Sense on Cents

Paul Volcker

What will the future of Wall Street hold? No man is attracting more attention regarding that very question than former Fed Chair Paul Volcker. What might the Volcker Rule mean for Wall Street? For those with an interest in the global economy and markets, Volcker provided an extensive interview recently to the Financial Times.

In this interview, the former Fed chair talks more ‘sense on cents’ than anybody I have come across since launching this blog a year ago. I STRONGLY recommend reading it and saving it. Volcker’s interview will serve as a fabulous reference map as we collectively navigate our economic landscape.

Paul Volcker is seen as one of the wise men of American public life. As chairman of the Federal Reserve under Presidents Jimmy Carter and Ronald Reagan he subdued inflation, for which he is lauded today, although it was controversial at the time. After President Obama’s election, Mr Volcker was made chairman of the President’s Economic Recovery Advisory Board, a position which initially seemed largely ceremonial. But Mr Volcker returned to the centre of financial and economic debate last month when Mr Obama endorsed his proposed separation of commercial banking and proprietary trading, a plan dubbed the “Volcker Rule”.

Chrystia Freeland, US managing editor, interviewed Mr Volcker in New York. This is a transcript of that interview.

FT: Thank you for joining us, Mr Volcker.

PV: Good morning. Nice to be here, have you in my office.

FT: It’s great to be here. So, will the Volcker rule be enacted?

PV: Course. Makes good sense so it ought to be enacted. It’s gotten more attention in the world. I think it’s important obviously, but more attention than it deserves. People think it’s the whole of reform.

It’s one piece of reform that is a complement to other measures. I think what’s not distinctive about this, but what’s important is the reform includes, I think, what I would call structural measures that have to be enacted into law and not just rely upon supervisors’ judgment and regulators’ judgment, which is important or changes in practices and banks, but those things can all slip.

We’ve got to set down some rules of framework within which all of that should operate.

FT: How do you think you fared before the Senate Banking Committee last week?

PV: Well it was okay, but I was a little bit concerned that the dialogue of the questioning proceeded as to whether there wasn’t some influence from the overall political impasse in Washington and things weren’t necessarily looked at entirely on their merits, but how they fit into a broader political, [what] can only be described I think fairly, as an impasse in Washington.

I would have thought, and I hope it’s still true, that banking regulatory matters and banking regulation, given the crisis that we’ve had and the need is so obvious and it’s a fairly technical subject, would get moved out of the difficult political climate.

FT: You mean you hope that the Republicans will support reform put forward by a Democratic White House?

PV: I would hope that Republicans and the Democrats could support necessary and reasonable reform, yes, and not react just – Mr Obama presented this so we’re against it. I hope it gets out of that kind of context.

FT: To hope is one thing. How likely do you think it is that that hope will be –?

PV: Well, we’re going to keep working at it and I hope – it’s more than hope. I think this is a particular subject where the need, I’m repeating myself, is so clear that we ought to get out of any temptation to get into that mindset.

FT: It looked at the beginning of this administration as if you weren’t perhaps the president’s most influential economic counselor. Then we saw in January the president turning to you. What happened?

PV: Well, this is all exaggerated. You say look at a year ago that I wasn’t the president’s primary economic – I shouldn’t have been. His primary economic counselor is in the White House, Mr Summers, it’s in the Treasury, Mr Geithner, to name two. There are others. I’m not part of the administration. I come in from outside and he thought of this idea of an advisory board.

But if I was the most influential advisor, what are those other people doing? They’ve got the responsibility and are right there working with him day by day.

FT: What do you think turned the tide? Why did we see the president coming out quite late in the reform process on this one?

PV: You say turn the tide. This is one particular issue.

FT: It’s a big issue though.

PV: Well I think it’s an important issue and partly because it reflects, I think, determination of how you want to structure the financial markets, but it’s only a part of that whole picture.

But why he came up, I honestly can’t answer that. It went back some months. I was asked to go to a meeting and it was clear that he was kind of rethinking this and making other points, but at that point he had made up his mind.

He was persuaded I guess by the logic and I think some other people were weighing in and he decided that some time ago that this seemed to make sense, which I of course was delighted, since I thought it made sense from the beginning.

FT: So people who thought the Massachusetts Senate race was the turning point for the President are wrong –?

