mortgage market is desirable but requires political consideration. The insurance business is not a central issue for regulatory reform.
Current Congressional Hearings: Ongoing congressional hearings on financial regulatory reform focus on minor aspects. Piecemeal changes may weaken regulation and supervision. Comprehensive legislation is needed to address systemic issues.
Challenges and Opportunities: The political climate is not conducive to major legislation, but it is a challenge worth pursuing. A well-crafted legislation can avoid ideological divisions and achieve success. The failures of regulation and supervision in the financial crisis provide a framework for reform.
Conclusion: Financial regulation needs to adapt to the changing nature of financial markets. Enhanced supervision of non-bank financial institutions is necessary. The Treasury should be involved but not in charge of the regulatory process. Comprehensive legislation is needed to address systemic issues and prevent future crises.
00:26:24 Rethinking Financial Regulation and Supervision
Background and Need for Oversight: Paul Volcker emphasizes the urgent need for adequate surveillance and oversight of the broader financial system, including non-traditional banking institutions. The Dodd-Frank Act created the Financial Stability Oversight Council (FSOC) and the Office of Financial Research (OFR) to address this need.
Reforming FSOC and OFR: Volcker suggests modifying the current FSOC and OFR arrangements to enhance their effectiveness. He proposes that the Treasury Secretary remains the FSOC chair but without voting power to ensure impartial decision-making. Volcker envisions FSOC’s role as a check against other agencies’ decisions and a consultative and oversight body.
Unified Supervision and Regulation: Volcker advocates for unifying supervision under a single agency connected to the Federal Reserve. He proposes separating supervision from regulation, with the Federal Reserve handling regulation and the unified agency managing supervision. This division aims to streamline supervisory functions and concentrate regulatory authority within the Federal Reserve.
SEC’s Role in Supervision: Volcker emphasizes the need to address the SEC’s limited role in supervising broker-dealers, which include prominent financial institutions. He proposes transferring supervisory authority over broker-dealers from the SEC to the unified supervisory agency.
Strengthening the SEC: Volcker suggests bolstering the SEC’s capacity and effectiveness in its core functions. He recommends combining the SEC with the Commodity Futures Trading Commission (CFTC) to enhance its capabilities.
00:31:41 Volcker Rule: Assessing Its Impact and Legacy
Volcker Report Overview: Paul Volcker highlights the need for a comprehensive report addressing the regulation of the financial industry. The report aims to strengthen supervision and investor protection, encompassing the responsibilities of the CFTC and the SEC. It seeks to generate a regulatory structure that is more coherent and effective in light of recent events.
Central Bank Supervision and Delegation: Volcker emphasizes the importance of a strong central bank position with delegated supervision. He cites the UK model as an example, where the central bank maintains a strong link to supervision and market conduct. This structure ensures a comprehensive and coordinated regulatory approach.
Lessons from International Models: Volcker acknowledges that most countries’ regulatory models are not directly applicable due to differences in market size and international significance. He believes that there is limited value in drawing lessons from their experiences.
Volcker Rule and Compliance Industry: The Volcker Rule, known for its impact on Dodd-Frank, has generated a significant industry for compliance officers, consultants, and lobbyists. Volcker expresses curiosity about the amount of money being made in consultancies related to the Volcker Rule. He ponders whether he would have modified the rule if he had known about the extent of this industry.
00:35:06 Weaknesses of FSOC and the Lobbying System in Washington
Problems with the Volcker Rule Implementation: The Volcker Rule’s implementation took an extended period, around four to five years, highlighting the weaknesses of the Financial Stability Oversight Council (FSOC) and the multi-agency regulatory system. The lengthy rulemaking process allowed ample time for lobbying and consulting, resulting in delays in the effective date of the regulation. Lobbyists exploit the regulatory process by seeking favorable outcomes for their clients, perpetuating a system where influence and personal connections hold sway. The lack of clarity and reliance on principles, rather than specific rules, exacerbates the regulatory complexities and uncertainties.
Critique of the Regulatory System: Paul Volcker criticizes the current regulatory system, emphasizing the need for clear and concise rules instead of relying solely on principles. He draws a comparison between international accounting practices, which emphasize principles, and the American approach, which favors detailed rules. Volcker highlights the role of lobbyists and lawyers in shaping the regulatory landscape, suggesting that their actions prioritize personal interests over the broader public good.
Volcker’s Perspective on the Volcker Rule: Volcker expresses disappointment with the final version of the Volcker Rule, stating that it deviated from his initial intentions. He acknowledges the challenges in implementing such a complex regulation and the influence of various stakeholders, including accountants and lawyers, in shaping the outcome.
