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Paul Volcker


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Following is the unofficial transcript of a CNBC EXCLUSIVE interview with Paul Volcker, Former Fed Chairman, and Bill Isaac, Former FDIC Chairman today throughout CNBC's Business Day Programming.

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Volcker & Isaac On Fin Reg

Insight on financial reform, the Volcker rule and derivatives legislation, with Bill Isaac, former FDIC chief and Paul Volcker, former Federal Reserve chairman.

LARRY KUDLOW: All right, many thanks to Paul Volcker, former chairman of the Federal Reserve Board. And Bill Isaac, former chairman of the Federal Deposit Insurance Corporation. The book, by the way, is Senseless Panic. Mr. Isaac has just written this book. Paul Volcker writes very complimentary introduction. I don't know about what that’s going to cost yo-- (laughing) it's a very lovely forward that you wrote.

I also want to say, right at the beginning, that Mr. Volcker is-- headlined in the Financial Times this morning. And I really want to begin there on this bank regulation issue. Essentially, Bill Isaac argues the essential fact that we could have avoided this meltdown in 2008. Paul, I just want to ask you, since you're in the news this morning, regarding-- banks swapping out their derivative position, spinning off their derivative positions, the papers are reporting that you are now coming around that they should do that? Is that correct?

PAUL VOLCKER: Well I --, I have not said they should do that but--This has been, obviously, a very controversial issue. And the original proposal was very sweeping and raised questions about whether the banks could engage in-- and derivates are derivates at all. And particularly credit default swaps whether they could even—at least the question was raised whether they could do credit default swaps for their customers, whether they could hedge their own position with the derivative.

And I actually-- wrote the Congress, at that point, saying, "I thought this was much too sweeping. That-- the legitimate concern about trading would be taken care of." But what’s become known as the Volcker rule—where trading and derivates would be excluded by banks. The legislation now, which I-- proposed legislation, which I’m not as familiar with as I should be, is certainly taking account of some of the objectives. That those leave, at the very least, derivative trading in a subsidiary of the bank whether, rather than the bank itself.

LARRY KUDLOW: Are you okay with that----affiliate (?) of the bank's holding company, Paul, how would you do this?

PAUL VOLCKER: Well, I— you know there are lots of affiliate bank holding companies. I—-my mental approach of all of this stuff these days, Not back 20 years, these days, It’s very hard to make a distinction between the bank and the holding company and its affiliates. They're all together on the common management. They're all mutually, at the end of the day, mutually supportive. And it may be useful in some cases to have particular activities separated out. Issue here seems to resolve itself around how much capital you would put beyond the-- derivatives desk. There certainly should be capital behind it, whether it's in the bank (LAUGH) or separately, in the holding company. But that—

LARRY KUDLOW: Just to-- I don't mean to push, but it's so important, because literally the whole world is-- is hanging. You have great influence on this project right now. The-- the confidence-- House/Senate confidence, as I understand it, needs tomorrow to make a bill in the next week or two. Can you live with these derivatives in the bank holding company, outside the bank? Can you live with that? Or do you want to spin it off altogether?

PAUL VOLCKER: No, no. I don't want to spin it off outside the-- the whole commercial bank. The whole commercial banking organization, which was I think the original idea. Which was, in my terms, too sweeping. I don't think that's necessary. Whether it ends up in a subsidiary of the bank itself-- useful debate. But the banks should not be prohibited-- I think this becomes clearer, which I tried to say to this reporter. I don't think now there's any question about whether the bank can use the derivatives in terms of its own mismanagement. Or indeed sell those derivatives, and respond to a customer's request to buy a derivative, kind of be a middleman in response to a customer request. In any event, they don't want to miss trading operations, because that's excluded in the amendment which I have forcefully-- supported.



LARRY KUDLOW: I'm gonna come back to the Volcker in effect. Let me just get Bill Isaac, former FDIC head. Can you have a firewall-- if-- if Paul's idea works, and the bank can trade just derivatives to swap and so forth, it's all risk management. Can you have it inside the holding company, as an affiliate this time with a real firewall from the taxpayer-insured FDIC deposit-- Does that work for you?

BILL ISAAC: That's not going to work. Either you’re going to-- either you're gonna protect the whole organization or you're not. We can't-- you can't let-- an affiliate fail. If you're-- if you're-- if you're objective is to-- is to-- to protect the entire organization. And I-- I've been of the view that-- and I think the FDIC has been of the view that rather than have activities outside the bank and holding company affiliates where they create a moral hazard and a legal hazard-- and a reputational hazard to the bank.

