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Apr-13-2008Economy's downturn boosts Volcker's legacy as Fed chief(topic overview)
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Volcker: Fearful Fed Heads They don't make Federal Reserve chairmen like they used to, at least that's former Fed Chairman Paul Volcker's assessment of his successors. Ben Bernanke has caved in to the demands of Wall Street at every turn in this credit crunch. Alan Greenspan's linguistic contortions in explaining why he bears no responsibility for the credit bubble that began when he cranked down interest rates to record lows for years makes many observers long for days of yore, when he gave merely inscrutable answers to the most mundane questions. Perhaps emboldened by his favorable comparisons, Volcker, a true hero of the Federal Reserve who slew stagflation in the 1970s by imposing unpopular measures, minced no words in a speech at the Economic Club of New York this week. [1] A few days ago an unusual event took place: Paul Volcker, the mythical U.S. Federal Reserve Board chairman from the Reagan years, criticized the policy of the current Fed chairman, Ben Bernanke, in a speech to the Economic Club of New York. Just so you grasp how extraordinary this was, you should first understand that normally a past Fed chairman scrupulously avoids saying anything at all about current Fed policy - for the simple reason that the current Fed chairman's words are one of his most important tools: They can sway markets. This ability does not fade entirely when a Fed chairman leaves. When a past Fed chairman speaks, his words can clash with those of the present one and make that one's job difficult.[2]
Former Fed Chairman Paul Volcker criticized the Fed's actions in a speech in New York. "The Federal Reserve has judged it necessary to take actions that extend to the very edge of its lawful and implied powers, transcending in the process certain long-embedded central banking principles and practices." He wonders whether the Fed taking on bad debt will break the central bank: "What appears to be in substance a direct transfer of mortgage and mortgage-backed securities of questionable pedigree from an investment bank to the Federal Reserve seems to test the time-honored central bank mantra in time of crisis: Lend freely at high rates against good collateral; test it to the point of no return."[3] Volcker said that recent actions to extend a hand to investment banks, which have not until now been under the Fed's aegis, "will surely be interpreted as an implied promise of similar action in times of future turmoil." Without mentioning Bear Stearns by name, he said the deal to rescue it by taking $30 billion worth of questionable collateral stretches "to the point of no return," the banking mantra of lending freely against good collateral. On Apr. 9, however, Volcker appeared chagrined that his remarks were taken as a criticism of Bernanke, whom he never mentioned by name. In a public address at the Harvard Club of New York City and in remarks to reporters beforehand, he said the Federal Reserve had to do something to avoid a financial crisis that was exacerbated by the use of exotic derivatives and extreme financial leverage. He said "it is a sign of the nature of a new financial system that these seldom-used powers had to be taken out of the knapsack."[4] Referring to a New York Times headline that said "Ex-Fed Chairman Chides Current One," Volcker said "I thought that was ridiculous." He added: "It's the opposite of what I think." Until now, Volcker has been far quieter about the institution he used to run than has Bernanke's immediate predecessor, Alan Greenspan. On the lecture circuit, Greenspan has repeatedly offered his views on the state of the U.S. and global economies, though he has generally avoided specific comments about Bernanke. Volcker preferred to keep his views to himself. That changed in a big way on Apr. 8 in a keynote speech to the Economic Club of New York in which Volcker waved some rhetorical red flags about the Fed's recent actions, such as opening the discount window for the first time for emergency borrowings by investment banks and helping finance JPMorgan Chase's ( JPM ) takeover of crippled Bear Stearns ( BSC ).[4]
The Big Apple soon recovered and has since flourished as a world financial center. He said Bernanke's willingness to use government to rescue Bear Stearns BSC from bankruptcy and provide direct financing to its investment banking counterparts "will surely be interpreted as an implied promise of similar action in times of future turmoil." He also said the Fed's recent actions raised political concerns about "the proper use and allocation of government power" and "embedded economic interests and lobbying." He noted that the New York financial crisis came after the country had been free from any clear sense of financial crisis for more than 40 years, while today's credit crisis is the culmination of at least five serious breakdowns of systemic significance over the past quarter century.[1] The Federal Reserve has moved from being behind the curve on the current credit crisis to leading the central bank into areas that stretch its legal mandate, possibly to a breaking point. The expanded role of the Fed -- including the Bear Stearns BSC intervention and tapping into taxpayer dollars -- has many questioning its future. Fed chairmen past and present have raised their political profile recently, speaking their minds about the Fed's actions and the 2008 political campaigns. Ben Bernanke appeared this week at the Group of Seven meetings, where the credit crisis has taken center stage. He urged haste on reforming regulations here at home: "Indeed, many of the necessary changes that have been identified -- including increasing transparency, improving risk management and attaining better coordination among regulators -- could provide important support to the process of normalizing our financial markets."