Paul Volcker, Dodd-Frank and the Cult of Personality
Look in my eyes, what do you see?
The cult of personality
I know your anger, I know your dreams
I've been everything you want to be
I'm the cult of personality
Like Mussolini and Kennedy
I'm the cult of personality
The cult of personality
The cult of personality
"Cult of Personality"
Living Color/ Muzzy Skillings, Corey Glover, Vernon Reid, Will Calhoun
Bloomberg hit today: "Volker Rule Sets us Up for a Really Bad Day"
Update 1 | The implementation of the new regulatory stricture on big banks known as the “Volcker Rule” after former Federal Reserve Board Chairman Paul Volcker (1979-1987) is nearing completion today. The New York Times reports: “Five years after the financial crisis, federal regulators are poised to approve the so-called Volcker Rule, the keystone of the most sweeping overhaul of financial regulation since the Depression. The rule, a copy of which was reviewed by The New York Times, imposes some requirements that are tougher than the banks had hoped.
Like the construction of the pyramids in ancient Egypt, the Volcker Rule is a monument, a memorial to Chairman Volcker erected by an American populace and media whose collective memory is somewhat shorter than that of the average hamster. Peter Eavis of the Times reports that Volcker “proposed limits on banks’ activities when he was chairman of the Federal Reserve.” Really? This is odd because the Paul Volcker that I know has always and everywhere been the friendly enabler of the depredations of the big banks. We discussed this in the February 2012 post on Zero Hedge, “The Trouble with the Volcker Rule.”
I called Volcker “the father of too big to fail” in my 2010 book, “Inflated: How Money & Debt Built the American Dream,” but frankly watching the American media fawn over Chairman Volcker today suggests that this description was too generous. Paul Volcker is the father of off-balance-sheet finance. Just as FDR is remembered for his famous statement that “we have nothing to fear but fear itself,” and not for actively making the terrible deflation and banking crisis of 1932 far worse, Volcker is lionized as the great inflation fighter and financial reformer for fixing problems that he himself caused.
The Volcker aura begins with the heroic battle against inflation in the late 1970s. Who can forget the image of Tall Paul standing before Congress, mumbling in barely intelligible tones about the need for high interest rates to wage the fight against inflation. By his own words, Volcker became a “practical monetarist” when the situation required it, adopting the latest style in policy to fit the political situation.
But how many people recall that it was Volcker, then a young Treasury official, who engineered the closing of the gold window by President Nixon? By breaking the formal price link between the dollar and gold that had governed the post-WWII monetary world, Volcker and then Treasury Secretary John Connally loosed the US Treasury from the bounds of earth. (Milton Friedman once did a regression analysis correlating recovery from the Great Depression with dumping the Gold Standard and found among the highest coefficients of correlation EVER for a "non-identity" relationship.)
As James Rickards notes in his new book, “The Death of Money,” the decision to abandon the gold standard by Volcker set in motion a decade of uncertainty and economic malaise that led to wage and price controls. The closing of the gold window more than four decades ago set the stage for the madness of zero interest rates and “quantitative easing” that we see today from the Federal Open Market Committee. Yet no one in the media ever questions Volcker about this reckless act.
When it comes to the big banks, the cult of personality surrounding Chairman Volcker is even more deluded and bizarre. When the Times talks about Chairman Volcker wanting to impose greater restraints on the largest banks, was this before or after he proposed the government bailout of Penn Square Bank to then FDIC chairman William Issac? Along with his sidekick Issac, who was the Chairman of the FDIC in the 1980s, Volcker advocated allowing the largest banks to use off balance sheet Structured Investment Vehicles (SIVs) to increase leverage and profits. As with the closing of the gold window in 1971, Volcker was the enabler of a problem that would cause enormous damage to the US markets. Yet no one in the media knows the financial history of the US well enough to call him out on decisions and positions that are easily visible in the public record.
In all of the 450 pages of “Volcker: The Triumph of Persistence,” William Silber never mentions the fact that former Chairman Volcker set into motion the process at the Fed that would eventually encourage bank entry into areas such as off-balance-sheet financial vehicles and over-the-counter derivatives. After the debt crisis of the 1980s, Fed officials led by Volcker began to understand that the core operations of the big banks were unprofitable.
Banks argued that the need to loosen regulatory restrictions such as Glass-Steagall was driven by the need for global competitiveness, but in fact they big bank were destroying investor capital. Along with Volcker, another key enabler of this period of financial deregulation, Rodgin Cohen, chairman of Sullivan & Cromwell LLP, likewise receives almost no critical attention from the media as he argues that repealing Glass Steagall had no impact on the 2007 financial crisis.
