Paul Volcker was the Chairman of the Federal Reserve under Presidents Carter and Reagan from 1979 to 1987, and the Chairman of the Economic Recovery Advisory Board under President Obama during 2009 and 2010. (August 2013)
The erosion of confidence and trust in the financial world, in the financial authorities that oversee it, and in government generally is palpable. That can’t be healthy for markets or for the regulatory community. It surely can’t be healthy for the world’s greatest democracy, now challenged in its role of political and economic leadership. Instead of complaining, let’s do something about it.
Where is the solid ground upon which to build, to restore some clear sense of national interest and national purpose, to restore confidence in the political process and in government itself? We don’t simply have a financial problem, a problem of economic balance and structure: we have a more fundamental problem of effective governance.
Americans have long been eager consumers and home owners. But there is no doubt we collectively overdid it during the years leading up to the financial and economic crisis of 2008. The personal savings rate dropped close to zero. Mortgage indebtedness grew to new (and ultimately unsustainable) heights. All that occurred as real income for average American households rose little if at all. That’s not supposed to happen in a growing, productive economy. High consumption maintained at the expense of saving and increasing indebtedness simply could not be sustained in the face of the stalled income of the “99 percent.”
The greatest structural challenge facing the financial system is how to deal with the widespread impression—many would say conviction—that important institutions, such as the large international banks, are deemed “too large” or “too interconnected” to fail. There are real, behavioral consequences of the rescue effort that was made. The expectation that taxpayers will help absorb potential losses can only reassure creditors that risks will be minimized and help induce risk-taking on the assumption that losses will be repaid out of public funds.
To a substantial extent, it was “nonbanks”—investment houses, hedge and private equity funds—that were at the epicenter of the financial crisis. Contrary to well-established practices, many of those same institutions received extensive government assistance to remain viable. Dealing with this great extension of moral hazard has become the largest challenge for financial reform. What failing institutions need is a dignified burial—not intensive care with hopes for recovery.