Larry Summers Has Had Enough Financial Regulation

by: Felix Salmon

The financial crisis? Regrettable, obviously. But let’s not rush to judgment here. Our financial system, pre-crisis, worked pretty well. Let’s not break it just because there was a crisis.

That’s the message being peddled by Alan Greenspan, predictably, sadly, and hilariously. And now he has a high-profile bedfellow from the other side of the aisle: Larry Summers, who was hanging out in Bretton Woods this weekend. Stephen Gandel summarizes:

One of the other big questions was what, if anything, Summers would have done differently in terms of regulating the banking system. The answer – not much. “I’ve been more cautious than many about constraining financial innovation,” he said, adding that he didn’t believe the financial crisis had its roots in “new-fangled financial instruments” but rather in a simple real estate bubble. Hmmm — tell that to Iceland. One thing Summers said that most of the crowd could agree with is that “anger and dissatisfaction with the financial system doesn’t constitute a [coherent regulatory] policy.”

There’s much more where that came from. This, for instance, is classic Larry:

It’s common in a moment like this to go into a general bash on economics. And everyone who hates economics because they don’t like markets in any context, or because they don’t do math, and so if you do a subject with math you have a bias towards believing that math is useless — everyone who doesn’t like economics has piled on at this moment to regard this crisis as a repudiation of economics. And I don’t think that’s right …

How we think about the design of regulatory institutions … the public choice school has taken that very seriously, but they have driven it relentlessly towards nihilism.

Larry’s keen on saying that “we’d make a serious mistake if we threw the baby out with the bathwater here.” But it seems to me that most people talking about babies and bathwater — and Summers is a prime example here — tend to be much more keen to protect their precious babies than they are constructive when it comes to the big questions of how to drain away the poisonous bathwater.

In this case, Summers has gone so far as to launch ad hominem attacks on reformers, calling them angry people who hate economics and don’t do math. At one point in his talk, Summers explains that people who want to regulate the financial system are very much like the smart people who became communists and who went on to create the Soviet Union.

Today, of course, the angry people who hate economics and don’t do math are mostly on the other side of the debate, hanging out at Tea Party rallies and trying to dismantle just about any kind of government financial regulation. Meanwhile, it’s generally unhelpful to characterize the people asking important questions about regulatory capture as nihilists or communists.

Summers, of course, has made very good money for himself from financial innovation — over $5 million for one day’s work per week from hedge fund DE Shaw in 2008 alone. And he has lost vast amounts of other people’s money using financial innovation: $1 billion of Harvard’s cash, to be precise, lost in misadventures with things called forward-start interest rate swaps. (A trade which TED called “either rank hubris or free money for Wall Street swap desks.”)

So it seems to me that Summers should be demonstrating substantially more humility here on the subject of encouraging financial innovation, when countries which constrained it did pretty well during the crisis compared to those with a deregulatory philosophy — and when very wise minds like Paul Volcker are credibly arguing that financial innovation almost never adds real economic value. Instead, he seems to have decided that insofar as any reform is warranted, Dodd-Frank did everything that was necessary, and the basic philosophy from here on in should be much the same as it was pre-crisis: that at the margin, having too much regulatory activity is worse than having too little.

This is astonishing, given that Summers actually conceded during his talk that the biggest economic successes in the world over the past couple of decades, China foremost among them, owe essentially nothing of their success to financial innovation or deregulation.

In the Ireland vs Iceland debate, Summers is decidedly Irish: “I don’t think any country is likely to allow the complete implosion of its financial system,” he said, effectively saying that Iceland isn’t even a country, or perhaps simply forgetting that it exists.

This seems to me to be a recipe for boom and bust — where the fruits of the boom accrue to a tiny handful of financial engineers and executives, while the costs of the bust are borne by citizens who never really participated in the boom in the first place. if you’re a multimillionaire technocrat with tenure at Harvard, you don’t feel recessions in the way that people do who are losing their homes and jobs, and who are running out of unemployment insurance. It’s worth remembering that, when you dismiss such people as ignorant and uneducated folks who hate economics and math. Because if there’s one thing we’ve learned from this crisis, it’s that what’s good for Larry Summers is not necessarily good for the rest of us.

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