Paul Volcker told a large Toronto business audience that unlike some previous speakers at the Canadian Economic Forum like Sarah Palin, he believes in government. But it hasn't been doing well lately.
He then proceeded to discuss growing global imbalances and deep flaws in the financial system that led to a collapse.
The U.S. and Europe overborrowed. Borrowed Chinese money went to subprime mortgages instead of investments to make the economy more efficient and productive.
He also criticized fancy theorizing about efficient markets that dazzled economists and enabled Wall Street to justify excesses.
Mr. Volcker, who was chairman of the U.S. Federal Reserve under Jimmy Carter and Ronald Reagan, still refuses to second-guess Ben Bernanke, but says unprecedented Fed actions have hurt the central bank's ability to stay above the political fray.
He still, however, believes the Fed should be the top regulator of the financial system and approves of new legislation doing just that, with a vice-chairman assigned just to oversee regulation.
On the economic front, he said stimulus helped keep things from getting worse. He suggested that now is not the time to raise taxes, but said Americans will have to be convinced that future tax hikes will be required to rein in the deficit.
He also called for reform to U.S. social security to reduce the massive expansion of its cost.
Mr. Volcker said the Basel rules on banking failed to safeguard the financial system. He said reforms will help, but will face a fight from the global bank lobby. He said new laws will have to be passed along with the structural changes or the same problem will reappear.
He repeated the "old fashioned" view that banks benefiting from safety nets provided by governments should not engage in proprietary trading, saying public money should not be used to rescue the casino in the back room.
Mr. Volcker, however, repeated his view that the mortgage market should eventually go back in the hands of the private sector. The residential mortgage market in the U.S. "is now a wholly owned subsidiary of the federal government."
Globally, imbalances hurt both China and the United States. But for years, this situation benefited both sides, so nobody did anything about it.
"Were we all blind?"
Japan had a shock in late 1980s and early 1990s that was much greater in percentage terms than anything that hit the United States. The Japanese are still suffering and can't solve the problem with monetary policy.
Mr. Volcker doesn't believe in inflation targeting. The key, he says, is price stability.
When he hears people say there's not enough inflation, he says "Whoa, I've seen this movie before."