Volcker emphasized that the “tone at the top” matters, and the FSOC agreed. Its report includes in its summary recommendations that regulators “Require banking entities to implement a robust compliance regime, including public attestation by the CEO of the regime’s effectiveness.”31 But the report went even further, suggesting that regulators consider imposing joint obligations on the board of directors and the CEO. “For example, the Board of Directors could be made responsible for … approving the compliance program … and for ensuring that these policies are adhered to in practice … The CEO could be made responsible for … communicating and reinforcing the compliance culture established by the Board of Directors.”32
Public reaction to the report, especially commentary on the CEO’s new responsibilities, pleased Volcker. Winthrop Brown, a partner at the law firm Milbank, Tweed, Hadley & McCloy, which represents banks, said, “I would be troubled if I were a chief compliance officer. It seems to be very burdensome.”33 William Sweet, a former lawyer at the Federal Reserve and now a partner at Skadden, Arps, Slate, Meagher & Flom, said the sign-off requirement “puts the CEO in a very difficult position.”34 Paul Miller, an analyst at FBR Capital Markets in Arlington, Virginia, added, “The only real negative [in the report] is that CEOs must publicly attest to the rule in some way. CEOs will not like this—but nothing else is really a surprise.”35
Volcker had promised a surprise and had delivered more than most CEOs wanted to see. He knew that a worried CEO could devote more resources to ensuring compliance than all the regulators money could buy. The financial columnist Floyd Norris quipped, “Certification concentrates attention.”36
Volcker concludes, “I have strongly advocated that the CEO and board of directors of commercial banks personally attest to their firm’s compliance with the legal restriction … To my mind bankers who contend that they cannot distinguish in practice between a continuing pattern of proprietary trading and trading in response to established customer needs cannot be considered either serious or qualified bank managers, no matter how many lawyers and layers of financial manipulation are employed to subvert the plain prohibition.”37
He is right. CEOs of major financial institutions know the difference between speculation and market-making. They also have the internal controls to manage trader behavior. Regulators do not have the resources to restrain speculation at commercial banks by themselves. The Volcker Rule will work if regulators force bank management to make it work. Otherwise it will fail.
19. Trust
Gold, the ancient monarch of world finance, lost its crown in 1971, when President Richard Nixon ended foreign central banks’ right to convert dollars into the precious metal.1 Nixon followed Volcker’s blueprint in administering the coup that began in Congress six years earlier.2 Since then the world has been on a dollar standard, a fiat currency backed only by the full faith and credit of the United States. Dollars serve Americans as “legal tender for all debts, public and private,” but without a fixed link to any commodity.3
Milton Friedman, an apostle of monetary rectitude, supported the overthrow of gold. He testified in Congress that the “gold reserve requirement is an anachronistic survival from an earlier age.”4 Friedman echoed the famous denunciation of gold as a “barbarous relic” by the British economist John Maynard Keynes, and reflected the sentiment of most American economists alive when he testified. But he worried.
Friedman wrote that the worldwide experiment in fiat currency “has no historical precedent,” and cited the warning of Irving Fisher, the great U.S. monetary expert of the early twentieth century.5 “Irredeemable paper money has almost invariably proved a curse to the country employing it.”6 Friedman was less pessimistic than Fisher, who worried about hyperinflation, but not by much. “It is not possible to say whether Fisher’s 1911 generalization … will hold true in coming decades.” It will depend, Friedman said, on whether we “find a substitute for convertibility into [gold] that will serve the same function: maintaining pressure on the government to refrain from … inflation as a source of revenue.”
The 1970s nearly confirmed Irving Fisher’s worst fears. Debate over the cause of the Great Inflation in the United States continues, but cannot dismiss as coincidence the removal of gold as the monetary anchor.7 Congress might have prevented irresponsible monetary policy by refusing to adjust the gold reserve requirement, had it still been the law, the same way it occasionally refuses to raise the debt ceiling to extract fiscal concessions.
Volcker rescued the experiment in fiat currency from failure. His belief that price stability belongs in the social contract and that inflation undermines trust in government encouraged policies to restore monetary discipline during the 1980s. He showed that a determined central banker can behave like a surrogate for gold. But even Volcker needed help. His refusal to monetize federal deficits forced Congress to implement a plan for fiscal responsibility, reinforcing the Federal Reserve’s credibility.8 The combination brought decades of price stability to America and preserved trust in the U.S. dollar both at home and abroad.
The crisis that began in 2007 threatens that trust.
Foreigners hold dollars because America has demonstrated fiscal and monetary integrity, and because the United States is a nation of laws and markets, providing a safe haven for storing wealth. Broad, deep, and resilient financial markets that are free from manipulation and excessive regulation have allowed investors to commit and withdraw funds with ease and without challenge. Foreign appetite for U.S. securities has bestowed a gift of low interest rates on spendthrift Americans. But the need for massive government intervention during September 2008 tarnished the reputation of American finance. And the policies implemented since then harbor seeds of further damage.
