A generation ago, Paul A. Volcker was a household name, the Federal Reserve chief who waged a hard-nosed but successful battle against virulent inflation that clouded the nation’s economic future. He did it by engineering a horrific recession, clamping on the financial brakes and sending the economy into a tailspin in 1981.
Nobody knew whether his strategy would work. It certainly caused widespread pain. But by 1986, double-digit inflation was gone and price increases had dropped to about 2% annually, setting the stage for the next two decades of economic stability.
Now Volcker is back, tapped by Barack Obama as a special economic advisor. And if the president-elect follows his advice on the current economic crisis, there could be pain again and no doubt many protests -- but also the possibility of long-term benefits.
In speeches, interviews, public policy reports and congressional testimony, Volcker, 81, has laid out a fairly clear outline of what he thinks is wrong with the present-day financial system and the government’s management of the economy.
His concerns go to the very core of how America lives and how Wall Street operates. A child of the Great Depression and a man of legendary personal thrift, Volcker thinks Americans have been living above their means for too long.
“It is the United States as a whole that became addicted to spending and consuming beyond its capacity to produce,” Volcker lectured the Economic Club of New York in April. “It all seemed so comfortable.”
Bringing consumption back in line with income would not only crimp individuals and families, but also require major readjustments in the global economy, which has relied on the U.S. as consumer of last resort.
Volcker has become a skeptic of modern Wall Street, worried that the nation’s entire financial system has evolved to a point that the government no longer has effective control over all of its important components. And the financial industry has become beholden to complex financial engineering that clouds the picture.
“The market was being run by mathematicians who didn’t know financial markets,” he said this year after the crisis struck.
Clearly, he wants tough new regulations on securities markets, including oversight of hedge funds, in order to avoid the need for a bailout effort by the Fed ever again. It seems likely that he will advise Obama that the growth of U.S. consumption -- everything from government spending to household outlays -- should not be financed by selling ever larger amounts of debt to foreign interests.
But he warns people not to expect an easy ride. “It’s going to be a tough period,” Volcker said in a speech at the Urban Land Institute in late October. “But when we dealt with inflation, it laid the groundwork for 20 years of growth. I’d like to see that happen this time.”
In pressing his case, economists and policy experts say, Volcker will have a level of experience, credibility and integrity that should carry great weight in the new administration.
“It is less about his ideas but more about his stature, wisdom and integrity,” said Princeton University economist Alan Blinder. “There is not another person on the planet who can match that combination.”
“Paul has a very quiet but forceful way of expressing his views,” said Princeton University economist Peter B. Kenen, who began working with Volcker during the Kennedy administration. “He can say, ‘I look back on 50 years of public service and I can count the times that Idea A worked and Idea B didn’t work.’ ”
Volcker will not occupy a position in the Obama administration that gives him any direct authority, a big change from the days when he ran the Fed with an iron grip. While the Treasury, Federal Reserve, Securities and Exchange Commission and other agencies all have turf to protect, Volcker has no turf.
He also will have to work with some outsized egos and giant intellects on Obama’s economic team: Lawrence H. Summers, chairman-designate of the National Economic Council; Timothy F. Geithner, nominated to be Treasury secretary; and Christina Romer, chosen to lead the Council of Economic Advisors.
The group is generally not of one mind. Major differences exist in how they view regulation, monetary control and fiscal policy. Summers, for example, was among the Clinton administration officials who helped relax federal regulation on Wall Street, recalled David R. Henderson, a conservative economist at the Hoover Institution. Romer has questioned how well fiscal policy works at all, a central tenant of Democratic economic thinking.
Further complicating the picture, Volcker has an entirely new and untested organization to head.
The day before Thanksgiving, Obama named him chairman of the Economic Recovery Advisory Board, an entity seemingly created to bring Volcker, his experience, knowledge and credibility into the administration. The board is supposed to provide “fresh thinking and bold new ideas from the leading minds across America,” Obama said.
Volcker is the chairman and Austan Goolsbee, a noted University of Chicago economist and longtime Obama advisor on economics, will be staff director.
But those who know Volcker think his influence will be clearly felt, regardless of his portfolio.
His career has spanned half a century. He began working at the New York Fed in the 1950s, and five years later went to Chase Manhattan Bank, where he became a lifelong confidant of the Rockefeller family. By the early 1960s, President Kennedy brought Volcker into the Treasury Department in his first government job at the policy-making level.
He later held top appointments under Presidents Johnson, Nixon, Carter and Reagan.
In recent years, he has led investigations into how Swiss bankers handled the accounts of Holocaust victims, the United Nations’ troubled food-for-oil program and the accounting scandal surrounding the collapse of Enron Corp. He also chairs the Group of Thirty, a who’s who of world economists that examines complex public policy issues. It met over the weekend to discuss an upcoming report on the overhaul of financial regulations.
Volcker grew up during the Depression, raised by a father who taught him one lesson above everything else: Integrity is a person’s greatest asset, said Volcker’s sister, Virginia Streitfeld. She calls Volcker, who stands 6-foot-7, her “little brother.”
He is known for practicing what he preaches about the nation living within its means. He travels with one business suit and lives in the same Manhattan apartment that he bought decades ago.
When he was Fed chief, he lived in a modest Maryland apartment and did his laundry on Saturdays at his daughter’s house nearby, recalled Marina v.N.Whitman, a University of Michigan economist who has known Volcker for decades.
“Paul is one of the most frugal guys on Earth,” Whitman said. “The advice he gives and the way he views the world are entirely consistent with his personal ethics and lifestyle.”
He is outraged by executive compensation packages, seeing them as part of a larger breakdown on Wall Street.
“Paul can’t imagine anybody wanting or needing that much compensation for consumption purposes,” said Whitman, a member of the Group of Thirty. “It probably offends his sense of right and proper.”
As for the bigger picture, Volcker feels that tremendous changes in the financial system have eclipsed government regulators, allowing excesses to go unchecked and subjecting the economy to ever greater shocks. Over time, the U.S. has moved from a system of highly regulated banks that funded the economy to a system of highly engineered financial markets that operated outside the scope of regulators.
Complex financial instruments were created that attempted to slice and dice the risks, handing them to investors who would be most willing to accept them.
But the mathematical models that were supposed to measure those risks actually hid the true risk from the marketplace, Volcker has said: For one thing, no mathematical model can accurately predict human hysteria in a financial panic. “Simply stated, the bright new financial system . . . failed the test of the marketplace,” Volcker said this year.
“Paul has long been skeptical about financial engineering, which is another way of saying concocting schemes on Wall Street that nobody can understand,” economist Blinder said. “He has some old-fashioned ideas that banks should apply some common sense to loaning money -- like making sure borrowers can repay.”
The result of such problems was that the Federal Reserve, the linchpin of U.S. economic power, was forced to “take actions to the very edge of its lawful and implied powers” that violated “time-honored central bank practices,” Volcker told the Economic Club of New York.
“The only reason I sleep at night,” said a longtime friend and business partner of Volcker’s, speaking on background, “is that Paul Volcker will have the president’s ear.”