PV: That’s nonsense. Massachusetts was a Monday and suddenly – it was a Monday or Tuesday. Maybe it was a Tuesday and he announces this on Thursday. Whoa. We lost in Massachusetts to haul out this plan. I mean it’s crazy.

He had been ruminating about this I can tell you and made up his mind weeks if not months before that.

FT: Do you feel that this particular part of reforms that you’ve been advocating, the Volcker rule, now is supported across the board by the president’s economic team?

PV: I think they’re part of a team and the president has accepted this and I think the others accept it and understand it and some very enthusiastically.

FT: And some less enthusiastically?

PV: I think it’s part of the program and it’s a good part of the program and similarly there are other parts of the program that I’m enthusiastically in favor of that were in the president’s program from the beginning. This is part of the pattern.

I think the important thing is we get the structure figured out right. This idea of a – get my terms right, the resolution authority I guess is what we’re calling it, which definitely needs legislation.

It is another key structural part of the approach, which kind of interacts with this restriction on proprietary trading tries to accomplish, is another big element as you know in the derivatives and how to handle derivatives and whether derivatives should be put in more clearer and established clearance or settlements procedures one way or another.

There are some other issues. Some of them are going to have to wait, like what we do about the mortgage market, which is a big structural issue. There’s an issue out there in my mind about what to do about money market funds, which can be taken care of to some degree by regulation and supervision, but I think that may require some legislation, too.

So it all fits together hopefully in a package. Everybody’s been talking about capital requirements, leverage restrictions, liquidity requirements, which is all important, too, but that’s in the area of supervision.

FT: One of the criticisms of the Volcker rule has been that it doesn’t address the direct causes of this latest financial crisis. What’s your response to that?

PV: Well my response first of all, is we’re looking ahead; not backwards, but certainly proprietary trading in all its forms was an important part of the crisis and people say the specifics of this plan apply to banks. There was a lot of problem in non-banks. That’s not directly addressed by these proposals.

What is addressed by these proposals is a combination of what banks can do, which are protected, that have the safety net, they have deposit insurance, they have access to the Federal Reserve and what non-banks can do. Non-banks in my view by and large are not regulated as tightly as banks, but they’re going to be subject to this resolution procedure.

If they got in trouble, the theory is they will not be rescued, but they will have an orderly demise where I think of as euthanasia rather than life support and that’s a big difference. We have to kind of embed this in consciousness.

So much of the early part of this crisis was the non-banks were actively engaged in trading and proprietary activity, which in some sense was at the heart of the crisis. But you remember back with Société Générale I guess it was, they had one rogue trader that cost them how much? I think the threat was several billion dollars from one rogue trader.

Had a rogue trader in Barings some years ago that brought down the whole organisation. Those are kind of one-off things where you see the damage that one trader can do in purely proprietary trading. In those cases, for their own interests as well as the banks’ interests I’m afraid. It’s the kind of things you don’t want banks doing.

FT: If the Volcker rule were to be enacted, should a financial institution be allowed to give out its bank holding company status to evade the Volcker rule? Goldman Sachs comes to mind as –

PV: Well, I think any organisation would have to make up its mind. They want to be a bank, be a bank holding company, have access to the Federal Reserve, have access to deposit insurance, then they’ve got to follow the rules for banks.

If they don’t want to follow the rules for banks then they shouldn’t have a banking charter. It’s as simple as that. Pretty simple.

FT: And you think it would be okay for financial institutions to say ‘Right, with these new rules of the game with the Volcker rule we choose not to have bank holding company status?’

PV: Yes, absolutely, but that doesn’t mean they’re going to escape from all oversight and regulation. The administration has proposed from the beginning that if you have a large, systemically sensitive institution you’re going to be subject to some oversight. You’re going to be subject to some capital restraints, some leverage restraints, liquidity provisions. So you don’t escape.

If you’re really big and potentially your failure would be very disturbing, you’re going to have some oversight. So you don’t escape all the oversight, but you escape – escape maybe is not the right word. You’re not going to have the special privileges of a bank.

You can’t, mind you, combine the special privileges of a bank with unrestricted proprietary activity. They don’t mix.

FT: Wouldn’t you be concerned though if we saw some institutions that became bank holding companies to survive the crisis give up that status afterwards? Wouldn’t you be worried about the moral hazard that we now know that the government will bail them out?

