To: President Obama
From: Your Political Team
Re: Larry Summers Vetting Report
Dear Mr. President,
Welcome home. You have several immense challenges in the coming days and weeks: marshaling support for the Syria attack, dealing with the next artificial budget crisis contrived by the Republicans, and continuing to move forward with implementation of the Affordable Care Act against fierce partisan opposition.
This memo on Larry Summers’s confirmation as Federal Reserve Chairman is written with all that in mind.
The staff investigation of Summers in anticipation of a potentially bruising confirmation hearing is now complete, and you face a tricky decision. On the one hand, there is no single smoking gun that disqualifies him outright. With a lot of political heavy lifting, we might get Summers confirmed. On the other hand, it would eat up a lot of political capital and credibility at a time when we are seeking to rebuild both, not to incur political debts needlessly.
Here are Summers’s main substantive and political problems in getting confirmed.
There is a great deal of criticism that he is temperamentally unsuited to be Fed chairman. This is in one sense “soft” criticism, but politically it is real and widely shared. Even his supporters concede that he can be a bull in a china shop.
His Wall Street activities since leaving government will raise more than eyebrows. They will raise questions of flat-out conflicts of interest and bad judgment.
Since leaving government, Summers took a lot of money from Citigroup. As one of the key architects of the bailout, he was responsible for the decision to prop up Citi with hundreds of billions of dollars of public money and Federal Reserve cheap capital rather than breaking Citi up. As Fed Chair, he will be a principal regulator of too-big-to-fail banks including Citi.
At the very least, this looks terrible. He saves Citi management and shareholders, then he gets a nice pile of money from them for not much work, and now he is regulating them again. This revolving door at the Fed is so unusual that it doesn’t even have applicable conflict of rules for chairmen. It’s not possible for the chair to recuse himself because every major regulatory decision—capital standards, derivatives, Volcker Rule—affects Citi. If he is precluded from participating, he might as well not take the job.
There is also Summers’s odd choice to join the board of directors of Lending Club, a lightly regulated quasi-bank, of the sort that the Fed will need to decide whether to regulate more tightly. Summers critics will ask what he was thinking. With several of the same players, he also joined the board of Square, an internet-based payments system.
Further, there is a lot of dirty laundry left over from Summers’s tenure at Harvard both as university president before he served the administration and also since he returned as a senior professor. Much of this has been aired, but it has never been systematically subjected to a senate inquiry.
Summers’s questioning of the intellectual capacity of women contributed to his downfall, but in many ways it was the least of his problems. Far more serious were his penchant for overruling the Harvard endowment’s professional money managers with impulsive investment decisions that cost Harvard billions, and his involvement in the Andrei Shleifer affair.
The most authoritative article on Shleifer and Summers appeared in the magazine Institutional Investor. Shleifer in the mid-1990s, while running the technical-assistance program on Russian privatization underwritten by USAID and administered through Harvard Institute for International Development, enriched himself through investments based on privileged information. Eventually, after a criminal investigation, Harvard and Schleifer, during Summers’s tenure as president, settled the criminal complaint by paying heavy fines.
Summers, a close friend of Shleifer, nominally recused himself, but acted to protect his friend and even kept Shleifer on as a full professor. Harvard ended up paying over $26 million in fines plus $10 to $15 million in legal fees to defend the actions of a corrupt professor of whose activities senior officials at the university, except for Summers, were unaware. It was the Shleifer affair, as much as anything else, that cost Summers the confidence of his faculty and his job. The details have never been the subject of a congressional inquiry, and could be extremely embarrassing with Summers testifying under oath.
Summers is also vulnerable for his activities since 2010. Harvard has a strict rule requiring that full-time faculty spend at least 80 percent of their professional time on Harvard business. With all of his extracurricular Wall Street affairs, there is no realistic way that Summers could have met this rule. Either Harvard bent its own rules, or the companies on whose boards Summers served were violating their legal duties by using Summers as a marquee name or paying him in the expectation of future IOUs, but not as a true fiduciary. This will also be awkward for him (and us) to explain.
In that respect, Summers is also likely to be charged with hypocrisy on the subject of senior faculty freelancing. In 2001, as Harvard president, he railed against then Harvard professor Cornel West for West’s pop-culture activities, specifically for making a hip-hop CD. Summers called West to his office in October 2001 to complain, arguing that this was the sort of extra-curricular activity that brought embarrassment to the university. Summers critics might argue that hip-hop was pretty tame compared to working part time for Citi and Lending Club. Summers eventually drove West out, an act that did not endear him to the African American community.
There are also the well known policy questions of Summers having promoted the deregulation that led to the financial collapse, having bullied Brooksley Born, former chair of the Commodity Futures Trading Commission in the late 1990s, for wanting government to explore ways to limit derivatives abuses, and his rather soft views of regulation in the context of the Dodd-Frank Act rules.
Politically, our efforts to create a sense of inevitability for Summers over the past several weeks seemed to be working. But then, contrary to the White House story about an easy confirmation, three leading Democrats on the Senate Banking Committee, advised us that under no circumstances will they vote for Summers, and that was leaked to the press. See this piece from last Friday’s Wall Street Journal.
The New York Times also weighed in with a blistering anti-Summers editorial.
Even if we hold all other Democrats on the committee, that makes us reliant on the Republicans to get Summers out of committee. As you know, we have redoubled our efforts to get our Wall Street friends to lobby Republicans to support Summers.
Other things being equal, Republicans should be favorable to Summers because of his soft views on regulation and his concerns about inflation. But other things are not equal. Most Republicans do not like him personally. They will be torn between giving Wall Street a vote for a friendly Fed chairman and embarrassing the White House. If they smell blood in the water, we probably cannot count on their support.
It’s not at all clear whether we would prevent a runaway hearing. We have Committee Chairman Tim Johnson’s commitment to try to keep the lid on. Johnson has the back office operations of big banks in his home state of South Dakota thanks to their lax consumer laws and is one of the most Wall Street-friendly Democrats in Congress.
However, Johnson is not going to short-circuit a hearing if he has several committee members pressing for a full investigation. That would make him look bad for trying to railroad the nomination through.
We don’t yet know who will ask to testify. But the list could include several high-powered and prestigious people, such as other senators, former regulators, and senior Harvard officials, both present and former—people who could not be dismissed lightly. The hearing might drag on for days. We withdrew Tom Daschle as our Health and Human Services nominee for a lot less. It would not paint a pretty picture.
To reiterate, despite numerous conversations, we can’t know which way the Republicans will play this. In principle, there is no “linkage” between the Fed nomination and other pending battles. But in practice, you don’t have very many IOUs to call in with the Republicans and you need to consider if it makes the most sense to spend your limited bipartisan political capital on Summers.
One of our strongest cases for Summers is that he will reassure financial markets. But a confirmation hearing that turned out to be a donnybrook would do just the opposite. By contrast, we have unearthed nothing on the other leading candidate, Janet Yellen. A confirmation hearing for Yellen would be decorous, and the main opposition would be from monetary conservatives.
This raises one final question. The economy is still a lot softer than your economic team forecast. The Fed has been making noises about pulling back on monetary stimulus in the next month or two, a policy that would slow down the recovery. Summers has been more favorably inclined towards a pullback, while Yellen has stressed the need for continued stimulus to create jobs. Though she is not as personally well known to you and our economic team as Summers is, Yellen might actually pursue economic policies more in the administration’s political interest.