Fixing Wall Street: "So, What Do You Do NOW?"

Looking for the New Volcker's

Regular readers of this blog know that I could hardly be a harsher critic of modern-day Wall Street: its practices; its obscene pay for little or no economic contribution ("Wall Street is Worthless"); and its corrupting influence on our government and society generally.

And I've got plenty of company.

As the fog lifts on the cause(s) of The Crash of '08, more and more people -- dare I say a consensus -- now share that viewpoint.

But as the "Wall Street-as-culprit" narrative gains traction, it logically begs the (entirely fair) question: "So, what do you do now?"

Next Steps

My answer is to go back to the airplane metaphor in "Wall Street's Uncontained Failure."

When trying to save a hijacked plane, however badly disabled, the first order of business is always to . . . replace the pilots.

Only once that's done, do you turn your attention to the altimeter, air speed, flap settings, etc.

And only once the plane has been stabilized do you turn your attention to longer term tasks like redesigning the defective engine(s) that just exploded.

Volcker 2.0

So, my starting point would be to look for the next Paul Volcker -- ideally, lots of them.

That is, people who are very bright (but by no means brilliant), honest, public-spirited, etc.

Plus two more things: 1) they're not tied to Wall Street ("Bye, bye, Tim Geithner, et al"); and 2) they're financially sophisticated -- but not too.

Fidelity Magellan guru Peter Lynch famously advised investors to put their money in businesses that "any idiot can run -- because sooner or later, any idiot is probably going to run them."

The next generation of Paul Volcker's will intuitively understand the government equivalent, and oversee financial reforms simple enough that they can be implemented and enforced without Wall Street "expertise."

And exactly who will find and appoint these new, enlightened financial stewards?

Try, elected officials whose campaign money didn't come from Wall Street.

P.S.: One more example of how some problems don't yield to direct solutions, especially when they're symptoms of a bigger problem: my notoriously unreliable garage overhead light -- a real headache when it gets dark before 5 p.m., as it does in Minnesota this time of year.

Over the last few years, I have experimented with every type of bulb there is, including "industrial" bulbs that have more durable filaments.

Result? A little extra use, perhaps, but no long term solution.

Then, this Fall, my garage door opener finally breathed its last, and needed replacing.

The new one is whisper-quiet and vibration-free -- and doesn't eat light bulbs.

Jeremy Grantham, Animal Spirits, and "Bubble Business"

"Don't Just Stand There -- Buy Something!"

Some people wait for a new episode of a favorite TV series (Seinfeld, The Sopranos).

Others for a new album from a favorite artist.

I look forward to Jeremy Grantham's latest quarterly newsletter. Seriously.

The man's honest, brilliantly insightful -- and a great writer, to boot:

Greenspan was lucky enough to inherit Volcker’s good work, and that gave him a base from which he could launch or blow a huge equity bubble; he also had the advantage that the country’s balance sheet was in excellent shape. Even Bernanke inherited a reasonably solid position from which to fund a second bailout. But a third time? It is hard to work out where the resources would come from to resuscitate the economy if a real shock were to be delivered by another collapse of a major asset class.

--Jeremy Grantham, "Playing With Fire"; GMO Q1 2010 Newsletter

Subscribing to the notion that the "bigger the bubble, the more damaging the bust," what is Grantham's antidote?

"We had better hope that something lucky turns up to break the speculative spirit."

Shhh!! Don't Tell the Tea Partiers

"Hands Off My Mortga . . . Oops! Never Mind!"

As best I can tell, the tea party movement is angry about out-of-control government intrusion into people's lives.

Apparently, they're not aware of the following factoid:

There were $390 billion in new mortgage origination's in the last quarter of 2009. Excluding home equity lines, Fannie Mae, Freddie Mac, the FHA, and the VA stood behind up to 95% of those mortgages.

"Anyone who looks at the numbers says, 'My God, look what it's come to,'" said Guy Cecala, publisher of Inside Mortgage Finance.

--"Paul Volcker Says Mortgage Market Will 'Have to be Reconstructed"; The Huffington Post (2/19/2010)

The predicament reminds me of a scene from Annie Hall, an early Woodie Allen movie.

A woman is lamenting to a friend that her uncle thinks he's a chicken.

