By Yalman Onaran
June 25 (Bloomberg) -- The salad was made with the first green shoots from the White House garden. The main course was roast beef. The topic of conversation in the second-story Family Dining Room on a warm evening in April: President Barack Obama’s economic policies.
Obama sat at the head of the table, administration insiders arrayed along one side to his right. To his left, facing a French marble fireplace, were some of his harshest critics: Nobel laureates Joseph Stiglitz and Paul Krugman, Harvard University professor Kenneth Rogoff and former Federal Reserve Vice Chairman Alan Blinder.
One chair on the insiders’ side was empty, according to attendees. It was reserved for Paul Volcker, the 81-year-old former chairman of the Fed, who was an adviser to Obama during the campaign and now heads the President’s Economic Recovery Advisory Board, or PERAB. He was stuck at the White House gate, trying to convince guards that he was expected for dinner. His plane from New York had been delayed by a storm, and his security clearance to enter the building that day had expired.
That Volcker’s seat was on the same side of the table as Treasury Secretary Timothy Geithner’s and National Economic Council (NEC) Director Lawrence Summers’s was a clear sign he’s one of the president’s most valued advisers. That he was stuck outside suggested his role is ambiguous. While he doesn’t have a full-time job, isn’t paid for his advice and lives in New York, the 6-foot-7-inch (2.01-meter) Volcker is hard to ignore.
‘Semi-Insider’
Volcker, who eventually made his way to the dinner table the evening of April 27, earned a reputation for standing up to Wall Street in the 1980s when, as Fed chairman, he brought inflation down to 1 percent from 15 percent by pushing the fed funds rate up to 20 percent. Now, he’s urging radical regulatory reforms that would limit how big banks can get, separate deposit taking from trading at financial institutions and force all derivatives trading onto public exchanges. His proposals go beyond what Geithner, Summers and other members of the Obama administration have advocated.
“Volcker has a semi-insider, semi-outsider role in the administration,” says Blinder, now an economics professor at Princeton University in Princeton, New Jersey. “If he has the president’s ear, the regulatory regime will come out tougher and more comprehensive. That’s a good thing at this point, because I worry more about not doing enough to patch up the regulatory system than doing too much.”
Obama’s Ear
The former Fed chairman, who declined to comment for this article, certainly had Obama’s ear when he backed the candidate in January 2008 -- after more than two decades sitting on the political sidelines. He did so, he said at the time, because of concerns about where the U.S. was headed.
“I’ve been reluctant to engage in political campaigns,” Volcker said in his endorsement statement. “However, it’s not the current turmoil in markets or the economic uncertainties that have impelled my decision. Rather, it’s the breadth and depth of challenges that face our nation at home and abroad. Those challenges demand a new leadership and a fresh approach.”
During the campaign and after the election, Volcker was among the two dozen people Obama turned to for advice about the financial crisis, says Penny Pritzker, the billionaire chairman and founder of Chicago-based Pritzker Realty Group LLC, who was in charge of fundraising for Obama and now sits on Volcker’s board.
“He brought this incredible wealth of knowledge and extraordinary experience to the table,” she says.
Elbowed Aside
Volcker helped Obama with a speech he delivered at Cooper Union in New York in March 2008, says Austan Goolsbee, a senior economic adviser to the president and the man who first reached out to Volcker on Obama’s behalf in the summer of 2007. The former Fed chairman sat behind the candidate as he assailed the deregulation of the 1990s, putting some of the blame for the financial crisis on the failure to formulate new rules while dismantling old ones. The future president called for a regulatory framework to meet the needs of the 21st century.
After the inauguration and Geithner’s confirmation, Volcker was elbowed aside, White House insiders say. His economic recovery board took weeks to get off the ground -- a delay people close to Volcker say he blames on Summers. And Volcker’s access to the president was limited.
Goolsbee denies Summers was obstructing Volcker. Summers’s spokesman Matthew Vogel says the NEC director “wanted to ensure that the president had access to the best possible advice from Volcker and others.”
Regulatory Reforms
Things began to change in April. The advisory board’s six subcommittees now hold twice-weekly conference calls. The full group -- which includes General Electric Co. Chief Executive Officer Jeffrey Immelt and Robert Wolf, head of UBS AG’s Americas unit -- held its first meeting at the White House on May 20, with Obama in attendance. Volcker is invited to meetings of the Financial Regulatory Working Group, which includes key staff from the Treasury and the NEC, and he joins sessions by phone if he can’t attend in person. He has sent more than 10 memos to Obama outlining his views and has met with the president more than a dozen times since March, people familiar with the group say.
Volcker’s influence can be seen in the proposals for regulatory change offered by Obama on June 17. While there’s no mention of separating banking and proprietary risk taking, the administration is proposing to set higher capital requirements for trading positions and equity investments. Volcker also pushed for better coordination among banking regulators, an idea that was adopted in the Obama blueprint.
