volckertvIt has been only a year since we suffered a national economic heart attack, the nitroglycerin in this case having been hundreds of billions in cash pumped through the financial system to avoid a fatal event. There were no heroes in this story, although Ben Bernanke, having done his scholarly work on The Great Depression, knew how to stave one off at that moment, more a paramedic than a cardiologist. And now, just a year later, we are back to our old bad habits.

The last man standing who has any integrity, in my view, is Tall Paul Volcker. When he was Fed Chairman, he got death threats. Builders facing interest rates of 18 percent and 20 percent mailed in two by fours with impolite language to express their unhappiness. But Volcker broke the back of inflation and gave Greenspan an economy he could coast on for a while.

When Volcker talks, we should all listen. And he talked recently, this time to Congress. What to do about the financial system? Here are some points from Tall Paul’s testimony, available here.

“What all this amounts to is an unintended and unanticipated extension of the official ‘safety net,’ an arrangement designed decades ago to protect the stability of the commercial banking system. The obvious danger is that with the passage of time, risk-taking will by encouraged and efforts at prudential restraint will be resisted. Ultimately, the possibility of further crises — even greater crises — will increase.”

Our heart attack came from RISK and DEBT, from leverage gone wild.

One major Volcker point is to reinstate Glass-Steagall. That New Deal effort said the commercial banks had to stick to lending, and could not trade, like investment banks. But Glass-Steagall got blown away in 1999. Banks, as public companies, wanted to show earnings growing quarterly, and so took on more and more debt, and more risk. In effect, they became hedge funds with a window into the Fed, so instead of borrowing 7 to 1 or even 10 to 1, they could go to 30 to 1. They took the risks, pocketed the profits, and now the taxpayers have bailed them out.

So Tall Paul’s top point is to get the banks out of the casino. We should also, he says:

– regulate derivatives as a typical financial product

– encourage more prudent compensation practices

– register and establish reporting requirements for hedge funds and private equity

I can’t see a thing wrong with any of this. Derivatives are not going to go away, but they could be transparent and traded transparently. Leading up to the national heart attack, the derivatives got so complex that probably not a single bank CEO could explain some of his products. We taxpayers spent $180 billion — that’s billion with a “b” — to prop up AIG, and the whole AIG mess was done with complex derivatives (and large dollops of greed and stupidity).

As for “prudent compensation practices,” let’s not get hung up on the numbers. The basic idea, to me, is that when you run up risk and leverage and pocket the immediate profits where is the “clawback” when your firm goes so busted the taxpayers have to bail it out? Those AIG people KEPT THE MONEY. So did the Merrill people who lost $27 billion in a single quarter, and were given BONUSES of $3.5 billion. Some of them got a hundred million dollars for the worst disaster in Merrill’s history. That’s essentially our money. They KEPT THE MONEY, too.

In his testimony, Volcker said we have to coordinate with other countries to work on a global approach for oversight. Well, of course that’s not going to be easy.

We find ourselves saying, “of course, of course, why hasn’t this already happened?”

Where Volcker will have a harder time is in his arguments about “moral hazard.” Where is the punishment for the sinners? Did we have to let Lehman go to make sure some investment banks got the message? Will that message stick?

Tall Paul of course took the opportunity to underline the sanctity of the independence of The Federal Reserve, a passionate concern of his.

Here is Volcker doing some pen-to-yellow-pad thinking:

We threw all of this money at the banking system because of systemic risk. Your dry cleaner or your gas station can go four paws up in the air, but we have to float Citi — and AIG — because they present “systemic risk.” They are “too big to fail.” That just offends Tall Paul’s sense of how to run a financial system. Instead of throwing trillions at self-wounded entities, we should instead appoint a special “Conservator” to take control of a bank that’s clearly going to default. The Conservator would do just what Paulson and Bernanke did under such high pressure — arrange mergers or sales, or orderly liquidation, or negotiate debt for new stock. But can’t you hear the screams from the Limbaugh radio fans now? The government is already too big? Who’s to say what is a systemic risk? This works for me as long as I imagine Volcker as The Conservator. But this is what we had to do last year, and we improvised it.

We can’t go back to 2008. That was too close.

Tall Paul is not actually in the government. He is listed as an advisor, and I am sure some people will listen, just as some Congresspeople will. But for each item he has suggested, there is a militant constituency opposed, so it can keep its pockets full.

We ignore Tall Paul at our peril.