As Obama Taps Larry Summers, Recalling Summer’s Days as a Regulation Foe

Fight disinformation: Sign up for the free Mother Jones Daily newsletter and follow the news that matters.


On Monday, President-elect Barack Obama announced his economic team, noting that Lawrence Summers would be the director of his National Economic Council. In touting Summers, Obama praised the former treasury secretary for his work during the Clinton years

Larry helped guide us through several major international financial crises – and was a central architect of the policies that led to the longest economic expansion in American history, with record surpluses, rising family incomes and more than 20 million new jobs. He also championed a range of measures – from tax credits to enhanced lending programs to consumer financial protections – that greatly benefited middle income families.

As a thought leader, Larry has urged us to confront the problems of income inequality and the middle class squeeze, consistently arguing that the key to a strong economy is a strong and growing middle class….And as one of the great economic minds of our time, Larry has earned a global reputation for being able to cut to the heart of the most complex and novel policy challenges.

While some of that might be true, Summers has been a controversial figure, and it’s likely no accident that he is being handed a position that does require him to be confirmed by the Senate.

But despite Summer’s intellect and experience, it’s worth remembering that he did blow one of the major calls of the 1990s: what to do about financial derivatives–those esoteric financial products (such as credit default swaps) that helped grease the way to the subprime meltdown. Not only did Summers oppose greater regulation for those financial instruments; he led the opposition against it.

Back in May 1998, the Commodity Futures Trading Commission, then chaired by Brooksley Born, issued a memo noting it was “re-examining its approach to the over-the-counter (OTC) derivatives market.” It noted:

While OTC derivatives serve important economic functions, these products, like any complex financial instrument, can present significant risks if misused or misunderstood. A number of large, well-publicized financial losses over the last few years have focused the attention of the financial services industry, its regulators, derivatives end-users and the general public on potential problems and abuses in the OTC derivatives market.

At the time the OTC derivatives market was valued at $28 trillion, according to the CFTC. The CFTC noted that it was time “to review its regulator approach to OTC derivatives.” The CFTC was suggesting the time had come for it to regulate this complicated, opaque corner–or hidden continent–of the economy.

Summers, then the deputy secretary of the Treasury, had another idea–as did Robert Rubin, the secretary of the Treasury, and Alan Greenspan, the chairman of the Federal Reserve. These wise men each gazed with horror upon Born’s proposed consideration of regulation for derivatives. Speaking for them, on July 30, 1998, Summers testified in the Senate against the notion of the CFTC even pondering rules governing the trading of derivatives. By releasing its memo, the CFTC, Summers complained, “has cast the shadow of regulatory uncertainty over an otherwise thriving market–raising risks for the stability and competitiveness of American derivative trading.”

Summers blasted the CFTC for having raised” the possibility of increased regulation over this market.” And he hailed derivatives:

The dramatic growth of the market in recent years is testament not merely to the dynamism of modern financial markets, but to the benefits that derivatives provide for American businesses.

By helping participants manage their risk exposures better and lower their financing costs, derivatives facilitate domestic and international commerce and support a more efficient allocation of capital across the economy. They can also improve the functioning of financial markets themselves by potentially raising liquidity….OTC derivatives directly and indirectly support higher investment and growth in living standards in the United States and around the world.

Even “small regulatory changes,” Summers cautioned, could throw the whole system out of whack. Determined to slap down the CFTC, his Treasury Department, the Fed, and the Securities and Exchange Commission crafted a proposal that would prohibit the CFTC from issuing new rules regulating any swap or “hybrid instrument.”

Summers told the Senate he and his fellow economic bigfoots were not slamming Born and the CFTC cavalierly:

We understood the seriousness of making this proposal. To question an independent agency’s concept of its jurisdiction and then to propose legislation that would temporarily curtail that agency’s ability to act is not something we do lightly. We concluded, however, that such legislation was necessary to avoid disruption and dislocation in the market while the underlying issues were being considered by Congress.

Congress in late 2000 did end up implementing the Summers approach, when Senator Phil Gramm, then the head of the Senate banking committee, used a back-room maneuver to slip into a must-pass spending bill a measure that prevented the CFTC or the SEC from regulating derivatives.