"Send him to a shrink," the friend advises.

"We can't," the niece replies. "We need the eggs."

Paul Volcker: 'No Substitute for Structural Change'

Volcker's Clarion Call

Imagine being able to consult Albert Einstein about a physics conundrum, or FDR or Lincoln about an existential national emergency (like the one we're facing now, perhaps).

Having Paul Volcker, the 82 year-old former Fed Chairman, still on the scene and available to advise and guide is truly a stroke of good luck.

So what is he prescribing?

Basically, the same thing he's been saying for over two years, only now with a little more traction:

I am well aware that there are interested parties that long to return to “business as usual,” even while retaining the comfort of remaining within the confines of the official safety net. They will argue that they themselves and intelligent regulators and supervisors, armed with recent experience, can maintain the needed surveillance, foresee the dangers and manage the risks.

In contrast, I tell you that is no substitute for structural change, the point the president himself has set out so strongly.

I’ve been there — as regulator, as central banker, as commercial bank official and director — for almost 60 years. I have observed how memories dim. Individuals change. Institutional and political pressures to “lay off” tough regulation will remain — most notably in the fair weather that inevitably precedes the storm.

The implication is clear. We need to face up to needed structural changes, and place them into law. To do less will simply mean ultimate failure — failure to accept responsibility for learning from the lessons of the past and anticipating the needs of the future.

--Paul Volcker, "How to Reform Our Financial System"; The New York Times (1/30/2010)

Let's see . . . as a nation, we can heed the distilled wisdom of one of the country's wisest, most successful financial stewards and public servants . . . ever.

Or, we can do what Wall Street wants (basically, nothing -- but keep the government backstops and free money flowing, thanks very much).

Not much of a choice.

P.S.: If you read the entirety of Volcker's piece, you'll note that he demurs -- because of space limitations -- on a number of thorny issues, including revamping how U.S. home purchases are financed:

We also face a large challenge in rebuilding an efficient, competitive private mortgage market, an area in which commercial bank participation is needed. Those are matters for another day.

Let me translate the above: 'Fannie Mae and Freddie Mac are toast. Time to start over' (as even Barney Frank now admits).

Reform Shorthand: Where's Volcker Standing?

The Wall Street Journal's Take on Wall Street

President Barack Obama proposed new limits on the size and activities of the nation's largest banks, pushing a more muscular approach toward regulation that yanked down bank stocks and raised the stakes in his campaign to show he's tough on Wall Street.

--"New Bank Rules Sink Stocks"; The Wall Street Journal (1/22/2010)

So, government's iron fist is once again coming down (too) hard on private enterprise, imposing (more) bureaucratic red tape on businesses, and hurting job growth and the stock market.

Right?

Umm . . . well . . . not exactly.

If the Journal had asked me to re-write the lead, here's what I would have said instead:

President Obama belatedly announced the first, limited steps to address the root causes of today's economic melt-down: reckless Wall Street banks that have required trillions in taxpayer bailouts to deal with the consequences of their highly leveraged, bad bets -- bets that have caused millions of Americans to lose their jobs, savings and homes.

In other economic news yesterday, Goldman Sachs announced blowout earnings from . . . making more, reckless bets with taxpayers' money.

In my opinion, the only thing worse than 'governing-by-poll' is 'governing-by-Dow-Jones,' i.e., doing whatever makes the stock market go up, and refraining from whatever makes it go down -- at least in the short run.

With the market now down a couple hundred points in the wake of the newly announced bank "reforms," it will be interesting to see if Obama sticks to his guns.

P.S.: want a short-hand way to tell? Figure out how close (or far) Paul Volcker is standing from him (yesterday, he was standing at his side).

"Financial Innovation" Winners & Losers

I'm a huge fan of Nobel laureate (economics) Joseph Stiglitz. This paragraph is an example of why:

Financial engineering did not create products that would help ordinary citizens manage the simple risk of home ownership - with the consequence that millions have lost their homes, and millions more are likely to do so. Instead, innovation was directed at perfecting the exploitation of those who are less educated, and at circumventing the regulations and accounting standards that were designed to make markets more efficient and stable.

--Joseph Stiglitz, "Harsh lessons we may need to learn again" (China Daily, 12/31/09).

