Richard Whalen

Former Federal Reserve Chairman Paul Volcker made an extremely important speech this week to the New York Economic Club, his first appearance there in 30 years. Volcker occupies a unique position of personal leadership in the U.S. and the world. His integrity, long-public service and brilliant capability make him the most successful central banker of our time. He recalled his earlier speech on the near-bankruptcy of New York City during the 1970s, which he called “child’s play” compared to the enormous economic, financial and currency crisis the U.S. now faces.

He sounded a familiar warning: the U.S. has become “addicted to spending and consuming beyond its capacity to produce. The result has been a practical disappearance of savings, rapidly rising imports and a huge deficit in trade. The process has been extended by the willingness of other countries – foreign investors, businesses and governments – to close the gap by buying our Treasury securities, by directly or indirectly financing our home buyers as well as our banks and increasingly by buying into our businesses.”

That familiar list summarizes American failings and self-indulgences that at last reached “a breaking point” last August, says Volcker, “triggered by excesses in the subprime housing mortgage market.” Now says Volcker, “we face painful but necessary adjustments” to modernize the “official safety net” that preserves the U.S. financial and economic systems in time of stress.

Will we face up to this challenge or doze off again? Ever the optimist, Volcker, a feisty 80-year-old, told me yesterday that we will face up to these adjustments as soon as a new Congress hears from a new president in 2009. During our conversation, Volcker said that he thought Fed Chairman Ben Bernanke “is doing a pretty good job.”

During the potentially hyper-inflationary siege threatening the U.S. economy, soon after his appointment in 1979, I worked closely with him as the informal liaison with Ronald Reagan and watched him make brutally difficult decisions daily for months on end. Volcker raised interest rates to the highest level in almost a century – and kept them there despite a storm of protest from Congress, business and labor. But he broke the inflationary fever, rescued the dollar and made possible Reagan’s success in his first term. A conservative New York Democrat, Volcker is a centrist by instinct and always seeks to balance contending points of view.

Today, Volcker has in mind a financial reform agenda for the candidate he has endorsed – Barack Obama – but the calendar is not on his side. The fundamental reforms in Wall Street that Treasury Secretary Henry Paulson has proposed and that Volcker endorses will not be considered by Congress until sometime in 2009 or later. By then, the current recession and the credit crunch will have a two-year head start on any Congressional attempts to bring them under control.

Politically, Congress wants to make the connection between the day Bear Stearns – the fifth largest investment bank – that almost went belly up and got a Fed bailout and the harried homeowners facing mortgage foreclosure. There is no such connection. There are no villains in this complicated tale. What is at stake is the survival of an economic and financial systems that have become too complicated to understand, much less take apart and reform.

What I propose is that Congress concentrate on the housing financial crisis and the long-established loan guarantee agencies – Fannie Mae, Freddie Mac and the Federal Home Loan Banks – whose mandates can be extended to cover all aspects of the subprime and other sectoral credit problems. And leave the Federal Reserve System alone.