Later on, of course, Volcker would argue that the banks needed more capital to prevent the bad acts that led to the accumulation of some $60 trillion in toxic waste by 2007. But for some reason, nobody in the financial media is able to ask Volcker just why it was that he believed back in the 1980s that large banks could manage the financial, legal and reputational risk of off-balance sheet financial vehicles that were completely unsupported by capital.
In 1982, under the chairmanship of William Isaac, the FDIC issued a “policy statement” that state chartered non-Federal Reserve member banks could establish subsidiaries to underwrite and deal in securities. Also in 1982 the OCC, under Comptroller C. Todd Conover, approved the mutual fund company Dreyfus Corporation and the retailer Sears establishing “nonbank bank” subsidiaries that were not covered by the Bank Holding Company Act. While the Federal Reserve Board under Volcker did ask Congress to overrule both the FDIC’s and the OCC’s actions, the Fed quietly supported the idea that banks should have broader securities powers and use SIVs to increase their effective leverage.
By 1987, just as Volcker’s term was ending, the Fed approved regulations allowing bank holding companies to underwrite and deal in residential mortgage-backed securities, municipal revenue bonds, and commercial paper. Glass–Steagall’s Section 20 prohibited a bank from affiliating with a firm “primarily engaged” in underwriting and dealing in securities. Half a century later, Citigroup, Lehman Brothers, Washington Mutual, Countrywide and other banks would fail because of acts of financial fraud related to underwriting bad securities, securities which were “sold” to SIVs that were in fact controlled by the sponsoring banks. These transaction violated the dictum established by Supreme Court Justice Louis Brandeis in 1925 that failure to release control over an asset that was ostensibly being sold was “fraud on its face.”
The damages Volcker and Isaac caused do, however, continue. They are still the "heart" of the "participation" problem, where unsecured and even subordinate borrowings are fraudulently reported as "asset sales." That, I believe, is FAR more significant than Volcker's fight against inflation. The tolerance for securities fraud by regulators is growing into the next bubble (along with derivative abuses equal to the "Lehman Repo-105" deal). All of these maladies stem from decisions made by Volcker, Issac and their contemporaries decades ago.
When we look at the Volcker Rule being approved by the Fed today, what is apparent is that the key issues which caused the subprime crisis – securities fraud and off-balance-sheet financial vehicles of banks -- remain unaddressed. The Volcker Rule places limits on the principal trading activities of large banks, essentially sequestering the bank’s capital from the market, but does nothing to reign in the creation of bad assets by banks for sale to customers. One could argue that the Volcker Rule is a canard, a diversion to prevent the public from focusing on the real problem, namely financial fraud by the officers and directors of the largest banks. Since principal trading had little or nothing to do with the crisis, it seems reasonable to ask why we are even bothering with the Volcker Rule. Nobody in the media ever asks this question.
The answer, sadly, goes back to the point about monuments. The Volcker Rule is a monument to Paul Volcker the man. It is a memorial to the idea that members of the media and the public, in their ignorance and naïveté, want to believe in, but the proposal does little to address the true causes of the subprime financial crisis. Just as the Sarbanes-Oxley law was a monument to my friend Charles Bowsher, the former Arthur Anderson partner and head of the General Accounting Office (1981-1996), the Volcker Rule is a pyramid erected to honor Volcker the man, Volcker the idea, but has nothing to do with financial reform. Like the quote from FDR, the cult of personality which surrounds Paul Volcker illustrates the superficial and puerile nature of American society when it comes to matters of economics and finance.
Sarbanes Oxley, which was enacted in the wake of the securities fraud perpetrated by Enron and Worldcom (using off-balance sheet vehicles, please note) did nothing to address the issue of financial fraud using SIVs. Likewise, the Volcker Rule limits the trading by banks for their own account, but does absolutely nothing to prevent banks from engaging in wanton acts of securities fraud against their customers. Indeed, by limiting the ability of banks to deploy capital in the financial markets, the Volcker Rule arguably limits market liquidity and creates the circumstances for future financial contagion.
Just look at the rout in the bond market after the June 19, 2013 press conference by Fed Chairman Ben Bernanke and you start to appreciate how the implementation of the Volcker Rule has added volatility and instability to the US markets. One must wonder whether even Volcker himself understands how his eponymous rule will really impact financial institutions and markets in the months and years ahead. But such is life in a democracy. As the last line of the Living Color song “Cult of Personality” reminds us, “The only thing we have to fear is fear itself.”
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