What Paul Volcker Got Right About Global Finance

Though he’s mainly renowned for defeating the raging inflation of the 1970s and early ’80s, Paul Volcker leaves another important legacy: From his earliest years as chairman of the Federal Reserve to his last days as a gray eminence of finance, Volcker, who died Sunday at age 92,  resisted the excessive deregulation of global financial markets.

And though he fought the good fight—and ultimately proved largely correct in his skepticism—Volcker had somewhat less success reining in Wall Street’s worst excesses than he had against inflation.

Volcker began warning of the dangers of too much financial deregulation during the Reagan administration, even though it was U.S. President Ronald Reagan—a champion of small government—who nominated him for another term as chairman in 1983. (Volcker was first appointed by President Jimmy Carter in 1979.) He understood that financial markets behave differently than markets in goods and services, that they are far more prone to panics and manias, and they are vulnerable to catastrophic failure in a way that ordinary markets are not, thus imperiling the entire economy.  It was a theme that played out over three decades of his career—ultimately in the on-again, off-again relationship Volcker had with President Barack Obama, who alternately ignored him and embraced him as his administration temporized over how deeply to restructure Wall Street in the aftermath of the Great Recession. 

Volcker was unusual in his resistance to the deregulation of Wall Street, especially during an era in which the laissez-faire approach of his successor at the Fed, Alan Greenspan, dominated. But during the crucial years when the libertarian Greenspan was overseeing the virtual destruction of financial regulation, Volcker didn’t always object publicly—a stance that he later told friends he deeply regretted. “He was absolutely apoplectic about what was taking place in deregulation under Greenspan. Yet he was conflicted about attacking another Fed chairman who succeeded him, and he kept mute. Later in life he told me it was the biggest mistake he ever made,” said Robert Johnson, a longtime friend and an economist who is the executive director of the Institute for New Economic Thinking, a progressive think tank. “Paul is characterized as the person who crushed wages, like he was a warrior for the elite. But he had a philosophical sense of integrity; he was a public servant who believed in systemic balance.” 

As Federal Reserve chairman, the 6-foot-7, cigar-chomping Volcker was revered for speaking truth to power. Indeed, at the height of his efforts to crush inflation by jacking up interest rates in the Carter and Reagan years, he refused to bend to the White House and even declined to pay the president a visit, thinking it would compromise his independence. Volcker proved so stubborn that then-Treasury Secretary Donald Regan didn’t want him reappointed in 1983, but Wall Street, at the time, insisted: The big firms loved the low-inflation environment Volcker had created.

Yet Volcker eventually became the scourge of Wall Street too. His misgivings about financial deregulation were evident as early as February 1987, shortly before Volcker’s tenure ended and Greenspan’s began, when the big Wall Street banks made the latest in a series of bids to chip away at the Depression-era Glass-Steagall law, which separated commercial and investment banking. At a hearing room in Washington, in one of his last acts as chairman, Volcker listened skeptically as Thomas Theobald, then the vice chairman of Citicorp, argued that “the world has changed a hell of a lot” since the Great Depression and the financial crash that led to it. Theobald declared that there were new “outside checks” on corporate misconduct thanks to “a very effective” Securities and Exchange Commission, knowledgeable investors, and “very sophisticated” rating agencies. Volcker responded with gruff sarcasm. They made it sound so “innocuous,” so “sensible,” that “we don’t have to worry a bit,” Volcker said, according to an account of the meeting in the Wall Street Journal. “But I guess I worry a little bit.” Volcker declared then that without Glass-Steagall, lenders might begin recklessly lowering loan standards and begin marketing bad loans to an unsuspecting public. 

This was 20 years before the historic crisis precipitated by fraudulent subprime mortgage-backed securities that were sold globally by giant Wall Street banks, aided and abetted by U.S. ratings agencies that deliberately falsified their assessments of those securities.

No one listened. In that episode, Volcker was outvoted three to two by his board, which included two Reagan free-market appointees, on new rules that allowed Citicorp, J.P. Morgan, and Bankers Trust to move into some underwriting. It was the beginning of the process by which Glass-Steagall became effectively moot by the time it was formally repealed in 1999. Two decades later, some of Volcker’s worst fears came true, when it became clear that even the CEOs of these now-huge (and too big to fail) Wall Street banks no longer understood what their traders were doing as they marketed incomprehensibly complex—and unsound—loan-backed securities around the world. 