[3] From the credit markets hellfroth, to hedge funds, and to China'''s position at the epicentre of global growth. Some knowledgeable souls say that the U.S. credit markets crisis, which has spread its tentacles across the globe since exploding in August 2007 is the most significant financial markets event since the October 1929 Wall Street crash, which in turn triggered a Great Depression. Speculators lie bleeding: the lending crackdown is the most savage to have hit the $1.9 trillion global hedge-fund industry since Russia's 1998 debt default, an event which forced the U.S. central bank, the Federal Reserve, to orchestrate a $3.6bn bailout of Greenwich, Connecticut-based hedge fund, Long-Term Capital Management LP. Just last month, the Federal Reserve had to issue certain guarantees as JP Morgan, a Wall Street investment bank, gobbled up Bear Stearns, another Wall Street investment bank which relied heavily on hedge funds for its business. Since mid-February this year, at least six known hedge funds - among a highly secretive and lightly regulated global sector - with a paper value of $5.4bn, have been forced to liquidate or sell holdings because their lenders - pulverized by nearly $200bn of asset write-downs and credit losses caused by the collapse of the subprime mortgage market - raised borrowing rates as much as 10 times, with ever fresher claims for extra collateral. This week, Lehman Brothers, another Wall Street investment bank, liquidated three stricken investment funds.[5]
The entry of the hero of the anti-inflation wars of the 1980s into the public debate over recent moves by the Federal Reserve may provide an opening into the monetary policy that would be followed during an Obama presidency. Paul Volcker, a former Fed chairman who endorsed Senator Obama earlier this year, this week gave a resounding critique of the Fed, deriding its decisions to bail out Bear Stearns and to allow the dollar's steep depreciation. His decision to enter the fray couldn't come at a better time for Mr. Obama, who will likely benefit from having such a well-known economic figure backing his campaign during a period of economic slowdown.[6] On the page before that is the signature of Timothy Geithner, president of the Federal Reserve Bank of New York. They're both illegible scrawls, sloppier than the signature that you or I would put on a personal check at the grocery store. Looking at these signatures, you could almost get the impression that both men were too busy to be bothered. More likely they were both in a terrible hurry - both desperately eager to sign this agreement, Geithner to keep markets from imploding and Dimon to lock down the sweet deal of the century for his bank. Former Fed Chairman Paul Volcker remarked skeptically this week that this deal caused the Fed to "extend to the very edge of its lawful and implied powers." He's right.[7]
The more Alan Greenspan whines about his tarnished legacy since leaving the helm of the Federal Reserve, the more his predecessor Paul Volcker looks to claim the title as the greatest central banker who ever lived. That's what Greenspan was hailed as in 2005, when the economy was booming and inflation remained low. Economists lauded his significant contributions during his 18-year Fed tenure, which included making the central bank more communicative and weathering two recessions. Those accolades largely overshadowed Volcker's achievements. He left the Fed in 1987 after an eight-year run of steering the economy through a tough battle against double-digit gains in inflation and a punishing economic decline. Volcker's legacy seems to be soaring now, while Greenspan's is sinking - despite his intense effort to shift blame away from himself as the cause of today's punishing financial crisis.[8] For instance, he notes that households in 2005 spent $531 billion more than they earned after taxes, compared with the surplus of earnings over spending of $108 billion seen in 1987 when Greenspan took over at the Fed. And while leverage has surged to record highs, household liquidity has sunk to near record lows of around 9.5 percent in 2005 from 14.2 percent in 1987. "Greenspan's argument that it was not his doing that set off the U.S. housing bubble reminds me of my two perfect children," Kasriel said. "When they appear to err, it was never their fault." The more Greenspan tries to spin his legacy in his favor, the less it looks likely to happen. The public is growing numb to his attempts to pin the makings of this crisis on others. That may be why the attention shifted to Volcker in recent days. He never sought publicity after he left the Fed; he expressed his views occasionally on the state of the economy or monetary policy. This week was an exception. During two speaking engagements on Tuesday and Wednesday that were closely watched, Volcker didn't sugarcoat his assessment of the roots of the current financial crisis - whereby "complexity, opaqueness and systematic risks" were embedded in new markets - and the policies now being used to clean it up. "Simply stated, the bright new financial system, for all its talented participants, for all its rich rewards, has failed the test of the marketplace," Volcker said during a speech Tuesday to the Economic Club of New York.[8] Greenspan, who is entitled to earn a living post Fed service, has largely done so through book writing and speech giving. That has resulted, even if unintentionally, in a sort of shadow Fed during Bernanke's time in office. Paul Volcker, largely credited with breaking the back of stubborn stagflation in his time leading the Fed before Greenspan, has been more 'old school' in his post-Fed life. He has not written or commented regularly on monetary policy or related issues. That makes Volcker's views made public earlier this week all the more intriguing, especially because they look to the long term and carry the emeritus tone of a wise and disciplined man forever disappointed with the weaknesses and profligacy of the human character. "Simply stated, the bright new financial system - for all its talented participants, for all its rich rewards - has failed the test of the market place."[9]