Well, all the risks are there no matter where it is, to the whole enterprise. Can you imagine one of the largest banks in the country seeing its derivatives-- affiliate go down and not have it cause a run on the bank? And-- and a total loss of confidence in the bank? So, the FDIC's view has been-- it is better to have these activities in the bank, where they can be regulated properly by bank regulators, and where the bank gets the profit from it, not just the risk, if it's going bad.

If it's-- I mean, the bank's gonna have the risk, whether it's in the holding company affiliate or in the bank. There's gonna be a risk to the banking organization, the bank should have the profit from it. And I think Paul made a really good point. This is all about capital. Are you going to capitalize these derivatives activities properly? And so far, you know, in the past, we have not.

LARRY KUDLOW: I mean, my understanding is that Senator Blanche Lincoln (PH), who has won her primary race finally, comes back to Washington. She wanted banks to spin it out altogether.

PAUL VOLCKER: Well I think that was the original motion, as I understood it. That's what I that's going too far. Now, just where it stands, I don't know. Lots of what Bill says about it in the banking organizations, that’s in the banking organizations. Very hard to separate this out. Regardless of the particular rules there are about trading between the bank and the subsidiary. I mean there are such rules.

So, it comes down to a matter of-- I think how you arrange the capitalization, how you arrange the supervision of this entity, I think you can argue both ways. But I don’t disagree with what Bill says—Once you’re part of the holding company. Once you’re part of that banking organization, you can’t have parts of it go down and parts of it not go down.

LARRY KUDLOW: All right, so, let's go to the Volcker Rule, the next big topic of discussion. And from everything I've read in your statements, you've given a couple of speeches recently. You are being tough on this. I'm calling it mean, nasty, and brutish. You want no exceptions. There should be no hedge funds, no private equity funds owned by the bank. Is that correct?

PAUL VOLCKER: Owned by the banks? Is correct.

LARRY KUDLOW: All right. And is that gonna be in the legislation?

PAUL VOLCKER: Well, that's the way it is in-- in both the Senate Bill and then the—-main amendment that’s being debated, the Merkley Levin amendment. The problem with making the exceptions with plausible cases by individual institutions is once you begin, you can never stop. And if you make enough exceptions, you no longer have a rule. So, yeah, I would like to see the rule, well, au naturel, the basic rule. And I think a lot of the banks-- very few banks are involved in this, first of all. There are maybe five banks in the United States for which this is a big issue, but because they’re big banks, this issue is if I can—it’s not what happens in those present banks, what did happen, and what happens now.

But if you don’t have this rule, what stops any financial institution from buying the bank, saying, "I'm a bank," getting a banking license, mixing up their trading activities with their-- their banking activities. I-- we do not want, in my view, the United States government implicitly standing behind the trading activities of these institutions, whether they're in a bank or outside the bank.

LARRY KUDLOW: What about industrial company? And in fact, I have one in mind. Our parent-- NBC's parent, General Electric. They have a big financial and capital operation.

PAUL VOLCKER: That is why I am aware of this. Every time there is a banking law, somebody would say, "Well, in Utah we have an industrial bank. Let’s let them inside the tent.” And somebody else says, "A little thrift. Let’s let them inside the tent" And after awhile, they-- people who don't have both say, "I want them too." And it’s hard to draw the line. That’s why I would like to make this as clean as possible.

LARRY KUDLOW: All right, so Volcker to banks, "No hedge funds, no pr-- no private equity

PAUL VOLCKER: Let me—let me say -- I am saying a bank can do investment management. It’s a big business for these big banks. And I think in most cases, they can reorganize to the extent they have hedge funds, which is not common. To the extent they have an equity fund, which is not common. They can provide access by their customers, clearly the hedge funds, and equity funds, the other people have. They can also, in effect, have-- what amounts to a mutual fund, within the bank. That they can put their customer’s money in, but no bank ownership.

LARRY KUDLOW: No I--I hear you. I think Congress hears you. I think you're gonna win this battle. Bill Isaac, do you agree with Mr. Volcker on this?

BILL ISAAC: Absolutely.

LARRY KUDLOW: Yeah. That comes out in your book. I just wanted to give you a chance to—


LARRY KUDLOW: Well, if he wrote such a lovely forward, you really have to go with him on it.

BILL ISAAC: Act-- actually, I would go further with that. I-- I actually would like to see us return to the Glass-Steigl restraints. As they were in 1999 when we repealed the last of them. I-- I think we've gone too far in-- in-- repealing Glass-Steigl. I-- I actually was in favor of it at the time.

LARRY KUDLOW: Yeah, I remember.

