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    Larry Summers Is Bad with Money

    So, apparently Larry Summers is now the leading candidate for Chairman of the Federal Reserve. This is a bad idea, for lots of reasons, not least of which is that Summers' sudden ascendancy is a sign that The Usual Suspects are talking him up, and it's The Usual Suspects who not only got our economy into this mess but made our government's top priority not getting out of the mess "too quickly." Summers himself was one of Obama's leading economic advisers during the first term, and neither his advice nor Obama's first-term policy were effective in turning the Great Recession around. The result of Summers's advice was always too little, too late. It was Summers who insisted on asking Congress for a smaller stimulus package than the economy needed, on the theory that the smaller package would get passed. Of course, Congress took that smaller package and cut it down even more.

    Larry Summers is also responsible for doing major financial damage to America's largest educational non-profit. People mainly remember Summers's stint at Harvard for the way it ended, with Summers making stupid and self-destructive remarks that cost him the job. That's a real problem; without wading into everything problematic about that speech, it displays a lack of discipline that may be disqualifying. But people generally don't focus on the dire financial consequences of Summers's leadership. Summers's bad economic decisions cost Harvard a staggering amount of money. His main legacy at Harvard is an enormous hole in the ground.

    During the bubble/boom years, Summers decided to put billions of dollars of Harvard's endowment into complex financial derivatives, mainly interest rate swaps. He got his way. After all, wasn't he an economist? Hadn't be been Treasury Secretary? Surely, he knew what he was doing. But Summers put three and a half billion dollars into some of the most toxic and illiquid investments possible. When the crash happened in 2008, those investments got hammered: a billion dollar loss for starters, followed by hundreds and hundreds of millions more in interest and bankers' fees as the school had to borrow money at a disadvantage to meet margin calls on all those toxic securities. All told, Harvard lost nearly $11 billion dollars of its endowment in the crash. It survived; going from $37 billion to $26 billion is not the end of the world. But it is an enormous waste, and Summers made it worse by billions. That money has not been made back. And Washington power players are now seriously talking about putting this man in charge of our national bank. Really.

    [UPDATE: Here's a piece from Bloomberg setting all of this out in greater detail.]

    But that's not all. Back in the heady days of the bubble, Larry Summers decided to bend one of Harvard's oldest fiscal rules. Harvard, which is rich in part because it has traditionally been cautious with its money, has a long-standing rule about not starting construction on any new buildings until after it has raised the cash. First you get the money, then you build the building. It's not complicated, and it works. (As I've said elsewhere, one of the biggest differences between a fiscally sane university and a university headed for financial trouble is that a healthy university raises the capital for new buildings and an unhealthy university borrows it.) Larry Summers was impatient with that rule. And he wanted to build a huge new science building across the river from Cambridge, in Boston's Allston neighborhood. So he broke Harvard's money-in-the-bank rule for new construction. He had the pledges for the money he needed, so he gave the go-ahead. Then the 2008 bust hit, and the donors who had promised money no longer had the money they promised.

    Harvard's contractors had dug the hole for the foundation of that big, ambitious new building when the money dried up. So they stopped work. Harvard (and the neighborhood) was left with nothing but a five-acre hole in the ground. That hole is still there. It's been there longer than it takes to get a Harvard degree; the students who graduated last month have never known a Harvard that did not own a massive hole in the ground. Harvard hopes to do something about that hole next year, maybe.

    Is the five acre hole in the middle of a major city going unused? Of course not. Rats are using it.

    That's what Larry Summers's fiscal mind brought to the richest university on earth: a gaping five-acre pit. That is the genius being proposed as leader of the Fed. Because here's the truth: the American economy is another huge hole, even bigger than the one in Allston, dug in 2008 and still, all these years later, not filled in. The work has not even begun. Larry Summers is not the man to get us out of that hole. He's one of the men who dug it.


    The WaPo on Summers pluses that the White House likes:

    1. someone who cares about the Federal Reserve’s mandate to maintain full employment as well as its mandate to keep inflation low.

    analysis: who are the high inflation high unemployment loving Fed candidates?

     2. This White House is very comfortable with how Summers handles a crisis.

    analysis: he quits or is fired.

    3. ability to manage the Federal Reserve’s Open Markets Committee.

    analysis: manages by making up his own rules, or breaking established ones.

    Yes, I hope Obama's vast political capital does not win this guy the nomination.

    Employment and inflation are the issues. Of course, everyone wants low unemployment and low inflation. The question is how low, and what are the relative priorities?