The criticisms of Greenspan are all implicitly criticisms of Ben Bernanke, as well - but almost none of the critics are willing to connect the dots, at least not in public. Bernanke was a Federal Reserve Board governor during the whole shameful episode, before he was elevated to chairman in early 2006. Beyond that, he was the leading spokesman for Greenspan's flawed policies. It was Bernanke, not Greenspan, who made that infamous speech in late 2002 extolling the virtues of "helicopter drops of money" and the Fed's inexhaustible "printing press." It was Bernanke, not Greenspan, who later gave speeches arguing for keeping interest rates at 1% for a "considerable period" because, with there supposedly being so much "slack" in the economy, it would not lead to inflationary excesses. Bernanke gave a speech yesterday in which, while he probably doesn't realize it, he emerges as one of Greenspan's - and his own - harshest critics. While preening about how much wiser the lessons learned from the credit crisis have made us, he says, "greater supervisory scrutiny of the processes that originators follow and the incentives they face, are also needed.at both the federal and state levels. its implementation is well under way. Specifically, the Federal Reserve has used its authority under the Home Ownership and Equity Protection Act to propose and seek comment on new rules that. ensure that lenders give sufficient consideration to borrowers' ability to repay."[7] "Obama needs Volcker," the political consultant Hank Sheinkopf said. "There is only one Volcker, and who better to help Obama prove that he has the ability to deal with the largest issue concerning voters ' which isn't the war, it's the economy." As another former Fed chairman, Alan Greenspan, is derided by critics who argue his policy of keeping interest rates low has led to the current market slowdown, Mr. Volcker is more important than ever as a heavyweight persona in the universe of central bankers.[6] "Paul Volcker is the last god of central banking left standing," the director of international economics at the Council on Foreign Relations, Benn Steil, said. "He has an impeachable reputation." Best known for breaking the back of inflation by raising interest rates to 21% when he was Fed chairman, Mr. Volcker is a proponent of a strong dollar ' he even supported a fixed-exchange rate, whereby the dollar would be fixed against other currencies so as to prevent a steep slide in its value. In a speech at the Economics Club of New York on Tuesday, he criticized the weakness of the greenback, and took issue with the Fed for orchestrating JPMorgan Chase & Co.' s acquisition of Bear Stearns.[6] As Fed chairman, Volcker eventually cleaned up the excesses of the '70s in the early '80s by fighting inflation with higher interest rates and supporting the dollar. Volcker has greater concerns about the direction of the country than the Fed and says that the economy plays a small role in his outlook. He believes the average American has lost faith in the political system. He hopes it can be restored, and for the first time has decided to publicly endorse a presidential candidate: Barack Obama. Obama has passed ethics reform legislation in both the Illinois State Senate and the U.S. Senate.[3]
Volcker, whose Fed is credited for halting the stagflation crisis of the 1970s, also maintained the central bank's interest rate cuts won't be an easy fix to current financial problems. "The history of markets is littered with the idea you can solve problems by raising inflation," he said.[10] Up to now Mr. Volcker kept quiet, but no more. In his speech he just said, in effect, that the recession is not the Fed's problem. It's the government's. The Fed's job is to defend the currency and fight inflation - exactly the opposite of what this Fed is doing. The solution? Raise interest rates, Mr. Volcker practically said, no matter the consequences now, because if you don't, you'll have to raise them even more later, with even more awful consequences. Will rates indeed rise? I have no doubt they must. Not now, perhaps, but at the end of this year or the beginning of 2009, with a new president in the White House. The stock market, which usually looks six to nine months ahead, already understands this and may soon react. When Mr. Volcker's words sink in, the markets are likely to sink as this bear market rally ends.[2] Out of professional courtesy, past Fed chairmen therefore keep quiet; Mr. Volcker especially - the man who hiked interest rates to 20 per cent to kill inflation, at the cost of a deep recession. Last week Mr. Volcker spoke his mind bluntly. He said, in effect, that the current Fed is not doing its job.[2]
When it comes to dealing with recessionary tendencies, inflation, rising commodity prices, and the threat of stagflation, Paul Volcker, as the kids might say, boasts more than his share of "street cred." It was Mr. Volcker who, as head of the Fed nearly 30 years ago, felt compelled to administer the heroic treatment of higher interest rates to rein in galloping inflation.[11]
Bernanke is busy, employing everything from the traditional policy moves (short-term interest rate cuts) to the definitely non-traditional (direct lending to investment banks) to unstick frozen markets and get financial institutions onto sounder footings. Alan Greenspan, who occupied the chair for 18 years before Bernanke took over a couple years back, is busy defending his own record. He's refuting claims that his regime's decision to keep the federal funds target rate at a recession-resisting 1 percent kick-started the housing price bubble or that lax Fed regulation is to be faulted for sloppy mortgage lending standards.[9] Once upon a time, Greenspan's monetary policies and lax approach to regulation won him praise, not criticism. An academic paper written in 2005 said he had a legitimate claim to being the "greatest" central banker ever and touted his "magic formula" - where discretion rather than rules went into the Fed's decision- making. Now, in the midst of today's financial market turmoil and economic downturn, Greenspan, who was knighted by Britain for his achievements, is finding his legacy being called into question. Critics say he kept interest rates too low for too long, fueling the housing bubble. They also say he encouraged Americans to load up on leverage, ignored warnings on risky mortgage lending, and didn't properly monitor financial institutions. "He urged people to borrow against their homes because it would help fuel the economy," said Robert Brusca, who heads the independent research firm Fact and Opinion Economics.[8]
