The Wrongologist

What’s
Wrong Today:

Ben
Bernanke will step down at the end of his second term as Chairman of the
Federal Reserve (“FRB”) in January, 2014. There is much speculation regarding who
will be his successor. The two top contenders are FRB Vice Chair Janet Yellen
and former Treasury Secretary Lawrence Summers. So there’s a horse race underway
in Washington.

The next Fed chair
will have enormous power and influence over our entire financial system and the
direction of the economy. The Chair is also a key regulator of financial
institutions.

Sen.
Bernie Sanders (I-VT) and Sen. Elizabeth Warren (D-MA) are planning to ask four questions of the two FRB candidates.
The questions seem targeted at Larry Summers, who was a key player in
dismantling Glass-Steagall and deregulating derivatives,
both of which helped fuel the financial crisis of 2008.

Question
1:
Do you believe that the Fed’s top priority should be to fulfill its full
employment mandate?

Question
2:
If you were to be confirmed as Chair of the Fed, would you work to break up
“too-big-to-fail” financial institutions so that they could no longer
pose a catastrophic risk to the economy?

(The
background here is that the too-big-to-fail (TBTF) banks played a major role in
undermining the economy and driving our country into the Great Recession.
 Yet today the four biggest banks are 30% bigger than they were then, and the six
largest financial institutions now have assets equivalent to two-thirds of our GDP).   

Question
3:
Do you believe that the deregulation of Wall Street, including the repeal of
the Glass-Steagall Act and exempting derivatives from regulation, significantly
contributed to the worst financial crisis since the Great Depression?

Question
4:
What would you do to divert the $2 trillion in excess reserves that financial
institutions have parked at the Fed into more productive purposes, such as
helping small- and medium-sized businesses create jobs?

(Background:
Five years ago, the Fed bailed out the largest financial institutions in the
country by injecting huge amounts of cash into them, but put no restrictions on
how they could use the funds. The banks simply deposited those funds back at
the Fed as excess reserves. The Fed has been paying interest on those excess
reserves, and that gives no-risk profits to the banks. So, their question is how
the next Fed Chair can promote more lending by the TBTF banks).

Who knows whether
any candidate will ever answer these questions. It would be illuminating if
they did.  

For many
liberals, Summers is this season’s chew toy: There is petition demanding that Mr.
Obama not appoint Mr. Summers and it has almost 100,000 signatures. 20 Senators,
about a third of Democrats in the Senate, wrote
a letter
suggesting he nominate Ms. Yellen.

Summers supporters include most
of Mr. Obama’s economic team: Director of the National Economic Council Gene
Sperling, Chair of the president’s Council of Economic Advisers Jason Furman,
director of the White House OMB Sylvia Burwell and Treasury Secretary Jack Lew.
The
Center for American Progress (CAP), a liberal think
tank allied with corporate Democrats, is pushing
for Summers.
Former Treasury Secretary Tim Geithner helped
Summers plan his campaign for the job during a private strategy call.

Ms.
Yellen has far less support from White House insiders. Christina Romer, a
former chairman of the Council of Economic Advisers encouraged her former
colleagues in the White House to introduce Yellen to a wider range of Obama
aides, but little came of it. WaPo reports that WH logs show that Yellen visited the White House only once over the past 2 ½
years, compared to 15 times by Summers.

Yves Smith
hypothesizes that Mr. Obama will
nominate Summers since he is a friend of Wall Street and deregulation. That
faction has the right combination of pedigree and influence to help Mr. Obama
in his post-presidential career. There is no point in alienating a group of
your soon-to-be-future loyal backers if you don’t need to.

So, backing
Summers may just be a no-lose proposition for Mr. Obama. There is no personal
upside for him to support Ms. Yellen. Most critics, like Felix Salmon at Reuters, focus on Summers’s
fealty to financial firms and the near-certainty that he’ll continue to
strongly favor deregulation.

So let’s
unpack Mr. Summers and his role in deregulation. In 1999, while he was Director
of the National Economic Council for Mr. Clinton, Summers endorsed the Gramm-Leach-Bliley
Act that ended Glass-Steagall and removed the separation between investment
and commercial bank activities, saying:

He
continued:

Mr. Obama,
among others, has suggested the 2007 subprime mortgage financial crisis was
caused in part by the repeal of the 1933 Glass–Steagall Act.

Summers also
had a major role in turning back a proposal to regulate the financial derivatives
market. In 1998, then-Deputy Secretary of the Treasury Summers testified
before the US Congress:

Summers and
former FRB Chair Alan Greenspan worked together to oppose regulating
derivatives. More from his testimony:

After the
big derivatives fail, Mr. Summers flip-flopped, saying to
George Stephanopoulos:

The
fact that Summers played a key role in enabling AIG and other financial
institutions to sell derivatives without regulation was beyond ironic. In 2010,
Mr. Clinton said
that Summers’s
advice that the president not regulate derivatives was wrong.

Ironically,
Summers later had a reverse Midas
touch with derivatives during his tenure as president of Harvard. The University placed
contracts totaling $3.52 billion of derivatives called interest rate swaps. By late 2008, those
positions had lost approximately $1 billion in value. This decision has been called
by Felix
Salmon of Reuters, a “massive interest-rate gamble” that ended very
badly.

Mr.
Summers had a disastrous tenure as Harvard president, beyond the losses, he
demonstrated the lack of a basic ethical compass in refusing to discipline a
colleague over egregious and politically damaging mismanagement of a Harvard consulting
contract with Russia. He sparked controversy in a discussion of why women are
underrepresented in tenured positions in science and engineering that led to
accusations of sexism. He fought with Dr. Cornel West, an African-American member
of the faculty saying that Dr. West contributed to grade inflation. That led to
accusations of racial insensitivity on Summers’s part.

He lost a
vote of no confidence by the Faculty of Arts and Sciences, and eventually
resigned in February 2008. He had served from 2001-2008. He got a $1 million
loan and tenure on the faculty as part of his good-bye kiss.

All
of this suggests that the #1 Question for Larry Summers should be: If you couldn’t succeed at the best job
in the world, president of Harvard, why will you be able to succeed as Chair of
the Federal Reserve?

He is another required quota hire. We obviously have a critical shortage of
white, male Wall Street-affiliated fuck-ups in Washington.

So, all aboard the Summers Express to DC.