Former Fed Chairman Paul Volcker puts it in even starker terms: in his view, the last significant financial innovation was . . . the ATM.

To name something is to own it.

So, instead of framing the issue as being "pro" or "anti" financial innovation, how about characterizing it as being for or against prudent financial "speed limits."

After the biggest financial crack-up since The Great Depression, you'd think there be little opposition to lowering the prevailing speed limit from, oh, say 200 mph, to maybe 50 mph.

But you'd be wrong . . .

"The Biggest Loser"

Revisionist History

As historians know full well, Presidential reputations sometimes take decades to settle out, experiencing ups and downs in the meantime.

For example, Harry Truman left office in 1953 quite unpopular.

Over time, though, his stock gradually rose as society came to appreciate -- after the fact -- his straight-talking populism, common sense, and decency.

It also helped that, unlike contemporaries, later generations were less inclined to see him in FDR's (enormous) shadow.

Ironically, Truman's successor, Dwight D. Eisenhower, was another politician who left office under appreciated.

Viewed through the prism of the tumultuous '60's and turbulent '70's, the relatively placid '50's that Eisenhower presided over could easily inspire nostalgia a generation later. The nation's top general in World War II, his prescient valedictory warning about the "military-industrial complex" has also endeared him to posterity.

Finally, later generations, who only caught glimpses of JFK's charisma on movie reels, were more inclined to focus on JFK's substance and record (promising but incomplete) rather than his style (dazzling).

Today's Crop of Leaders

So, roughly two years into what appears to be shaping up as The Great Recession, how do today's leaders and recent-leaders fare?

Using a scale of minus-100 (-100) to plus-100 (+100), here's my take on the shifts to date:

Paul Volcker. Then: 50; Now: 100. Net gain: +50. Steered the country through the last comparable mess in the early '80's. Never worked for Goldman Sachs -- or aspired to. None of this would have happened on his watch. Tall Paul, indeed.

Alan Greenspan: Then: 90; Now: -75. Net loss: -165 (sets "the Biggest Loser" bar for a long time). "The maestro" now "the charlatan." Every one of his major tenets and policies have now been discredited if not repudiated, i.e., : 1) markets are self-regulating; 2) the Fed's job is to mitigate the damage from bubbles, not identify and prevent them; 3) financial actors pursue self-preservation above all other goals (wrong! they chase short-term profits and maximum compensation); and 4) excessively accommodative monetary policies don't risk liquidity traps (wrong! they do -- and we're clearly in one now).

Bill Clinton: Then: 40. Now: 10. Net loss: -30. The "Party Hearty" President from Arkansas (by way of Yale and Oxford). If the 1990's were the 1920's redux, that makes Clinton this era's Coolidge -- a feel good, go-with-the-flow leader whose lieutenants (Rubin, Summers, et al) did everything they could to keep the party going.

Ronald Reagan: Then: 60. Now: 40. Net loss: -20. Yeah, he gets splattered by this, too. Conservatives' darling, he pushed the pendulum rightward at a time when there was a strong case for it (sorry, liberals, but the Great Society overshot, and Carter never measured up). Unfortunately, the pendulum . . . kept going.

On the other hand, Reagan's resolve and optimism were a welcome tonic after Carter's malaise. He also gets much credit for the demise of the Soviet Union ("a good thing," as Martha Stewart would say).

Bonus question: if Reagan had been President 20 years later, would he have recognized the financial excesses, and shifted course? (He did finally fire Don Regan, formerly head of Merrill Lynch, but mostly because he was a jerk, not over policy disagreements).

Herbert Hoover: Then: -90. Now: -40. Net gain: +50. OK, he screwed it up. But it was harder to get right than we thought. At least his Treasury Secretary did what he thought was best for the country, not his own pocket or Goldman Sachs'.

FDR: Then: +70. Now: +90. Net gain: +20. Another beneficiary of "it was harder to get right than we thought." They were lucky to have him (and where's ours??)

George W. Bush: Who?

Global Glass Steagall

Canadian De Tocqueville Does Finance

The world's concentrated financial sector has been grabbing more than its fair share of wealth because it has been able to and this must stop.