Unemployment is ticking up, and the tightfisted lending by cash-short banks threatens to stifle economic growth. Greenspan is aware of these problems, but he doesn't seem to believe there was any way he could have done anything - such as raising interest rates earlier in the economic recovery earlier this decade, or cracking down on loose lending practices - to restrain them. He prefers to hide behind the limitations of the statistics he famously devours. Greenspan contended in a piece in the Financial Times last month that "the essential problem is that our models - both risk models and econometric models - as complex as they have become, are still too simple to capture the full array of governing variables that drive global economic reality."[12]
Bristling at charges he fueled the housing bubble by being loose with interest rates and lax with bank regulation, Greenspan has launched a media crusade of sorts. This week alone he has penned an opinion piece in the Financial Times, participated in a front-page profile in The Wall Street Journal and conducted a live interview with CNBC.[12] "I can't imagine a more outrageous thing for a Fed chairman to do." Greenspan has been on the defensive for months over such attacks, but in recent days he has stepped up his fight against them. Through comments in the Financial Times, Wall Street Journal and CNBC, he laid out a case for why he didn't do anything wrong. "I have no regrets on any of the Federal Reserve policies that we initiated back then, because I think they were very professionally done," Greenspan told CNBC on Tuesday. It's hard to buy that "don't blame me" argument, given the current economic predicament.[8] I probably made a mistake." Shorn of that ambiguity, his message - that the Fed's role in fostering an unprecedented run-up of house prices has been vastly overstated, and that regulators aren't up to the task of preventing financial crises anyway - sounds almost willfully obtuse. "The U.S. bubble was close to median world experience, and the evidence that monetary policy added to the bubble is statistically very fragile," Greenspan wrote in the FT. He told CNBC that "I have no regrets on any of the Federal Reserve policies that we initiated back then, because I think they were very professionally done." Greenspan may well be correct on those counts. The problem is that Americans generally aren't interested in comparing worldwide house-price trends or considering how the Fed arrives at its decisions. What they expect from the Fed is policy that fosters stable economic growth and cushions ordinary people from the booms and busts associated with the free markets Greenspan so ardently defends. On those scores, it's clear, something has gone awry.[12]
Alan Greenspan also supports a presidential candidate. He has said publicly that he will vote for Sen. John McCain (R., Ariz.). Both fell out of favor with some Republicans for opposing the Bush tax cuts, though McCain now disavows his vote. He has endorsed extending the Bush tax cuts. Of course, the focus on Greenspan hasn't been taxes, but rather his role in the subprime crisis. He has defended himself in The Wall Street Journal and in the Financial Times, writing: "Doubtless, each individual housing bubble has its own idiosyncratic characteristics and some point to Fed monetary policy complicity in the U.S. bubble.[3] The Bear Stearns episode in particular seems to have crystallized sentiment that the pendulum has swung too far in the direction of self-regulation. Asked earlier this month by Congress to explain why the Fed was using taxpayer dollars to finance Bear's sale to JPMorgan Chase ( JPM, Fortune 500 ), Treasury Undersecretary Robert Steel responded, "The failure of a firm that was connected to so many corners of our markets would have caused financial disruptions beyond Wall Street." He was saying the mighty U.S. economy couldn't withstand the failure of a second-rate brokerage firm - a notion that fairly calls out for substantial changes aimed at reducing so-called systemic risk. Greenspan retains his faith in modest, market-based solutions. "Bank loan officers, in my experience, know far more about the risks and workings of their counterparties than do bank regulators," Greenspan wrote in his most recent FT piece.[12] Stagflation inevitably results. As Mr. Volcker emphasized, muddling this current crisis is another massively destabilizing element -- the run of housing foreclosures. While he did not preclude some measure of governmental intervention to stem this rising tide, he did point to the dangers of a bias toward "particular institutions and politically sensitive constituencies." Again, his concern was for the viability of the dollar -- and the Fed's seeming inability (refusal?) to protect its value. What is the relation of the dollar's relative demise to the travails of the housing market? Specifically this: When dollars are exchanged for what Mr. Volcker called "mortgage-backed securities of questionable pedigree" -- witness its $29 billion worth of ballast to a sinking Bear Stearns -- faith in the Fed can be diminished. In describing this disturbing turn of events, The Wall Street Journal spoke warmly of "the specter of moral hazard" raised by such actions.[11]
The 80-year-old Volcker labeled our current economic predicament the "mother of all crises." He laid blame for it directly at the feet of paper-pushers on Wall Street and the enormously complicated, mostly unregulated, little understood and highly engineered financial system they have concocted since he left the Fed with their trillions upon trillions of complex derivative securities. "Simply stated, the bright new financial system, for all its talented participants, for all its rich rewards, has failed the test of the marketplace,'' said Volcker.[1]
