Monday, April 6, 2009

More Larry Summers

"During his senior year of college, Summers was considering graduate school in both theoretical physics and economics. For weeks, he anguished over whether to pursue his passion (physics) or the family business (in addition to his economist parents, Summers has two uncles -- Paul Samuelson and Kenneth Arrow -- who won Nobel prizes in the field). After he finally decided on the latter, he explained his thinking to Rollins: "What does a bad theoretical physicist do for a living? He walks into an office, sits at a desk, and stares at a plain white sheet of paper." "But," Summers added, "there's a lot of work in the world for a bad economist"."

Scheiber, Noam. 2009. "Free Larry Summers." The New Republic (1 April).


Jack said...

I guess that Summers knows himself better than does anyone else knows him.

Shag from Brookline said...

Apparently Economics has its own "Big Bang" theory - bubbles.

Shag from Brookline said...

Richard Cohen supports Summers and those similarly wealthy who give up big paychecks to work for the government in his WaPo OpEd today. But Glenn Greenwald has a contrary view at Salon. Ah, the revolving door creates quite a spin. What came first, government service or the private sector for these individuals? Would Summers have garnered those big paydays in 2006-8 but for his service as Sec'y. of the Treasury under Clinton? Many who serve in government do so for honorable reasons. Even some of the honorable ones decide to cash-in on their government contacts. They return to government, despite pay cuts, to replenish their resumes for when once again they may pass through the revolving door. Last Friday Bill Moyers featured Glenn Greenwald and Amy Goodman who pointed out the role of the Washington beltway elite. Perhaps more of the media will take up I.F. Stone's "All governments lie" and restore the integrity of journalism. We need more C. Wright Mills and his "The Power Elite" published in 1956, five years before Ike's farewell speech about the military-industrial complex.

So my fellow townie Larry it appears will not be getting a free ride.

Myrtle Blackwood said...

More on Summers and Geithner:

"...In the Bill Clinton administration of 2000, the Treasury secretary was
Larry Summers, who had just been promoted from number two under former Goldman Sachs banker Robert Rubin to be number one when Rubin left Washington to take up the post of Citigroup vice chairman. As I describe
in detail in my new book, Power of Money: The Rise and Fall of the
American Century, to be released this summer, Summers convinced president Clinton to sign several Republican bills into law that opened the floodgates for banks to abuse their powers. The fact that the Wall Street big banks spent some US$5 billion in lobbying for these changes after
1998 was likely not lost on Clinton.

One significant law was the repeal of the 1933 Depression-era
Glass-Steagall Act, which prohibited mergers of commercial banks, insurance companies and brokerage firms such as Merrill Lynch or Goldman Sachs. A second law backed by Treasury secretary Summers in 2000 was an obscure but deadly important Commodity Futures Modernization Act of 2000.
That law prevented the responsible US government regulatory agency, Commodity Futures Trading Corporation (CFTC), from having any oversight
over the trading of financial derivatives. The new CFMA law stipulated that so-called over-the-counter (OTC) derivatives like credit default
swaps, such as those involved in the AIG insurance disaster, (and whichinvestor Warren Buffett once called "weapons of mass financial
destruction"), be free from government regulation.

At the time Summers was busy opening the floodgates of financial abuse for the Wall Street Money Trust, his assistant was none other than Tim Geithner, the man who today is US Treasury Secretary, while Geithner's
old boss, the self-same Summers, is President Obama's chief economic adviser as head of the White House Economic Council. To have Geithner and Summers responsible for cleaning up the financial mess is tantamount to
putting the proverbial fox in to guard the henhouse.

What Geithner does not want the public to understand, his "dirty little secret", is that the repeal of Glass-Steagall and the passage of the Commodity Futures Modernization Act in 2000 allowed the creation of a tiny handful of banks that would virtually monopolize key parts of the
global "off-balance sheet" or OTC derivatives issuance.

Today, five US banks, according to data in the just-released Federal Office of Comptroller of the Currency's Quarterly Report on Bank Trading and Derivatives Activity, hold 96% of all US bank derivatives positions in terms of nominal values, and an eye-popping 81% of the total net
credit risk exposure in event of default.

The top three are, in declining order of importance: JPMorgan Chase, which holds a staggering $88 trillion in derivatives; Bank of America with $38 trillion, and Citibank with $32 trillion. Number four in the derivatives sweepstakes is Goldman Sachs, with a mere $30 trillion in
derivatives; number five, the merged Wells Fargo-Wachovia Bank, drops dramatically in size to $5 trillion. Number six, Britain's HSBC Bank USA, has $3.7 trillion.

