The Summers Bubble

The choice of a new treasury secretary presents an early test of President-elect Obama's commitment to change in the realm of economic policy, where the need for a new direction is most painfully evident. Will the new administration find a bold answer to decades of trickle-down economics? Or will Wall Street-affiliated party insiders summon the political muscle to remain relevant and deliver for their friends in finance? A battle for the soul of Obama's White House is underway.

Considering what is at stake, the emergence of Lawrence Summers as a leading candidate for treasury secretary is an alarming indicator that Wall Street Democrats with abysmal records are gaining an upper hand over the broad progressive coalition that lifted Obama to victory.

Summers' candidacy, pushed heavily by Democratic Party rainmaker and Citigroup executive Robert Rubin, is premised on the notion that Summers' expertise and experience is urgently needed in our time of crisis. Whatever his gaffes at Harvard, the argument goes, Summers has a proven capacity to lead the economy in the right direction.

But a sober look at history suggests the opposite; it is precisely Summers' record of service that is his biggest liability. On the critical economic issues he encountered as a Clinton administration official, Summers' expertise translated into consistent advocacy for policies that infected the financial system with deadly risk.

Recently, Summers has tilted toward progressive stances on several questions of economic policy. But when considered against the backdrop of his career, his pontifications are an unconvincing resumé point -- especially when many other economists got it right all along, without the benefits of hindsight.

On three major issues that have had special bearing on the recent crisis -- financial deregulation, asset bubbles, and government bailouts -- Summers flouted basic tenets of his profession, ignored warnings, and pursued a short-sighted strategy. A thorough review of this record undermines Summers' only serious claim to the Treasury: his much-hyped expertise.

Deregulating Financial Markets

As stewards of the Clinton economy, Summers and his mentor Rubin embraced the delusion that an unregulated financial marketplace is an ideal economic configuration. They pursued this vision with gusto, consistently bowing to Wall Street interests in championing voluntary, "market based" solutions over enforceable government regulations.

With respect to today's crisis, the most consequential example of Summers' penchant for deregulation was his support for the Commodity Futures Modernization Act, which ensured that over-the-counter derivatives (those not traded on exchanges) would go unregulated. It was a major giveaway to Wall Street banks. These financial instruments have played a starring role in the recent financial crisis.

Brooksley Born, chair of the Commodity Futures Trading Commission during the late 1990s, had the foresight at the time to understand that Summers' position on derivatives was deeply problematic. She argued that an unregulated derivatives market posed serious systemic risk and began taking steps to establish a framework for oversight.

Summers and Rubin, together with Alan Greenspan, went to great lengths to marginalize Born and eventually succeeded in derailing her efforts. Recent events have underscored the soundness of her position, but Summers has failed to concede his error, maintaining that Born's positions were "deeply problematic." This raises an important point -- without any distance from the worst policy mistakes of the Clinton administration, Summers has no incentive to offer an honest critique of these errors and guide the country in a different economic direction.

Encouraging Asset Bubbles

Summers' encouragement of ill-fated asset bubbles was a second major policy failure with direct bearing on the current crisis. At the Clinton Treasury, he pursued a policy of strong support for the overvalued dollar and the rising stock market, remained silent about the downside risks, and made no attempt to rein in the speculative stampede. The subsequent collapse of the dot-com economy was largely a result of these failures.

While the 1990s are often remembered as an economic boom time for the nation, growth was very much the product of overvaluation in these areas. Households felt richer because they had greater stock wealth, and this fueled American consumption, the engine of the global economy. But the length of the boom only added to the severity of the bust. Economist Dean Baker has observed that the Clinton crowd traded "short-term gain for long-term pain" by willfully ignoring and encouraging asset bubble growth.

We are only now beginning to reckon fully with that long-term pain. Though the housing bubble -- the prime culprit in the recent crisis -- reached its peak under Bush's watch, it owed its existence to Clinton's bubbles; the stock market collapse left policy-makers scrambling to find a replacement, and housing provided that alternative.

This fondness for asset bubbles highlights Summers' fundamental lack of vision. Instead of pursuing a long-term strategy for sustainable economic growth, he promoted a finance-fueled economy premised on a cascade of speculative bubbles.

Bailing Out Wall Street Cronies

From the Mexican bailout of 1994, which he engineered, to the intervention that saved a wildly leveraged hedge fund named Long Term Capital Management in 1998, Summers consistently supported the use of public funds and government clout to rescue Wall Street speculators during his time in the Clinton administration.

From a purely economic standpoint, bailouts of wealthy investors can cause great damage in the form of heightened moral hazard. When investors perceive that the government is ready and willing to come to their rescue, they are encouraged to take even greater risks, necessitating larger bailouts down the road when their speculative positions once again turn sour. We are locked in just such a vicious cycle right now; the bailout of 2008 is the sort of intervention that Wall Street learned to rely on during the Clinton years.

When government bailouts make little sense economically and are not packaged with substantial reforms or punitive measures, questions of cronyism naturally arise. Summers brings significant baggage in this regard.

Summers showed a certain coziness with Enron, for one, before the company's collapse. At a time when the energy company was lobbying heavily for the deregulation of energy trades, Summers scrawled the following note on a letter to CEO Ken Lay: "I will keep my eye on power deregulation and energy market infrastructure issues." Later, as Enron's exploitation of a newly deregulated energy market caused unprecedented blackouts in California, Summers told Gov. Gray Davis to avoid criticizing Enron and recommended further deregulatory measures.

Of Summer's lesser-known scandals as president of Harvard, one that deserves more scrutiny is his role in bailing out his close friend and protégé Andrei Shleifer with $26 million of the university's endowment. The U.S. government was suing Shleifer and his employer, Harvard, for profiting on Russian stock speculation while helping engineer the Russian economy's privatization -- a blatant conflict of interest and a gross violation of his contract with the U.S. Harvard negotiated a settlement whereby the university picked up the tab and Shleifer kept his job.

The Need for Accountability

Summers' ascendancy as a candidate for treasury secretary points to a fundamental problem underlying the recent financial crisis: top-tier leaders in the public and private sectors are rarely held accountable for their failures.

This is most obviously the case on Wall Street, where executives are reportedly preparing for a new round of multimillion-dollar bonuses. Many of their banks would no longer exist were it not for taxpayers' billions, yet these executives are rewarded for their efforts.

The appointment of Summers as treasury secretary would parallel these absurd Wall Street bonus payouts; President-elect Obama would be giving someone with a poor record of job performance the highest economic post in the land. It would be a grievous error to follow the lead of Wall Street and reward Summers' brand of incompetence.

Fortunately, alternatives can be found outside the Summers-Rubin school of expertise. Other prospective treasury secretary candidates with comparable establishment credentials -- such as economists Laura Tyson and Nobel laureate Joseph Stiglitz -- have demonstrated far greater acuity in analyzing the dynamics governing global capitalism over the past two decades.

Like many of Wall Street's recently disgraced leaders, Summers is currently riding a credibility bubble of his own. Its burst would be inevitable and would only bring swift disillusionment with Barack Obama's message of change.

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