Paul Volcker Concerned with Bernanke’s Fed

The Financial Times’ (3/19/08) “Administration urged to share credit burden” reports on an interview former Federal Reserve chairman gave to Charlie Rose. Volcker, who slayed the inflation dragon of the 1970’s, said today’s climate is reminiscent of the start of inflation during that decade. Inflation can quickly get out of control when not dealt with promptly. Cutting interest rates further certainly accelerates inflation.

Volcker states that today’s problems are not about interest rates, it’s about rebuilding confidence. The markets had been run by mathematicians who did not understand financial behavior. “Once in a hundred year” crises have been occurring every few years.

Volcker goes on to imply that Bernanke is stretching the Fed’s authority and playing the role that should belong to the government. (He uses the term government to refer to the Treasury.) Volcker does not approve of the Fed directly lending to the investment banks and accepting potentially bad assets as collateral. If the Fed lends to investment banks, the investment banks must be strongly regulated. The SEC never had the role of regulating the solvency of investment banks.

Volcker much prefers to have government channel funds through Fannie Mae (FNM) and Freddie Mac (FRE). He does not say whether he approves of Treasury Secretary Paulson strong arming Fannie and Freddie into raising more capital to soak up more mortgage paper. But, Volcker does say that the Treasury secretary’s strong dollar rhetoric is meaningless. The collapse of the dollar is causing friction in world trade.

Fannie and Freddie were privatized to remove their impact on the federal budget. Volcker would like them to actively use their line of credit with the Treasury. He regrets the government losing ownership, and giving up this lever on the economy.

Clearly Volcker does not approve of Bernanke’s scope expansion, and implies that Bernanke is lost. Volcker thinks the Fed should focus strictly on inflation and let the “government” solve financial crises.

From The Wall Street Journal “Volcker: Fed’s ‘Extreme’ Intervention ‘Raises Some Real Questions’, a video of the Volcker interview. Very compelling viewing.

Disclosures: Author is long FNM and FRE.

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