Paul Volcker is back, and he warns of tough times ahead

[DeepModem Mom]

LAT: Paul Volcker is back, and he warns of tough times ahead
Volcker has been chosen by President-elect Barack Obama as a special economic advisor. His 'no pain, no gain' fiscal strategy worked in the '80s and there's no sign he's softened that philosophy.
By Ralph Vartabedian
December 8, 2008

....Volcker is back, tapped by Barack Obama as a special economic advisor. And if the president-elect follows his advice on the current economic crisis, there could be pain again and no doubt many protests -- but also the possibility of long-term benefits.

In speeches, interviews, public policy reports and congressional testimony, Volcker, 81, has laid out a fairly clear outline of what he thinks is wrong with the present-day financial system and the government's management of the economy. His concerns go to the very core of how America lives and how Wall Street operates. A child of the Great Depression and a man of legendary personal thrift, Volcker thinks Americans have been living above their means for too long.

"It is the United States as a whole that became addicted to spending and consuming beyond its capacity to produce," Volcker lectured the Economic Club of New York in April. "It all seemed so comfortable." Bringing consumption back in line with income would not only crimp individuals and families, but also require major readjustments in the global economy, which has relied on the U.S. as consumer of last resort.

Volcker has become a skeptic of modern Wall Street, worried that the nation's entire financial system has evolved to a point that the government no longer has effective control over all of its important components. And the financial industry has become beholden to complex financial engineering that clouds the picture. "The market was being run by mathematicians who didn't know financial markets," he said earlier this year after the crisis struck.

Clearly, he wants tough new regulations on securities markets, including oversight of hedge funds, in order to avoid the need for a bailout effort by the Fed ever again. It seems likely that he will advise Obama that the growth of U.S. consumption -- everything from government spending to household outlays -- should not be financed by selling ever larger amounts of debt to foreign interests.

But he warns people not to expect an easy ride. "It's going to be a tough period," Volcker said in a speech at the Urban Land Institute in late October. "But when we dealt with inflation, it laid the groundwork for 20 years of growth. I'd like to see that happen this time."...

http://www.latimes.com/news/nationworld/washingtondc/la-na-volcker8-2008dec08,0,2328439,full.story

[MasonJar]

1. Some very wise words in above wynopsis; it also appears that Obama

was in sinc with this thinking in his interview today. Good! I know that I personally need to tighten my belt several notches and am prepared to do it.

[Nikki Stone1]

2. Americans have been ENCOURAGED to live beyond their means by Volker and his ken

I'm tired of these economic "gods" telling people to spend to keep the economy going and then dissing them when they do. The real problem is the system itself. At its very roots, it cannot sustain itself. It can't pay people less and less and then expect their spending to support the world economy.

[HamdenRice]

3. And this is just the psychopath to engineer a crash instead of a rational

readjustment, just because he apparently believes economic suffering is good for the masses.

How Obama let this moronic psychopath anywhere near his economic policy is stupefying.

[Cronopio]

4. That "psychopath" predicted the current financial meltdown back in 1987.

The last year he was Fed chairman he said that relaxing the firewall provisions of the Glass-Steagall act would create a tsunami of financial speculation that would "recklessly lower loan standards in pursuit of lucrative securities offerings and market bad loans to the public."

The economic policies of that "psychopath" succeeded in getting our economy out of the stagflationary slump of the '70s. This has been admitted even by people who opposed his policies at the time.

When a "psychopath" is proven right by reality on important issues, it probably means that he really isn't a psychopath. He is just being called one.

[galloglas]

5. Volcker is correct

the Glass-Steagall act would create a tsunami of financial speculation "recklessly lower loan standards in pursuit of lucrative securities offerings and market bad loans to the public."

The Glass-Steagall Act was originally planned to head into the trash (planning, couretesy of Wall Street money Barons) in 1986-87, concurrent with the Stock Crash (a mere fender-bender compared to what we have today) 0f 1987.

If the Glass-Steagall Act had been repealed then, the S&L Crisis would have steamed us into the Wall, rather than the current "liquidity crisis".

