Last week CME Group held its inaugural Global Financial Leadership Conference. The timing was prescient. There may never have been a time when national leadership is more important and unfortunately lacking than today.

The conference began the Monday following the collapse of Lehman Brothers and the acquisition of Merrill Lynch by Bank of America. And CME could not have selected a more appropriate speaker than former Federal Reserve Chairman Paul Volcker to open up the conference.

Volcker offered several warnings. He said that one of the consequences of the current crisis is that the remaining institutions get larger. “However necessary and desirable those mergers were in the short run, I worry about this tendency for these few financial [institutions] to get bigger and bigger. That is a somewhat troublesome tendency.”

Not a small point given that taxpayers are faced with a bill of well over $1 trillion dollars when you add the $700 billion bailout package still being debated with the rescue of Fannie Mae, Freddie Mac, AIG and Bear Stearns; who were bailed out because “they were too big to fail”

Now we may end up in an environment where we have fewer but larger institutions. They, of course, will be too big too fail and more worrisome is that they will know it.

“We have a failed financial structure,” Volcker went on to say. “It has been held together by extraordinary official acts. Actions that are unprecedented and goes to the edge of their legal responsibility.”

He was referring the unprecedented actions of the Federal Reserve and Treasury and he said it prior to Treasury Secretary Hank Paulson’s $700 billion bailout proposal.

Two days after he spoke, Volcker coauthored an op-ed piece in the Wall Street Journal where he suggested the creation of a mechanism to pull the bad debt out of the credit markets similar to the Resolution Trust Corporation, which was created to work off the excess following the Savings and Loan debacle of the early 1990s.

Volcker said the most important point was, “How do we deal with the compensation practices that seem to have violated any sensible limits in recent years. Compensation practices that seem to encourage risk taking without sufficiently discouraging those who take the risk.”

With all of the poor decisions, financials breakdowns, bad risk models, this is what Volcker said was the most important. It is telling that Democratic leaders had to fight to amend the initial Paulson proposal to include caps on compensation for executives from firms being helped by the bailout. How was that not in there in the first place?

Volcker did not say that the Treasury should do it alone, taking on more direct responsibility as was part of the original Paulson proposal. The Paulson plan may or may not be passed with modifications but the debate was similar to so many debates over the past seven years, where the administration basically asked Congress to allocate money but was not particularly forthcoming with details though the consequences of inaction were “dire.”

The warnings are coming from those who had not acknowledged a problem at all until very recently. One thing is certain, the consequences of not asking hard questions regarding the details have been dire.

Tags: bailout, Volcker

This entry was posted on Friday, September 26th, 2008 at 5:25 pm and is filed under Regulatory/actions. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.