Volcker urges bank basics, cites 'Great Recession'

Business Times - 24 Apr 2009

Former Federal Reserve Chairman Paul Volcker, an Obama administration economic adviser, on Thursday urged banks to stick to basics and suggested possibly barring them from sponsoring hedge funds.

Wading into the intensifying debate on financial regulation reform, he raised concerns about giving the Fed new duties as a regulator of 'systemic risk' and warned against being too clear about government protections for financial institutions.

'A certain degree of ambiguity, in that respect, I would hope, could help temper moral hazard concerns,' he said in remarks at a conference on banking and financial oversight.

At 81, the tall and deep-voiced Mr Volcker is a legend in financial markets. As head of the US central bank during the Carter and Reagan administrations, he pursued an aggressive monetary policy that purged inflation from the US economy.

President Barack Obama early in his administration named Mr Volcker to be chairman of an Economic Recovery Advisory Board.

He was recently tapped to head a panel on US tax reform.

One of few policy-makers in Washington today to have lived through the Great Depression, Mr Volcker said at the conference that the US economy is mired in a 'Great Recession.'

As the administration tries to stabilise the financial system, Mr Volcker warned the government should not be too clear on which institutions deserve taxpayer help, and which don't.

'We should not encourage ... the view that some financial institutions are to be assured of official support, which in the midst of the present turmoil is, of course, the present presumption,' he said.

Focus on customers

Banks 'are and should remain strong and stable providers of financial services,' he said. 'The priority is and should be to respond to the needs of customers' for safe and liquid assets, credit and financial advice and counsel.

'What does not seem to me to be central to the banking mission ... is extensive participation in impersonal, transaction-oriented capital markets,' he said.

Too much market involvement poses risks, distracts management and conflicts with customer relationships, he said.

'The logic calls, for me, to prohibition of banking organisations sponsoring hedge funds or equity funds and strict supervision, with appropriate capital requirements, for proprietary securities and derivatives trading.'

He said reforming bank oversight along these lines would not mean 'a resurrection of Glass-Steagall,' a 1933 federal law that prohibited bank holding companies from diversifying too broadly into other financial activities.

But reforms like those he discussed would mean 'rewriting of some part of Gramm-Leach-Bliley,' Mr Volcker said, referring to a 1999 law that rolled back much of Glass-Steagall, ushering in an era of aggressive bank mergers and diversification.

Vast banking supermarkets such as Citigroup, Bank of America and JPMorgan Chase resulted.

With their balance sheets now weighed down by toxic assets they helped create, these same banks in recent months have received billions of dollars in taxpayer bailout aid.

Lack of focus

Mr Volcker said large financial institutions have suffered in recent years from overreaching. 'I do suspect that the relatively recent participation in capital markets has contributed, for some important institutions, to an unfortunate lack of focus on core banking functions,' he said.

One of many reform proposals making the rounds in Washington is an idea to create a 'systemic risk regulator' to monitor and manage financial risk in the economy.

'If systemic regulator means that somebody - the Federal Reserve or somebody else - is going to supervise in detail big banks, that's not my vision,' Mr Volcker said.

'But somebody ought to be looking at the overall system ... That's the job for the overall overseer, in my view. It's natural to think that the Federal Reserve is in that role.'

Commenting broadly on the crisis, Mr Volcker added: 'I never thought I would live to see the day when the American financial markets were dependent on the degree of government support and intervention that we have today. There is a plain need for making reform.'