There are moments in history that define a change of direction, Paul Volcker’s testimony on Capitol Hill Tuesday night was one of them. Perhaps it’s a coincidence, but the minute he opened his mouth the 10-Year yield dropped, gold’s new breakout attempt stalled and the S&P 500 rose.
Outside of the generally good natured sniping from the Senate Committee, the most coherent criticism of the Volcker Rule that has been tabled so far was from The Economist’s US Business Editor who said that it was “rather too narrow and that the world, the “global economy,” has moved on.”
Fair enough; but USA, humbled as it may be, is still the center of the global economy. And with regard to moving on, well, few people would argue that of late it’s moved on to quite a few places that many would have preferred it not to move on to.
“Narrow”? OK, but give the guy a chance, they only just dusted him off and rolled him out of the closet. In any case, as Senator Dodd pointed out in his summing up last night, the danger is trying to do too much and in the end failing to do anything; or more important, to do anything right.
Paul Volcker was relaxed, straight-forward, so knowledgeable that one could hardly resist writing down what he said and, most of all, he had integrity oozing out of his skin. He didn’t stutter like Hank Paulson, wriggle like Tim Geithner, or give “non-answers” like Bernake. What you saw was what you got; the overriding impression that he left behind was, “At last, a safe pair of hands.”
When Volcker was asked, “what is the one big evil thing this bill will wrest out of the system,” the answer was crystal clear and it came straight back without a moment’s hesitation:
“What I want to get is to stop taxpayer support for speculative activity”
Now that’s change, that’s big change.
Break it down and you can explain the whole of the credit crunch in those terms, from the tax-break that home-ownership attracted from way-back before the Clinton era (someone else still had to pay taxes), to the taxpayer’s “implicit”, and when push came to a shove, “explicit” support for the speculation by Fannie and Freddie. To the emergency opening up of the Fed’s discount window to shadow banks who had put on sheep’s clothing, allowing them to “earn” their way out of trouble by borrowing at 0% and then lending that money back to the government at 3.5% - risk free. Some have even claimed that part of that money went to fuel the rally in the stock market; (personally I find that one conspiracy theory too far, but then again, it’s the thought that counts).
One of the many commentaries on the Volker Rule is that my heroes at Goldman Sachs will be able to skip around it because less than 5% of their funds come from deposits.
That misses the point. What the rule will do is close down the discount window, or even the option of that window, to any bank or approximation of a bank that wants to use that money to speculate on their “own” account (funded directly or indirectly by the taxpayer). Now that is a silver dagger straight into the heart of “God’s Workers."
But the Volcker Rule will affect the viability of Commercial Banking!
One of the accusations put forward by the Committee was that if “normal” commercial banks could not “play” they would lose an important source of revenue, and this would put a drag on the primary and essential function of commercial banks to fund economic growth.
Volcker didn’t have any problem putting that one to bed. He started off by explaining that the he acknowledges the vital role that commercial banking plays in supporting economic activity, and that’s why the US Central bank underwrites them by providing facilities for emergencies like the discount window (as do all central banks). But he rejected the idea that providing them with funds to speculate, either directly or indirectly, would stop them making money out of their core utility, which is making sensible loans to sensible people so they can do sensible things that help build the economy.
What he didn’t say was that the system as it is structured at the moment discriminates against “normal” banks, because the key to success these days is determined to a great extent by proprietary trading, which allows the entities that get that right (thanks in part to the funding they get from taxpayers) to distort the market for straightforward commercial banking. Which is why so little of the Fed’s recent largess, which taxpayers will eventually pay for in one way or another, has actually got out into the real economy; but then some things are better left unsaid.
What he did say (in so may words) was that banking is a risky business and it needs public support, but providing taxpayer money to support proprietary trading is not helping your constituents, it helps a small group of individuals who are not making money for you (the taxpayer), they are making money for themselves.
“I don’t want to restrict commercial banks; I want to encourage them to do what they do."
But all the Good Banks Will Leave America!
Another concern of the Committee was that if USA becomes “banker-unfriendly” the banks will move away and the American financial system will become marginalized (and implicitly the sources of foreign funds that help support America’s chronic deficit will dry up).
That’s easy, and Volcker pushed the right button without even blinking. The answer is simply that what banks and foreign investors want above everything else is that the US Banking system is, to use Henry Paulson’s hollow expression of July 2008, “Safe and Sound."
So would this regulation have stopped the credit crunch?
That’s a stock question that get’s rolled out every time. When Secretary Geithner was asked that one about his “fire-fighting plan” last March, he wriggled and squirmed almost as much as when he was being grilled about tax-evasion (and I can’t wait to see him squirm and wriggle out of the 100 cents on the dollar that he paid out to Goldman Sachs and all the other “God’s Workers”), but eventually after a few "Ums"…and "Errs," he could only say, “Err…No."
Volcker had no hesitation. When pressed about “for example AIG (NYSE:AIG),” he said (a) that’s an insurance company so that’s not even on the table, (b) what we want to do is stop a lot of stupid things and what happened with AIG is a good example of one of them.
His point was that the supervisors should have been keeping a closer eye on AIG and should have asked them what on earth they were doing with those CDS in London. And, yes, in that regard, his proposal, and the proposal as a whole, would strengthen the oversight power of regulators.
But the regulators have powers – so what will this achieve?
Volcker disagreed. He remarked that although regulators have some “powers” what that basically amounts to is an advisory role that the financial participants can heed or not so long as they stay within the boundaries of the laws set by Congress. The implication was that it wasn’t enough, and it failed.
On this subject one of the Senators made a good point, that the Volcker approach was more “principle-based” than rule based, and he remarked that “the system” will always find ways to get around rules, but principles are much harder to circumvent.
Ah, but this is just a case of “Never let a Good Crisis Go To Waste – to promote your pet agenda”
Along with that line, was the position made more than once that “proprietary trading did not cause the credit crunch."
That brought out the best in Volker. He pointed out that “we” need to look ahead to the next crisis, and that: “if the new regulation gives free reign to speculation (with taxpayers’ money), I may not live long enough to see the crisis that causes, but my soul will come back to haunt you”!
That raised a laugh. But it was a threat, and my impression is that Paul Volcker is not someone who makes threats lightly, so be warned!
I was pleased to hear that at least someone understands that the priority now is not to build a Maginot Line to protect against yesterday’s wars, or to prepare to do fire-fighting once the damage has been done, it’s about building something to protect against the next war even starting.
“Oh…But what about Innovation and American Ingenuity?”
That was of course an easy stone to throw, seeing as Volcker is on record as saying that the “only really useful financial innovation that happened over the past twenty years was the invention of the ATM machine”.
The answer to that was as usual, simple, straightforward, and credible. What he said (in so many words) was: “I’ve got nothing against innovation; just it’s not the place of the taxpayer to pay, when it fails”.
The Old American
The first American I ever met was a guy called Frank Perez (his dad was half-Spanish and his mum was German Scandinavian, a real mongrel like many Americans). He was a “driller of oil wells”, really, just like in the song; and I was “just a kid.”
Big heart; generous with his time and his advice, full of laughs and stories, but no nonsense about stuff that was serious.
That was old-school American, and that's what I see in Paul Volcker.
In those days it used to be about integrity, and above all, competency. Could this be the signal for the change that Obama was elected on?
Disclosure: No Positions