Wednesday, December 9, 2009

PAUL VOLCKER'S THE MAN (and Reagan Blew It)

In 1987 the Federal Reserve Board voted 3-2 to allow commercial banks to underwrite (invest in or accept some of the risk for) a limited amount of financial instruments like municipal bonds and mortgage backed securities. Underwriting bonds and securities had been a problem before the Great Depression because banks took depositor money and jumped into bigger and riskier investment schemes. As is the case today, bankers got greedy and stupid. Funny how some things never change.

Anyways, when bond markets and security investments tanked in 1929 banks who had taken bigger and bigger risks collapsed and took their depositor's money with them. There was no Federal Deposit Insurance Corporation (FDIC) back then so ordinary depositors lost their money to the stupid deals bankers made. You know the rest of the story.

Fast forward back to the Federal Reserve's 3-2 decision in 1987 ... By allowing our FDIC-insured banks to take on the risk of underwriting securities the Federal Reserve opened the door that would eventually enable our FDIC-insured commercial banks to get involved in the financial crap (CDOs, MBS, CDS, etc.) that brought down our economy last year. This is important to know because one of two board members who voted "no" on the 3-2 Fed decision was then Chair of the Federal Reserve, Paul Volcker.

I provide this background because Paul Volcker once again is doing us all a favor, which will probably go unnoticed (again). Via we learn that while in Sussex, England Mr. Volcker gave a speech and told some of the world’s most senior financiers that their industry’s “single most important” contribution in the last 25 years has been automatic telling machines, which he said had at least proved “useful”. Imagine, telling a group of financial executives with big wallets - and even bigger egos - that their greatest gift to humanity over the past generation was ATMs. Beautiful. But he didn't end there.

Mr. Volcker then went on to tell the group - after being asked about the importance of securities - that the commercial banks could innovate all they want "but do it within a structure that doesn’t put the whole economy at risk." The real surprise here is that many in the crowd were "stunned" by his common sense approach to banking.

Mr. Volcker finished by saying the industry needed to "wake up" and that investment banks and hedge funds should be the only financial groups taking on high risk investments. He added that our governments should also be telling them "If you fail, fail. I’m not going to help you. Your stock is gone, creditors are at risk, but no one else is affected."  That this even needed to be said - and that anyone would be offended or "stunned" by the suggestion - says much about where we're at today.

And, for those of you keeping score at home, Ronald Reagan effectively fired Paul Volcker and replaced him with Alan Greenspan. You do the math.

- Mark

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