Volcker Pulls Back The Curtain

Funny how this speech didn’t get any ink over here in the United States… I wonder why?

The former US Federal Reserve chairman told an audience that included some of the world’s most senior financiers that their industry’s “single most important” contribution in the last 25 years has been automatic telling machines, which he said had at least proved “useful”.

Echoing FSA chairman Lord Turner’s comments that banks are “socially useless”, Mr Volcker told delegates who had been discussing how to rebuild the financial system to “wake up”. He said credit default swaps and collateralised debt obligations had taken the economy “right to the brink of disaster” and added that the economy had grown at “greater rates of speed” during the 1960s without such products.

Right on both points.

But what Mr. Volcker didn’t say (but should have) is why government has sat back and watched all this so-called “innovation” that, in fact, has done nothing but screw us.

Let’s go back to the “big picture” chart on GDP and debt:

Note that the debt-to-GDP ratio for the entire financial system was around the 150-175% level for a long time. 

It was only in the 1980s that this ratio became “unhinged” and started its parabolic blowoff toward the present level of approximately 375% – more than a doubling.


For that one must look at the aggregate GDP generated since 1980.  That’s roughly $228 trillion (give or take a bit.)

So let’s “back” out the accumulation of half of this debt – that is, take the $53 trillion and reduce it to a reasonable 175% of GDP, which would cut some $25ish trillion from the debt in the system.

What would have happened?

We would have to subtract 10%, roughly, from GDP during the entire period.

That is, the accumulation of this debt has caused an over-reporting of GDP by 10% over it’s true value on an annual basis, since every dollar of debt buys something, and that “something” winds up being counted in GDP.

So we have a perverse cycle here fed by government and private business – both with a simple motive to cheat for as long as possible.

What holds this behavior back?

Only the certainty that when the math catches up with the cheating (and all the participants in this scam know it will) those who cheated will be the ones who get the bill.

Unfortunately our so-called “financial innovation” has impaired this natural feedback function in two distinct but intertwined ways:

  1. By bailing out “too big to fails”, starting with LTCM and continuing onward, we have made clear that there is an implicit taxpayer backstop.  That is, you won’t wind up in the street if you’re a (big) bank and push the math too far.
  2. By refusing to enforce the laws forbidding fraud in all it’s forms, including fraud by deception, we have put in place an economic and political system where large firms can cheat while smaller ones (and others unprotected, from consumers to municipalities) suffer.

A dramatic example of the latter was offered up by McClatchy yesterday in the following article:

During the past three years, some of the nation’s largest financial firms have been accused by the government of cheating or misleading clients and ripping off tens of thousands of consumers of their investments.

Despite these findings, these financial giants got, sometimes repeatedly, special exemptions from the Securities and Exchange Commission that have saved them from a regulatory death penalty that could have decimated their lucrative mutual fund businesses.

If you remember a month ago I talked about how Pfizer had pled guilty to two instances of the same felony charge.  The man who was their general counsel in the first case and the firm’s CEO in the second was subsequently “elected” to the Board of the Federal Reserve Bank of New York.

The voters were not, however, the general citizenry.  Rather they were the members of the NY Fed, which just happens to include those firms that the NY Fed regulates.

I’m quite sure you could have elected Charles Manson to the position of County Sheriff – so long as those doing the voting were all imprisoned felons!

Look at who is running The SEC today – and the revolving door that exists in that agency.  From the private sector (regulated by the SEC) to the SEC and then back to the so-called “regulated” firms.

This sort of incestuous nonsense is part and parcel of why we are here.  It is, indeed, one of the biggest issues we face in any attempt to enact meaningful reform.  The big banks and other financial interests have intentionally designed things this way to guarantee weak or non-existent “enforcement” of the laws that purport to protect the public against various forms of deception and even outright theft and then they come bleating to Congress and the people claiming that Armageddon will ensue if they’re not bailed out and allowed to shift the consequences of their idiocy to the taxpayer.

Paul Volcker is right to expose the charade, but he doesn’t go anywhere near far enough.  What we need is people who are willing to talk about the why – not just the “what” – and who are willing to raise whatever amount of hell it takes to get the public enraged enough to demand change.

Unless, of course, you like having your pocket serially picked and are willing to suffer the inevitable consequence of economic collapse that the math says must eventually be the outcome of the policies we have promulgated and practiced over the last two decades.