[It is no secret that Paul Volcker was and remains a hero to me. Paul died in December 2019 at the age of 92, so the interview below with Yale University might be the last in-depth interview with a great American (and citizen of the world). The interview is extensive, and I’m not sure how Paul was able to pull it off as he was struggling from the effects of cancer. Paul and I had disagreements when he and I dealt with the banking and thrift crises that ran from 1978 through 1992 during which some 3,000 banks and thrifts failed and thousands more were severely weakened. The Great Depression was a more difficult period but it did not have nearly as many very large banks in serious trouble. And it is possible our current economic struggles resulting from Covid-19 might in the end be more difficult, but I pray not. I am very thankful that our nation had a Paul Volcker when he was really needed. And I am honored to have served at his side.]
Yale Program on Financial Stability Lessons Learned
A Conversation with Paul A. Volcker
By Andrew Metrick, Rosalind Z. Wiggins and Kaleb Nygaard
On March 26, 2019, Andrew Metrick, the Janet Yellen Professor of Finance at the Yale School of Management and Founder and Director of the Yale Program on Financial Stability1 sat down with Paul A. Volcker to discuss his perspectives on the Federal Reserve, central banking autonomy, “too big to fail,” and how his perspectives on these topics have changed over the decades. It turned out to be one of the last interviews given by the former Chairman of the Federal Reserve System who passed away on December 8, 2019, at the age of 92.
An Esteemed Legacy
During the 2007-09 financial crisis, the government’s interventions to shore up the collapsing financial system were unprecedented as to scale and quantity. Support to specific entities was often discussed as being made on the basis that the entity was “too-big-to-fail,” a term first coined in 1984 when the government intervened to save Continental Illinois National Bank and Trust Company, a large national bank that was about to fail. It would have been the largest bank failure in U.S. history at the time and would have remained the largest until the 2007-09 crisis. The Federal Reserve coordinated with the FDIC to save Continental, the rescue of which gave rise to the term “too-big-to-fail.”
Paul A. Volcker was Chairman of the Board of Governors of the Federal Reserve System during the administrations of Presidents Jimmy Carter and Ronald Reagan from August 1979 to August 1987. In 1984, he was instrumental in the decisions and actions taken to save Continental Illinois. Previously, Volcker had also, from August 1975, served as President of the Federal Reserve Bank of New York, where he was actively involved with monetary policy decision-making processes and became a proponent of monetary restraint. He also served as an economist with the Federal Reserve from 1952 to 1957 when he left to work in the private sector.
Volcker was the proponent of the namesake, Volcker Rule (adopted in 2010 as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act), which limits proprietary trading by banks. Volcker was appointed by President Barack Obama as the chair of the President’s Economic Recovery Advisory Board on February 6, 2009. He also was the founder of the Volcker Alliance whose mission is “to advance effective management of government to achieve results that matter to citizens.”
Continental Illinois and Too-Big-To-Fail
Metrick: Today we were hoping to talk to you about topics that we focus on at the Yale Program on Financial Stability where we study crisis fighting. Of all of the many things that you worked on, the decisions around Continental Illinois [National Bank and Trust Company] were really important at the time and important for the future. It only received five pages in the Silber Volcker book but I detect in reading your book7 that you’re happy about some parts of it and unhappy about other parts of it. There are hints in the book that you wish you had objected more to certain things or done some things a little bit differently.
Volcker: There are a number of lessons to be drawn from that scenario. You know from the book or otherwise that at that time, the penchant of the Federal Reserve, or any other regulator, for effective regulation was not very great. At one point I think they had been worried about capital positions, but that had all died away. By the time that I becameChairman [in 1979] there weren’t any capital requirements that meant anything.
We knew that Continental Illinois was in trouble after learning about a bank in Oklahoma, Penn Square Bank, that was having trouble. The Oklahoma bank had made all these oil loans and then pitched them off to Continental Illinois and another bank, Seattle First.
In the summer of 1982 Roger Anderson, the chairman of Continental Illinois, visited me on a fishing trip and told me they were going bust. At some point we said we were ready to lend them quite a lot of money.
