by Ron Suskind
The pressurized bubble Barack Obama had entered by June 2008 demanded some seasoned tending. After Hillary Clinton’s formal withdrawal that month from the race, professional managers were on their way.
Lawrence Summers had at this point been in exile from public life since his 2006 ouster from the Harvard presidency. In this last major job, he’d managed to lose the confidence of the university and its directors, most notably over comments suggesting that he held a discriminatory attitude toward women. At a meeting of the National Bureau of Economic Research in January 2005, Summers had opined that women’s underrepresentation in the advanced sciences might be due to “innate gender differences.” In the fallout that ensued, it looked suddenly like more than a coincidence that, during his time in office, Summers had overseen the tenure appointment of just four women to Harvard’s Faculty of Arts and Sciences, out of thirty-two total appointments.
This flap would generally be cited as the cause of his dismissal, but the real story was a bit more complicated. Other Harvard presidents, after all, might have survived the incident. But then, most would also have been familiar with the many studies on the so-called stereotyped threat, the faulty seeing-is-believing tendency that’s been shown to have a tightening effect at the highest ends of academic disciplines. Whether Summers knew about this research or not, in those comments at the NBER meeting for which he would later apologize, he certainly never mentioned it.
But this has been a pattern with Summers: to assume that his opinions in areas well outside his expertise are nonetheless sound. He trusts his analytical capacities to a remarkable degree, his ability to frame both sides of an argument and then decide which side is right. Many would say he trusts them to a fault. As he has aged, he has grown less troubled by being uninformed. This is at least what his friends say, while all the same pointing to his overall brilliance. His enemies—a substantial community by 2008—are less charitable. They point to the many instances in which Summers has marshaled powerful arguments for actions and policies that turned out to be disastrously wrong.
In an odd way, Summers’s extraordinary self-confidence would grow both harder and more brittle as he spent time in the public sphere. The architecture of his personality, in this way, recalls that of Nixon and Henry Kissinger, or, more recently, Dick Cheney—all men who blurred the line between ends and means. On issues of domestic policy and economics, Summers has long been rising to a similar status.
“Like Rome,” an old friend of Larry’s said, “he has spread himself too thin and must ever be on guard to put down even the slightest challenge or insurrection in intellectual territories which he claims but can’t hold.”
By most accounts, Summers exhibited less of this pomposity at earlier stages of his career, when he was still on the upward thrust of his meteoric ascent. As the child of two economists, with two Nobel laureate uncles in the field, Summers was primed for a life among the top economic minds of academia. He spent the first five years of his life in New Haven, Connecticut, while his father taught at Yale, then moved with his family to Philadelphia when his father got a professorship at Penn. As a teenager, in the span of just two years, Summers would see his uncles Kenneth Arrow and Paul Samuelson each win the Nobel Prize in Economics.
The lofty standard set by his family threw Summers full tilt into a scramble up the academic meritocracy. During his adolescence, when left home alone, he would get a math problem from his parents. If they forgot to leave a problem for him, he would chase after them demanding one. He matriculated at MIT at age sixteen, starred on the debate team, got his PhD in economics from Harvard by his midtwenties, and received tenure at the tender age of twenty-eight, becoming one of the very youngest tenured professors in Harvard’s 350-year history.
But for all his academic success, Summers did less well in his leadership roles. In the Clinton administration, he only really stepped out of Bob Rubin’s shadow at the end of that president’s second term. He then managed, in his own brief tenure as Treasury secretary, to preside over perhaps the most disastrous piece of deregulatory legislation since the Great Depression: the Financial Services Modernization Act of 1999 (also known as Gramm-Leach-Bliley), which, in undoing a major provision of Glass-Steagall, directly precipitated the “too big to fail” crisis nine years later. But it was as Harvard president that Summers provoked the most acrimony. Along with his knack for the public faux pas, he succeeded in antagonizing his bosses behind closed doors, specifically through meddling in the university’s investment strategy for its multibillion-dollar endowment. In addition to championing Gramm-Leach-Bliley in 1999, Summers played a central role, that same year, in making sure the burgeoning derivatives market was left unregulated. When he became president of Harvard a few years later, his faith in derivatives was so great that it was all but indistinguishable from his expertise in how the products actually worked.
The result of this particular overreach came with merciless speed when Harvard lost nearly one-third of its endowment, largely because of investments in interest rate swaps and other derivatives. Summers had talked in 2003 about overseeing a period of expansion at Harvard “not unlike the growth of the early Renaissance.” By 2005 the wildly overcommitted university was freezing professors’ salaries, cutting support staff, and canceling construction projects left and right.
It all boils down to the classic Larry Summers problem: he can frame arguments with such force and conviction that people think he knows more than he does. Instead of looking at a record pockmarked with bad decisions, people see his extemporaneous brilliance and let themselves be dazzled. Summers’s long career has come to look, more and more, like one long demonstration of the difference between wisdom and smarts.
