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Friday, June 04, 2010

Volcker: The Time We Have Is Growing Short

Here's part of a much longer essay by Paul Volcker on financial reform (and a few other issues):

The Time We Have Is Growing Short, by Paul Volcker, NYRB: ...The nature and depth of the financial crisis is forcing us to reconsider some of the basic tenets of financial theory. ... One basic flaw running through much of the recent financial innovation is that thinking embedded in mathematics and physics could be directly adapted to markets. A search for repetitive patterns of behavior ... are a big part of the physical sciences. However, financial markets are not driven by changes in natural forces but by human phenomena, with all their implications for herd behavior, for wide swings in emotion, and for political intervention and uncertainties.

Important questions about ... governance ... and the relationships between principals and their agents are being reexamined. Most obviously and appropriately, the role of regulation and supervision... To me, the lesson is clear. There are deep-seated structural issues that must be dealt with by legislation. Moreover, there should be common elements among nations hosting significant international financial markets and institutions. ...

The central issue with which we have been grappling is the doctrine of “too big to fail.” Its corollary is so-called moral hazard: the sense that an institution—its creditors, its management, even its stockholders—will be inclined to tolerate highly aggressive risk in the expectation that it will be rescued from possible failure by official financial support. ...
Dealing with this ... moral hazard has become the largest challenge for financial reform. Central to that effort ... in the United States and in Europe has been the creation of a new “resolution authority” that could supersede conventional bankruptcy procedures when the potential failure of a “systemically important” financial institution threatens to undermine the stability of the financial system. ... Put simply, the concept is to prepare for a dignified burial—not intensive care with hopes for recovery. ...
None of these reforms will assure crisis-free financial markets in the years ahead. The point is to keep the inevitable excesses and points of strain manageable, to reduce their scale and frequency...
As we well know, the critical policy issues we face go way beyond the ... regulation of financial markets. There is growing awareness of historically large and persistent fiscal deficits in a number of well-developed economies. ... If we need any further illustration of the potential threats..., we have only to look to ... Europe. ...
In an uncertain world, our currency and credit are well established. But there are serious questions ... about the sustainability of our commitment to growing entitlement programs. Looking only a little further ahead, there are even larger questions of critical importance for those of less advanced age than I. The need ... for effective action against global warming, for energy independence, and for protecting the environment is not going to go away. Are we really prepared to meet those problems, and the related fiscal implications? If not, today’s concerns may soon become tomorrow’s existential crises. ...
Restoring our fiscal position..., sorting out a reasonable approach toward limiting carbon omissions, and producing domestic energy without unacceptable environmental risks all take time. We’d better get started. That will require a greater sense of common purpose and political consensus than has been evident in Washington or the country at large.

    Posted by on Friday, June 4, 2010 at 01:08 AM in Budget Deficit, Economics, Financial System, Regulation | Permalink  Comments (53)


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