Saturday, October 11, 2008

Volcker: "The last god of central banking"

(Paraphrased transcript, highlights mine):

We have the tools in place, now we just leadership to fix the problems.

The problem has been handled piecemeal up to now, bailing out individual firms like Bear Stearns, AIG, etc, now it has to be co-ordinated better.

Europe has learned that they have a problem too, but they have to work together to protect the major international banks.  

Monetary policy is not the heart of the problem, but it is important that the central banks co-ordinate their approach.

The approach has been mainly a reaction up to this point, and the criticisms will be the lack of credibility up until now.  We can do better than that.  

We've got to deal with the financial problem, but also the threat to the real economy such as employment.  We should not fear that this will another Great Depression.

In February 2005, Volcker said that a crisis will come more likely than a whimper, but the financial situation is poor.

Implementing the bailout program is a difficult technical problem.  We also have to deal with home mortgages with people who got in over their heads and needs to be dealt with on an individual basis.  Perhaps judges could be used as arbitrators and mediators of these cases.

Reconstruction Finance Corp from 1932, as proposed by Warren Buffett, is the same thing Volcker is saying.  Jesse Jones was the trustee who administered the RFC, and the same thing today would add capital and liquidity.

Where is the liquidity in banks going?  It's sitting idle in short term securities and gold die to a lack of trust in fellow banks.  The government must step in to ensure trust, which is unfortunate.

The five great investment banks are gone.  The marketplace is changing itself.  Large banks add stability, but we need more players to diversify the competition.  Hedge funds will need to be regulated, especially on leverage and short-selling.  Regulation of large commercial banks will be increased, and the conflicts of interests need to be addressed.  Glass-Steagal repeal was inevitible, but adaptation to this change was too slow in reference to the the fast paced change in technology.

Nobody listens when things are going well.  But it was unsustainable.  China and Japan will continue to lend us money because they have a lack of alternatives.  The US is still the greatest strongest most vital economy.

These crises do not "just work themselves out."  The Mexican Crises in the 1980's and 1990's were resolved only with intervention.  A lot of money was made available and they went through a recession, but the recovery was fairly quick.

We need the specific tools and leadership as I said before, but the basic economy is strong and we are still the leaders in high tech and we still do well in manufacturing.  We need less financial engineers and more mechanical engineers and electrical engineers.

The outcome of this will be that we will be left with a stronger financial system.  We will restore our savings and reduce our consumption and reduce our dependence on foreign capital-- and these are good things.  This kind of agony focuses you on what we need to do.

This crisis will force the political will to enforce reduced consumption through taxes, etc, because now we know it's necessary.  That's leadership.  FDR's fireside chat after he was inaugurated explained the crisis.  People had confidence that FDR had fixed things and bank runs and failures did not happen because they had confidence that the probem was fixed even though nothing was substantively different.  Leadership.

We want to avoid the effects on the real economy that would weaken us over time as had happened in the 1930's. 

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