PV: The whole point of this is importantly to get at the moral hazard problem. I want to make it as clear as we can that these non-banks if they get in trouble are not going to be saved. Then they will have to conduct their business accordingly.

That’s why we have the resolution authority that if they do with whatever supervision and regulation they have, whether they still get in trouble, as could happen, you can have this new tool of the resolution authority to let them down easy, but they’re going to be let down, not rescued.

Their creditors can’t sit there and say, ‘I’m going to be protected.’ The management can’t expect to stay in office. The stockholders can expect to lose, which that attitude that people can be rescued is what we’re trying to deal with.

Success in this whole effort would be if we set up this resolution authority and you never need to use it. The perfect success would be we have that in the background. It’s available as a tool, but these financial institutions all behave themselves to the point they don’t risk failure and they don’t risk disturbing the whole financial system if they do fail.

FT: If a company, like for example Goldman Sachs, were to give up its bank holding company status, do you think the government and the regulator could credibly say to the markets that this institution will be allowed to fail?

PV: Well, that’s the objective.

FT: Is that possible, even with an institution as big as Goldman Sachs?

PV: Well, I think that’s why you need the resolution authority so we can credibly say that. First of all, if they’re really big, are going to have some oversight. That’s common to all these – internationally that’s common to almost everybody’s opinions. There’s going to be some oversight, but yes, we want to make it credible that they can fail, but you will have some designated agency step in and maintain continuity of operations as they are liquidated.

FT: Some people have talked about the Volcker rule as being part of restricting this issue of too big to fail. Is that your intention? Is it about limiting size?

PV: No; these issues have gotten mixed up. The President said something about it at the same time, but my focus has been on the proprietary trading thing, but that doesn’t mean I’m against the general idea of some restriction on size. I think there’s a lot of misunderstanding about this that the government’s out to cut these people all up, but they haven’t said anything like that.

They said what they’re thinking of proposing would not affect any present institution or wouldn’t force any present institution to shrink, but they say at some point there ought to be some –

FT: What they’re thinking of proposing in terms of limits on size.

PV: On size, yeah. So I think it’s sensible as a matter of judgment or common sense. The United States is a huge market and isn’t there some point upon which is a matter of kind of general public policy you might say you’re big enough in the sense of competition and variety of services and power? Depends on size and power, some reasonable limit on the size has always been accepted. That idea is not new.

FT: And what would that limit be?

PV: I don’t know. They’ll have to decide, but they have said that it’s not going to be lower than the size of existing institutions. But philosophically, let me just make this point, philosophically the idea of putting some limit on it is not new. You’re a young woman, but you forget that in the United States we didn’t even have interstate banking 20-30 years ago.

When that was first proposed when I was chairman, he said, ‘Well, it’s going to be politically unpopular. Maybe there ought to be some limit on the size of these institutions.’ We had said five per cent. By the time it finally got enacted it turned out 10 per cent on deposits.

So you already have the precedent, which nobody thought was terrible I think that 10 per cent of the deposits in this whole vast market doesn’t seem an unreasonable restriction, but so much of bank assets are not deposits now, are liabilities, not deposits. That’s kind of been outmoded.

So they say well, we have the same philosophy, but let’s apply it to all the liabilities. Now they haven’t made up their mind just where they want to put it, but they’ve been pretty clear that it’s not designed to push the present institutions down. The concept is they can’t merge or acquire other institutions if they have normal organic growth, okay.

FT: What about the argument, though, that focusing on size as an issue rather than the businesses in which banks engage really is a bit of a red herring. After all you could make an argument looking at, you know I like to cite the Canadian example, where they have five or six really big banks. The Canadian regulators would say that made it easier to regulate the market.

PV: Well I think it did in a way, but there is kind of a matter of philosophy. With all respect, Canada isn’t quite the size of the United States.

If you had banks in the United States that had 25 per cent of the whole banking market of the United States, I think almost anybody would say, there’s something wrong with that degree, that size institution and not just in the United States market, but in the world market. Is it easy to manage? Is it manageable? Is it going to be quick on its feet? Will it take care of small businesses? On and on and on.

You’re talking about if an American bank was that big in size of the American market, it’d be bigger than all the Canadian banks put together.

