Paul Volcker (center) with Alan Greenspan and Ben Bernanke in 2014. Photo courtesy the Federal Reserve.
Paul Volcker was the right man for his moment in history. For that, my generation – the baby boomers – will always owe him a great debt.
But Volcker, who died on Sunday at age 92, returned to public prominence at the height of the 2008 financial crisis, long after his moment had passed. We boomers may hold warm feelings for the physical and intellectual giant of a man who led the Federal Reserve in a successful fight against the inflation demon of our youth, but our children – the millennials – don’t have the same instinctive regard. Most would never have heard of Volcker at all had he not inspired the “Volcker rule” that tangled financial institutions in the red tape that contributed to the so-called new normal of tepid economic, employment and wage growth that marked most of the Obama administration’s tenure.
Volcker, an economist, alternated between public service and the private sector at Chase Manhattan Bank in the 1950s and 1960s. He then joined the Nixon administration as a Treasury undersecretary. This put Volcker in the midst of the action in 1971. That pivotal summer, Richard Nixon reordered the global financial system by abandoning the dollar’s link to gold, and imposing wage and price controls to fight inflation that was in the mid-single digits at the time.
After a brief, recession-induced respite during Gerald Ford’s tenure in office, inflation roared back once Jimmy Carter entered the White House. By that time, Volcker was president of the Federal Reserve Bank of New York. In 1979, as I was in my first full year in the workforce, inflation soared into double digits, fueled in part by surging oil prices. There were renewed calls for price controls as Carter geared up for his ultimately unsuccessful reelection campaign. But the president, whose bias was toward freeing the economy from stifling regulation (which he did most notably in the airline and trucking sectors), instead called for “voluntary restraint.” Carter turned to Volcker to chair the Federal Reserve that summer.
Carter got exactly what he wanted – and paid a steep price for it. Rather than support a return to price controls, Volcker pushed the Fed to greatly tighten the supply of paper money, which was fueling inflation. In response, interest rates soared. When I opened my first money market mutual fund account the following year, I earned interest of about 12%. Consumer borrowers, including home buyers, faced even higher rates; by October 1981 the average mortgage rate reached an all-time high of over 18%. The economy plunged into a “double dip” recession, first in 1980 (which helped Ronald Reagan defeat Carter), and again early in Reagan’s first term.
But the Fed had broken inflation’s back. By 1982 I was writing stories for The Associated Press about how rapidly price increases were slowing; in some instances, prices were even falling. Interest rates gradually came down as well. When cooling inflation combined with the tax cuts Reagan pushed through Congress in his first term, the economy began a growth streak that has since been interrupted only by a brief recession in 1991, the tech crash at the start of the millennium, and the financial crisis of 2008. Apart from these three instances, my generation has enjoyed an economy that has mostly produced prosperity, especially for those of us who were able to go to college.
Despite his avoidance of price controls when I was a young adult, Volcker proved over time to be an interventionist at heart, like many of his generation (even Nixon). He came of age during the administration of Franklin D. Roosevelt and would have remembered growing up during the Great Depression. The hagiography of that era often paints Roosevelt’s policies as having overcome the economic downturn, which is wrong. Roosevelt’s vast expansion of government’s role in economic life certainly reduced the misery of that era for millions of Americans, for which it deserves credit. But it did not restore sustained economic growth. The outbreak of World War II did that. Some feared at the time that the end of the war would bring a return to depression. In reality, the country’s remaining industrial might amid the rest of the world’s devastation eliminated any risk of that outcome.
I think this chronology helps explain how Volcker reemerged amid the 2008 financial crisis and its aftermath as a vocal advocate for restrictions on bank trading activities. Those restrictions came to be known as the Volcker rule, codified as part of the Dodd-Frank legislation that Congress passed in 2010.
Volcker was an old-school banker. He thought banks should stick to the business of taking deposits and making safe loans. He detested modern banks’ inclination to use their cheap, government-insured deposits to fund risky speculative investments intended primarily to benefit bank shareholders.
Bank risk-taking did, indeed, contribute to the financial crisis a decade ago, but not the particular risks to which Volcker objected. The banks got caught up in a frenzy of making risky mortgage loans to underqualified buyers so they could buy overpriced homes. With some notable exceptions, most institutions escaped the worst consequences because they quickly sold the majority of those risky loans to nonbank investors. Profits from the banks’ other activities actually helped the institutions maintain and rebuild their capital, and reduced the costs of dealing with the crisis for the government. Ultimately, the government made money from its bailout of financial institutions, including some that regulators forced to take funds they did not need to avoid stigmatizing others that did.
It took regulators about three years to write regulations implementing the Volcker rules. In the interim, banks were on their own to try to figure out exactly which activities the rules permitted or prohibited, and to what extent. Along with other regulatory burdens that Dodd-Frank imposed, Volcker rule uncertainty led to a sharp pullback in banks’ lending activities, especially unsecured loans to small businesses. It also dried up liquidity in some sectors of the credit markets, raising borrowing and transaction costs.
In his later years, Volcker continued to insist on the importance of his regulatory legacy and downplayed its burdens. These burdens have been eased, though not eliminated, by the deregulatory priorities of the Trump administration. Not coincidentally, although certainly not entirely for this reason, both economic and wage growth have accelerated as unemployment has declined to half-century lows.
Although he was hardly a partisan warrior, and his record commands much respect, Volcker ended his life in an intellectual space where Democrats are generally more comfortable than Republicans. He came to advocate a national value-added tax, or VAT, which is a hallmark of stagnating European economies. He was never a loud voice in favor of entitlement reform or broader deregulation in other parts of our economy.
Volcker, like all of us, was a product of his life and times. He reached his professional peak at just the right time for America. Whatever one thinks of his later contributions, we would not have achieved all we have over the past four decades without him.