Volcker Disses Treasury Reform Plan

Former Fed Chairman Paul Volcker, certainly no anti-regulation advocate, will testify this morning before the House financial services committee.

In part of his prepared remarks, he warns, justifiably, about some of the problems with the Treasury reform plan:

The approach proposed by the Treasury is to designate in advance financial institutions “whose size, leverage, and interconnection could pose a threat to financial stability if it failed”. Those institutions, bank or non-bank, connected to a commercial firm or not, would be subject to particularly strict and conservative prudential supervision and regulation. The Federal Reserve would be designated as consolidated supervisor. The precise criteria for designation as “systemically important” have not, so far as I know, been set out. However, the clear implication of such designation whether officially acknowledged or not will be that such institutions, in whole or in part, will be sheltered by access to a Federal safety net in time of crisis; they will be broadly understood to be “too big to fail”.

Think of the practical difficulties of such designation. Can we really anticipate which institutions will be systemically significant amid the uncertainties in future crises and the complex inter-relationships of markets? Was Long Term Capital Management, a hedge fund, systemically significant in 1998? Was Bear Stearns, but not Lehman? How about General Electric’s huge financial affiliate, or the large affiliates of other substantial commercial firms? What about foreign institutions operating in the United States?

All hard questions. In practice the “border problem” seems intractable. In fair financial weather, the important institutions will feel competitively hobbled by stricter standards. In times of potential crisis, it would be the institution left out of the “too big to fail” club that will fear disadvantage.

Also of note, he raises this important question:

Are community or regional banks to be deemed “too small to save”, raising questions of competitive viability?

If you have two classifications of banks, those that are "too big to fail" and those that are "too small to save", where are corporations, pension funds and wealthy individuals going to put their sizable non-FDIC insured funds? Clearly with the "too big to fail banks."

I do not think this point is lost on the Treasury. They are really pushing for a big bank world, where small banks are marginalized or pushed into the open arms of private equity.

Volcker probably gets this also. You always have to read between the lines with him. He will give you enough to let you know what he is thinking, but he is not about to lay it out in a manner that he burns bridges with the political elite.

I saw this in person at WSJ's Financial Futures Forum. While everyone else was getting carried away with new mad regulatory proposals, Volcker stood up, but he didn't say the proposals were mad, he just said everyone needed to slowdown that there shouldn't be any rush. Everybody (I think) got the message.

Here are the complete prepared remarks of Volcker.