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Back to class for Summers after the free-market lunch

by Kevin Rafferty

LONDON — Larry Summers was snatching lunch during the African Development Bank annual meeting while I interviewed him. Under no circumstances, his minder said, were we to take pictures while he was eating — a wise precaution as it spared our cameras from the backlash of presenting him chomping greedily on a huge burger.

It was a fascinating experience that said much about Summers, his voracious hunger, a man in a hurry, not thinking of all the consequences. Summers was then undersecretary for international affairs at the U.S. Treasury with a glittering career behind him, including entering MIT at 16, Harvard’s youngest tenured professor at 28 and vice president for economics at the World Bank, and a still more glittering one ahead as U.S. treasury secretary, president of Harvard and, most recently, President Barack Obama’s economic czar.

Summers’ announcement that he will give up the leadership of Obama’s economic team at yearend should give the U.S. president time to pause for thought about who should replace this brilliant, highly ambitious but deeply flawed man.

His supporters say that his biggest achievement was in sorting out the 2008-09 financial mess and putting the American economy, and thus the world economy, back on its feet. The bailout of U.S. automakers as well as the “cash for clunkers” program, the massive stimulus package plus the revamped Troubled Assets Relief Program, and government support for Fannie Mae and Freddie Mac are the hallmarks.

Critics on the right say that the stimulus was too much and too expensive; those on the left respond that it did not go far enough, just as they claim that the subsequent laws to prevent another such crisis did not go far enough and pandered to the big bankers, who had caused the mess in the first place.

Critics really hate Summers because he was a key player in creating the system that encouraged the excesses and led to the financial crisis. As deputy and then successor to Robert Rubin as Bill Clinton’s treasury secretary, Summers was part of the team that backed deregulation of the financial markets. Indeed, Summers was treasury secretary when Glass-Steagall, the 1930s legislation that separated commercial banking from securities broking, was finally repealed. He heralded the new laws as “a system for the 21st century.”

Summers not only bought the arguments about the efficiency of markets, but yielded to the free-market absolutists. Barry Ritholtz, who runs the blog The Big Picture comments: “Instead of speaking out against the irresponsible Gramm-Leach-Bliley Act (Financial Services Modernization Act of 1999), he actively supported it. Instead of explaining to the public how Glass- Steagall prevented Wall Street crises from spilling over into Main Street for 65 years, he rolled over for Citibank. The repeal of Glass-Steagall was not a cause of the crisis, but it allowed the net damage to be far, far worse than it would have otherwise been.”

Equally damaging was the role that Summers played as overseer of the Commodities Futures Modernization Act of 2000, which exempted financial derivatives from regulatory oversight, thus permitting AIG Financial Products to write more than $3 trillion in derivatives without reserving a single dollar, and helping to pave the way for the downfall of Lehman Brothers and Bear Sterns. Bill Clinton belatedly this year admitted that Summers was wrong in the advice he gave not to regulate derivatives.

Critics claim that the damage goes much further and reaches deep into the American economy and society. According to Ritholtz, the new legislation was “emblematic of the corporate takeover of the legislative process.”

Today, U.S. corporate balance sheets are the healthiest in 50 years and leading companies are borrowing at 1 percent or less. But for millions of ordinary Americans, the recession has not ended. Unemployment remains at 9.6 percent, 2 percentage points higher than when Obama took over, while multinational U.S. companies are employing hundreds of thousands of workers in foreign factories.

In his love-fest with big banks and deregulation, Summers forgot that the American Dream was in producing goods. During the Great Depression, Franklin D. Roosevelt borrowed money mostly from Americans and put them to work building things like the Golden Gate Bridge, and they spent their wages on buying American goods.

Today, Obama is borrowing money from China, Japan and Asia and sending it to Americans in unemployment checks, and they are spending it at Wal-Mart to pay Chinese workers.

When Bill Clinton left office, Summers went back to Harvard and became its president. He lasted just five years and was embroiled in several controversies, including Harvard’s billion-dollar losses on interest-rate swap contracts, until the faculty passed a vote of no confidence in him and he resigned. He stayed on as an economics professor.

Both at Harvard and earlier at the World Bank, Summers had got into trouble because of controversial things he had written without considering the political and social consequences.

At the bank, writing of trade liberalization, he suggested that “the economic logic behind dumping a load of toxic waste in the lowest wage country is impeccable. . . I’ve always thought that underpopulated countries in Africa are vastly underpolluted.” It was an idea that Brazilian environmentalist Jose Lutzenberger described as “perfectly logical but totally insane.” It took Summers more than a decade to claim that his idea was meant sarcastically. Summers urged Clinton not to take a lead in reducing greenhouse gases or to join the Kyoto Protocol, although this was not revealed until last year.

Henry Kissinger had urged that Summers should be given a key role in the White House to use his formidable brain to shoot down bad ideas. But one of the problems in his current role is that he is a figure looming large in the background with little certainty about what advice he is giving or whose ideas — good or bad — he is shooting down.

With the help of Treasury Secretary Timothy Geithner, he watered down the more radical financial reform proposals of former Federal Reserve chairman Paul Volcker. A Washington insider says, “Larry Summers has a brilliantly sharp brain, but he tends to be an intellectual thug, who will use any means to silence an argument he disapproves of.”

Summers is going back to Harvard to retain his tenure, although by most accounts he was frustrated that Obama renewed Ben Bernanke’s term at the Fed because Summers had long coveted the position. But he will leave behind a team under Geithner who share the same philosophy, so there is not likely to be a real change unless Obama appoints someone to succeed Summers who takes a different view of what ails the U.S.

There is reason to do so. For all his time dealing with international affairs, Summers seems to have little consciousness of America’s changing role in the world economy and the need to be more active in formulating a global view. Obama has spoken several times of how the U.S. cannot rule the world alone, but in economic policy there is no sign that anyone in Washington is listening or has a plan with any global vision.

So how can you expect Beijing to show any interest?

Kevin Rafferty is a freelance journalist based in Hong Kong.