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October 24, 2010
David Warsh, Proprietor


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The Vainglory of Economists, and Other Campaign Issues

The single hardest and potentially most costly decision Barack Obama made in his first few weeks as president-elect may have been to hire Lawrence Summers to oversee his administration’s economic response to the aftermath of the crisis.

If you doubt that, see Inside Job, a documentary film by Charles Ferguson designed to get you mad all over again about the financial crisis and its resolution. Artfully edited interviews with economists, bankers and policymaker arranged to tell a story (with empty screens accorded those who declined to sit), interspersed with helicopter shots of tall buildings and accompanied by spooky music – it’s a two-hour negative ad, only much more fun. Don’t look for any exculpatory evidence. Except in the case of Eliot Spitzer, Ferguson doesn’t believe in it.

In Larry Summers and the Subversion of Economics, an accompanying opinion piece in The Chronicle of Higher Education, Ferguson writes, “Over the past 30 years, the economics profession – in economics departments, and in business, public policy, and law schools – has become so compromised by conflicts of interest that it now functions almost as a support group for financial services and other industries whose profits depend heavily on government policy.”

With the election less than two weeks away, the Tea Party is not the only angry faction out there.  The left wing of the Democratic Party is roiling, too.

For the record, then, let me  make the case that the Obama administration has done pretty well, before admitting that Ferguson clearly has a point when it comes to self-dealing. On two of its biggest issues, health care and finance, the administration coaxed landmark legislation from his Democratic majority in Congress. (Has there been a more determined dug-in opposition?)  By 2012, chances are that the administration will be seen as having disengaged successfully from two foreign wars.  It is true that the economic recovery is not yet very robust. But business expansion probably will be vigorous in two years, thanks to decisions already taken. Summers is not the easiest guy in the world to defend, but let me try.

Policy economists are like generals. They go to school and train from an early age to fight a great battle – not at service academies, but at the Massachusetts Institute of Technology, Harvard, Yale, Princeton, Chicago, the University of California at Berkeley. Most of today’s big shots met in the 1970s at MIT and Harvard, studying under people like Stanley Fischer and Rudiger Dornbusch, Martin Feldstein and Dale Jorgenson. The top ranks are a smallish club and, given the personalities involved, once Ben Bernanke had been installed at the Federal Reserve Board by George W. Bush, it was almost inevitable that Summers’s services would be required by Bush’s Democratic successor. I’ll explain.

Just as John F. Kennedy and Ronald Reagan put their respective stamps on political generations, the economists identified with their policies acquired similar influence: Paul Samuelson and Robert Solow in the case of the Kennedy administration, Martin Feldstein in that of Reagan. When Feldstein went to Washington in 1982 to as Chairman of the Council of Economic Advisers to lend coherence to President Reagan’s portfolio of improvisational economic polices, several of his students went along as junior staffers, including Summers, Paul Krugman and N. Gregory Mankiw.  All acquired a lasting taste for public policy. By 1988, the 33-year-old Summers had signed on to the Michael Dukakis presidential campaign as its economist. Even though George H.W. Bush was elected instead, Summers went to Washington in 1990 as chief economist for the World Bank. In 1993, he was awarded the John Bates Clark Medal for having made a substantial contribution to economics before turning forty.

With Bill Clinton’s victory in 1992, Summers had his chance. He went to work in the Treasury Department, establishing close ties to National Economic Adviser Robert Rubin. (It was at this point, too, that Krugman set off on his path to journalism as a critic.) And from the first deal on, Summers played a key and growing role in all the major economic dramas of the 1990s – the budgetary stringency agreement that laid the foundation for the vibrant economy of the 1990s, the Mexican crisis in ’94, the Asia financial crisis of ’97-98, and the accelerating financial roll-up that culminated in Citicorp’s acquisition of Travelers Insurance, marking the collapse of the separation of banking and commerce that had been mandated half a century before by the Glass-Steagall Act. By the end of the decade, Summers was Secretary of the Treasury – the youngest since Alexander Hamilton.

Then came the tie election of 2001, resolved by the Supreme Court in favor of George W. Bush (who ten years before had aspired to no higher office that that of commissioner of Major League Baseball). In those dramatic circumstances, Harvard University, looking for change, offered Summers its presidency.

