EDITORIALS

Volcker’s words of wisdom

Posted Nov. 08, 2011, at 4:55 p.m.
Last modified Nov. 08, 2011, at 9:07 p.m.
Paul Volcker, former head of the Federal Reserve Board
United States Federal Government
Paul Volcker, former head of the Federal Reserve Board

With new bleak predictions for re-employment, improved growth and an easing of hard times, some people are turning for help to Paul A. Volcker, former chairman of the Federal Reserve.

In 1979, Mr. Volcker won brickbats at first but eventual respect in tackling 10 percent inflation by pushing up interest rates and risking a temporary rise in unemployment to bring down inflation and unemployment to normal levels.

Last month he told a group of international bankers some things they may have known but didn’t want to talk about on what needs to be done to straighten out international and domestic finance. His lecture in Washington, at a meeting of the Group of 30, included nuggets of wisdom about the present financial mess.

On the huge banking firms deemed “too big to fail,” he conceded that the injection of trillions of dollars to save them probably was warranted but carried dire consequences. The rescue effort actually promoted the risk-taking that figured heavily in the crash. As he put it, the bailouts reassured creditors that risks would be minimized and that “losses will be socialized, with the potential gains all private.” He urged regulation to break them up in orderly fashion if they start to fail.

On the financial crisis in Europe, he stressed the difficulty in enforcing standards of liquidity in view of intense lobbying by affected institutions and questions of how to deal with “shadow banks,” institutions that often defy regulation. He opposed any retreat from an integrated Euro Zone and urged a new international structure to enforce greater consistency in banking and financial standards.

Mr. Volcker noted that money market mutual funds in the United States, which now total more than $2.5 trillion, invested heavily in European banks and now are increasing the strains in Europe by withdrawing those investments.

He afterward told Gretchen Morgenson of the New York Times that many people mistakenly think that money market funds are as safe as bank accounts. But most of them lack the safeguards of bank deposits such as federal deposit insurance and strong bank capital requirements. Although typically managed conservatively, they are vulnerable to runs, as happened at one large fund when Lehman Brothers collapsed.

He told Ms. Morgenson that money market funds should end the system of valuing shares at $1 and instead value their assets every day to reflect market fluctuations. “It seems to me that if you are a mutual fund you should act like a mutual fund instead of a pseudo-bank.”

He was equally hard on the big “government-sponsored enterprises” that dominate the mortgage market. He said it would take years to develop a healthy, privately supported market, but he urged planning for the time when Fannie Mae, Freddie Mac and the Home Loan Banks are no longer part of the market structure.

Mr. Volcker’s sound judgment and clear recommendations, untainted by personal interest, are worth considering. A financial specialist with the courage to speak the truth as he sees it is a rare and valuable commodity.

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