How Obama Screwed Volcker

The president needed the gravitas of the former Fed chairman to sell his bank reform to Wall Street. But when the big banks didn't buy it, Obama sold him out.

Barack Obama owes Paul Volcker a lot, but he apparently owes the fat cats on Wall Street even more. That’s the only reasonable conclusion that can be made from the president’s timely and, in some ways, bizarre about-face on the former Fed chairman’s plans to reform the financial industry and prevent another meltdown.

As first reported by the New York Post, Volcker’s bank-reform idea—the one trotted out by the president with Volcker standing at his side just hours after Republican Scott Brown won Teddy Kennedy’s seat and vowed to help crush Obama’s economic agenda—has been nixed in favor of a watered-down version that bank chiefs like J.P. Morgan CEO Jamie Dimon and other Obama supporters on Wall Street are advocating.

I am told that both Larry Summers and Treasury Secretary Tim Geithner, good friends of Wall Street, considered the 82-year-old Volcker little more than a crank who should be ignored. And so he was.

The Volcker Plan, as I have reported in The Daily Beast, certainly had its shortcomings; its main emphasis was to stop banks that are deemed Too Big to Fail from engaging in so-called proprietary trading, or engaging in risky trades with their own capital—the theory being that taxpayers would again have to bail out the banks if their bets turned sour, as they did in 2007 and 2008.

The problem with the proposal was that proprietary trading wasn’t the major reason for all those big losses that led to the financial collapse and the taxpayer bailouts.

Yet for all its drawbacks, at least the Volcker Plan was the start of a conversation about whether taxpayers should be forced to subsidize the risk-taking activities of Wall Street. That debate, as we know now, is over. Sources tell me a coalition of Wall Street heavyweights from Dimon to people like Larry Fink, the head of money-management powerhouse BlackRock—Obama supporters all—made their opposition to the plan well-known to the administration.

The message was clear: Wall Street, which helped elect Barack Obama with an unprecedented support for a Democratic presidential candidate (Goldman Sachs was the second largest contributor to the president’s campaign), was ready to start backing the opposition of the so-called Volcker Rule. The bottom line: Even as Main Street struggles with severe unemployment, Wall Street still wants its billions in bonuses.

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And with that, Volcker, one of the nation’s great economists, was thrown under the bus. Of course, the administration is still pushing for “reform” of the banking system to prevent another meltdown, but by all accounts, the measures floated so far will do nothing more than force the firms to hold a little more capital if they want to roll the dice in the markets. The main thrust of what Volcker wanted to do and needs to be done—prevent the American taxpayer from ever again having to subsidized banks' risk taking—appears nowhere to be found.

Of course, you don’t have to be a political junkie to understand why the president did a 180 on Volcker and his plan; already, Wall Street has begun to hedge its bets by supporting some Republicans, and it isn’t a good thing having someone as powerful as Jamie Dimon, a lifelong Democrat and Obama supporter, against you. (People close to Dimon say while he still supports the president, he’s also angered by some of his agenda.)

Even so, there was something particularly smarmy about how the former Fed chairman was used. Volcker’s greatest achievement was defeating an economic calamity known as stagflation—the combination of high unemployment and high inflation—that scorched the American economy in the late 1970s, and threatened the country’s status as the world’s pre-eminent superpower.

Volcker left the Fed in the mid-1980s and since then has been sounding the alarm bells on all those financial “innovations” that blew up in 2008 and still haunt the banking system. He hated one of the greatest of these “innovations”: the creation of the financial supermarket model of banking that combined risk-taking trading activities with federally insured deposits. If Volcker had his way, there would have been no Citigroup, one of the most costly of the bailed-out banks, and we would have been all better off for it.

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In 2007, Volcker became an early supporter of then-candidate Obama. I am told Volcker believed Obama had the temperament to tackle the massive spending in Washington—remember, while campaigning, Obama often sounded right of George Bush on fiscal matters, and in reforming the banking system. When Volcker publicly announced that he was supporting Obama, he lent economic credibility to a candidate that his Republican challenger John McCain said would spend the country into economic oblivion.

Obama rewarded Volcker with an allegedly senior role in his economic team. I use the word "allegedly" because for the most part he was being ignored, particularly as he began pushing his ideas to prevent banks that are backed by the federal government from handling customers’ deposits that are insured by the government and still take risks in the markets by trading bonds.

I am told that both Larry Summers and Treasury Secretary Tim Geithner, good friends of Wall Street, considered the 82-year-old Volcker little more than a crank who should be ignored. And so he was—that is until Scott Brown’s victory. The popular theory about Brown’s victory was that it was a vote against Obama’s health-care reform. That’s only part of the story; the same president who publicly called Wall Street CEOs “fat cats” was now being accused of aiding and abetting Wall Street’s huge bonus pools, while unemployment remains near 10 percent.

It didn’t take the American public long to figure out that when you deem all these banks too big to fail, and then subsidize their long-term debt and keep interest rates close to zero, they will make money hand over fist.

That’s why just hours after the Brown victory, it was such an enticing photo-op for the president to be standing next to Volcker, the wise old man who has been accurately decrying Wall Street risk-taking for years.

Then reality set in. Those same fat cats threatened to pull their support for a president who will no doubt need all the support he can get given the state of the economy and his rapidly evaporating agenda of stalled health-care reform and failed economic policies.

And just like that, the wise old man became the crazy uncle that no one listens to anymore.

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 new book about the financial crisis, The Sellout, was published by HarperBusiness.