Not that Summers himself would admit this—or admit to having been wrong in more than a public relations sense. His disastrous foray into private investing at Harvard might have sidelined a lesser man, but by 2007, Summers was signed on at the hedge fund DE Shaw as an absentee consultant. Despite spending just one day a week at the fund, Summers was paid $5.2 million in his second year with Shaw, according to a report in the New York Times. He had now fulfilled one key goal he set for himself after leaving Harvard: to make money. Now it was time to burnish his image.
The idea of retiring from public life at age fifty-three, of receding into the private sector to make money hand over fist, was not enough for Summers. As the Bush era lurched to its ignoble end and a troop of resurgent Democrats took the field, Summers began putting considerable energy into writing columns for the Financial Times. They were state-of-the-world renderings, most of which looked at the global economy and the challenges it presented. The columns were artfully crafted bids for reappraisal, for the world to take another look at Larry Summers. He wanted back in the game.
But Obama already had a formidable team of economic advisers, several of whom claimed long, troubled histories with Summers dating back to the Clinton years. They knew him and they understood him too well. Yet somehow, in the ensuing shakeout, Summers would wind up with a coveted spot as head of the National Economic Council.
The real antecedent to Summers’s blazing return to prominence was Obama’s decision, in the week that Hillary conceded, to appoint Jason Furman as head of the campaign’s economic team. It was a job that Obama’s friend and adviser Austan Goolsbee had wanted, and this fateful decision would open the door through which those Rubinite economists such as Summers would slowly slip back in. In his new role, Furman became the bottleneck between Obama and his other economic advisers, the gatekeeper deciding whom the senator spoke to. For Summers, the appointment could not have been more propitious. Furman had been a teenage phenom and Summers had known him for years. Now, with Furman advising Obama, Summers saw his opening.
According to those on the staff at the time, Furman and Summers had conversations to the effect that Furman could get Summers access to Obama’s economic circle, but Summers would have to do the rest.
No problem. This was Summers’s stron
g suit: conference calls—free-form, wide-ranging, and loosely organized. No one had Summers’s rhetorical command, the skills of argument and persuasion he had been honing since his days on the MIT debate team. Summers would work his magic on the president-to-be, and in spite of all those trusted economic advisers on the team—such as Volcker, Goolsbee, and Wolf—Obama came slowly to invest confidence in what amounted to a Clinton-era redux, with Summers’s brash voice carrying high above the rest.
If the opposite of certainty is doubt, humility must lie somewhere between the two. By August 2008, as hundreds of financial professionals gathered for their annual meeting in Wyoming, humility had finally begun to set in—albeit too little, too late.
Within a month, the financial system would begin its free fall, and those prudential voices that had urged caution and humility through the years would get, for their trouble, I-told-you-sos they’d just as soon have gone without. Hindsight is twenty-twenty, of course, but the truth of the 2008 crisis was that some had seen it coming a mile away. Foresight had not been wanting; it had been ignored. And though the early critics would be cast as outliers, if they were it was largely for having been shouted down by an arrogant, self-congratulatory consensus.
As Fed chairman Ben Bernanke stepped to the podium, in the shade of the nearby Teton Range, it was all too clear that the market in certainty had begun to correct.
“The financial storm that reached gale force some weeks before our last meeting here in Jackson Hole has not yet subsided,” Bernanke said, opening a speech titled “Reducing Systemic Risk.” The chairman continued: “Its effects on the broader economy are becoming apparent in the form of softening economic activity and rising unemployment.”
This was hardly news to the attendees by this late date of August 22. After the past year—to say nothing of the past few months—it would not have been at all odd to see these staid central bankers trading their light beer and Chablis for a few stiff shots. The conference’s same-time-next-year spirit was now clouded with uncertainty. How many of those now in attendance would be here next time around, and what sort of financial storm, at what battering force, would they be discussing then?
One audience member, a Wharton professor by the name of Gary Gorton, thought he had a pretty good idea.
It was Gorton’s first time at the Jackson Hole conference, and though he had been invited as a guest presenter, he was there now as a Jeremiah.
The night before, he had spotted Bernanke at the cocktail reception and sidled up. The ever-polite Fed chairman nodded attentively as Gorton introduced himself. He wanted to alert Bernanke, to warn someone with power and sway, about what he had found in his research. But he wasn’t quite sure now how to broach the topic.
Fishing for the right way in, Gorton heard himself say, “You’re doing a great job for the country, and we’re all behind you.” Bernanke took the compliment graciously and listened as Gorton explained who he was. He managed to touch briefly on the journey that had brought him there, and thought he’d succeeded in piquing Bernanke’s interest, one academic to another, but other revelers had crowded in before he could get to his main point: repos.
For a decade, Gorton had been studying the growth of the repo market and had become increasingly troubled by what he found. Firms were funding more and more of their operation with repos, often basic expenses and even salaries. The size of the repo market alone remained a mystery. Gorton and his colleague Andrew Metrick, a Yale professor who had that summer drawn Gorton from Wharton to a professorship in New Haven, estimated it could be a whopping $12 trillion, slightly more than all the bank lending in the United States. But repos were not the province of just banks, or mostly banks. Anyone with cash could do it. The largest repo vendors were the huge fund companies, such as BlackRock, Fidelity, and Pimco. Industrial companies did it, too (even if they didn’t have large finance subsidiaries, as General Electric or General Motors did), as did manufacturers with significant cash flow. Everyone had become a bank. What concerned both men, though, was that any slight disruption—any small loss of confidence—threatened sweeping consequences for this so-called shadow banking industry. This was exactly what had happened to Bear Stearns, which found itself with no money to do business when confidence in the company flagged and its repo market dried up.