    Yellen is an inflation "dove." In the 90s, she successfully persuaded the Federal Reserve Board that Greenspan's zero inflation target was too low. Her target of two percent is now Fed policy. More recently, she has argued that the Fed should even allow even higher inflation in order to reduce unemployment.

    Summers has been mum on monetary policy--which is concerning in itself--but he is expected to be more hawkish than Yellen. He would probably hold inflation to two percent, regardless of the employment figures.

    I would go further. Not everyone wants low unemployment and low inflation. Some members of the Fed Board, and arguably some Fed Chairs, have acted as if their mission were ONLY to hold down inflation, unemployment rates be damned. We've suffered from that one-sided focus over the past five years.



    as if their mission were ONLY to hold down inflation

    It is. Why else would the Fed have any mission regarding unemployment. 

    the Phillips curve is a historical inverse relationship between the rate of unemployment and the rate of inflation in an economy. Stated simply, lower unemployment in an economy is correlated with a higher rate of inflation. [at least in the short-term]


    But in fact, the Fed is legally charged to hold down both.

    Yes, its dual mandate enacted by Congress in 1977 when confidence in the Phillips Curve was as great as for it would later be for the Laffer Curve. The year after Milton Friedman won the Nobel Prize.

    Here is the actual wording of their mandate:

    "The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates."

    But even if the Fed once believed it could fulfill that mandate, post-2008, doubts are surfacing:

    What are the Federal Reserve's objectives in conducting monetary policy? (excerpts)

    Following its meeting in January 2012, the FOMC issued a statement regarding its longer-run goals and monetary policy strategy. The FOMC noted in its statement that the Committee judges that inflation at the rate of 2 percent (as measured by the annual change in the price index for personal consumption expenditures, or PCE) is most consistent over the longer run with the Federal Reserve's statutory mandate. [...]

    The maximum level of employment is largely determined by nonmonetary factors that affect the structure and dynamics of the job market. These factors may change over time and may not be directly measurable. As a result, the FOMC does not specify a fixed goal for maximum employment; rather, the FOMC's policy decisions must be informed by its members' assessments of the maximum level of employment, though such assessments are necessarily uncertain and subject to revision. [...]

    In setting monetary policy, the Committee seeks to mitigate deviations of inflation from its longer-run goal and deviations of employment from the Committee's assessments of its maximum level. These objectives are generally complementary. However, under circumstances in which the Committee judges that the objectives are not complementary, it follows a balanced approach in promoting them, taking into account the magnitude of the deviations and the potentially different time horizons over which employment and inflation are projected to return to levels judged consistent with its mandate.

    So how are they doing? Despite increasing their balance sheet fourfold since 2008, they have not managed to boost core inflation up to their 2% target nor reduce unemployment to their goal estimate of 6% and interest rates continue to hug the zero lower bound. They are in uncharted waters now and rowing as hard as they can just to keep inflation and interest rates out of negative territory.

    Brad Delong's July 25 edition has a discussion of Summers or Some other that's worth reading. 

    The particular section is under the title 


        Ezra Klein and Evan Soltas: "If the President is Making Any Calls Himself , He is MakingVery Few of Them


    Don't be put off by that title.The general political position of the contributors is slightly  to the left of Dagblog. But their economics savvy ness is somewhat  more than slightly to the north of ours.

    The overall conclusion: Yellen , not Summers.

    Probably only Brad prefers Summers.


    Flav, it is good to see you contributing again. That is all. smiley

    (Except here's a link to the piece you recommend.)


    Nice work Doctor.  Thanks.  I enjoyed reading this and digesting your take on this.  Happy weekend.

    Summers himself was one of Obama's leading economic advisers during the first term, and neither his advice nor Obama's first-term policy were effective in turning the Great Recession around.

    That is the most relevant answer to the question raised by the sight of Summers' trial balloon floating around. If that answer was different then other evidence that he is a poor choice could be discounted.

    By now everybody and their brother has weighed in on the idea of a Summers nomination, and the hostility is as palpable as the summer heat. (We already knew what everybody and their sister thinks about Summers.) [Eskow]

    Richard Eskow also has a good write up on the subject and here is his excellent first paragraph tease.

    Whoever said, “What you don’t know can’t hurt you” doesn’t know much about economics. That goes double for the nomination of Lawrence Summers to head the Federal Reserve. For all the ink that’s been spilled on the topic, there’s at least one surprise ending people don’t seem to be considering.

    Congress has weighed in on this.  They want Janet Yellen to head the Fed.  I am a fan of hers for a long time.  I agree.  

    Hey Cleveland, the NYT agrees with you:


    They want Yellin.


    Gotta keep pushing back against the Rubinites. They never quit, no matter how wrong they are.

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