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October 3, 2010
Jim Watson, Agence France-Presse, Getty Images
Lawrence H. Summers (right) joined Secretary of the Treasury Timothy Geithner as President Obama spoke about the nation's financial health in January.
The Obama administration recently announced that Larry Summers is resigning as director of the National Economic Council and will return to Harvard early next year. His imminent departure raises several questions: Who will replace him? What will he do next? But more important, it's a chance to consider the hugely damaging conflicts of interest of the senior academic economists who move among universities, government, and banking.
Summers is unquestionably brilliant, as all who have dealt with him, including myself, quickly realize. And yet rarely has one individual embodied so much of what is wrong with economics, with academe, and indeed with the American economy. For the past two years, I have immersed myself in those worlds in order to make a film, Inside Job, that takes a sweeping look at the financial crisis. And I found Summers everywhere I turned.
Consider: As a rising economist at Harvard and at the World Bank, Summers argued for privatization and deregulation in many domains, including finance. Later, as deputy secretary of the treasury and then treasury secretary in the Clinton administration, he implemented those policies. Summers oversaw passage of the Gramm-Leach-Bliley Act, which repealed Glass-Steagall, permitted the previously illegal merger that created Citigroup, and allowed further consolidation in the financial sector. He also successfully fought attempts by Brooksley Born, chair of the Commodity Futures Trading Commission in the Clinton administration, to regulate the financial derivatives that would cause so much damage in the housing bubble and the 2008 economic crisis. He then oversaw passage of the Commodity Futures Modernization Act, which banned all regulation of derivatives, including exempting them from state antigambling laws.
After Summers left the Clinton administration, his candidacy for president of Harvard was championed by his mentor Robert Rubin, a former CEO of Goldman Sachs, who was his boss and predecessor as treasury secretary. Rubin, after leaving the Treasury Department—where he championed the law that made Citigroup's creation legal—became both vice chairman of Citigroup and a powerful member of Harvard's governing board.
Over the past decade, Summers continued to advocate financial deregulation, both as president of Harvard and as a University Professor after being forced out of the presidency. During this time, Summers became wealthy through consulting and speaking engagements with financial firms. Between 2001 and his entry into the Obama administration, he made more than $20-million from the financial-services industry. (His 2009 federal financial-disclosure form listed his net worth as $17-million to $39-million.)
Summers remained close to Rubin and to Alan Greenspan, a former chairman of the Federal Reserve. When other economists began warning of abuses and systemic risk in the financial system deriving from the environment that Summers, Greenspan, and Rubin had created, Summers mocked and dismissed those warnings. In 2005, at the annual Jackson Hole, Wyo., conference of the world's leading central bankers, the chief economist of the International Monetary Fund, Raghuram Rajan, presented a brilliant paper that constituted the first prominent warning of the coming crisis. Rajan pointed out that the structure of financial-sector compensation, in combination with complex financial products, gave bankers huge cash incentives to take risks with other people's money, while imposing no penalties for any subsequent losses. Rajan warned that this bonus culture rewarded bankers for actions that could destroy their own institutions, or even the entire system, and that this could generate a "full-blown financial crisis" and a "catastrophic meltdown."
When Rajan finished speaking, Summers rose up from the audience and attacked him, calling him a "Luddite," dismissing his concerns, and warning that increased regulation would reduce the productivity of the financial sector. (Ben Bernanke, Tim Geithner, and Alan Greenspan were also in the audience.)
Soon after that, Summers lost his job as president of Harvard after suggesting that women might be innately inferior to men at scientific work. In another part of the same speech, he had used laissez-faire economic theory to argue that discrimination was unlikely to be a major cause of women's underrepresentation in either science or business. After all, he argued, if discrimination existed, then others, seeking a competitive advantage, would have access to a superior work force, causing those who discriminate to fail in the marketplace. It appeared that Summers had denied even the possibility of decades, indeed centuries, of racial, gender, and other discrimination in America and other societies. After the resulting outcry forced him to resign, Summers remained at Harvard as a faculty member, and he accelerated his financial-sector activities, receiving $135,000 for one speech at Goldman Sachs.
Then, after the 2008 financial crisis and its consequent recession, Summers was placed in charge of coordinating U.S. economic policy, deftly marginalizing others who challenged him. Under the stewardship of Summers, Geithner, and Bernanke, the Obama administration adopted policies as favorable toward the financial sector as those of the Clinton and Bush administrations—quite a feat. Never once has Summers publicly apologized or admitted any responsibility for causing the crisis. And now Harvard is welcoming him back.
Summers is unique but not alone. By now we are all familiar with the role of lobbying and campaign contributions, and with the revolving door between industry and government. What few Americans realize is that the revolving door is now a three-way intersection. Summers's career is the result of an extraordinary and underappreciated scandal in American society: the convergence of academic economics, Wall Street, and political power.
