Paul Volcker, “Not one shred of evidence…”

10 01 2010

From The Times December 9, 2009

One of the most senior figures in the financial world surprised a conference of high-level bankers yesterday when he criticised them for failing to grasp the magnitude of the financial crisis and belittled their suggested reforms.

Paul Volcker, a former chairman of the US Federal Reserve, berated the bankers for their failure to acknowledge a problem with personal rewards and questioned their claims for financial innovation.

As bankers demanded that new regulation should not stifle innovation, a clearly irritated Mr Volcker said that the biggest innovation in the industry over the past 20 years had been the cash machine. He went on to attack the rise of complex products such as credit default swaps (CDS).

“I wish someone would give me one shred of neutral evidence that financial innovation has led to economic growth — one shred of evidence,” said Mr Volcker, who ran the Fed from 1979 to 1987 and is now chairman of President Obama’s Economic Recovery Advisory Board.

He said that financial services in the United States had increased its share of value added from 2 per cent to 6.5 per cent, but he asked: “Is that a reflection of your financial innovation, or just a reflection of what you’re paid?”

Mr Volcker’s broadside punctured a slightly cosy atmosphere among bankers and regulators, assembled in a Sussex country house hotel to consider reform measures, at the Future of Finance Initiative, a conference organised by The Wall Street Journal.

Another chilling contribution came from Sir Deryck Maughan, a partner in Kohlberg Kravis Roberts, the private equity firm, who in the 1990s was head of Salomon Brothers, the investment bank.

He warned delegates that many of the flawed mathematical techniques that underpinned banks’ risk management approaches were still being used, saying that the industry had not “faced up to the intellectual failure of risk management systems, which are still hardwired into many banks and many trading floors”.

Sir Deryck also questioned whether it was right that taxpayers should continue to underwrite many of those risks: “There’s something wrong about large proprietary risks being taken at the risk of taxpayers. The asymmetry will not hold. I’m not sure we’ve thought about that.”

Earlier Baroness Vadera, adviser to the G20 — and an adviser to Gordon Brown during the banking crisis — had warned the world’s most senior bankers that continental lenders had yet to acknowledge the scale of their losses and bad debts. She said: “It’s not the UK banks that have to come clean, but some of the continental banks still have issues.”

She added that, contrary to City assumptions, the supposedly hardline French and German governments were more relaxed about leverage and liquidity constraints than Britain and America.

The former UBS banker said that she continued to have nightmares about how close the British banking system came to collapse last year.

She also warned bankers that the G20 process was “like herding cats” and that one of the main problems with the group of the world’s wealthiest nations was that they did not want to give up national sovereignty and co-ordinate their behaviour.

Meanwhile, George Soros argued that CDS should be banned. The billionaire investor likened the widely traded securities to buying life assurance and then giving someone a licence to shoot the insured person.

“They really are a toxic market,” he said. “Credit default swaps give you a chance to bear-raid bonds. And bear raids certainly can work.”

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