“Simply stated, the bright new financial system – for all its talented participants, for all its rich rewards – has failed the test of the market place.” Paul Volcker, April 8 2008.
There you have it. In one sentence, the man who really was the greatest central banker of our times, and probably of all time, summed up the whole gigantic mess. For the benefit of younger readers, Paul Volcker was Chairman of the Federal Reserve from 1979-1987, during which time he directed the long, hard and ultimately successful campaign to bring inflation back under control. Facing entrenched inflation at double-digit levels and massive erosion in the value of the dollar globally as well as at home, Volcker raised interest rates to unheard-of levels – the prime rate peaked at over 20% in 1981 – and held them there long enough to crush inflationary expectations. In so doing, he displayed courage and tenacity and laid the ground for the ‘Goldilocks’ era of low inflation, rising productivity and solid growth that characterised the 1990s.
Twenty years after leaving office, Volcker retains his unique moral and professional status, so that his opinion is eagerly sought, highly regarded and carries great weight. In his speech some weeks ago, of which the above quote is the summation, he did far more than criticise this or that feature of the markets, or a specific policy decision. To say that the emperor has no clothes is important, if everyone is pretending that he is fully dressed. But to say that everyone has no clothes, when an entire society is pretending to be garbed in the finest and most fashionable clothes available, demands bravery above and beyond the line of duty. Almost anyone else presenting such unpalatable ideas to an audience of bankers and financial types in New York City would be dismissed as a crank or a trouble-maker; Volcker cannot be dispatched to oblivion so contemptuously, leaving his immediate and wider audience – indeed, the entire financial world – to try and find a flaw in his argument.
That is rather hard, because he is right and they are wrong, he is telling the truth and they are lying, he is clothed and they are naked. When he says that “today’s financial crisis is the culmination, as I count them, of at least five serious breakdowns of systemic significance in the past 25 years – on the average one every five years”, he is merely thrusting in their faces the bald, unadjusted and unanswerable statistic. His conclusion is similarly rooted in common sense. Those five crises are “warning enough that something rather basic is amiss” – therefore basic things have to change, unless the people who, by sins of omission and commission, caused and/or benefited from these crises are so blind as to believe that the rest of America, and the world at large, will allow them to continue along the same path.
The real beauty of Volcker’s summation, which serves at one and the same time to bear witness and pass judgement on the excesses of the last two decades, is that he uses the yardstick of the markets themselves, rather than that of outsiders. The ‘bright new financial system’ is not – or at least not only – corrupt, self-seeking, socially divisive and lacking any ethical compass, it ‘has failed the test of the market-place’. We all know what happens to people, companies, systems and theories that fail the test of the market-place: they are fired, eliminated, tossed into the garbage or, better, the shredder. There is no room on Wall Street for failure, certainly not for serial failure.
As the financial crisis moves takes its inexorable course, through shock, denial, anger and so on, thoughts and ideas that were previously unthinkable and unspeakable rise to the surface and finally emerge into the public sphere. Once that happens, the way is open for behaviour to begin to change, marking the most open and final break with the past. There is therefore a clear link between Volcker’s speech last month, which – in the wake of the climax reached in the crisis in mid-March with the Bear Stearns bail-out — highlights a new readiness to hear and absorb the most painful truths, and between the announcement from Merrill Lynch on Wednesday of this week. Merrill, another leading Wall Street firm that came to the brink of self-destruction by indulging in unrestrained risk-taking, has instructed its analysts that henceforth at least 20% of their recommendations should be ‘sell’ – a total break from the historic pattern in which equities were always worth buying, no matter what.
If Merrill Lynch, the firm whose symbol is the raging bull, has grasped that the old paradigm is dead, then indeed a new day has dawned in Wall Street.