{"id":1956,"date":"2010-02-02T08:20:15","date_gmt":"2010-02-02T12:20:15","guid":{"rendered":"https:\/\/freedom24.org\/rationalpost\/?p=1956"},"modified":"2014-04-09T20:32:06","modified_gmt":"2014-04-10T00:32:06","slug":"volcker-rule-sustainable-reform","status":"publish","type":"post","link":"https:\/\/freedom24.org\/rationalpost\/volcker-rule-sustainable-reform\/","title":{"rendered":"volcker rules"},"content":{"rendered":"

\"\"<\/a>A perennial hot ticket on the lecture circuit at economic clubs<\/a> and grad schools<\/a> around the planet, Paul Volcker<\/a>‘s influence is finally starting to resonate where it counts: at both ends of Pennsylvania Avenue. As his testimony<\/a> in front of the Senate Banking Committee looms, the broader premise of a more responsible financial services sector pursuing sustainable, profitable growth needs to get out in clear journalistic prose from a messenger untarnished by the last 18 months of political and economic triage. This Sunday NYTimes op-ed<\/a> attempts to do just that, despite the complexity of the topic. Unfortunately, it falls a little short for those either too stubborn or greedy to listen <\/em>or too impatient to digest his astute commentary on the benefits and challenges of regulatory reform…
\n<\/em><\/p>\n

How to Reform Our Financial System<\/strong>
\nBy PAUL VOLCKER in the NYTimes<\/a><\/p>\n

PRESIDENT OBAMA 10 days ago set out one important element in the needed structural reform of the financial system. No one can reasonably contest the need for such reform, in the United States and in other countries as well. We have after all a system that broke down in the most serious crisis in 75 years. The cost has been enormous in terms of unemployment and lost production. The repercussions have been international.<\/p>\n

Aggressive action by governments and central banks \u00e2\u20ac\u201d really unprecedented in both magnitude and scope \u00e2\u20ac\u201d has been necessary to revive and maintain market functions. Some of that support has continued to this day. Here in the United States as elsewhere, some of the largest and proudest financial institutions \u00e2\u20ac\u201d including both investment and commercial banks \u00e2\u20ac\u201d have been rescued or merged with the help of massive official funds. Those actions were taken out of well-justified concern that their outright failure would irreparably impair market functioning and further damage the real economy already in recession.<\/p>\n

Now the economy is recovering, if at a still modest pace. Funds are flowing more readily in financial markets, but still far from normally. Discussion is underway here and abroad about specific reforms, many of which have been set out by the United States administration: appropriate capital and liquidity requirements for banks; better official supervision on the one hand and on the other improved risk management and board oversight for private institutions; a review of accounting approaches toward financial institutions; and others.<\/p>\n

As President Obama has emphasized, some central structural issues have not yet been satisfactorily addressed.<\/p>\n

A large concern is the residue of moral hazard from the extensive and successful efforts of central banks and governments to rescue large failing and potentially failing financial institutions. The long-established \u00e2\u20ac\u0153safety net\u00e2\u20ac\u009d undergirding the stability of commercial banks \u00e2\u20ac\u201d deposit insurance and lender of last resort facilities \u00e2\u20ac\u201d has been both reinforced and extended in a series of ad hoc decisions to support investment banks, mortgage providers and the world\u00e2\u20ac\u2122s largest insurance company. In the process, managements, creditors and to some extent stockholders of these non-banks have been protected.<\/p>\n

The phrase \u00e2\u20ac\u0153too big to fail\u00e2\u20ac\u009d has entered into our everyday vocabulary. It carries the implication that really large, complex and highly interconnected financial institutions can count on public support at critical times. The sense of public outrage over seemingly unfair treatment is palpable. Beyond the emotion, the result is to provide those institutions with a competitive advantage in their financing, in their size and in their ability to take and absorb risks.<\/p>\n

