"We Face a Real Challenge in Dealing with that Feeling that the Crisis is Over"

Paul Volcker is interviewed:

Interview with Paul Volcker, by Gabor Steingart, Spiegel: ...Spiegel: ...[E]ven though there are still more people being fired than hired,... Ben Bernanke is saying that the recession is technically over. Do you agree with him?

Volcker: ...We had a quarter of increased growth but I don't think we are out of the woods. ... The recovery is quite slow and I expect it to continue to be pretty slow and restrained for a variety of reasons and the possibility of a relapse can't be entirely discounted. ... We have not yet achieved self-reinforcing recovery. We are heavily dependent upon government support so far..., both in the financial markets and in the economy. ...

I think we ... have a challenge... There is concern in our recovery advisory group about how to rebuild the competitiveness of the United States, which inevitably means rebuilding, in part, the manufacturing sector of the economy.

Spiegel: What part of the manufacturing sector do you envision?

Volcker: I think there are a lot of opportunities in the so-called green economy for taking leadership. ...

Spiegel: Outsourcing and off-shoring have been the key words of the last decades. You don't think that the times of "made in America" are over forever?

Volcker: That has been the mentality and we have to change that somehow. I think it's self-correcting in part. The glamour of going to Wall Street is not as great today as it was a few years ago.

Spiegel: Are you sure? The Wall Street businesses are doing well. The big bonuses are back.

Volcker: It's amazing how quickly some people want to forget about the trouble and go back to business as usual. We face a real challenge in dealing with that feeling that the crisis is over. The need for reform is obviously not over. ...

Spiegel: But the American government seems to have lost some eagerness in setting a tougher regime of rules and regulations to control Wall Street. Everything is being watered down. Why?

Volcker: I will do the best I can to fight any tendency to water it down. What we need is broad international consensus to make things happen. ...

Spiegel: During your tenure as chairman of the Federal Reserve, the bank was always part of the solution. Today..., many experts see it as part of the problem. ... Lawmakers on Capitol Hill are thinking about tougher controls over the Federal Reserve.

Volcker: I think the loss of independence and authority of the Federal Reserve would be a very serious matter for the United States. Not just in terms of monetary policy but in terms of our place in the world. People look to strong, credible institutions and I think the Federal Reserve has been such an institution. If that's lost or too hamstrung by legislation I think we will regret it.

Spiegel: But is the Fed still the same kind of institution as during your tenure as chairman? Or is it now more of a governmental instrument? The Fed is managing the TARP program and is also buying government bonds.

Volcker: In some sense the Federal Reserve is always an instrument of the government. It is a government body but it is independent within government. But you are right in the sense that part of the concern is that they have involved themselves quantitatively in entering markets and in that process, you are supporting some markets and not others. That is an area in which the Federal Reserve has never wanted to get into and one that most central banks don't want to get into. If you are going to maintain your independence you have to avoid that. To intervene in particular sectors of the market is not the proper role for the central bank over time. It could be justified only by extreme emergency.

Spiegel: So what do you expect in the very near future?

Volcker: As an American, I have to be an optimist. But we have got a big challenge and we have to face up to it. And as you know, there is a lot of concern about the dysfunction of the political system. ...

I think he's right that the Fed's support of the financial market and financial institutions made it appear that it favored some markets and some firms over others, and that has been a problem. But I don't think the Fed had a lot of choice. It lacked the authority to dismantle large financial institutions outside the traditional banking system, it lacked the plans to do so even if it had the authority, and the fact that regulators allowed these institutions to become such a threat to the economy if they failed meant the Fed had to intervene. That's why, going forward, three things need to happen. Regulators need to reduce the threat these banks pose, they need to have plans ready if a threat develops anyway, and legislators need to give regulators the authority to take control of troubled institutions outside the traditional banking system.

But I have to admit that "the dysfunction of the political system" makes me wary of what will happen once the legislative process begins. Things could get worse rather than better, and reducing the independence of the Fed is but one of many ways that could happen. Even so, the need for reform of the financial sector is sufficiently strong to justify taking that chance.