BILL ISAAC: Paul was opposed to it, at the time. He-- I think he was right. And-- and I thought we could regulate these activities better than we can. And-- so, I really would like to see us go further than the Volcker Rule. But I certainly would like to make sure we go at least that far.

PAUL VOLCKER: Well, I-- I actually was not opposed to banks getting into underwriting. And consistent what I am proposing now banks--banks could do what was considered traditional investment banking. 20, 30 years ago. You could do underwriting. And trade in the securities that they have underwritten. In the after market, which is an essential part, I think, of underwriting. We didn't have credit default swaps. We didn't have all this trading activity-- back 20 years ago.

We didn't have it even when Glass-Steigl was finally-- ended in-- in 99, no. Credit default swap's only invented in '98, right? Something like that--And-- and the trading activities has become so dominant in some cases. And what really sparks a concern is big trading organizations, not that many were trading but in the midst of the crisis, they were given banking licenses. The implication is that they could have access, they have access to the FDIC, which means government support. And we don't want to give, I think, the message that basically trading operations. They should stand on their own. If they fail, they fail. But they shouldn't be supported by the government.

LARRY KUDLOW: Okay. I think a lot of people agree with you about that point. But Bill Isaac, look you and I have talked about this on Kudlow Report many times. It’s in the book. Do you really, in your heart of hearts, don't believe we can end too big to fail?

BILL ISAAC: No. I-- we-- we clearly will never allow our largest banks to go down. Uhh, I’m making Paul uncomfortable right now--.

LARRY KUDLOW: --I mean, look this is a gigantic issue. I think that you just gave a talk -- or at least I read it in the New York review of books-- that you said big—too big to fail and the moral hazard going along with that is the preeminent question. You're saying, you said this to me on the air very directly or very consistent. You’ve said we are not gonna end it for the big bank, we really won’t end it, and you’re saying we shouldn’t end it.

BILL ISAAC: We have five banks that control over 50 percent of the banking system. No government can allow very large banks that control over half the financial system to go down. It-- it would-- destroy the economy. And-- and in the case of the United States, it would destroy the economy of the world. And I don't believe-- even if this legislation said expressly, "You may not do anything to support a big bank."

PAUL VOLCKER: Which it doesn't.

BILL ISAAC: Which it doesn't go that far. But if it did, we would-- when the next crisis came, we would jump in with more legislation to-- to bail out those banks. I-- I don't have any doubt about that. And I think that-- that what-- what-- what that leads me to is that we've got to come up with a much better way to regulate these banks than we-- than we have right now. And that's-- that's the signal deficiency proficiency in the legislation before the Congress.

LARRY KUDLOW: I see-- I love it when I see a smile like this. (Laughing). Go ahead, what? What are Paul Volcker.

PAUL VOLCKER: I think the answer to Bill’s legitimate concern has to be that these handful of megabanks are gonna be regulated closely enough, and because this rule against proprietary trading is just one part of that. It's a much larger question than simply proprietary trading. But I would expect that they are gonna be regulated closely enough and have their own responsibility amplified clearly enough so we won’t face this -- this quandary he has. But there's an important provision in this bill that's kind of, in my view, the heart of the bill.

It’s got this provision for a regulatory-- for a resolution authority. And that will prevent a government agency, presumably the FDIC, to step in at a failing financial institution and take it over. And take it over with the end objective of liquidating it. Now, I think that's a workable proposition for anything short of these biggest banks.

LARRY KUDLOW: Do you believe that? Seriously you believe they would do it? I mean, I have to agree with you, on paper it sounds great.

PAUL VOLCKER: Well, we—-we sure should give it--give it a full try, because I don't see any other way to do it. And this is kind of common ground internationally. This concept has been accepted by most banking regulators in Europe and the U.K. and elsewhere as the way to approach it. So, we don't have what we had during the crisis. We had the government not just saving banks, they were saving everybody. They weren't just saving-- that was the least of the probably, saving the big banks frankly. The problem was they were saving the investment banks, they were saving industrial companies, they were saving all-- all kinds of people.

LARRY KUDLOW: So, you would say no to that.

PAUL VOLCKER: No to all that. No to all that.

LARRY KUDLOW: And you think this leg—let me ask both of you—this legislation and subsequent implementation of this legislation say no to all that?

PAUL VOLCKER: The legislation certainly says it. And I don't-- I think it is a practical proposition, certainly with those institutions.

LARRY KUDLOW: Do you-- do you agree, Bill? Is this legislation tough enough to do what Paul wants?

