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Paul Nitze: The ghost of crises past

Paul Nitze
The Aspen Times
Aspen, CO Colorado

Two bright spots appeared for otherwise beleaguered Democrats this week. First was the news that Wall Street is starting to pour money into Republican campaign coffers. Second was the emergence, finally, of Paul Volcker as the president’s point man on banking reform.

Volcker, now in his 80s, has taken on a sort of shaman status among those who shudder at the thought of watching bankers gamble house money for another decade. Volcker salted away a lifetime’s store of credibility by doubling interest rates during his tenure as Federal Reserve chairman in the ’80s

President Carter’s nominee in 1979, Volcker earned Republicans’ admiration by getting the economic pain out of the way early in Reagan’s first term, paving the way for re-election in 1984. And to his credit, Volcker was nowhere to be seen when President Clinton’s economic team drank deeply of the deregulatory Kool Aid.

He was probably the least popular Fed chairman ever, and he exemplified why central bankers should be insulated from politics. If only Ben Bernanke, who has yet to show any willingness to wean banks from easy money, had skin as thick as Volcker’s. Presumably Volcker doesn’t revel in being despised, but he sure is good at taking the heat. Time for another turn at the stove.

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For all the talk of bipartisanship, it’s no secret that the White House is hunting for a wedge issue to take to voters this fall. If that’s what they’re after, financial reform is about as good as it gets. Polls show that bankers are deeply unpopular and more than two in three voters support the president’s proposed tax on the biggest banks’ balance sheets.

With Volcker as the trusted face of the administration’s reform proposal, other members of the administration can do pitched political battle with Republicans in Congress. Think of Colin Powell’s roll in the run-up to the Iraq War, with the added benefit that Volcker happens to be right.

Looking for a villain? Richard Shelby, the senior Republican on the Senate Banking Committee, fits the bill nicely. Sen. Shelby has recently made a name for himself by putting a hold on every single one of the president’s nominees. The good senator from Alabama is a poster boy for the politics of “no.” Some reform-minded comments notwithstanding, he can be counted on to obstruct whatever comes through the committee.

The icing on the cake is that Volcker’s proposal at last week’s hearing has the potential to pit one side of the banking industry against the other. What Volcker took to the committee was a plan to force banks to choose between proprietary trading and “traditional” commercial banking. That’s a much easier line to draw in theory than in practice, but the idea is sound.

Banks that want to continue to receive a backstop from the federal government, i.e. a full Federal Reserve credit facility and depositor insurance, would no longer be able to function as giant hedge funds. “Hedge fund” doesn’t even properly describe the way that prop desks at Goldman Sachs work. No independent hedge fund can draw on an endless zero-interest credit line, wink at investors that they’ll be bailed out if trades go south, and use a massive, diversified balance sheet to fuel its speculation.

A plan to split prop trading and plainer vanilla lending, even if it’s not airtight, can be combined with a bank tax in ways that isolate investment banks from the likes of Wells Fargo and Bank of America. If you’re sitting in the executive suite at Bank of America, it’s going to be harder for you to make common cause with your brethren at Morgan Stanley if you have to pay insurance on Morgan’s risks.

The end goal of all of this is a banking industry that’s much, much smaller than the current one, in which no single bank poses enough systemic risk to take us down with it. One way to get there is via a strong Federal Reserve that ratchets down the banking sector by restricting cheap credit. But as part-time Aspenite, and former Reagan budget chief, David Stockman pointed out in a scorching January op-ed, the Fed will never do that. Taxation is the next best option.

Volcker’s plan to split the riskiest bank activities from the rest, combined with a new bank tax, pushes the ball forward in a meaningful way. Add some transparency to derivative markets and new capital adequacy requirements for all banks, and you’ve made real progress.

Wall Street will fight these initiatives until the last vote is cast. And they are already moving contributions from Democrats to Republicans. Democratic politicians should wear that as a badge of honor in the fall. If Democrats aren’t galvanized by the fact that we’ve lost nearly a quarter of our national wealth during this crisis, perhaps the mid-terms will focus their minds.

Sen. Chris Dodd’s peevish performance during the Volcker hearing indicates he’s still busy rearranging deck chairs on the Titanic. He’s already at the end of his political career. If other Congressional Democrats share his attitude, they’ll be joining him.


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