Former Fed Chairman Volcker: Bring Back a Version of Glass-Steagall

Former Federal Reserve Chairman Paul Volcker wants the nation's banks to be prohibited from owning and trading risky securities. He is proposing that commercial banking be separated from investment operations. To achieve that goal, Congress would have to enact a modern-day version of the 1933 Glass-Steagall Act, which mandated separation.

Volcker was chairman of the Fed from 1979 to 1987, and he currently serves as head of President Obama's Economic Recovery Advisory Board, which makes him the administration's most prominent outside economic adviser. The problem for Volcker is he doesn't seem to have great influence within the administration. At age 82, he is dealing with Treasury officials who are young enough to be his grandchildren. More importantly, they are veterans of investment banks. The administration has said it will not separate commercial banking from investment operations.

Volcker's proposal would roll back the nation's commercial banks to an earlier era, when they were restricted to commercial banking and prohibited from engaging in risky Wall Street activities. The Obama team, in contrast, would let the giants survive, but would regulate them extensively, so they could not get themselves and the nation into trouble again.

"The banks are there to serve the public," Volcker said in an interview with the New York Times. "And that is what they should concentrate on. These other activities create conflicts of interest. They create risks, and if you try to control the risks with supervision, that just creates friction and difficulties" and ultimately fails. Volcker wants to break up the financial giants, which have been getting even bigger since the federal government bailed them out.

The remarks by Volcker were echoed in a recent speech by Bank of England Governor Mervyn King. "The massive support extended to the banking sector around the world, while necessary to avert economic disaster, has created possibly the biggest moral hazard in history," King said in a speech in Scotland. "The 'too important to fail' problem is too important to ignore. Never in the field of financial endeavor has so much money been owed by so few to so many. And, one might add, so far with little real reform."

"People say I'm old-fashioned and banks can no longer be separated from nonbank activity," Volcker said in the interview, acknowledging criticism that he is nostalgic for an earlier era. "That argument," he added ruefully, "brought us to where we are today."

Volcker Fails to Sell a Bank Strategy (New York Times 10/20/09)