After that the size of US bank exposure to these explosive
off-balance-sheet unregulated derivative obligations falls off
dramatically. Continuing to pour taxpayer money into these five banks without changing their operating system, is tantamount to treating an alcoholic with unlimited free booze....

Geithner's dirty little secret
By F William Engdahl
Apr 3, 2009

brian said...

Brenda, that article is somewhat misleading.

1. The repeal of Glass-Steagall has nothing to do with this crisis. The fact is that many of the main culprits in this Lehman, Washington Mutual, ect did not have a commercial side and Glass-Steagall would not have kept these companies along with AIG in engaging in huge over-leveraging.

Also the article makes it seem like all derivatives are risky, which isn't the case at all. It doesn't mention the types of derivatives that Goldman Sachs, JPMorgan, Citibank holds. Derivatives can be used to hedge not just to speculate.

Also, the article does not provide any empirical evidence of Summers' lobbying in behalf of those bills.

Myrtle Blackwood said...

Brian, I don't think that anyone can legitimately claim that the repeal of Glass Steagall was not behind at least part - an important part - of the current crisis.

See the following history:
1999 - President Bill Clinton repeals the Glass Steagall Act of 1933 that mandated separation of bank types according to their business. The Act originated to avoid collusion between commercial and investment banks. Super-banks are now able to re-enact the same kinds of structural conflicts of interest that were endemic in the 1920s -- lending to speculators, packaging and securitizing credits (credit derivatives) in an opaque way and then selling them off, wholesale or retail, and extracting fees at every step along the way. The whole process is supercharged by computers and automated formulas. While these credit derivatives are said to increase liquidity and serve as shock absorbers, in fact their bets are often in the same direction – assuming perpetually rising asset prices -- so in a credit crisis they can act as net de-stabilizers

“…it is worth noting that Wall Street security/dealer balance sheets expanded three-fold in the eight years since the repeal of the (Depression-era) Glass-Steagall Act.”
From: Economic Structure and the "Liquidationist Thesis"
Credit Bubble Bulletin by Doug Noland. 4th April 2008

“The Glass Steagall Act of 1933 mandated the separation of bank types according to their business, after the Senate-led Pecora Commission investigation of the crash found that collusion between commercial and investment banks played a major role in it. That act stood for 66 years, until none other than Bill Clinton repealed it in 1999, and here we are again…”

“…securitization of credit. Some people think this is a recent innovation, but in fact it was the core technique that made possible the dangerous practices of the 1920. Banks would originate and repackage highly speculative loans, market them as securities through their retail networks, using the prestigious brand name of the bank -- e.g. Morgan or Chase -- as a proxy for the soundness of the security. It was this practice, and the ensuing collapse when so much of the paper went bad, that led Congress to enact the Glass-Steagall Act, requiring bankers to decide either to be commercial banks -- part of the monetary system, closely supervised and subject to reserve requirements, given deposit insurance, and access to the Fed's discount window; or investment banks that were not government guaranteed, but that were soon subjected to an extensive disclosure regime under the SEC. Since repeal of Glass Steagall in 1999, after more than a decade of de facto inroads, super-banks have been able to re-enact the same kinds of structural conflicts of interest that were endemic in the 1920s -- lending to speculators, packaging and securitizing credits and then selling them off, wholesale or retail, and extracting fees at every step along the way. And, much of this paper is even more opaque to bank examiners than its counterparts were in the 1920s. Much of it isn't paper at all, and the whole process is supercharged by computers and automated formulas. An independent source of instability is that while these credit derivatives are said to increase liquidity and serve as shock absorbers, in fact their bets are often in the same direction – assuming perpetually rising asset prices -- so in a credit crisis they can act as net de-stabilizers…”

'The Alarming Parallels Between 1929 and 2007'
Testimony of Robert Kuttner Before the Committee on Financial Services
Rep. Barney Frank, ChairmanU.S. House of Representatives
Washington, D.C.
October 2, 2007


Testimony of Robert Kuttner Before the Committee on Financial Services
Rep. Barney Frank, Chairman U.S. House of Representatives Washington, D.C.
October 2, 2007

