Paul Volcker Blasts The Goldman Business Model, Moral Hazard, And Calls For A Return Of Glass-Steagall

Tomorrow at 9 am, former Fed Chairman Paul Volcker will testify before the House Committee on Financial Services, discussing topics on Systemic Risk and Resolution Issues. Since a former Fed Chairman will effectively be discussing the actions undertaken by the current one, this promises to be a most interesting testimony. We present some key points from Volcker's prepared remarks below: at first blush it would appear that the former Chairman is distancing himself substantially from the activities of the current one, and among other things, is proposing serious curbs on Moral Hazard, on the lack of Fed's accountability, highlights the need for a return to a Glass-Steagall system, and blasts the prop trading/hedge fund business model, whereby in discussing what he believes should be prohibited activities by systemically important firms, he highlights "ownership or sponsorship of hedge funds and private equity funds [as] should in my view a heavy volume of proprietary trading with its inherent risks." If that is not a direct stab at Goldman Sachs, nothing is.

The testimony, which will also include other influential financial experts such as Arthur Levitt, and Moody's Mark Zandi, will be broadcast live tomorrow at 9 am, and the webcast can be seen here,  without commercial breaks in which fat bearded men sing and cry, extolling the virtues of General Electric turbofan engines.

Volcker on moral hazard:

However well justified in terms of dealing with the extreme threats to the financial system in the midst of crisis, the emergency actions of the Federal Reserve, the Treasury, and ultimately the Congress to protect the viability of particular institutions – their bond holders and to some extent even their stockholders – have inevitably left an indelible mark on attitudes and behavior patterns of market participants.

  • Will not the pattern of protection for the largest banks and their holding companies tend to encourage greater risk-taking, including active participation in volatile capital markets, especially when compensation practices so greatly reward short-term success?
  • Are community or regional banks to be deemed “too small to save”, raising questions of competitive viability?
  • Does not the extension of support to non-banks, and even to affiliates of commercial firms, undercut the banking/commerce divide, ultimately weakening the commercial banking system?
  • Will not investors in money market mutual funds find reassurance in the fact that when push came to shove, the Treasury with an extreme interpretation of its authority, took action to preserve those funds ability to meet their declared commitment to pay their investors at par upon demand?

What all this amounts to is an unintended and unanticipated extension of the official “safety net”, an arrangement designed decades ago to protect the stability of the commercial banking system. The obvious danger is that with the passage of time, risk-taking will be encouraged and efforts at prudential restraint will be resisted. Ultimately, the possibility of further crises – even greater crises – will increase.


Think of the practical difficulties of [a Too Big To Fail] designation. Can we really anticipate which institutions will be systemically significant amid the uncertainties in future crises and the complex inter-relationships of markets? Was Long Term Capital Management, a hedge fund, systemically significant in 1998? Was Bear Stearns, but not Lehman? How about General Electric’s huge financial affiliate, or the large affiliates of other substantial commercial firms? What about foreign institutions operating in the United States?

On what is effectively a repeal of Glass-Stegal

As a general matter, I would exclude from commercial banking institutions, which are potential beneficiaries of official (i.e., taxpayer) financial support, certain risky activities entirely suitable for our capital markets.

And here is where life gets interesting for the biggest too big to fail hedge fund in the world - Goldman Sachs:

Ownership or sponsorship of hedge funds and private equity funds should be among those prohibited activities. So should in my view a heavy volume of proprietary trading with its inherent risks. Some trading, it is reasonably argued, is necessary as part of a full service customer relationship. The distinction between “proprietary” and “customer-related” may be cloudy at the border. But surely by the active use of capital requirements and the exercise of supervisory authority, appropriate restraint can be maintained.


The point is not only the substantial risks inherent in capital market activities. There are deep-seated, almost unmanageable, conflicts of interest with normal banking relationships – individuals, businesses, investment management clients seeking credit, underwriting and unbiased advisory services.

On Federal Reserve accountability:

I am not alone in suggesting that a Fed governor should be nominated by the President and confirmed by the Senate as a second Vice Chairman of the Board with particular responsibility for overseeing Regulation and Supervision. The point is to pinpoint responsibility, including relevant reporting to the Congress, for a review of market developments and regulatory and supervisory practices. Staff authority, independence, professionalism, experience, and size should be reinforced.

On duration of unbridled Fed intervention:

There is also an interesting question as to the period over which events are both “unusual and exigent”. What is involved in emergency lending is the need to act immediately and forcefully, which only the Fed may be able to do. But after several months, the Congress working with the Administration should be able to determine the proper amount and time for continuing extraordinary assistance.

Full Volcker testimony: