A Legend of Finance Still Speaks Large: In Looking Back to Earlier Struggles, Paul Volcker Offers Fresh Thoughts on the Impact of Today's Crisis

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In preparing for our interview with Paul Volcker, we came across a comment in a biographical sketch of the former Federal Reserve Board Chairman that said that while excellent at dealing with financial crises, he was less successful in preventing them. When asked about that during the interview he deadpanned, "You wouldn't believe that, would you?" He then said that a regulator can't prevent the tendency of the market to go to extremes, "but you can do your best to moderate them."

That's why he does not agree with former Securities and Exchange Commission Chairman Arthur Levitt, who wrote in The Wall Street Journal, Aug. 5, that "A regulator can never, and should never attempt to, control the animal spirits of the market." Volcker's response: "Part of the responsibility for a regulator is to modify animal spirits either on the exuberance side or on the gloom side. What are you there for?"

Paul Volcker's reputation never diminished after he left office--quite the opposite--although he slipped off the radar to a certain extent. Recently we've heard more than one person say they wish he could play a role in the current crisis. He is involved, just not in an official capacity, at least as of the middle of October. At 81, he is still very well connected, and is chairman of the Regulatory Systems Working Group of the Group of Thirty. The latter is composed of "senior representatives of the private and public sectors and academia." On Oct. 6 the working group issued a comprehensive report on "The Structure of Financial Supervision," which examines in detail the approaches used by 17 countries.

With a bang, not a whimper

Whether or not he takes an official post again, Volcker is not standing on the sidelines.

He delivered a very clear--and strikingly prescient--economic warning in a short speech at Stanford in February 2005. He said:

"Under the placid surface [of positive economic conditions], there are disturbing trends: huge imbalances, disequilibria, risks.... Altogether the circumstances seem to me as dangerous and intractable as any I can remember.... As a nation we are consuming and investing about 6% more than we are producing. What holds it all together is a massive and growing flow of capital from abroad.... The difficulty is that this seemingly comfortable pattern can't go on indefinitely.... I don't know whether change will come with a bang or a whimper, whether sooner or later. But as things stand, it is more likely than not that it will be financial crises...." Now we know.

During the interview he acknowledged that it's difficult for a sitting regulator to change behavior when nothing yet has happened.

"Congress is not very receptive to tough regulation when everything is going well and their constituents are all happily contributing to them and supporting them. They don't want this big, bad regulatory agency making problems for their constituents. Then, of course, when things go bad, they say, 'Why weren't you tougher?'"

Volcker recalled how he had expressed concerns about the expansion of powers granted to federal savings and loans by the Garn-St Germain Act of 1982.

"When I testified before [Sen.] Garn about six months after it passed and expressed those concerns, he'd say, 'Mr. Chairman, have you seen any adverse consequences of this bill?' And I'd say, 'No, sir, I haven't seen any.' When I'd return a year later, he'd say, 'Mr. Chairman, have you seen any adverse consequences of this bill?' And I'd say, 'I'm a little worried, but, no, I can't tell you that I have.' I don't know how many times this went on, but, of course, by the time I was out of office, the answer was, 'Yes, Mr. Chairman, huge'."

The will to see it through

When Paul Volcker was named Fed Chairman by President Carter in 1979, inflation was virulent and the economy was teetering. Once he had secured support within the Fed to break the cycle of inflation, he did so vigorously. …