“..In America the Glass-Steagall Act has prevented commercial banks from acting as investment banks and also from underwriting insurance. Japan has a similar rule. Although the act is now likely to be repealed in America, its effects have already been much weakened. Commercial banks have been able to underwrite some securities. Investment banks have offered services that look exactly like current accounts. Some now even offer credit cards. As well as entering the investment-banking business, commercial banks have responded to increased competition by trying to cut costs. The way is being led by banks in America and Britain, where shareholders hold more sway, labour laws are less restrictive and deregulation is more advanced. They have merged, replaced costly branches with cheaper ones in supermarkets and such places, laid off expensive staff and moved processing to cheap “back-office” administration centres. Those that fail to get costs under control become the target of takeover bids. This is because it is easier to cut costs by buying a rival bank and eliminating overlapping branches and overheads. As chart 2 shows, this process has led to increased concentration in some banking markets around the world (in Britain the figures are distorted by the reclassification of many building societies as banks, thereby enlarging the banking market). Rivals in other countries, especially in continental Europe and Asia, have found it difficult to cut labour costs. Until recently, they have tried to increase profits by lending more or by expanding the number of branches (see chart 3). However, thanks to the single market in financial services, European banks have tried to cut costs by merging, too. Since monetary union at the beginning of the year, the restructuring has gathered pace. In Japan, where consolidation has been painfully slow, banks are at last starting to do the same. … ”

The firewall between universal banks - as we've known them - and investment banks and hedge funds is a fundamental problem of leverage in which the latter have become global investment houses with little or no capital controls. By removing the firewall, in 1999, Citi was able to expand (under Weil) into a conglomerate with uncontrolled growth and expansion world-wide. At the time, Congress considered it a good idea and approved deregulation...bringing us to the current dismal massacre of the financial houses. It'd be difficult to return to pre-1999 banking system. However, if Hedge Funds and Investment Banks are to stay as part of the global banking system, they'd need to be strictly brought under regulatory control. If not, they shld be discarded as financial institutions. And, above all, there is imperative need to also establish a gloabl banking regulatory regime to avoid future crisis like this one.
Posted by: hari | Link to comment | September 20, 2008 at 01:08 PM
An Overview of the Crisis and What to Do about It. September 20, 2008

Anatomy of a Crisis
By Barry Eichengreen
First Published: September 19, 2008

BERKELEY: Getting out of our current financial mess requires understanding how we got into it in the first place. The fundamental cause, according to the likes of John McCain, was greed and corruption on Wall Street. Though not one to deny the existence of such base motives, I would insist that the crisis has its roots in key policy decisions stretching back over decades.

In the United States, there were two key decisions. The first, in the 1970’s, deregulated commissions paid to stockbrokers. The second, in the 1990’s, removed the Glass-Steagall Act’s restrictions on mixing commercial and investment banking. In the days of fixed commissions, investment banks could make a comfortable living booking stock trades. Deregulation meant competition and thinner margins. Elimination of Glass-Steagall then allowed commercial banks to encroach on the investment banks’ other traditional preserves.

In response, investment banks branched into new businesses like originating and distributing complex derivative securities. They borrowed money and put it to work to sustain their profitability. This gave rise to the first causes of the crisis: the originate-and-distribute model of securitization and the extensive use of leverage.

It is important to note that these were unintended consequences of basically sensible policy decisions. Other things being equal, deregulation allowed small investors to trade stocks more cheaply, which made them better off. But other things were not equal. In particular, the fact that investment banks, which were propelled into riskier activities by these policy changes, were entirely outside the regulatory net was a recipe for disaster.

Similarly, eliminating Glass-Steagall was fundamentally sensible. Conglomerates allow financial institutions to diversify their business, and combining with commercial banks allows investment banks to fund their operations using relatively stable deposits instead of fickle money markets. This model has proven its viability in Europe over a period of centuries, and its advantages are evident in the US even now with Bank of America’s purchase of Merrill Lynch.

But conglomeratization takes time. In the short run, Merrill, like the other investment banks, was allowed to double up its bets. It remained entirely outside the purview of the regulators. As a stand-alone entity, it was then vulnerable to market swings. A crisis sufficient to threaten the entire financial system was required to precipitate the inevitable conglomeratization.

The other element in the crisis was the set of policies that gave rise to global imbalances. The Bush administration cut taxes. The Fed cut interest rates in response to the 2001 recession. Financial innovation, meanwhile, worked to make credit even cheaper and more widely available. This, of course, is just the story of subprime mortgages in another guise. The result was increased US spending and the descent of measured household savings into negative territory.

