A Timely Message from Paul Volcker: "Wake Up, Gentlemen"
The guiding myth underpinning the reconstruction of our dangerous banking system is: Financial innovation as we know it is valuable and must be preserved. Anyone opposed to this approach is a populist, with or without a pitchfork.
Single-handedly, Paul Volcker has exploded this myth. Responding to a Wall Street insider's Future of Finance "report," he was quoted in the Wall Street Journal yesterday as saying: "Wake up gentlemen. I can only say that your response is inadequate."
Volcker has three main points, with which we wholeheartedly agree:
- "[Financial engineering] moves around the rents in the financial system, but not only this, as it seems to have vastly increased them."
- "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."
and most important:
3. "I am probably going to win in the end."
Volcker wants tough constraints on banks and their activities, separating the payments system—which must be protected and therefore tightly regulated—from other "extraneous" functions, which include trading and managing money.
This is entirely reasonable—although we can surely argue about details, including whether a very large "regulated" bank would be able to escape the limits placed on its behavior and whether a very large "trading" bank could (without running the payments system) still cause massive damage.
But how can Mr. Volcker possibly prevail? Even President Obama was reduced, yesterday, to asking the banks nicely to lend more to small business—against which Jamie Dimon will presumably respond that such firms either: (1) are not creditworthy (so give us a subsidy if you want such loans); or (2) don't want to borrow (so give them a subsidy). (Some of the bankers, it seems, didn't even try hard to attend—they just called it in.)
The reason for Volcker's confidence in his victory is simple—he is moving the consensus. It's not radicals against reasonable bankers. It's the dean of American banking, with a bigger and better reputation than any other economic policymaker alive—and with a lot of people at his back—saying, very simply: Enough.
He says it plainly, he increasingly says it publicly, and he now says it often. He waited on the sidelines for his moment. And this is it.
Paul Volcker wants to stop the financial system before it blows up again. And when he persuades you—and people like you—he will win. You can help; tell everyone you know to read what Paul Volcker is saying and to pass it on.
Also posted on Simon Johnson's blog, Baseline Scenario. The following was previously posted.
The Flaws in Gerald Corrigan's Case for Large Integrated Financial Groups
December 8, 2009
Increasingly, leading bankers repeat versions of the argument made recently by E. Gerald Corrigan in his Dolan Lecture at Fairfield University. Corrigan, former president of the New York Fed and a senior executive at Goldman Sachs [pdf] for more than a decade, makes three main points. [pdf]
- "Large integrated financial groups"—at or around their current size—offer unique functions that cannot otherwise be provided. The economy needs these groups.
- Breaking up such groups would be extremely complex and almost certainly very disruptive.
- An "enhanced resolution authority" can mitigate the problems that are likely to occur in the future when one, or more, group fails.
These assertions are all completely wrong.
Gerry Corrigan's first claim that Large Groups are indispensable is completely at odds with the data. The current size of our biggest financial firms is a recent phenomenon. In 1998, when Corrigan already worked there, Goldman Sachs was roughly one-fourth of its current size and was regarded a top international investment bank.
More generally, in the mid-1990s today's big six "large integrated financial groups" added together had assets worth less than 20 percent of GDP—with no bank being larger than 4 percent of GDP (including off–balance sheet liabilities). Today, these 6 are over 60 percent of GDP combined and still growing.
What has changed for the better in the functioning of our financial system—in how it assists the real economy or in how it facilitates government fiscal policy since the mid-1990s?
The financial system worked fine (not great, but fine) in the mid-1990s. It should be rolled back to that level. Hard size caps, as a percent of GDP, are the way to achieve this (e.g., no high-rolling investment bank can exceed 2 percent of GDP; no boring commercial bank can be bigger than 4 percent of GDP).
Corrigan's second claim, that breaking up banks would be hard to do, is based on assessing a "straw man" proposal—that the government dictate the microstructure of any bank downsizing. But no one serious has put forward such an idea.
A hard size cap for total assets would operate just as the hard cap (10 percent) on share of total retail deposits was envisaged by the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. The bank itself is responsible for complying with this regulation, subject to supervision by the authorities.
If any bank complies with any regulation in a way that reduces shareholder value, its shareholders are going to be very upset. Goldman Sachs is filled to the brim with smart people; they can figure this out.
Corrigan's final claim that an enhanced resolution authority can deal with the manifest problems of too big to fail is simply wishful thinking.
It is a fantasy to think that any national resolution authority would make a difference. All banking experts, when pressed, agree that you need to have a cross-border resolution authority in order to deal with the failure of a large international integrated financial group. Show me the G-20 process in place or any other international initiative that can achieve this faster than in 20 years. (I made this point recently to leading financial officials; one of the most influential people present said, in effect, "It will never happen.")
At moments in his speech, Corrigan is brutally honest.
"First; it is inevitable that at some point in the future, asset price bubbles, financial shocks, and seriously troubled financial institutions will again occur."
"Unfortunately, events—and not only those associated with the current crisis—have graphically illustrated that the threat associated with financially driven systemic risk has not diminished but has sharply increased [since 1987]."
But if you combine that blunt assessment with his policy prescription, what do you get? Our top bankers are publicly and blatantly proposing the recipe for repeated debilitating bailouts. This is an antigrowth and anti-jobs agenda.