Conclusion: Volcker’s critique of the Volcker Rule implementation and the regulatory system underscores the need for reforms to address inefficiencies, reduce lobbying influence, and enhance the clarity and effectiveness of regulations.
00:37:33 Volcker’s Observations on Financial System Dynamics
Federal Reserve’s Truth in Lending Regulation: Paul Volcker, former Chairman of the Federal Reserve, simplified the Truth in Lending Regulation from over 200 pages to 100 pages to make it more understandable. Despite his efforts, bankers’ comments led to more complexity, resulting in a potential return to the original length of the regulation.
Volcker Rule and Wall Street Culture: Bart Naylor, representing Public Citizen, highlights the public’s support for the Volcker Rule and a simple separation of banks from proprietary trading. Naylor mentions New York Fed President Dudley’s proposal for senior banker pay deferral as a penalty for bank violations.
Volcker’s Views on Modern Management Practices: Volcker criticizes modern management practices that solely focus on profitability, leading to a lack of genuine relationships and fiduciary responsibility. He emphasizes the impersonal nature of big investment banks, where bonuses are determined by computer-generated data rather than personal judgment.
Challenges in Ameliorating Negative Behavior Patterns: Volcker acknowledges the difficulty in devising schemes to mitigate the impact of negative behavior patterns in the financial world. He cites the British as being more aggressive in addressing these issues.
Tri-Mandate of the Federal Reserve: Volcker highlights the tri-mandate of the Federal Reserve, which includes maximum employment, stable prices, and moderate interest rates. He emphasizes the importance of financial stability, which was an implied purpose of the Federal Reserve Act of 1914.
00:44:09 Addressing Financial Stability in Complex Markets
Challenges in Avoiding Financial Crises: Paul Volcker emphasized the difficulty in avoiding financial crises due to human behavior and the cumulative nature of market reactions. He highlighted the influence of “animal spirits” and the impact of housing market dynamics on financial stability.
Importance of Banking System Stability: Volcker expressed his previous belief that maintaining the stability of the banking system was sufficient to prevent financial crises. However, the growth and complexity of financial institutions have made this approach insufficient.
Regulatory Arbitrage and Systemic Risk: Volcker criticized the regulatory arbitrage and escape practices of certain institutions that avoid proper oversight as banks or mutual funds. He emphasized the need to address regulatory weaknesses exposed during the financial crisis.
FSOC Authority and Federal Reserve’s Role: Volcker proposed granting the Federal Reserve the principal regulatory initiative in financial oversight. The Federal Reserve would exercise surveillance over the entire system, while the Office of Financial Research (OFR) would focus on system oversight rather than statistical analysis. FSOC’s authority would be determined, allowing it to review and potentially remand regulations issued by the Federal Reserve.
Political Implications and Persuading Congress: Volcker acknowledged the political challenges in implementing his proposals, particularly in convincing current regulators and Congress to consolidate the financial oversight system. He recognized that regulators are concerned about potential losses in their authority and the complexity of merging different agencies. The key to persuasion lies in educating Congress about the systemic risks and inefficiencies of the current system.
00:49:11 Volcker's Views on Financial Regulation Reform
Volcker’s Perspective on Financial Regulation: Paul Volcker believes that the current financial regulatory system needs to be improved, particularly in terms of coordination and policy coherence. He emphasizes the need for unification to achieve better coordination, suggesting that the creation of a new organization with representatives from various regulatory bodies could be a solution. Volcker acknowledges that such changes may face resistance from existing regulatory agencies, but he believes that the benefits could ultimately outweigh the challenges.
The Significance of Recent Events: Volcker highlights the recent financial crisis as a stark demonstration of the need for improved coordination and policymaking. He stresses that the complexity and interconnectedness of the financial system demand a more unified approach to regulation.
Volcker’s Assessment of Dodd-Frank: While acknowledging that the Dodd-Frank Act was a step in the right direction, Volcker believes that it needs further refinement and improvement. He specifically mentions the Systemically Important Financial Institutions (SIFIs) and the Office of Financial Research (OFR) as areas where adjustments could be made to enhance their effectiveness.
Importance of Substance Over Political Rhetoric: Volcker emphasizes the importance of focusing on substance and meaningful reforms rather than getting caught up in extraneous issues and political rhetoric. He criticizes the Tea Party’s approach to financial regulation, stating that it often distracts from addressing the core issues.