We kept an eye on it, but I didn’t think that Anderson was doing enough to fix their problemand I said as much to the lead director, but he deferred to Anderson. I remember that was typical of the kind of strength of banking regulation and of the seriousness of which directors and so forth took supervision.
The Oklahoma bank, Penn Square Bank, had preceded this by about a year. We finally let that go, but they had almost no uninsured deposits, so there wasn’t much [good business] about it except that one of the big depositors was a credit union of the U.S. Congress.
We had had this earlier situation with another bank, First Pennsylvania, right after I became Chairman. It was an interesting case because that was the first big failure. They had bought a load of long-term Treasuries and then they went sour. They had so many of them that it jeopardized the whole bank. In the end we arranged a rescue where, as a formality, some of the private banks put some money in with us so it looked like a private rescue.
That was the plan that I had in mind with Continental, which was a much bigger fish. So, we put the proposition to FDIC Chairman, William Isaac.
We were together on this. The FDIC put in a little capital and we asked the banks to put some more capital, and we would provide all the liquidity it needed. Well, the banks weren’t in the mood to put any more capital in.
So, we had to go ahead anyway. And I was unhappy about it at the time, I thought Isaac was probably right. I had to go get an honorary degree that day at Columbia, and if I didn’t showup….
Metrick: They would know something was wrong with Continental Illinois.
Volcker: Right. So, we left it to Isaac to arrange it all. And when I got back it was basically all arranged with one difference, he was going to guarantee all the deposits.
Metrick: Even the uninsured ones.
Volcker: Yeah, which, as a matter of policy I didn’t want to do. I thought if the FDIC put in some more capital, the Federal Reserve would pledge to provide all of the liquidity and so forth, and things would straighten out without formally guaranteeing the deposits. But Isaac wanted to be sure, and he may have been right. He thought he was protecting the FDIC by going all the way.
I don’t remember any debate about this, but the way he put in the capital included protection for the subordinated debt of the holding company as well. We didn’t want to do that, but that was Issac’s decision. So, the bank stumbled along and eventually got sold to some company and then it disappeared.
On the Role of Financial Supervision
Metrick: You hinted about the role of Fed supervision during the time of Continental Illinois as being very different from its monetary policy function. Care to elaborate?
Volcker: Continental Illinois was an example of a lack of effective supervision that existed back in 1984. It was all an illustration of what the matter with the regulatory system was. You had three regulators for the bank (the Fed, the FDIC, and the OCC was the third because it was a national bank) and certainly Continental looked at the Fed as the principal supervisor as they should have. At the time, I also thought that we were the premier agency in terms of supervision. But we were not doing a good job, nobody was.
I never read the book, The Secrets of the Temple, because I knew it was anti-Federal Reserve, but it’s actually a very knowledgeable book. So, in this book the author interviewed Chuck [J Charles] Partee, who was head of the Federal Reserve staff for many years. He was put on the Board, which is a precedent in itself.
The author of the book interviewed him, and the author says that he thought we were very efficient in dealing with inflation, but he said, “Even if I grant your case that inflation was an enemy and you had to deal with it, you could have dealt with it more effectively if you used your supervisory tools instead of putting us all in a recession. Why didn’t you do that?” It’s a good question.
You are politically exposed, particularly when you’re tightening up. But by and large, at the end of the day people know you’re responsible for monetary policy and they don’t really lobby you that much.
In supervision, they lobby the hell out of you. And all the lobbying money goes into supervision and you don’t want to take on two enemies at the same time.
The supervised is never happy, and the supervisor is never happy, and it’s just as true today. This continues to be a big problem today. How do you effectively supervise these institutions?
It’s just very hard to get a Federal Reserve Bank to toughen up its supervision. I think it’s probably better now than when I was first there. The Presidents of the Federal Reserve banks weren’t so noisy as they are now on policy and so forth.
The Presidents have a dilemma. They want to be an established member in the business community in Kansas City. They want to be friendly; they want to be on the Chamber of Commerce. And you don’t get to be a respected figure in Kansas City if you’re attacking, or seen to be attacking, the local banks in Kansas City.
It’s not a comfortable place to be, but the Reserve Banks can hide behind the Board regarding the supervisory responsibilities.
Metrick: And not be so tough on their own banks?
