Volcker Criticizes Financial Engineering

Former Fed Chair urges return to production-based economy

Former Chairman of the Federal Reserve Paul A. Volcker harshly criticized financial engineering and emphasized the need to return to a more production-based economy in a speech last night at the Kennedy School’s Institute of Politics.

Volcker—who also serves as chairman of the newly formed Economic Recovery Advisory Board—spoke before a packed audience and fielded questions about the state of the economy.

In his speech, the 1951 graduate of Harvard School of Public Administration (the precursor to the Kennedy School), stressed that many of the causes of the recession have not been fully repaired.

“I don’t think we will have a sustainable recovery unless we deal with the underlying structural issues,” Volcker said.

He pointed to the proliferation of financial engineering techniques—such as credit derivatives and credit default swaps—as methods of “taking bad paper and making it look like good paper.”

Volcker also expressed fears about the government rescue of troubled banks. He argued in favor of a system in which the government could take over faltering institutions to prevent collapse—with the ultimate goal of dissolving such financial groups.

Volcker’s speech began somewhat inauspiciously, as the audience initially struggled to hear him.

“He is 6 foot 7, so he was too tall for the microphone on the podium to record him,” explained Christopher J. Hollyday ’11, the chair of the IOP Forum Committee. Volcker, nicknamed “Tall Paul,” was quickly fitted with a personal microphone instead.

Following his speech, Volcker spent nearly an hour answering questions from the audience about the lessons that could be learned from the economic meltdown.

When Adam B. Chepenik, a student at HKS and Harvard Business School, asked Volcker for his advice to students, the former Fed Chair discouraged young audience members from going into the world of finance.

“Producing something real can be as much of a challenge as making a million dollars in the financial market,” he said.

Following the event, Grant N. Wonders ’12 said he was pleased with Volcker’s ability to respond to a wide array of questions.

“He did a good job of bridging the gap between an academic perspective and applying practicality in a modern economy,” Wonders said.

Hollyday said he was similarly impressed by Volcker’s talk.

“It was really cool to hear such a giant in economics speak about the current crisis,” he said.

—Staff writer Evan T. R. Rosenman can be reached at erosenm@fas.harvard.