Larry Summers Should Keep His Mouth Shut

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:

2014.6.10.Speakout.Graph.1(Click here to enlarge image)

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:

2014.6.10.Speakout.Graph.2(Click here to enlarge image)

This 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.