Larry Summers Should Keep His Mouth Shut

By James Kwak

Larry Summers is well on his way to rehabilitating his public image as a brilliant intellectual, moving on from his checkered record as president of Harvard University and as President Obama’s chief economic adviser during the first years of the administration. Unfortunately, he can’t resist taking on his critics—and he can’t do it without letting his debating instincts take over.

I was reading his review of House of Debt by Mian and Sufi. Everything seemed reasonable until I got to this passage justifying the steps taken to bail out the financial system:

“The government got back substantially more money than it invested. All of the senior executives who created these big messes were out of their jobs within a year. And stockholders lost 90 per cent or more of their investments in all the institutions that required special treatment by the government.”

I have no doubt that every word in this passage is true in some meaninglessly narrow sense or other. But on the whole it is simply false.

Yes, the government got back more money than it invested, if you are looking solely at TARP disbursements. But if Larry Summers evaluates his own investments that way, then he should find someone else to manage his money. The government systematically bought preferred stock in banks for more than it was worth, and it sold assets guarantees to banks for less than they were worth. The fact that it got lucky doesn’t mean those weren’t bad investments.

For example, the government guaranteed a pool of assets owned by Bank of America for something like $5 billion plus warrants. Six months later, after the worst of the crisis passed, Bank of America decided it no longer needed the insurance and wanted out of the deal; Treasury let them out for a payment of $425 million. Larry Summers counts that as a good deal, since Treasury netted $425 million. But that just means they got lucky. By that logic, Summers could sell earthquake insurance on California homes for $10 per year and call himself a genius after one year without an earthquake. Treasury should have collected the difference between the value of the insurance when the deal was struck and when Bank of American wanted out, which would have been a whole lot more than $425 million.

If that’s confusing, there’s an even easier way to think about it. TARP made its first round of investments on Monday, October 13, 2008. As of November 21 last year, TARP was about to turn a paper profit, at least according to the Treasury Department, getting $432 billion back on $422 billion in investments. That’s a 2.4% total return over more than five years, or an annualized return of less than 0.5%. If the government had instead put its money into the stock market on Friday, October 10, 2008, it would have earned a total return of 132% over the same period, or more than 18.3% per year. If Treasury had simply used TARP to buy 5-year Treasury bonds and held them to maturity, it would have earned an annual yield of 2.8%. In short the government only got back “substantially more than it invested” if you ignore the time value of money and risk.

Next, Summers says, “All of the senior executives who created these big messes were out of their jobs within a year.” I’m sure he has a list of the “senior executives” who “created these big messes.” Maybe it includes Chuck Prince (Citigroup), Angelo Mozilo (Countrywide), Dick Fuld (Lehman), and Martin Sullivan (AIG), all of whom were actually gone before Summers showed up on the scene. Maybe it includes Ken Lewis (Bank of America), who left at the end of 2009. But it must not include Jamie Dimon, Lloyd Blankfein, Vikram Pandit, and dozens of other “senior executives,” since there’s little indication that the administration made any effort to force anyone out, except at AIG, where the Bush administration pushed aside the placeholder who had replaced Sullivan.

Finally, “stockholders lost 90 per cent or more of their investments in all the institutions that required special treatment by the government.” Summers must have a pretty narrow definition of “special treatment.” Here’s the Goldman stock price from its 2007 peak to today:

Screen Shot 2014-06-09 at 11.41.38 AM

There’s no 90% fall in there no matter where you look.

But even if you say Goldman didn’t get “special treatment” (OK, come on—what else do you call the emergency transformation into a bank holding company and the back-door bailout through government-controlled AIG?), this is Bank of America, which did get the extra bailout in January 2009:

Screen Shot 2014-06-09 at 11.45.08 AMThis time there is a 90% fall, but only if you go from October 2007 to March 2009—which means it only applies to shareholders who sold at the bottom. But what does that 90% fall mean, anyway? On January 16, 2009, when Bank of America got its special bailout, its stock was worth $8.32 (that’s the previous day’s close). The stock had already lost most of its value, which is what is supposed to happen when a company blows up. Its price was only distinguishable from zero because of option value predicated on the possibility of a government bailout. The government delivered on the bailout, and although the stock fell to a low of $3.14, by the end of the year it was up to $15.06. In other words, from the point where the government gave Bank of America “special treatment,” its stock almost doubled in less than a year.

All of this is before I got to the real howler, where Summers says he was in favor of mortgage cramdown and that it was rejected for political reasons. But Adam Levitin already called Summers on this blatant attempt to rewrite history, so I’ll let him take care of that one. I’ll just add that Summers claims the administration didn’t pursue cramdown because it didn’t have the votes, while prior reporting has indicated that the Obama economic team was against it in principle.

If Larry Summers could just keep quiet, someday people will think of him as a respected elder statesman (hey, it happened to Ronald Reagan and even Henry Kissinger). But if he continues trying to prove that he was right about everything that every happened in the universe, it isn’t going to happen.

 

16 responses to “Larry Summers Should Keep His Mouth Shut

  1. I think this is among the most significant info for me.
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  2. Perhaps most startling in both Summers’ and Geithner’s treatment of this “we made a profit on this strategy” is the very basic premise underlying the US Government itself; “We the people” ARE the government and “We the people” did not turn a profit… talk about a flawed syllogism out of the gate.

    And they have the nerve to call themselves, “public servants.”

