Is Volcker Speaking Up More?

Here are some excerpts from his appearance at something called the Future of Finance Initiative. Emphasis mine. Will our leaders listen?

You concluded with financial-services executives showing cultural sensitivity and responsible leadership. Well, I have been around the financial markets for 60 years, and how many responsible financial leaders have we heard speaking against the huge compensation practices?

Every day I hear financial leaders saying that they are necessary and desirable, they are wonderful and they are God's work. Has there been one financial leader to stand out and say that maybe this is excessive and that maybe we should get together privately to think about some restraint?

I hear about these wonderful innovations in the financial markets, and they sure as hell need a lot of innovation. I can tell you of two—credit-default swaps and collateralized debt obligations—which took us right to the brink of disaster. Were they wonderful innovations that we want to create more of?

I mean: Wake up, gentlemen. I can only say that your response is inadequate. I wish that somebody would give me some shred of neutral evidence about the relationship between financial innovation recently and the growth of the economy, just one shred of information. I am getting a bit wound up here.

In Britain, I was just talking to a high-tech company about the immense attraction to go into finance when both Britain and the United States are suffering from a basic inability to produce things competitively, to keep up with the new economy. Is this a result of financial innovation that we should be really worried about?

I made a wiseacre remark that the most important financial innovation that I have seen the past 20 years is the automatic teller machine. That really helps people and prevents visits to the bank and is a real convenience.

How many other innovations can you tell me that have been as important to the individual as the automatic teller machine, which is in fact more of a mechanical innovation than a financial one?

I have found very little evidence that vast amounts of innovation in financial markets in recent years have had a visible effect on the productivity of the economy. Maybe you can show me that I am wrong. All I know is that the economy was rising very nicely in the 1950s and 1960s without all of these innovations. Indeed, it was quite good in the 1980s without credit-default swaps and without securitization and without CDOs.

I do not know if something happened that suddenly made these innovations essential for growth. In fact, we had greater speed of growth and particularly did not put the whole economy at risk of collapse. That is the main concern that I think we all need to have.

If it is really true that the world economy was on the brink of a great depression that was greatly complicated by financial problems, then we have a rather basic problem that calls for our best thinking, and structural innovation if necessary. I do not want to stop you all from innovating, but do it within a structure that will not put the entire world economy at risk.

First, let us agree that we have a problem with moral hazard. I do not think that there is any perfect answer in dealing with it, but I would suggest that we can approach an answer by recognizing that elements of finance have always been risky and that's certainly true of the commercial-banking system.

I think we need the commercial banking system for more than automatic teller machines. Commercial banks are still at the heart of the system.

In a crisis, everybody runs back to the commercial banks. They, after all, run the payment system. We cannot have this global economy without commercial banks operating an efficient payment system globally as well as nationally. They provide a depository outlet for individuals and businesses, and they are still big credit providers for small and medium-size businesses, but they backstop most of the big borrowers as well. The commercial-paper market is totally dependent on the commercial banking market. They are an essential financial institution that has historically been protected. It has been protected on one side and regulated on the other side.

I think that fundamental is going to remain. People are going to think it is important, it is important, it needs regulation and in extremis it needs protection—deposit insurance, lender of last resort and so forth.

I think that it is extraneous to that function that they do hedge funds, equity funds and that they trade in commodities and securities, and a lot of other stuff, which is secondary in terms of direct responsibilities for lenders, borrowers, depositors and all the rest.

There is nothing wrong with any of those activities, but let you nonbank people do it and you can provide fluidity in markets and flexibility. If you fail, you're going to fail, and I am not going to help you, and your stockholders are going to be gone, and your creditors will be at risk, and that is the way that it should be.

How can I be so blithe about making that statement? We need a new institutional arrangement which I believe has a lot of support. We need a resolution facility. What can that resolution facility do? If one of you fails and has systemic risk, then it steps in, takes you over and either liquidates or merges you, but it does not save you. That ought to be a kind of iron cross.