Everybody knows how that turned out. Summers lacked a certain sort of judgment. He picked a fight with Prof. Cornel West, of the university’s African-American studies program. He was slow to force out Enron-tainted Herbert “Pug” Winokur from the seven-member corporation that governed Harvard, then replaced him with his former boss, Robert Rubin, by then working a vice chairman of Citicorp. He doubled-down on an earlier decision to shield his friend Harvard professor Andrei Shleifer from charges of self-dealing while advising the Russian government on behalf of the US State Department. He ran off the highly-successful veteran manager of the university’s $30 billion endowment and took a hand in investment strategy himself. And, of course, he gave his famous estimate of the effects of the distribution of intrinsic aptitude among women to for mathematics and the sciences, as reinforced by culture. When he resigned, in February ’06, the cause was, as they say, “overdetermined,” the result of multiple reasons, any one of which alone might have been enough to account for the effect.

The international financial community he had earlier supervised quickly put him back in business. The Financial Times offered him a column. Goldman Sachs is thought to have offered him a job. Instead, D.E. Shaw, a highly-successful Manhattan quantitative hedge fund, hired him to consult one day a week. He joined the lavishly-funded Hamilton Project, which Citicorp’s Rubin had set up at the Brookings Institution in Washington.  He became a favored speaker among financial companies.

Then came the crisis.

It now seems clear that the greatest mistakes were made on George Bush’s watch, most of them at the Treasury Department. The decision to withhold from Lehman Brothers the same federal deposit insurance that a couple of days later led to the government takeover of insurance giant American International Group was especially disastrous. Robert Aliber, who has now taken over authorship of the late Charles P. Kindleberger’s classic textbook, Manias, Panics and Crashes: A History of Financial Crises, puts it this way:  “Saving Lehman would have cost US taxpayers $75 billion, plus or minus $25 billion.  Lehman’s shareholders would have been wiped out, its management banished to northern Siberia.  Not saving Lehman will cost the taxpayers more than $2,500 billion” – because of the panic and deep recession that ensued.

On the other hand, it can scarcely be overstated how successful Bernanke was in avoiding an even worse abyss. He may have been a little slow to recognize the developing peril, but once he understood the situation, he pumped $600 billion of new reserves into the private sector, using its  massive balance sheet to lend against troubled assets. Robert Lucas, of the University of Chicago, applauded the move in December 2008 as “the boldest lender-of-last-resort function in the history of the Federal Reserve System” (subscription required).

With a chairman as strong and well-trained at the Fed as Bernanke, Obama knew the White House would require as personality of equal or perhaps greater rank. Summers was the obvious, perhaps the only, suitable candidate if parity was to be maintained. That he had a judgment problem was well understood by the White House. Obama solved it by keeping him on a short leash, despite Summers’s oft-expressed desire for an nomination to run the Fed or, at least, to return to the Treasury.

The result has been a continuous stream of policy decisions – not just the controversial stimulus bill of last spring, but health care reorganization, financial re-regulation, automotive restructuring, education experimentation, and, now trade and exchange-rate policy. (Climate policy has been forced to the bottom of the list.)  My guess is that the decisions have been mostly good, that benefits from having hired Summers will turn out to be much greater than the costs. Unfortunately for Obama, the returns won’t be in for a while, and meanwhile there are the midterm, elections.

If there was a serious error in the administration’s policy, it lay in insisting on the use of A textbook term, “stimulus,” instead of identifying a series of spending programs with which voters could emotionally identify and actually see. Amped-up government spending on R&D went forward smoothly; Harvard’s Feldstein pointed out that the Defense Department had a long list of “shovel ready” projects that were never authorized. And a truly effective spending program for transportation infrastructure (tunnels, bridges, airports and the like) failed to materialize — much less longed-for symbols of national will like the Work Projects Administration and Civilian Conservation Corps. Instead of strong policies, the nation has been treated to a series of lessons about debates among economists concerning the relative stature of John Maynard Keynes.

Summers will be heading back to Harvard in January, where his university professorship  is waiting; he may teach whatever he pleases. Probably he is finally going to write a long-promised book. A certain amount of embarrassment is inevitable: when Drew Faust, who succeeded Summers as president, convened a panel of five faculty economists recently to discuss the crisis after two years, Summers’s name didn’t come up.