Of equal importance were the rise of China and the decline of investment in Asia following the 1997-1998 financial crisis. With China saving nearly 50% of its GNP, all that money had to go somewhere. Much of it went into US treasuries and the obligations of Fannie Mae and Freddie Mac. This propped up the dollar and reduced the cost of borrowing for US households, encouraging them to live beyond their means. It also created a more buoyant market for the securities of Freddie and Fannie, feeding the originate-and-distribute machine.

Again, these were not outright policy mistakes. Lifting a billion Chinese out of poverty is arguably the single most important event in our lifetimes. The fact that the Fed responded quickly prevented the 2001 recession from worsening. But there were unintended consequences. The failure of US regulators to tighten capital and lending standards when abundant capital inflows combined with loose Fed policies ignited a furious credit boom. The failure of China to move more quickly to encourage higher domestic spending commensurate with its higher incomes added fuel to the fire.

Now, a bloated financial sector is being forced to retrench. Some outcomes, like the marriage of Bank of America and Merrill Lynch, are happier than others, like the bankruptcy of Lehman Brothers. But, either way, there will be downsizing. Foreign central banks are suffering capital losses on their unthinking investments. As they absorb their losses on US treasury and agency securities, capital flows toward the US will diminish. The US current-account deficit and the Asian surplus will shrink. US households will have to start saving again.

The one anomaly is that the dollar has strengthened in recent weeks. With the US no longer viewed as a supplier of high-quality financial assets, one would expect the dollar to have weakened. The dollar’s strength reflects the knee-jerk reaction of investors rushing into US treasuries as a safe haven. It is worth remembering that the same thing happened in August 2007, when the sub-prime crisis erupted. But once investors realized the extent of US financial problems, the rush into treasuries subsided, and the dollar resumed its decline. Now, as investors recall the extent of US financial problems, we will again see the dollar resume its decline.

Emphasizing greed and corruption as causes of the crisis leads to a bleak prognosis. We are not going to change human nature. We cannot make investors less greedy. But an emphasis on policy decisions suggests a more optimistic outlook. Unintended consequences cannot always be prevented. Policy mistakes may not always be avoidable. But they at least can be corrected. That, however, requires first looking more deeply into the root causes of the problem.

Barry Eichengreenis Professor of Economics at the University of California, Berkeley.This commentary was published by DAILY NEWS EGYPT in collaboration with Project Syndicate (

I'm not sure what you mean when you say that Lehman and Washington Mutual did not have a 'commercial side'. The currency contracts that Lehman Bros (for instance) had with large multinational companies looks pretty commercial to me. See:

On the financial crisis, from my time at Lehman and in China
Elizabeth Aab
Thursday, October 16th, 2008

You said: "Glass-Steagall would not have kept these companies along with AIG in engaging in huge over-leveraging....

The article by F William Engdahl did not make such a claim in any case. He is outlining the deregulated free-for-all financial environment in which Summers held a key position.

"the article makes it seem like all derivatives are risky

Well, I'm not sure how well that assertion would go down with Gao Xiqing, president of the China Investment Corporation. He said:

"In 1999 or 2000, I gave a talk to the State Council [China’s main ruling body], with Premier Zhu Rongji. They wanted me to explain about capital markets and how they worked. These were all ministers and mostly not from a financial background. So I wondered, How do I explain derivatives?, and I used the model of mirrors.

First of all, you have this book to sell. [He picks up a leather-bound book.] This is worth something, because of all the labor and so on you put in it. But then someone says, “I don’t have to sell the book itself! I have a mirror, and I can sell the mirror image of the book!” Okay. That’s a stock certificate. And then someone else says, “I have another mirror—I can sell a mirror image of that mirror.” Derivatives. That’s fine too, for a while. Then you have 10,000 mirrors, and the image is almost perfect. People start to believe that these mirrors are almost the real thing. But at some point, the image is interrupted. And all the rest will go.

When I told the State Council about the mirrors, they all started laughing. “How can you sell a mirror image! Won’t there be distortion?” But this is what happened with the American economy, and it will be a long and painful process to come down.

I think we should do an overhaul and say, “Let’s get rid of 90 percent of the derivatives.” Of course, that’s going to be very unpopular, because many people will lose jobs...

“Be Nice to the Countries That Lend You Money” By James Fallows. December 2008 Atlantic