Former chairman Paul Volcker, Greenspan's predecessor, told the Economics Club of New York that Bernanke has gone to "the very edge" of the Fed's legal authority, and that "out of perceived necessity, sweeping powers have been exercised in a manner that is neither natural nor comfortable for a central bank".[13] Volcker also had words for the current shaky hand on the wheel at the U.S. central bank. There were urgent calls for the Fed to help the city avoid a default by resorting to emergency lending authorities left over from the Great Depression like those used recently for investment banks by Bernanke. Unlike the current Fed chairman, Volcker resisted those calls to "instill discipline."[1] In another nod in Bernanke's direction, Volcker said the Fed was forced to step in because of the ineffectual response of other players, including Fannie Mae ( FNM ) and Freddie Mac ( FRE ), the giant, government-chartered mortgage insurers and buyers. He said too much of the burden for solving the crisis was being placed on the Fed. "If the market needs more support, which it well may, the government ought to do it " (BusinessWeek.com, 3/30/08) through measures other than purely monetary policy, Volcker told reporters. "Don't shoot the central bank" for problems it didn't cause, he said. Volcker himself was hardly a free-market purist during his tenure at the Fed. Irvine Sprague, a former FDIC director, recalled in a 1986 book that Volcker was a leading force in the bailouts of Philadelphia's First Pennsylvania Bank in 1980 and Continental Illinois in 1983.[4]
I assume that judgment reflected the increased delinquency behavior that is now evident for loans initiated in late 2005 and subsequently." Greenspan feels the Fed shouldn't "lean on the wind" to stop bubbles before they happen. He wrote: "I know of no instance in which such a policy has been successful." Greenspan offers a warning that contradicts Bernanke and Volcker in the WSJ, asking for more time to perceive the cause of the credit crisis problem: "The evaluation of this period -- and how to avoid the problems associated with it -- will give you the wrong answers and the wrong policies."[3]
Testifying in 1984 on the Fed's loans to prop up Continental Illinois, Volcker said: "The operation is the most basic function of the Federal Reserve. It was why it was founded." One difference between then and now: Those two were commercial banks, for which the Fed has traditionally taken responsibility. Volcker didn't completely change his tune on Apr. 9. He kept returning to the idea that the Fed needs to focus on preserving the value of money by keeping inflation low. "Don't think you can find an easy escape by inflating your way out," he said during a question-and-answer session.[4] The ex-Fed chief is a stern inflation hawk who engineered a severe recession in the early 1980s by sharply raising interest rates to knock down an inflation rate that reached nearly 15% by 1980. "As custodian of the nation's money, the Federal Reserve has the basic responsibility to protect its value and resist chronic pressures toward inflation," he said (BusinessWeek.com, 3/13/08). In another comment that is bound to be quoted and re-quoted (including here), Volcker said: "To meet the challenge, the Federal Reserve judged it necessary to take actions that extend to the very edge of its lawful and implied powers, transcending certain long-embedded central banking principles and practices."[4] Former Federal Reserve Board chairman Alan Greenspan is being blamed for America's house-price bubble. It seems he kept interest rates too low, too long, and failed to target asset prices.[13] The stock market is made up of millions of participants as is the global economy. Why doesn't anyone blame the investors and participants rather than a REACTIONARY agent like the Federal Reserve? Did Greenspan drive the prices of the Nasdaq stocks to unsustainable levels? No. Did Greenspan force investors to buy 1, 2, 3 or 4 houses they couldn't afford? No. What would you say, Mr. Luskin, if Greenspan had not cut rates so much in 2002 and we had entered an incredible recession like that of Japan in the 90's. What if the S&P; hadn't recovered all of its gain from 2002-2006? What would you say then? In hindsight it is easy to point the finger.[7] In Congressional testimony last week, Federal Reserve chairman Bernanke spent hours trying to articulate just what had happened in credit markets, and just why it was that the Federal Reserve had stepped in to bail out Bear Stearns. In talking his natural book, Bernanke explained that the worst for the U.S. economy is "almost over", when just about every empirical factor points to a recession.[5]
President Bush praised the Federal Reserve on Monday for taking unprecedented, sweeping steps to stave off panic in financial markets after the collapse of investment bank Bear Stearns.[14]
President Calvin Coolidge once said, "There is no dignity quite so impressive, and no one independence quite so important, as living within your means." Former Federal Reserve Chairman Paul Volcker agrees--and he wants spendthrift Americans to know they only have themselves to blame. On Wednesday at a conference at the Harvard Club in New York, Volcker said years of consuming more than it produces is what has gotten the U.S. into the financial trouble that it's in.[15] The U.S. Federal Reserve has sent staff into some of Wall Street's biggest firms and its New York branch is gathering evidence on key traders' activities as it raises its scrutiny of risk to an unprecedented level.[16]
