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Larry Summers, the Fed & Re-writing History

We don't generally comment on possible/prospective/rumored candidates for government positions (trial balloons or not), but the possibility of Larry Summers being the next Chairman of the Federal Reserve Board raises such critically important issues that we're going to make an exception. (Full disclosure: we made an exception when it was reported that the President was going to replace CFTC Chairman Gary Gensler.)

While the debate over the next Chairman of the Fed, including the President's remarkable defense of Summers before Congressional Democrats yesterday, has many aspects to it, at the moment we're going to limit our comments to what appears to be an attempted re-writing of history. Ben White at Politico's Morning Money quoted Summers supporter Cal Berkeley professor Brad DeLong, "'Brooksley Born approach’ made all existing derivatives contracts unenforceable.Very bad idea.”

As has been widely reported, there are many, many issues related to then-CFTC Chairman Brooksley Born’s proposal to regulate derivatives and the disputes she had with then-Treasury Secretary Robert Rubin, Fed Chairman Alan Greenspan, Deputy Treasury Secretary Larry Summers and SEC Chairman Arthur Levitt.

However, it is misleading in the extreme to suggest that the particular alleged infirmities of Born’s proposal are what prevented the regulation of derivatives or somehow exonerate Summers from his role in opposing her and in deregulating derivatives, the building blocks of the financial crisis that almost caused a second Great Depression. If it was merely the alleged deficiencies of Born’s approach, there were lots of other ways to accomplish her goal: prevent the non-regulation of a market that was high-risk and likely to grown substantially.

Their real problem with the proposal was that Born thought derivatives should have been regulated at all. Unlike Summers and the others, she didn’t believe in deregulation or the markets-know-best ideology that infected the other senior policy makers. Any arguments about the merits or alleged problems with her proposals are nothing more than a smokescreen.

How do we know that? Having killed Born’s proposal, what Rubin, Summers, Greenspan, et al, did was to legally prohibit the regulation of derivatives. That of course was the exact opposite of what Born wanted and was trying to do. Going to that extreme was not the act of people who were concerned with how she was going to accomplish her objective; it was done by people who didn’t believe at all in what she was trying to do. In fact, they believed the opposite.

As always happens with deregulation, this caused a rush of “products” and Wall Street “innovation” into the newly unregulated swaps markets. Many now talk about the regulatory arbitrage referred to as the futurization of swaps, which is merely the reformatting of swaps as futures because they are less regulated than swaps under the new post-crash Dodd-Frank rules. No one mentions it, but it’s really the re-futurization because once Summers et al prohibited the regulation of swaps in the late 1990's, many then-regulated futures were reformatted as unregulated swaps. (No regulation + no transparency = big fat margins for the Wall Street dealers, and high risk for everyone else.)

While there may have been many causes of the financial crash, no one can legitimately deny that it was invisibly incubated, ignited and spread throughout the globe via derivatives, all unregulated thanks to Summers et al.

To claim otherwise is to re-write history. While there are many other issues with Summers potentially becoming the next Chairman of the Fed, a little honesty on the basic facts would seem in order as to this point. (Another point worth making is that Summers has never acknowledged any of this, as John Cassidy at The New Yorker points out.)

 

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