Volcker Says Finance System `Broken'

Volcker Says Finance System `Broken,' Losses May Rise

By Doug Alexander and Steve Matthews | 6 September 2008

Sept. 5 (Bloomberg)— Former Federal Reserve Chairman Paul Volcker said the U.S. financial system, dependent upon securitization rather than traditional bank loans, is broken, and may contribute to the weakest expansion since the 1930s. "This bright new system, this practice in the United States, this practice in the United Kingdom and elsewhere, has broken down," Volcker said today at a banking conference in Calgary. "Growth in the economy in this decade will be the slowest of any decade since the Great Depression, right in the middle of all this financial innovation."

The former Fed chief projected "a lot" more losses from the collapse in the mortgage-backed debt market, after the more than $500 billion tallied so far, should the U.S., European and Japanese economies fail to pick up. He urged changes in financial regulations, echoing calls among sitting officials and legislators. "It is the most complicated financial crisis I have ever experienced, and I have experienced a few," said Volcker, who has endorsed Democratic presidential candidate Barack Obama. Volcker ran the Fed from 1979 to 1987, and engineered an increase in interest rates to 20 percent to quell inflation that exceeded 10 percent.

Job Losses

Volcker's comments came after a government report today showed the U.S. unemployment rate rose to a five-year high as the economy lost more jobs than forecast in August. The report underscored concerns that U.S. consumer spending will weaken and push the American economy into a recession. Fed Chairman Ben S. Bernanke said on Aug. 22 that financial turmoil has "not yet subsided," and is contributing to weaker growth and higher unemployment.

Policy makers will "continue to review" the Fed's measures to ensure liquidity to determine "if they are having their intended effects," Bernanke said. "Changes are going to have to be made" to the global financial system, Volcker said. Banks three decades ago accounted for about 60 percent of U.S. credit. That later declined to about 30 percent as securitization— where financial firms package assets into bonds and other instruments and sell them on to investors and other companies— spread.

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