Starting in the 1980s, and heavily influenced by laissez-faire economics, the United States began deregulating financial services. Shortly thereafter, America began to experience financial crises for the first time since the Great Depression. The first one arose from the savings-and-loan and junk-bond scandals of the 1980s; then came the dot-com bubble of the late 1990s, the Asian financial crisis; the collapse of Long Term Capital Management, in 1998; Enron; and then the housing bubble, which led to the global financial crisis. Yet through the entire period, the U.S. financial sector grew larger, more powerful, and enormously more profitable. By 2006, financial services accounted for 40 percent of total American corporate profits. In large part, this was because the financial sector was corrupting the political system. But it was also subverting economics.
Over the past 30 years, the economics profession—in economics departments, and in business, public policy, and law schools—has become so compromised by conflicts of interest that it now functions almost as a support group for financial services and other industries whose profits depend heavily on government policy. The route to the 2008 financial crisis, and the economic problems that still plague us, runs straight through the economics discipline. And it's due not just to ideology; it's also about straightforward, old-fashioned money.
Prominent academic economists (and sometimes also professors of law and public policy) are paid by companies and interest groups to testify before Congress, to write papers, to give speeches, to participate in conferences, to serve on boards of directors, to write briefs in regulatory proceedings, to defend companies in antitrust cases, and, of course, to lobby. This is now, literally, a billion-dollar industry. The Law and Economics Consulting Group, started 22 years ago by professors at the University of California at Berkeley (David Teece in the business school, Thomas Jorde in the law school, and the economists Richard Gilbert and Gordon Rausser), is now a $300-million publicly held company. Others specializing in the sale (or rental) of academic expertise include Competition Policy (now Compass Lexecon), started by Richard Gilbert and Daniel Rubinfeld, both of whom served as chief economist of the Justice Department's Antitrust Division in the Clinton administration; the Analysis Group; and Charles River Associates.
In my film you will see many famous economists looking very uncomfortable when confronted with their financial-sector activities; others appear only on archival video, because they declined to be interviewed. You'll hear from:
Martin Feldstein, a Harvard professor, a major architect of deregulation in the Reagan administration, president for 30 years of the National Bureau of Economic Research, and for 20 years on the boards of directors of both AIG, which paid him more than $6-million, and AIG Financial Products, whose derivatives deals destroyed the company. Feldstein has written several hundred papers, on many subjects; none of them address the dangers of unregulated financial derivatives or financial-industry compensation.
Glenn Hubbard, chairman of the Council of Economic Advisers in the first George W. Bush administration, dean of Columbia Business School, adviser to many financial firms, on the board of Metropolitan Life ($250,000 per year), and formerly on the board of Capmark, a major commercial mortgage lender, from which he resigned shortly before its bankruptcy, in 2009. In 2004, Hubbard wrote a paper with William C. Dudley, then chief economist of Goldman Sachs, praising securitization and derivatives as improving the stability of both financial markets and the wider economy.
Frederic Mishkin, a professor at the Columbia Business School, and a member of the Federal Reserve Board from 2006 to 2008. He was paid $124,000 by the Icelandic Chamber of Commerce to write a paper praising its regulatory and banking systems, two years before the Icelandic banks' Ponzi scheme collapsed, causing $100-billion in losses. His 2006 federal financial-disclosure form listed his net worth as $6-million to $17-million.
Laura Tyson, a professor at Berkeley, director of the National Economic Council in the Clinton administration, and also on the Board of Directors of Morgan Stanley, which pays her $350,000 per year.
Richard Portes, a professor at London Business School and founding director of the British Centre for Economic Policy Research, paid by the Icelandic Chamber of Commerce to write a report praising Iceland's financial system in 2007, only one year before it collapsed.
And John Campbell, chairman of Harvard's economics department, who finds it very difficult to explain why conflicts of interest in economics should not concern us.
But could he be right? Are these professors simply being paid to say what they would otherwise say anyway? Unlikely. Mishkin and Portes showed no interest whatever in Iceland until they were paid to do so, and they got it totally wrong. Nor do all these professors seem to make policy statements contrary to the financial interests of their clients. Even more telling, they uniformly oppose disclosure of their financial relationships.
The universities avert their eyes and deliberately don't require faculty members either to disclose their conflicts of interest or to report their outside income. As you can imagine, when Larry Summers was president of Harvard, he didn't work too hard to change this.
Now, however, as the national recovery is faltering, Summers is being eased out while Harvard is welcoming him back. How will the academic world receive him? The simple answer: Better than he deserves.
While making my film, we wrote to the presidents and provosts of Harvard, Columbia, and other universities with detailed questions about their conflict-of-interest policies, requesting interviews about the subject. None of them replied, except to refer us to their Web sites.
Academe, heal thyself.