"In normal times, the free market works well. In a crisis like this one, few are willing to sit back and let the market find its own equilibrium." The Fed's "new risk-taking is an extraordinary expansion" of its "traditional crisis role," said The Wall Street Journal in an editorial.[14] Oh, how the mighty have fallen. Greenspan has even had to come out in his own defense, both writing a lengthy reply to his critics in the Financial Times this week, and answering probing questions in an interview with The Wall Street Journal.[7] We must elect no one endorsed by anyone in Office now. This situation will "hit bottom" eventually so now is the time to design and implement regulatory fixes so that Wall Street can not do this to themselves -- and us -- again.[14]
Volcker is one of Barack Obama's advisers, so should the senator from Illinois end up in the White House, Bernanke cannot bank on reappointment. At the Bank of England, governor Mervyn King's infamy stems from his continued insistence that moral hazard is so great a problem that he has to go slow in lowering interest rates lest he encourage foolish borrowers and lenders to repeat their folly, and also trigger inflation. Critics want him to lower rates to give a boost to a flagging economy. Never mind that unlike his American counterpart, King has no remit to maintain growth, and is mandated by law to focus solely on containing inflation, which is already 0.5 points above the government's 2% target. [13] Never mind that similar bubbles foamed up in Spain, Ireland and Britain, to name just a few countries in which house prices soared and which are far beyond Greenspan's jurisdiction. Greenspan's successor, Ben Bernanke, is being criticised both for being too slow to cut interest rates, and for cutting them so much that he will trigger inflation. His charge sheet also includes an entry alleging that he was too slow to understand the gravity of the liquidity squeeze and too quick to bail out investment banks caught in it.[13]
Many observers are musing publicly that the Bear Stearns collapse wouldn't have happened in the first place - indeed, that the whole housing bubble and subprime lending debacle that led to the Bear Stearns collapse, and to so much other agony in markets - if it weren't for Greenspan's missteps. I've made many of these same criticisms myself in this column over the years. I have argued, and now many other commentators are chiming in, that Greenspan lowered interest rates too low in 2002 and 2003, and left them too low for too long in 2004 and 2005.[7]
There is no record of Mr. Bernanke's reaction, nor that of anyone else inside the Fed. But there was plenty of buzz in the market because what Mr. Volcker said amounted to a rousing call to raise interest rates.[2] Volcker also employed the word fragile, saying "a demonstrably fragile financial system. needs repair and reform." Based on his speech text, Volcker seemed uncomfortable with the "emergency powers" recently employed by Bernanke's Fed, calling them "neither natural nor comfortable for a central bank." He wondered why so much of the burden of restoring liquidity to the mortgage market is falling to the Fed, since housing is a "politically sensitive" area that he believes the Fed is best served staying away from.[9] The age of go-it-alone central banking is over, in two senses. It is now clear that central banks cannot cope with big upheavals without close coordination with politicians. Bernanke spends more time than many critics feel he should meeting congressmen - and being photographed so they can send pictures home proving they are working with the Fed to solve the economy's problems.[13]
The Fed intervention also calls into question what role the central bank might be expected to play if and when other such scenarios arise, said Volcker, who chaired the Fed from 1979 to 1987. "Taking this kind of action in an emergency does create a precedent in people's minds. the more you support the market, the more political concerns arise.[10]
Volcker's abrupt emergence into the public forum got economists' and analysts' attention. "He almost seems to say, 'I don't know what else Bernanke could do, but I'm still worried,'" says Milton Ezrati, senior economist and strategist of Jersey City (N.J.) -based Lord, Abbett & Co. "On the one hand, he has a notion that Greenspan clearly does not share, that he should be quiet. He's worried about his legacy" of suppressing inflation, Ezrati says. In his prepared remarks to the Economic Club, Volcker used strong language: "Out of perceived necessity, sweeping powers have been exercised in a manner that is neither natural nor comfortable for a central bank."[4] Volcker certainly knows the political sensitivity of housing. In 1979, as he and his colleagues engineered an inflation-fighting policy that sent interest rates skyward, distressed builders suffering the business consequences of those high rates mailed two-by-fours in droves to the central bank to register their protest.[9] When it is over - in the next few weeks, methinks - the waterfall could continue, as the market begins to digest the inevitability of higher inflation and higher interest rates ahead. Against all protocol, Mr. Volcker just went out on a limb and warned you of this. I urge you to heed his words.[2]
Mr. Volcker sees the need for a similar tonic -- or laxative. In a speech earlier this week to the Economic Club of New York, not only did he compare today's economic situation to the '70s -- note the dramatic rise in the prices of such commodities as oil and soybeans, just as in that decade -- but also, through implication, cast doubt on the current response to the burgeoning crisis. His primary concern was the state of the dollar, now languishing in the world marketplace. [11] The good news - in a relative sense - is found on the other side of the world. This week, the Chinese Yuan has traded better than seven to the dollar for the first time in more than a decade, underlining China's growing economic muscle and its increasing use of currency as a policy tool.[5]
