Volcker warns how serious things have become

In a very downbeat assessment of the ability of financial and monetary stewards to deal with the most protracted financial crisis is some 75 years, Paul Volcker, the esteemed former Fed Chariman warned that the economic slump has spread in a way that greatly challenges the Obama administration’s ability to restore order.

The Telegraph’s Ambrose Evans-Pritchard has a very good column reporting on this in today’s newspaper.

Paul Volcker, the former chairman of the U.S. Federal Reserve, has warned that the economic slump has begun to metastasise after a shocking collapse in output over the past two months, threatening to overwhelm the incoming Obama administration as it struggles to restore confidence.

“What this crisis reveals is a broken financial system like no other in my lifetime,” he told a conference at Lombard Street Research in London.

“Normal monetary policy is not able to get money flowing. The trouble is that, even with all this [government] protection, the market is not moving again. The only other time we have seen the U.S. economy drop as suddenly as this was when the Carter administration imposed credit controls, which was artificial.”

His comments come as the blizzard of dire data in the U.S. continues to crush spirits. The Empire State index of manufacturing dropped to minus 24.6 in October, the lowest ever recorded. Paul Ashworth, U.S. economist at Capital Economics, said business spending was now going into “meltdown”, compounding the collapse in consumer spending that is already under way.

Edward here. These are very strong words. And, given Mr. Volcker’s position as the man who is said to have broken the back of inflation in the previously worst economic crisis, this statement should reinforce the severity of the challenge facing the President-elect. But, notice how Volcker puts the blame squarely on credit, debt and leverage in the quotes below. He also suggests that the American crisis response thus far has not been systematic or well-planned when he says Obama “can’t just throw money at the auto industry.”

Mr Volcker, an adviser to President-Elect Barack Obama and a short-list candidate for Treasury Secretary, warned that it is already too late to avoid a severe downturn even if the credit markets stabilise over coming months. “I don’t think anybody thinks we’re going to get through this recession in a hurry,” he said.

He advised Mr Obama to tread a fine line, embarking on bold action with a “compelling economic logic” rather than scattering fiscal stimulus or resorting to a wholesale bail-out of Detroit. “He can’t just throw money at the auto industry.”

Mr Volcker is a towering figure in the US, praised for taming the great inflation of the late 1970s with unpopular monetary rigour. He is no friend of Alan Greenspan, who replaced him at the Fed and presided over credit excess that pushed private debt to 300pc of GDP.

“There has been leveraging in the economy beyond imagination, and nobody was saying we need to do something,” he said. “There are cycles in human nature and it is up to regulators to moderate these excesses. Alan was not a big regulator.”

Even so, he said the arch-culprit was the bonus system that allowed bankers to draw forward “tremendous rewards” before the disastrous consequences of their actions became clear, as well as the new means of credit alchemy that let them slice and dice mortgage debt into packages that disguised risk.

Mr. Volcker’s last statements should be seen as a shot across the bow of financial firms in America. The Obama Administration is going to look askance at excessive compensation and will certainly look to regulation if necessary to amend Wall Street’s profligate ways. In essence, Volcker has said the Wall Street bonus system bears a large measure of the blame for the present crisis.

The halcyon days of Wall Street are now well and truly over.

Volcker issues dire warning on slump – Ambrose Evans-Pritchard, Telegraph

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