By Simon Johnson
Three years ago, a financial crisis threatened to bring down the United States economy – and to spread economic disaster around the world. How far have we come in preventing any kind of recurrence? And will the much-discussed Volcker Rule – attempting to limit the risks that big banks can take – play a positive role as we move forward?
Bad loans were the primary cause of the 2007-8 financial debacle. When the full extent of the problems with those loans became apparent, there was a sharp fall in the values of all securities that had been constructed based on the underlying mortgages – and a collapse in the value of related bets that had been made using derivatives.
The damage to the economy became huge because these losses were not dispersed throughout the economy or around the world. Rather, many of the so-called “toxic assets” were held by the country’s largest banks. Financial institutions that used to lend to consumers and businesses had instead become drawn into various forms of gambling on the booming mortgage market (as well as on commodities, equities and all kinds of derivatives). “Wall Street gets the upside, and society gets the downside” was the operating principle. Continue reading
Should We Trust Paid Experts On The Volcker Rule?
By Simon Johnson
On Wednesday morning, two subcommittees of the House Financial Services Committee held a joint hearing on the Volcker Rule. The Rule, named for former Fed chair Paul Volcker, is aimed at restricting certain kinds of “proprietary trading” activities by big banks – with the goal of making it harder for these institutions to blow themselves up and inflict another deep recession on the rest of us.
The Volcker Rule was passed as part of the Dodd-Frank financial reform legislation (it is Section 619) and regulators are currently in the process of requesting comments on their proposed draft rules to implement. Part of the issue currently is claims made by some members of the financial services industry that the Volcker Rule will restrict liquidity in markets, pushing up interest rates on corporate debt in particular and therefore slowing economic growth.
This argument rests in part on a report produced by Oliver Wyman, a financial consulting company. Oliver Wyman has a strong technical reputation and is most definitely capable of producing high quality work. But their work on this issue is not convincing. (The points below are adapted from my written testimony and verbal exchanges at the hearing; the testimony is available here.) Continue reading →
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Tagged Oliver Wyman, Volcker Rule