"This is like looting," said outspoken Boston money manager Jeremy Grantham. "This industry can grow to gobble up all the benefits of the real economy if allowed to. It is trying to grab our cash. It's obscene."

--Diane Francis, "Time to Bust Up the World's Banking Giants"; National Post (10/24/09)

The above quote is just one of the highlights from Diane Francis' SUPERB piece in Canada's National Post yesterday.

What makes the piece especially worthwhile are: 1) her sweeping, historical take, alighting on everything from Standard Oil more than a century ago to the Microsoft anti-trust saga in the '90's; and 2) her non-U.S. perspective (think of her as "de Tocqueville does finance").

Here's one of Francis' milder indictments of the financial status quo: 'Excessively large banks destroy democracies, like the United States, through inordinate influence on policy, politicians and regulators.'

Her prescription -- and one endorsed by such luminaries as Paul Volcker and Bank of England Governor Mervyn King:

Enact a "global Glass Steagall on steroids" -- making sure that investment banks can't make bets with savers' insured deposits -- and break up the too-big-to fail banks, starting with Goldman Sachs.

Not just great, timely ideas -- but, in Glass Steagall's case, the law of the land for 67 out of the last 76 years.

Devastating arguments, and a truly great read.

P.S.: So is Jeremy Grantham a bomb-throwing Commie? Hardly. More like a Boston Brahmin-type, very Establishment, who runs an $87 billion investment fund.

Paul Volcker

Paul Volcker, Window Dressing (Sadly)

[Former Federal Reserve Chairman Paul] Volcker scoffs at the reports that he is losing clout. “I did not have influence to start with,” he said.

--Louis Uchitelle, "Volcker’s Voice Fails to Sell a Bank Strategy"; The New York Times(10/20/2009).

I don't have many heroes, political or otherwise.

Teddy Roosevelt. FDR. Abraham Lincoln. (If you're keeping score, that's two Republicans and one Democrat.)

My list of living heroes is even shorter.

But Paul Volcker's on it.

His leadership as Fed Reserve Chairman in the early '80's was perhaps the crucial piece in subduing inflation -- which threatened to spiral out of control at the time -- and thereby helped set the stage for an unprecedented 20 year-plus period of prosperity.

Now, he is on record recommending that too-big-to-fail financial institutions be broken up; that commercial banks, whose deposits are federally insured, not be allowed to use that money to make risky financial bets; and that credit derivatives be strictly regulated (and in many cases, banned).

Hard to argue with any of that.

But none of these proposals are going anywhere, because Volcker and others like him no longer have any power.

We are all poorer, in many ways, for that.

P.S.: Near the end of the Reagan administration, when Iran-Contra and other scandals were undermining Presidential authority, a satirical bumper sticker came out saying, "None of this would be happening if Reagan were still alive." Today, substitute "Volcker" for "Reagan."

Saying "No"

Who are Obama's Air Traffic Controllers?

One of the things I remember about the beginning of the Reagan administration -- yes, I'm old enough to remember very well -- was the abrupt change in tone from the Carter administration.

Suddenly, the country's leadership seemed capable of saying "no."

One of the first important constituencies to find that out were the air traffic controllers. When they went out on strike in 1981, Reagan summarily fired them. The move was unpopular, but it very likely was the turning point in the fight against wage inflation, which was then spiraling out of control. (Of course, Reagan's first "no" was to negotiating with Iran over the release of U.S. hostages.)

The other turning point was Fed Reserve Chairman Paul Volcker's decision to raise interest rates to over 14% (this was the monetary policy equivalent of "No"). Volcker made the move in the face of almost incredible political pressure, and the immediate result was the worst recession -- at least until now -- since The Great Depression.

However, within a year, inflation was vanquished, and the stage was set for two decades of unmatched prosperity (and yes, every expansion sows the seeds of its own demise).

The contrast between President Reagan then and President Obama now is striking.

So far, at least, no one seems to have been told "no." Not Detroit, not AIG creditors, and certainly not Wall Street (assuming there's a difference between it and AIG creditors).

As Reagan demonstrated, it's a lot easier to say "yes" once you've credibly said "no," then to get tough once you're pegged as being weak. The best example of the latter problem would be . . . the Carter administration.

P.S.: of course, Reagan's other big "no" was to detente with the former Soviet Union.