Volcker: Right. But, once in a while you get a tough regulator. Dan Tarullo—now he was the toughest supervisor I think the Federal Reserve had. Dan Tarullo was very experienced, very knowledgeable. And Tarullo wasn’t brought up in the banking world; he was a lawyer.
Metrick: But you think he did a good job?
Volcker: I think he made a difference, he made it more consistent and toughened it up and so forth.
I love to describe this experience Janet Yellen had when she was being quizzed by this government report about supervision when she was the president of the San Francisco Federal Reserve Bank. The conversation, not quoting directly, went something like this. Theysaid, “We understand Mrs. Yellen, that you’re one of the people who called attention to thedeteriorating mortgage market and subprime loans.”
She said, “Thank you for mentioning it; that’s true.”
Next question, “Why didn’t you do something about it?”
Yellen says, “Well, it wasn’t the responsibility of the San Francisco Fed. It was up to the Board. We mentioned it to Mr. Greenspan, but they weren’t much interested, and it wasn’t really our business anyway, so I didn’t get aggressive and the Board was not aggressive.”
It was a good question, and the Partee answer [splitting-off the regulatory role from the Federal Reserve] was compelling. I strongly believe that the Federal Reserve ought to be the principal regulator, but when you listen to Partee’s answer you begin wondering whetherwe ought to have a special regulator. But the British tried that.
Metrick: And it didn’t work.
Volcker: They fell completely on their face because that independent, special regulator was more overwhelmed by lobbying than the Federal Reserve would be.
But how do you deal with this problem? You have it today. It’s not going to go away, so what do you do? That’s what you’re struggling with still.
Deciding Between Non-Ideal Choices
Metrick: Yes, that’s what we’re struggling with. So, what I think I’m hearing you say is that in the Continental Illinois case, because of how weak regulation was going into it, the situation just had no good choices. And ultimately, you’re not happy with the fact that some too-big-to-fail beliefs got created by what happened, but at the same time you don’t have a specifically different path that you think would have worked better.
Volcker: No, I don’t. The thing I disagreed with was, I wanted to put so much firepower behind it, but I didn’t want to guarantee everything. But it didn’t make much difference. If we had not guaranteed everything, I think the same thing would have happened.
Metrick: So, if you had done the alternative strategy of, “we’re not going to make this statement about guaranteeing everything, but the Federal Reserve is going to lend, lend, lend…” It wasn’t the statement that created the belief, it was the firepower.
Volcker: Isaac’s issue was, “Okay we, the FDIC, don’t guarantee everything. You, the Fed, are going to put in all this liquidity. But if it goes bad, we’ve [the FDIC] got to pick up all the mess, and the Federal Reserve will go home with all the collateral.” And he was absolutely right. If it had happened that way, he would have been right.
And he said, “That’s not going to happen.”
Metrick: It sounds like, with regards to the FDIC’s specific decisions, you would have done things a little bit differently, but you think it would have engendered basically the same result in the market.
Volcker: I don’t know. Suppose in the original plan the banks had put in a billion or so and the FDIC had put in two billion.
The Federal Reserve would have put in the liquidity. There was some discussion of this scenario, but the banks turned it down. Whether the appearances of that would have modified the too-big-to-fail rhetoric, I don’t know. The stockholders did fail.
Metrick: Yes, and that’s an important distinction, the same thing happened in the recent crisis. Stockholders often got hit badly. But the big alternative would be to have let them go. And your view was that that would have led to real panic.
Volcker: Continental was a big correspondent bank in the Midwest, so it probably had 400 little Western, Midwestern banks that had a big investment in it, and it had those big oil loans, which would have been exposed, which eventually were exposed anyway. That exposure killed First Seattle Bank. Chase Bank had a lot also. I don’t know what would have happened to Chase if Continental Illinois had failed. Chances were very high that you would have had a run on some of the other banks and you certainly would have had runs on some of the smallbanks. You can say, “So what? They’re mostly FDIC insured and so forth…” But it sure would have shook up the system. How much it would have shaken up the system, I don’t know.
Metrick: Enough that you didn’t want to risk it.
Volcker: That’s for sure. Not on my watch.
The Federal Reserve as Regulator was Different Then
Metrick: Now you had talked a little bit I think in one of the events that you came into at Yale about how you had gone out to Chicago earlier to try to get Continental Illinois to get their act together. Can you reflect on that?
