Volcker: The Triumph of Persistence
William L. Silber
Bloomsbury, $30 (cloth)

Paul Volcker’s remarkable career of public service reads as a history of the last half-century of American money. After apprenticeships at the Federal Reserve Bank of New York and Chase Manhattan Bank, Volcker joined the Treasury Department during the Kennedy administration, as the first cracks in the foundation of the then-mighty dollar standard were quietly observed and patched. As undersecretary of the Treasury for international monetary affairs from 1969–1974, he was at the center of the storm surrounding President Nixon’s decision to sever the dollar’s link with gold and was the point man in subsequent efforts to reconstruct the international monetary system. In the early ’70s, the previously obscure Treasury official became a highly visible, globetrotting diplomat of the dollar.

In 1975 Volcker became president of the Federal Reserve Bank of New York, and then, in 1979, was appointed chairman of the Federal Reserve by a post-malaise Jimmy Carter desperate to signal a commitment to monetary stability in the face of apparently uncontainable inflation. Volcker did more than signal. He imposed draconian monetary measures that would, over the course of several terrible years (then the worst economic downturn since the Great Depression), wring inflation out of the American economy. It was an achievement for which he is justly credited but for which he was subjected to sharp criticism at the time. During two busy terms as Fed chair he also was confronted with the Mexican financial crisis, the failure and bail out of a major American Bank (Continental Illinois), and the 1985–87 trip “from the Plaza to the Louvre”—coordinated international efforts to depreciate and then stabilize the dangerously overvalued dollar.

After stepping down from the Federal Reserve in 1987, the legendarily Spartan Volcker became Chairman of James D. Wolfensohn, Inc., a New York investment bank. Still, his dedication to public service was undiminished. With an unquestioned reputation for integrity, he directed the independent committee charged with investigating the disposition of the assets of Jewish Holocaust victims disgracefully buried in Swiss Banks, served as chairman of the board of trustees of the International Accounting Standards Committee, and was put in charge of the UN’s investigation of its corrupt Oil-for-Food Programme. In 2008 President-elect Obama appointed Volcker as the head of the newly created President’s Economic Recovery Advisory Board. Volcker has, in short, been close to the center of U.S. monetary policy for 50 years. And monetary policy has been close to the center of American politics.

William L. Silber’s new biography is therefore to be welcomed, and Volcker: The Triumph of Persistence will likely be regarded as the authoritative treatment of its subject. A professor of finance and economics at New York University’s Stern School of business and previously a senior vice president at Lehman Brothers, Silber brings an uncommon level of expertise and experience to the table. Moreover, he is armed with access to thousands of newly released documents from the Treasury and the Fed (their release facilitated by Volcker), pored over by a team of research assistants.

The result is an important but ultimately disappointing book. One problem is that Silber too easily comes across as a cheerleader. He compares Volcker to Clarence Darrow, James Bond, and Shakespeare, among others. More substantively, over the course of a hundred hours of interviews, either Volcker ducked every hard question, or too few were thrown. The statements mined from these sessions are, with a few exceptions, quips, asides, and bland homilies that add little to what we already know. “I just wanted to show . . . that I would back up my tough talk on inflation with action,” “the only time I ever rolled the dice was playing monopoly,” etc.

These shortcomings are reinforced by a faux-folksy writing style, as if Silber’s publishers urged him to make a complex subject intelligible to the broadest possible readership. But this strategy is often unsuccessful, as with the lengthy but unhelpful illustration of the law of supply and demand by way of analogy to the diamond cartel De Beers, or with the explanation that markets reacted to Volcker’s resignation from the Fed “as though Fidel Castro had become Fed Chairman.” The dollar did drop rapidly, but recovered its losses within days.

Finally, and most importantly, the book has an idiosyncratic structure. It is not a proper biography—for that, Joseph Treaster’s The Making of a Financial Legend (2004) is a better option. Instead, Silber homes in on “three crises”: the collapse of Bretton Woods (1971), the Volcker deflation (1979), and the Global Financial Crisis (2008). These are the right crises, and Silber adds to our understanding of all three. But he glosses over things like the Swiss Banks and Oil-for-Food. Worse, 1971 and 1979—fields already well tilled by scholars—are overrepresented, whereas the current crisis is allotted only two short chapters. This is a pity, because these brief discussions are the book’s best. More fundamentally, they suggest an arc to Volcker’s story that is obscured by the book’s episodic structure. For nearly three decades, Volcker, in dissent, has been pressing concerns about the growing risk of systemic crisis in the American financial system. It is not obvious that those risks have yet been adequately contained.

