Volcker’s Perspective and Experience:
Volcker highlighted his unique perspective as the most experienced attendee at Dewey Dane celebrations over the years. He acknowledged the aging of the attendees and his own advancing age.

Repetitive Economic Cycles:
Volcker observed the recurring pattern of economic cycles, marked by confidence, exuberance, risk-taking, and eventual collapse.

Complexity of the Current Crisis:
Volcker emphasized the unprecedented nature of the current financial and economic crisis. He recognized that even Dewey Dane had not encountered a situation of such complexity before.

Unique Aspects of the Crisis:
Volcker attributed the crisis to long-standing imbalances in the international economy. He cited the over-saving in Asia and China, the lack of savings in the United States, and the excessive capital flows between these regions. The crisis was further exacerbated by the depth and interconnectedness of global financial markets, which acted as one global market.

Background Factors Contributing to the Financial Crisis:
Modern communications, technology, and financial market developments led to increased interconnectedness and vulnerabilities. The shift from banks as the dominant credit creators to open markets resulted in securitization, subprime mortgages, and credit default swaps, which contributed to contagion. The speed and worldwide nature of the economic decline after September 2008 were unprecedented.

Causes of the Financial Crisis:
Excessive exuberance and leverage in banking and financial markets. Regulatory weaknesses and gaps in coverage. Failures of risk management in big financial institutions. Misbegotten financial engineering and excessive reliance on mathematical techniques. Supercharged compensation practices that rewarded risk beyond prudence.

Consequences of the Financial Crisis:
Worldwide recession, with the United States as the epicenter but other countries experiencing deeper recessions. Comatose financial system, despite government support, hindering economic recovery. Accumulation of bad credits as the recession continues.

Proposed Solutions:
Major regulatory and market changes are in store, and comprehensive thinking is needed before making big changes. Focus on addressing important parts of the problem, considering the impact on other parts of the system.

Background:
The financial system has undergone significant changes in the past 20-30 years, shifting towards an open market-oriented system. This shift raises questions about the desired structure of the financial system and whether a bank-centered system may offer advantages.

Key Points:

Bank-Centered System:
Banks have traditionally been central to the provision of credit and the maintenance of the payment system. The recent crisis highlighted the importance of banks as they became the focus of government support and assistance to stabilize the system. Banks retain custody of the payment system and financial market infrastructure, enabling them to provide a significant portion of the country’s credit supply.

Open Market-Oriented System:
The open market-oriented system has been characterized by a reduction in the role of banks in credit provision. This shift has led to the rise of hedge funds and other non-bank financial institutions. The distinction between banks and hedge funds has become blurred, with some arguing that all financial institutions are essentially hedge funds.

Debate:
There is a debate about whether the financial system should continue to be open market-oriented or whether a return to a more bank-centered system is desirable. Proponents of a bank-centered system argue that banks offer stability and are better equipped to handle financial crises. Opponents argue that an open market-oriented system promotes innovation and competition, leading to greater efficiency and growth.

Conclusion:
The choice between a bank-centered and an open market-oriented financial system is a complex issue with no easy answers. The decision should consider factors such as stability, efficiency, innovation, and the role of banks in the payment system and financial market infrastructure.

Introduction:
Paul Volcker emphasizes the importance of distinguishing between banks and the rest of the market-oriented financial system, advocating for different regulatory approaches based on their distinct roles.

Banking System’s Service-Oriented Approach:
Banks should maintain a service-oriented relationship with clients, serving individuals, businesses, and governments. They perform fundamental economic functions, such as international transactions and operating the payment system. Traditionally, the banking system has received protection due to its vital role.

Distinction Between Banks and Market-Oriented System:
Volcker proposes separating banks from the market-oriented system, which includes entities like hedge funds that engage in transaction-based activities. The market-oriented system lacks customer relationships and continuity, making it distinct from banks’ service-oriented approach.

Protection and Regulation:
Volcker suggests providing continued protection for the banking system while avoiding protection for the large capital market-oriented system. He acknowledges the need for careful consideration in implementing this distinction. The regulatory approach should focus on prudential purposes (safety and soundness) for banks and business practices (consumer affairs, transparency, securities registration) for the market-oriented system.

