While keynote speaker Paul Volcker gave Global Financial
Leadership Conference attendees a glimpse of presidential thinking
on how to revamp the economy (see my earlier post), the bulk of his
speech and the question period after revolved around the more
pressing matter of how to reform Wall Street without creating
further moral hazards, a topic that dominated the day.
The influential Volcker agued that commercial banks need to be
refocused on valuing customer relationships rather than hedge
fund-like operations and trading their own book. "At one point
the financial [sector's] profits was 40 percent of all the
profits of the country - and that was measured after all the
bonuses. It's very hard to imagine that the financial sector was
contributing something worth 40 percent of all the profits of the
country. That's a sign something was amiss," he said, adding
later, "Let's encourage the basic functions of commerical
banking and discourage those that create conditions conducive to
financial breakdown."
To Volcker that doesn't mean a return to Glass-Steagall - but
something close to it wouldn't be bad. Operations that lead to an
increase in commercial activity and lending would be okay - so
corporate bond underwriting, banned under Glass Steagall to
commercial banks - would be acceptable by a commercial bank.
Private equity funds, hedge funds and money market funds that
aren't regulated as tightly as traditional corporate savings
accounts would not be okay at all for commercial banks. For
freestanding hedge funds and private equity funds, more stringent
reporting requirements would be neccessary to find out who posed a
systemic risk.
Just how to manage systemic risk was a contentious issue.
Volcker argued the Federal Reserve or something like it would be
perfectly justified in having 'resolution ability' to be able to
split up, shut down or otherwise curtail a financial institutions
activity in case of systemic emergency. In fact, Volcker contends
the Fed already has the implicit power to do so.
As a counterpoint, Nobel Prize winner Robert Merton of Harvard
University contended in his address (on perceptions of risk) that a
government agency couldn't be an effective resolution authority
because it may be part of the problem and so can't be trusted
to police itself. A better solution: an independent cadre of
well-paid forensic accountants, contended Merton. This group could
swoop in and autopsy failed institutions and make public
recommendations on how to avoid the problem in the future. The
group would be freed to be blunt and honest because it would have
no actual regulatory power. Think of it like a National
Transportation Safety Board for finance.
Goldman Sachs Chief Risk officer Craig Broderick, Dartmouth
professor Matthew Slaughter and former Senator John Sununu largely
agreed the government resolution power could have the unintended
side effect of lending an arbitrariness to financial contracts.
Think of it like with the automaker bailouts, said Sununu, which
saw the autoworkers union gain a greater equity stake for its old
equity stake than most bondholders got for their superior stakes.
Above all, the market needs to be able to quantify potential risks
from financial transactions in order to allocate capital most
efficiently and cheaply to borrowers, explained Broderick.
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If the casual observer dismisses Wall Street as one big private
party, it seems financial industry insiders see it like that as
well, at least to judge by the metaphorical punchbowl, which was
mentioned by nearly every speaker at the Naples, Fla. conference.
It started with opening speaker Michael Moskow, the former head of
the Chicago Federal Reserve bank, who predicted the Fed would need
to act to raise interest rates before the market and the government
will want in order to quash inflationary pressures. "They will have
to take away the punchbowl right when the party is starting," he
explained
One questioner later in the afternoon asked keynote
speaker Paul Volcker "the punchbowl question" about if the Fed
should act to pop bubbles they see forming (Volcker said he
believed the Fed should), while a panel on the future after the
financial crisis, chaired by CNBC's Maria Bartiromo, entered into a
lengthy discussion of punchbowls as it related to TARP, commercial
real estate and excessive leverage on Wall Street. Basically, each
of those areas still have a punchbowl left out for the enjoyment of
partygoers.Not to be outdone was John Sununu, currently on a
congressional panel overseeing TARP spending, who said "there are
actually two punchbowls" - one at the Fed for its mortgage
support program which Sununu is skeptical of, and the other in
Congress, where tax breaks and programs for mortgages are the life
of the party, at least according to the former New Hampshire
senator.
For the record, the evening outdoor cocktail hour had no
punchbowls whatsoever. That didn't keep Paul Volcker and most of
the executive attendees from mingling freely, however.