FT: And you think that’s too big?

PV: Yeah; I think to take that extreme example, yes. I do think that’s too big.

FT: One criticism that we’ve heard particularly from the banks of your approach is it would limit the competitiveness of American institutions in the world. What’s your response to that?

PV: Well first of all, obviously it’d be desirable. We get an international consensus on this point and I don’t think that’s at all impossible and as chairman Dodd said actually when he introduced the hearing the other day, he says, ‘I’m favorably inclined toward this, but as I said in my statement it ought to be internationalised.’

And he made a very sensible point that if it’s going to become a general consensus around the world, the United States is going to have to take the lead.

I absolutely agree with him on that that the United States has to be out there making this case and I think there’s a lot of latent support for it, I tell you, in the rest of the world.

FT: Have you spoken to policy makers in other countries about this?

PV: Well, occasionally I run into them or something. I haven’t gone out –

FT: You haven’t gone out lobbying?

PV: I haven’t gone out lobbying at this point anyway, but I know what some of them feel and obviously in some cases, as the governor of the Bank of England, I think he came out publicly for this before I did. Mr Sarkozy is not always in line with every American idea; went out of his way at Davos to say he welcomes President Obama’s initiative in this area and we ought to get to it with the implication.

There are very few banks that this affects. It’s amazing.

FT: But those banks are powerful banks.

PV: Well, that’s the point I’m making. It’s amazing how few banks are affected and what a lot of noise raised about it given that, which maybe four banks in the United States. Then there are a couple of investment banks that recently got a licence and I don’t know. Like I said, there may be two dozen institutions in the world and that’s probably a liberal estimate. That probably would take in the Canadian banks that don’t want to do it anyway. Maybe some of them do, but when I say there are two dozen systemically important banks in the world, not all of those are concerned. There are a real handful that are.

FT: Given the relatively small number of institutions this rule would affect do you think the lobbying counter pressure has surprised you with its strength?

PV: Nothing surprises me about the strength of lobbying pressures these days.

FT: Is it stronger than when you were running the Fed?

PV: Well I think it’s certainly more organised, more money involved, but certainly the pressures were always strong when it came to bank regulatory matters, real changes in – in that case, the lobbying pressures were mostly liberalised. So these lobbying pressures are in favor of not restricting. It’s a little different.

FT: Maybe an easier battle to fight, preserving the status quo is presumably easier.

PV: Maybe, but it certainly has more force to the argument. But again, I’m not restricting. Just in the American context what are we talking about? As banks we’re talking about at the most, five in any significant way and then there are –

FT: But the five most important ones.

PV: Well, there’s no question, the five biggest banks.

FT: Sorry to interrupt you, Mr Volcker. Have you spoken directly to the leaders of those five big banks about the Volcker rule? Have they been in touch with you to talk to you about it?

PV: I have talked to some and not talked to others. Some of them come to me. Yeah.

FT: What has happened in those conversations?

PV: I frankly think when you – I shouldn’t make judgments, but the amount of noise in the press and the seeming opposition, I think there’s a lot more understanding of the leadership of these institutions as to what it’s all about and what it means and is sometimes reflected in the press, with all due respect to the press.

FT: A lot of the focus in this press attention has been on what the implications of the Volcker rules would be for Goldman Sachs. Have you talked to Lloyd Blankfein about them?

PV: I haven’t talked to him in recent months anyway. I’ve had no communication with Mr Blankfein, no.

FT: What do you think the implications would be for Goldman?

PV: Well, the implication for Goldman Sachs or any other institution is do you want to be a bank? You want to come within the safety net, follow the banking rules. If you don’t want to follow those rules, you want to go out and do a lot of proprietary stuff, fine, but don’t do it with a banking licence.

Don’t expect the support that you would get from being a bank within the club of insured deposits and access to the Federal Reserve and all the loving attention you get as a banking organisation.

As I say, if you just repeat, if you’re outside that circle and you’re very big, you’re still going to get some regulatory attention. That’s been in the Treasury’s plan from the beginning. So it just hasn’t been an issue here. Doesn’t get discussed because it’s not an issue so far as this conversation is concerned.