After the financial crash, Volcker finally became publicly outspoken, to the point where he began questioning almost everything new that Wall Street had created in recent decades. Beyond the ATM machine, Volcker asked at a conference in Britain in 2009, what have new banking products really added to the economy? Exhibit one was derivatives, which had turned Wall Street into a trillion-dollar casino. “Wake up, gentlemen!” Volcker told his fellow regulators. “I wish that somebody would give me some shred of neutral evidence about the relationship between financial innovation recently and the growth of the economy, just one shred of information. I am getting a bit wound up here.”

Ultimately Volcker managed to get Barack Obama wound up as well—though it took him awhile.

In an interview with me in 2010, Volcker spoke of feeling somewhat betrayed by Obama at first, even though he’d been one of the president’s earliest political supporters. “I hadn’t been a Democrat for 20 years” by the time the 2008 election rolled around, Volcker recalled. But he said he was so deeply distressed by what had happened in the fiscally and geopolitically reckless George W. Bush years that he came out for Obama, who “impressed me greatly as an agent for needed change.” Way back in January 2008, a time when Hillary Clinton was still considered the odds-on favorite for the Democratic presidential nominee against the insurgent Obama, Volcker wrote an endorsement statement for the Illinois Democrat, which he thought “was reasonably eloquent.”

To his dismay, Volcker was largely ignored by the Obama team at first. Though he was installed as head of the new president’s Economic Recovery Advisory Board, Volcker found his access limited by National Economic Council Director Larry Summers, and he was snubbed by Treasury Secretary Tim Geithner, who initially resisted some of the tougher Dodd-Frank rules intended to reduce risk and provide far more oversight of Wall Street. But presidential aides said Obama grew more and more outraged by Wall Street’s brazenness in going back to business as usual in the year after the crisis. “As we have come out of the crisis and seen major financial institutions make significant profits on their proprietary trading and using the [federal] safety net to do that,” one Treasury official told me back then, “it persuaded the president it was worth looking into” Volcker’s ideas. Finally in January 2010, after scarcely mentioning him and (rarely talking to him) for a year, Obama called a news conference at which Volcker was notably placed right behind him, with Geithner and Summers well off to the side, out of camera range. Obama said he now had something to add to what his Treasury secretary and chief economic advisor had prescribed for fixing the financial system. “We’re calling it the Volcker rule after the tall guy behind me,” Obama said. 

It was the first mention of what became a keystone of Dodd-Frank reform. Nearly a year before the president’s announcement, Volcker had proposed keeping major commercial banks that enjoy federal-deposit guarantees away from big-time speculative or proprietary trading—acting like a hedge fund, in effect, with taxpayer-backed money. “I would like to draw a line there and say that’s the heavily regulated part of the market,” he told me. “They shouldn’t be doing risky capital market stuff. They should not be large proprietary traders. They should not operate their own hedge funds or equity funds.”

Today, however, the big Wall Street banks are engaged in a long-term campaign to undermine and hollow out the Volcker rule—an effort that Volcker himself was fighting almost until the day he died. In October, five U.S. regulatory agencies approved a revised rule, set to go into effect Jan. 1, that weakens strictures against banks conducting speculative trading with government-insured deposits. Though Wall Street commercial banks are still nominally barred from engaging in proprietary trading or investing in or sponsoring hedge funds or private equity funds, they have managed to shrink the amounts and types of assets affected by the rule, in a reform supported by President Donald Trump’s administration. The only dissent on the Fed board came from Lael Brainard, a former member of the Obama economic team, who warned the revision “weakens the core protections against speculative trading within the banking federal safety net.”

Another dissenter was Volcker, who in one of his final acts of rebellion against Wall Street wrote of his worries in a letter to Fed Chairman Jerome Powell in August. 

“The new rule amplifies risk in the financial system, increases moral hazard and erodes protections against conflicts of interest that were so glaringly on display during the last crisis,” Volcker said.

Michael Greenberger, a former senior regulator at the Commodity Futures Trading Commission who was a key advisor on the Dodd-Frank legislation, said that while the Volcker Rule is being “de facto repealed through thousands of pages of debilitating regulatory ‘implementation,’” Volcker’s legacy lives on.  

“He cast a long and enduring shadow that will continue to instruct market reformers and their elected allies on a path forward to protect the U.S. and world economy from reckless speculation,” Greenberger said. “The question is: Will the American electorate follow that lead?”