01.05.11

Volcker Rule Is a Sad End to a Brilliant Career

He's one of the greatest economists of our time and tamed inflation as Fed chief, but when Paul Volcker resigns as Obama's adviser, he'll be forever tied to a watered-down financial reform that won't prevent another collapse.

One of the saddest things about Paul Volcker’s probable resignation as one of President Obama’s top economic advisers is how he will be remembered. He won’t just be the Fed chairman who decades earlier performed a national service by defeating the economic evil known as inflation, but the bureaucrat who helped craft a convoluted financial “reform” law that has done little in the way of reforming activities that caused the 2008 financial collapse.

I am of course talking about the so-called Volcker Rule, a key provision of last year’s massive Dodd-Frank financial-reform act that was supposed to curtail Wall Street risk-taking but which even Volcker these days is disavowing. Volcker, it should be noted, came to the Obama administration with great fanfare. And why shouldn’t he have? One of the greatest economists of modern times, he was largely responsible for repairing the economy from “stagflation”—high unemployment and high inflation—and for the ensuing economic prosperity of the next three decades. Now he was advising a bright new president on how to rebound from the financial crisis of 2008 and the Great Recession that followed.

But Volcker spent much of his first year in the administration with very little influence on economic policy. The White House and its economic brain trust of Treasury Secretary Tim Geithner, chief economist Larry Summers, and senior adviser Valerie Jarrett were still cozying up to bankers and campaign contributors like JPMorgan Chase’s Jamie Dimon and Goldman Sachs’ Lloyd Blankfein. They didn’t want to hear advice from the crazy old man who showed up occasionally at economic policy meetings and groused about putting an end to Wall Street risk-taking once and for all.

Volcker didn’t seem to care. He spent long hours devising his plan to take Wall Street out of the risk-taking business, meeting occasionally with bankers he knew and trusted from his days as Fed chairman and later as a chief economist for an independent investment firm. These people said he spent most of his time listening to how Wall Street changed over the past three decades leading to the financial collapse, how it became less of a business that was paid to give advice and more of a gambling den that rolled the dice with shareholders' money with little accountability from regulators.

The great Paul Volcker spent his last days in public service putting his name to a watered-down rule that wouldn’t have prevented the financial collapse of 2008 and won’t prevent one in the future.

With that, Volcker came up with a plan that he believed would stop a crisis of the magnitude of the one that hit in 2008 and led to the destruction of two firms, Lehman Brothers and Bear Stearns, and the near destruction of the rest, from happening again. The banks, he believed, would no long be able to risk the firm’s own capital and blow it in a single trade. The banks would have to sell off other risky businesses like hedge funds and private-equity accounts not just because they created the opportunity to lose lots of money but also because, like trading, they have little to do with what Wall Street is supposed to be about—dispensing advice to corporations as well as investors.

Volcker, of course, had never really liked the big banks. He once quipped that the greatest innovation coming from the men of high finance was the ATM. He didn’t like the banks when he was Fed chairman, certainly not when he was out of government (just check some of his speeches), and certainly not now. And because of that, the bankers’ friends in high places, namely Geithner and Summers and ultimately the president himself, marginalized Volcker’s plan to make Wall Street a safer place.

That is, until the end of 2009, when Obama noticed a steep decline in his poll numbers and the public beginning to associate the most liberal president in years with the Wall Street risk-takers because unemployment remained at close to 10 percent on Main Street while Wall Street bonuses soared just a year after the bailouts.

First Obama went on national television to call his old friends on Wall Street—who supported him overwhelmingly during the 2008 presidential campaign—“fat cats” and professed his disgust at the billions in Wall Street bonuses only months after the bailouts. Then he announced, with Volcker at his side, that the era of risk-taking was over and that Paul Volcker would once again have his day in the the spotlight.

The Volcker Rule was then a key part of the new financial-reform bill being crafted by then-House Financial Services Committee Chairman Barney Frank and Senate Banking Committee Chairman Chris Dodd. From the start, Volcker should have smelled a rat. Frank, for all his liberal bona fides, was always a close friend of the banking industry. Dodd, for his part, feasted off low-interest loans from Angelo Mozilo’s subprime monstrosity, Countrywide Financial.

In the months that followed, the Volcker Rule was watered down by the Wall Street special interests and the compromisers in Congress. Traders, for example, can continue to trade as long as they interface with clients; it’s unclear if the banks will ever have to shed any part of their private-equity funds and hedge funds. It also was exposed as a colossal waste of time, along with most of the rest of the financial-reform bill that was signed into law by the president last summer.

Clearly, firms lost money trading and investing in private-equity or hedge funds, but that was only a blip on their screens. The big money was lost servicing clients, the very thing the Volcker Rule is supposed to make Wall Street do more of; all those mortgage bonds that collapsed and ate into the solvency of the big banks were cobbled together for their clients. The Wall Street firms merely kept a piece for themselves when they couldn’t sell the entire batch.

As the housing market began to implode, the banks were keeping more and more of those bonds on their books. When those bonds became truly toxic in late 2007 and 2008, the banks were holding the bag as investors ran for the safety of Treasury bonds.

In other words, the great Paul Volcker spent his last days in public service putting his name to a watered-down rule that wouldn’t have prevented the financial collapse of 2008, and won’t prevent one in the future.

It’s a sad end to an otherwise great career.

Charlie Gasparino is a senior correspondent for Fox Business Network. He is a columnist for The Daily Beast and a frequent contributor to the New York Post, Forbes, and other publications. His latest book, Bought and Paid For, is about the Obama administration and Wall Street.