I think it was all incorporated in the House bill and I think everybody assumes that there’s going to be some capacity in this new world for regulators. Some regulatory agency is going to have some oversight over what used to be investment banks or huge hedge funds or huge equity funds. That used to be a role for the SEC, but they weren’t paying much attention. In the future somebody’s going to be paying attention.

FT: Do you really believe, Mr Volcker, that having been rescued by the government, having become a bank holding company in the teeth of the crisis, a company like Goldman Sachs could give up that status –

PV: Absolutely.

FT: And credibly not still benefit from the government guarantee in the next crisis?

PV: Goldman Sachs is a wonderful investment bank, has a very proud history. They’re very proud of their risk management techniques. They’re proud of their trading prowess. They lived for almost a century, but they lived for decades and decades very nicely until 2008 when they suddenly got a banking licence in extremis, but that doesn’t mean they’re entitled to a banking licence forever.

FT: No, but it might mean that the markets would assume in the next crisis they would be given a banking licence if they were on the edge.

PV: That is why we have the resolution authority. They say don’t assume they’re going to be treated like a bank. They’re going to be under the resolution authority. The resolution authority’s going to have adequate not just authority, they will have adequate resources to let it down easily. That might take time, but the whole purpose is to, on top of whatever regulatory restraints they had, they have a sufficient authority and resources to provide a really proper burial. It wouldn be a very nice burial, but a burial.

FT: And you think that that could be done. That’s achievable.

PV: Absolutely. That’s common to all these proposals.

FT: Building an international consensus around the Volcker rule clearly would be a good thing.

PV: Yeah.

FT: Even absent that sort of a consensus, do you think the United States should press ahead alone?

PV: Yes; it gets messier and more difficult, but don’t exaggerate the problem of international consensus. You don’t have to get consensus from 200 countries. You don’t have to get consensus among 100 countries. You don’t have to have a consensus among 20 countries.

I think you do, it will be very nice to have a consensus with the UK, the other big financial market with the European Commission, other major countries in Europe. Be nice to have the Canadians join in. I don’t think that’s such a big deal, but that’s about as far as you have to go.

FT: So who would be essential in an international consensus? The US, the UK.

PV: And I think some individual European countries or the European Union.

FT: Which individual European countries would you focus on the most?

PV: Well, the ones that have banks that are active in this business. The French have a couple and the Germans have one. It’s not huge. Maybe the French have three. I don’t know.

But it’s not like you’ve got hundreds of institutions out there. You don’t.

FT: Another area that you’ve spoken about as being essential for reform is the credit derivatives market. What do you think needs to be done there?

PV: Well, the most obvious thing and of course there’s a lot of resistance here, this has been in some sense a bigger issue than the other. Credit derivatives have gotten pretty big. This idea that you have $60 trillion worth of credit derivatives, which is ten times the number of credits that you had in itself, suggests a certain vulnerability in the system.

But this is an area I’m not going to claim any special expertise, but it obviously makes sense to have arrangements either through an organised clearing system or an organised market that demands adequate insurance against failure of derivatives of those providing the derivatives, either through a collective responsibility as a clearing organisation, which then has the responsibility of making sure that collateral requirements and margin requirements are enforced or simply a greater discipline in enforcing appropriate collateral requirements and margin requirements.

Now, the market immediately responds by saying well, we want to make very complicated derivatives that you can’t put through a clearing house so easily and it comes down to a practical question. If they’re going to make every derivative deliberately complicated so it doesn’t go through the clearing house, that’s not the kind of behavior you want to see.

FT: So do you think there should be a requirement that derivatives have to be standardised so they can all go through a central clearing –?

PV: Well, you want to encourage that to the extent possible. I’m not ready to say right now you could not have a derivative that doesn’t go through the clearing house, but you will not have met the objective of the great bulk of the amount that way. So there’s resistance to that; very strong resistance.

FT: Another counter argument to central clearing of derivatives that we’ve heard is from industry players who are concerned that the derivatives would be more expensive for them if they have to go through central clearing. Are you sympathetic to –?

PV: No, I am so cynical I wonder whether some of that industry opposition isn’t because their banker went to them and said, ‘Why don’t you say that?’

FT: Surely not.

PV: No, I know that’s being very cynical, but there we are. That’s how cynical you get in your old age.

FT: Do you think the White House is prepared to put up a fight for central clearing of credit derivatives?