Film maker Ferguson, who earned a PhD in political science at MIT in the late ’80s, calculates that Summers made “more than $20 million from the financial services industry” between 2001 and the time he re-entered government service in 2008.  How does Ferguson know? Summers’s 2009 financial disclosure firm listed his net worth as $17 million to $39 million. Some $8 million of that was booked in 2008, nearly $5.2 million from D.E. Shaw and the rest from speaking fees. How good for him was calendar 2007?

Little noted has been a casual aside in a story by Louise Story in The New York Times, A Rich Education for Summers (After Harvard), to the effect that Summers had consulted for a hedge fund, Taconic Capital Advisors, from 2004 until 2006, while president of Harvard. Its founders, Kenneth Brody and Frank P. Brosens, had earlier been Goldman Sachs partners; from 1993 until 1996, Brody served as president of the US Export-Import Bank. Professors report their outside consulting income to their deans, and deans report theirs to the president. Presumably the president reports his outside earnings to the Harvard Corporation, of which he is a member. Summers is going to have some explaining to do to his Harvard colleagues when he returns.

Ferguson complains that “Never once has Summers publicly apologized or admitted any responsibility for causing the crisis.” To me, that seems over-emotional and mistaken; my hunch is that Summers has done much more good than harm. But the filmmaker is clearly right when he argues that university economics has become a handmaiden to the rapid growth – and probable serious hypertrophy – of  the financial sector of the US economy, that conflicts of interest are rife, and that Summers is a prime example. The point has been made more forcibly by others, including Kenneth Rogoff of Harvard and, most recently, by Margaret Blair, of the Vanderbilt Law School. The agitprop of Inside Game is a starting gun. The task of getting finance under control has barely begun.

.                                             xxx

So Summers was chosen partly because of his acceptability to Wall Street. The question of his service in the Obama administration just one facet of a still thornier issue: the efficacy of Obama’s nonpartisan strategy in the face of continuing – indeed, deepening – Republican intransigence. The most interesting analysis of this problem I have seen is Winning Ugly, by Mark Schmitt, executive editor of The American Prospect, and former policy director for former Senator Bill Bradley.

“The Obama presidency is far from over,” he writes, “but little survives of the original theory behind it.” It is true that the legislative victories he gained are the most significant since Lyndon Johnson, Schmitt continues, but by deferring to Congress to gain them, he relinquished the image of a forceful leader. And the Republicans have succeeded in turning his achievements into a burden.

The plan to govern by bridging differences and making a start on reforms that would gather strength in future years is defunct, he says.

I’m not so sure. The huge Democratic majority that made possible the health care reorganization and the Dodd-Frank financial reform is the sort of thing that only happens once every twenty-five or thirty years.  Obama took advantage of the moment; he can afford to coast for the next couple years with the sharply divided Congress this election seems certain to give him.

The economy will improve.  The Republican Party’s internal contradictions will increase. Obama doesn’t need to turn himself into a fire-breathing ideologue for which some Democrats, including Ferguson, long. His re-election seems highly likely. He can take advantage of the foil that the GOP has provided.

And by 2016, twenty-five years of Republican stonewalling will have will have begun to wear thin.  By then the party may have begun to produce the sort of moderates with whom Obama had hoped to bargain when he began. His strategy will have worked.

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One Comment

  1. David, I just wanted to say I found this to be a very informative and intriguing article.

    I agree with you on every level. I found your website searching around for some more in depth analysis of the movie inside job because I felt a sense that it lacked a real perspective on the full story.

    I’ve always thought that Obamas strategy is shrewd and well measured. I think people just don’t understand how great a chess game/poker game he’s playing and the incredible effectiveness of it lies in keeping his hand hidden and the algorithim behind the ultimate intentions of his moves only spoken of in terms of ideals and vision instead of strategy. I think from the beginning he had the intention of keeping himself from ideological hysteria and making rational decisions on a case by case basis.

    I wish more people would read his book Audicity of Hope carefully and understand how nuanced his ideas have been even before he had any intention to run for president.

    Tuesday, March 1, 2011 at 3:21 am | Permalink

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  1. FT Alphaville » Introducing: Further, further reading on Monday, October 25, 2010 at 4:22 pm

    [...] – The conflicted relationship between finance and academic economists [...]

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