Volcker (2 page)

Few would say that going forward.

The president offered a brief history in his opening remarks.

Over the past two years more than seven million Americans have lost their jobs in the deepest recession our country has known in generations … But even as we dig our way out of this deep hole it's important that we not lose sight of what led us into this mess in the first place. This economic crisis began as a financial crisis when banks and financial institutions took huge, reckless risks in pursuit of quick profits and massive bonuses. And to avoid this calamity, the American people … were forced to rescue financial firms facing [crises] largely of their own making.
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Obama's populist analysis rings true. Excessive risk taking, enabled by easy access to borrowed funds by brokerage firms such as Bear Stearns and Lehman Brothers, and by insurance giant AIG, turned a decline in home prices into a financial earthquake. President Obama wanted to redesign the regulatory system to avoid future bailouts.

“Limits on the risks major financial firms can take are central to the reforms that I have proposed … We simply cannot accept a system in which hedge funds or private equity firms inside banks can place huge risky bets that are subsidized by taxpayers … It's for these reasons that I'm proposing a simple and common sense reform, which we're calling the Volcker Rule, after this tall guy behind me.”
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Obama hooked his thumb like a hitchhiker in Volcker's direction, just in case the assembled press had failed to notice the financial giant standing behind him. The president cracked a smile, and Vice President Biden laughed. Volcker nodded his large head, apparently enjoying the recognition he deserved. Few knew how upset he was.

Volcker had been fighting a losing battle for a year, pushing his vision of regulatory reform, including a comprehensive plan to restrain banks from reckless risk taking. Geithner and Summers had beaten down his proposals, labeling them a throwback to the 1950s, when commercial
banks were different from the rest of finance. Now that all financial institutions did the same thing, it made no sense to single out banks for a separate set of restrictions.

Volcker felt marginalized. “They considered me an old man … which I may be, but banks are still the center of the American financial system. As long as we protect them with government-sponsored deposit insurance and provide loans from the central bank as needed, they should be treated differently. So I took my
Back to the Future
regulatory framework directly to Congress.”
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Volcker's testimony before the House Banking and Financial Services Committee on September 24, 2009, caught the attention of Vice President Joseph Biden, who said, “His position makes sense to me and it'll make sense to the American people.”
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Biden urged Obama to reconsider, rescuing Volcker from the Dumpster.
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Volcker had met with the president in the Oval Office immediately before the news conference on January 21, 2010, but the Volcker Rule designation caught him by surprise. The christening had been a last-minute suggestion to Obama by David Axelrod, the president's chief political strategist. Most people would have paid for the naming rights to a presidential initiative, but not Paul Volcker. His first thought was “Now, why did he do that?”
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Volcker could find fault with the
Mona Lisa
. He made those who viewed the glass as half-empty seem like wild-eyed optimists. Paul thought the label with his name attached sounded boastful, like a Madison Avenue advertisement. His mother was a Lutheran and his father an Episcopalian, but they both taught that Presbyterian modesty was a cardinal virtue. He also worried that the Volcker Rule label would narrow his life into two words of limited scope. He doubted that Alois Alzheimer, a noted psychiatrist, would be pleased with his memorial.

Volcker had always fought like a zealot to get his way, but withdrew when the limelight reflected too brightly off his brow. This time he relented. He lent his name to Obama's initiative because this would be his last chance to set the American monetary system on the right course. Volcker had emerged from the shadows twice before, launching new financial arrangements in August 1971 and in October 1979, when crises threatened to undermine American leadership in world finance. January 2010 would be his third and final installment.

Before the monetary meltdown of the new millennium, Volcker had confronted two financial disasters that had simmered over many years. The promise by the U.S. Treasury to convert dollar holdings of foreign central banks into gold had served as the foundation of the Bretton Woods System of fixed exchange rates since the end of World War II. But a decade of eroding U.S. balance of payments during the 1960s threatened America's promise and undermined the greenback's credibility as international money. The escalating crisis convinced Volcker, as undersecretary of the treasury for monetary affairs in 1971, to recommend cutting the dollar's link to gold. The suspension was announced by President Nixon on August 15, 1971, and Volcker then negotiated the transition to the system of floating exchange rates that we have today.

The absence of gold as its anchor tested American finance. A decade of monetary mismanagement under the leadership of Arthur Burns, appointed by Nixon as chairman of the Federal Reserve System, America's central bank, nearly destroyed U.S. financial credibility. The escalating inflation during the 1970s led President Jimmy Carter to appoint Volcker as Federal Reserve chairman in 1979.

Volcker initiated a new program of monetary control on October 6, 1979, allowing real interest rates to fluctuate widely to reduce inflationary expectations, but his main contribution occurred later. His policy of preemptive restraint during the economic upturn after 1983 increased real interest rates and pushed Congress and the president to adopt a plan to balance the budget. The combination of sound money and fiscal integrity sustained the goal of price stability through Volcker's departure in 1987 and served as a prototype going forward. His leadership of the Federal Reserve from 1979 through 1987 revived confidence in the central bank—almost as though he had restored the gold standard—and ushered in a generation of economic stability.

Volcker's approach to crisis control cannot be reduced to a precise metric. It is an art form, a blend of principle and compromise, like the justice administered by a frontier sheriff. Volcker never acted hastily, always trying to preserve the status quo. And like a reluctant peace officer pressed into making a stand, he was not above using controversial tactics to restore order.

In 1971 he accepted capital controls, an undesirable interference with free trade, while basing exchange rates on the dollar rather than gold.
In 1982, when skyrocketing interest rates threatened to bankrupt Mexico and impair the capital positions of America's largest banks, Volcker papered over the problem with questionable loans. In 1984, when Continental Illinois, the seventh-largest bank in the United States, nearly failed, he helped rescue the embattled giant from bankruptcy, and in the process sanctioned the problematic principle of Too Big to Fail in American finance. Both bailouts permitted the battle against inflation to proceed.