PV: Look, this is not my specialty and I haven’t spent a lot of time discussing this stuff, but yeah, I think this is one of the areas that the government, the administration thinks is critical. They certainly think the idea of a resolution authority is critical. They now think my kind of idea is critical.

They certainly think some authority over non-bank institutions is critical. The idea of an oversight agency, which I am strongly in favor of. It’s a question of who should do it, but the idea of an overseer of the market as a whole beyond regulating individual institutions and supervising individual institutions, who is watching out for the growth of the CDS market?

Who is watching out for the growth of subprime mortgages? Shouldn’t somebody be in there saying this looks a little dangerous to us? Somebody ought to blow the whistle, even if didn’t affect or necessarily jeopardise a particular institution.

FT: Where do you think that kind of authority should be vested?

PV: Well, I happen to think, I’ve said many times I think the Federal Reserve is the highest candidate, but the administration has proposed this kind of joint council led by the Treasury.

So there are only three options. I think you put it in the Treasury, which is kind of what the administration does. It’d be something new for the Treasury.

You put it in the Federal Reserve where I think is a natural extension of what the Federal Reserve should have been doing anyway or you have a new, independent agency overseer with a chairman that that’s his job.

I think it’s important to get into this area, but the Federal Reserve if it’s going to remain in the regulatory area, which I think it should, but it’s under some discussion, is going to have to be reorganised itself. So that it is less likely to drop the ball in the future.

FT: And you think it did drop the ball?

PV: Well I think they all did. My problem is the Federal Reserve gets singled out, but I think it wasn’t just the Federal Reserve, but the SEC. If anybody dropped the ball in the investment bank area it was the SEC and the OCC and the people in Fannie Mae and Freddie Mac.

That was a collective undo relaxation, if I may put it kindly, a regulatory or supervisory discipline, but it’s philosophical. The idea that the market was going to take care of itself and all these new techniques and high degree of financial engineering was taking care of the risk. It was distributing it in ways it could be absorbed.

In the end we found out it concentrated some of it instead of distributing it. But this was a kind of mindset which was broadly supported in the academic community and elsewhere.

FT: Even in the journalistic community?

PV: They probably led the parade. I have no doubt. With some exceptions. Maybe the Financial Times was cautious and balanced.

But anyway, where were we?

FT: The reorganisation of the Federal Reserve.

PV: Oh, the reorganisation of the Federal Reserve. I proposed two years ago now I guess that in order to be a vice chairman on the Federal Reserve board, vice chairman for regulation or supervision, he’s going to be nominated and confirmed with the knowledge that’s his particular responsibility. He’s going to be asked to report to the Congress once in awhile. What’s the state of the financial system.

Follows from that some reorganisation within the Federal Reserve System to clarify the responsibilities between the boards and the banks and I think it’s really important to have somebody really responsible for that and not just rely upon somebody who’s going to think his principle responsibility is monetary policy.

Some people in the Federal Reserve have taken a close interest in regulatory matters and some have not. There’s one school of thought that says the Federal Reserve shouldn’t be involved in regulatory matters at all and of course the British followed that. It’s a little sweeping to say not at all, but they pretty much followed that pattern in the UK.

FT: Didn’t work out so well.

PV: Well, when the crisis came they decided that didn’t work out too well and I think they should have been more cautious about it in the first place.

I do think you can’t separate banking supervision and regular financial supervision and regulation entirely for monetary policy without running the risk that monetary policy becomes kind of an abstract thing probably dominated by economists who in some sense are not fully in the real world and don’t understand all the implications of the monetary policy decisions for our financial markets.

It’s the other way around. All this talk about bubbles and what you should do about it. It’s now I think fairly clearly understood that you can’t deal with bubbles entirely by – well, first of all, yeah, bubbles are a problem when they get too big and have too many consequences through the whole financial system and the economy that they are a matter of concern, number one.

Number two, it’s difficult or impossible to deal with them all by the general tool of monetary policy by changing interface. Therefore you need some supervisory and regulatory authority where you can be a little more directed –

FT: Even before the bubble has burst? This would be run countered to the Greenspan philosophy –

PV: No; this is to prevent the bubble from getting so big that the bursting undermines the economy.

FT: So the central banks should take on that role?

