http://www.latimes.com/news/nationworld/washingtondc/la-na-volcker8-2008dec08,0,108304.story
From the Los Angeles Times
Paul Volcker is back, and he warns of tough times ahead
Volcker has been chosen by President-elect Barack Obama as a special
economic advisor. His 'no pain, no gain' fiscal strategy worked in the
'80s, and there's no sign he's softened that philosophy.
By Ralph Vartabedian
December 8, 2008
A generation ago, Paul A. Volcker was a household name, the Federal
Reserve chief who waged a hard-nosed but successful battle against
virulent inflation that clouded the nation's economic future. He did it
by engineering a horrific recession, clamping on the financial brakes
and sending the economy into a tailspin in 1981.
Nobody knew whether his strategy would work. It certainly caused
widespread pain. But by 1986, double-digit inflation was gone and price
increases had dropped to about 2% annually, setting the stage for the
next two decades of economic stability.
Now Volcker is back, tapped by Barack Obama as a special economic
advisor. And if the president-elect follows his advice on the current
economic crisis, there could be pain again and no doubt many protests --
but also the possibility of long-term benefits.
In speeches, interviews, public policy reports and congressional
testimony, Volcker, 81, has laid out a fairly clear outline of what he
thinks is wrong with the present-day financial system and the
government's management of the economy.
His concerns go to the very core of how America lives and how Wall
Street operates. A child of the Great Depression and a man of legendary
personal thrift, Volcker thinks Americans have been living above their
means for too long.
"It is the United States as a whole that became addicted to spending and
consuming beyond its capacity to produce," Volcker lectured the Economic
Club of New York in April. "It all seemed so comfortable."
Bringing consumption back in line with income would not only crimp
individuals and families, but also require major readjustments in the
global economy, which has relied on the U.S. as consumer of last resort.
More oversight
Volcker has become a skeptic of modern Wall Street, worried that the
nation's entire financial system has evolved to a point that the
government no longer has effective control over all of its important
components. And the financial industry has become beholden to complex
financial engineering that clouds the picture.
"The market was being run by mathematicians who didn't know financial
markets," he said this year after the crisis struck.
Clearly, he wants tough new regulations on securities markets, including
oversight of hedge funds, in order to avoid the need for a bailout
effort by the Fed ever again. It seems likely that he will advise Obama
that the growth of U.S. consumption -- everything from government
spending to household outlays -- should not be financed by selling ever
larger amounts of debt to foreign interests.
But he warns people not to expect an easy ride. "It's going to be a
tough period," Volcker said in a speech at the Urban Land Institute in
late October. "But when we dealt with inflation, it laid the groundwork
for 20 years of growth. I'd like to see that happen this time."
In pressing his case, economists and policy experts say, Volcker will
have a level of experience, credibility and integrity that should carry
great weight in the new administration.
"It is less about his ideas but more about his stature, wisdom and
integrity," said Princeton University economist Alan Blinder. "There is
not another person on the planet who can match that combination."
"Paul has a very quiet but forceful way of expressing his views," said
Princeton University economist Peter B. Kenen, who began working with
Volcker during the Kennedy administration. "He can say, 'I look back on
50 years of public service and I can count the times that Idea A worked
and Idea B didn't work.' "
Volcker will not occupy a position in the Obama administration that
gives him any direct authority, a big change from the days when he ran
the Fed with an iron grip. While the Treasury, Federal Reserve,
Securities and Exchange Commission and other agencies all have turf to
protect, Volcker has no turf.
He also will have to work with some outsized egos and giant intellects
on Obama's economic team: Lawrence H. Summers, chairman-designate of the
National Economic Council; Timothy F. Geithner, nominated to be Treasury
secretary; and Christina Romer, chosen to lead the Council of Economic
Advisors.
