At the Table

Paul Volcker: The Lion Lets Loose


There has been chatter in recent months about Paul Volcker, the chairman of President Barack Obama's Economic Advisory Board, being muffled by the Administration—especially when it comes to his views on bank regulation. But that hasn't stopped Volcker from taking his argument for separating commercial and investment banking on the road, scolding bankers in Britain in early December and telling politicians in Germany that "this is no time for a return to business as usual." The former Fed chairman has also been hard at work leading a panel that will report back to the President early next year with proposals for tax reform. And at 82, he recently got engaged. We talked at Volcker's Manhattan apartment on Dec. 29.

CHARLIE ROSEWhat will economic growth look like in 2010?

PAUL VOLCKEREconomists are terrible at forecasting, but it's going to be a slog. The most recent figures are a little bit better than we would have expected, but that doesn't mean they're very strong.

And jobs?
Jobs are going to be slow to recover. A permanent loss of jobs?
No, we shouldn't have a permanent loss of jobs, but we have a considerable adjustment process to go through here. We've got to restore investment, we've got to restore our manufacturing industry, not the old-fashioned manufacturing industry, but we have to do a better job at the new industries that are coming along—the so-called green economy. Other countries are ahead of us in production that's related to change.

How did that happen?
What happened is our best and brightest got attracted to Wall Street. You've read about those big bonuses. These are generalizations, but I do think that the pull of Wall Street on bright young people, ambitious young people, has been tremendous.

Will it change?
I think we're in the process of change now. Wall Street hasn't got quite the glamor that it had a few years ago.

Yes, but I hear bonuses are coming back.
Well, I hope you'll get more competition on Wall Street and get some reforms, and profitability won't seem quite so great. At one point, Wall Street had almost 40% of all the profits in the country. And, you know, its contribution to the welfare of the country does not approach 40%. Something's out of line here.

Let's talk about the financial system. You have said it failed the test of the marketplace.
Yes. It collapsed on us. And I think that's the test of a financial system—is it facilitating reasonable stability and growth? No, it's had a breakdown at great risk to the economy. It became dysfunctional, and it is still largely dependent upon government assistance.

How should we create a well-oiled financial system?
The kind of reform I've been advocating is acceptance of the fact that the core of the system remains commercial banking. If that breaks down then you have an enormous crisis. And commercial banks have expanded into areas I don't think are so central. I would cut back their so-called capital market activities—hedge funds, equity funds, commodities trading, trading in derivatives. They're all legitimate functions, but they're not so central. And I don't want to protect all those functions. I don't want to protect everybody because when people act like they're protected, you get in trouble. So let's leave the capital markets to their own devices without any expectation of government protection and keep the existing safety net for the commercial banking system.

In my judgment we don't need to regulate the capital markets so heavily. You have some extreme cases where individual institutions are so big and so vulnerable, yes, you might want some regulation of capital and leverage, but that would be the exception. But if they fail, let 'em fail. We will have some kind of a new resolution process. Some agency will go in there and say, "You're going to fail, but we're going to provide a more orderly exit."

But if you're a commercial bank, no matter how big you are, you should not be allowed to fail?
I wouldn't go so far as to say you're not going to be allowed to fail, but you're going to have a lot more protection available so that it would take pretty extreme circumstances to fail to the point that the institution disappears. The quid pro quo for that is more regulation and a limitation on your activities. I don't want [commercial banks] out doing a lot of speculative trading.

So does this mean we should restore Glass-Steagall?
No. That's a false statement people make about my position. Glass-Steagall basically said banks cannot underwrite corporate securities or deal with corporate securities. But I would let commercial banks do underwriting of corporate customers. So you could argue that what I propose is somewhat in the spirit of Glass-Steagall in making a distinction between capital-market activities and trading activities and banking activities. But it is not specifically going back to Glass-Steagall.

Do you think that Congress will see it your way?
Eventually, yes. They need a little more persuasion.

So why haven't your views prevailed with the Administration?
I wasn't persuasive enough. How many meetings have you had with the President about this?
Not very many but...the President has heard my arguments a number of times.

Has he heard them one on one, where you've had an opportunity to say "This, Mr. President, is why you need to make sure that commercial banks..."
That's not the way the process works. But do you feel like you have had sufficient opportunity with the President to make your case?
Well, what's sufficient? He's the President. He decides.

You have one of the most powerful and persuasive voices in the global financial conversation.
You flatter everybody. I am one voice in the conversation, and there are others.

Does Ben Bernanke agree with you?
I don't want to speak for him. He can speak for himself.

Britain now has a system in which they tax 50% of financial bonuses.What would you do as far as compensation goes?
I've thought about this, and I don't know the answer. I think the whole system is broken, frankly. The best article I've seen about this was in The Wall Street Journal a week or two ago. Some professor said: "Let's get rid of all the stock compensation business. It all gives bad incentives. It's the wrong way to go about it. You ought to pay a guy cash, pay him a salary, pay him a bonus if you decide that he's done a good job. But don't attach a lot of criteria that he's going to manipulate to his advantage."

Isn't that exactly what they do on Wall Street? They basically say, if you've brought in $50 billion worth of business, then we're prepared to give you a huge income?
Sometimes they do it on the basis of stock and sometimes not. That isn't going to solve all the problems, I agree. But you take the trading guy who says: "I brought in $100 million worth of profits, therefore I want $25 million." Have they really taken into account that this trading guy is going on [the firm's] reputation, capital, and risk when he went out there and made the $100 million? If he's so good, let him go out and do it himself.

Wall Street has a history of creating financial instruments that will meet any new challenge. Any reason to believe that's going to stop?
No. They will continue to try to get around all these restrictions. You have to have a much stronger supervisory and regulatory apparatus to have any chance of keeping up with that.

You feel strongly that the financial system has gotten out of whack. Do you think the American political process is capable of fixing it?
The American political process is about as broken as the financial system. Therefore, one has to be a bit skeptical. Just to give you one little example, one unrelated to the financial crisis. Here we are on Dec. 29, almost a year after the Inauguration, and there is no Under Secretary of the Treasury. That should be an important position. How can we run a government in the middle of a financial crisis without doing the ordinary, garden-variety administrative work of filling the relevant agencies? The Treasury is an outstanding example of a broken system, but it's not the only one.

Is part of the problem that Congress is slow in the process of approving?
Slow is too fast a word to describe what's going on. The Administration is one quarter over, and it hasn't manned the ramparts of government yet.

So it's the Administration's problem? They haven't gotten their Executive Branch in place?
It's partly a reflection of the discord in government and extreme views on either side and fighting each other for every scrap of advantage.

In interviews in the past you said that's why we needed to change the political process; that's why you thought that candidate Obama was the best choice for President.
True. But has he been able to do that at this point? It doesn't look that way. I think that's unfortunate. I wish the Administration would pay more attention to what's needed to improve the ordinary functioning of government. We can't even fight a war with our own people any more. We've got to hire Blackwater. I think people have lost confidence in government, they've lost trust in government, and it shows. This isn't a question just of this Administration. It's been kind of a steady, downhill path.

Yes, but this Administration came in and said it would change. That was the mantra of the campaign. So what happened?
It shows you it's not that easy to change.

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