A lot of threads related to our financial crisis come together in the form of Larry Summers and derivatives.
Actions taken out of a fear of global instability and ignorance of the potency of leveraged bets using derivatives weave through this story. It’s a long list of damage caused by Wall Street banks and derivatives and the involvement of Larry Summers.
Mr. Summers is currently the Director of the National Economic Council and Assistant to the President for Economic Policy. His background is a sterling litany of distinguished positions…
“…he served as the 27th president of Harvard University from July 2001 until June 2006. From 1999 to 2001, he served as the 71st United States Secretary of the Treasury following his earlier service as Deputy and Under Secretary of the Treasury and as Chief Economist of the World Bank. Summers has taught economics at Harvard and MIT. His research contributions were recognized when he received the John Bates Clark Medal, given every two years to the outstanding American economist under the age of 40, and when he was the first social scientist to receive the National Science Foundation’s Alan T. Waterman Award for outstanding scientific achievement…”
So why is such a smart man right in the center of so many important events related to derivatives?
PBS Frontline aired a program on the crisis and reported how Mr. Summers blocked derivatives regulation 10 years ago:
“[Brooksley] Born’s battle behind closed doors was epic, Kirk finds. The members of the President’s Working Group vehemently opposed [derivatives] regulation — especially when proposed by a Washington outsider like Born.
“I walk into Brooksley’s office one day; the blood has drained from her face,” says Michael Greenberger, a former top official at the CFTC who worked closely with Born. “She’s hanging up the telephone; she says to me: ‘That was [former Assistant Treasury Secretary] Larry Summers. He says, “You’re going to cause the worst financial crisis since the end of World War II.”… [He says he has] 13 bankers in his office who informed him of this. Stop, right away. No more.’”
Who were those bankers? And how is that someone who is so smart can be so supine?
If derivatives were going to collapse the financial system when they were relatively small in notional value how could leaving them unregulated protect our nation?
Here is how the market grew in size since Mr. Summers told Ms. Born to back down. (Bank for International Settlements and Office of the Comptroller of the Currency data)
This is an astounding escalation of the most dangerous financial product. The result of the actions of Mr. Summers, Alan Greenspan and Robert Rubin was the near collapse of our financial markets in 2007-2008 and the severe financial distress we face today.
Who were the 13 bankers in Mr. Summers office? We should at least know the names of their banks.
Following his tenure at the Treasury Mr. Summers went on to serve as the President of Harvard University. Harvard has a Larry Summers derivatives story too.
~~~~”Harvard paid $497.6 million to investment banks during the fiscal year ended June 30 to get out of $1.1 billion of interest-rate swaps intended to hedge variable-rate debt for capital projects, the report said. The university in Cambridge, Massachusetts, said it also agreed to pay $425 million over 30 to 40 years to offset an additional $764 million in swaps…
…The annual report provides new details on Harvard’s derivative-related losses. Many were entered into in 2004, said Harvard spokeswoman Christine Heenan. Lawrence Summers, director of President Barack Obama’s National Economic Council, was the university’s president at the time. White House spokesman Matthew Vogel declined to comment…
.…Harvard had 19 swap contracts with New York-based Goldman Sachs; JPMorgan Chase & Co.; Morgan Stanley; Charlotte, North Carolina-based Bank of America Corp. and other large banks, according to a bond-ratings report by Standard & Poor’s released on Jan. 18, 2008.”~~~~
Were these the same banks that stood in Larry Summers’ office and told him to block the efforts of Brooksley Born?
America has a right to know who these bankers were…
And finally we come to the current efforts of the Administration and Congress to reform the derivatives markets. I’m not encouraged so far… except for the courage of Gary Gensler and Collin Peterson to stand up and fight back against the banks.
I recently met a lawyer from Davis Polk Wardwell. I inquired if he had been the one to write the legislation that the Treasury department sent to Capitol Hill for derivatives reform… this had been reported in the media (NYT version)… he admitted to it and seemed pleased with the whole matter… the problem is that Davis Polk is counsel to many leading Wall Street banks… Davis Polk is the counsel to SIFMA the trade association for the Wall Street dealers … legislation drafted by them has the same effect as the 13 lawyers standing in Mr. Summers office drafting the legislation…
Mr. Summers aren’t you seeing any threads here? It’s obvious to me and I’m not nearly as educated as you.
Wall Street levaged up their balance sheets with toxic securities. Much of this is CDS buried in level 3 accounting. And now the whole toxic merry-go-round is gearing up again… can you say “rush the resolution authority“?
ICE, the derivatives trading and clearing firm owned by the same banks that likely stood in Mr. Summers office and told him what to say to Brooksly Born so long ago, is now reporting that CDS markets are “back”… The Financial Times reports “Mr Sprecher [the Chair of ICE] added that the credit derivative market, which wilted in the financial crisis, was starting to bounce back. “The banks are hiring in the credit derivative space,” he said.
