We Have the Tools to Manage the Crisis
Now we need the leadership to use them.
By PAUL VOLCKER
Today, the financial crisis has reached a critical point. The sharp
decline in the stock market and its volatility dramatically make the
point. More important if less visible, the flow of credit through the
banking system and the financial markets is seriously impaired -- even
in part frozen.
For months, the real economy, apart from housing, had not been much
affected by the developing crisis. Now, a full-scale recession appears
unavoidable. Important state and local governments face deficits they
may be unable to finance. Recessionary forces are apparent in other
important countries and exchange rates are unstable.
Those are facts.
They are the culmination of economic imbalances, a succession of
financial bubbles and financial crises that have been building for
years. It's no wonder that confidence in markets, banks, and financial
management has been badly eroded. Without effective action, fear might
take hold, threatening orderly recovery.
Fortunately, there is also good reason to believe that the means are
now available to turn the tide. Financial authorities, in the United
States and elsewhere, are now in a position to take needed and
convincing action to stabilize markets and to restore trust.
First of all, there is now clear recognition that the problem is
international, and international coordination and cooperation is both
necessary and underway. The days of finger pointing and schadenfreude
are over. The concerted reduction in central bank interest rates is
one concrete manifestation of that fact.
More important in existing circumstances is the clear determination of
our Treasury, of European finance ministries, and of central banks to
support and defend the stability of major international banks. That
approach extends to providing fresh capital to supplement private
funds if necessary.
In the U.S., with higher limits of deposit insurance in place, the
FDIC has demonstrated its ability to protect depositors, to arrange
mergers, and to provide capital for troubled banks. Most other
countries now have a comparable capacity.
Recent U.S. legislation has provided authority for large-scale direct
intervention by the Treasury in the mortgage and other troubled
markets. Along with increased purchases by Fannie Mae and Freddie Mac,
now under government control, means of restoring needed liquidity are
Other key sectors of financial markets are now protected or supported
by either the Treasury or Federal Reserve, specifically by temporary
insurance of money-market funds and by direct purchase of commercial
Active efforts are underway to develop stronger netting, clearing and
settlement arrangements for certain derivatives, in particular the
notional trillions of credit default swaps, the absence of which has
contributed to uncertainty and large demands for scarce collateral.
None of that is easy. Some of it poses risks for the taxpayer. All of
it is decidedly unattractive in the sense of large official
intervention in what should be private markets able to stand on their
own feet. Unattractive or not in normal circumstances, the point is
the needed tools to restore and maintain functioning markets are
there. Now is the time to use them. To that end, the immediate and
critical need is determined, forceful and persistent leadership --
extending across administrations and Congresses. Both the public and
private sectors must be involved.
The inevitable recession can be moderated. The groundwork can be laid
for reconstructing the financial system and the regulatory and
supervisory arrangements from the bottom up. The extraordinary
interventions by the government (and taxpayer) should be ended as soon
as reasonably feasible.
That rebuilding will be the job of another day -- of a new
administration here in the U.S., of finance ministries and central
banks working together. It must draw upon the strength of the now
chastened private sector. It will require more understanding of the
risks embedded in so-called financial engineering and of the perverse
compensation incentives that have exalted risk over prudence.
There is, and must be, recognition of the essential role that free and
competitive financial markets play in a vigorous, innovative economic
system. There needs to be understanding, in that context, that
financial ups and downs -- and financial crises -- will be inevitable,
even with responsible economic policies and sensible regulation. But
never again should so much economic damage be risked by a financial
structure so fragile, so overextended, so opaque as that of recent
Mr. Volcker was chairman of the Federal Reserve from 1979-1987.