Comments on: Annals of rank hubris, Larry Summers edition

By: ArtFart

ArtFart — Thu, 23 Jul 2009 17:00:06 +0000

Summers may look like an idiot at the moment, but this ploy might yet become a stroke of genius if Bernanke ever stops printing money and giving it away.

By: Rick Kane

Rick Kane — Thu, 23 Jul 2009 16:39:03 +0000

I kind of disagree with “it seemed a good idea at the time defense.” Extrapolations twenty years out to the future are guesses in the extreme. To many Black Swans can happen. I don’t think a prudent fiduciary, who really feared being held accountable for his or her breaching a fiduciary duty would make such a gamble.

By: csissoko

csissoko — Thu, 23 Jul 2009 16:34:21 +0000

If Summers entered into the swaps when short term rates were at 1% i.e. 2003 to 2004, it’s not unreasonable to believe that he was just trying to lock in low interest rates on the debt. (He probably figured that the likelihood that the Federal Funds Rate would fall below 1% was tiny.)

In fact, given the likelihood of inflation in the middle run, unwinding these contracts may turn out to be an incredibly stupid decision.

The problem really is that collateralized interest rate swaps aren’t really hedges (unless you’ve got a direct line to the Federal Reserve for liquidity). When the contract moves against you the cash call can be so large that retail derivatives customers can’t carry them to the point in time where they would be valuable. Calling a product with these characteristics a hedge is misleading.

By: AD_NYC

AD_NYC — Thu, 23 Jul 2009 15:37:45 +0000

While I do not agree with Larry Summers on many things, I think comparing his actions (or anyone else’s who were involved) related to these interest rate swaps to Robert Citron’s actions is one hell of a stretch. For those interested, the book “Big Bets Gone Bad: Derivatives and Bankruptcy in Orange County” does a nice job of describing what happened with Citron’s investment strategy.

Regarding the article that is linked, we see this type of reporting from Bloomberg frequently. They are very good at pointing out trades that don’t look good on an ex post basis.
While their reporting in this manner might be an interesting story, it does nothing to assist decision makers with future decisions related to these matters. In fact it may be detrimental to the decision making process. Decision makers may remove viable options, regardless of how logical they may be on an ex ante basis, from the spectrum of possible options out of fear from articles similar to this one that could be written in the future.

By: HB

HB — Thu, 23 Jul 2009 15:32:59 +0000

Larry is mentioned in this article as being the one who suggested entering into the swap deals. It also details the other screw-ups that caused Harvard’s endowment to tank.

http://nytimes.com/2009/02/21/business/e conomy/21harvard.html

So shame on Larry. He belongs in the same doghouse as Ben Stein.

By: Gregg Stone

Gregg Stone — Thu, 23 Jul 2009 14:06:30 +0000

Excelent observation except please not ethat Larry Summers is an MIT grad, not Harvard.

By: dvictr

dvictr — Thu, 23 Jul 2009 13:54:41 +0000

I agree with Sean above…

However, the endowment would be much better off by hiring Penn MBAs.

On another note.. I think the “epicurean dealmaker” has coined the term “rank hubris”, a search on google is very dry.

By: sean

sean — Thu, 23 Jul 2009 12:42:43 +0000

are we really supposed to believe that Summers played a role in putting on this trade? there is nothing in the article that suggests Summers was being consulted by his $20mm/yr portfolio managers on trades like this.

By: jck

jck — Thu, 23 Jul 2009 12:18:11 +0000

it may be stupid (in hindsight…), but it’s a hedge.

By: Ron Mexico

Ron Mexico — Thu, 23 Jul 2009 12:13:15 +0000

Of course it could be considered a hedge. Harvard was going to start a big expansion and knew it would need to borrow a lot of money in the future, so it paid fixed on a forward starting swap to lock in a rate. It’s the same thing as the eurodollar futures market, or any commodity market (except for wheat, I guess), for that matter.

But even ex-ante, it’s a stupid hedge, because it doesn’t protect Harvard from a scenario where its debt widens a lot relative to swaps.

By: sunsetbeachguy

sunsetbeachguy — Thu, 23 Jul 2009 03:01:33 +0000

Felix:

Keep it up on Summers.

Easily Obama’s worst appointment.

Check out the broadside from the economist community on LS.

http://firelarrysummersnow.blogspot.com/