Recently I had the pleasure of attending a session with Paul Volcker, the former Governor of The US Federal Reserve (1979-87), along with about 2,000 other Toronto financial types. Mr Volcker is now in his 80s, but his 6 and half foot frame is still pretty erect and his mind and sense of humour as sharp as ever. He began by remarking that his predecessors in this series of distinguished speakers in Canada had been Bill Clinton, Tony Blair, Alan Greenspan (“several times”), George W Bush and lastly Sarah Palin. “You may notice a trend in the attitude of the speakers towards government intervention” he drolly remarked “which I would disassociate myself from. While I think it’s fair to say the latter speakers probably disapprove of government, I believe in government intervention, in the right areas.”
He went on to make case for increased government control and regulation of the commercial banking industry. While at pains to avoid direct criticism of his successors (“it’s not appropriate for me to comment on the conduct of monetary policy”), Mr Volcker made the point, as he had done elsewhere as senior adviser to President Obama, that if commercial banks received government guarantees of their deposits, then they should not be permitted to use their balance sheets to speculate. This had led to problems of moral hazard that had caused the financial crisis of 2008-09, where management of universal banks had been willing to take on risky financial exposure through Credit Default Swaps (CDS) and other derivatives, most of which, it was plain from his comments, he believed that they had failed to understand. Of course, Mr Volcker has famously remarked that the only useful financial invention of the last 30 years is the ATM, so it was unsurprising to find him unenthusiastic about the growth of opaque financial instruments. He had no problem with investment banks using their balance sheets and capital to speculate and make markets, as long as they were allowed to fail if they got it wrong, and didn’t cause systemic risk to the world banking system, which is what had happened with commercial banks being allowed to participate in such activities.
In essence, Mr Volcker seemed to be advocating a return to the separation between commercial and investment banking required by the Glass-Steagall Act of 1934, which had been abolished in 1998. The Financial Reform measure that the Obama administration had introduced this summer supposedly prohibits the universal banks from using their capital to invest in hedge funds and derivatives of most kinds, but as always, the devil will be in the details of enforcement. It is astonishing that some of the same managements that led the major banks into the present crisis are still largely in place and paying themselves enormous bonuses once again. Asked by moderator Don Drummond, Senior Economist at TD, about some banks being regarded as “too big to fail”, Mr Volcker did not disagree with the principle. He pointed out that the utility functions of banks, such as cheque-clearing and payment systems, as well as being able to extract cash from ATMs, required that the bank networks remain operating to allow commerce to continue. It was evident that he didn’t think that meant the commercial bankers needed to pretend to be Goldman Sachs and pay themselves accordingly.
In a passing comment, Mr Volcker remarked that it was remarkable to hear central bankers complaining about inflation being too low. “We know how that movie ends” he said.