Charles Ferguson is director of the new documentary Inside Job and the 2007 documentary No End in Sight: The American Occupation of Iraq.
Mr. Ferguson, thank you, thank you for exposing this two-faced, self-rightous, pompous hypocrite whom you demonstrate is also a bully of the first order! I have been telling anyone who would listen, for more than a year, that this guy who is part of the team which demonized the private banking sector, which resulted in the appointment of a pay czar, is the root of the problem (other than congress itself). I have pointed out that whilst Geitner and especially Obama were railing against the Wall Street and banking "fat cats," Summers was coming off a two-year run of bringing in $2million+ in fees from the very companies which were at the core of the meltdown.Harvard welcomes him back? And people on this website have criticized the Savannah College of Art for paying its founding president too much money? Again, thank you Mr. Ferguson for this commentary and exposing these hypocrites on film!
Thanks for the piece. Let us see how the profession responds not only to this essay, but to its legitimacy itself in the wake of the Great Recession.
The profession is not being hypocritical -- indeed, the problem is that the profession is not being hypocritical! These professors actually BELIEVE what they spout. It is true that they would not likely have turned their attention to Iceland without the money but if they had, they would likely have said exactly what they said. Thus the problem is not a conflict of interests but a lack of accountability -- if the economics professional wants to argue that only predictions matter, not the assumptions (the classic tenant of the Friedman positivist agenda), then the results better match what the theory suggests will occur. Uh oh . . . they don't.
This problem pervades the university--from med schools with their pharmaceutical company ties to ed schools with their publisher ties. Where's the conflict of interest reporting in these institutions?
I look forward to watching Mr. Ferguson's documentary, but I heard nothing in his article that made a case for Larry Summers or any other economist being anything but a practitioner of the dismal science as he or she has learned and theorized it. There are brilliant economists and there are Harvard professors and they only place they meet is in the humor of Twain, who is said to have written brilliantly on government that "there is no such thing as good government,"... and whose Tom Sawyer wrote ofwork, that it "consists of whatever a body is obliged to do, and that play consists of whatever a body is not obliged to do. And this would help him to understand why constructing artificial flowers, or performing on a treadmill, is work, whilst rolling nine-pins or climbing Mont Blanc is only amusement. There are wealthy gentlemen in England who drive four-horse passenger-coaches twenty or thirty miles on a daily line, in the summer, because the privilege costs them considerable money; but if they were offered wages for the service that would turn it into work, then they would resign."Is there any more to it than that?
"Starting in the 1980s, and heavily influenced by laissez-faire economics, the United States began deregulating financial services. Shortly thereafter, America began to experience financial crises for the first time since the Great Depression." The implication of the author is that laissez-faire economics leads to financial crises and that we need more/better regulation. Nothing could be further from the truth. On the contrary, the lesson from Summers and others is that manipulation of the regulatory state enriches insiders at the expense of the rest of us. Hoping that the answer is more/better regulation from more/better regulators is foolish. What we need is minimal regulation that puts the burden of losses on those that stand to benefit if things go well. What we have now is a corporate-government state with private benefits and socialized losses.
Although there was a voe of no confidence in Summers' presidency at Harvard after he made the remarks about women, that was not what forced him to resign. His resignation came a year later, when faculty members became concerned about quite different issues--notably the Andrei Shleifer case--and a second vote of no confidence was scheduled (it did not take place because Summers resigned). The Shleifer case is pertinent to the column above, because it has to do with money and ethics. Harvard University paid a huge sum of money to settle the lawsuit that the government had brought against Shleifer for his misconduct as a consultant in Russia. I believe that Shleifer paid a fine of $2 million out of his own pocket, while Harvard paid something like $26 million to settle the case.
This is an impressive piece, and it's articles like these that make me support the Chronicle. I wonder though if it will do any good since people like Summers are so entrenched in both academe and government. But thanks for trying to point out how academe, government, and the financial services sector have begun to intersect in disturbing ways. Too bad explanations like this one don't make their way into textbooks. If they did, kids might have more faith in textbooks and what they have to offer i.e. a way of understanding the world around them. Current textbooks, particularly those for government and business, paint a picture of a world that doesn't exist, a perfectly functioning laissez faire democracy. No wonder students don't want to read.
I will be interested to observe the notice that is given to the documentary by the media that is so in love with the current government. I saw Mr. Feguson on Morning Joe today and though he did a great job of outlining the facets of Summers' shifty career and of the crimes of the bankers, he was more or less ignored--very little interest on the part of the "show's" cast. Summers and the others involved in these scandals have too much government and Wall Street clout at this moment to be easy to expose or at least for that exposure to get the attention it deserves. The media will pass over this with its usual easy style and focus on Washington's and Wall Street's importance to the rest of us--especially with the midterm elections so near. Perhaps with more bipartisan power in Congress we will see some of these issues examined in the open. We live in hope.
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