The Federal Reserve, under the chairmanship of Ben Bernanke, served as lender of last resort during the fragile days and weeks following the bankruptcy of Lehman Brothers on September 15, 2008. Congress established the Federal Reserve System in 1914 for precisely that purpose, to lend when no one else would to prevent the spread of financial panic. And Bernanke deserves credit for avoiding a catastrophe like the Great Depression. But by mid-2011, though the overnight interest rate had been kept near zero for almost three years, and the banks had been provided with unprecedented liquidity, the economy had failed to recover fully and unemployment remained unacceptably high.
On Tuesday, August 9, 2011, the central bank announced that the FOMC had decided “to keep the target range for the [overnight] federal funds rate at zero to one-quarter percent [and] anticipates that economic conditions … are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.”9 The Fed’s commitment to maintaining low interest rates for two years disturbed Volcker. “How can they know now what is appropriate for that length of time? They may be painting themselves into a corner.”10
The 1970s taught central bankers two big lessons: Monetary policy can lower unemployment only temporarily, while inflationary expectations remain dormant, and inflationary expectations percolate to the surface even before the economy reaches full employment. Volcker brought that message forward with an op-ed article in September 2011: “The danger is that if, in desperation, we turn to deliberately seeking inflation to solve real problems—our economic imbalances, sluggish productivity, and excessive leverage—we would soon find that a little inflation doesn’t work … What we know, or should know, from the past is that once inflation becomes anticipated and ingrained—as it eventually would—then the stimulating effects are lost. Once an independent central bank … invokes inflation as a policy, it becomes very difficult to eliminate.”11
Expansionary fiscal policy, the Keynesian recipe for combating economic stagnation, shifts concern to the exploding federal deficit. But only the structural budget deficit that would prevail at full employment poses a problem, rather than the temporary increase in the deficit during recession. The increased borrowing required by cyclically declining income tax revenues, f
or example, reverses itself as the economy recovers, making room for corporate borrowing when it matters. In 2011, however, the full employment budget deficit was 5 percent of national output, a number reminiscent of the Reagan-era deficits, and that signals trouble.12 The United States has thus far escaped the high interest rates that come with such unsustainable deficit spending because the economy remains in recession and because investors in U.S. Treasury securities trust the American political system to curtail fiscal excess as in the past. But that trust demands action before it dissipates.
Long-term budgetary extravagance combined with a banking system brimming with liquidity threatens investors with inflation. Increases in real interest rates as the economy expands, Volcker’s medicine during the 1980s, can preserve investor confidence by restraining private spending and by persuading Congress to legislate a balanced budget. But Volcker acted after years of inflation had galvanized public opinion behind him, while in the second decade of the twenty-first century, Americans have been weakened by recession and unemployment. The Federal Reserve may not have the public support it needs to act preemptively.
Inflation is ancient history to most Americans, like some medieval curse, but the risk of resurgence in a world of fiat currency demands vigilance. Volcker worries that the international financial system is especially vulnerable now, “when foreign countries own trillions of our dollars, when we are dependent on borrowing still more abroad, and when the whole world counts on the dollar’s maintaining its purchasing power.”13
A commitment to a full-employment balanced budget would confirm the fiscal integrity needed to neutralize the danger at the source. Nobel Laureate Thomas Sargent, Volcker’s favorite rational expectations expert, said that central banks need help. “They cannot do it alone.”14 Federal Reserve chairman Ben Bernanke delivered a similar message: “A large and increasing level of government debt relative to national income risks serious economic consequences … High levels of debt … impair the ability of policymakers to respond effectively to future economic shocks and other adverse events.”15
Bernanke did not say that long-term budget balance sustains trust in the Federal Reserve’s commitment to price stability. He did not have to. History delivers that message—courtesy of Paul Volcker.
Personal Records and Correspondence
Kindergarten report card, page 1.
Kindergarten report card, page 2: having difficulty with numbers 5 and 9.
Grade six report card: fancy Volcker Sr. signature.
A Princeton semester: excellent … but for basketball.
Postcard home from Harvard: a traffic ticket.
Handwritten Harvard transcript: two A− grades.
Handwritten notes from first FOMC meeting as chairman, page 1.
Handwritten notes from first FOMC meeting as chairman, page 2.
A Volcker FOMC doodle.
Another Volcker FOMC doodle.
February 26, 1981, letter from Congressman Ron Paul: on integrity.
June 5, 1987, letter from Congressman Bill Gradison: “as a citizen.”
June 10, 1987, letter from Prime Minister Margaret Thatcher: on missing Volcker.
November 28, 2008, letter from Italian president Carlo Ciampi: on trust.