BILL ISAAC: Well, keep in mind that it-- the legislation is not gonna top-- it's not gonna prevent the-- the top five banks from being saved. We will save them. And-- and probably go down lower than th-.

LARRY KUDLOW: How about G.E.? How about G.E.? What about-- what is the G.E. capital--

BILL ISAAC: will probably go down lower than the top five. I would also point out though that in this latest go around. We actually used taxpayer money to bailout car company and automobile finance companies. Insurance companies and the like. And the-- the question is whether we-- we're going to have the courage in the middle of the next crisis to enforce that. And my guess is if-- if-- if it's bad enough, no, we’re not. We're gonna—

PAUL VOLCKER: Well look, you have an enormous crisis, who knows what happens, but I think the automobile companies, the industrial companies are a different problem. That's a political decision. It was a political decision. It took legislation to do it—-So put that aside, but we're talking about financial institutions. And I agree with what their message here with General Electric and others that they had a financial institution that was big enough and precarious enough to threaten the whole, United States’ best industrial company.

LARRY KUDLOW: G.E. Capital. It's a gigantic bank.

PAUL VOLCKER: And that-- that shouldn't happen. And they should be excluded from the banking li--it doesn’t just on the face—- it doesn’t make sense for General Electric to have a banking license, in my view. And that if it did fail—so it goes.

LARRY KUDLOW: All right. Speaking of all this too big to fail, your book, Senseless Panic, it's a great read. It's a short book, right to the point. I appreciate that and I think you can get a lot of sales on this book. You basically think we could have avoided the panic of 2008. You basically didn't like Tarp. You hated the idea of Tarp. If you could just elaborate on that. Then I want to get the great man to weigh in on it.

BILL ISAAC: Well that—it’d be a fair assessment, I hated Tarp—

LARRY KUDLOW: Yes, I-- I mean, I read the book. I did my best. I was crashing on it all day yesterday. Right after my tennis game, I sat down and committed the book to memory. But you really hated the Tarp. I think there's a lot of people that agree with you. But just give us a point or two why.

BILL ISAAC: Well, I-- there's-- there's two reasons why I believe we got into the mess we got into. And that is, we put in place a whole bunch of faulty policies during the 1990s and through the 2000s that were-- we had a whole series of highly pro-cyclical accounting and regulatory rules that really helped us feed the boom, the economic boom-- and-- and-- and then once the-- the best hit, it was really hard to pull ourselves out of it because of all of this—this pro-cyclicality And I’m talking about capital rules I'm talking about liquidity rules, I’m talking about and talking about FDIC insurance premiums.

LARRY KUDLOW: You're talking about mark to market, right?

BILL ISAAC: I'm talking about—I’m very defiantly talking about mark to market.

LARRY KUDLOW: That was one of the dumbest things in the history of the world.

BILL ISAAC: Exactly. And then I believe-- mark to market was-- was-- one of the worst things that's ever happened.

LARRY KUDLOW: And how much capital did that cost the bank?

BILL ISAAC: It destroyed over $500 billion in capital. And it-- it's really interesting, because you-- you look at the charts on-- on the financial aspects that they were marking to market. They went down like this. And now they're all back up here.


BILL ISAAC: It was senseless to write off all of that capital—

LARRY KUDLOW: And you prefer-- just to clarify this-- I don't want to spend too much time, but you want cash flow accounting or cash flow valuation rather than-- trading valuations from minute to minute which may or may not be—

BILL ISAAC: If instruments are in trading accounts, and they're part of the inventory, of course I want them mark for market. But if they're not in trading accounts, if they are—alone—

PAUL VOLCKER: But the basic loan---loan portfolio—

BILL ISAAC: The loan—no you would never mark right now (UNINTEL PHRASE) about mark to mark on.

LARRY KUDLOW: Paul they’re talking right now, as your know about mark to market on loans—

PAUL VOLCKER: I’m glad you raised the point.

BILL ISAAC: What the heck is that-- this is like the—


BILL ISAAC:-- number two.

PAUL VOLCKER: Well, Bill and I basically view the mark to market accounting-- thing alike. And it’s appropriate for trading operations, it’s appropriate for instance, if your going to trade. It's not appropriate for the basic portfolio of instruments that you have created with a customer and intend to hold. The loan portfolio. Now we have coincidentally a question of where we're going in international accounting generally.

And you have a int-- international accounting standards board. And you have a domestic fasby. The object is to bring them together. And there’s a lot of support to bringing them together, to convergence. So, we have one accounting standard around the world. Now, a rock has been thrown into that particular puddle by fasby reiterating a very strict mark to market for banks. The international people, after reviewing the situation said “no , we have a much more differentiated approach.” The loan book is evaluated-- on its own merit.