Separation of Regulatory Functions:
Volcker advocates separating the two regulatory functions: prudential regulation for banks and business practices regulation for the market-oriented system. This separation would provide clarity and streamline the regulatory structure.

Federal Reserve’s Role:
Volcker proposes avoiding consideration of the Federal Reserve’s role in this context, suggesting that it may not be central to the discussion.

Volcker’s Concerns about the Federal Reserve’s Future:
The Federal Reserve Act will be reviewed due to the unprecedented level of activity by the Fed in the past year. The political system will not tolerate the extent of the Fed’s actions, prompting a review of responsibilities and the Fed’s appropriate role. The review will be extensive, with possible outcomes ranging from increased supervisory and regulatory responsibilities to decreased authority. Volcker emphasizes the need for a calm and thoughtful approach to consider a new financial system rather than piecemeal legislation.

Volcker’s Involvement in the G30 Report:
Volcker was involved in the G30 report, which highlighted the importance of transparent accounting information in the financial system.

Accounting Standards and the Role of Accountants:
Volcker expressed concern about accounting standards and the importance of maintaining the independence of accounting standard setters. He believes accountants have an inferiority complex compared to lawyers and investment bankers, despite the intellectual challenges of accounting.

Criticisms of the Mark-to-Market Approach:
Volcker criticized the extreme mark-to-market, fair value accounting approach, which he believes has weaknesses. He acknowledges the disturbed situation caused by the financial crisis, but emphasizes the need for thoughtful consideration of solutions.

Volcker’s Criticism of Mark-to-Market Accounting:
Mark-to-market accounting, which values assets at their current market prices, can lead to extreme cascading declines in valuations, especially in markets where it’s difficult to determine the value of complex instruments. It creates inconsistencies among institutions, making it challenging to assess their financial health accurately.

Mark-to-Market Accounting’s Conflict with Traditional Banking:
Mark-to-market accounting is fundamentally incompatible with the traditional banking system, insurance companies, and pension funds. These regulated institutions act as intermediaries, transferring maturity and credit differences to generate profits. Mark-to-market accounting restricts these institutions from taking maturity or credit risks, which can lead to excessive volatility and hinder their ability to fulfill their economic function.

Economic Implications of Excessive Volatility:
The excessive volatility caused by mark-to-market accounting undermines stable and orderly economic growth. It disrupts the financial system’s ability to facilitate credit intermediation and maturity transformation, essential for economic stability.

The Need for an Accounting System Suited for Intermediation:
There’s a need for an accounting system that recognizes the importance of intermediation and credit markets, especially for regulated institutions. This system should allow these institutions to take maturity and credit risks, ensuring their ability to perform their vital economic functions.

Regulators’ Role in Safeguarding Integrity:
The concern about managers manipulating reporting to suit their purposes is valid. Regulators can play a crucial role in safeguarding the integrity of the reporting process for regulated financial institutions.

A Simple Example of Mark-to-Market Accounting’s Challenges:
Volcker provides an example of a bank holding a long-term loan with a fixed interest rate. If interest rates rise, the value of the loan decreases under mark-to-market accounting, even though the bank will likely collect the full amount of the loan in the future.

The Problem of Loan Loss Reserves:
Paul Volcker discusses the strict application of market-to-market fair value accounting, which prevents banks from making orderly provisions for potential loan losses. He argues that this approach is inconsistent with maintaining a healthy banking system. Volcker expresses hope that international accounting bodies are reconsidering this issue.

Too Much Bailout Protection:
Volcker criticizes the excessive protection given to systemically important institutions. He believes that this creates incentives to save failing institutions, even when it is not in the best interest of the financial system. Volcker calls for reducing these incentives and making it easier to resolve non-bank financial institutions.

The Distinction Between Service-Oriented Banks and the Rest of the Market:
Volcker proposes distinguishing between service-oriented banks and other financial institutions. He hopes that this distinction can prevent non-banks from becoming subject to the too-big-to-fail doctrine. Volcker emphasizes the need to change insurance company regulation but also wants to avoid bailing out hedge funds and equity funds.