Paul Volker's tougher line on banks has gained sway with the president, write DAVID CHOand BINYAMIN APPELBAUM
FOR MUCH of last year Paul Volcker wandered the country arguing for tougher restraints on big banks while the Obama administration pursued a more moderate regulatory agenda driven by treasury secretary Timothy Geithner.
Thursday morning at the White House, it seemed as if the two men had swapped places. A beaming Volcker stood at Obama’s right as the president endorsed his proposal and branded it the “Volcker Rule”. Geithner stood farther away, compelled to accommodate a stance he once considered less effective than his own.
The moment was the product of Volcker’s persistence and a desire by the White House to impose harsher checks on the financial industry than Geithner had been advocating. It was Obama’s most visible break yet from the reform philosophy that Geithner and his allies had been promoting earlier.
Senior administration officials say there is now broad consensus within the White House and the treasury for the plan advanced by Volcker, who leads an outside economic advisory group for the president. At its heart, Volcker’s plan restricts banks from making speculative investments that do not benefit their customers. He has argued that such speculative activity played a key role in the financial crisis. The administration also wants to limit the ability of the largest banks to use borrowed money to fund expansion plans.
The proposals, which require congressional approval, are the most explicit restrictions the administration has tried to impose on the banking industry. It will help to have Volcker, a legendary former Federal Reserve chairman who garners respect on both sides of the aisle, on Obama’s side as the White House makes a final push for a financial reform Bill on Capitol Hill.
Advocates of Volcker’s ideas were delighted. “This is a complete change of policy . . . a fundamental shift,” said Simon Johnson, a professor at MIT’s Sloan School of Management. “This is coming from the political side. There are classic signs of major policy changes under pressure . . . but in a new and much more sensible direction.”
Industry officials, however, said they were startled and disheartened that Geithner was overruled, in part because they supported his more moderate approach. “His influence may have slipped,” said a senior industry official. “But you could also argue that it wasn’t Geithner who lost power. It’s just that the president needed Volcker politically [to look tough on big banks].”
Geithner agreed with Volcker that banks’ risk-taking needed to be constrained. But through much of the past year, he said the best approach to limiting it is to require banks to hold more capital in reserve to cover losses, reducing their potential profits. Geithner said blanket prohibitions on specific activities would be less effective, in part because such banks would eliminate some legitimate activity unnecessarily.
The shift towards Volcker’s thinking began last autumn, according to government officials.
Volcker had been arguing that banks, which are sheltered by the government because lending is important to the economy, should be prevented from taking advantage of that safety net to make speculative investments.
To make his case, he met with lawmakers on Capitol Hill and gave numerous speeches on the subject, travelling to at least nine cities on several continents to warn that banks had developed “unmanageable conflicts of interest” as they made investments for clients and themselves simultaneously.
“We ought to have some very large institutions whose primary purpose is a kind of fiduciary responsibility to service consumers, individuals, businesses and governments by providing outlets for their money and by providing credit,” he said during one speech. “Those institutions should not engage in highly risky entrepreneurial activity.”
Gradually, Volcker picked up allies. John Reed, the former chairman of Citigroup, expressed his public support. So did Mervyn King, governor of the Bank of England. His ideas began gaining traction within the administration in late October, when the president convened a meeting of his senior economic advisers to hear a detailed presentation by the former Fed chairman.
There was no immediate change of course. But after the House passed a regulatory reform Bill in December that was largely based on Geithner’s vision, the administration began to warm to Volcker’s ideas, which had the political value of seeming tough on Wall Street.
At the time, administration officials were growing concerned that government guarantees designed to spur lending by letting banks borrow cheaply were instead funding banks’ speculative investments and fueling soaring profits, said Austan Goolsbee, a member of the president’s council of economic advisers.
“You saw some of the biggest financial institutions . . . who had access to cheap financing . . . use that money without lending or anything, just doing their own investments,” he said. “That clearly started putting [the issue] on the radar screen for us.”
In mid-December, the president formally endorsed Volcker’s approach and asked Geithner and Lawrence H Summers, the director of the National Economic Council, to work closely with the former Fed chairman to develop proposals that could be sent to Capitol Hill. The three men had long discussions about the idea, including a lengthy lunch between Geithner and Volcker on Christmas Eve.
Summers and Geithner had been reluctant to take on battles that weren't at the heart of the problem that fuelled the crisis. But ultimately, an administration official said, the two men concluded that reform needs to be about more than just fighting the last war – it needs to address sources of future risk as well.– ( Washington Postservice)