PV: Given that interconnection I think it’s hard to separate the central bank from supervision. I think it’s just an illustration of how important it is. Mr Bernanke’s recent speech where he was defending the proposition that monetary policy didn’t create the housing bubble. He says no, but on the other hand we would not have been sufficiently attentive in our supervisory policy and we’re not going to permit that to happen again.

FT: So do you think there has been this profound philosophical shift that the Fed now takes on responsibility for trying to prevent the next bubble?

PV: No, I think there has been some philosophical shift that says we just simply cannot rely upon picking up the pieces after the bubble has burst. Now that leaves a very difficult matter of judgment about how you go about it technically and otherwise.

FT: And you think that’s the right course though for the Fed to take responsibility for trying to burst the bubble? Take the punch bowl away?

PV: Yes, certainly the principle is to take the punch bowl away which is generally thought about more broadly than bubbles, but the most difficult judgment to make and it inevitably becomes highly political is when you begin restraining and how much you restrain because it’s never very popular to restrain. That’s why you have an independent central bank to put them in a better position for taking these kinds of decisions.

FT: You are an expert in restraint and that was one of your great accomplishments. Has the time come now for the Fed and the government to begin exercising the strength?

PV: I’m not going to get into this argument about monetary policy. I’d like to stay away from it. But right now, if you’re asking this question right at the moment, I don’t think there’s any strong reason for acting right now, but that’s something you’ve got to keep under review.

FT: What about within the next six months?

PV: I’m not going to follow you down this little route.

FT: One criticism of the Volcker rule and your advice in –

PV: Somebody possibly criticised it?

FT: A few people have. One comment that some people have made maybe tending to be anonymous when they make it is they’ve said, ‘Well Paul Volcker is a man of great and historical accomplishments, but how connected is he with the markets today?’

PV: That’s right. He’s out of touch. As one of my friends put it the other day, going back to the future. That was apparently a movie at some point. I don’t know the movie, but I think the lesson of the movie was sometimes you wanted some lessons from the past and apply them to the future. That’s what I would like to think we were trying to do here.

FT: What about this observation that today’s capital markets are so complicated and Mr Volcker, for all his great achievements, doesn’t really understand that?

PV: I’m sure I do not understand all the complications of the financial market. Part of my problem is I don’t know how many of the leaders of these institutions understand it either.

If you’re not 26 years old and just graduated from a degree in mathematics or physics or something, you’re not going to understand it all. I’m not sure that’s a terribly bad thing, but I do understand it’s very complicated.

It’s given rise to a great amount of opaqueness which has made it difficult to manage and I know that you have a different psychology among the traders than you associate with – maybe it’s old fashioned, but basic commercial banking serving the public, serving your customers, providing solid services at reasonable costs and safely is a different mentality than the typical proprietary trader, typical hedge fund guy. I’m not saying it’s wrong. It’s just different.

We’ve got to watch out for all those complications, which I’m sure I don’t understand, of bringing down the system. I also think it is apparent that a lot of this trading activity raises enormous conflicts of interest within these institutions which are themselves, at the very least, the most mildest comment I can make, are very difficult to manage.

FT: But surely those conflicts of interests are a problem for the clients of the institution. Why should the government be involved?

PV: Well, I don’t say the government should absolve itself from worrying about market behavior or economic behavior that’s full of conflicts of interest. There’s lots of banking rules that are designed to prevent conflicts of interest. It’s a question how effectively you can do it.

FT: There was maybe a little bit earlier in the crisis or earlier in the aftermath of the crisis a lot of focus on compensation and on the wrong incentives being embedded in bankers’ compensation. How worried are you about that?

PV: Now you talk about complexities and difficulties, that’s a big one. I haven’t much to contribute to this debate. I do think that the compensation practices have, not just in finance, but particularly in finance have gotten out of touch and created incentives that are not very helpful. That’s a very mild statement again.

They’ve gotten obscenely large in terms of the discrepancies between the average worker and the leaders. It’s not only the amount of the compensation, but the manner in which it was paid. That so much emphasis was put on short-term performance and so much emphasis put on the stock price, which I think is a really fundamental mistake. It’s not only true in the financial world. It’s true in industry generally.