Especially worrisome was the way repos allowed companies to fund their off-balance-sheet activities. Repos made possible the vast world of shadow banking—a realm of operations and transactions hidden from the public and from shareholders. In shadow banking, firms had found a way to shift risky activities and liabilities off their books. With the ready spigot of repo money, they could then tailor their cash flows and balance sheets to create the illusion of health and stability. And as liabilities disappeared from their books, the amount of leverage the firms could operate with increased.
The prevalence of repos and their undisclosed nature meant it had become impossible to assess the country’s financial stability. But even with Bear Stearns—toward the end, “dialing for dollars” each morning to fund its operation—regulators still did not seem to understand the severity of the situation. One whole point of repos was, after all, to escape notice: the agreements were typically made on a bilateral or tripartite basis, meaning the deal was struck and known about by just the two firms involved (borrower and lender) and occasionally a third, middleman firm. But Gorton and Metrick had an inside track.
Though a professor of finance at Wharton for nearly two decades, Gorton had been a regular consultant for AIG since the late 1990s. There he’d developed some of the models the firm used—and, in cases, misused—in its investment decisions, and he happened to be on AIG’s trading floor on August 9, 2007, just a week after Barack Obama got his all-points alert from Robert Wolf, when the rest of the financial world saw a full-blown credit crunch unfold. Gorton saw the traders’ shock and fear firsthand. It was palpable and frightening, and all driven by the shifting winds of confidence.
Gorton had left shaken. He returned to Wharton, put on his professorial robes, and began to cast a hard, cold eye at what had beset the financial markets. It was at this point that Metrick entered the picture. He, too, was an academic with a window on the inner operations of the finance industry. His father, Richie, was the deputy and so-called other brain to Alan Schwartz, the head of Bear Stearns at the end of its run. Andrew had spent Bear Stearns’ final chapter visiting regularly with his father.
A “financing dilemma”—in Wolf’s parlance—is the specific cause of death for Bear Stearns. As fears about the company’s exposure to toxic CDOs grew in January and February of 2008, its repo book began to tighten. The repo deals Bear Stearns struck were with every type of company, financial and otherwise. If corporate treasurers have excess cash, they lend it as a repo, and then purchase it back. Their money gets parked in a repo, as opposed to being put in a bank, where the $100,000 of federal insurance—fine for an individual, and, after the coming crash raised to $250,000—is so small for a company as to be no insurance at all. The lender of a repo gets a tiny percentage of short-term interest, in the area of .03 percent a month, as well as collateral, which the recipient has to post. If there’s a default on the repurchase, there’s someone to call.
And there was no doubt, since 2005, that they’d pick up. That last part is a crucial addition to the repo equation. After many years of sustained lobbying, the financial industry pushed through a key provision in the 2005 Bankruptcy Act, which overhauled the U.S. bankruptcy system. All repos and swaps, like those soon-to-be-fatal credit default swaps, were exempt from bankruptcy’s famous “automatic stay”—the defining provision, really, of bankruptcy, where all assets and liabilities are frozen as a company seeks the protection from creditors that bankruptcy court provides. Creditors then get in line at the court, with the most secure, or senior, creditors first, then unsecured creditors, and so forth. Repo and swap contracts, though, are exempt from the stay. They must be honored, even if a company goes bankrupt. That make
s them the safest item on any balance sheet—safer, even, than cash accounts, which are frozen in a bankruptcy like everything else. In terms of debt, safe means cheap. Repos, thereby, became the cheapest, safest funding source available, and repo growth was dramatic after 2005.
In the specific case of Bear Stearns, the firm was using repos to fund many operations and most of its special investment vehicles—the legal vessels not noted on the company’s balance sheets and which held CDOs and other exotic investments. This is the sort of creative license that repos offered financial engineers across corporate America, helping them craft earnings, especially at the end of each quarter, to hide losses, pump up their share price, or, maybe, make certain stock option–based compensation packages hit their strike points. An odd twist on the repo market that both Gorton and Metrick discovered is that repos, inexplicably, become more expensive at the end of each quarter—something both men feel is worth investigating. It might indicate that their prime value is in obfuscating a company’s public disclosures, which would be fraud.
But even with the bankruptcy exemption, fears about Bear Stearns’ condition tightened its repo “durations” dramatically as March 2008 approached. In the week of Bear Stearns’ collapse, Metrick watched his father suppress panic as the firm’s traders were rolling over a stunning $50 billion a night in repos. On Thursday night, March 13, 2008—three days before the Fed sold off the collapsing Bear Stearns to JPMorgan—Andrew’s father and Alan Schwartz called Geithner’s office to say that the firm needed to declare bankruptcy. They couldn’t roll over their repo book by morning. Geithner told them to hold out one more day, and New York Fed officials made sure Bear got the overnight infusions it needed.