8 CME GROUP MAGAZINE

Former Federal Reserve System Chairman Paul Volcker calls
for action on the U.S. credit crisis, the economy and inflation.
“The mother of all financial crises” is how for- Volcker achieved a relatively speedy decline in banks have just 30 percent of the credit market.
mer Federal Reserve System Chairman Paul inflation by tightening the money supply and Compared with 25 years ago, a much higher
Volcker described the current situation in the raising interest rates, despite concerns about percentage of real estate credit and other loans
United States. a recession and high unemployment. The con- are securitized and sold to non-bank financial
“What we’ve been seeing is a really sumer price index increased just 3.8 percent in institutions promptly after origination.
wrenching reversal of exuberance that only 1982 and 4.4 percent in 1987, the year Volcker Before the financial crisis began in mid-
a few years ago sent stock markets and then stepped down as Federal Reserve chairman. 2007, this arbitrage appeared to spread credit
residential values through the roof to precari- He is now serving as an economic advisor to risk, encourage pricing consistency and im-
ous levels,” said Volcker, the first-day keynote U.S. presidential candidate Barack Obama. prove market efficiency. The increasingly ob-
speaker at CME Group’s Global Financial Lead- vious bad news is that a lender did not need
ership Conference. “It’s not uncharacteristic HOW DID WE GET HERE? to be as concerned about creditworthiness if
of financial markets to move from exuberance Volcker believes that today’s situation was a loan was not staying on its books. Further-
to fear, from greed to fear – and it’s the fear triggered by the very complexity that fueled more, secondary market purchasers may not
that’s driving values today.” strong economic growth over the past 25 have been able to assess credit or maturity
Volcker knows a crisis when he sees years – a level of prosperity comparable to the risk accurately, despite internal due diligence
one. He identified inflation as the nation’s boom years of the 1950s and 1960s. or credit agency ratings.
number-one problem during the 1979 Senate Twenty-five years ago, banks were the “Instead of spreading the risk, in some ways
Banking Committee hearing that confirmed dominant operators in the credit markets, with today’s market seems to have concentrated risk,”
him as Federal Reserve chairman. That year about a 60 percent market share in the United Volcker said. “Its very complexity has made the
the Consumer Price Index rose 13.3 percent. States and much more in other countries. Today, system more opaque, not more transparent.
FALL 2008 9

ECONOMIC OUTLOOK
When the crisis broke, enormous uncertainty un- Great Depression in the 1930s. In this vein,
raveled mutual trust among market participants the U.S. Treasury-administered Troubled Asset
“Instead of spreading
and contributed to the market breakdown. We Relief Program (TARP) went into effect in early the risk, in some ways
have a failed financial structure.” October. TARP has authority to buy residential
When the excesses of the subprime mort- and commercial mortgage loans, credit card today’s market seems
gage were exposed, doubts about financial securitizations, auto loans and other financial
values spread and painful adjustments were assets for which there is no current market.
to have concentrated
forced on the U.S. economy, said Volcker in Volcker is not the only one calling for ac- risk. Its very complexity
an April 2008 speech to the Economic Club tion, as today’s pendulum swings from less
of New York. At that time he stated, “Finan- regulation to more regulation. In recent years, has made the system
cial crises have been a recurrent feature of the rationale was that heavy-handed regula-
free and open capital markets, not least in tions would damage the competitive position more opaque, not more
the United States. Those past 40 years of of financial institutions operating in interna-
relative tranquility were the exception, not the tional markets. Today, the loudest calls are
transparent. When the
norm. Any return to heavily regulated, bank- for more regulation to address the systemic crisis broke, enormous
dominated, nationally insulated markets is failures that led to today’s crisis.
pure nostalgia, not possible in this world of “In the long run, we have to rebuild a stron- uncertainty unraveled
sophisticated financial techniques made pos- ger system, a system that’s innovative, competi-
sible by the wonders of electronic technology.” tive, but also more secure – a system better able mutual trust among
to stand on its own feet without the expectation
WHERE DO WE GO FROM HERE? of official support,” concluded Volcker.
market participants
Daily and even hourly headlines attest to the and contributed to the
rapidly unfolding nature of the U.S. credit crisis. DON’T FORGET ABOUT INFLATION
Some of this was not a complete surprise. For Not reassuringly, Volcker sees numerous market breakdown.
example, editorial writers have expressed anxi- similarities between today’s situation and the
ety for years if not decades about Fannie Mae early 1970s. In both cases, he cites the fear of We have a failed
and Freddie Mac. These agencies were created a recession, skyrocketing oil prices, fast-rising
by the U.S. government in part to finance afford- commodity prices and a weak dollar. Any move
financial structure.”
able housing, and are able to borrow at rates by the Federal Reserve to cut short-term inter-
lower than their competitors. It is not altogether est rates and increase credit at its reserve
a surprise that we are now being asked to make banks to address the credit crisis could ex-
good on this implied U.S. government backing. acerbate inflationary pressures and further
It is the blue-chip names in the headlines weaken the U.S. dollar.
that are truly astonishing. A year or even six “I think we have the opportunity to get the
months ago, who would have predicted the inflation rate back at a very low level that we like
demise of Bear Stearns or Lehman Brothers? to see,” Volcker added. “The other side of that
Or the fact that Goldman Sachs and Morgan coin is that the typical wage earner is losing real
Stanley would voluntarily transform them- income right now, with the inflation rate up…
selves into Federal Reserve-regulated bank I expect a higher level of unemployment and
holding companies? very slow growth at best. The pressure will be
“Our failed financial structure has been held to keep costs down and keep wages down.”
together in recent months only by really, truly However, the credit crisis itself will affect
extraordinary official actions, actions without prices, as demand drops for everything from
any precedent and going right to the edge of houses to luxury goods. In this financial crisis,
their legal responsibilities,” said Volcker. While both individuals and businesses are finding it
he characterizes those actions by the Federal more difficult to borrow and are likely to worry
Reserve and Treasury Department as “neces- about too much debt. Lower U.S. demand
sary,” Volcker has called for clarification of the already has led to a dramatic decline in the
Fed’s role as both regulator and lender of last price of oil, which reached a high of more than
resort. Among his concerns is that the Fed may $147.00 a barrel in mid-July before touching a
be perceived to favor particular institutions or seven-month low of $91.54 a barrel in mid-Sep-
politically sensitive constituencies when exer- tember 2008. Volcker noted that our economy
cising its sweeping emergency powers. can make up for somewhat slower domestic
To restore market confidence and a sense consumption by ramping up exports – which
of reasonable valuations, Volcker also sug- comprise a much larger share of the U.S. econ-
gests that the government establish a tempo- omy than the housing industry as a whole.
rary entity with broader powers than currently “The real economy – the economy apart
given to the Fed and Treasury. Precedents from the financial and housing markets – so far
include the Resolution Trust Corp. in the early has not been severely impacted,” said Volcker. Former Federal Reserve System Chairman Paul Volcker
1990s after the savings and loan crisis, and “It is a tribute to the relatively good shape of delivered his keynote speech on the first day of CME Group’s
Global Financial Leadership Conference, September 2008
the Reconstruction Finance Corp. during the most companies that actually produce things.”
10 CME GROUP MAGAZINE