As Time magazine anoints Federal Reserve Chairman Ben Bernanke as its “Person of the Year,” I am reminded of the contributions of another economist, Paul Volcker.
Bernanke, for my money, doesn’t hold a candle to the grumpy old man. Volcker, the former Fed chairman and current economic adviser to President Obama, defeated inflation, while Bernanke, by keeping interest rates at near zero, may be setting the stage for its return. More than that, Bernanke watched silently as Wall Street risk-taking grew to immense proportions, first as a Fed governor and then as its chairman, appointed to that position by President George W. Bush to succeed another enabler of Wall Street risk, former Fed Chairman Alan Greenspan.
Volcker worried that by mixing traders with commercial bankers, unfettered risk would infect savings and checking accounts. And he was right, as we’re all painfully aware.
Volcker met recently with an old source of mine, a former banker at Goldman Sachs. The meeting, I am told, focused on Volcker’s belief that last year’s financial meltdown can be traced back to a decision back in 1999, to allow banks that hold customer deposits to merge with investment banks that take risk on their trading desks
It was, of course, Volcker who helped save the nation from the hyperinflation of the 1970s and early 1980s, when he was Fed chairman, withstanding political pressure to keep pumping free money into the system, because he knew there’s no such thing as free money. Volcker’s legendary style—analytical brilliance combined with his gruff demeanor, as he smoked one of his cheap cigars when questioned about his policies during congressional hearings—made him a legend.
More than that, without Paul Volcker there would be no economic recovery that began under President Reagan and continued, save for a few bumps in the road, until relatively recently. For that, he is a national hero. But you wouldn’t know it by the way he’s now treated inside the Obama White House. Volcker, according to the former investment banker, all but conceded he has no stroke inside the White House, particularly for his current pet project: bringing back the law known as Glass-Steagall, which made it illegal to create firms that mixed risk-taking with plain-vanilla commercial-banking activities, like holding checking and savings accounts and making small business loans.
Glass-Steagall would have prevented the creation of Citigroup, which cost taxpayers billions of dollars in bailout money. Allowing nearly $1 trillion in deposits to be flushed down the drain because of the bank’s excessive risk-taking on its bond desk would have been unthinkable. It also would have prevented the massive bailout that followed Bank of America’s ill-fated purchase of money-losing Merrill Lynch last year.
“Volcker is very passionate about bringing back Glass-Steagall,” this banker told me, “but no one on the inside is listening.”
Obama, of course, inherited an economic mess of immense proportions, but in many ways he’s taken a bad hand and made it even worse, promising to raise taxes when the economy remains soft and wasting time and energy on a health-care debate as unemployment hovers at 10 percent, thus ignoring the simple reality that when people are working, they generally get health-care coverage.
Add one more economic miscue to Obama’s list: marginalizing Volcker, one of the nation’s great economic minds, who joined the administration to provide guidance to an economically unsophisticated president, only to find himself ignored, particularly as a debate rages about how to prevent the financial catastrophe that occurred last year from ever happening again.
For years, Greenspan and Bernanke supported a financial system that believed financial innovations like the creation of all those toxic mortgage bonds and insurance policies like credit default swaps actually reduced risk. Volcker saw these innovations as nothing more than a shell game, providing a false sense of security that risk is spread among various financial counterparties when in fact risk is magnified because these counterparties are so interdependent.
No one listened to Volcker. They also didn’t listen when he rallied against the creation of the megabank, like Citigroup, and later banks like JPMorgan Chase and Bank of America, which combined commercial- and investment-banking activities under one roof. Such diversification was supposed to make the banks stronger and more competitive on a global scale. The commercial-banking activities of loans and hoarding deposits could be “cross sold” with investment-banking activities. A bank customer could buy a stock or a mutual fund as he deposited his paycheck at the local Citigroup branch office.
It sounded so easy, and people like Citigroup founder Sandy Weill, his partner in creating the firm, Jamie Dimon (now at JPMorgan), and former Treasury Secretary Bob Rubin, who joined Citi after helping kill Glass-Steagall in 1999, said it was. But Volcker was suspicious. He called Citigroup and banks like it “bundles of conflicts.” He worried whether the consumer being prodded to buy a mutual fund while visiting the bank branch was getting the best deal, as the bank had an incentive to sell only its own funds, not others with better track records.
Volcker also worried that by mixing traders with commercial bankers, unfettered risk would infect savings and checking accounts, which the government vows to insure. And he was right, as we’re all painfully aware, though Volcker isn’t doing victory laps telling the financial world “I told you so,” which he has every right to do. Instead, in his own grumpy, straight-talking way (minus the cigar), he’s letting people like Goldman Sachs’ Lloyd Blankfein, and the other captains of industry who think they’re doing “God’s work,” know that he doesn’t think much of them.
As he recently told The Wall Street Journal’s Alan Murray: “I have found very little evidence that vast amounts of innovation in financial markets in recent years have had a visible effect on the productivity of the economy. Maybe you can show me that I am wrong.
“All I know is that the economy was rising very nicely in the 1950s and 1960s, without all of these innovations. Indeed, it was quite good in the 1980s without credit-default swaps and without securitization and without CDOs.
“The most important financial innovation that I have seen the past 20 years is the automatic teller machine…. How many other innovations can you tell me that have been as important to the individual as the automatic teller machine, which is in fact more of a mechanical innovation than a financial one?”
Charles Gasparino is CNBC's on-air editor and appears as a daily member of CNBC's ensemble. He is a columnist for The Daily Beast and a frequent contributor to the New York Post, Forbes, and other publications. His new book about the financial crisis, The Sellout, was published by HarperBusiness.