“There were many experts who contributed to this framework, but Volcker was one of the most important and insightful,” says Goolsbee, 39.
Summers, Geithner
Goolsbee, a professor of economics at the University of Chicago, where Obama once taught constitutional law, says he talks to Volcker several times a week to solicit his opinions on a wide range of topics and relays those views to the president during daily economic briefings and at other meetings.
If Volcker is at one end of the spectrum arguing for tougher financial rules, Summers and Geithner are at the other. Summers pushed for deregulation while Treasury secretary under President Bill Clinton, advocating the repeal of the Glass- Steagall Act, which had separated investment and commercial banking for more than 60 years. Geithner was president of the Federal Reserve Bank of New York during a period when banks ratcheted up their leverage.
Both men are proteges of Robert Rubin, a former Clinton Treasury secretary who served on Citigroup Inc.’s board from 1999 until this year and has been criticized for allowing the bank to pile up $544 billion of derivatives and securities before it became the recipient of more government assistance than any other bank. Rubin declined to comment.
What Volcker Wants
The reform proposals presented by the Obama administration, crafted largely by Summers and Geithner, fall short of what Volcker wants. The derivatives regulation calls for a central clearinghouse to handle trades rather than an exchange, which would provide more information to investors.
Geithner, 47, and Summers, 54, have also put forward a mechanism for dismantling large banks that fail. It doesn’t include rules for preventing them from getting too big, as Volcker urged. Many of the reforms need approval from Congress, which will likely make changes and where Volcker’s influence will continue to be felt.
“While Summers and Geithner worry about not antagonizing the banks, Volcker is the only one who can say loudly what needs to be done,” says Timur Gok, who teaches finance at Northern Illinois University in DeKalb, Illinois. “The Summers-Geithner stamp is clear in this framework because it’s not very radical. We’ll see whether Volcker’s views are heeded more in Congress.”
Confronting Power
Volcker, who grew up in Teaneck, New Jersey, during the Great Depression, has never shied away from confronting powerful interests.
As Fed chairman during the Latin American debt crisis in the 1980s, he arm-twisted the largest U.S. banks to restructure their loans, says Gerald Corrigan, head of the New York Fed at the time. Volcker brought the chief executives of the 25 largest banks to the Fed and told them nobody could leave until an agreement on the debt issues was reached, Corrigan says.
When Continental Illinois National Bank & Trust Co. failed in 1984, Volcker forced other banks to contribute $500 million to the government’s emergency package to backstop the deposits, according to Secrets of the Temple, a 1987 book about the Fed written by William Greider.
Walter Wriston, who was chairman and CEO of Citicorp at the time and resisted contributing to the bailout, called Volcker a “big nanny” for his overzealous regulatory approach.
‘Utter Conviction’
“There were some testy moments in those meetings,” says Corrigan, 68, now a managing director at Goldman Sachs Group Inc. “He did a lot of things, in all his different roles serving the public, knowing that he’d be criticized. He has never flinched. He doesn’t flinch because he’s a man of utter conviction and absolute integrity.”
Volcker’s character was forged in Teaneck, where his father, a civil engineer who became town manager, wore his double-breasted suits until they frayed and his three sisters made their own clothes. When Volcker was a teenager, his father had him fired from a town job as a sledding safety monitor to avoid the appearance of a conflict of interest, according to Paul Volcker: The Making of a Financial Legend, a 2004 biography by Joseph Treaster.
Macy’s Handkerchiefs
The frugality was handed down. When he was Fed chairman in the 1980s, Volcker lived in a one-bedroom apartment in Washington, shunned chauffeured limousines and bought his suits at Goodwill stores. He did his laundry at his daughter’s house in the suburbs and returned to New York on weekends to be with his wife, Barbara, who suffered from diabetes and rheumatoid arthritis.
Even now, his tastes are modest. When he ran out of handkerchiefs on a trip to Washington this spring, his daughter, Janice Volcker Zima, says she took him to Macy’s, where he bought the cheapest brand he could find -- at three for $11.
His one indulgence: fly-fishing. He’s hooked on Atlantic salmon, which he has pursued in Russia, north of the Arctic Circle, and in Canada’s Nova Scotia and New Brunswick provinces.
“The biggest skill in fly-fishing is patience, which is a rather important trait for a central banker too,” says Corrigan, a fishing buddy.
Princeton, Harvard
What makes Volcker loom large, more than his height, is the breadth of his six-decade career. He was at the Treasury in 1973 when the Bretton Woods system that governed financial relations among nations collapsed. He led the Fed in a fight against the worst postwar bout of inflation. He dug into Swiss bank accounts in the late 1990s to find the money owed to thousands of Holocaust victims. He tried to save Arthur Andersen LLP from collapsing with a restructuring plan in 2002. He exposed corruption in the United Nations oil-for-food program in 2005.