If the value is impaired, if the loan is not paying or threatens not to pay, well, you have to make some adjustment on the book. You may have a footnote for-- market valuation and some of these stuff. But the basic account should assume—it as a growing organization with a stable book—except on the trading side. Fasby’s going the other direction. Now this is a big clash between the international and the domestic.

LARRY KUDLOW: Have-- have you talked with Members of Congress about this? I mean, doesn't fasby need adult supervision?

PAUL VOLCKER: Well, I don’t know why fasby felt at this point that it had to go out and make this. It’s not settled fortunately. Fasby has it out for comment. And I hope they will get enough comments to say that this is not suitable on its own merits. And certainly not suitable to lead to -- unnecessary flare ups with the international where I think the weight of the evidence is certainly on the international side—and we end up with a, hopefully an international accounting system that makes sense.

LARRY KUDLOW: Let me ask-- I guess the last question about the-- we're almost two years after this financial panic. Not quite two years. We've got people out there worried about European, Greece, and not only the sovereign debt, but also the-- loans in the bank that own the sovereign debt. You've got a lot of observers here at home, worrying about a new wave of subprime, adjustable rate mortgage delinquencies. Bill Isaac, start with you. Can our-- is our banking system healthy enough today to defend against these new threats?

BILL ISAAC: I believe it is. But-- but I-- but I-- I share your concerns. I mean, I-- I really think the world is still—a pretty dicey place. And-- that we can't-- we can't rest right now. We-- we really have to be vigilant and make sure that-- that we're prepared for-- whatever comes. And I'm-- I'm hoping that-- that this-- recovery we're in will stay and we'll-- we'll continue to see economic-- growth.

But-- but I-- I-- I don't think we can let our guard down. And I think the Fed has to be very vigilant about things. And I would-- I would-- just one last word-- if I could on-- on-- I didn't really answer your last question. Yes, I really dislike TARP. I believe that it was a serious mistake. And I believe it did more harm just trying to sell it. We scared people. And-- and they never even knew that the $700 billion of toxic assets, that I said was a really bad idea.

LARRY KUDLOW: It was a classic political statement—

BILL ISAAC: Yeah, they didn't even use it—

LARRY KUDLOW: But you're saying that the FDIC guarantees the interbank market and the other debt and liabilities, along with the Fed, backstopping commercial paper and-- money market accounts.

BILL ISAAC: I believe the FDIC and the Fed stopped the crisis—

LARRY KUDLOW: That really stopped the panic and we didn't need to throw this money around. And then fixing the market to market just to satisfy your point.

BILL ISAAC: Yeah, I-- I would agree with that. And I failure resolution process was-- was-- schizophrenic. We-- we really scared people. Nobody knew what to expect. Let this one fail, bail this one out and so forth, back and forth. And nobody really had a way of predicting what was gonna happen next. Who was gonna fail next. How was the failure gonna be handled? And we scared people. They didn't know. I-- I really think there's—

PAUL VOLCKER: I agree with Bill's comments about looking ahead. The banking system, I think it’s in a better position now than it was before. It absorbed a lot of losses, it’s been able to make a lot of profit from various operations and interest rates of zero them. So it turns out, it’s advantage of banks for making money. But still, there’s the whole world is suffering from the fact that you had to much debt out there. All you do is see too much leverage. We now see it in Europe—we see it in European countries, we see it in states, in the United States, you see it in Japan—

LARRY KUDLOW: And you-- just in the last-- 24-48 hours, we got another $50 billion spending bill. Congress is looking at another couple hundred billion dollar stimulus package. The Treasury just declared, what? $20 trillion debt—

PAUL VOLCKER: When we get through this—regulatory business. I-- I actually think this regulatory bill, if it passes, has enough good, basic stuff in it, it's gonna help getting some international congruence and-- and better supervision regulation. But we've got the whole mortgage market to worry about in the future. We've got the deficits to worry about in the future. Those are things for next year. And we can't solve those immediately, both of them are gonna take a long time to resolve and we've gotta get at it-- begin to get at it next year.

LARRY KUDLOW: All right, next year. Paul Volker, thank you very much. Bill Isaac, thank you very much. Name of the book is Senseless Panic. Mr. Volcker wrote one heck of a nice introduction for Mr. Isaac. I just want to say I've known Bill Isaac many years, it's an honor. I actually once worked as a secretary for Paul Volcker. I don't know if he has recovered from that yet. I'm Larry Kudlow. Thank you.

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