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Paul Volcker is a retired Federal Reserve Chairman who destroyed massive inflation buy attacking the American Standard of Living using massive interest rates. He stopped trying to fix the economy, protecting jobs, and economic stimulus. He made everyone suffer which solved economic problems.
On Charlie Rose are answers to aimeecc questions. There are no sound byte answers. These notes from his discussion are some of the best answers that aimeecc might get.
Financial crisis is due to excessives in mortgage lending.
Federal Reserve action raises questions. Function is to provide liquidity to the financial industry center.
Now they stepped in to save Bear Stearns that was highly (excessively) leveraged. All investment banks are highly leveraged and interconnected. Federal Reserve now lends to investment banks - a major change. Is it wise? Could we have risked the demise of Bear Stearns? Unknown because all firms are so interconnected and also highly leveraged. So this is a test of a new financial system where banks are no longer the dominate center of our financial system. Investment banks are now larger, mostly unregulated, especially since SEC (ie remember Harvey Pitts) does little to no oversight.
Fed Reserve was not conceived as a place to put bad assets. Now that is what has happened. (Something like 50% of the Feds budget may be tied up with questionable mortgages.) Fed is taking over bad assets from these highly leveraged investment bankers. Volcker says this is wrong in the long term. Federal Government (Treasury) did not step in because government currently has no tools. That should change.
Freddie Mac, et al are government institutions intended to solve mortgage problems in times of stress. But for 1970 budget games, Freddie Mac became a big private intuition torn between whether it is a profit center or a mortgage solution organization. Fed had to step in because nobody else could (or would) - ie Freddie Mac and Sally Mae. That should change. Freddie and Sally have direct credit lines to the Treasury that were not used.
All this should have been seen coming. We did not ask obvious questions because short term profits and low cost imports made everyone happy - unaware because we wanted to be. Financial situation was unsustainable. We have been consuming more than we produce for a long time made worse because foreign investment let us ignore these impending problems.
Economy not too bad, especially exporters. But we have lost manufacturing capacity. If we can get through this crisis, we will have a better balance economy. Question is 1) how and 2) how long the pain,
How? Confidence among asset holders is too low. Even Freddie Mac & Sally Mae should go out and buy back their own paper. Things would be worse if commercial banks were not properly capitalized.
We convinced ourselves that complex financial instruments created market stability. Literally mathematical models with no basis in financial reality were used to justify absurd conclusions. Mathematicians without financial experience were making predictions that others believed. Humans got too exuberant.
Having the dollar as a world currency has been good for everyone - as long as the US economy is stable. Things such as protectionism has been harmful. Off balance accounting has been harmful. Instability in America creates instability internationally. Even Swiss Franc is worth more than a dollar. US has ignored these international problems created by a dropping dollar. Dropping dollar made worse by lower interest rates and resulting inflation. Volcker specifically mentioned increasing food prices. These rates are no where near to what Volcker had to fix, but equivalent to what was starting in 1970 that created the problems he eventually fixed with 15 and 20+% interest rates.
How long to fix? Business firms are strong. Problems are only in financial institutions and housing. Rest of economy is still in good shape although economy may now be in recession.
Past recessions verse now - confidence has not been lost. Concern would have existed had Bear Stearns declared bankruptcy causing non-performance with third parties. Would it have created a panic? Yes or no - also called unknown.
People are paying high for credit protection. When that diminishes, then stability is being restored.
What we must do? Take a serious look at the entire regulatory system. Financial system is now doing excessive risk taking. Too much off-balance financial statements. Too many people getting highly compensated for taking risk without suffering from their mistakes - sitting happy in Palm Beach - including those who decide these compensation packages. Banking system does not have this problem due to proper regulation. But investment banking system has no such regulation and is doing so with better contributions to Congressmen.
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