Paul Volcker – a general fighting the last war

I promised a solid critique of VoBama’s reform measures announced recently as the Obama team desperately seeks something, anything, that helps make them look like they know what they are doing when it comes to the economy in the wake of the electorate’s rebuke in the recent Massachusetts by-election.

But Yves Smith over at Naked Capitalism has beat me to the punch and makes the essential point: Volcker is a general fighting the last war.

He wants to break up the “too big to fail” banks by splitting off proprietary trading, hedge funds and PE funds. But he ignores that these were not the source of the ongoing crisis! In fact, many PE funds and hedge funds and prop desks were its victims.

The source of the problem is the trading based nature of modern credit. Banks today do not hold credit, they originate it and then re-package it and sell it off to secondary markets. This helps capitalism in many ways but also sets up an often dangerously fragile new market. That market crashed in the 08 and 09 and we are still reeling from its impact.

Volcker, charmingly, wants to restore the banks of the days of Jimmy Stewart, which may be the last time Volcker was actually inside a bank. But that model of loan and hold in a local bank is long dead.

Obama needs to send his whole economic team packing and start again. He could do worse than hire Joe Stiglitz who, at least, understands the agency and information asymmetry problems created by today’s credit markets form of “banking.”

Volcker Does Not Get It « naked capitalism.