More specifically, Mr. Volcker warned of the consequences of a Fed succumbing to political pressure. When "concerns about recession are rife" and the central bankers feel the urge to bolster a foundering economy, he told his audience, "the fundamental need to maintain a reliable currency" will be "subordinate(d)." This, he obviously believes, is wrong, for this reason: One cannot ignore the dollar and rescue the economy. [11] Volcker, in two rare, back-to-back speeches, gave a critical assessment of the current economy and the Fed's role in creating and managing the crisis. Their styles have always contrasted, now and when they were at the Fed. Economists say Greenspan is as much a politician as he is a policymaker - always looking for opportunities to claim the spotlight - a tactic that may be hindering rather helping his reputation now. It's just the opposite for Volcker.[8] Having saved the world, the Fed must feel a little stung by Volcker's rather pointed second-guessing. It's nearly unprecedented for a former Fed official to speak out publicly against the actions of that august and secretive institution. Then again it's an election year, and Volcker is a Democrat who was appointed by Jimmy Carter, while current Fed Chief Ben Bernanke is a Republican appointed by George W. Bush. Former Fed Chief Alan Greenspan has been coming in for his share of criticism, too.[7] Volcker, who himself ran the Fed from 1979 to 1987, broke his silence on Bernanke's performance in a major address on Apr. 8, saying the Fed's recent dramatic actions ( BusinessWeek, 3/26/08) to arrest the credit crunch "extend to the very edge of its lawful and implied powers." That seemed like a pretty clear criticism of Bernanke. A day later, Volcker told reporters he felt his remarks had been misinterpreted.[4]
How to fix it? No problem, say the actions of Mr. Bernanke's Fed. Let's print the missing money - and it doesn't matter if it causes inflation and tanks the dollar.[2]
Economists are "more and more" coming to the conclusion that nothing the Fed Chairman Ben Bernanke does can prevent the nation from slipping into recession, because we're already there. "It's said that we're in the worst financial crisis since the Great Depression," said Robert Samuelson in The Washington Post (free registration).[14] U.S. house prices didn't start peaking till 2006, after Greenspan gave way atop the Fed to Ben Bernanke.[12] "But the culprit was not imperfect models," Rivlin added. "It was failure to ask common sense questions." Rivlin, who previously was director of the Congressional Budget Office and a Fed governor, wrote that Greenspan should have been asking whether house prices could rise forever (not likely, she answered) and what would happen to the value of mortgage-related securities when house prices stalled (they would decline). Ironically, one result of Greenspan's failure to pose those questions is Washington's march toward re-regulation of the financial sector - an outcome, as columinst Caroline Baum recently pointed out on Bloomberg, that Greenspan has spent his career opposing.[12]
The critics are also faulting Greenspan for not being a better regulator. The Fed regulates many of the nation's largest banks, and has broad authority to set lending and consumer protection standards - both of which seem to have been too lax during the crazy years of subprime lending. It's ironic. When Greenspan left the Fed in 2006, he went out in a blaze of adulation - hailed universally as "the greatest central banker who ever lived."[7] The Fed needs to get out of our business, or become a federal agency! They saved the politicians investments with Bear Sterns in a matter of hours, but why aren't those banks passing on their largesse to their credit card holders, and consumers with loans? This is a travesty, and all of the Free World and less is laughing at the mismanagement and abuse of U.S. citizens going on with this great Christian president. It's not coincidental, if it was every Christian group would have already stormed the halls of government decrying this travesty.[14] Which is why the generally antiinterventionist Bush administration approved the use of taxpayers' money to make it possible for JP Morgan to take over Bear Stearns before it went bust. Why the Fed has opened its discount window to investment banks so they can trade in their often less-than-safe, illiquid paper for cash. From now on these once-lightly regulated institutions will have to meet capital requirements and other constraints on their operations that the Fed will deem appropriate for firms able to tap Fed cash.[13]
The Fed's "dramatic intervention" prevented a meltdown over Bear Stearns, said David Ivanovich in the Houston Chronicle, "but the balm may not soothe other wounds in the U.S. economy."[14] Was the deal legal? Hey - who cares? This was save the world stuff. If the Fed hadn't bought this portfolio, the resulting chaotic Bear Stearns collapse would have literally shut down world capital markets for months. When James Bond saves the world, does he worry about the legal niceties? (Well, I suppose he does have a license to kill.)[7] Of course, the Fed and Treasury officials negotiated the Bear Stearns deal to JPMorgan Chase JPM together, which could account for some of the heightened activity.[3]
By statute, the Fed can buy plain-vanilla mortgage-backed securities, although in practice it virtually never does. This deal with J.P. Morgan - which for all the world has every defining characteristic of an outright purchase of the Bear portfolio of very much not plain-vanilla securities - is elaborately structured to masquerade as a loan.[7] The Fed had to guarantee $30 billion in Bear's mortgage-related loans to clear the way for J.P. Morgan Chase to buy it, even at a fire-sale price.[14]
Of course, the Fed filled a vacuum that the administration wasn't filling. The media and the general public mostly applauded the unusual actions without questioning their legality. Volcker wonders why other federal agencies and surrogates such as Fannie Mae FNM or Freddie Mac FRE have not taken action. It's a question many have been asking. [3] It'll cause even greater economic suffering. In plain words, Mr. Volcker implied that the current Fed is not only incompetent, but that its actions are dangerous.[2]