A child of the depression and the war, and son of the first municipal manager of Teaneck, New Jersey, Volcker holds traditional views about the tendency of unregulated finance to lead to crisis, the importance of economic stability, and a commitment to public service. And when it comes to banking, boring is better. “The fact is, God created the financial sector to help the real economy, not to help itself,” Nobel Laureate Robert Solow recently reminded a congressional committee. “We have got to the point where the financial services sector is creating risk rather than allocating it,” he added. These essentially conservative positions about the role and disposition of finance within the economy are part of Volcker’s DNA as well, but since the 1980s, they have been the positions of a dwindling minority.

Volcker joined the Nixon administration in 1969 with some ambivalence. A Democrat, he had campaigned for Adlai Stevenson and had not forgotten Nixon’s scorched-earth rhetoric against the Illinois Senator in the 1952 and 1956 presidential elections. But Volcker had a passion for public service, and the number-three job at Treasury was the one he wanted. The strains on the Bretton Woods system he had first witnessed in the Kennedy years were intensifying, exacerbated by the inflationary finance of the Vietnam War. The dollar was going to be at the center of things, and the undersecretary for international money would therefore wield considerable influence.

For nearly three decades, Volcker has pressed concerns about the risk of systemic crisis.

Push came to shove in 1971, when mounting pressure on the dollar forced dramatic action. The standard remedy would have been a dose of deflationary medicine. But Nixon, heading into an election year trailing in the polls, gathered his economic advisors at Camp David and decided instead on an option only available to great powers: he changed the rules of the game. Cutting the dollar’s ties with gold, he slapped on a unilateral import tax as well, to force allies in Western Europe and Japan to come around to the American way of thinking on currency realignment.

It fell to Volcker to negotiate these new efforts at repairing the system, which he very much wished to see—he had a well-deserved reputation for favoring international coordination and cooperation. Treasury Secretary John Connolly was known for a different perspective, famously boasting, “My basic approach is that the foreigners are out to screw us. Our job is to screw them first.” Silber reveals, however, that it was Volcker who urged Connolly to enhance U.S. bargaining leverage by letting the crisis fester “without action or strong intervention by the U.S.” Despite that leverage, Volcker’s two efforts to rebuild the system failed: the Smithsonian Agreement—Nixon called it “the greatest monetary agreement in the history of the world”—and the “Volcker Agreement,” reached after the greatest agreement collapsed. The subsequent wreckage gave way to a “non-system” of floating exchange rates.

Volcker held on in the Nixon administration for some time, eventually resigning in May 1974. Uncertain as to what would come next, he landed well, appointed president of the New York Fed, where he developed a reputation as a “hard-money” man—a vigilant hawk against inflation. When President Carter, trying to take charge of an economic and political crisis, took the resignation of his entire cabinet and pulled William Miller from the Fed and named him Treasury secretary, a new Fed chair was needed. Carter was wary of the advice he received. “Who is Paul Volcker?” was his initial reaction, and the answer—a tough, independent-minded conservative—did not win him over. But the name resurfaced in every discussion, and with inflation hitting double digits, desperate times demanded desperate measures.

Volcker tamed inflation, which approached 15 percent per year in 1980, and proved to be a stubborn customer. In retrospect the victory is well remembered, but at the time it was enormously controversial and brought about only at very high economic cost—unnecessarily high, many argued, and still do. This episode, and indeed Volcker’s entire tenure as head of the Federal Reserve, is covered in William Greider’s magisterial and essential Secrets of the Temple: How the Federal Reserve Runs the Country (1987). Volcker’s policies, as Greider emphasizes, undoubtedly hurt Carter’s chances for reelection. Interest rates under Volcker reached seemingly impossible levels: when he took over, the prime interest rate was already at its all time high of 11.75 percent. Within three months, it had risen to 15.5 percent; six months later it hit 20 percent; after the 1980 election it topped out at 21.5 percent. Adding insult to injury was an increase in the discount rate (the interest the Fed charges on loans to member banks) announced six weeks before the election.

Here Silber’s interviews come through, offering a distinctive insight into these pivotal events. “The timing of the discount rate increase was unfortunate right in the middle of the presidential campaign, and it might have contributed to Carter’s defeat,” Volcker recalls. “It was among the most difficult things I’ve done in my professional life.” Reading Triumph, this rings true. Volcker reports that he voted for Carter in 1976 and 1980, although one might speculate that this made the rate increase more likely. Perhaps the fiercely independent Volcker sought to distinguish himself, at least in his own mind, from Nixon’s Fed Chair Arthur Burns, whose policies met his president’s political needs. In any event, Volcker’s relentless stance on inflation extended well into the Reagan administration, and officials there held his policies accountable for their party’s dismal showing in the 1982 midterm elections.