Volcker chose to defend an ambitious goal, sustaining both the domestic and the international integrity of the U.S. currency. Some view the two faces of the dollar as separate objectives, but he insists, “They are the same. Preserving purchasing power at home promotes confidence in the dollar abroad.”
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His success as an inflation fighter revived trust in the Federal Reserve System and maintained the greenback as the world's reserve currency. Americans have been able to consume more than they have produced domestically thanks to the dollar's role as international money. The United States exports financial services to the rest of the world, in exchange for cars, televisions, and manhole covers.

Volcker's victory over inflation had unintended consequences. The generation of economic growth and low inflation that followed between 1987 and 2007 fostered a myth that the business cycle had disappeared and encouraged excessive risk taking by consumers and investors, who borrowed more than they could reasonably expect to repay. The crisis simmered as regulators relaxed safeguards no longer needed under the so-called Great Moderation.

Paul Volcker expected trouble.

In a speech at Stanford University in February 2005 he said, “Baby boomers are spending like there is no tomorrow … and we are buying a lot of houses at rising prices.”
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He warned that “The capital markets which have been so benign in providing flexibility … can become a point of great vulnerability.” And then predicted “Big adjustments will inevitably come … And as things stand it is more likely than not that it will be financial crises rather than policy foresight that will force the change.”

Volcker knew whereof he spoke. His prediction that crisis would force change came from experience. In 1971 he proposed allowing a
“foreign exchange crisis to develop without action or strong intervention by the U.S.,” and to use “suspension of gold convertibility” as negotiating leverage for currency revaluation.
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In 1979 he used the growing popular disgust with the inequities of inflation to galvanize support. “People were prepared to sacrifice to win the battle. I could not have pushed the anti-inflation program without favorable public opinion.”
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In 1984 he agreed with Senator John Heinz at hearings in the Senate that “an inevitable consequence” of the Federal Reserve's tight monetary policy and high interest rates might be a crisis that forced Congress and the president to reduce the federal deficit.
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Congress passed the Gramm-Rudman-Hollings Act the following year, a first step toward budgetary reform that cheered financial markets, despite its flaws.

Almost no one paid attention to Volcker's warning in 2005. He was old, old-fashioned, and a worrier by nature. He had been eclipsed by time and circumstance. Less than 10 percent of young adults knew who had preceded the then-chairman of the Federal Reserve, Alan Greenspan, when Volcker gave his 2005 speech.
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The monetary meltdown that began in 2007 changed everything. The upheaval threatened to destroy American financial credibility. Bear Stearns and Lehman Brothers, two of the country's preeminent investment banks, evaporated over separate weekends in March and September 2008. The collapse of those giants threatened to undermine the financial trust that the United States exports to the rest of the world.

Volcker returned in 2010 to repair the system he had rescued twice before, and as with those earlier efforts, his plan combined principle and compromise to achieve a noble goal. But unlike 1979, when he was the sheriff, and unlike 1971, when his position at Treasury carried administrative power, Volcker relied primarily on patience and persistence to implement his plan. The Volcker Rule became law on July 21, 2010, a testament to the moral authority he had earned in fifty years of public service.
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Paul A. Volcker learned integrity at home. He was born on September 5, 1927, in Cape May, New Jersey, to Alma and Paul A. Volcker Sr. In 1930 his family moved to the northern part of the Garden State when Paul Sr. became the town manager of Teaneck, a small suburban community five miles west of New York City. Volcker Sr., a civil engineering graduate of Rensselaer Polytechnic Institute in upstate New York, rescued the town from the Great Depression and managed its affairs for twenty years, creating a zoning system, a paid fire department, and civil service for township employees.
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“The population doubled while my dad was manager,” Volcker recalls. “I've always been proud of his success.”
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A quote from George Washington hanging on the wall in his father's office burrowed into young Paul's brain: “Do not suffer your good nature … to say yes when you ought to say no; remember that it is a public not a private cause that is to be injured or benefited by your choice.”
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Paul Volcker Sr. lived by those words, going to extreme measures to avoid even the hint of impropriety, no matter what the consequence, sometimes at young Paul's expense.

Dick Rodda, the Teaneck recreation director, had hired fifteen high school students, including Buddy Volcker, as Paul was called, to work part-time as safety monitors after a snowstorm. When Paul Sr. found out, he called Dick to his office and said, “I want Buddy off the
payroll … I want you to fire him.” When Dick protested, Paul Sr. said, “If you won't fire him I'll find a new recreation superintendent who will.” Dick Rodda did as he was told.
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Paul watched his father purge the emotion from every decision, deliberating like the pipe smoker he was. “If someone came by on a Monday with a request he had not considered before, he would say, ‘Come back on Thursday and I'll have an answer.' He almost turned procrastination into a virtue. He was thoughtful and scrupulous, weighing every option in the process. I learned never to make a decision before its time … for better and worse.”
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As far back as he can remember, Paul craved his family's approval. It began when he was five, in kindergarten, the day he brought home his first evaluation from Miss Constance Palmer. Maybe every boy thinks that his first teacher is beautiful, but he insists she really was. “I remember when she led me by the hand into the circle with the other kids. I liked the attention until she added a note to my report: ‘Paul does not take part in group discussion and does not play well with others.'”
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Those comments worried his parents, especially when his sisters chimed in, “And when Buddy plays with his friends they hardly ever speak.” Their concern only deepened Buddy's natural reticence.