The important point is this: The Wall Street Bandits have always intended to loot the pockets of our populace. But Glass-Steagall prevented that until 1999. This (see Paul Krugman) 8 Trillion dollar looting has been plannned for decades.

[indepat]

6. $8 trillion here, $8 trillion there: pretty soon you are talking big bucks

:P

[Cronopio]

7. "recklessly lower loan standards ..."

Gee, I wish I'd written that. :eyes:

[HamdenRice]

8. One small problem with this thesis --->

The repeal of Glass Steagal has nothing to do with the current economic meltdown.

While repealing it may have been a bad idea, it's repeal is absolutely irrelevant.

Ergo, his "prediction" is about as valuable as his insatiable need to see average families suffer unemployment because of his psychopathology.

[Cronopio]

9. With words like "thesis' and "ergo" I would have expected something more than a dogmatic statement.

If you missed the point that -

1. allowing investment bankers to create derivative financial instruments and,
2. base the valuations of those instruments on the mortgages that conventional banking systems created,

- was the main reason that the investment banking system imploded, I suggest you do some more research into the Glass-Steagall Act and why it was passed in the first place. I assure you that economists such as Paul Krugman and James Kenneth Galbraith figured this out and were sounding the same alarm in the 2000s that Volcker was in the '80s. Their predictions are now fact.

[HamdenRice]

12. uhhh

"1. allowing investment bankers to create derivative financial instruments and,"

They were allowed to do that before the repeal of G-S. Therefore G-S cannot be the variable that caused the meltdown.

2. base the valuations of those instruments on the mortgages that conventional banking systems created,

See above.

G-S repeal had nothing to do with the current crisis. Can you provide a plausible explanation for how it did?

No?

I didn't think so.

[Cronopio]

14. Hmmm ...

"They were allowed to do that before the repeal of G-S. Therefore G-S cannot be the variable that caused the meltdown."

Note my use of the term "and".

"See above."

They were not allowed to create mortgage-backed securities before the restrictions of Glass-Steagall were modified in 1987. The derivatives market didn't explode until the restrictions were eliminated in 1999.

Again, please do your homework and you'll find that I'm right.

[HamdenRice]

17. I used to design mortgage backed securities, and am well aware of the market

I used to design mortgage backed securities in the mid 90s, and am well aware of the market, and its history.

G-S had no role in making the market for mortgage backed securities "explode." I also used to teach a course on, inter alia, real estate finance and real estate policy, and used a NYPIRG report from the early 80s (the report that led to the Community Reinvestment Act) that summarized the portfolios of all the savings and loans and savings banks in New York, and by that time, most banks' portfolios were already 30% mortgage backed securities.

In fact, the secondary mortgage market goes all the way back to the creation of Fannie Mae, the privatization of Fannie and the origins of a national securitization market. Fannie Mae began issuing mortgage backed securities in 1981, but the private market was already huge by then. The market for mortgage backed securities actually began to experience "explosive" growth long before the repeal of G-S, and can be traced to the 1985 plan by Reagan Administration Treasury Secretary, James Baker, to "securitize" Latin American debt to relieve the Latin American debt crisis, and the discovery by Baker and the investment bankers of the large appetite of institutional investors for bonds based on securitized risky assets (Latin American bank loans).

Before the repeal of G-S, savings banks, commercial banks and savings and loans sold their mortgages to investment banks which securitized them for fees. All the repeal of G-S did was to allow some big commercial banks to get in on the action. The repeal of G-S was inside baseball -- the investment banks versus the commercial banks -- and a fight over who got the fees. Securitization was already well under way.

I realize that it has become some sort of incontrovertible urban myth that the repeal of G-S led to the crisis, but it didn't, which is why no one is able to actually explain the relationship between the repeal and what happened. Securitization was already huge before the repeal of G-S, so G-S did not cause securitization.

Far more important to the creation of the current mess was the Reagan era Garn-St. Germain Depository Institutions Act of 1982. That was the most sweeping deregulation of depository banks (commercial, savings and S&Ls) in American history. It was that law that led to the S&L crisis, and even after that mess was semi cleaned up, led to the current crisis as well.