Volcker: Actually, it was just a routine visit. Right after I became the new Chairman of the Federal Reserve, I was visiting the Chicago Reserve Bank.
While I was out there, I looked at the position of First Chicago and Continental, and I said I want to talk to those guys. I had both the Chairman and a Director in the room. I said, “Look here, you’re undercapitalized, you got to get your capital up.” Here I was, brand new Chairman of the Federal Reserve. I was going to be the boss, “You got to get your capital up.”
And they basically said, “You have no authority over our capital.” Which at the time was a debatable point, whether we could have used our general supervisory authority. But theytold me, “You don’t have any authority over our capital.”
If you went back ten years earlier the Fed did have a formula for capital, but nobody followed it and they finally dropped it.
So, I say “We’re going to get you guys supervised.” And that got me off on this capital business. But I admit being a little shocked at the rude treatment as the new Chair of the Federal Reserve.
I’ll tell you another similar story. Years earlier, when I was the brand-new President of the Federal Reserve Bank of New York, I’m sitting in my little office and the First Vice Presidentcomes in and sees me and he says, “Tomorrow we have our annual lunch with Citibank.”
“Having lunch? What’re we having lunch for?” I ask.
“We get together and discuss what’s going on in the market and what problems they foresee.” “Do you use this to get them in shape, with capital?”
“No, no, this is just chatting about good customer relationship.”
So, I say, “Let me see their goddamn balances.”
He gives me the balance sheet. And I look at it and I don’t understand it. I’m thinking he gave me the wrong bank. It says National Citi, but I don’t recognize any of the figures. “What’sgoing on here?”
He said, “Oh, that’s just the domestic bank, that’s all we look at.”
And at that point Citibank was probably as big as its domestic bank, but they didn’t look atthat. “Who looks at that?” I asked.
“The Comptroller looks at that.”
“Do you ever consult?”
This is the famous time when they came around and told me quite seriously, “Citibank didn’tneed any capital. Why do we need any capital? We gain profit every year.”
They actually had a memorandum supporting this theory. They believed it.
Metrick: If we make money every year, why would we need any capital? There’s no risk that we won’t make money.
Metrick: So, if you look now at the decisions that were made in 1984 around Continental Illinois, and you were advising yourself—so Paul Volcker 2019 is advising Fed Chairman Paul Volcker 1984 (who was still a little green at the job)—would you recommend anything differently? Other than not getting the honorary degree from Columbia, so that you would be there for everything. Was there anything you think you would do differently having seen what then happened 35 years later?
Volcker: Well I’m sorry that we didn’t guarantee the nonbank holding company. They had maybe $400 million or something of obligations to the holding company that they wereselling as the crisis unfolded. The bondholders, they were selling…They had bought back halfof those ventures, bonds, whatever they had. I discovered that just a few days before and Isaid, “Stop it, you can’t…”
Metrick: Buying them back at discount.
Volcker: Yeah, you’re not going to buy your liabilities back with Federal Reserve monies. It’s ridiculous. So that’s why there was still a couple hundred million leftover, which they got guaranteed. It was a little messy.
The Status of “Too-Big-To-Fail” Today
Metrick: Although Continental Illinois happened in 1984, “too-big-to-fail” played asignificant part in the 2008-09 crisis. What’s your assessment of where we stand todayon this issue of “too-big-to- fail,” after all the legislation that you were part of, where doyou think this stands?
Volcker: Well I would like to think, maybe overoptimistically, that with enough cooperation in London and elsewhere, you could try out the authorities that the FDIC has, Title II, the Orderly Liquidation Authority.
People know that it’s there. It deals with the stockholder problem. It permits an effective bailout of the debt holders and effectively kills the stockholders. I think politically that’ssellable. I see that it could work.
Metrick: What you said around the time of Continental Illinois I think is still an issue today, which was something along the lines of, “We could probably handle one $40 billion bank going down, but if it’s multiple $40 billion banks, it’s going to be a real problem.” I think the sense that a lot of people have about the Orderly Liquidation Authority is that it could maybe work in an idiosyncratic special case, but in a real systemic crisis we would need something else.