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Thursday, September 24, 2009

Volcker Speaks

As I mentioned this morning, Paul Volcker testified before Congress, and gave a refreshing perspective on what has been going on. The second paragraph summarizes what has been going on for the last 6 months or so:


Now the financial pressures have eased and there are
signs of renewed economic growth. There are some on “Wall
Street” who would like to return to ”business as usual”.
After all, for a time, and for some that system was
enormously remunerative. However, it placed at risk not
only the American economy, but also large parts of the
world economy. The challenge is not to paper over or tinker
around the edges of the broken system. We need to minimize
the danger that the uncertainties and risks inherent in the
functioning of a market-based financial system do not again
jeopardize the functioning and foundation of our economy.


I might quibble with the "renewed growth" statement, but I heartily agree with the "business as usual" part. I also like how he differentiates between the "financial system" and "the economy". They are not one and the same.

Registration and certain reporting requirements for
hedge funds and private equity funds will req.uire your
support. Substantial progress is being made on a voluntary
basis in the area of derivative markets, including
particularly in clearance and settlement arrangements. That
work will also need to be reinforced by further grants of
legislative authority to appropriate regulatory agencies,
including clarification of the overlapping jurisdiction of
the SEC and the CFTC.

The "fleece the suckers" casino needs to be closed.

• Are community or regional banks to be deemed
“too small to save”, raising questions of
competitive viability?

• Does not the extension of support to non-banks,
and even to affiliates of commercial firms,
undercut the banking/commerce divide, ultimately
weakening the commercial banking system?

AIG, anyone?

What all this amounts to is an unintended and
unanticipated extension of the official “safety net”, an
arrangement designed decades ago to protect the stability
of the commercial banking system. The obvious danger is
that with the passage of time, risk-taking will be
encouraged and efforts at prudential restraint will be
resisted. Ultimately, the possibility of further crises –
even greater crises – will increase.

I would probably rephrase that to say that further crisis are inevitable, and deliberately created.

He goes on to say this about "too big to fail":

Think of the practical difficulties of such
designation. Can we really anticipate which institutions
will be systemically significant amid the uncertainties in
future crises and the complex inter-relationships of
markets? Was Long Term Capital Management, a hedge fund,
systemically significant in 1998? Was Bear Stearns, but not
Lehman? How about General Electric’s huge financial
affiliate, or the large affiliates of other substantial
commercial firms? What about foreign institutions operating
in the United States?



All hard questions. In practice the “border problem”
seems intractable. In fair financial weather, the important
institutions will feel competitively hobbled by stricter
standards. In times of potential crisis, it would be the
institution left out of the “too big to fail” club that
will fear disadvantage.

Not terribly hard questions at all. Eliminate the designation "too big to fail", remove the backstops, and the first big failure would teach the others a lesson. The lesson of LTCM was, the more systemic risk you create, the better. That's why we are in the position we are in today.

It's unfortunate that the President apparently isn't paying as much attention to Volcker as he was during the campaign. I don't know how much our government is going t learn from this crisis, and I hope to God they don't learn the wrong lessons, as they did during the Great Depression.

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