“He was brilliant, eminently logical, and steadfastly devoted to his work,” says David Rockefeller, 94, who hired the Princeton graduate to work as an economist at Chase Manhattan Bank in 1957 after a stint in the research department of the New York Fed.
Volcker, who also received a master’s degree in political economy and government from Harvard University in Cambridge, Massachusetts, left Chase to become the director of financial analysis at the Treasury Department in 1962. He rose to deputy undersecretary the following year during the administration of Lyndon Johnson, returned to Chase in 1965 and, when Richard Nixon became president, rejoined Treasury as undersecretary for international monetary affairs.
Bretton Woods
When the U.S. abandoned the gold standard in 1971 after the dollar came under attack amid inflationary pressure, Volcker became the point man at Treasury to help devise an alternative to Bretton Woods, which pegged currencies to gold and the U.S. dollar. The plan he negotiated with other global powers during meetings in Europe and Asia in 1973 established a floating currency regime. That meant central banks wouldn’t be required to buy or sell their currencies to maintain a fixed rate and that their exchange value would be determined by market forces.
Two years later, Volcker was recruited to run the Federal Reserve Bank of New York by Fed Chairman Arthur Burns. When inflation, fueled by the soaring price of oil, surged to 11 percent in 1979 and Fed Chairman G. William Miller was named Treasury secretary, President Jimmy Carter turned to Volcker. His first choice, Rockefeller, then chairman of Chase Manhattan Corp., declined the job, telling the president that Volcker was the only person who could tackle inflation. Others were saying the same thing, according to Treaster’s biography.
Fighting Inflation
In October 1979, two months after his appointment was confirmed by the Senate, Volcker convened a secret Saturday meeting of Fed governors -- some told their offices they were going fishing for the weekend -- where he convinced them to switch the agency’s focus to tightening the money supply instead of setting short-term rates. When the Fed restricted the money available to banks, interest rates surged, throwing the economy into a recession.
Volcker knew the medicine had to be painful to work, says Fred Schultz, vice chairman of the Fed at the time. There were demonstrations every day in front of the Fed building in Washington by groups ranging from homebuilders to car dealers. Volcker received car keys in the mail, symbolizing vehicles not sold as the economy sputtered. Gross domestic product fell almost 8 percent in one quarter. Yet the remedy worked: By 1986, inflation fell to its lowest level in two decades.
“People didn’t believe the Fed would stay the course,” says Schultz, 80, who is retired and lives in Jacksonville, Florida. “Congress was pressing us all the time to ease our harsh stance. It was hard to stick with it, but Paul was determined, and we did stick with it.”
Replaced by Greenspan
Even now, Volcker’s inflation-fighting tactics stir anger.
“Volcker’s attack on the inflation issue was much too harsh and led to a huge amount of damage inside and outside the U.S.,” says James Galbraith, an economist at the University of Texas at Austin. “It wasn’t necessary to put the entire world through a decade of recession. It was one way out, but not the best way.”
President Ronald Reagan, who reappointed Volcker in 1983, decided not to give him a third term in 1987 after he resisted lowering interest rates even as inflation almost vanished.
He was replaced with Alan Greenspan, who brought down interest rates and presided over two decades of almost unbroken economic growth until the 2007 collapse of a housing bubble led to the worst financial crisis since the Great Depression. The slump, blamed mostly on easy availability of credit that fueled consumer and corporate debt, has cast a shadow over Greenspan’s accomplishments.
‘Formula for Disaster’
“When you help set up one of the greatest crashes in the history of civilization, people will hold you responsible,” Galbraith says. “Greenspan was dreadful on regulatory questions, and that we know now is a formula for disaster. Volcker’s star has been rising due to his regulatory stance.”
Although never attacking Greenspan by name, Volcker has criticized the easy-money policies of the period.
“We bent over backwards to ease money for reasons I didn’t understand,” he said during an interview last October with Charlie Rose.
Returning to New York after his Fed stint, Volcker became a partner at James D. Wolfensohn Inc., a New York boutique investment bank founded by James Wolfensohn. When Wolfensohn left to run the World Bank in 1995, Volcker became CEO. He stepped down the following year when the firm was sold to Bankers Trust New York Co.
‘Lose His Marbles’
Volcker also spent more time caring for his wife, who died of complications from diabetes in 1998. Toward the end, when she couldn’t walk anymore, he would push her wheelchair to restaurants in New York, says Robert Kavesh, an economics professor at New York University who has known him for six decades.
“He had no life for so long, just taking care of her,” says his daughter, 53, a nurse who lives near Washington. “I’m surprised he didn’t lose his marbles.”
Kavesh says Volcker was just as patient teaching his son, James, born with cerebral palsy, how to play Wiffle ball. James, 51, lives in Brookline, Massachusetts, and works as a grants manager at a hospital.