The group is generally not of one mind. Major differences exist in how
they view regulation, monetary control and fiscal policy. Summers, for
example, was among the Clinton administration officials who helped relax
federal regulation on Wall Street, recalled David R. Henderson, a
conservative economist at the Hoover Institution. Romer has questioned
how well fiscal policy works at all, a central tenant of Democratic
economic thinking.
Further complicating the picture, Volcker has an entirely new and
untested organization to head.
The day before Thanksgiving, Obama named him chairman of the Economic
Recovery Advisory Board, an entity seemingly created to bring Volcker,
his experience, knowledge and credibility into the administration. The
board is supposed to provide "fresh thinking and bold new ideas from the
leading minds across America," Obama said.
Half-century career
Volcker is the chairman and Austan Goolsbee, a noted University of
Chicago economist and longtime Obama advisor on economics, will be staff
director.
But those who know Volcker think his influence will be clearly felt,
regardless of his portfolio.
His career has spanned half a century. He began working at the New York
Fed in the 1950s, and five years later went to Chase Manhattan Bank,
where he became a lifelong confidant of the Rockefeller family. By the
early 1960s, President Kennedy brought Volcker into the Treasury
Department in his first government job at the policy-making level.
He later held top appointments under Presidents Johnson, Nixon, Carter
and Reagan.
In recent years, he has led investigations into how Swiss bankers
handled the accounts of Holocaust victims, the United Nations' troubled
food-for-oil program and the accounting scandal surrounding the collapse
of Enron Corp. He also chairs the Group of Thirty, a who's who of world
economists that examines complex public policy issues. It met over the
weekend to discuss an upcoming report on the overhaul of financial
regulations.
Volcker grew up during the Depression, raised by a father who taught him
one lesson above everything else: Integrity is a person's greatest
asset, said Volcker's sister, Virginia Streitfeld. She calls Volcker,
who stands 6-foot-7, her "little brother."
He is known for practicing what he preaches about the nation living
within its means. He travels with one business suit and lives in the
same Manhattan apartment that he bought decades ago.
When he was Fed chief, he lived in a modest Maryland apartment and did
his laundry on Saturdays at his daughter's house nearby, recalled Marina
v.N.Whitman, a University of Michigan economist who has known Volcker
for decades.
"Paul is one of the most frugal guys on Earth," Whitman said. "The
advice he gives and the way he views the world are entirely consistent
with his personal ethics and lifestyle."
He is outraged by executive compensation packages, seeing them as part
of a larger breakdown on Wall Street.
"Paul can't imagine anybody wanting or needing that much compensation
for consumption purposes," said Whitman, a member of the Group of
Thirty. "It probably offends his sense of right and proper."
As for the bigger picture, Volcker feels that tremendous changes in the
financial system have eclipsed government regulators, allowing excesses
to go unchecked and subjecting the economy to ever greater shocks. Over
time, the U.S. has moved from a system of highly regulated banks that
funded the economy to a system of highly engineered financial markets
that operated outside the scope of regulators.
Complex financial instruments were created that attempted to slice and
dice the risks, handing them to investors who would be most willing to
accept them.
But the mathematical models that were supposed to measure those risks
actually hid the true risk from the marketplace, Volcker has said: For
one thing, no mathematical model can accurately predict human hysteria
in a financial panic. "Simply stated, the bright new financial system .
. . failed the test of the marketplace," Volcker said this year.
'Old-fashioned'
"Paul has long been skeptical about financial engineering, which is
another way of saying concocting schemes on Wall Street that nobody can
understand," economist Blinder said. "He has some old-fashioned ideas
that banks should apply some common sense to loaning money -- like
making sure borrowers can repay."
The result of such problems was that the Federal Reserve, the linchpin
of U.S. economic power, was forced to "take actions to the very edge of
its lawful and implied powers" that violated "time-honored central bank
practices," Volcker told the Economic Club of New York.
"The only reason I sleep at night," said a longtime friend and business
partner of Volcker's, speaking on background, "is that Paul Volcker will
have the president's ear."
Vartabedian is a Times staff writer.
ralph.vartabedian
@latimes.com
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