As things stand, the consequence will be to enhance incentives to risk-taking and leverage, with the implication of an even more fragile financial system. We need to find more effective fail-safe arrangements.<\/p>\n

In approaching that challenge, we need to recognize that the basic operations of commercial banks are integral to a well-functioning private financial system. It is those institutions, after all, that manage and protect the basic payments systems upon which we all depend. More broadly, they provide the essential intermediating function of matching the need for safe and readily available depositories for liquid funds with the need for reliable sources of credit for businesses, individuals and governments.<\/p>\n

Combining those essential functions unavoidably entails risk, sometimes substantial risk. That is why Adam Smith more than 200 years ago advocated keeping banks small. Then an individual failure would not be so destructive for the economy. That approach does not really seem feasible in today\u00e2\u20ac\u2122s world, not given the size of businesses, the substantial investment required in technology and the national and international reach required.<\/p>\n

Instead, governments have long provided commercial banks with the public \u00e2\u20ac\u0153safety net.\u00e2\u20ac\u009d The implied moral hazard has been balanced by close regulation and supervision. Improved capital requirements and leverage restrictions are now also under consideration in international forums as a key element of reform.<\/p>\n

The further proposal set out by the president recently to limit the proprietary activities of banks approaches the problem from a complementary direction. The point of departure is that adding further layers of risk to the inherent risks of essential commercial bank functions doesn\u00e2\u20ac\u2122t make sense, not when those risks arise from more speculative activities far better suited for other areas of the financial markets.<\/p>\n

The specific points at issue are ownership or sponsorship of hedge funds and private equity funds, and proprietary trading \u00e2\u20ac\u201d that is, placing bank capital at risk in the search of speculative profit rather than in response to customer needs. Those activities are actively engaged in by only a handful of American mega-commercial banks, perhaps four or five. Only 25 or 30 may be significant internationally.<\/p>\n

Apart from the risks inherent in these activities, they also present virtually insolvable conflicts of interest with customer relationships, conflicts that simply cannot be escaped by an elaboration of so-called Chinese walls between different divisions of an institution. The further point is that the three activities at issue \u00e2\u20ac\u201d which in themselves are legitimate and useful parts of our capital markets \u00e2\u20ac\u201d are in no way dependent on commercial banks\u00e2\u20ac\u2122 ownership. These days there are literally thousands of independent hedge funds and equity funds of widely varying size perfectly capable of maintaining innovative competitive markets. Individually, such independent capital market institutions, typically financed privately, are heavily dependent like other businesses upon commercial bank services, including in their case prime brokerage. Commercial bank ownership only tilts a \u00e2\u20ac\u0153level playing field\u00e2\u20ac\u009d without clear value added.<\/p>\n

Very few of those capital market institutions, both because of their typically more limited size and more stable sources of finance, could present a credible claim to be \u00e2\u20ac\u0153too big\u00e2\u20ac\u009d or \u00e2\u20ac\u0153too interconnected\u00e2\u20ac\u009d to fail. In fact, sizable numbers of such institutions fail or voluntarily cease business in troubled times with no adverse consequences for the viability of markets.<\/p>\n

What we do need is protection against the outliers. There are a limited number of investment banks (or perhaps insurance companies or other firms) the failure of which would be so disturbing as to raise concern about a broader market disruption. In such cases, authority by a relevant supervisory agency to limit their capital and leverage would be important, as the president has proposed.<\/p>\n

To meet the possibility that failure of such institutions may nonetheless threaten the system, the reform proposals of the Obama administration and other governments point to the need for a new \u00e2\u20ac\u0153resolution authority.\u00e2\u20ac\u009d Specifically, the appropriately designated agency should be authorized to intervene in the event that a systemically critical capital market institution is on the brink of failure. The agency would assume control for the sole purpose of arranging an orderly liquidation or merger. Limited funds would be made available to maintain continuity of operations while preparing for the demise of the organization.<\/p>\n