Greider also overstates the extent to which Volcker espoused “monetarism,” the macroeconomic philosophy associated (especially then) with Milton Friedman. Monetarism holds that inflation is the result of undisciplined government policies and can be tamed by simply controlling the supply of money. Volcker was often associated with monetarism due to the fact the he orchestrated, in late 1980, a radical shift in Fed policy, from the targeting of interest rates to the targeting of the money supply. Traditionally, the Fed attempted to influence the economy by changing interest rates; the money supply would find its own level. With monetary targeting, the Fed would instead aim to influence the amount of money in the economy (this is actually much harder than it sounds in practice—the money supply is a very slippery beast) and interest rates would be set adrift. Volcker stuck with this approach, for better or worse, for three full years. And it was often worse. As Volcker plainly admits, interest rates rose higher, and disinflation proved costlier, than he had anticipated.

But Volcker, who was certainly no Keynesian, was no monetarist either. Nor did he have much time for the new kid on the block, rational expectations theory, which emphasized the efficiency of unfettered market forces and was deeply skeptical of the potential effectiveness of any government policy. (Volcker dismissively describes rational expectations to Silber as the product of “those crazy economists up in Minnesota.”) Rather, Volcker was always and everywhere a pragmatist. As he explains in his valuable oral history, Changing Fortunes (1992), it was unfortunate that interest rates rose to the point where they severely constricted economic activity, but if that’s what it took to tame inflation, then it was probably necessary. And it was only possible with monetary targeting because he “would not have had support for deliberately raising short term rates that much.”

Volcker’s resignation was met with glee in the Reagan White House.

This is not Volcker rewriting history, covering up a flirtation with orthodox monetarism. In 1978, as head of the New York Fed, he published “The Role of Monetary Targets in an Age of Inflation,” in which he explained that his “support of the use of monetary ‘targets’ does not start from a ‘monetarist’ perspective.” Not for the first time, he also expressed his theoretical reservations about that perspective. For good measure, and in contrast with those who saw monetarism as a quick and easy solution, he added, “The setting of monetary objectives should not by itself obscure the harsh realities confronting efforts to eliminate inflation.” Slaying inflation would inevitably hurt the real economy. Carter was right to be wary.

In 1981 Volcker became Reagan’s “problem,” and the new administration got off to a dismal economic start. Volcker would not back off his single-minded focus on bringing down inflation. In addition, he was an outspoken critic of the new president’s massive budget deficits. (Reagan ran on promises of big tax cuts, huge increases in defense spending, and a balanced budget. Forced to choose, he delivered on the first two.) Volcker clashed with all the president’s men—Donald Regan, James Baker, Ed Meese—who wanted Volcker out and a more accommodating monetary policy in. But when the economy turned the corner in 1983, Volcker’s reputation rose. With an election year coming up, dumping a highly respected, independent Fed chair was bad politics, so Volcker was appointed to a second term. Reappointment, but not rapprochement: Silber recounts the virtual guerrilla warfare waged by administration officials against Volcker, a battle in which time was on their side, as more and more Reagan appointees came to populate the Fed. After vacillating, Reagan ultimately chose not to appoint Volcker to a third term, and Volcker resigned, a decision met with barely restrained glee from administration officials (an episode well-covered in William Neikirk’s 1987 biography, Portrait of the Money Man).

With the end of the Fed years, Triumph leaps ahead to the present day. But this approach obscures fundamental continuities in the Volcker story. Silber does note in passing Volcker’s resistance to deregulation, and his later prescience about increasing risks of financial crisis. But he understates the intense clash between Volcker and the Reagan administration over financial supervision and regulation—responsibilities that fell within the Federal Reserve’s portfolio—and does not appreciate the extent to which Volcker’s regulatory commitments went hand-in-hand with his persistent concerns about financial stability.

Administration officials found Volcker’s resistance to deregulation almost as exasperating as his inevitably tight monetary policy. One example of the clash over regulation came in 1983 when a working group headed by Vice President Bush proposed shifting much of the Fed’s oversight and regulatory authority to the Justice Department. Fighting a pitched battle that extended into 1984, “an angry Volcker,” as the New York Times put it, “resisted efforts by the Bush staff to strip the Fed of most of its authority to supervise banks” and fought successfully to keep “what he called sufficient ‘hands-on’ supervisory responsibility to properly fulfill its role as a central bank.” In 1985 Volcker repeatedly testified before Congress in efforts to preserve the integrity of the Glass-Steagall Act, the depression-era law that established, among other protections, essential firewalls between commercial and investment banks.