Photographs and Cartoons
The Magnificent Seven: members of the Federal Reserve Board as of October 6, 1979—the date that the Fed met, under Volcker’s leadership, and committed to bold steps to battle inflation. Seated, from left: Henry Wallich, Paul Volcker, Frederick Schultz, Philip Coldwell. Standing, from left: Emmett Rice, Nancy Teeters, Charles Partee. (Photograph by Black Star Photo)
A young Brooklyn Dodgers fan from Teaneck, New Jersey. (Undated photograph from Volcker’s personal collection)
Preparing for congressional testimony? Volcker demonstrates bullfighting technique during a visit to Madrid in September 1973 while under secretary of the Treasury. (Photograph from Volcker’s personal collection)
Volcker indulges in his two favorite activities while on vacation: He used a public telephone while on a fishing trip to accept the presidency of the Federal Reserve Bank of New York starting in 1975. (Photograph from Volcker’s personal collection)
Judge A. Leon Higginbotham swears in Paul Volcker as chairman of the Federal Reserve Board, August 6, 1979. Barbara Volcker holds the Bible; Jimmy Carter prays. (White House photograph)
Volcker thanks Pope John Paul II. Volcker had joked during a Fed telephone conference call on October 5, 1979, that he would request a papal blessing for the committee’s fateful meeting the following day. (Photograph from L’Osservatore Romano)
Smoke signals: Volcker testifies before Congress, February 19, 1980. (George Tames/The New York Times/Redux)
“Very nice, but we’re going to stop printing this stuff.” Volcker (right) inspects new greenbacks at the U.S. Treasury’s Bureau of Engraving and Printing. As Fed chairman, he would labor mightily to convince Americans that the government was serious about restraining the money supply. (Photograph from Volcker’s personal collection)
“When does the FOMC meeting start?” (Undated photograph from Volcker’s personal collection)
Volcker and Ronald Reagan. Volcker came to the White House residence on Washington’s Birthday, 1982, for a conversation with the president. “I think we’ve broken ground for a new & better relationship,” Reagan wrote afterward in his diary. (White House photograph)
An honorary degree, but no umbrella: Volcker receives an LL.D. from Yale, 1984. (Photograph by T. Charles Erickson, Yale University Office of Public Information, from Volcker’s personal collection)
Harvard outperforms Yale, inviting Volcker to give its commencement speech in 1985 and providing the company of an appreciative Harvard president, Derek Bok. (Photograph from Volcker’s personal collection)
The man who vanquished gold offers guidance to the Iron Lady. Prime Minister Margaret Thatcher visits the Federal Reserve in February 1985. (Paul Hosefros/The New York Times/Redux)
Where does he keep the money? Fiat chairman Gianni Agnelli at a reception with Volcker during his tenure as Fed chairman. (Undated photograph from Volcker’s personal collection)
Laughter in the Oval Office: Ronald Reagan’s team was relieved when the independent-minded Volcker stepped down as Fed chairman, to be replaced by Alan Greenspan. Left to right: Greenspan, Volcker, Vice President George H. W. Bush, Reagan, and Treasury Secretary James Baker. (White House photograph)
Volcker checks the president’s notes: At a White House press conference, June 2, 1987, Reagan announces that Greenspan will replace Volcker. (White House photograph)
Casting a long shadow: Volcker at the Federal Reserve building in Washington. (Photograph by Dennis Brack, via Black Star Photo)
Discussing a full court press: With the U.S. economy in free fall, presidential candidate Barack Obama consults with Volcker at a meeting in Coral Gables, Florida, in September 2008. (AP Photo/Chris Carlson)
Happy days are here again? Volcker returned to government service as chairman of President Obama’s Economic Recovery Board. Here he listens to an Obama address in New York City, flanked by White House Chief of Staff Rahm Emanuel and real estate executive Penny Pritzker. (Photograph by Daniel Acker/European Pressphoto Agency)
“How about we call it the Obama Rule?” Volcker was not particularly pleased at having his name attached to the rule that restricted trading at banks. He thought it sounded boastful and might narrow his legacy to two words of limited scope. (Photograph by Joshua Roberts/Bloomberg via Getty Images)
Volcker loses—but finishes in the money: a racehorse named for the financial icon, ridden by John Velasquez, is beaten at Saratoga by a half length by Forum, under Javier Castellano, August 28, 2010. (Photograph from Thoroughbred Report.com)
Cartoon by Bil Canfield. (Used with permission of PARS International)
October 22, 1985, cartoon by Draper Hill. (Reprinted by permission of the Detroit News)
(Used with the permission of
Steve Kelley and Creators Syndicate. All rights reserved)
Cartoon by Joe Azar, originally published in Legal Times. (Reprinted by permission of Joe Azar)
Source Material and Data
The narrative in this biography relies first and foremost on contemporary documents. These include: (1) publicly available documents, such as transcripts of the Federal Open Market Committee and the minutes of meetings released by the U.S. Treasury; and (2) private documents made available from the personal files of Paul Volcker, such as personal correspondence and memos from the U.S. Treasury and the Federal Reserve. Interviews with Paul Volcker and his contemporaries, those who worked both with him and for him, supplement the written record. Here are some details.
Volcker Page 34