To help facilitate that process, the concept of a \u00e2\u20ac\u0153living will\u00e2\u20ac\u009d has been set forth by a number of governments. Stockholders and management would not be protected. Creditors would be at risk, and would suffer to the extent that the ultimate liquidation value of the firm would fall short of its debts.<\/p>\n

To put it simply, in no sense would these capital market institutions be deemed \u00e2\u20ac\u0153too big to fail.\u00e2\u20ac\u009d What they would be free to do is to innovate, to trade, to speculate, to manage private pools of capital \u00e2\u20ac\u201d and as ordinary businesses in a capitalist economy, to fail.<\/p>\n

I do not deal here with other key issues of structural reform. Surely, effective arrangements for clearing and settlement and other restrictions in the now enormous market for derivatives should be agreed to as part of the present reform program. So should the need for a designated agency \u00e2\u20ac\u201d preferably the Federal Reserve \u00e2\u20ac\u201d charged with reviewing and appraising market developments, identifying sources of weakness and recommending action to deal with the emerging problems. Those and other matters are part of the administration\u00e2\u20ac\u2122s program and now under international consideration.<\/p>\n

In this country, I believe regulation of large insurance companies operating over many states needs to be reviewed. We also face a large challenge in rebuilding an efficient, competitive private mortgage market, an area in which commercial bank participation is needed. Those are matters for another day.<\/p>\n

What is essential now is that we work with other nations hosting large financial markets to reach a broad consensus on an outline for the needed structural reforms, certainly including those that the president has recently set out. My clear sense is that relevant international and foreign authorities are prepared to engage in that effort. In the process, significant points of operational detail will need to be resolved, including clarifying the range of trading activity appropriate for commercial banks in support of customer relationships.<\/p>\n

I am well aware that there are interested parties that long to return to \u00e2\u20ac\u0153business as usual,\u00e2\u20ac\u009d even while retaining the comfort of remaining within the confines of the official safety net. They will argue that they themselves and intelligent regulators and supervisors, armed with recent experience, can maintain the needed surveillance, foresee the dangers and manage the risks.<\/p>\n

In contrast, I tell you that is no substitute for structural change, the point the president himself has set out so strongly.<\/p>\n

I\u00e2\u20ac\u2122ve been there \u00e2\u20ac\u201d as regulator, as central banker, as commercial bank official and director \u00e2\u20ac\u201d for almost 60 years. I have observed how memories dim. Individuals change. Institutional and political pressures to \u00e2\u20ac\u0153lay off\u00e2\u20ac\u009d tough regulation will remain \u00e2\u20ac\u201d most notably in the fair weather that inevitably precedes the storm.<\/p>\n

The implication is clear. We need to face up to needed structural changes, and place them into law. To do less will simply mean ultimate failure \u00e2\u20ac\u201d failure to accept responsibility for learning from the lessons of the past and anticipating the needs of the future.<\/p>\n

\n

Paul Volcker, a former chairman of the Federal Reserve, is the chairman of the president\u00e2\u20ac\u2122s Economic Recovery Advisory Board.<\/p>\n<\/div>\n","protected":false},"excerpt":{"rendered":"

Paul Volcker’s influence is finally starting to resonate where it counts: at both ends of Pennsylvania Avenue.<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_exactmetrics_skip_tracking":false,"_exactmetrics_sitenote_active":false,"_exactmetrics_sitenote_note":"","_exactmetrics_sitenote_category":0,"_s2mail":"yes","footnotes":""},"categories":[21,12,1],"tags":[126,28,99,17,33,49,262],"class_list":["post-1956","post","type-post","status-publish","format-standard","hentry","category-financial-crisis","category-history-society","category-other","tag-bubble","tag-history","tag-macroeconomics","tag-policy","tag-regulation","tag-speculation","tag-volcker"],"yoast_head":"\nvolcker rules - The Rational Post<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/freedom24.org\/rationalpost\/volcker-rule-sustainable-reform\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"volcker rules - 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