Did Larry Summers Really Save the World?
08/15/2013 12:00 pm EST
When you think about the overall and ever-changing Fed, it's important to pay attention to every detail, especially now, while the president's decision on who will succeed chairman Ben Bernanke is postponed, writes MoneyShow's Howard R. Gold.
President Obama has postponed his decision on who will succeed Ben Bernanke as Federal Reserve chairman, with former Treasury Secretary Larry Summers, and current Fed vice chair Janet Yellen, the front runners.
Some senators and many rank-and-file Democrats back Yellen, while Summers has the strong support of White House economists and Wall Streeters. Former Deputy Treasury Secretary Roger Altman, now executive chairman of Evercore Partners, states the case that Summers is “battle-hardened” and would be a good firefighter-in-chief in future international crises:
“…Summers had the key role in the Clinton Treasury during both the Asian financial crisis and the Mexican default. And, later, in the Obama White House during the huge credit crisis in 2009.”
Leaving aside Summers' close financial ties to Wall Street firms he would oversee as Fed chairman; his role in deregulating banking and derivatives in the late 1990s, and his disastrous tenure as president of Harvard, did he really “save the world,” as his supporters claim? Or did his actions pave the way for something much worse?
Summers' reputation as a crisis manager was burnished in a February 1999 Time cover story, featuring him, Rubin, and then-Fed chairman Alan Greenspan as The Committee to Save the World.
I recently reread that famous story. Written by Joshua Cooper Ramo, it was a piece of staggering puffery, full of the myopic triumphalism of the late Clinton era. Here's one example:
“In late-night phone calls, in marathon meetings, and over bagels, orange juice, and quiche, these three men—Robert Rubin, Alan Greenspan, and Larry Summers—are working to stop what has become a plague of economic panic…
“What holds them together is a passion for thinking and an inextinguishable curiosity about a new economic order that is unfolding before them like an Alice in Wonderland world.”
I could go on—especially the part when Rubin says “the joy of working with Greenspan lies in both the power of his intellect and the sweetness of his soul”—but I won't.
In his autobiography, The Age of Turbulence, Greenspan called the three “economic foxhole buddies” who met for long breakfast meetings each week, for more than four years.
These “foxhole buddies” spent the mid- to late 1990s going from Mexico to Thailand to Russia, bailout buckets in hand, saving the global economy from itself.
- Read Howard's take on how U.S. investors got burned in emerging markets on MoneyShow.com.
But the Committee's most enduring legacy may have been the rescue of Long-Term Capital Management, which probably undermined whatever was left of moral hazard on Wall Street.
LTCM, launched by legendary Salomon Brothers trader John Meriwether (of Liar's Poker fame), included two Nobel Prize winners, Robert Merton and Myron Scholes. But as world markets seized up following the Russian currency crisis of August 1998—15 years ago, this month—the private partnership, betting heavily on risky assets and leveraged 55 to 1, found itself hemorrhaging hundreds of millions of dollars overnight.
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That caused the big Wall Street banks to panic. They were on the hook for $2.8 billion to LTCM amid what The Wall Street Journal labeled a “global margin call.”
Fear of contagion prompted the Federal Reserve Bank of New York to prod the big Wall Street firms to chip in on a $3.5-billion rescue package to LTCM. That ended the crisis, and stocks took off that fall amid a wave of dot.com IPOs.
The rescue of LTCM didn't include taxpayer money, and it was handled directly by the New York Fed. But it was the culmination of everything Greenspan, Rubin,, and Summers had been doing: When in doubt, bail it out, and ask questions later. Still, by averting a temporary panic, we paid a huge long-term price.
“Had LTCM been allowed to fail naturally, perhaps a lesson might have been learned: risk and reward are each sides of the same coin,” wrote Barry Ritholtz in his book Bailout Nation. “Alas, it was a missed opportunity for the traders and risk managers at major banks and brokers to learn this simple truism…. Long Term Capital Management was the predecessor for the great credit crisis of 2008.”
Even William McDonough, the president of the New York Fed who oversaw the LTCM rescue, later acknowledged:
“Fed intervention, despite its limited character, may have indeed increased moral hazard by increasing the perception of too-big-to-fail.”
And Greenspan himself told a Congressional hearing:
“My own guess is that the probability [of a systemic collapse] was significantly below 50% but still large enough to be worrisome...”
- Read why Howard thinks investors should stop listening to Ben Bernankeon MoneyShow.com.
In his definitive book on the LTCM crisis, When Genius Failed, Roger Lowenstein wrote:
“If one looks at the Long-Term episode in isolation, one would tend to agree that the Fed was right to intervene….But the Long-Term Capital case [was] the latest in a series in which an agency of the government (or the IMF) has come to the rescue of private speculators….Long-Term's exposure was huge, but, spread over all of Wall Street, it was hardly of apocalyptic proportions….” (Italics added.)
“On balance, the Fed's decision to get involved—though understandable given the panicky conditions of September 1998—regrettably squandered a choice opportunity to send the markets a needed dose of discipline.”
That message wasn't lost on James Cayne of Bear Stearns or Richard Fuld of Lehman Brothers, who were both in the room at the New York Fed when the LTCM deal was struck and whose own firms imploded a decade later. Also present: Jon Corzine and John Thain.
Hindsight is always 20/20, of course, and it's easier to pass judgment 15 years later than in the heat of the moment.
But whoever the president nominates as Fed chair must explain what he or she learned from that past so the rest of us aren't condemned to repeat it.
Howard R. Gold is editor at large for MoneyShow.com and a columnist at MarketWatch. Follow him on Twitter @howardrgold and see his live webcast “Your Ideal Portfolio for Now,” free, from the San Francisco MoneyShow at 3:50 PM Pacific time (6:50 PM Eastern) Friday, August 16th. To view the webcast, click here.