Paul Volcker: First He Challenged Obama, Then He Changed Wall Street

How the former Fed Chair and Gary Gensler created the "Volcker Rule."
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Reuters

As 2009 rolled on and the panic receded, Paul Volcker felt there was something very wrong with the Obama administration's plans for reforming Wall Street. But no one was listening to him. The gruff-voiced, cigar-chomping former Fed chairman may have been nominally a member of the Obama team—chairman of the president's new Economic Recovery Advisory Board—as well as a living legend of finance, the conquerer of runaway inflation in the '70s.

But the then-82-year-old Volcker found that his rep wasn't getting him anywhere with the president's inner circle, especially Obama's bank-friendly Treasury secretary, Tim Geithner, and chief economic advisor Larry Summers, both of whom had little time for him. In an interview in late 2009, Volcker said he felt somewhat used early on by Obama (whom he had publicly backed for president)--merely trotted out for the cameras during the presidential campaign, but then sidelined when the real decisions were being made. "When the economy began going sour, then they decided I could be some kind of symbol of responsibility and prudence of their economic policy," he said with a sour smile.

What bothered Volcker was very simple: After hundreds of billions of dollars in taxpayer bailouts, he was appalled that the biggest banks—which Obama allowed to remain intact despite having caused the worst financial crisis since the Great Depression—had been permitted to resume their pre-crisis habits of behaving like hedge funds, trading recklessly with taxpayer-guaranteed money. Volcker wanted a rule that would bar commercial banks from indulging in "proprietary" trading (in other words, gambling for the firm's own gain), thus cordoning off federally guaranteed bank deposits and Federal Reserve lending from the heaviest risk-taking on the Street. It was the closest thing he could get to a return of Glass-Steagall, the 1933 law that forced big banks like J.P. Morgan to spin off their riskier investment banking sides into new firms (in that case, Morgan Stanley) after the Crash that led to the Depression.

Commercial banks that lie at the heart of the economy and are able to draw cheap money from the Fed discount window "shouldn't be doing risky capital market stuff," Volcker told me. "I don't want them to be Goldman Sachs, running a zillion proprietary operations." But the president "obviously decided not to accept" his recommendations, Volcker said then.

Channeling the views of Wall Street, Geithner and Summers thought Volcker's proposals were not feasible: How was anybody supposed to know when a trade was "proprietary" as opposed to a legitimate hedging or "market-making" transaction for clients. Just couldn't work, they said. And so Volcker began traveling all over the country to deliver a series of speeches pushing for even more fundamental reform of the financial system—parting ways with both the Obama administration and most of the Congress.

By late 2009 and early 2010—especially after the stunning special Senate election result in Massachusetts gave the once-Democratic seat to a Republican, Scott Brown—Obama began to think that his administration looked vulnerable on the issue. According to a senior administration official involved in economic policy-making, the president came to believe that Geithner and Summers hadn't gone far enough with financial reform. They had, in fact, resisted almost every structural change to Wall Street, not only Volcker's plan but also Arkansas Sen. Blanche Lincoln's idea to bar banks from swaps trading.

And Wall Street didn't seem to be changing on its own: In December 2009, the president was outraged to hear that year-end bonuses would actually be larger in 2009 than they had been in 2007, the year prior to the catastrophe. "Wait, let me get this straight," Obama said at a White House meeting. "These guys are reserving record bonuses because they're profitable, and they're profitable only because we rescued them." And so at a meeting late that year in the Roosevelt Room, Obama said: "I'm not convinced Volcker's not right about this." Vice President Joe Biden, a longtime fan of Volcker's, bluntly piped up: "I'm quite convinced Volcker is right about this!"

Obama formally proposed the rule at a White House news conference on Jan. 21, 2010 with Volcker in rare attendance, announcing: "We're calling it the Volcker Rule after the tall guy behind me." Senators Jeff Merkley, D-Ore., and Carl Levin, D-Mich, later formally introduced the rule into the Dodd-Frank law. But even then Geithner dragged his feet on implementation, and for the next two and a half years Wall Street lawyers loaded the proposal down with loopholes and exemptions.

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Michael Hirsh is chief correspondent for National Journal.

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