Paul Volcker (USA Former Chairman of the Federal Reserve) – Remarks about economic crisis |Financial Markets Research Center Conference at Vanderbilt (Apr 2009)
Chapters
Abstract
Navigating the Maze: Paul Volcker’s Insightful Analysis of the Financial Crisis and the Future of Banking Regulation
In an insightful commentary, Paul Volcker, with his rich experience and expertise, delves into the complexities of the recent financial crisis, its causes, and the implications for future financial regulation. Volcker emphasizes the unprecedented nature of the current crisis, marked by globalized financial markets, regulatory weaknesses, and a distinct blend of greed and hubris. He advocates for comprehensive regulatory changes, questioning the blurred lines between banks and hedge funds, and stresses the importance of distinct regulatory functions for prudential and business practices. Furthermore, Volcker highlights the need for a thorough review of the Federal Reserve’s role and calls for global, independent accounting standards. His perspective is crucial in understanding the intricacies of the crisis and the path forward for a more stable financial system.
Expanding on the Main Ideas:
The Uniqueness of the Current Crisis:
Volcker outlines how the current financial and economic crisis is unique in its complexity, dwarfing past experiences. The prolonged international economic imbalances, fueled by excessive saving in Asia and insufficient saving in the U.S., coupled with free capital flows, have created unsustainable patterns leading to extreme financial market conditions. This has culminated in an unprecedented decline in global economic activity.
The crisis is further exacerbated by its prolonged nature, with no clear end in sight. Volcker acknowledges that even Dewey Dane, who has witnessed numerous economic cycles, has not encountered a situation of such complexity before.
Globalized Financial Markets:
Highlighting the depth and interconnectedness of global markets, Volcker points out that these markets, especially in finance, have essentially merged into a single global entity. This new reality is a product of advancements in technology, a shift from bank-dominated credit creation to open markets, and the development of complex financial instruments like securitization, subprime mortgages, and credit default swaps.
Causes and Consequences of the Crisis:
Volcker identifies excessive exuberance, regulatory failures, risk management shortcomings, and an overreliance on financial engineering as key factors leading to the crisis. The consequences have been severe, including a global recession with the U.S. at its epicenter and a hindered recovery due to a less vibrant financial system.
The Need for Comprehensive Regulatory Changes:
Emphasizing the need for major regulatory and market reforms, Volcker cautions against hasty actions and highlights the necessity for a holistic approach to address the interconnectedness and vulnerabilities of the system.
Banking System Dynamics:
Discussing the choice between a bank-oriented and an open market-oriented financial system, Volcker underscores the enduring significance of banks in credit provision and maintaining the payment system. He calls for a clear distinction between banks, with their traditional service orientation, and market-oriented entities like hedge funds that focus on transactional relationships.
Added Information:
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.
– Volcker observed the recurring pattern of economic cycles, marked by confidence, exuberance, risk-taking, and eventual collapse.
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.
Regulation and the Federal Reserve’s Role:
Volcker suggests separating regulation into prudential regulation for banks and business practices regulation for other financial entities. He also touches on the need to reconsider the Federal Reserve’s role, given its extensive involvement in the crisis, and advocates for a comprehensive review of the Federal Reserve Act.
The Federal Reserve Act will be reviewed due to the unprecedented level of activity by the Fed in the past year. Volcker emphasizes the need for a calm and thoughtful approach to consider a new financial system rather than piecemeal legislation.
Accounting Standards and Their Role:
With his background as a former chairman of the International Accounting Standards Committee, Volcker stresses the importance of maintaining independent, globally accepted accounting standards. He critiques the extreme mark-to-market and fair value approach, arguing for an alternative system that recognizes the needs of credit markets and regulated financial institutions.
Added Information:
The Problem of Loan Loss Reserves:
– 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.
Notes by: Alkaid