During that 1998 Senate appearance, Summers did acknowledge that there could be problems with derivatives:

They can also be abused. And there have been certain problems that have arisen in recent years in both the OTC and exchange-traded derivatives market, as well as problems arising from inappropriate investments in complex securities with embedded derivatives. More broadly, questions have been raised as to whether the derivatives markets could exacerbate a large, sudden market decline.

But all he–and Rubin and Greenspan–wanted to do at the time was to study the matter. After all, Summers noted, the Big Finance institutions buying and selling “these kinds of contract are largely sophisticated financial institutions that would appear to be eminently capable of protecting themselves” from any problems with derivatives. In other words: fear not, the high-flyers of Wall Street and the world’s financial markets know what they are doing.

Summers got that wrong. (See Citigroup.) While others–such as Born and her staff at the CFTC–presciently spotted potential problems arising from the exploding derivatives market, Summers, Rubin and Greenspan blithely fell back on the conventional view: regulation is a growth-killer. Summers’ 1998 testimony was imbued with the hubris that led to the current financial disaster. Obama–and the rest of the nation–should hope that when it comes to thinking about regulation these days, Summers has experienced a market-driven correction.

AN IMPORTANT UPDATE

We’re falling behind our online fundraising goals and we can’t sustain coming up short on donations month after month. Perhaps you’ve heard? It is impossibly hard in the news business right now, with layoffs intensifying and fancy new startups and funding going kaput.

The crisis facing journalism and democracy isn’t going away anytime soon. And neither is Mother Jones, our readers, or our unique way of doing in-depth reporting that exists to bring about change.

Which is exactly why, despite the challenges we face, we just took a big gulp and joined forces with the Center for Investigative Reporting, a team of ace journalists who create the amazing podcast and public radio show Reveal.

If you can part with even just a few bucks, please help us pick up the pace of donations. We simply can’t afford to keep falling behind on our fundraising targets month after month.

Editor-in-Chief Clara Jeffery said it well to our team recently, and that team 100 percent includes readers like you who make it all possible: “This is a year to prove that we can pull off this merger, grow our audiences and impact, attract more funding and keep growing. More broadly, it’s a year when the very future of both journalism and democracy is on the line. We have to go for every important story, every reader/listener/viewer, and leave it all on the field. I’m very proud of all the hard work that’s gotten us to this moment, and confident that we can meet it.”

Let’s do this. If you can right now, please support Mother Jones and investigative journalism with an urgently needed donation today.

payment methods

AN IMPORTANT UPDATE

We’re falling behind our online fundraising goals and we can’t sustain coming up short on donations month after month. Perhaps you’ve heard? It is impossibly hard in the news business right now, with layoffs intensifying and fancy new startups and funding going kaput.

The crisis facing journalism and democracy isn’t going away anytime soon. And neither is Mother Jones, our readers, or our unique way of doing in-depth reporting that exists to bring about change.

Which is exactly why, despite the challenges we face, we just took a big gulp and joined forces with the Center for Investigative Reporting, a team of ace journalists who create the amazing podcast and public radio show Reveal.

If you can part with even just a few bucks, please help us pick up the pace of donations. We simply can’t afford to keep falling behind on our fundraising targets month after month.

Editor-in-Chief Clara Jeffery said it well to our team recently, and that team 100 percent includes readers like you who make it all possible: “This is a year to prove that we can pull off this merger, grow our audiences and impact, attract more funding and keep growing. More broadly, it’s a year when the very future of both journalism and democracy is on the line. We have to go for every important story, every reader/listener/viewer, and leave it all on the field. I’m very proud of all the hard work that’s gotten us to this moment, and confident that we can meet it.”

Let’s do this. If you can right now, please support Mother Jones and investigative journalism with an urgently needed donation today.

payment methods

We Recommend

Latest

Sign up for our free newsletter

Subscribe to the Mother Jones Daily to have our top stories delivered directly to your inbox.

Get our award-winning magazine

Save big on a full year of investigations, ideas, and insights.

Subscribe

Support our journalism

Help Mother Jones' reporters dig deep with a tax-deductible donation.

Donate