In the decade after his wife’s death, Volcker took on a number of ad hoc assignments, from reclaiming Holocaust victims’ bank accounts to investigating the UN’s business ties with a company led by then Secretary-General Kofi Annan’s son. Arthur Levitt, a former chairman of the Securities and Exchange Commission, says people turned to Volcker for such controversial tasks because they could trust his integrity.
“He’s always had a sense of balance without any political agenda,” says Levitt, a board member of Bloomberg LP, the parent of Bloomberg News.
Derivatives Trading
Now, as Obama’s inside outsider, he’s trying to maintain his balance amid conflicting political agendas. In February, he complained to administration officials and friends about being kept away from policy discussions. While he’s happier now, he’s still worried that he won’t have enough impact on the regulatory reforms he cares about most, the friends say.
In May, Geithner announced plans to regulate derivatives trading, which would require most of it to move through a clearinghouse and, in theory, reduce the risk that a trader’s collapse could send shock waves through the market. While the proposal includes many of the suggestions Volcker laid out in a Jan. 15 report by the Group of 30 that he helped write, it doesn’t go all the way. Volcker chairs the board of the G-30, which includes former central bank chiefs and economic officials from around the world.
Volcker’s Suspicions
The Geithner plan allows contracts that can’t be standardized to be traded outside the central clearinghouse. Volcker wants to discourage that by imposing capital requirements on trading parties, people familiar with his thinking say. He also wants derivatives to be traded on exchanges, where investors can see prices for themselves, which would bring down profits for the dealers who act as intermediaries.
Geithner’s plan leaves the door open for more-onerous capital demands and a bigger role for exchanges. Wall Street banks, including JPMorgan Chase & Co. and Goldman Sachs, sent a letter to the New York Fed on June 2 supporting a clearinghouse.
Volcker has long been suspicious of financial products that most people can’t understand. One of his four grandchildren, Colin Zima, heard about it a lot when he studied financial engineering.
“He would constantly joke about me studying to be a crook,” says Zima, 25, who worked at UBS for a year before taking a job in 2007 as a statistician at Google Inc. in San Francisco.
The new job made his grandfather happier, he says.
‘Speculative Fever’
The former Fed chairman started worrying about derivatives and structured debt such as mortgage-backed bonds in the early 2000s, his grandson says. In a 2000 interview with the New York Times, Volcker said he couldn’t make sense of the financial innovation going on.
“You obviously have a kind of speculative fever,” he told the paper. “It’s a kind of casino. It’s all the rage, trading certificates that have no intrinsic value.”
In 2005, Volcker was worried about the housing bubble, the U.S.’s growing trade deficit and banks’ increased risk taking.
“Under the placid surface, there are disturbing trends,” Volcker wrote in the Washington Post. “Altogether the circumstances seem to me as dangerous and intractable as any I can remember, and I can remember quite a lot.”
Overstretched Fed
The Obama administration initially wanted to give the Fed a larger role, people close to the discussions say. Volcker was opposed, arguing that too much weight on the institution could threaten its independence in setting monetary policy.
“Do we want to make the Federal Reserve the chief regulator too?” Volcker asked during a Bloomberg TV interview on April 29. “Maybe that’s going a little too far.”
The administration has since shifted away from having a single regulator, instead giving the Fed a partial role in monitoring systemic risk, along with a council of regulators.
Volcker’s concern about an overstretched Fed has shaped the views of key congressmen, aides on Capitol Hill say. House Financial Services Committee Chairman Barney Frank echoed Volcker’s views on regulatory oversight on May 28, saying he opposed a single regulator.
“My own preference is for a dual-track regulation,” Frank said, referring to two separate channels of regulation that would focus on the health of the banks and the need to monitor for systemic risk as suggested by Volcker’s G-30 report.
‘Political Games’
The PERAB is taking a broad look at financial reforms, including whether banks that take deposits should be barred from engaging in high-risk trading, according to some members. While Volcker has strong views on that -- he thinks commercial banks should be prohibited from owning hedge funds or private equity units, people familiar with his thinking say -- he’s listening to others in the group.
“We’re an advisory board, so we can present different viewpoints at the end to the president,” says board member Wolf.
The biggest obstacle to Volcker’s reform agenda is Summers, Volcker’s friends say. While the president’s top economic adviser has softened his anti-regulatory stance from his days as Clinton’s Treasury secretary, it will be difficult for him to accept some of Volcker’s proposals, they say.
That hasn’t fazed Volcker.
“If he’s of a different view, I’m sure he’ll recognize the wisdom of my view sooner or later,” Volcker said in the April interview.
“Don’t rule Volcker out yet,” says Kavesh, his longtime friend. “Paul worked under five presidents before, and he knows how to play the political games. As events unfold, he’ll take on a more direct, stronger role.”
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