Volcker’s Role in Establishing Scholarships at GW: Volcker expresses gratitude for the scholarships established in his name at George Washington University, which aim to support individuals pursuing careers in public service and financial regulation. He acknowledges the significance of these scholarships in promoting the values of reform and responsible financial regulation.
Abstract
Paul Volcker: A Visionary in Financial Reform and Public Service
Paul Volcker, a luminary in economic leadership and public service, left an indelible mark through his roles as Chairman of the Federal Reserve, a leader in various governmental and international positions, and a founder of nonpartisan initiatives. His tenure at the Federal Reserve is most notable for his successful combat against the high inflation of the 1970s, and his post-retirement years were marked by significant contributions to financial regulation and public trust in government. Volcker’s insights into behavioral economics, the Federal Reserve’s regulatory responsibilities, and the challenges of modern financial systems underscore the complexity and necessity of comprehensive financial reform. As the financial landscape evolved, so did Volcker’s perspectives, focusing on the stability of the banking system, regulatory arbitrage, and the need for stronger oversight, while always maintaining a strong commitment to public service as evidenced by his gratitude for the GW scholarship program in his name.
Princeton Ties:
Volcker’s ties to George Washington University are highlighted through scholarships and graduate fellowships. Princeton, Volcker’s alma mater, highly regards him as an exemplary embodiment of their motto, “Princeton in the Nation’s Service.”
Government Service and Professional Accomplishments:
Paul Volcker, a Princeton graduate, significantly impacted the U.S. and global economy through his extensive government service. As Chairman of the Federal Reserve for two terms, Volcker’s most notable achievement was taming the rampant inflation of the 1970s. His career also included roles such as Undersecretary of the Treasury and President of the Federal Reserve Bank of New York, reflecting his deep involvement in economic policy and financial regulation.
Post-Retirement Roles and International Recognition:
After retiring from the Federal Reserve, Volcker continued to influence economic policy. He chaired Wolfensohn and Company and served on prestigious commissions, including investigating dormant Holocaust-era bank accounts. His expertise was internationally recognized, leading to his appointment as Chairman of the International Accounting Standards Board.
Volcker Alliance and Behavioral Economics:
In 2013, Volcker founded the nonpartisan Volcker Alliance, aiming to address challenges in policy execution and rebuild public trust in government. His focus on behavioral economics highlighted the human element in economic decision-making, acknowledging that individuals are not always rational actors, a perspective crucial for financial regulation.
Federal Reserve’s Role in Financial Regulation:
Volcker emphasized the Federal Reserve’s responsibility in regulating banks, stressing the need to consider human behavior in financial systems. He aligned with Alice Rivlin’s view that the Fed’s main job is to prevent financial crises, consistent with its historical purpose.
Challenges and Attempts at Financial Regulation Reform:
The financial regulation landscape has faced challenges, with differing views on the Federal Reserve’s role and a traditional macroeconomic focus that neglected financial markets. Despite over 20 attempts at financial system reform since World War II, the regulatory framework remains outdated and fragmented. The Dodd-Frank Act and initiatives by the Bipartisan Policy Center attempted to address some aspects of regulatory reform.
Shadow Banking and Bank Complexity:
The growing shadow banking sector, accounting for 70% of the financial system, and the increasing size and complexity of banks, have presented new challenges in regulation. These developments have led to overlapping turf and political interests hindering effective regulation.
Key Proposals and Treasury’s Role:
Volcker proposed avoiding concentration of banking and financial supervision in a single organization and emphasized the Treasury’s role in reflecting broad economic policy. The functioning of FSOC and OFR, created to formalize Treasury’s involvement, faced criticism for their effectiveness.
Agencies’ Roles and Reform Nuts and Bolts:
The need for a clearer definition of agencies’ individual and collective responsibilities was highlighted, along with the necessity for strong supervisory staff and a focus on the broader financial system for effective reform.
Congressional Involvement and Historical Perspective:
The current congressional hearings on financial regulatory reform have been criticized for addressing minor issues. Learning from history, as emphasized by Walter Bagehot, and acknowledging failures in regulation and supervision is crucial to avoid repeating past mistakes.
Key Directions for Reform and FSOC and OFR:
Reform should extend beyond commercial banks to the entire market, focusing on systemic risk and financial stability. The creation of FSOC and OFR in Dodd-Frank was a response to market developments, but their structure needs reevaluation.
Unified Supervision and SEC and CFTC:
Supervision should be unified under one agency connected to the Federal Reserve, with strengthened SEC and a combined CFTC and SEC for improved effectiveness.
