Larry Summers has had enough financial regulation

By Felix Salmon
April 13, 2011

The financial crisis? Regrettable, obviously. But let’s not rush to judgment here. Our financial system, pre-crisis, worked pretty well. Let’s not break it just because there was a crisis.

That’s the message being peddled by Alan Greenspan, predictably, sadly, and hilariously. And now he has a high-profile bedfellow from the other side of the aisle: Larry Summers, who was hanging out in Bretton Woods this weekend. Stephen Gandel Rana Foroohar summarizes:

One of the other big questions was what, if anything, Summers would have done differently in terms of regulating the banking system. The answer – not much. “I’ve been more cautious than many about constraining financial innovation,” he said, adding that he didn’t believe the financial crisis had its roots in “new-fangled financial instruments” but rather in a simple real estate bubble. Hmmm—tell that to Iceland. One thing Summers said that most of the crowd could agree with is that “anger and dissatisfaction with the financial system doesn’t constitute a [coherent regulatory] policy.”

There’s much more where that came from. This, for instance, is classic Larry:

It’s common in a moment like this to go into a general bash on economics. And everyone who hates economics because they don’t like markets in any context, or because they don’t do math, and so if you do a subject with math you have a bias towards believing that math is useless — everyone who doesn’t like economics has piled on at this moment to regard this crisis as a repudiation of economics. And I don’t think that’s right…

How we think about the design of regulatory institutions… the public choice school has taken that very seriously, but they have driven it relentlessly towards nihilism.

Larry’s keen on saying that “we’d make a serious mistake if we threw the baby out with the bathwater here.” But it seems to me that most people talking about babies and bathwater — and Summers is a prime example here — tend to be much more keen to protect their precious babies than they are constructive when it comes to the big questions of how to drain away the poisonous bathwater. In this case, Summers has gone so far as to launch ad hominem attacks on reformers, calling them angry people who hate economics and don’t do math. At one point in his talk, Summers explains that people who want to regulate the financial system are very much like the smart people who became communists and who went on to create the Soviet Union.

Today, of course, the angry people who hate economics and don’t do math are mostly on the other side of the debate, hanging out at Tea Party rallies and trying to dismantle just about any kind of government financial regulation. Meanwhile, it’s generally unhelpful to characterize the people asking important questions about regulatory capture as nihilists or communists.

Summers, of course, has made very good money for himself from financial innovation — over $5 million for one day’s work per week from hedge fund DE Shaw in 2008 alone. And he has lost vast amounts of other people’s money using financial innovation: $1 billion of Harvard’s cash, to be precise, lost in misadventures with things called forward-start interest rate swaps. (A trade which TED called “either rank hubris or free money for Wall Street swap desks.”)

So it seems to me that Summers should be demonstrating substantially more humility here on the subject of encouraging financial innovation, when countries which constrained it did pretty well during the crisis compared to those with a deregulatory philosophy — and when very wise minds like Paul Volcker are credibly arguing that financial innovation almost never adds real economic value. Instead, he seems to have decided that insofar as any reform is warranted, Dodd-Frank did everything that was necessary, and the basic philosophy from here on in should be much the same as it was pre-crisis: that at the margin, having too much regulatory activity is worse than having too little.

This is astonishing, given that Summers actually conceded, during his talk, that the biggest economic successes in the world over the past couple of decades, China foremost among them, owe essentially nothing of their success to financial innovation or deregulation.

In the Ireland vs Iceland debate, Summers is decidedly Irish: “I don’t think any country is likely to allow the complete implosion of its financial system,” he said, effectively saying that Iceland isn’t even a country, or perhaps simply forgetting that it exists.

This seems to me to be a recipe for boom and bust — where the fruits of the boom accrue to a tiny handful of financial engineers and executives, while the costs of the bust are borne by citizens who never really participated in the boom in the first place. if you’re a multimillionaire technocrat with tenure at Harvard, you don’t feel recessions in the way that people do who are losing their homes and jobs, and who are running out of unemployment insurance. It’s worth remembering that, when you dismiss such people as ignorant and uneducated folks who hate economics and math. Because if there’s one thing we’ve learned from this crisis, it’s that what’s good for Larry Summers is not necessarily good for the rest of us.

Update: Brad DeLong puts Summers’s quotes into broader context, and points out that it was actually Rana Foroohar writing for Time, not Stephen Gandel (whose name is on the RSS entry). There’s no doubt that Summers endorsed Dodd-Frank — but at the same time he does seem worried about some of the regulation which comes with it, and he evinces no particular appetite for further regulation on top of Dodd-Frank. I don’t think he’s calling for deregulation, necessarily. But he does seem opposed to having more regulation.


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Larry rarely misses an opportunity to remind everyone how smart he is, nor to dismiss anyone with a contrary viewpoint is a fool.