With the tide shifting in favor of financial deregulation, Volcker became, as Greider says, “the foremost advocate for the re-regulation of finance,” which “outraged” the financial community and administration officials. Volcker lost this battle, as Reagan-appointed officials at the Fed, reluctant to challenge the chairman on monetary policy, voted against him on other issues. In Volcker’s final months as chairman, the Federal Reserve Board approved the request of three New York banks to expand their business into new areas of securities underwriting. “Bank Curb Eased in Volcker Defeat,” as the Times headline put it.

Volcker was replaced as chairman of the Fed by the libertarian economist and reliable Republican Alan Greenspan. Greenspan immediately used his authority to undermine Glass-Steagall, whose ultimate repeal in 1999 he would applaud as a “milestone of business legislation” that was “long overdue.” Later, he campaigned tirelessly in support of the successful efforts of Treasury Secretary Lawrence Summers and Senator Phil Gramm to prevent any regulation of derivatives. The ascendant deregulation crowd saw the rise of big finance as a triumph of sophistication, innovation, and opportunity. Volcker saw paper profits and systemic risk. He attributed the stock market crash of 1987 to volatility-inducing financial innovations, pausing to observe, “I don’t think these techniques add much to the sum of human endeavor.”

The market recovered, and in the 1990s, smart bankers were increasingly seen as more capable of policing finance than a dull, inefficient government could be. The sophisticated financial community could regulate itself via what Greenspan liked to call “counterparty surveillance”—each side in a deal had incentive to evaluate the other’s soundness. But for Volcker, big finance still meant big risk. Silber notes Volcker’s 1995 observation, “If you had a large investment bank aligned with a large [commercial] bank, the possibility of a systemic risk arising is evident.”

Concern for systemic risk is the red thread that weaves its way through Volcker’s thinking in the ’80s, ’90s, and ’00s. In an April 2000 interview published in the journal Macroeconomic Dynamics—still the best 25 pages on Volcker—he explains, “I think that financial deregulation has been another big strand of what I’ve been concerned about.” Seeing through the system, he expresses basic doubts about the risk models favored on Wall Street. “The banks want to run a risk management system based upon the idea that we have a normal distribution of outcomes,” he explained, suggesting that banks routinely set sail for uncharted economic waters yet assume the sea will always be calm. “But there ain’t no normal distribution when it comes to financial crises.” Volcker carried these concerns into the new century. But his worries about systemic risk were largely disregarded on Wall Street, in Washington, and even in university economics departments.

In 2007, on the eve of the financial crisis, Volcker surveyed the financial terrain of securitization, derivatives, collateralized debt obligations, and custom-tailored structured investment vehicles—“mysterious conduits of uncertain parentage,” he called them—and again sounded the alarm: “To those of us of a certain age, perhaps more sensitive to market history and the nature of human behavior than to the attraction of mathematical algorithms, it all looks confused and even dangerous, susceptible to excesses and breakdowns.” He dissented from the au courant position that “the financial market itself, left free and unfettered by official oversight . . . can reliably be self-stabilizing,” and expressed regret at the rejection of an older philosophy of regulation designed “to protect the core of the financial system from the recurrent bouts of speculative excesses and frightful contractions that have marked financial markets from time immemorial.”

Not bad. Unfortunately in 2008 President-elect Obama threw in his lot with the Clinton-era figures who led us to ruin. Dust for fingerprints at the scene of the global financial crisis, and those of Greenspan, Summers, and Gramm will be easily found. At one promising moment, Volcker, who had supported Obama during his difficult primary fight, discussed with the new president the possibility of serving as Treasury secretary. But instead Obama appointed Summers to head the White House National Economic Council (avoiding what would have been a bruising confirmation process for Treasury) and nominated Timothy Geithner, one of Summers’s top lieutenants in the Clinton administration, for the job Volcker had long coveted. Volcker’s consolation prize was a newly invented position, chairman of the President’s Economic Recovery Advisory Board. The Board had no resources or staff of its own, and Volcker worked virtually freelance. From his distant perch, he routinely clashed with Geithner and Summers. “They considered me an old man,” out of touch with the realities of modern finance, Volcker tells Silber.

But Volcker was also an energetic and influential man, and, by dint of his own efforts, championed what became known as the Volcker Rule, which was publicly endorsed by former Treasury Secretaries W. Michael Blumenthal, Nicholas Brady, Paul O’Neill, George Shultz, and John Snow. Designed to limit high-risk speculation by commercial banks, the Rule reflects Volcker’s longstanding fears of financial instability in a world of big finance. After much tumult, debate, contestation, and revision, it was passed, with vague provisions about exceptions, as part of the Dodd-Frank financial reforms.

As Silber concludes, “the Volcker Rule will work if regulators force bank management to make it work. Otherwise it will fail.” History does not leave us with much optimism.