Former Fed chief rails at regulators and bankers

Paul Volcker, the chairman of President Obama’s Economic Recovery Advisory Board and former Fed chief said that the nation's banking system is still broken and placed some of the blame of the credit crisis on regulators as well as the nation's central bank.

Speaking at an event late Thursday at the Federal Reserve Bank of Chicago, Volcker said "the reason we are all here is that the financial system is broken.”

He pointed out that “we can [sic] use that term in late 2008, and I think it’s fair to still use the term, unfortunately. We know that parts of it are absolutely broken, like the mortgage market, which only happens to be the most important part of our capital markets—totally a subsidiary of the U.S. government.”

Volcker’s broadside cut across a wide swath of targets—the financial system itself, regulators, bankers and even business schools among them.

“This was not supposed to happen,” said Volcker, whose speech was broadcast on the Reuters Insider Web site Friday. “I mean in all these years, we had these derivatives. We had the securitization. We had all the best business schools in the United States pouring out financial engineers. All the risks were going to be sliced and diced and the market would be resilient. It would not face any crises. We took care of all that stuff.”

“Central banks became—I don’t think preoccupied is the right word--maybe a little too infatuated with their own skills and authority and they’d found the secret to maintain price stability. That didn’t solve every problem in the world. It’s fair to say there’s was a certain neglect of supervisory responsibility, certainly not confined to the Federal Reserve, but including the Federal Reserve.”

Charles Geisst, a professor of finance at Manhattan College and the author of several histories about Wall Street, saw frustration in Volcker, who served as Federal Reserve chairman from 1979 to 1987, during the administrations of Jimmy Carter and Ronald Reagan.

“Quite frankly, he and [Arkansas Republican Sen.] Blanche Lincoln were the only people who called for structural reform in the system, and they didn’t get it,” Geisst told IDD on Friday. “After he proposed the Volcker rule, politics entered the mix, and I think this is what this is about.”

Volcker, 83, warned about hard days ahead. “It’s been so difficult to get out of this recession because of, in my judgment, the disequilibrium in the economy.”

Better and more sensible regulators won’t solve problems, according to Volcker. “This is a plea for structural changes in market regulation to supplement the inevitable human judgment,” he said. “We have this cumbersome council now of 10 sets of institutions and I’m not sure if that helps or hurts, but it’s a human institution that rests upon no mechanical formulas that I know of to arrive at some judgment that something is potentially going to be disturbing in the markets and disturbing enough that somebody is going to do something about it.”

Geisst said Volcker should have been more direct. “I think he rambled a bit. He would have been more effective had he said, ‘Look, we need some structural reform.’”

Geisst said Obama feels less discomfort fielding Volcker’s criticisms from the inner circle. “Unlike most of his predecessors—and his successors—Volcker has been fairly outspoken, even when he was Fed chairman. So yes, politically it’s better for the president to field his criticisms from than inside as opposed to from the outside.”

“When it’s all in place, I think the system will be fixed, but that is probably two to four years from now,’ said Peter Chepucavage of Plexus Consulting Group LLC, a Washington firm that has advised financial services companies on regulatory matters.

Chepucavage said uncertainty about financial regulatory overhaul was the theme at Thursday’s inaugural CFAW-GIC Washington Investment and Regulation Conference, hosted by the CFA Society of Washington, D.C., and the Global Interdependence Center. Panelists worried about costs related to regulatory overhaul. “If people like Chairman Volcker say the system is broken and Congress and the Senate voted on it, then it has to be fixed and we have to put up with uncertainty,” Chepucavage said.