Mr. Volcker went further. Not only is the Fed not doing its job, he said, but it is doing the wrong job: It is defending the economy and the market, instead of defending the dollar. Just to stick the knife in, Mr. Volcker added that this bad job now will make the real job - defending the greenback - much harder later.[2]
"Financial crises do not happen in a vacuum and the current U.S. banking debacle is linked to imbalances in an economy that favored spending at the expense of saving," Volcker said.[15] "In a technical sense the recession will have ended when the next president takes office," although the climate may not feel much improved, said Summers, a Harvard University professor who led the U.S. Treasury during the Clinton Administration. David Walker, up until recent weeks the country's comptroller general, lashed out at the "imprudent and immoral practices of the Federal government," saying the current policy of low taxes and high government spending means "tomorrow's taxpayers will pay the bill, (including) those too young to vote and some of them not born yet."[10]
You surely have read about the residential real estate problems - subprime loans syndicated and resold, causing the implosion of several U.S. financial institutions. [2] Greenspan agrees with Bernanke on where to point the finger for the problem, at investment banks like Goldman Sachs GS and Citigroup C : "The core of the subprime problem lies with the misjudgments of the investment community. Subprime did not break from its localized niche status until 2005.[3] All that begs another question for Bernanke. Look, I'm not saying it's easy running the Fed. Put me in charge, and I'd probably blow it, too. If I made the kind of mistakes Greenspan and Bernanke have made, I'd admit it, just like I admit the mistakes I make in this column.[7] In an interesting juxtaposition of events in recent days, the two former Fed chairmen collided in the headlines. Greenspan, who left the Fed two years ago, took to print and television media to defend his battered reputation.[8]
Raise rates, and do it now. Can you imagine what this would do to the market? I sure can, which brings me to the gap between physical economic reality as we witness it every day in our physical investigations, and the surreal market chatter we see and hear on TV. This gap has never been wider - but it will inevitably close as markets catch up to reality - as just forecast by former president Ronald Reagan's Fed chairman.[2] If things get worse, "Wall Street pressure will build for the Fed to buy up mortgage securities wholesale. This could end up ruining the Fed's balance sheet," and then the trouble will really begin.[14] Nobody has a clue how bad it will get, or whether the Fed is only making matters worse by spewing out money and credit, weakening the dollar, in an attempt to restore calm.[14]
In contrast to Alan Greenspan's pleas Tuesday for a laissez-faire approach to the credit crisis, Volcker wants policymakers to get involved before the situation worsens.[15] Intended or not, Volcker's remarks looked like a direct rebuke to Greenspan, who once hailed derivatives as a triumph of financial innovation over risk. Of course, recent events show these "innovations" to be the "financial weapons of mass destruction" that Berkshire Hathaway's BRK-A Warren Buffett once predicted they would become.[1] "What has plainly been at risk is a disorderly unraveling of the mutual trust among respected market participants upon which any strong and efficient financial system must rest." Those comments drowned out Greenspan's woes. With them, Volcker began to reclaim the praise and recognition he deserves.[8]
"Maybe." This crisis is "more mystifying" than "its predecessors," including the S&L; crisis of the mid-1980s, and the the 1997-98 Asian financial crisis. This time, "it involves the entire financial system."[14]
Since last summer, we have seen the collapse of the market for subprime-related securities, the disclosure of hundreds of billions of dollars in writedowns at major financial institutions and the related CEO shakeups at Citi ( C, Fortune 500 ), Merrill Lynch ( MER, Fortune 500 ) and UBS ( UBS ), and a government-brokered rescue of Bear Stearns ( BSC, Fortune 500 ).[12]
Well if Greenspan was not the cause of the problem who was?Surely you cannot believe this trouble is a natural phenominum? No Greenspan made a huge mess and nearly caused a depression let alone recession. Now he sits smuggly enjoying a huge retirement benefit. Thats the problem with the world today top executives have no pain at all when they mess up. [13] Northern Trust economist Paul Kasriel, for instance, said flatly in a June 2004 interview with Investment News that "housing is a bubble." He predicted "a real shakeout in the housing sector because today's real estate prices won't be justified by higher interest rates."[12] The central bank is reportedly considering ways to expand it lending powers.[1]
SOURCES
1. Five Dumbest Things on Wall Street: April 11 | The Five Dumbest Things on Wall Street This Week | BRK.A BSC GOOG JPM LEH NWS TWX YHOO - TheStreet.com
2. reportonbusiness.com: A blunt former Fed chairman takes on Bernanke. Take heed of what he says
3. Former Fed Chairmen Pipe Up on Politics | Market Features | BSC C FNM FRE GS JPM - TheStreet.com
4. Volcker Shuns the Blame Game
5. Mineweb - INTERNATIONAL - Investing: a whole new era
6. Volcker's Stance May Offer View Of Obama's - April 10, 2008 - The New York Sun
7. Greenspan and Bernanke's Big Mistakes (Bear Stearns, JP Morgan Chase) at SmartMoney.com
8. Economy's downturn boosts Volcker's legacy as Fed chief / Greenspan works to avoid blame for financial crisis
9. Column: Volcker on System's Weakness - Forbes.com
10. UPDATE: Former Fed Chief Volcker Questions Wisdom Of Bear Bailout, Cuts
11. The Daily News Record:
12. Greenspan's media blitz - Apr. 11, 2008
13. Carry OnTaking the Blame, central bankers - Times Online
14. Top News: Important news around the world at THEWEEKDaily.com
15. Volcker: Spendthrift Americans Bred Credit Crisis - Forbes.com
16. Legalbrief - Fed policing Wall Street
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