The other cause, which you will also not hear any mainstream or alternative sources talk about (because most people don't understand this market) was the role of the Bush era SEC. It was the SEC's job to make sure that investors in mbs knew what was "inside" them, and that the rating agencies' ratings were accurate, and during the Bush administration, they simply stopped doing that.

[Cronopio]

20. Sorry, but I have a hard time believing that a financial insider doesn't know that Steagall ...

... is *not* spelled with one "l". I would expect that someone whose job was closely related to that legislation would have caught that early on.

"G-S had no role in making the market for mortgage backed securities "explode.""

My statement was "... was the main reason that the investment banking system imploded". I never said that MBSs themselves made the investment banking system implode, but that giving investment bankers free rein to speculate with those instruments did.

"Before the repeal of G-S, savings banks, commercial banks and savings and loans sold their mortgages to investment banks which securitized them for fees."

This argues past the point. Before 1987, investment banks could not create revenues for themselves with the securities they created. Their revenues came strictly from the fees.

"In fact, the secondary mortgage market goes all the way back to the creation of Fannie Mae ..."

But Fannie Mae isn't an investment bank, is it? You're arguing past the point again, which is that commercial banks could not engage in the underwriting business before 1987. Until that year, Glass-Steagall banned commercial bankers from speculating with their deposits. After that year, investment banks could take deposits, create securities, and gamble in the securities market with them. With derivative financial instruments, they could legally leverage the value of their deposits to an unsustainable degree. As we are all seeing now in the market-wide deleveraging going on.

"Far more important to the creation of the current mess was the Reagan era Garn-St. Germain Depository Institutions Act of 1982 ..."

ARMs contributed to the crisis, but were not the cause. The current level of mortgage defaults are about the same as 2001, so mortgage defaults are not the reason that (for example) Lehmann Brothers went broke and Goldman Sachs is no longer a investment banking institution. Speculation on MBSs was the fuse that set off the crisis in mid-2007. When too many gamblers called in too many chips at once, the casino went broke.

[HamdenRice]

22. Much of what you wrote doesn't make sense

There is no correlation between the repeal of G-S and the current crisis. You still have not even attempted to show that correlation. Much of the rest of your post is kind of like financial "language salad."

"giving investment bankers free rein to speculate with those instruments did. "

This makes no sense. How did G-S enable investment banks to speculate in mortgage backed securities? Investment banks were always allowed to buy, sell, trade and issue mbs -- before the repeal of G-S and after. So were depository banks. How did the repeal of G-S enable investment banks to "speculate" in mbs?

Moreover, mbs generally were not speculative instruments. They were the bread and butter of treasury functions, and considered simply a safe place to park cash. That's why the crisis is so severe. They were supposed to be triple A rated securities, and were treated like t-bills and cash, not speculative instruments.

"Before 1987, investment banks could not create revenues for themselves with the securities they created. Their revenues came strictly from the fees."

While this barely makes sense, if I understand what you are trying to say, it's simply false. Investment banks could create revenues with securities they created, by trading. Their revenues did not come "stricly from fees." Repeal of G-S had nothing to do with that.

"But Fannie Mae isn't an investment bank, is it? "

As I said, the fact that Fannie started issuing mbs in 1981 is simply illustrative of the fact that a huge mbs market already existed, and Fannie's participation was provided as an example to show that the mbs market already existed by 1981. As I stated several times, depository banks were selling mortgages to investment banks to create mbs long before the repeal of G-S. That is the point.

"You're arguing past the point again, which is that commercial banks could not engage in the underwriting business before 1987. Until that year, Glass-Steagall banned commercial bankers from speculating with their deposits. After that year, investment banks could take deposits, create securities, and gamble in the securities market with them. With derivative financial instruments, they could legally leverage the value of their deposits to an unsustainable degree."

The repeal of G-S allowed commercial banks to engage in underwriting. But G-S did not allow commercial banks to "speculate with their deposits." Depository institutions (commercial banks, savings banks and S&Ls) always had to invest their deposits in (to simplify somewhat) (1) loans, including mortgages and (2) investment grade securities. The repeal of G-S did not change that at all. It said that investment banks and commercial banks could acquire each other or set up separate divisions of investment and commercial banking.

