The good things about Larry Summers

By Felix Salmon
October 5, 2009
Ryan Lizza piece on Larry Summers is long -- over 11,500 words. And even then it manages to say absolutely nothing about some key issues, such as the $5.2 million he was paid by DE Shaw to work one day a week in 2008; neither does it talk at all about the allegations of Summers actively working to marginalize the influence of Paul Volcker. But Lizza does get Summers to admit to mistakes during his tenure at Treasury, at least as regards the subject of derivatives:

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Yikes the Ryan Lizza piece on Larry Summers is long — over 11,500 words. And even then it manages to say absolutely nothing about some key issues, such as the $5.2 million he was paid by DE Shaw to work one day a week in 2008; or the allegations of Summers actively working to marginalize the influence of Paul Volcker; or l’affaire Shleifer. But Lizza does get Summers to admit to mistakes during his tenure at Treasury, at least as regards the subject of derivatives:

In Rubin’s memoir, “In an Uncertain World: Tough Choices from Wall Street to Washington,” he describes the debate that he and Summers had over the issue. “Larry thought I was overly concerned with the risks of derivatives,” Rubin writes. “His argument was characteristic of many students of markets, who argue that derivatives serve an important purpose in allocating risk by letting each person take as much of whatever kind of risk he wants. Larry’s position held together under normal circumstances but seemed to me not to take into account what might happen under extraordinary circumstances.” Summers told me, “If we had known that derivatives markets would mushroom the way they did and that regulators would remain spectators, we would have acted. With hindsight, all of us with involvement in financial policy wish we had done more to forestall problems.”

This is a good find from Rubin’s book — which was written, remember, in 2002, many years before the CDS exposure at AIG Financial Products threatened to bring down the entire global financial architecture. And although it’s now pretty clear that Summers’s deregulatory impulses as Treasury secretary had pretty gruesome consequences, it still reflects well on Summers — a man of no small ego — that he is willing to admit as much.

Lizza also provides a lot of detail on Obama’s decision not to nationalize the banks:

On March 31st, Summers sent the President a page-and-a-half memo outlining the reasoning behind the decision not to nationalize any banks. Obama was on his way to the G-20 meeting in London, and he wanted to be prepared with the best case against it.

The memo was divided into four sections. First, Summers explained that there was no legal authority to take over large bank-holding companies like Bank of America and Citigroup. Next, he pointed out that full nationalization of a financial institution might trigger systemic shocks, as investors retreated from other banks, creating exactly the kind of panic that nationalization was intended to prevent. (As Sperling often argued, “You might come out and say, ‘I’m gonna take over Bank of America and Wells Fargo, but everybody else is safe!’ Maybe they believe you. And maybe they don’t. But if you get this wrong the Dow’s at thirty-five hundred! You’re the worst economic manager in the history of the United States!”)

Furthermore, Summers said, there was a medium-term risk that nationalized banks would lose value, in the same way that the act of foreclosure decreases the value of a home. Summers pointed to the example of Sweden, which was regularly cited by economists who favored nationalization. But Summers noted that Sweden didn’t nationalize for two and a half years, by which time the situation had become so severe—interest rates had reached a hundred per cent—that there were no other options. In addition, Nordbanken, the largest bank nationalized in Sweden, was already eighty per cent government-owned. Summers concluded by emphasizing that nationalization was a strategy that governments turn to only after it is very clear that nothing else can work.

In hindsight, Summers was right and those urging nationalization were wrong. (Which group includes Paul Krugman and Nouriel Roubini, as well as me.) What I’m particularly happy about is that the debate took place, in a lot of detail, within the White House, between people who had no ideological axe to grind and who were intent on working out the objectively right thing to do, given the uncertainty surrounding the banking system and the economy.

I can see why Summers’s memo could not have been leaked at the time — the worst possible outcome would have been to reveal that the nationalization option was being seriously debated at the White House, sending markets into a tailspin which then would have gotten even worse when the government revealed that it wasn’t going to nationalize after all. But in hindsight, Summers seems to have made some very strong arguments.

Lizza’s article concludes with this:

So far, none of the worst fears of those who believed that the stimulus was too small or that nationalization was the only option or that taking over car companies would destroy the fabric of capitalism have materialized. Indeed, several private forecasters have credited the stimulus with blunting the impact of the recession—it probably added around three points to the G.D.P. last quarter—and the banking system has dramatically stabilized since the stress tests were completed.

This doesn’t mean that all these decisions were necessarily exactly right. But in politics, the quality of the implementation is often at least as important as the quality of the original decision. And the way that the Obama administration has spent its $787 billion, or avoided nationalizing the banks, or bailed out the auto industry, has been extremely professional and effective.

Indeed, in homage to the great dsquared, I’ll ask a question: can anybody give me an example of something with the following three characteristics:

  1. It is a policy initiative of the current Obama administration
  2. It was significant enough in scale that I’d have heard of it (at a pinch, that I should have heard of it)
  3. It wasn’t fundamentally extremely well-managed during the execution.

The point here is that policy initiatives are sometimes good and sometimes bad. We all disagree with some of the Obama administration’s decisions, like for instance the tariffs on Chinese tires. But once that decision was made, it was handled very well, and seems to have had very little in the way of negative knock-on consequences. Similarly, after the PPIP was announced with great fanfare, it was allowed to get scaled back to a tiny fraction of its original size and ambition once it became clear that it was neither particularly useful nor particularly popular.

I don’t know how much credit can be given to Summers for this one; I personally would be inclined to give most of the credit to Obama himself. But Summers has clearly settled into a very important role in this administration, and I can see how his ingrained contrarianism and skepticism might be very good at keeping everybody else that much more intellectually honest and well-prepared.

Update: Dean Baker is unimpressed.

Update 2: The consensus of the commenters seems to be that Afghanistan and pushing healthcare reform through Congress both meet my criteria. I also like Carol Shannon’s nomination of Cash-for-Clunkers.

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