Monitor Breakfast

Thursday morning was Paul Volcker's third appearance at a Monitor breakfast. His first was in August, 1979, the month he took office as chairman of the Board of Governors of the Federal Reserve System.

Mr. Volcker has had a distinguished career of public service. He was undersecretary of the Treasury for Monetary affairs (1969–'74) and later served as president of the New York Federal Reserve Bank (1975–79) before becoming chairman of the Board of Governors.

After leaving the Fed in 1987, was chairman and chief executive officer of Wolfensohn & Co. He also chaired the Independent Committee of Eminent Persons investigating the role of Swiss banks in handling the accounts of victims of Nazi persecution.

In February of this year, Mr. Volcker was named Chairman of the Independent Oversight Board for Arthur Andersen LLP.

Mr. Volcker is also chairman of the Trustees of the International Accounting Standards Committee and chairman of the National Commission on Public Service.

"It is widespread. It depends, I think, partly on what industry you are in.

But you have a whole profession that has arisen in the past 15 years or so called financial engineering. That has kind of a connotation of very sophisticated operations to take advantage of aberrations in the market to protect yourself from risk or whatever. But a large part of it is how to get around accounting rules and IRS rules... You have a lot of people figuring out how to get around the rules, how to strain the rules or whatever.

The cumulative impact I think is substantial. Now how you deal with that is what we are grappling with."

"It depends on the company again. But I think you have a basic problem there. Business has gotten a lot more complex. Particularly in the financial area with all these derivatives, options, swaptions, and all the financial engineering that is going on.

You have got all that complexity, maybe partly kind of phony but partly real. You have a great increase in the relative importance of intangibles...Part of the problem is, I think, the accounting standards, the accounting rules, haven't kept up with reality. Having said that, I don't know any magic bullet for catching them up. It is a very complex area and I don't know if we are being sufficiently imaginative. In some areas maybe we are being too imaginative."

"I think the average American with no particular expertise in this area and no particular background that enables him to decipher statements has to rely on the professional investor. You have to go to a mutual fund, other avenues of that sort.

Then it is a question of how you pick that (professional investor). I think it is very hard for the average person to do better than an index. I think it is very hard for the professional to do better than the index."

"What is even more striking than the resistance to auditing reform is the degree to which American industry and the Congress rise in wrath when there is any talk about expensing stock options.

....as part of the process which you are describing [how corporate executive pay in 2000 was 458 times as much as ordinary workers] the abuse of stock options has been enormous.

We have discovered that an instrument that was rationalized as aligning the interests of management with the stockholder has, in my opinion, too often become an instrument for aligning the stockholder with the interests of management.

They could be used, like derivatives, constructively but the way they are ordinarily used...has very capricious results. You can get a big payoff when your company is doing relatively poorly, relative to its peers in the midst of a great stock boom. You can get a big payoff when your stock hasn't done as well as you would have done investing money in government bonds.

The relationship between reward and prudent, effective management is obscure in many case and I think it gives a bad incentive ...."

"All this talk about what we do when we get rid of the federal debt never kept me up awake. It sure got reversed in a hurry.

Because of Sept. 11, it was a great excuse to forget about all this consensus that existed on fiscal discipline. The feeling was 'Throw off that straightjacket and we've got to spend all this money on defense.' And since we are spending it on defense, we will spend it on everything else, too. It is fairly obvious it is going to give us some problems over time.

What happened to the lockbox? The lockbox didn't lock very well. We not only blew through the lockbox, we blew through the whole surplus."

"I think there are some unsustainable disequilibria in the American economy that might have been partly corrected during the so called recession...but I don't think were.

They resolve around the conundrum of we spend everything we earn, we import everything we consume, that's exaggerating a bit but not by much, we have a big current account deficit. The counterpart of that has been a great influx of capital and that influx of capital has made up for our lack of domestic saving. It has been fine so long as it has lasted.

But we have to ask if that particular pattern is sustainable. It looks even less sustainable if you have a [federal] budget deficit than if you have a budget surplus ...I don't think it is sustainable. At some point, that adjustment is going to have to be made. ....I can't convert that into a short-term prediction.

...Sooner or later, there are going to have to be some big corrections..."