Paul Volcker, chairman of the president’s Economic Recovery Advisory Board, contributes an important op-ed to today's NY Times. And the message to big banks is clear: Your "too-big-to-fail" ass has been saved for the last time:
The phrase "too big to fail" has entered into our everyday vocabulary. It carries the implication that really large, complex and highly interconnected financial institutions can count on public support at critical times. The sense of public outrage over seemingly unfair treatment is palpable. Beyond the emotion, the result is to provide those institutions with a competitive advantage in their financing, in their size and in their ability to take and absorb risks.
As things stand, the consequence will be to enhance incentives to risk-taking and leverage, with the implication of an even more fragile financial system. We need to find more effective fail-safe arrangements.
How to Reform Our Financial System
Volcker makes it clear that President Obama's proposed financial reform (warning: PDF) will be aimed at clearing out the "residue of moral hazard" that remains now that the economy has been pulled back from the brink of a second depression caused by irresponsible behavior on the part of the big banks.
Volcker outlines some of the proposed reforms, which would include more regulation and external oversight (you'd be better served by reading the op-ed than by my translations here), but the important conclusion, the one that has the financial industry quaking in its boots is the following:
To put it simply, in no sense would these capital market institutions be deemed "too big to fail." What they would be free to do is to innovate, to trade, to speculate, to manage private pools of capital — and as ordinary businesses in a capitalist economy, to fail.
Does this also signal a paradigm shift in the approach to corporate welfare in general? That the "free market" can no longer expect the wildly flexible, durable safety net of "socialism" that has encouraged their excesses and the profits-above-all favoritism that has characterized government's relationship with big business? Are we entering a new era of corporate responsibility and accountability through government regulation and oversight?
Volcker, long involved in government, knows that the backlash against these long-needed structural reforms will be strong. But the time has come.
I am well aware that there are interested parties that long to return to "business as usual," even while retaining the comfort of remaining within the confines of the official safety net. They will argue that they themselves and intelligent regulators and supervisors, armed with recent experience, can maintain the needed surveillance, foresee the dangers and manage the risks.
But perhaps echoing the President's exhortation to Democrats not to run for the hills, Volcker says that we must have the strength to make these changes.
I have observed how memories dim. Individuals change. Institutional and political pressures to "lay off" tough regulation will remain — most notably in the fair weather that inevitably precedes the storm.
The implication is clear. We need to face up to needed structural changes, and place them into law. To do less will simply mean ultimate failure — failure to accept responsibility for learning from the lessons of the past and anticipating the needs of the future.
Now that we have perhaps made it through the worst of the storm is precisely the time to make the necessary big changes so that we don't sail ourselves straight into the next one.
Mr. Volcker, President Obama, now this kind of structural change is change we can believe in.