Volcker and Trans-national Regulation
All those mind-boggling financial products that nobody understood were no help to the U.S. economy, and led it to the sorry state from which it is now attempting to recover. So says Paul Volcker, chairman of the President’s Economic Recovery Advisory Board, in an interview with The Wall Street Journal, at the Journal’s Future of Finance Initiative conference in London recently, according to a report in MarketWatch.
There is not a “shred of evidence” that innovation provided any benefit, said Volcker, who was Chairman of the Federal Reserve under Presidents Carter and Reagan. Volcker pointed to credit default swaps and collateralized debt obligations as among the innovative financial products that, “took us right to the brink of disaster.”
The economy “was quite good in the 1980’s without credit-default swaps and without securitization and without CDOs,” Volcker said. Volcker was quick to assert, however, that he was not opposed to innovation per se.
“I do not want to stop you all from innovating, but do it within a structure that will not put the entire world economy at risk.” (my emphasis)
What structure would that be I wonder.
When capital runs out beyond the capacity of the framework of a nation-state, exactly what structure would be feasible and required to prevent the financialized economy from global risk? In other words, what is the proper regulatory structure when we no longer live in the nation-state but rather that of the market-state?
the Dodd resolution authority would not help resolve (i.e., shut down in an orderly manner) large cross-border financial firms, because the authority is U.S. and not international (or cross-border). Do not misunderstand me: The resolution authority in the bill is a fine idea and worth supporting – it will help create a clear legal framework for the resolution of bank holding companies and nonbank financial companies (i.e., it would extent the FDIC-type resolution process, which is far from being a bailout).
But the Dodd resolution authority simply will not work for the cross-border megabanks; this is not my opinion, this is an incontrovertible fact that is true by definition. A domestic resolution authority does not give you the right to manage the failure process in other countries or across borders – for that you would need an international resolution authority and this is not in the cards now or in the foreseeable future (and the Dodd bill does not change that fact in the slightest).
I suppose a more far-out thinker might at this point say that what the above reveals is the necessity of a world governance structure. Something within which capital could be contained. While I think such an idea isn’t feasible nor necessarily a good one, I can appreciate it’s radical (“to the root”) nature relative to the current situation.*
What I think in the end we’ll get is what Noam Scheiber aptly hypothesizes:
Here’s how I see the tradeoff: If resolution authority passes, it will only be as meaningful as its first test-case. Somewhere down the road, a megabank will get in trouble, requiring Treasury and the FDIC to step in. If, at that point, the government has the nerve to make the resolution process stick, bondholders will thereafter price in the possibility of future losses, and we’ll suddenly have a much safer, more competitive banking system. If, on the other hand, the government backs down and arranges another bailout, our moral hazard problem is here to stay. I give this between a 25 and 50 percent chance of working out the right way. (If bondholders agree with my assessment, they’ll start discounting somewhat even before the test case.)
Those odds sound pretty lousy, I know. But then ask yourself how likely it is that the administration could break up the megabanks today, and I think you come up with something considerably less than 25 percent. Which is why I don’t think you need to invoke intellectual capture to explain the administration’s approach. You just need a hard-nosed assessment of its chances of success.
* In terms of my own preferences for radical solutions, I prefer the resilient community idea, a de-centralized network of city-states across the globe. Instead of think global, act local. It’s think local, act local, spread global.