If there is one aspect of the mbs crisis that I wish more people understood, it is that mbs were not marketed as risky securities, and purchasing them was not "gambling." There were intended to be, and sold as, gold plated, triple A rated, investment grade securities. Depository banks could buy them before the repeal of G-S; and depository banks could buy them after the repeal of G-S. They were marketed for their "spread over treasuries," which meant the slight interest rate advantage of mbs over the other ultra safe investment -- US treasury bills. The repeal of G-S had nothing to do with the investment by banks in mbs. If mbs had been risky securities, then this crisis would be minor because only institutions that "gambled" would be in trouble. The reason the crisis is so profound is that the securities that the entire world thought were almost as good as cash have been found out to be very risky. That's why the credit markets are frozen. You don't seem to understand that the purchase of vanilla mbs was not speculation; it was thought to be ultra safe investing. That's why the culprit is not the depository banks who purchased mbs (they've been doing that since the early 80s); it's the investment banks who fraudulently and incompetently packaged and marketed mbs as triple A rated investment grade securities, and the ratings agencies who gave them those rating.

As for Garn-St. Germain, again, you don't seem to understand what it did. Before GSG, there was an entire sector of banks, the thrifts (savings banks and S&Ls) that was required to engage solely in a highly localized, highly regulated business of taking deposits from consumers and making mortgage loans to consumers. Because it was localized, thrift banks remained relatively small, and thrift bankers had a much better grasp of the risks involved in their portfolios and were able to work with borrowers who got into trouble, including rescheduling loans. The packaging of mortgages in mbs has taken away the legal authority of anyone to work with borrowers, but the destruction of the entire thrift industry was an even more profound cause.

The repeal of G-S was a bad idea, but it wasn't the cause of the current crisis. This false meme seems to have started because people on both the right and anti-Clinton left have reasons for blaming the Clinton administration rather than the Reagan, Bush I and Bush II administrations. No one has been able to explain how the repeal of G-S led to the current crisis, other than just asserting it. That's because there is no such explanation.

[ShortnFiery]

21. Sadly, I "buy into" your commentary.

The following passage I found particularly elucidating:

"The market for mortgage backed securities actually began to experience "explosive" growth long before the repeal of G-S, and can be traced to the 1985 plan by Reagan Administration Treasury Secretary, James Baker, to "securitize" Latin American debt to relieve the Latin American debt crisis, and the discovery by Baker and the investment bankers of the large appetite of institutional investors for bonds based on securitized risky assets (Latin American bank loans)."

I remember THAT time. :(

[digidigido]

13. WHAT? WTF are you talking about Hamden?

[HamdenRice]

18. See post 17 nt

[Waiting For Everyman]

11. Maybe like reverse psychology, so he'll know what NOT to do!

:)

You're so right.

[Waiting For Everyman]

10. Correction: living beyond our $8 per hour paychecks.

Like for stupid stuff such as utilities. If they want us to save, pay us more. Just like with blaming the collapse on unqualified buyers instead of the banks, the credit card spending is depicted as some kind of spree. Maybe some do that, but it's another cover up.

Screw Paul Volcker. He set many of us back years with his dumb ass policies. Lots of people lost everything, when they were stuck with two mortgages at 15%, just for trying sell their homes at the wrong time. He made a ghost town out of a formerly prosperous small city in my area, which is just an example of how it was everywhere.

He's just another economic idiot. We should try common sense next time. We'd do better with that.

[Tutonic]

15. Yeah lay the ground work for fat ass Jeb Bush to come in around

2020 and work that Bush magic one more time. We need to work to defeat anyone with the last name BUSH!

[acmavm]

16. Right, I care what Volker says. If he's so smart, where was he before it

all went to hell in a handcart? Pushing his own special propaganda, running around with his head up his ass with the rest of 'em.

[fasttense]

19. The only thing I like about Volker is that he is offended by the outrageous salaries thieving

CEOs make.

His supposed recovery was just another "job-less recovery". (If it is a job-less recovery, it is Not a recovery for the middle class.)

The real problems is the very low wages of the few remaining jobs. You can't have an economy when 90% of your population is living on starvation wages and can't buy anything. Unless of course, you want to go back to feudalism.