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The Tall Man

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The Tall Man

Paul Volcker helped make the economy what it is today, for better and for worse. December 10, 2019
Economy, finance, and budgets
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Paul Volcker, who died Sunday at 92, towered, physically and metaphorically, over his contemporaries. At 6 foot 7, he was the tallest person in any room. Volcker was also among a small number of men who, starting in the late 1970s, ushered in a 40-year era of Western monetary and financial policy. Volcker made the world safe for post-industrial finance—but a financial industry no longer subject to market discipline has since subjected the world to perilous levels of debt.

Volcker became chairman of the Federal Reserve in 1979, appointed by President Jimmy Carter. The nation’s biggest economic challenge then was raging inflation. After remaining below 2 percent annually through the postwar era, the inflation rate crossed 3 percent in 1966, and, by the mid-70s, had veered into the double digits. In 1979, inflation was 11 percent.

Inflation wrought havoc on the economy. It pushed up borrowing costs, because lenders demanded compensation for the fact that they could expect future repayment of debt in less valuable dollars. How could companies and individuals plan ahead if they knew that anything purchased or created in today’s dollars could be worth half as much, in half a decade, if the inflation rate stayed high?

At the press conference announcing Volcker’s appointment, Carter said that he had chosen the then-head of the New York Fed, as “he shares my determination to pursue the battle against inflation.” At the same event, Volcker foreshadowed his tough stance, hinting that he would stand firm against easy money, even if the economy turned down, noting that “you can’t reflate yourself out of a recession.”

Carter had not known how zealously Volcker would carry out his mandate. By January 1981, Volcker’s Fed had hiked the country’s basic interest rate, at which banks can borrow from the Fed, to 19 percent, largely by curtailing the supply of money. (Until the mid-70s, when Volcker’s predecessor had made a short-lived attempt to accomplish the same goal, this “fed funds” rate had never gone above 9 percent.)

Powerful interests such as house builders, as well as average Americans, were confused about why the cure for the problem seemed worse than the disease, as even higher interest rates slowed the economy and pushed unemployment up. The joblessness rate rose from around 6 percent in 1979 to 8 percent on the eve of the 1980 election. Volcker’s steadfastness in the face of public criticism helped cost Carter that election, as the former president obliquely acknowledged.

But the strategy worked, if slowly. By 1983, the inflation rate was 3 percent, and it’s never gone above 6 percent since then. (The Fed has generally been able to keep it below 2 percent.) Unemployment peaked in late 1982, and fell steadily afterward. Though cyclical recessions intruded, Volcker set the state for the eighties, nineties, and 2000s: stable prices that helped give businesses and households the confidence to make long-term decisions.

Stable prices, in other words, ushered in stability—but, as economist Hyman Minsky once said, stability causes instability. Stable prices allowed the financial system to lend without worry—and so it did. In 1980, America—its government, its people, and its companies—owed $4.1 trillion. Today, it owes $53 trillion. Against growth in inflation, population, and productivity, that’s a big increase.

Volcker is hardly to blame for keeping prices stable; no one would suggest that we try to keep borrowing down by keeping inflation high. Volcker is partly responsible, though, for another significant change in the 1980s: the creation of financial institutions that are “too big to fail.” In 1984, Continental Illinois, then the nation’s eighth-largest bank, was on the brink of failure, because of its executives’ imprudent decision to rely on fickle, short-term global investors, who withdrew their financing of the bank at the first sign of crisis. Volcker was instrumental in helping to arrange a $4.5 billion government bailout of the bank.

Since the Great Depression, the government had rescued small depositors of banks, but never large ones; the Continental Illinois deal was the first time in modern history that Washington had protected the supposedly sophisticated large bondholders who had put their money into a large bank, and who might have suffered losses if the bank failed. Volcker insisted to Congress that the rescue was not a precedent. But then-Treasury Secretary Donald Regan had it right at the time: “We believe it is bad public policy . . . and represents an unauthorized and unlegislated expansion of federal guarantees in contravention of executive branch policy,” he warned.

The Continental rescue would become a template for the next two and a half decades. With big banks and their investors increasingly exempt from the free-market possibility of failure, they grew even bigger, and took more risks. This “too-big-to-fail” strategy culminated in the autumn of 2008, when Citigroup and Bank of America were among institutions that received extraordinary government help.

Volcker had long before grown uneasy with the banking behemoths that started to emerge in the aftermath of Continental Illinois. In 1987, just before he left the Fed, he voted against the easing of the rules separating commercial banking from investment banking, a trend that continued until 1999, when President Clinton and Congress repealed the Depression-era Glass-Steagall Act that separated the two lines of businesses.

After the 2008 financial crisis, Volcker helped convince President Obama and Congress to pass something Obama christened “the Volcker Rule,” intended to curtail the risks that financial firms could take with their implicit taxpayer guarantees. But the rule that Congress legislated is far more convoluted than what Volcker intended, and the bigger problem, for large financial firms, remains those implicit taxpayer guarantees, which still go far beyond deposit insurance for small bank customers.

Paul Volcker was the first Federal Reserve chairman to become a household name. Can anyone, outside of an academic, name any of his predecessors? After Volcker came Alan Greenspan, perhaps more famous. Today, though, Fed chairs are once again somewhat obscure figures: Jay Powell, the current chairman, and his predecessor, Janet Yellen, are hardly rock stars. They’ve retreated into obscurity, though, not because the Fed doesn’t do much to gain public attention, as was the case before Volcker, but because it has already done too much: with interest rates near zero for most of the past decade, and close to record lows now, it long ago reached the limits of what traditional Fed policy can do. Just as easy money helped cause the inflation of goods and services that plagued the 1970s, the easy money of the past decade has enabled the debt that has spurred the inflation in asset prices—houses, office buildings, stocks, and bonds—that may trigger the next crisis.

Volcker’s most lasting legacy is his example of independence. Even when it meant harming the economy in the short term, under both Carter and Reagan, Volcker’s Fed kept the courage of its convictions. In the final decade of his life, Volcker used his reputation for integrity and wisdom to call attention to other grave financial, economic, and fiscal difficulties. His Volcker Alliance has reported not just on systemic risks in the financial system, but on untenable state and local budgets and on the need to invest wisely in the nation’s infrastructure.

In person, Volcker was kind and thoughtful, typically preferring to listen rather than to speak, and when he did talk, often salting his comments with self-deprecating wit. The last time I saw him was not during an interview or at a small private dinner—I had those rare privileges—but on Fifth Avenue, where, a couple of years ago, he ambled up the sidewalk alone, head and shoulders above everyone around him.

Photo by Chris Hondros/Getty Images

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