“In fact, we hear there is tremendous competition to bring in qualified people into this space. There is a real anticipation from a staffing standpoint and a systems standpoint that we’ve been working on that this market is going to recover and recover strongly.”…
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OK Chairman Summers… first it was fear of a global meltdown, then ignorance of the possible implosion and losses from interest rate swaps going the wrong way in a six sigma event… now you are right in the middle of the reformation of our nation’s financial system… and Davis Polk, SIFMA and JP Morgan have written the new rules…
If all the CDS trades are concentrated in a clearing house owned by the same banks that have the counterparty exposure then we are not reducing systemic risk… this is what Blythe Masters of JP Morgan has been saying in Europe…
Really reducing systemic risk can only happen by separating depository banking from market making and proprietary trading in TBTF firms, haircutting debtholders and creating enhanced bankruptcty or wind downs for systemically relevant firms (like CIT’s prepack as asserted by Congressman Randy Neugebauer) It means those 13 bankers standing in your office ten years ago can no longer call the tunes for our financial system.
So it’s no more excuses… we wont survive another round of FDIC backed, Fed overseen Wall Street banks gearing up their casino again… we just wont … time to move pass fear and ignorance to some real reform.
Transparent reform that creates systemic stability. We can do it but the banks must be reined in on the issue of derivatives.
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See Derivatives and CDS clearing, and Vanity Fair on Summers and an attempt to level the field from the Kansas City Federal Reserve:
Resolution Process for Financial Companies that Pose Systemic Risk To the Financial System and Overall Economy
Federal Reserve Bank of Kansas City President Thomas M. Hoenig has been a strong proponent of addressing the issue of so-called “too-big-to-fail” financial firms by establishing a legal process that is consistent to firms of all sizes and holds those responsible for the firms condition accountable for its performance. The Federal Reserve Bank of Kansas City has prepared this document explaining exactly how that process could work.
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…Summers had a huge influence over Harvard money matters during his tenure, according to several people who worked with him. Known for his love of intellectual debate, he would hear out the opinions of others but ultimately was forceful in his own views. He was more financially sophisticated than most other Harvard presidents, and more deeply involved in decisions, from how to maximize returns on Harvard’s cash to using financial instruments called swaps, to hedge against the risk of rising interest rates – a hedge that would ultimately backfire.
In Harvard’s 2001-2002 financial report, Summers’s opening letter states, “During my first year as President, we took the opportunity to look anew at some of Harvard’s financial procedures to make sure we are making the most of our resources.’’ He closes the letter noting the need for “prudent fiscal management.’’
Despite the warnings from Meyer, Harvard Management’s chief for 15 years, Summers felt the cash risk was worth taking at the time, according to people who know him. He was not the sole decision maker on the matter: Members of the financial staff, a broader financial advisory committee, and the university’s elite six-member board all weighed in. But Summers was a powerful advocate, and with the returns so good for so long, there was little support for exercising caution.
And soon, Harvard would enter a period of upheaval. Meyer left in the fall of 2005, after clashing with Summers over the compensation of the endowment staff. And Summers announced his own resignation in February 2006 – as it happened, just days after the arrival of Meyer’s successor, El-Erian. A month later, Harvard’s top in-house financial official, Ann E. Berman, vice president for finance, also resigned.
Summers was gone by July that year, but not before El-Erian issued a new round of warnings about what he saw as an alarming amount of cash being put at risk in the endowment pool, according to several people who were there. El-Erian left Harvard after just two years, at the end of 2007, to return to his old bond firm, PIMCO. Both he and Meyer declined to comment on whether the cash concerns contributed to their decision to leave.
For other university officials, warnings about Harvard’s finances were easy to gloss over. The endowment had been a virtual money machine for more than 15 years, and the markets were still rising in 2006. And after Summers resigned, forced out by an angry faculty after comments about women lagging in the sciences and other controversies, there were more urgent fires to tend to.
Derek Bok, a former Harvard president from the ’70s and ’80s, took over as interim president. He was, by his own admission, unplugged from the complexities of the financial picture.
“I concentrated on academic issues,’’ Bok said in a Globe interview. He said that his strength was not in investments and that Harvard had an experienced treasurer and board to oversee those issues. “I think they would have come to see me if there were really important changes,’’ he said.
Harry Lewis, a Harvard professor and a former dean of the college, attributes the failure to address the university’s financial risks to the ancient structure of the Harvard corporation, which functions as its board. “With only the six fellows plus the president, there is inevitably going be a lot of deference to the people who seem to have the most authority, especially if the president is strong-willed,’’ Lewis said. “Whether or not anyone in particular made a mistake in this situation, it shows a fundamental structural problem. The power is just in the hands of too few people with too little accountability.’’
http://www.boston.com/news/local/massachusetts/articles/2009/11/29/harvard_ignored_warnings_about_investments/?page=full
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