Volcker: Financial System Still at Risk

“Normal distribution curves — if I would submit to you — do not exist in financial markets. Its not that they are fat tails, they don’t exist. I keep hearing about fat tails, and Jesus, it’s only supposed to occur every 100 years, and it appears every 10 years.”

-Former Federal Reserve Chairman Paul Volcker


Real Time Economics reports that former Fed Chair Paul Volcker ditched his prepared remarks at a Federal Reserve of Chicago event yesterday. In its stead, he opened fire on all of the corruption in banking and Wall Street.

It was a “blistering, off-the-cuff critique leveled at nearly every corner of the the US financial system.

Volcker unloaded on banks and CEOs; he trashed regulators and the inept business schools. He opened fire on the Fed, bombed money-market funds. And while he had good things to say about the financial overhaul law, the bottom line is the system remains at risk.

Rather than subject us to future “judgments” of regulators — all subject to capture by “relentless corporate lobbying by banks and politicians to soften the rules.

Volcker made a plea for “structural changes in markets and market regulation.”

Real Time Economics noted the following:

Banking: Investment banks became “trading machines instead of investment banks [leading to] encroachment on the territory of commercial banks, and commercial banks encroached on the territory of others in a way that couldn’t easily be managed by the old supervisory system.”

Financial system: “The financial system is broken. We can 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…”

Business schools: I think that was the general philosophy that markets are efficient and self correcting and we don’t have to worry about them too much.

Central banks and the Fed: “Central banks became…maybe a little too infatuated with their own skills and authority because they found secrets to price stability…I think its fair to say there was a certain neglect of supervisory responsibilities” [nonfeasance]

On procyclicality: “It’s the hardest thing as a regulator in my opinion…when things are really going well, the economy is going well, the market is not disturbed, but you see developments in an institution or in markets that is potentially destabilizing, doing something about it is extremely difficult.

Risk management: “Markets that are prone to excesses in one direction or another are not simply managed under the assumption that we can assume that everybody follows a normal distribution curve.

Derivatives: “I’ve heard so many stories about how important” derivatives are but “there doesn’t seem to be much doubt that the creation of derivatives has far exceeded any pressing need for hedging.”

Money market funds: “Money market funds have encroached so much on the banking market. They are nothing, in my view, but a regulatory arbitrage.

The Fed and Dodd-Frank: Volcker said it was a “miracle” that despite all the criticism aimed at the Fed the central bank “came out with enhanced regulatory authorities rather than reduced regulatory authorities.”

Go read the entire write up, its outstanding.

If this guy was in charge of Fin Reg, the market would be appreciably healthier over the long run. Yet another great missed opportunity . . .


Volcker Spares No One in Broad Critique
Damian Paletta
Real Time Economics, September 23, 2010 

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