  3. Perhaps most startling in both Summers’ and Geithner’s treatment of this “we made a profit on this strategy” is the very basic premise underlying the US Government itself; “We the people” ARE the government and “We the people” did not turn a profit… talk about a flawed syllogism out of the gate.

    And they have the nerve to call themselves, “public servants.”

  4. Isn’t that TARP argument a bit narrow though? Summers could easily argue that the 0.5% annualized return was a great one considering the possible opportunity cost of a second Lehman. Then you’d go into a whole debate about potential fallout costs and so on.

    What seems wholly false, however, is to look at TARP as a standalone investment and not mentioning all the other programs – including an FDIC led guarantee on all new bank debt.

    If someone told me that a bank which earns its money on interest differentials would be provided with a credible free debt guarantee, artificially lowering its interest costs substantially, then I’m pretty sure I would trust that bank to gradually earn its way back to health. That is certainly going to affect equity returns on instruments like TARP. It doesn’t however mean that the return is positive if you include the cost of the non-budgeted guarantees and guarantee-like arrangements.

    It would be fun to have on record Summers’ definition of zombie banks before the crisis – back when he was Oh So Serious about the Japanese errors and the need for accountability. Because I’m sure if asked now he’d have a new definition which would somehow conveniently exclude the current U.S. setup instigated by the 2008-2009 dream team.

  5. C’mon, be fair. don’t just dump on him for his record as President Obama’s chief economic advisor. Also dump on him for his record as President Clinton’s economic advisor, and his role in dismantling financial / banking regulations.

    I can’t think of a guy who has done more damage to the American economy who still has a good reputation among progressive types.

  6. reddut.com

    Your indebtedness will follow you to your grave, into the After Life, and then some more”. No forgiveness, jubilee, nor any plea for mercy…… Direct your rage and spite at the true source of the problem aka your elected representative in Congress:

    “Student loans were dischargeable in bankruptcy prior to 1976. With the introduction of the US Bankruptcy Code (11 USC 101 et seq) in 1978, the ability to discharge education loans was limited. Subsequent changes in the law have further narrowed the dischargeability of education debt…..The Bankruptcy Amendments and Federal Judgeship Act of 1984 made private student loans from all nonprofit lenders excepted from discharge, not just colleges, by striking the words “of higher education”. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 expanded this to include all “qualified education loans”, regardless of whether a nonprofit institution was involved in making the loans.”

    “And Apple pays very little taxes. they hold enough money in offshore accounts to give all 400,000 of their production workers in China a $100,000 bonus. workers that earn a slave wage. And they would still have enough money left over to buy a controlling interest in Toyota and Honda. If there is one company that proves that trickle down economics is pure B.S., the rotten apple is it.”

    RE: I’ll just add that Summers claims the administration didn’t pursue cramdown because it didn’t have the votes, while prior reporting has indicated that the Obama economic team was against it in principle.

    Summers “claim” was a fact – they didn’t have the votes, “google” it or read the link: “Known as “mortgage cramdown,” the measure was defeated in a 188-241 decision as a proposed amendment “..:

    http://www.reuters.com/article/2009/12/11/us-financial-regulation-house-cramdown-idUSTRE5BA3CN20091211

    Heads-on-a-stick pols used to have principles but they traded them in for corporate welfare, a cushy government job, and faux celebrity.

    It’s all talk from their rear end,

    so why be so serious………………

    http://goo.gl/ZBZQdv

  7. Summers is saying the same thing that Tim Geithner is saying. This reads just like Geithner’s interview on The Daily Show.

  8. Dianne Foster

    James, you didn’t pay money for this book, did you? (and BTW, I don’t know any progressives that don’t hate Summers; he’s the poster boy for corruption.

  9. Moses Herzog

    @Dianne Foster
    I don’t think it’s the Mian/Sufi book James Kwak has a problem with, it is Summer’s propaganda, disguised as “review” of the book, Kwak is criticizing. Might want to check your reading comprehension skills.

    BTW, an update on the Reaganite style LIE Kansas Republican Governor and Kansas Republicans are telling their constituents (who apparently Republicans now believe to be largely illiterate).
    http://www.kansascity.com/news/government-politics/article505376/Analyst-Kansas-leaders-distorted-research-about-tax-revenue-shortfalls.html

  10. Contracts issued by an institution committing fraud at the highest levels of economic control – LIBOR – cannot be enforced. They are fraudulent by default.

    End of debate about “student loans”, and mortgages from Fannie and Freddie et al….

  11. Getting lucky is not quite right. The whole (skimpy) stimulus program was designed to stop the recession which it just barely did. But it was not “luck” that made Tarp investment good but the success at preventing catastrophe. This is not to say that the terms should not have been more stringent.

  12. ‘If the government had instead put its money into the stock market on Friday, October 10, 2008, it would have earned a total return of 132% over the same period, or more than 18.3% per year.’

    As Summers is intelligent enough to point out, who is to say that if the govt had NOT engaged in TARP the stock market would have done much worse. Even as badly as it did in the 1930s.

    Btw, Jamie Dimon is in no way responsible for the financial crisis, He was more like one of the solutions. Tim Geithner came to him in 2008 begging for his help with Bear Stearns. Same for WAMU.

  13. There are shortfalls across the entire political spectrum, and have been for quite some time. Denial is not just a river in Egypt.

  14. In reply to an earlier comment, yes, we the people turned a profit, to the extent that when the government turns a profit, it means more money is in the U.S. Treasury. If you’ve ever been concerned with what the government is doing with “your tax money,” these are one and the same

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