Volcker Rule and International Model:
The Volcker Rule aimed to enhance investor protection and market integrity. Volcker also suggested an international model with a strong central bank position and separate handling of market and business conduct.
Volcker Rule’s Impact and Implementation Challenges:
The Volcker Rule led to a significant industry around compliance, but its implementation faced delays and inefficiencies due to FSOC’s weaknesses and lobbying influence.
Accounting Principles and Truth in Lending Regulation:
The debate between principles-based and rule-based accounting reflects differing national approaches to regulations. Volcker’s simplification of the Truth in Lending Regulation demonstrated his commitment to clarity and effectiveness in financial policies.
Volcker Rule and Bank Culture:
Volcker criticized the Wall Street culture of tying compensation to profitability, highlighting the importance of fiduciary responsibility and long-term stability over short-term gains.
Adding Financial Instability to the Fed’s Mandate:
Volcker emphasized the Federal Reserve’s role in ensuring financial stability, originally intended in the Federal Reserve Act of 1914, and the challenges in ameliorating compensation schemes.
Volcker’s Views on Financial Regulation:
Volcker’s perspective on financial regulation stressed the importance of banking system stability, the need for stronger oversight, and the challenges in implementing comprehensive reforms.
Financial System Evolution and Challenges:
The evolution of the financial system, with the burgeoning of the shadow banking sector and the growth of individual financial institutions, has brought forth significant challenges in regulation. These developments, along with the rise in complex compensation practices and political and lobbying influences, have made the regulatory landscape fragmented and uncoordinated. Volcker highlighted the need to address these issues for effective financial regulation.
Volcker’s Comprehensive Reforms Proposals:
Volcker’s proposals for financial reforms emphasize the importance of not centralizing banking and financial supervision in a single entity, including the Federal Reserve. He advocated for the involvement of the Treasury in crises while ensuring it does not dominate the regulatory process. Volcker stressed the need for clear responsibilities among regulatory agencies, strong supervisory staff, and a focus on the broader financial system. He also discussed the complexities of special relief for small banks and the government’s role in the mortgage market, underscoring the need for careful consideration in these areas.
Enhanced System Oversight and Regulation:
Volcker’s vision for effective financial regulation included enhancing the FSOC’s authority, reevaluating the OFR’s role, and transferring supervisory authority over broker-dealers from the SEC to a unified agency. He proposed a unified supervisory agency connected to the Federal Reserve, suggesting a division of regulation and supervision between the two. This approach aimed to streamline functions and concentrate regulatory authority, addressing the SEC’s limited role and proposing a merger with the CFTC for increased effectiveness.
Paul Volcker’s legacy in financial regulation and public service is marked by his deep understanding of economic complexities and his commitment to effective, comprehensive reform. His gratitude for the scholarship program in his name at GW, aligning
with Princeton’s motto of service, reflects his lifelong dedication to public service and financial regulation. Volcker’s insights and proposals continue to shape discussions on financial stability and regulation, emphasizing the need for adaptability, oversight, and a focus on public interest.
Paul Volcker's insights focus on economic recovery, financial reform, the Eurozone crisis, regulatory reforms, and the future of the financial sector. Central bank independence, regulatory reforms, and the international monetary system are among the key topics discussed....
The Federal Reserve faced challenges in balancing price stability and maximum employment, leading to high inflation in the 1960s and 1970s. Paul Volcker's disinflation policy successfully reduced inflation but resulted in high unemployment....
Paul Volcker's analysis of the 2008 financial crisis emphasizes the need for robust regulatory reforms and a balanced approach to free and competitive markets. He highlights the importance of addressing underlying economic imbalances and restoring confidence in the financial system....
Paul Volcker's career and views on the European monetary union offer insights into the complex interplay between economic policies and global financial stability. The journey of the euro reflects the dynamic interplay of economic policies, monetary management, and global financial stability....
Paul Volcker criticized the current state of U.S. governance, calling for effective public administration, policy reform, and a shift in public service education. He emphasized the need for practical implementation of policies, transparency in financial reporting, and a comprehensive review of financial regulation to improve governance....
Effective governance requires fiscal responsibility, professional management, and a skilled civil service, as exemplified by Paul Volcker's principles and experiences. Leaders like Volcker demonstrate the importance of vision, execution, and respect in overcoming opposition and achieving results....
The 2008 financial crisis was caused by financial imbalances, subprime mortgages, and regulatory failures. Paul Volcker emphasized the importance of addressing imbalances in consumption and savings and the need for financial system reform....