Volcker: Fed’s ‘Extreme’ Intervention ‘Raises Some Real Questions’

Former Federal Reserve Chairman Paul Volcker said the Fed’s decision to lend money to Bear Stearns Cos. to keep it from collapsing is unprecedented and “raises some real questions” about whether that’s the appropriate role for the Fed. The wisdom of the decision depends on “how severe this crisis was and their judgment about the threat of demise of Bear Stearns,” Mr. Volcker said on the Charlie Rose Show on Tuesday evening. “That’s a judgment they had to make and an understandable judgment.” It is “absolutely” not “what you want for the longstanding regulatory support system.”

Excerpts:

Volcker: We’ve seen the Federal Reserve take more extreme measures in some respects than any that have been taken in the past to deal with a financial crisis, which raises some real questions about not only for the Federal Reserve and its authorities, but for the structure of the financial system… The Federal Reserve is designed to lend to banks. And the banks were considered to be at the center of the financial system, and lend liquidity, provide cash in return for good assets, when a bank got in trouble. Now they found in this case, where some of the investment houses were in trouble, and prototypically Bear Stearns … it’s lightly regulated by the SEC or some other, but not for the same reasons. They haven’t got the concern over the stability of those things….We’re going to lend to them and protect them, shouldn’t they be regulated?

Rose: Is it a wise precedent?

Volcker: Whether it’s wise or not depended upon how severe this crisis was and their judgment about the threat of demise of Bear Stearns. That’s a judgment they had to make and an understandable judgment. There is no question about it.

Rose: Could we have risked the failure of Bear Stearns?

Volcker: Well who knows? It would take a lot of courage.

The Federal Reserve … has not, in the past, been conceived as a place where you put in bad assets, possibly bad assets. Lending institutions take risks. I’m not suggesting the assets are terrible, but they have collateral. But that is a new departure. And at some point, the government ought to — in my view, the government ought to be taking responsibility for that kind of action, not the Federal Reserve, which is an independent agency designed to provide an ample supply of liquidity to the economy but not too much, protect against inflation, not to protect particular sectors of the economy from bad loans.

Rose: So the Federal Reserve should not be doing that, in your judgment. It’s not because it shouldn’t be done, it’s the role of the federal government.

Volcker: Absolutely. In this situation, they stepped in and nobody else was there to do it…They stepped into a vacuum, and I think quite appropriately, it’s a judgment they had to make. But is this what you want for the longstanding regulatory support system? My answer is no.

Rose: Somebody said to me that we entered a period in which they were worshiping mathematical models … And mathematical models had no business sense.

Volcker: The market was being run by mathematicians that didn’t know financial markets. And you keep hearing, you know, god, that event should only happen once every hundred years, according to my model. But those every hundred years events are coming along every two or three years, which should raise some questions.

Rose: Tell me about how you see the relationship of the U.S. economy to the global economy. And is it changing?

Volcker: Here we have this factor entering into this domestic crisis that inevitably is international … because foreign institutions have invested in these American securities, but the world, as a whole, has been dependent upon the dollar. And you know it hurts my feelings, if nothing else, that the Swiss franc is worth more than the dollar.

Rose: Does it hurt your feelings that the Euro’s worth more than the dollar?

Volcker: Well, no, the Euro was sort of born more than the dollar.

Rose: Has [the economy] bottomed out, or have we seen the worst?

Volcker: Look. The basic economy is not irretrievably damaged in any way, shape, or form. We had to go through an adjustment, which is tough. It’s happening much quicker. You’d rather have it happen gradually. But I’m optimistic that, okay, we’ve got to get the consumption down, we got to get spending in line with our capacity to produce. I think that’s going on. And that process is going to take a while. If we can stabilize the financial market, we ought to come out of this. Then we’ve got a lot of work to do about what we do with the regulatory system, the supervisory system, what the role of the Federal Reserve is, what the role of the Treasury and the government is, because this is a different financial market.