Posted by JimInMissoula | Report as abusive

Still peddling the myth about Larry Summers personally making the interest-rate swap trades at Harvard, eh Felix? Classy.

Needless to say, this post is a *gross* mischaracterization of Summers’ actual talk, and puts all sorts of words in Summers’ mouth. Felix needs to be able to bash Summers though, so that he can stay in the good graces of all the internet populists. A nuanced, realistic discussion would just prove that he’s Captured By Teh Wall Street.

It’s sad, really. Felix used to be an interesting blogger. Now he just parrots the Yves Smith/Barry Ritholtz schtick (“Look at us! We’re savvy insiders who see through the banks’ and the administration’s BS!”).

Posted by Than | Report as abusive

Does “tell that to Iceland” mean that an international bank letting foreigners save money in their own currency is a “new-fangled financial instrument”? I suppose letting people in Iceland borrow in a different currency is a bit less precedented, but Iceland, perhaps uniquely, didn’t succumb to tranched structured products, to borrowing and lending in different currencies, which is pretty much going to happen in an international financial system, no matter how boring it is.

Posted by dWj | Report as abusive

I’d be wary of anyone lambasting others failing at math after ignoring Christina Romer’s superior computations.

And you’re correct to say “adding that he didn’t believe the financial crisis had its roots in ‘new-fangled financial instruments” but rather in a simple real estate bubble.’” It’s pretty clear that the demand for money increased in the run up to the financial crisis, and the Fed’s inability to relax the tightness worsened the origins of the financial crisis.

Posted by Schismatism | Report as abusive

Also from the Bretton Woods weekend -

SOROS: The financial markets produce the instabilities, the fluctuations, the volatility against which they also then provide the insurance.

The above says it all for me.

Posted by polit2k | Report as abusive

felix, thank you for writing this.

Posted by arrgh | Report as abusive

“It’s common in a moment like this to go into a general bash on economics. And everyone who hates economics because they don’t like markets in any context, or because they don’t do math, and so if you do a subject with math you have a bias towards believing that math is useless — everyone who doesn’t like economics has piled on at this moment to regard this crisis as a repudiation of economics.”

LOL. Isn’t that what he was saying at Harvard not too long ago? He still contends that there are certain people who just can’t do math. Formerly they were known as women. Now they are known as anyone who disagrees with LS on politics.

Posted by Christofurio | Report as abusive

It took me a while to fish this out from a foggy memory, but Frontline’s “The Warning”, covered CTFC head Brooksley Born’s fight against Alan Greenspan, Arthur Levitt, Robert Rubin and Larry Summers, on the regulation of derivatives, or the lack thereof.

There’s been plenty of signs of Summers’ ideology for some time now; I really hope you weren’t all that surprised.

Posted by GRRR | Report as abusive

Thank you , Felix.

Posted by Laster | Report as abusive

As some papers presented at the conference noted, the math of economics is largely based on concepts borrowed from physics that relate to the idea that systems return to equilibrium. It is beautiful math based on faulty assumptions that is unable to generate any predictions that can generate alpha vs. the market. It can be made to fit a thesis related to events in the past (a bit like evolutionary biologists).

Complexity economists while identifying problems with this math can do no more than point out problems and spot things like fat tails and power laws. Look another one! These scholars of complexity can generate no more predictive power than that models that assume return to equilibrium. But at least they are focused on the right questions and can generally caution people that systems should be made “robust to failure.” Complexity economists were assigned to a single breakfast session at 7 AM and were at the conference at all only because their ideas reflect the vague ramblings on reflexivity of Soros who paid for the event.

The academic world of economics is all about knowing the equilibrium-based math and there is rarely any point to going to graduate school unless this is your focus. Papers based on this math end up being a bit like dressage in that you follow a set of arbitrary rules and are judged based on compliance, with points awarded for the basics and showing off in equal measure.

Posted by tgriffin | Report as abusive

Why do people like Summers and Greenspan keep getting so much press coverage, and Shiller gets almost none? Shiller’s work on the psychological factors effect on the economy has been spot on in most cases. Call it herd economics if you want, but it explains the course of the macroeconomy better than anything Summers has done.

Posted by randymiller | Report as abusive

Did you see the portrayal of Summers in The Social Network? Hilarious and spot-on. Even though he was telling off two spoiled punks, you couldn’t root for him, because he was so obviously arrogant and clueless.

Posted by EconWatcher | Report as abusive

Funny that my comment pointing out that this is a *gross* mischaracterization of Summers’ talk was never approved.

Posted by Than | Report as abusive

Not only was it approved, Than, it’s the second comment in this thread. It’s been there all along.

The markets have proved Summers doesn’t know how they really work.

Summers’ ego obviously is so big that it prevents him from realizing he’s not infallible.

Posted by Gaius_Baltar | Report as abusive