President Obama seems to be slowly waking up to the fact that the American public has grown tired of the endless bailout of Fannie Mae and Freddie Mac. The public has also rejected the talking point that Fannie and Freddie were simply victims of a 100 year storm in the housing market. So what's Obama's response? To ask for public comment and have public forums.
This strategy is clearly one of delaying and avoiding any reform of Fannie and Freddie while pretending to care about the issue. Where was the public comment and forums on the Volcker rule? Seemingly the standard is that fixing the real causes of the financial crisis should be delayed and debated while efforts like the Dodd bill, which do nothing to avoid future financial crises, should be rushed without debate or comment.
Even more disingenious is couching reform of Fannie and Freddie under the rubic of "fixing mortgage finance". This is no more than an attempt to take the focus away from Fannie and Freddie and shift it to "abusive lending" and other non-causes of the crisis.
This isn't rocket science. The role of Fannie and Freddie in the financial crisis is well understood. The only thing missing is the willingness of Obama and Congress to stand up to the special interests and protect the taxpayer against future bailouts.
Today Paul Volcker appears before the Senate Banking Committee to argue for the separation of proprietary trading and commercial banking. In Mr. Volcker’s own works “what we plainly need are authority and methods to minimize the occurrence of those failures that threaten the basic fabric of financial markets.”
Using his own test, the Volcker Rule fails miserably. Had this rule been in place say five or even ten years ago, we’d most likely be in the same place we are today. It would have not avoided the crisis, and may potentially have made it worse.
First of all the proposal ignores the fact that those institutions at the heart of the crisis, Bear, Lehman, Fannie, Freddie, AIG, were not commercial banks. They were not using federally insured deposits to gamble in our financial markets. Those commercial banks with proprietary trading activities that did fail, such as Wachovia, were sunk not by proprietary trading, but by bad mortgage lending.
Mr. Volcker is correct in arguing for a change in assumptions that institutions and their creditors will not be bailed out. He errs in believing that the House passed financial “reform” bill achieves that. One has to wonder if he’s bother to even read the bill. The House bill explicitly allows for rescuing creditors. The House bill does not reduce the chance of bailouts, it increases them.
While the Obama Administration may have changed the face of its reforms, sadly the substance of its proposals continue to bear little relation to the actual causes of our financial crisis. Nowhere in the President’s proposals do we see any efforts at avoiding future housing bubbles. Perhaps this should come as no surprise given Washington’s continued attempts to re-inflate the last housing bubble.
In a recent edition of The Region magazine, published by the Federal Reserve Bank of Minneapolis, retiring Minn. Fed President Gary Stern interviews Paul Volcker on a variety of topics. It's an interview well worth reading, and reminds one why Volcker is one of the more thoughtful voices on economics and finance, even if he isn't always right.
Some highlights. On the Obama financial reform plan:
I do not share one part of the general philosophy which seemed to emerge from this, particularly the proposal that the Federal Reserve supervise directly all “systemically important” institutions. I don’t know what “systemically important” institutions are, incidentally, but I’m sure that if you picked them out, people will assume they’re going to be saved, that they’re too big to fail. At the same time, there’d be some that you don’t pick out in advance that you’d want to save under particular circumstances. So I think that is a mistake.
Volcker also express concern that those institutions at the center of the crisis are left out of the reform. Specifically he mentions that Obama Administration officials "haven't said anything about Fannie Mae or Freddie Mac."
Volcker also takes issue with the Administration's proposal to regulate non-banks, including hedge funds and private equity. "I wouldn't regulate so strictly the nonbanks. I'd like to create the impression...that there's no automatic bailout of those institutions."
Volcker also raises important questions about the Administration's Keynesian stimulus actions. As the stimulus was meant to replace a reduction in private sector demand, Volcker asks "are we really dealing with the underlying pressures in the economy without permitting a relative decline in consumption to proceed?"
Those are just a few of his comments. Here's to hoping the rest of the Obama Administration is listening. They could do a lot worse than Volcker's advice.
As I have argued elsewhere, Bernanke's record as both a Fed governor and Chair suggest we be better off with a new Fed Chair come January 2010, when Bernanke's term as Chair expires. Outside of those who believe the bailouts have saved capitalism, two very reasonable arguments are put forth for keeping Bernanke at the helm: 1) in a time of crisis, the markets need certainty and dislike change; and 2) the alternatives, such as Larry Summers, would be worse. Both these points have real merit, however I believe in both cases the pros of change outweigh the cons of staying the course with Bernanke. I will save the "certainty" debate for another time, for now, let's ask ourselves: Would Summers really be any worse than Bernanke?
Before I make the case for Summers, I do want to make clear, President Obama, and the country, would best be served by a "Carter picks Volcker" type moment. Go outside the Administration, go beyond the usual circle of easy-money, new Keynesians. The Fed lacks creditability in two (at least two) important areas: bailouts and inflation. And one doesn't even need to go outside of the Federal Reserve System to find candidates. Topping my list would be Jeff Lacker (Richmond Fed), Gary Stern (Minn Fed) and Charles Plosser (Philly Fed). Any of these three know the workings of the Fed, have the respect of the Fed staff, and have taken strong positions on both "too big to fail" and easy money. In the case of Gary Stern, it would seem especially appropriate, as his early warnings (see his 2004 book on bank bailouts) were largely ignored and dismissed. If we want to reward and promote those who got it right, these guys are at the top of the list.
But let's reasonably suppose that Obama wants someone close, someone he personally knows and will stick with tradition by picking a member of his own administration. Without going into any detail, picking Romer would offer little substantial difference with keeping Bernanke. The case for Summers is essentially that here is one instance where his enormous ego would be an asset. One easily gets the sense that when Summers sits next to President Obama, Summers is thinking to himself just how lucky the President is to be sitting next to Larry Summers. One can call Summers lots of things, starstruck is not one of them. Given what we now need most in a Fed Chair is true independence, from especially the Administration but also from Congress, Summers is the only qualified economist close to the President who displays even the slightest streak of independent thinking. Bernanke, in contrast, has endlessly pandered to the Administration and to Congressional Democrats. Summers has been willing on occasion to actually defend the sanctity of contract (remember the debates over the AIG bonuses), a rarity on the Left, and more than Bernanke was willing to say.
So forced to choose between Bernanke and Summers, the need for an independent Fed Chair willing to take on the Administration and Congress, when appropriate, makes Summers a far better choice. That said, here's to encouraging Obama go outside his comfort zone and pick someone who has the will to remove excess liquidity from the system before the next bubble gets going.