People being rewarded or not being rewarded on the basis of stock price going up or down when it may be part of a whole movement in the stock market and nothing they did had nothing to do with it. Oh, our stock price is up. Well so is everybody else’s stock price up.

It leads to peculiar incentives. Actions designed to influence the stock price rather than to create an environment for longer term growth. I think all those criticisms are fair and accurate. What you do about it is –

FT: Is there a role for the government to get involved there?

PV: Nobody has discovered yet the role for government that’s very effective and not counterproductive in some ways.

FT: In compensation?

PV: In compensation, yeah

FT: You’ve made a big splash with the Volcker rule. What’s going to be the next area –

PV: I haven’t made any big splash.

FT: Yeah; you did make a big splash. The President announced it. You stood behind him at the press conference –

PV: The President made a big splash –

FT: You were at the Senate Banking Committee –

PV: My mouth dropped open when he said, ‘This is the Volcker rule.’

FT: What’s going to be your next area of focus?

PV: I think I’m going to retire.

FT: I thought you were retired already.

PV: Well, I failed so far, but I –

FT: Is there a next area you’re going to focus on?

PV: Well, we’ve got a problem in governing in this country and other countries, too, but our inability to deal with very large evident problems is apparent. I spent half of my career worrying about public service and the efficiency and effectiveness error. I must say I’ve gotten a little cynical. I headed two commissions on this subject and I kind of feel what am I here for? Nothing’s happened. It’s gotten worse; not better.

Somebody quoted … there is a questionnaire – one of these things that they ask the same question every year or every two years for decades and try to get the trend of thinking.

One of the standard questions, I don’t know, this Gallup or somebody said, ‘Do you trust your government to do the right thing most of the time?’ That doesn’t sound like the toughest question in the world, but when I was in government way back in the Kennedy years, the answer to that question would be – I don’t know – 60-70 per cent, ‘yeah, we trust our government to do the right thing most of the time; 51 per cent of the time.’

You ask that question now and you’re down in the twenties. Somebody quoted a survey the other day. I don’t know if it’s the same survey. It was some politician that said the latest figure was 17 per cent. Now you’ve got a problem in running a democracy and running a government if the amount of trust in the government in general and trust in individual institutions and trust in the Congress, trust in the administration is not there.

It used to be one of the advantages of the Federal Reserve was I thought that was an institution that was generally considered to be competent, professional, independent and trusted. Not unanimously, but more than 20 per cent. I think some of that’s been lost. It’s a big challenge right now. That’s one of our most important institutions.

So we have a real rebuilding job to do and it’s not limited to the United States, but the United States I’d like to think is not in the unique position it was when I got into government in 1950 briefly and certainly in the 1960s. You’ve got a lot of other big actors out there, but I’m an American and I grew up with American leadership that I still think it is essential to some kind of reasonable international order. That ability to lead has to begin at home.

FT: You were an early supporter of now President Barack Obama.

PV: I know.

FT: How has he done so far?

PV: Well, he’s struggling in this atmosphere. There’s no question about it, but I think he’s a very intelligent man. I don’t know how he’s as unruffled as he seems to be in all this conflict, but I hope that he can still believe he can show the kind of leadership we need. This is very frustrating. I’m sure it’s frustrating for him. It’s frustrating for me. It’s frustrating for everybody that we seem to be in this kind of locked position.

I don’t know how we ever got in this position that it takes a 60 per cent vote in the Senate to do anything. I don’t know how that grew up and became – it’s nothing but a Senate rule, but how that rule –

FT: Maybe the President should be pushing through that more effectively. Lyndon B. Johnson did.

PV: Well, it’d be nice, but he needs some help from the other side, too, but I don’t want to get in that. Enough of this, but I do think the United States still at least in the early part of the twenty-first century has some special responsibilities and needs to show some leadership internationally and leadership internationally depends upon the ability to have coherent programs in the United States.

This is not just a question of the federal government or the Federal Reserve. Look at the state governments. Look at New York State. Look at California. Look at Illinois. They’re all in a big impasse. Not good, but we will survive and breakthrough all this.

FT: You’re sure of that?

PV: In time. In time.

FT: Thank you very much, Mr Volcker.

There is a wealth of information and thoughtful analysis embedded in this interview. Save it, ponder it, and review it so we can most effectively navigate our economic landscape.

LD

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