For most the past 12 months, Paul Volcker was sitting on the policy sidelines.
He had impressive sounding job titles — member of President Obama's Transition Economic Advisory Board immediately after last November's election, and then head of the new Economic Recovery Board. But the Recovery Board, and Mr. Volcker himself, has seldom met with the President.
Economic and financial sector policy, by all accounts, has been made largely by Tim Geithner at Treasury and Larry Summers at the White House, with help from Peter Orszag at the Office of Management and Budget, and Christina Romer at the Council of Economic Advisers.
With characteristic wry humor, Mr. Volcker denied in late October that he had lost clout within the administration: "I did not have influence to start with."
But that same front-page interview in The New York Times included a well-placed shock to the prevailing policy consensus.
Mr. Volcker, a legendary former chairman of the Federal Reserve Board with much more experience with Wall Street than any current policy maker, was blunt: We need to break up our biggest banks and return to the basic split of activities that existed under the Glass-Steagall Act of 1933 — one highly regulated (and somewhat boring) set of banks to run the payments system, and a completely separate set of financial entities to help firms raise capital (and to trade securities).
This proposal is not just at odds with the regulatory reform legislation then (and now) working its way through Congress; Mr. Volcker is basically saying that what the administration has proposed and what Congress looks likely to enact in early 2010 is essentially bunk.
Speaking to a group of senior finance executives, as reported in The Wall Street Journal on Monday, Mr. Volcker made his point even more forcefully. There is no benefit to running our financial system in its current fashion, with high risks (for society) and high returns (for top bankers). Most of financial innovation, in his view, is not just worthless to society – it is downright dangerous to our broader economic health.
Mr. Volcker seems to make substantive public statements only when he feels important issues are at stake. He also knows exactly how to influence policy — he has not been welcomed in the front door (controlled by the people who have daily meetings with the president), so he's going round the back, aiming at shifting mainstream views about what are "safe" banks. Many smart technocrats listen carefully to what he has to say.
This strategy is partly about timing — and in this regard Mr. Volcker has chosen his moment well.
The economy is starting to recover, but this process is clearly going to take a while and unemployment will stay high for the foreseeable future. At the same time, our biggest banks are making good money — mostly from trading, not much from lending to small business — and they are lining up to pay very big bonuses.
Not only is this contrast — high unemployment versus bankers' bonuses — annoying and unfair, it is also not good economics. Bankers are, in effect, being rewarded for taking the risks that created the global crisis and led to huge job losses. And they are being implicitly encouraged to do the same thing again.
The case for keeping big banks in their current configuration is completely lame. Even if we are lucky enough to avoid another major any time soon, the fiscal costs are enormous and coming right at you (and your taxes).
Now that Paul Volcker has picked up his hammer, he will not lightly set it aside. He knows how to sway the policy community and he knows how to escalate when they don't pay attention. Expect him to pound away until he prevails.
Simon Johnson, the former chief economist at the International Monetary Fund, is the co-author with James Kwak of "13 Bankers," forthcoming in April 2010.
